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OSMANIA UNIVERSITY LIBRARY
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PRINCIPLES OF ACCOUNTING
INTRODUCTORY
I'llKNTICK-HALL ACCOUNTING HKKIKS
//. .1. Finney, Kditot
PRINCIPLES
OF ACCOUNTING
INTRODUCTORY
by
H. A. FINNEY, Ph.B., C.P.A.
and
HERBERT E. MILLER, Ph.D., CP.A.
Professor of Accounting, University of Michigan
FOURTH EDITION
New York
PRENTICE-HALL, INC.
1953
Copyright, 1932, 1936, 1938, 1940, 1948, 1953, by
PKKNTICK-TIALL, INC.
70 Fifth Avenue, New York
ALL RIGHTS RESKRVED. No PART OF THIS BOOK MAY
BE RKPRODITKD IN ANY FORM, BY MIMEOGRAPH OR
ANY OTHER ME A NS/% WITHOUT PERMISSION IN WRITING
FROM TUB PFBLISHERS
FOURTH EDITION
L. C. Cat. Card No. 53-6779
First printing April, 1953
Second printing September, 1953
PRINTED IN THE UNITED 8TATRB OF AMKBICA
Preface
In the preparation of this revision, we have been largely guided
by the helpful suggestions of teachers. Some of the differences and
similarities between this edition and the preceding one are men-
tioned below.
Introduction to the accounting cycle. It is important to acquaint
the student, at the very earliest possible point in the course, with
the entire cycle of bookkeeping procedures: journalizing, posting,
taking a trial balance, preparing working papers and statements,
and adjusting and closing the books. In the preceding edition,
this cycle, with the exception of adjusting entries, was covered in
the first three chapters. In this edition, the first four chapters are
again devoted to the cycle, but they include some basic con-
siderations of adjusting entries. This change has been made for
two reasons: Making adjusting entries is part of the accounting
cycle; working papers become more purposeful when adjustments
are included in them.
In the preceding edition, the journal was not introduced until
the second chapter, and entries were made directly in ledger
accounts. In this edition, the journal is introduced in the first
chapter, after a basic discussion of the nature of accounts. Thus,
in conformity with one of the main objectives of the revision, the
student's work, in his first assignments, is in closer accord with
reality.
The discussion of changes in the proprietorship equity has been
postponed to the second chapter. By limiting Chapter 1 to the
consideration of the recording of the original investment and changes
in assets and liabilities, and by devoting the second chapter to
changes in the proprietorship equity, the student is introduced
more gradually to the whole framework of accounts. Also, by
devoting an entire chapter to changes in proprietorship, it is
possible, in the first discussion of the subject, to give a realistic
and sequential presentation of the use and closing of income,
expense, and dividend accounts.
Corporate approach. The prefaces of preceding editions con-
tained the following statement: " Students should obtain, at the
very beginning of the course, a clear concept, of net worth, or
capital. When the course begins with the individual proprietor-
ship, a needless source of confusion is introduced, as students find it
vi PREFACE
difficult to distinguish between the capital of the business and the
aggregate net worth of the proprietor. " Reaction to the corporate
approach seems to have been very generally favorable, and thai
approach has been retained. However, material on individual
proprietorships and partnerships appears much earlier in this
edition than in preceding editions.
Beginning with a nontrading business. In this edition, as in all
preceding editions, the illustrations and problems in the introduc-
tory chapters are based on the accounts of companies which derive
their income from fees for services rather than from merchandise
sales. It is thus possible to show more clearly how income and
expense affect the proprietorship equity, and to avoid the inventory
complications ip. the first explanations of working papers, state-
ments, and closing entries.
Perpetual inventories in first merchandise chapter. To postpone
further the troublesome feature of dealing with an end-of-period
inventory not shown by the accounts, the first chapter dealing
with merchandising businesses (Chapter 5) utilizes a simple
perpetual inventory procedure. After the student has been
introduced to merchandise accounting, he is shown, in Chapter 6,
how to deal with periodic inventories.
Reduced emphasis on nbtes and bills of exchange. The chapter
coverage on promissory notes has not been materially reduced, but
two-party drafts have been somewhat de-emphasized, and the
discussion of three-party commercial bills has been deleted, as
their use in business has been largely discontinued. Fewer note
and acceptance transactions appear in the terminal practice set
than heretofore.
Theory. To give an opportunity for review and synthesis, the
chapter on theory toward the end of the book has been retained,
with considerable revision. In addition, an effort has been made to
give greater consideration throughout the text to matters of theory.
Assignment material. There are more problems and practice
sets than in any preceding edition, and there is a wide assortment
of problems — short and long, easy and difficult. As in the past,
they have been designed to be specifically applicable to the related
text material. There are five kinds of assignment material :
Questions.
Group A problems. Envelopes of forms have been provided for this
assignment material ; the forms are tailor-made to suit the require-
ments of the problems, and numerous devices have been employed to
reduce the student's expenditure of time.
Group B problems. Some teachers like to have their students prepare
solutions to some problems on ordinary columnar paper, without
PREFACE vii
using the time- and labor-saving material provided for the A prob-
lems. Therefore the supplies provided for the Group B problems
consist of a pad of ruled forms mostly journal, ledger, and analysis
paper.
Practice sets. An additional practice set has been provided for
assignment after Chapter 1 1 (Specialized Books of Original Entry) ;
the content of the other practice set, designed for assignment
during the latter part of the second semester, has been materially
reduced. Books of original entry, ledgers, and other materials
required for the solution of the practice sets are included in the
envelopes of forms for the A problems.
A workbook. The material in the workbook has been designed as a
quick, but comprehensive, test of the material in the related
chapters.
We wish to acknowledge our obligation to the following people,
for their generous co-operation: Marcus H. Bean, Rutgers Uni-
versity; Thomas A. Budd, University of Pennsylvania; Albert H.
Cohen, University of Michigan; Thomas M. Dickerson, Western
Reserve University; Oscar S. Gellein, University of Denver;
Harold B. Goodall, Henry Ford Community College; Douglas 11.
Haines, Rutgers University; H. M. Heckman, University of
Georgia; S. R. Hepwortb, University of California; Charles E.
Johnson, University of Oregon; Robert E. Linde, University of
Michigan; Louis W. Matusiak, University of Detroit; otuart B.
Mead, Michigan State College; Carl L. Nelson, University of
Minnesota; Wayne E. Shroyer, University of Denver; Warren L.
Slagle, University of Tennessee; Robert T. Sprouse, University of
Minnesota; D. L. Sweeney, State University of Iowa; D. A.
Thomas, University of Michigan; William C. Tuthill, University of
Michigan; Harry H. Wade, State University of Iowa; S. M.
Wedeberg, University of Maryland; John T. Wheeler, University
of Minnesota; Mrs. Nina L. Youngs, University of Minnesota.
Accounting research bulletins of the American Institute of
Accountants are copyrighted by the Institute. Quotation in this
text is by their permission.
H. A. FINNBY
HERBERT E. MILLER
Foreword
The nature of accounting and its significance in the business
world can be described by noting the variety of work performed by
persons trained in the field of accounting.
(1) Installation of accounting systems: As a general rule, the first
accounting work performed for any business involves the
development of an accounting system. The accountant
studies the nature of the business, determines the types of
transactions that probably will occur, and plans or selects the
necessary forms and records in which the transactions of the
business may be recorded. As a business grows, it is
customary to review the accounting system from time
to time, and to initiate any desirable amplifications or
modifications.
(2) Record keeping: After the accounting system has been designed
and installed, the results of business transactions are
recorded in the accounting forms and records.
(3) Preparation of financial statements: At regular intervals the
accountant, using the financial data accumulated in the
accounting records, prepares statements showing the finan-
cial position of the business and the results of its operations.
Such statements furnish important information to manage-
ment, owners, investors, bankers, and governmental agencies.
(4) Auditing: Auditing is a procedure by which the accounting
records and statements are examined to safeguard against
fraud and error and to give assurance that these records and
statements are in accord with accepted accounting princi-
ples. Auditing is of two general classes:
(a) Continuous internal audit. Large businesses usually
have on their own payroll a st.'iff of accountants whose
duty it is to make continuous checks of the work
performed by the accounting department.
(b) Periodic audit by public accountants. To give added
assurance to the management and to outsiders, a
business may engage the services of an outside,
independent accountant to determine whether the
statements present fairly the financial position of the
ix
x FOREWORD
business and the results of operations in accordance
with generally accepted accounting principles, and to
express, in his audit report, an opinion on these
matters.
it should be mentioned that auditing is not the only service
performed by public accountants. They may, among other
things, install accounting systems, prepare or review tax
returns, and make special studies for their clients.
(5) Tax accounting: Most accountants have some contact with tax
matters, and many accountants specialize in this field.
(6) Budgeting: Although the preparation of budgets (plans and
forecasts for the future) may not be the exclusive responsi-
bility of the accountant, his understanding of the accounting
records and procedures and of the information previously
recorded makes him an important participant in budget
preparation.
(7) Cost accounting: Many accountants specialize in the field of cost
accounting. If a business manufactures the goods which it
sells, it is essential that it keep adequate detailed records
showing the cost of material, labor, and other items used in
the production of the various kinds of goods. Cost records
may also be maintained for the selling or distribution
phases of the business. The cost accountant participates in
determining how cost data shall be accumulated in the
records, and generally is charged with the responsibility of
interpreting cost information for management.
(8) Controller ship: The controller is the chief accounting officer of a
business and the financial advisor to its management.
Controllership is a specialized field of accounting calling for
broad and thorough training in accounting and business
management.
(9) Special investigations: Frequently, special investigations requir-
ing a thorough knowledge of accounting principles and
procedures must be made for such purposes as establishing a
price for the sale of an entire business or a department
thereof, deciding whether a given activity is or might be
profitable, or determining the feasibility of retirement or
bonus plans.
From the above discussion of the work of the accountant, it is
obvious that record keeping is only one part of this broad field of
activity. However, once the accounting system has been designed
and installed, the work of record keeping is extremely important,
because the satisfactory accomplishment of most of the other
FOREWORD xi
accounting activities depends, to a great extent, upon the accuracy
and completeness of the accounting records. Therefore, a major
objective of the first course in accounting is to expose the student
to the procedures of record keeping. To master this phase of the
subject, problem and practice work is essential.
But a knowledge of procedures is not the only objective. To
understand why things are recorded as they are requires a knowl-
edge of accounting principles. And finally, the end product of the
accounting process, the financial statements, should be understood.
Some knowledge of accounting is valuable even to those who do
not expect to earn a living as accountants. Too often business
executives, investors, and others who need the information con-
tained in accounting statements but who have had 110 training in
accounting are unable to grasp wholly the significance of the
reports prepared for their guidance. A knowledge of the funda-
mentals of accounting would enable them more adequately to
analyze the reports of companies with whose management they
are charged, or in which they have placed their funds or con-
template placing them.
Accounting is now recognized as one of the very important
professions. Employment opportunities are varied and numerous,
and the compensation to be expected compares very favorably
with that in other professions. There is always an opportunity
for qualified accountants to obtain satisfactory employment with
government agencies, private business, and public accounting
firms.
As in any other honorable calling, the accountant should be a
person of integrity; he must also be possessed of a high degree of
analytical ability; he must not be averse to dealing with vast
amounts of detail; he should be tactful; and he should maintain a
personal appearance consistent with his professional status.
Contents
CHAPTER
1. ASSETS, LIABILITIES, AND OWNERS' EQUITY.
The balance sheet; Assets; Liabilities; Owners' equity; Sources of owners'
equity; The balance sheet equation; Continuing balance sheet equality;
Accounts; Debit and credit; Debit and credit entries in accounts; Record-
ing transactions; How the words debit and credit came into use; Journal and
ledger; Journalizing; Advantages of the journal; Posting; Computing
balances of accounts; The trial balance; Uses of the trial balance; Accounts
receivable and payable in the balance shoot; Notes receivable and payable1,;
Compound journal entries.
2. CHANGES IN OWNERS' EQUITY. CLOSING THE BOOKS 17
Causes of changes in owners' equity: Income; Expenses: Dividends; Debit
and credit procedure; Illustrative entries; Complete journal: Ledger; Trial
balance; Statement of income and expense: Earned surplus; Balance sheet;
Periodic nature of income, expense, and dividend accounts: Closing the
books; Closing income accounts; Closing expense accounts: Ruling closed
accounts; Graphic summary; Closing Profit and Loss account: Closing the
Dividends account; Summary of closing entries: Journal with closing
entries, Lodger; Trial balance after closing; Sequence of accounting pro-
cedures; Punctuating numbers: Use of zeros and dashes, Dollar signs.
3. ADJUSTMENTS AT THE END OF THE PERIOD 31
Transactions and adjustments: Basis of illustration. Income and Kxpense
Correctly Reflected by Transaction Entries Only: Income: Expense. Ad-
justments Required for Accruals: Accrued income: Accrued expense.
Adjustments Required for Apportionments: Income apportionments; Cost
apportionments; Journal — Transaction entries; Trial balance sifter posting
transaction entries; Journal — Adjusting entries; Trial balances before and
after adjustments; Locating errors.
4. WORKING PAPERS AND THEIR USES .... 43
Working papers; Illustrative working papers; Statements prepared from
working papers; Adjusting entries; Closing entries: Accrual adjustments
and entries in subsequent periods
5. MERCHANDISE OPERATIONS PERPETUAL INVENTORY
METHOD . 50
Illustrative statement of income and expense: Perpetual and periodical
inventory methods; Bases of illustration; Inventories, purchases, sales, and
cost of goods sold; Detailed inventory records: Journal; Trial balance;
Completed working papers; Statements prepared from working papers;
Recording the adjusting and closing entries; Ledger accounts after adjust-
ing and closing; Net loss for period; Loss on sales; Deficit; Two principal
sources of income.
6. MERCHANDISE OPERATIONS- PERIODICAL INVENTORY
METHOD . . . . 68
Determining cost of goods sold and ending inventory; Perpetual inventory
method; Periodical inventory method; Comparative summary of book-
xiii
xiv CONTENTS
CHAPTER PAGE
6. MERCHANDISE OPERATIONS — PERIODICAL INVENTORY
METHOD (Continued).
keeping procedures; Comparative trial balances; Working papers —
Periodical inventory method; Financial statements -Periodical inventory
method; Adjusting journal entries — Periodical inventory method; Closing
entries —Periodical inventory method; Special note regarding a newly
organized business. Office Routines; Documents: Duties of the account-
ing department; Internal control. Purchase Routine: Purchase requisi-
tions; Purchase order; Invoice; Purchaser's verification of invoice; Pay-
ment of the invoice; Checks, advices, and receipts. Sales Routine:
Sales; Statements.
7. ADDITIONAL INCOME AND EXPENSE ACCOUNTS CLASSI-
FIED STATEMENTS 85
Introductory note; Expense classification; Transportation charges; Freight
terms, Returned sales and allowances; Returned purchases and allowances;
Trade discounts; Cash discounts; Accounting for bad debts; Nature of bad
debt reserve; Writing off bad accounts; Methods of estimating bad debt
provisions. Payroll and Sales Taxes: Payroll taxes and employees1 income
taxes withheld ; Statement presentation ; Sales taxes ; Income tax expense ,
Other income; Other expense; Illustrative statements; Balance sheet classi-
fications; Depreciation for fractional periods.
8. INDIVIDUAL PROPRIETORSHIPS. PARTNERSHIPS. 102
Individual Proprietorships: Capital and drawing accounts; Closing the
books; Proprietor's account^ after closing the books; Working papers;
Statements. Partnerships: Nature of a partnership; The partnership con-
tract; Capital and drawing accounts; Loan accounts; Opening the books:
The profit and loss ratio; Closing the books; Working papers; Profit and
loss statement; Statement of partners1 capitals; Balance sheet.
Q. PROMISSORY NOTES — BILLS OF EXCHANGE 114
Notes: Definition; Maturity. Interest: Computing interest — General
formula; Computing interest — Short methods. Notes Receivable: Notes
Receivable account; Kntries for note receivable transact ions. Notes
Payable: Notes Payable account; Entries for note payable transactions;
Discounting a note1 payable. Bills of Kxchange: Definition ; Classification ;
Acceptance; Accounts with notes and acceptances; Two-party time draft
for collection purposes ; Two-party time draft per terms of sale. Registers :
Notes receivable register; Notes payable register.
10. COLUMNAR JOURNALS. CONTROLLING ACCOUNTS . 182
Columnar Journals: Special columns to reduce postings; Cross-footing
columnar books of original entry. Controlling Accounts: Division of the
ledger; Controlling accounts; Controlling accounts help in locating errors,
Subsidiary ledger rulings; Illustration; General ledger; Accounts receivable
ledger; Accounts payable ledger; Proving the ledgers.
11. SPECIALIZED BOOKS OF ORIGINAL ENTRY 142
Division of labor; Books to be illustrated; Sales book; Purchase book;
Cash receipts book; Cash disbursements book; Journal; References to
books of original entry; General ledger; Accounts receivable ledger;
Accounts payable ledger; Proving the ledgers; Providing controlling
account columns in books of original entry; Posting to subsidiary ledgers
from general ledger column. Other Special-Purpose Columns in the Cash
CONTENTS xv
CHAPTER PAGE
11. SPECIALIZED BOOKS OF ORIGINAL ENTRY (Continued).
Receipts Book: Interest Income; Sales; Prepaid Interest Expense; Collec-
tion and Exchange. Other Special-Purpose Columns in the Cash Disburse-
ments Book: Interest Expense; Purchases, Freight In, and Freight Out;
Special columns to be used. Transactions Recorded on Two Lines of a
Cash Book or in a Cash Book and the General Journal: Two entries in the
General Ledger column; Entry in a cash book and the general journal;
Locating errors.
1*2. DEPARTMENTAL OPERATIONS . . . . 165
Departmental profits; Determining gross profits by departments; Colum-
nar sales and purchase records; Cash sales and cash purchases; Cash
discounts; Departmental inventories in the balance sheet; Gross profit
less selling expenses by departments; Dangers of approximations; Net
income by departments; Significance of the statement; Contribution to
overhead; Adjusting and closing entries.
13. MANUFACTURING ACCOUNTS 185
Manufacturing costs; Operating statements; Statement of cost of goods
sold; Surplus statement; Balance sheet; Working papers; Adjusting and
closing entries; Apportioned items in the working papers.
14. THE VOUCHER SYSTEM . . .194
Vouchers; Preparing the voucher; Recording the voucher; Filing the
voucher until payment; Paying the voucher; Recording the payment;
Filing the paid voucher; Vouchers for immediate disbursements; Extended
illustration; Posting from the voucher register; Posting from the check
register; Elimination of accounts payable ledger; Balance sheet title for lia-
bility; Partial payments; Exchange charges; Returned purchases and
allowances; Notes payable.
15. ALTERNATIVE ADJUSTMENT PROCEDURES . 215
Accrued Income: Procedures previously described; Alternative procedure;
Why reversing entries are desirable. Accrued Expense: Procedures pre-
viously described; Alternative procedure; Desirability of reversing entries.
Apportionments of Recorded Costs: Procedure previously described; Alter-
native* procedure; The* two procedures illustrated; Reason for the reversing
entry; A second alternative procedure, Custom and convenience affect
choice of method. Apportionments of Recorded Income: Procedure
previously described; Alternative procedure; The t\\o procedures illus-
trated; Second alternative procedure. Determining When Adjustments
Are Required and the Amounts Thereof.
16. PARTNERSHIPS (CONCLUDED) 220
Miscellaneous Methods of Dividing Profits and Losses: Determinants of an
equitable division; Methods of dividing profits and losses; Basis of illus-
trations; Salaries and/or interest in excess of net income. Changes in
Personnel: Procedures generally applicable to changes in personnel; Admis-
sion of a partner by purchase; Admission of a partner by investment;
Retirement of a partner; Death of a partner. Liquidation of the Partner-
ship: Disposal of assets; Division of the profit or loss; Distribution of cash;
Partner \\ ith a debit balance.
17. CORPORATIONS 242
Nature of the corporation; Organization of a corporation; Organization
costs : Corporate management ; Elements of net worth ; Capital stock. Re-
xvi CONTENTS
CBAPTKR
17. CORPORATIONS (Continued).
cording the Issuance of Par Value Stock: Group A illustrations — Immedi-
ate collection of subscriptions; Group B illustrations — Stock issued before
collection of subscriptions; Uncollected subscriptions in the balance sheet;
Premium and discount in the balance sheet; Disposition of stock premium
and discount accounts. Recording the Issuance of No-Par Stock: Advan-
tages and disadvantages of no-par stock; Accounting procedures; Basis of
illustrations; Group A illustrations — Immediate collection of subscrip-
tions; Paid-in surplus in the balance sheet; Group B illustrations — Stock
issued before collection of subscriptions; Stock issued for property.
18. CORPORATIONS (CONTINUED) . . .... 256
Stock not issued until collection of subscriptions; Illustrations — Par value
stock; Illustrations — No-par stock. Records Peculiar to Corporations:
Subscribers' ledger; Stock certificate and stub; Stockholders* ledger;
Transfer of shades; Transfer agent and registrar; Minute book. Changing
from Partnership to Corporation or Vice Versa: Basis of illustration;
Adjustment of asset values; additional investments; Alternative pro-
cedures; Partnership books retained; Partnership books closed ; new books
opened for corporation; Changing from a corporation to a partnership;
Entries if corporation books are retained; New books for the partnership.
Preferred Stock: Classes of stock; Stock preferred as to dividends; Stock
preferred as to assets; Reasons for classes of stock; Accounts with various
classes of stock; Common and preferred stock in the balance sheet. Stock
Values.
19. CORPORATIONS (CONCLUDED) 274
•«. %
The nature of surplus; Special points on paid-in surplus; Recommended
discontinuance of use of the word "surplus"; Appropriated surplus;
Appraisal increments; Stated capital; Dividends; Legality of dividends;
Financial policy with respect to dividends; Significant dates applicable
to dividends, and related entries; Unpaid declared dividends: Scrip divi-
dends; Dividends in arrears on preferred stock; Stock dividends; Treasury
stock; Unissued and treasury stock — Purchaser's liability for discount;
Treasury stock is not an asset; Treasury stock in the balance sheet;
Recording treasury stock acquisitions — Cost basis; Reissuance of treasury
shares; Recommended departure from the cost basis; Surplus restrictions
resulting from treasury stock acquisitions.
20. MISCELLANEOUS MATTERS 288
Purpose of the Chapter. Numerical Chart of Accounts: Account numbers ,
Illustrative chart of accounts; Organization of ledger; Use of account
numbers instead of account names; Use of account numbers, check marks,
and X's. Expense Controls: Controlling accounts; Subsidiary records;
Posting from vouchers; Use of account numbers on vouchers. Note
Registers as Books of Original Entry: Notes receivable register; Notes pay-
able register. Alternative Treatments of Cash Discounts: Treatment as
other income and expense; Purchase discounts lost.
21. BONDS, SINKING FUNDS, AND SINKING FUND RESERVES . 308
Sources of corporate funds; Mortgage notes and bonds; Stocks and bonds —
advantages and disadvantages; Classes of bonds; First and second mort-
gages; Registered and coupon bonds; Recording the bond issue; Issuances
between interest dates; Payment of interest; Bond discount; Amortization
of bond discount; Bond premium; Bond premium and discount in the
balance sheet; Retirement of bonds; Sinking funds; Sinking fund expense;
Sinking fund reserves.
CONTENTS xvii
CHAPTER PAGE
22. CASH 322
What is cash? Internal check; Cash receipts; Cash disbursements; Bank
columns in the cash books; Petty, or imprest, cash; Cash over and short.
Dealings with the Bank: Opening a bank account; Deposits; Maintaining
a record of the bank balance; Miscellaneous transactions; The bank
statement; Reconciling the bank account; Certified checks; Adjustments
after reconciliation; Payroll bank account; Dividend bank account; Bank
overdraft.
23. ACCOUNTS RECKIVABLE. DISCOUNTING NOTES AND AC-
CEPTANCES RECEIVABLE . . 343
Accounts Receivable : Accounts receivable in the balance sheet; Accounts
receivable and payable with same party; Ledger headings; Account and
statement at one impression; C.O.D. sales; Red balances in subsidiary
ledgers; Aging the receivables; Bad debt recoveries; Reserves for returns
and allowances, cash discounts, and freight; Discounts on returned sales;
Freight paid and discount taken by customer; Sales discount on customers'
partial payments; Uncollectible notes receivable. Discounting Notes and
Acceptances Receivable: Purposes of discounting notes and acceptances
receivable; Same methods apply to notes and acceptances; Endorsements;
Proceeds; Discounting notes receivable at the bank; Discounting notes
receivable with a creditor; Discounted note paid by maker at maturity;
Discounted note dishonored by maker; Disposition of Notes Receivable
Discounted account; Protest; Purpose of Notes Receivable Discounted
account; Notes receivable and notes receivable discounted in the balance
sheet ; Discounted notes taken from debtor on account
24. FIXED ASSETS . . . 361
Definitions; Charging fixed asset costs to operations; Classification of fixed
assets; Valuation of fixed assets; Depreciation; Computing and recorumg
depreciation; Depreciation vs. provision for replacement; Expenditures
during ownership; Disposal of fixed assets; Trade-ins; Depreciation
program revisions; Subsidiary records. Natural Resources: Valuation;
Depletion. Intangible Fixed Assets Normally Subject, to Amortization:
Reason for amortization; Patents; Copyrights; Franchises; Leaseholds
and leasehold improvements. Intangible Fixed Assets Not Normally
Subject to Amortization: Trademarks; Goodwill; Methods of computing
goodwill; Proper book value of goodwill. Fixed Assets in the Balance
Sheet.
25. INVENTORIES. . . . 382
Classes of inventories; Inventory all goods owned; Importance of accuracy
in taking and pricing the inventory; Procedure of inventory taking; Inven-
tory pricing; Cost; Cost selection for inventory pricing; Specific identifi-
cation; Weighted-average method; First-in, first -out method; Last-in,
first-out method; Cost or market, whichever is lower; Application of cost
or market; Effect of cost-or-market rule on gross profits; Obsolete and
damaged merchandise; Valuation basis should be disclosed; Gross profit
method of estimating inventories.
26. THEORY AND PRINCIPLES OF ACCOUNTING .... 394
Purpose of chapter; Accounting principles; Shift in emphasis; Periodic
statements. Income: The nature of income; When is income earned?
Income from production and sales activities; Income from services;
Unrealized appreciation; Income and savings. Costs: Terminology; The
cost principle; Departures from the cost basis; Classification of cost out-
xviii CONTENTS
CHAPTKH PAOK
26. THEOKY AND PRINCIPLES OF ACCOUNTING (Continued).
lays; Determination of asset costs; Cost transformations and expirations;
Cost expirations and residues. General Considerations: Matching income
and related costs; Basis of accounts; Fact, opinion, and policy; Conserva-
tism; Consistency; Disclosure; The latitude of a profession. The "Cur-
rent Operating" and "Clean Surplus" Concepts of Net Income: Current
operating concept; Clean surplus concept; Concluding note.
27. THE ANALYSIS OF FINANCIAL STATEMENTS . . 413
Purpose of the chapter; Basis of the illustrations; Outline of chapter.
The Results of Operations: Ratio of net income to average net worth;
Number of times preferred dividend earned; Earnings per share of com-
mon stock; Number of times bond interest earned; Analysis of the profit
and loss statement; Vertical analysis; Horizontal analysis. Working
Capital: Amount of working capital; Working capital ratio; Distribution
and movement of current assets; Distribution; Movement. General
Financial Condition: Ratio of worth to debt; Analysis of equities; Security
for long-term debt-; Possible overinvestment in fixed assets; Horizontal
and vertical analysis of the balance sheet. Conclusion. Underabsorbed
and Overabsorbed Burden. Working Papers Closing the Books.
28. MANUFACTURING COST CONTROLS . . 438
Perpetual Inventories: Materials purchased; Materials used; Production
orders; Raw materials; Direct labor; Manufacturing expense* y or overhead.
Completed production orders; Finished goods sold. Inventory Con-
trolling Accounts: Material, labor, and overhead Jici-ounts; Raw materials
used; Direct labor spent on goods in process; Manufacturing expenses
charged to goods in process; Ledger accounts after transfer of costs into
goods in process; Cost of goods finished; Cost of goods sold. Freight In,
Discount on Purchases, arid Returned Purchases and Allowances: Freight
in; Purchase Discounts; Returned purchases and allowances; Summary.
Underabsorbed and Overabsorbed Burden. Working Papers. Closing
the Books. Statements.
APPENDIX 1. MATTERS RELATED TO PAYROLLS . . . 459
Federal old age benefits taxes; Self-employed persons; Federal unemploy-
ment insurance taxes; State unemployment compensation taxes; Federal
income tax withholding, Other payroll deductions; Requirements of
Federal Fair Labor Standards Act; Payroll procedures; Wage payment
reports to employees.
APPENDIX 2. LOCATING ERRORS .471
Checking the general ledger; Posting to work sheets; Checking the sub-
sidiary ledgers; Checking other subsidiary records; Special tests; Cor-
recting errors.
APPENDIX 3. PREPARATION OF MONTHLY STATEMENTS WHEN
BOOKS ARK CLOSED ANNUALLY 478
ASSIGNMENT MATERIAL 487
INDEX 697
CHAPTER 1
Assets, Liabilities, and Owners9 Equity
The balance sheet. One of the major purposes of accounting
is to provide the information required for the preparation of a
statement showing the financial position of a business on a stated
date. This statement, called a balance sheet, shows the assets of
the business, its liabilities, and the owners' equity. Following is a
simple illustrative balance sheet .
COMMUNITY TELEVISIONS
Balance Sheet
August 31, 19
Assets Liabilities and Owners' Equity
Cash ... $2,89500 Liabilities:
Accounts receivable J ,250 00 Accounts payable $1 ,300 00
Installation and repair parts 3 , 800 00
Land 1 ,500 00 Owners' equity:
Capital stock $8,000 00
Earned surplus 145 00 8,145 00
$9.445^00 $9^445 00
Observe that the heading of the balance sheet shows (1) the
name of the business, (2) the name of the statement, and (3) the
date.
It will help us to understand the balance sheet if we consider
the nature of its elements: assets, liabilities, and owners' equity.
Assets. Assets are things of value owned. Cash, accounts
receivable, notes receivable, merchandise, land, buildings, machin-
ery and other equipment, and patents are some of the assets that
may be owned by a business.
Things may have value for several reasons. Cash has value
because other things can be acquired with it. Accounts and notes
receivable have value because they can be collected in cash.
Merchandise has value because it can be sold for cash or can be
sold on account and the account can be collected in cash.
But things may have value although there is no intention to
convert them into cash. Land, buildings, machinery, and equip-
ment are assets of this nature; although it may be possible to
sell them, their value to a business lies primarily, not in their
salability, but in their usefulness in operations. Other assets, such
as patents, copyrights, and franchises, have value because of the
special rights that they give to their owners and because they
help to make operations profitable.
1
2 ASSETS, LIABILITIES, AND OWNERS' EQUITY [Ch. 1
Liabilities. Liabilities are debts; they are amounts owed to
creditors. Accounts payable, notes payable, mortgages payable,
wages payable, and taxes payable are some of the liabilities that
may be owed by a business.
Owners1 equity. The excess of the assets over the liabilities
of a business is the owners' equity.
For instance,
If a business has assets in the amount of $9,445.00
And has liabilities of 1,300.00
The owners' equity is . . $8,145 00
Sources of owners5 equity. The owners' equity in a corpora-
tion may come from the following sources :
From stockholders' in vestments- -Shown in the illustrative
balance sheet as Capital Stock.
From earnings — Shown in the illustrative balance sheet as
Earned Surplus.
In this chapter, we shall deal only with the portion of the own-
ers' equity produced by stockholders' investments.
The balance sheet equation. The assets of a business are
always equalled by the sum of the liabilities and the owners' equity.
This fact can be expressed itt the form of an equation, thus :
ASSETS = LIABILITIES + OWNERS' EQUITY
$9,445 = $1,300 + $8,145
The illustrative balance sheet on page 1 is an expression of this
equation.
Continuing balance sheet equality. The totals of the two
sides of a balance sheet are always equal because, no matter what
transactions occur, the assets of a business are always equalled by
the interests of the creditors and the owners. To demonstrate
this fact, let us consider a number of transactions of a business,
prepare a balance sheet after each transaction, and observe the
equality of the two sides of each balance sheet.
Issuance of capital stock. J. C. White, Henry Dobson, and J. B.
Hudson organized a corporation called Community Televisions.
The charter obtained from the state authorized the corporation to
issue eighty shares of capital stock of $100 par value per share;
this gave the corporation an authorized capital stock of $8,000.
We shall assume that White invested $4,000, and that each of the
other men invested $2,000.
Investments in a corporation are evidenced by stock certifi-
cates. An illustration of a stock certificate appears on page 3.
Ch. I]. ASSETS, LIABILITIES, AND OWNERS' EQUITY
Certificate No. 1 20 Shares
CAPITAL STOCK $8,000.00
80 Shares of $100.00 Par Value
THIS CERTIFIES THAT Henry Dobson is the
owner of Twenty Shares of the Capital Stock of
COMMUNITY TELEVISIONS
transferable only on the books of the Corporation by the holder hereof in per-
son or by attorney upon the surrender of this Certificate properly endorsed.
IN WITNESS WHEREOF, the said Corporation has caused this Cer-
tificate to be signed by its duly authorized officers, and to be sealed with the
seal of the Corporation at Chicago. Illinois this 20th day of
July . 19
/ Secretary p President
Stock Certificate
As evidence of his investment, Dobson received this certificate
for 20 shares of stock, with a total par value of $2,000. Certifi-
cates were issued to the other incorporators for their investments.
After the issuance of $8,000 par value of capital stock for
cash on July 20, the company's balance sheet appeared as follows:
COMMUNITY TELEVISIONS
Balance Sheet
July 20, 19—
Assets Owners' Equity
Cash .......... ^J?00_0 Capital stock $8,000 00
Purchase of land. The company planned to erect its own shop
building, and purchased two adjoining pieces of land on July 22 for
$1,500 each, paying cash. As a result of this transaction, the
company acquired a new asset (land) and decreased its cash. After
this transaction, the company's balance sheet appeared as follows :
COMMUNITY TELEVISIONS
Balance Sheet
July 22, 19 -
Assets Owners' Equity
Cash ............ $5,000 00 Capital stock. . . $8,000.00
Land .............. 3,000.00 _
$8,000.00 $8,000.00
4 ASSETS, LIABILITIES, AND OWNERS1 EQUITY [Ch. 1
Sale of land. The management decided that more land had
been purchased than was needed, and one of the lots was sold to
G. E. Dutton on July 27 for $1,500, the amount it had cost the
company. No cash was received from Dutton on this date. This
transaction produced an account receivable asset of $1,500, and
correspondingly decreased the land asset. After this transaction,
the balance sheet appeared as follows:
COMMUNITY TELEVISIONS
Balance Sheet
July 27, 19
Assets Owners' Equity
Cash $5,000 00 Capital stork SK.OOO 00
Account receivable — G. K.
Dutton 1,500 00
Land I ,500 00
' $8,000 00 SS^OOO 00
Purchase of installation and repair parts. To conduct its
operations, the company will need a considerable quantity of
antennas and other installation and repair parts. Mr. White found
a dealer, O. E. Maltby, who was going out of business, and pur-
chased the dealer's entire stock of such parts for the company on
July 28. Mr. Maltby said that he thought he could easily obtain
at least $4,000 for the parts by selling them at auction, but was
willing to accept $3,800 for them at a quick sale. It is a generally
recognized accounting principle that the accounting basis for
assets, at the date of their acquisition, is the cost thereof, regard-
less of value; therefore, the parts are shown in the following
balance sheet at their $3,800 cost. Delivery was postponed until
the company acquired or rented a building. No cash payment wras
made to Maltby on this date.
By this transaction, the company acquired a new asset (instal-
lation and repair parts) and incurred an account payable liability.
After this transaction, the balance sheet appeared as follows:
COMMUNITY TELEVISIONS
Balance Sheet
July 28, 19
Assets Liabilities and Owners' Equity
Cash . . $ 5,000 00 Liabilities:
Account receivable — G. E. Account payable — O. K.
Dutton . 1,50000 Maltby $3,800.00
Installation and repair parts . 3 , 800 00
Land . . . . 1 ,500 00 Owners' equity:
Capital stock 8,000 00
$11,800 00 $11,800.00
Collection on an account receivable. On July 29, $1,000 in cash
was received from G. E. Dutton, in partial settlement of his
Ch. 1] ASSETS, LIABILITIES, AND OWNERS' EQUITY 5
account. This transaction increased the cash asset and decreased
the account receivable asset. The balance sheet after this trans-
action appeared as follows :
COMMUNITY TELEVISIONS
Balance Sheet
July 29, 19—
Assets Liabilities and Owners' Equity
Cash $ 0,000 00 Liabilities:
Account receivable; — G. K. Account payable O. K.
Button . 500 00 Maltby. . . $ 3,800 00
Installation and repair parts 8 , 800 00
Land ....... 1 ,500 00 Owners' equity:
_ __ Capital stock . . 8,000 00
$11,800 00 $11,800 00
Payment on an account payable. On July 31, the company paid
$2,500 to O. E. Maltby to apply on account. This transaction
decreased the account payable liability and also decreased the cash.
After this transaction, the balance sheet appeared as follows:
COMMUNITY TELEVISIONS
Assets
Balance Sheet
July 31, 19-
Liabihties and Owners' Equity
Cash $3,500 00 Liabilities:
Account receivable — G. K Account payable — O. JO.
Dutton 500 00 Maltby $1 ,300 00
Installation and repair parts 3,800 00
Land 1,50000 Owners' equity:
Capital stock ... 8,000 00
$9,300 00
$9.300 00
Accounts. It would be impracticable to prepare a balance sheet
for a business after each transaction. Instead, the transactions are
recorded in the accounting records, and the information accumu-
lated in these records is used for the preparation of balance sheets at
periodic intervals.
Transactions cause increases and decreases in the assets, the
liabilities, and the owners1 equity. These increases and decreases
are recorded in accounts. The following illustration shows an
account form :
DATE
EXPLANATION
REF
AMOUNT
DATE
EXPLANATION REF. AMOUNT
6 ASSETS, LIABILITIES, AND OWNERS1 EQUITY [Ch. 1
You will observe that the account form has two sides, with
identical columns. The column headings (Date, Explanation, Ref.,
and Amount) shown in the preceding illustration do not usually
appear in accounts, but are included in the illustration to indicate
the purpose of each column.
The Date column shows the date of the transaction.
The Explanation column may contain some short comment
indicating the reason for the entry. This column is used
only on rare occasions when it may be desirable to describe
some unusual transaction.
Ref. is an abbreviation of Reference. The use of this column is
explained later in the chapter.
The Amount column shows the dollar amount of the entry.
/
Accounts usually are kept in a loose-leaf binder or in a file.
The binder or file, together with the accounts therein, is called a
ledger.
A separate account is kept for each asset, each liability, and
each element of the owners' equity. The July 31 balance sheet of
Community Televisions on page 5 shows that, in order to record
the July transactions, the company needed the accounts listed
below. The accounts should be arranged in the ledger in the order
in which they will appear in the balance sheet, and they should be
numbered. The following list shows that some numbers have not
been assigned to any accounts; these numbers have been reserved
for other accounts which can be added in balance sheet sequence
later if required.
Account Number
Assets:
Cash . 1
G. E. Dutton 2
Installation and repair parts 10
Land 15
Liabilities:
O. E. Maltby . . 20
Owners* equity:
Capital stock. 50
Debit and credit. The left side of an account is called the debit
side; the right side is called the credit side. An entry on the left
side of an account is called a debit entry, or merely a debit; an entry
on the right side is called a credit entry, or a credit. The words debit
and credit are also used as verbs. When you make an entry on the
left side of an account, you are debiting the account. When you
make an entry on the right side, you are crediting the account.
Ch. 1] ASSETS, LIABILITIES, AND OWNERS' EQUITY 7
The difference between the total debits and the total credits in
an account is called the balance. If the debits exceed the credits,
the account has a debit balance; if the credits exceed the debits,
the account has a credit balance.
Debit and credit entries in accounts. As previously stated,
transactions cause increases and decreases in assets, in liabilities,
and in owners' equity. Accounts have two sides so that increases
can be recorded on one side and decreases can be recorded on the
other side. The nature of the account determines the side to be
used for increases and the side to be used for decreases.
Asset accounts. Assets are shown on the left side of the balance
sheet. Consistency suggests that asset accounts should therefore
have balances on the left, or debit, side. For an asset account to
have a debit balance, it is necessary that increases and decreases
in the asset be recorded thus:
Any Asset Account
Increases
Decreases
Liability mid owners' equity accounts. Since the liabilities and
the owners' equity are shown on the right side of the balance sheet,
consistency also suggests that increases and decreases in liabilities
and increases and decreases in owners' equity be recorded thus:
Any Liability Account or
Any Owners' Equity Account
Decreases Increases
i
Summary statement of debit and credit procedure. The proce-
dures stated above may be summarized as follows:
In ASSET accounts:
Increases are recorded by debits.
Decreases are recorded by credits.
In LIABILITY and OWNERS' EQUITY accounts:
Increases are recorded by credits.
Decreases are recorded by debits.
Recording transactions. To illustrate the debiting and credit-
ing of accounts, let us review the transactions of Community
Televisions, analyze each transaction to see what increases or
decreases occurred, and observe the debit and credit entries which
record these increases and decreases. To simplify the illustration,
skeleton accounts (often called "T-accounts") are used and only
the amounts of the debits and credits are shown. To help you
identify the entries, the debit and credit for each successive
8 ASSETS, LIABILITIES, AND OWNERS' EQUITY ICh. 1
transaction are shown in italics. Asset accounts are shown below
at the left ; liability and owners' equity accounts are shown at the
right.
Capital stock was issued for cash, $X,000.
The cash asset was increased Debit Cash.
The owners' equity was increased Credit Capital Stock.
Cash Capital Stock
8, (KM
Land was purchased for cash, $J,000.
The land asset was increased— Debit Land.
The cash asset was decreased — Credit Cash.
Land
3, 000
Cash
8,000
Land was sold to (1. K. Dutton on account, $1,500.
An account receivable asset was acquired- Debit (5. E.
Dutton.
The land asset was decreased Credit Land.
G. £. Dutton
Land
3,000 I 1,500
Installation and repair parts were purchased from 0. E. Maltby on
account, $3,800.
A new asset (installation and repair parts) was acquired
Debit Installation and Repair Parts.
An account payable liability was incurred Credit O. E.
Maltby.
Installation and Repair Parts O. £. Maltby
3,800
3,800
Cash was collected from G. E. Dutton to apply on account, $1,000.
The cash asset was increased- -Debit Cash.
The account receivable asset was decreased- -Credit G. E.
Dutton.
Ch. 1] ASSETS, LIABILITIES, AND OWNERS' EQUITY
Cash
8,000
1,000
G. £. Dutton
3,000
1,500
1,000
Cash was paid to 0. E. Maltby to apply on account, $£,500.
The account payable liability was decreased — Debit O. E.
Maltby.
The cash asset was decreased Credit ('ash.
Cash O. £. Maltby
8,000
1,000
3,000 2,500
2,500
3,800
How the words debit and credit came into use. The first
accounts kept were accounts with debtors. The account with
each debtor showed the amounts of sales made to him on account
and the amounts of subsequent collections. An entry for a sale
was the first entry in a debtor's account and was recorded on the
left side of the debtor's account, thus:
Name of Debtor
June 20 Sale 25 00 «
t
When a collection was received from the debtor, it was recorded
on the right side of the account, tliii*:
Name of Debtor
Juno 20 Sale 25.00 | July 12 Cash lOo
I
As long as the customer owed anything, hi* account had a
balance on the left side; this balance was called a debit (a Latin word
meaning "he owes") balance.
The next accounts kept were those with creditors, and the
procedure already developed for debtors' accounts was applied to
creditors1 accounts. This procedure may be stated thus:
Name of Debtor or Creditor
Things given to him on account
Things received from him on account
As long as anything was owed to a creditor, his account had a
balance on the right side ; this balance was called a credit (Latin for
"he trusts ") balance.
Now that accounts are kept with such things as cash and
land, which cannot owe or trust, the words debit and credit are no
10 ASSETS, LIABILITIES, AND OWNERS' EQUITY [Ch. 1
longer used in their original meanings. Debit merely indicates the
left side of an account, and credit indicates the right side.
Journal and ledger. Although transactions could be recorded
directly in the ledger accounts, it is customary (for reasons stated
later) to use at least two bookkeeping records:
(1) A Journal.
The first record of a transaction is made in a journal.
The procedure of recording transactions in the journal is
called journalizing. A journal is called a book of original
entry.
The entry for each transaction shows what accounts will
later be debited and credited in the ledger.
(2) A Ledger.
The debits and credits to the various accounts, as shown
by the journal entries, are entered in the accounts by a
process called posting.
Journalizing. On page 11 are journal entries recording, in
chronological order, the transactions of Community Televisions
previously mentioned. Following is the procedure for journalizing :
Analyze each transaction by asking yourself the question:
In what ways were the assets, the liabilities, or the owners'
equity of the business increased or decreased by this trans-
action? The answer to this question will indicate the
accounts to be debited and credited.
After each transaction is analyzed, it is recorded in the journal
in the following manner :
Write the date of the transaction in the Date column;
the year, month, and day of the month should be
written in the first journal entry on each page; entries
on the same page for subsequent transactions in the
same year and month need show only the day of the
month.
Write the name of the account to be debited, and enter
the amount of the debit in the left money column.
On the next line, write the name of the account to be
credited, and enter the amount of the credit in the right
money column. The name of the account credited
should be indented.
Write an explanation of the transaction.
Leave a blank line after each journal entry.
The account names written in journal entries should be the
exact names of the accounts as they appear in the ledger.
Ch. 1] ASSETS, LIABILITIES, AND OWNERS' EQUITY
11
The journal of Community Televisions appears below. The
transactions have been journalized, but the journal entries have
not been posted.
OKBITKO CMKOITCD
LF
AMOUNT
aa
aa.
44
Sao.
18
42
44
44
£4
£4
£6]
Advantages of the journal. The journal serves three useful
purposes. In the first place, it reduces the possibility of error.
If transactions were recorded directly in the ledger, there would be
considerable danger of omitting the debit or the credit entry, or of
making two debit entries or two credit entries. This danger is
reduced to a minimum by using the journal. In the journal, the
debits and credits for each transaction are recorded together,
where an error of this kind would be readily observed. Of course,
similar errors may be made in posting to the ledger, but such errors
can be readily detected by tracing the account entries back to the
journal.
In the second place, the journal shows offsetting debit and
credit entries for each transaction, and thus provides a complete
12 ASSETS, LIABILITIES, AND OWNERS' EQUITY [Ch. 1
record of the transaction in one place. Also, the journal provides
ample space for an explanation of the transaction.
In the third place, the journal shows all of the pertinent facts
about the transactions in their chronological order.
Posting. Posting is the process of recording in the ledger
accounts the debits and credits indicated by the journal entries.
The procedure of posting consists of the steps stated below :
First post the debit member of the entry :
Turn to the account to be debited.
Enter on the debit side of the account :
In the Date column- -the date.
In the Reference column- the number of the journal
page/rora which the entry was posted.
In the money column— the amount of the debit.
Turn to the journal and, in the "L. F." (which means ledger
folio or page or account number) column at the left of
the money column, enter the number of the account to
which the entry was posted.
Post the credit member of the journal entry in a similar
manner.
Entering the journal page number in the ledger and the account
number in the journal serves two purposes:
While the bookkeeper is posting, it shows how much of the
posting has been done. Thus, if the bookkeeper is called
away before the posting is completed, he knows that the
work should be taken up again with the first journal entry
showing no account number in the L. F. column.
After the posting has been completed, the numbers serve as
cross references between the journal and the ledger. This is
particularly helpful if the bookkeeper, when looking at some
account, wishes to find the journal entries from which the
postings were made.
The first journal entry of Community Televisions is repeated
below to show how the account numbers aie entered in the ledger
folio column.
Journal (Page 1)
8,00000
19—
July
20
Cash
1
50
Capital stock
Issuance of 80 shares of stock at $100 par value.
8,00000
Ch. 1] ASSETS, LIABILITIES, AND OWNERS' EQUITY
13
After this journal entry is posted, the accounts affected appear
as follows:
I 111111 1 1
After the completion of the posting of all of the journal entries,
the accounts appear as follows:
Cash
(Account No. 1)
19—
July
H
i
19— "|
July 27
19- f
July 28
119-
1
8,000
OOJuly
22
1
3,000
00
1
1,000
"1
31
1
2,500
00
G. E. Button (Account No.
2)
,1
1 119~
1 ,500 00 July
29
1
1,000
00
Installation and Repair Parts (Account No. 10)
1
3,800
H
Land
19—
July 22
19—1
July 31
I 3,000
|| 19—
iJuly
27
O. £. Maltby
(Account No. 15)
i
1, 1,50000
(Account No. 20)
2,500
1119 -
July
00
Capital Stock
3,80000
(Account No. 50)
H
II 8,00000
Computing balances of accounts. Account balances may be
computed, and shown in the accounts, in the manner described
below:
Add the debit column of the account, and enter the total in
small pencil figures at the bottom of the column.
Add the credit column of the account, and enter the total in
small pencil figures at the bottom of the column.
14 ASSETS, LIABILITIES, AND OWNERS' EQUITY [Ch, 1
Enter the balance in small pencil figures in the Explanation
column: on the line of the last debit entry if the account has a
debit balance; on the line of the last credit entry if the
account has a credit balance.
The following illustration shows the procedure.
Cash
— i i' |
1 3,00000
if 2,50000
19—
1»~,
July
20
1
8,000
00
July
221
29
3.500.00
1
1,000
00
31
9.000
00
5,500
00
If only one entry appears on either side of an account, a pencil
total of that side is, of course, unnecessary. If an account contains
only one entry, the amount of that entry is the balance of the
account, and it is unnecessary to write the balance again in the
Explanation column.
If an account contains only debit entries or credit entries, the
pencil total of the column shows the balance of the account, and
therefore it is unnecessary to enter the balance in the Explanation
column.
The trial balance. Double-entry bookkeeping derives its
name from the fact that the recording of each transaction requires
debit and credit entries of equal amount. Since the debit and
credit entries for each transaction are equal, it is obvious that
the total debit entries in all of the accounts should be equal to the
total credit entries. It is equally true that the total of the debit
balances in the accounts should be equal to the total of the credit
balances.
It is customary to check the equality of the debit and credit
balances in a ledger by listing and totaling them. Such a list is
called a trial balance. Following is the July 31 trial balance of
Community Televisions :
COMMUNITY TELEVISIONS
Trial Balance
July 31, 19—
Cash. .. . 3,500 00
G. E. Button 500 00
Installation and repair parts 3 , 800 00
Land.. .. ... 1,500.00
O. E. Maltby . . .. 1,300.00
Capital stock 8,000 00
9,300^00 9,300 00
Uses of the trial balance. A trial balance is useful in checking
the mathematical correctness of the ledger. But it should be
understood that a trial balance proves nothing more than the
Ch. 1] ASSETS, LIABILITIES, AND OWNERS1 EQUITY 15
equality of the debit and credit entries. The trial balance will
still " balance" even though a transaction was not journalized, or
though a wrong account was debited or credited in the journal, or
though a debit or credit was posted to a wrong account in the
ledger, or though there was a failure to post both the debit and
credit of a journal entry.
A trial balance is also useful to an accountant whenever
periodic statements are to be prepared. Although it is possible
for the accountant to prepare such statements by working directly
from the ledger, it is much easier to use the account balances shown
by a trial balance. You will observe that the account balances
shown in the above trial balance are the same as those shown in the
balance sheet on page 5.
Accounts receivable and payable in the balance sheet. If there
are several accounts receivable and accounts payable, they may
be detailed and totaled in the balance sheet in the manner illus-
trated below:
Accounts receivable: Accounts payable.
John Doty $300 00 A. B. Button $1,000 00
Fred Hoyt . 175 00 Davis & Co 050 00 $1,650 00
Frank Lane. . 80 00 $555 00
However, in most businesses there are so many accounts
receivable and accounts payable that listing them wrould make the
balance sheet cumbersome. Moreover, balance sheets are often
given to outsiders, such as bankers and other creditors, and are
frequently included in published reports; it might be inexpedient
for a business to disclose the names of its debtors and creditors.
For these reasons it is the usual custom to show, in the balance
sheet, only the totals of the accounts receivable and accounts
payable, thus:
Accounts receivable . $555 00 Accounts payable . $1,650 00
Notes receivable and payable. Although a separate account
is maintained for each account receivable and each account pay-
able, a separate account is not maintained for each note receivable
and note payable. All notes received may be debited to a single
Notes Receivable account, and all notes given may be credited to a
single Notes Payable account. The balances of these accounts
appear in the balance sheet without detailing of the individual
notes receivable or payable.
Compound journal entries. Sometimes the recording of a
transaction requires more than one debit and one credit. For
instance, assume that land which cost $10,000 was sold at cost, and
that U. S. Government bonds worth $6,000 and cash in the amount
16 ASSETS, LIABILITIES, AND OWNERS1 EQUITY [Ch. 1
of $4,000 were received in settlement; the entry to record the
transaction is :
U. S. Government bonds 0,000 00
Cash . 1,00000
Land... 10,000 00
Sale of land.
Such entries, having more than one debit and /or more than one
credit, are called compound journal entries.
CHAPTER 2
Changes in Owners' Equity. Closing the Books
Causes of changes in owners1 equity. The principal causes of
increases and decreases in the owners' equity in a corporation are
stated below :
Discussed in Chapter 1 :
Investments by stockholders.
Discussed in this chapter :
Income.
Expenses.
If the income of a business exceeds the expenses, a net
income is earned. If the expenses exceed the income,
a net loss is incurred.
Dividends to stockholders.
As an introduction to the accounting for income, expenses, and
dividends, we shall continue the Community Televisions illus-
tration through the month of August.
Income. Business operations are conducted with the cbject
of earning income. Community Televisions has a contract with
George Sloan, a television dealer, under which it expects to earn
income in the following ways:
Selling television sets on a commission basis.
Installing television sets and antennas.
Making inspections of television sets within thirty days from
the date of sale.
Repairing television sets.
Because of the time required for setting up its shop, the only
income earned by Community Televisions during August con-
sisted of commissions on the sale of television sets.
Expenses. Community Televisions incurred two kinds of
expense during August :
Salaries expense — the three stockholders worked for the com-
pany; their salaries, totaling $900 per month, were expenses.
Office expense — Pending the time when the company could
move into its own quarters, Mr. White arranged with an
acquaintance for telephone, stenographic, and other office
services at a monthly cost of $125.
17
18 CHANGES IN OWNERS9 EQUITY [Ch. 2
Dividends. Dividends are distributions of assets to stock-
holders. Such distributions usually are made in cash. Dividends
reduce the owners' equity, but they are not an expense. The
company paid an $80 dividend at the end of August.
Debit and credit procedure. The first chapter stated a general
rule for recording increases and decreases in the owners' equity.
This rule was:
In OWNERS' EQUITY accounts:
Increases are recorded by credits.
Decreases are recorded by debits.
In accordance^with this general rule,
Income, which increases the owners' equity, is credited to
income accounts.
Expenses, which decrease the owners' equity, are debited to
expense accounts.
Dividends, which decrease the owners' equity, are debited to
a Dividends account.
To provide detailed information about the operating activities
of a business, accountants' customarily use a separate income
account for each class of income, and a separate expense account
for each class of expense.
Illustrative entries. The transactions of Community Tele-
visions during August are stated and journalized below.
Income. On August 16, Community Televisions collected $500
cash from George Sloan for commissions on television sales made
during the first half of the month. The journal entry to record
this transaction was :
Aug. 16 Cash . 50000
Commissions earned . . . 500 00
Commissions for first half of August.
On August 31, the company billed Sloan $750 for commissions
earned during the last half of August ; no cash was received on this
date. The journal entry for the transaction was:
Aug. 31 George Sloan . . . 750 00
Commissions earned 750 00
Commissions for second half of August.
Expenses. The salaries and office expense previously men-
tioned were paid on August 31. The journal entries were:
Aug. 31 Salaries expense . . . .. 900.00
Cash 900.00
Salaries for August.
Ch.2]
CHANGES IN OWNERS' EQUITY
19
Aug. 31 Office expense 125.00
Cash .. 125.00
Use of office facilities during August.
Dividend. The dividend payment was made on August 31, and
was recorded as follows :
Aug. 31 Dividends .
Cash
Payment of dividend to stockholders.
80 00
80.00
Complete journal. Following is Community Televisions'
journal containing entries for all of its August transactions:
Journal
(Page 2)
19-
Aug.
16
31
31
31
31
Cash
Coin missions earned
Commissions for first half of August.
George Sloan ... .
Commissions earned
Commissions for second half of August.
Salaries expense
Cash
Salaries for August.
Office expense
Cash
Use of office facilities during August.
Dividends . .
Cash
Payment of dividend to stockholders.
500
00
500
00
750
00
750
00
900
00
900
00
125
00
125
00
80
00
80
00
i
1
Ledger. Following is the ledger of Community Televisions
after the posting of the August entries. The August entries are
shown in italics. Balances have been computed in all accounts
containing more than one entry.
Cash
(1)
19—
July
Aug.
2.895 00
19 —
\
1
8,000
00
July
22
1
1,000
00
31
'£
500
00
Aug.
31
9,500
00
31
31
I
3,000
00
1
2,500
00
2
900
00
2
125
00
2
80
00
6,605
00
G. E. Dutton
(2)
19—
July
27
500 00
1
H19-
July
George Slot
29
in
1
1,000
00
(3)
19—
Aug.
31\
m rsoloa
20 CHANGES IN OWNERS1 EQUITY [Ch. 2
Installation and Repair Parts (10)
19—
July
H
I
3,80000
Land (15)
19—
July
22| 1.500 oo
1
3,000
119-
OOJuly
27
1
1,500
00
O. E. Maltby (20)
19—
July
31
1 1
2,500
119-
00 July
28 1.300 oo
!'
1
3,800
00
Capital Stock (50)
r
19—
July
20
1
8,000
00
Dividends (52)
19—
Aug.
31
Jj 80
H
|
19—
Aug.
19—
Aug.
31
81
Commissions Earned
19 -|
Aug.\lt>
31
Salaries Expense
(«£)
MM) 00
?t>1) OO
1,250
00
Office Expense
U5 (MX
(71)
" I
(72)
Trial balance. The following trial balance was taken from the
foregoing ledger.
COMMUNITY TELEVISIONS
Trial Balance
August 31, 19—
Cash . 2,895 00
G. B. Button . 500 00
George Sloan 750 00
Installation and repair parts 3,800 00
Land ... 1,500 00
O. E. Maltby 1,300 00
Capital stock 8,000 00
Dividends . . 80 00
Commissions earned . . 1 ,250 00
Salaries expense . 900 00
Office expense . . . . 125 00
10,550 00 10,550 66
Ch. 2] CHANGES IN OWNERS' EQUITY 21
Statement of income and expense. Most businesses are
engaged in a continuing "stream" of operations which are con-
ducted with the object of earning a net income. The success of a
business is largely judged by the amount of its net income.
Not until a business has ceased to function as a going concern
and has disposed of its assets and paid its liabilities is it possible
to compute, with absolute accuracy, the amount of its entire
net income or net loss. But it obviously would be unsatisfactory
to make no attempt to measure the results of the operations of a
business until its life span had been completed. To get an idea of
the success of a business, it is customary to prepare periodic
statements of income and expense. Such statements usually are
prepared at least once a year ; they may be prepared more frequently.
Illustrative statement. Following is the income and expense
statement of Community Televisions for August. It was pre-
pared by using the balances of the income and expense accounts
shown in the trial balance.
COMMUNITY TELEVISIONS
Statement of Income and Expense
For the Month of August, 19 -
Income:
Commissions onrnod SI .250 00
Kxponsos:
Salaries oxponso $000 00
OflioeexpoiiKo 12500 1,025.L*0
Not inooino $ 225 00
Observe that the heading of the statement shows: (1) the name
of the business, (2) the name of the statement, and (3) the
period covered. The heading of a balance sheet and the heading
of a statement of income and expense differ in this important
particular : the heading of a balance sheet shows the date on which
the stated financial condition existed; the heading of the state-
ment of income and expense shows the period covered by the
statement.
Earned surplus. The earned surplus of a corporation is the
portion of the owners' equity derived from earnings. It is the
excess of the company's aggregate net income since organization
over all dividends distributed to stockholders.
Recently it has been suggested that the words "retained
earnings" be used instead of "earned surplus." Such substitute
terminology is gaining popularity. It is favored by many account-
ants who believe that the words retained earnings are more descrip-
tive and less subject to misunderstanding.
It is important to make a distinction between capital stock and
earned surplus, and to maintain this distinction in the statements
22 CHANGES IN OWNERS1 EQUITY [Ch. 2
and accounts, because the amount of the earned surplus usually has
a bearing on the amount of dividends which a corporation can
legally distribute. Furthermore, many statement users consider it
helpful to know how much of the owners' equity resulted from
investments by stockholders and how much is attributable to the
retention of earnings.
Illustrative statement. The amount of the retained earnings of
Community Televisions on August 31 is shown by the following
statement :
COMMUNITY TELEVISIONS
Statement of Earned Surplus
For the Month of August, 19 —
Net income for the month — per statement of income and expense $225 00
Deduct dividend . 80.00
Earned surplus, August 31, 19— $145 00
If a company has any earned surplus at the beginning of the
period for which the statement is being prepared, this begiiming-of-
period balance should be shown in the statement. See the illus-
tration on page 52.
Balance sheet. Using information presented in the trial
balance and the statement of earned surplus, the following balance
sheet may be prepared.
COMMUNITY TELEVISIONS
Balance Sheet
August 31, 19 -
Assets Liabilities and Owners' Equity
Cash . $2 , 895 00 Liabilities :
Accounts receivable 1,25000 Accounts payable $1.30000
Installation and repair parts . 3 , 800 00 .
Land 1,50000 Owners' equity:
Capital stock $8,000 00
Earned surplus __ 14 5 00 8.H5 00
$9±445_00 wTfllTqO
Periodic nature of income, expense, and dividend accounts.
The statement of income and expense and the statement of earned
surplus cover a period of time. Therefore, the income, expense,
and dividend accounts used in the preparation of these statements
should show the increases and decreases in the earned surplus
during that period.
It is a business custom to prepare statements annually : for the
twelve months ended on December 31 if the company is on a
calendar-year basis of accounting, or ending on some other date if
the company is on a fiscal-year basis. At the end of the accounting
year, whenever it may be, the income, expense, and dividend
accounts should show the changes in the earned surplus during the
year.
Ch.2]
CLOSING THE BOOKS
23
Statements may also be prepared at monthly intervals. For
instance, assume that a company on a calendar-year basis pre-
pares statements at the end of January; the accounts will show
data for January, and the statement will cover that month. If
the company prepares statements at the end of February, the
accounts will show data for January and February, and the state-
ments will cover the two-month period. And so on, throughout
the year.
Closing the books. At the end of the accounting year (whether
it be a calendar year or a fiscal year), the books should be " closed. "
The process of closing the books accomplishes two purposes :
A balance is produced in the Earned Surplus account which is
the amount of the earned surplus at the end of the year.
The income, expense, and dividend accounts are left with no
balances, so that, when entries are made in them during the
succeeding year, the account balances will show the results of
transactions during the succeeding year only, and will there-
fore furnish the data required for the preparation of state-
ments for such succeeding year.
Although it is customary to close the books only at the end of
the accounting year, we shall close the books of Community
Televisions at the end of August, to illustrate the procedure.
Closing income accounts. Income accounts are closed by
making and posting journal entries which transfer their credit
balances to the credit side of a new account called Profit and Loss.
Community Televisions has only one income account ; it is closed by
the following journal entry :
Journal
(Page 3)
19
Aug.
31
Commissions earned
Profit and loss
To close the income account.
61
55
1,250
00
1,250
00
The account numbers in the folio column of the journal show
that the postings have been made. Following are the two accounts
affected by this journal entry. In the following ledger accounts,
the debit and credit of each successive journal entry are shown in
italics, as an aid in identifying them.
Commissions Earned
(61)
19—
19—
Aug.
31
3
1,260
00
Aug.
16
31
ii. m
1,250
00
2
2
500
750
00
00
1,250
00
24
CLOSING THE BOOKS
Profit and Loss
[Ch. 2
(55)
1/0
l,26()\00
The Commissions Earned account has now been closed; that is,
it has no balance. This fact is indicated by the totals and rulings.
The closing entry transferred the credit balance of the Commissions
Earned account to the credit of Profit and Loss.
Closing expense accounts. Expense accounts are closed by
transferring their debit balances to the debit of the Profit and Loss
account. Community Televisions has two expense accounts; they
are closed by making and posting the following journal entries:
31
31
Journal
Profit and loss
Salaries expense
To dose the Salaries Expense account.
Profit and loss
Office expense
To close the Office Expense; account.
(Page 3 Continued)
90000
900 00
12500
12500
The accounts affected by these closing entries are shown below.
Salaries Expense
19—
Aug.
31
9QO|00 Amy. 31
19 —
Aug.
31
4
Office Expense
1 \i**—r~~
125|oo|Ai/r/.
Profit and Loss
(71)
MM) (H)
(72)
UK on
(55)
19—
Aug.
19—
8
900
00
Aug.
UJ
3
125
00
1,25000
The two expense accounts are closed. The Profit and Loss
account has a credit balance of $225, which is the amount of the
net income; the balance of this Profit and Loss account should, and
does, agree with the net income shown by ihe statement of income
and expense on page 21.
Ruling closed accounts. You should observe the method of
ruling closed accounts. In the Commissions Earned account, note
the single rulings on the same line in the debit and credit money
columns, the totals, and the double rulings in three places on the
line below the totals. Since the expense accounts contain only one
entry on each side, totals are unnecessary, and the accounts are
ruled with double lines only.
Ch. 2]
CLOSING THE BOOKS
25
Single rulings extend across the money columns only, whereas
the double rulings extend across the date, reference, and money
columns.
Graphic summary. The effect of these closing entries is shown
graphically below. The amounts of the closing entries are shown
in italics. The numbers in parentheses indicate the sequence in
which the closing entries are made.
Salaries Expense
Commissions Earned
900
900) - -
Office Expense
125 i
— (1,250
500
750
<n
Profit and Loss
HHMI ! 1,250+
Closing the Profit and Loss account. The earned surplus was
increased by the $225 of net income earned during August. There-
fore, the Profit and Loss account is closed by transferring its $225
credit balance to the Earned Surplus account.
Journal
( Pago 3 Continued j
Pro lit and loss J55|
Karned surplus ... 51
To close the Profit and Loss account and credit '
Karned Surplus with the net income for August.
225!
225JOO
The two accounts affected by this closing entry are shown below:
Profi
1 <)00
125
226
t a
00
00
00
ad L(
M)
Aug.
)SS
19 -
Aug.
31
31
SI
3
3
3
31
amimmiumu
m*tf
_
1,250
00
_
Earned Surplus
1
19—
Aug.
SI
(55)
1,25000
1,25000
22600
26
CLOSING THE BOOKS
[Ch.2
The nature and purpose of the Profit and Loss account should
now be clearly apparent. It is used only when the books are
closed. It has no balance before the closing procedure is begun,
and it has no balance after the closing procedure is completed.
It is used to assemble, in the ledger, the data required for the
computation of the net income, and it is closed when the net income
is transferred from Profit and Loss to Earned Surplus.
Closing the Dividends account. Since dividends are not an
expense, the Dividends account should not be closed to Profit and
Loss. But dividends do reduce the earned surplus; therefore,
the Dividends account is closed by transferring its debit balance
to the Earned Surplus account.
In the illustration, the earned surplus was decreased by the
payment of an $80 dividend. Therefore, the debit balance in the
Dividends account is transferred to the debit side of the Earned
Surplus account by the following closing entry :
Journal
(Page 3 Continued)
31
Earned surplus . .
Dividends . .
To close the Dividends account.
. . .
51
52
80
80
00
The two ledger accounts affected by this closing entry appear
below:
Dividends
19—
Aug.
31
2|| 80
00
19—
Sl\
Earned
Surplus
19—
Aug.
31
8\ 80
119-
OOAug.
31I
(52)
8000
(51)
22500
The Earned Surplus account now has a credit balance of $145,
the amount of the earned surplus on August 31, 19 — , as shown by
the statement on page 22.
Summary of closing entries. The procedure of closing the
books (that is, closing the income, expense, and dividend accounts)
is summarized as follows:
Close the income and expense accounts to the Profit and Loss
account. The balance of the Profit and Loss account then
shows the net income for the period.
Close the Profit and Loss account and the Dividends account to
Earned Surplus. The balance of the Earned Surplus account
then shows the accumulated, undistributed earnings at the end
of the period.
Ch. 2] CLOSING THE BOOKS
The complete closing procedure is shown graphically below.
Salaries Expense
27
Commissions
Earned
900
900)—-
Office Expense
125
—(1,260
500
750
Profit and Loss
>900
Dividends
80
80)--
(4)
(5)
Earned Surplus
+80
Journal with closing entries. The journal page containing all
of the closing entries, with posting references included, is shown
below :
Journal
(Page 3)
19—
Ante.
31
Commissions earned
61
1,250
00
* **•&•
Profit and loss
55
1,250
00
To close the income account.
31
Profit and loss
55
900
00
Salaries expense. .
71
900
00
To close the Salaries Expense account.
31
Profit and loss . . .
55
125
00
Office expense . . .
72
125
00
To close the Office Expense account.
31
Profit and loss ... ...
55
225
00
Earned surplus
51
225
00
To close the Profit and Loss account and credit
Earned Surplus with the net income for August.
31
Earned surplus
51
80
00
Dividends
52
80
00
To close the Dividends account.
8
CLOSING THE BOOKS
[Ch. 2
Ledger. To indicate as clearly as possible the effect of closing
he books, the accounts of Community Televisions are shown
>elow. They are arranged in two principal groups:
Accounts which remain open after the books are closed :
Accounts showing assets, liabilities, and owners' equity at the
end of the period.
Accounts which have no balances after the books are closed :
Income, expense, and dividend accounts, showing the changes
in earned surplus during the period.
Accounts which remain open after the books arc closed.
=H 3
§ 8
'
8.000
1,000
500
Cash
(
3,000
2,500
900
125
80
;D
00
00
00
00
00
19—
July
Aug.
20
29
16
1
1
2
00 July
00
00 Aug.
22 1
31 1
31 2
31 2
31 2
i i i.
27
1
G. E. Dutton
1 '
291; ! ii
(2)
19—
July
1,500
119-
00 July
1,000
00
31
Georj
2|l 750
ge Sloan
ooi , ;:
1 ',
[3)
19—
Aug.
28
Installation and Repair Parts (10)
19—
July
1
3,800
oo|: ! I !
II i
Land (15)
1~9--
July
22
H19-
July
,1 ll
27| if 1,500
ll il
00
O. E. Maltby
('
, 3,800
20)
, 19
July
31 lj, 2.500
ii
119
00 July
28 1
00
Capital Stock
(«
8,000
30)
19 -
I July
M
00
I 1 I
Earned Surplus (51)
19—
Aug.
31
3
H19-
Aug.
31 3| 225
00
Ch. 2]
CLOSING THE BOOKS
29
19—
Aug.
Accounts which hare no balances after the books are closed.
Dividends (52)
3J| 8000
31
19
..
80
||19-
OOj|Aug.
»i
Profit and Loss
3
3
3
900
125
225
00
00
00
19
Aug.
»i
1,250
00
(55)
1,25000
1,25000
Commissions Earned
(61)
19—
Aug.
31
1
19 |
3
1,250
00
Aug.i
1(5
31
1,250
00
2
2
500
750
00
00
1,250
00
Salaries Expense
19 -I
Vug.|3l|
fl!»-f I
5100 00|Aug $l\
Office Expense
(71)
3 900 00
(72)
19
Aug.
31
125 QO||Aug
si
125 00
Trial balance after closing. After the books are closed, it is
advisable to take an after-closing trial balance, to be sure that the
equality of debits and credits in the ledger has not been destroyed
by errors made in closing the books. The trial balance of Com-
munity Televisions after closing on August 31 is shown below:
COMMUNITY TELEVISIONS
After-Closing Trial Balance
August 31, 19
Cash
G. K. Dutton
George Sloan
Installation and repair parts
Land
O. 10. Mnlthy
Capital stock
Earned surplus
Before the books are closed:
2,895 00
500 00
750 00
3,800 00
1,500 00
1,300 00
8,000 00
145 00
9,445 00 9,445 00
The balance in the Earned Surplus account shows the earned
surplus, if any, at the beginning of the period.
The balances in the income, expense, and dividend accounts
show the changes in earned surplus during the period.
30 CLOSING THE BOOKS [Ch. 2
After the books are closed:
The balance in the Earned Surplus account shows the earned
surplus at the end of the period.
The income, expense, and dividend accounts have no bal-
ances. They are therefore ready for recording the changes
in earned surplus during a subsequent period.
Sequence of accounting procedures. The various accounting
procedures thus far explained are performed in the following
sequence :
Journalize.
Post.
Take a trial balance.
Prepare a statement of income and expense for the period.
Prepare a statement of earned surplus for the period.
Prepare a balance sheet showing the financial condition at the
end of the period.
Make and post the journal entries necessary to close the books.
Take an after-closing trial balance.
Punctuating numbers. When numbers are written on colum-
nar-ruled paper, it is unnecessary to indicate decimal locations by
using commas and periods; the rulings accomplish this purpose.
Numbers written on paper which does not have money-column
rulings should be punctuated, thus: 2,356,457.87.
Use of zeros and dashes. In books of original entry, ledger
accounts, and trial balances, the use of two zeros or a dash in the
cents column is a matter of choice. Thus, an amount may be
written 1 257 00 or 1 257 — . Many bookkeepers feel that a dash
is more easily written than two zeros, and that the use of dashes
facilitates the addition of the cents column.
In balance sheets and other statements it is preferable, for the
sake of appearance, to use zeros.
Dollar signs. Dollar signs need not be written in books of
original entry, ledger accounts, and trial balances. They should
be used in balance sheets and other formal statements. In such
statements, a dollar sign should be written:
Beside the first amount in each column. Look at the income
statement on page 21 and observe the dollar signs in
$1,250.00 and $900.00.
Beside each amount appearing below an underline. Look at
the same statement and observe the dollar sign in $225.00,
CHAPTER 3
Adjustments at the End of the Period
Transactions and adjustments. The statements prepared at
the end of the period should reflect, as correctly as possible, the
income earned and the expenses incurred during the period, and the
assets, liabilities, and owners' equity at the end of the period.
In some instances, the statements will conform to this require-
ment when they are prepared from accounts which contain no
entries other than those for transactions. But usually this is not
the case. Usually it is necessary to make adjusting entries at the
end of the period for some or all of the following:
Accruals of unrecorded :
Expense.
Income.
Apportionments of recorded:
Costs.
Income.
Adjustments of all of these classes are illustrated ic this
chapter.
Basis of illustration. For purposes of explanation, we shall
continue the Community Televisions illustration through Septem-
ber. The company's operations for that month, and the related
entries, are described below under the following captions :
Income and expense correctly reflected by transaction entries
only.
Adjustments required for accruals.
Adjustments required for apportionments.
Income and Expense Correctly Reflected
by Transaction Entries Only
Income. The company had three kinds of income during Sep-
tember which were correctly reflected by entries for transactions,
without any adjusting entries at the end of the month.
Commissions earned. On September 3 the company collected
from George Sloan the $750 which he was billed on August 31 for
commissions on sales of television sets during the last half of
August. The entry to record this transaction does not contain
a credit to an income account ; the income was earned in August and
31
32 ADJUSTMENTS AT THE END OF THE PERIOD [Ch. 3
an entry was made on August 31 debiting George Sloan and credit-
ing Commissions Earned $750. The following entry records the
collection of the receivable.
Sept. 3 Cash . 75000
George Sloan 750 . 00
Collection of commission hillings for last half
of August
On September 16 the company collected $625 from Sloan for
commissions on sales during the first half of September.
Sept. 10 Cash.. . 025 00
Coin missions earned 625 00
Collection of commissions for first half of
September.
On September 30 the company billed Sloan $700 for commis-
sions on sales during the last half of the month.
Sept. 30 (Jeorge Sloan 700 00
Commissions earned . 700 00
Commission hilling for last half of September.
After these entries are posted, the Commissions Earned account
will have a credit balance of $1,325, the amount of the commission
income for the month.
Repair job income. All repair work done by Community
Televisions on sets and antennas is done on orders from Sloan.
On September 27 the company received $160 from Sloan for repair
work done for his customers during the first 26 days of September.
Sept. 27 Cash 100 00
Repair job income . 10000
For repair work done* Sept. 1 through Sept. 20.
On September 30 the company" billed Sloan $35 for repair work
done from September 27 to September 30, inclusive.
Sept. 30 George Sloan . 35 00
Repair job ineome .... 35 00
Amount billed Sloan for repair \\ ork done from
Sept. 27 to Sept. 30, inclusive.
After these entries are posted, the Repair Job Income account
will have a credit balance of $195, the amount of the repair income
for the month.
Installation income. When a television set is sold, Community
Televisions is given the job of installing the set and of installing an
outside antenna if one is required. The company is paid by Sloan
at the end of the month for all such work done during the month.
The amount collected on September 30 was $825. The entry for
the collection is on page 33.
Ch. 3] ADJUSTMENTS AT THE END OF THE PERIOD 33
Sept. 30 Cash . 825 00
Installation income 825 00
For television set and antenna installations
during September.
The $825 credited to the income account in this transaction
entry is the amount of the installation income for the month.
Expense. The company had two classes of expense which were
correctly reflected by transaction entries for the month.
Building rent. The company management decided to rent
quarters instead of erecting a building. The building rent for
September, $250, was paid on September 1.
Sopt. 1 Building rent . 250 00
Cash 250 00
Payment of rent for September.
The $250 debited to the expense account correctly reflects the
rent expense for the month.
Salaries. Salaries for the month, in the amount of $1,150, were
paid on September 30.
Sept. 30 Salaries expense 1,150 00
Cash 1,150.00
Paul salaries for the month.
The $1,150 is the salaries expense for the month.
Adjustments Required for Accruals
The words accrual and accrued are applied to income which has
been earned or expenses which have been incurred for which no
transaction entry has been recorded.
Accrued income. The company had one item of accrued
income at the end of September.
Interest income. When the company decided, on September 1,
to rent a building instead of erecting one, it sold the land, receiving
$500 in cash and taking a $1,000 mortgage. The transaction was
recorded as follows :
Sept. I Cash 500 00
Mortgage receivable 1 ,000 00
Land 1,500 00
To record the sale of land.
The mortgage bore 6% interest, payable semiannually. Al-
though no interest was collected during September, one month's
interest, or $5 ($1,000 X .06 X iM, was earned during that month.
Therefore, the following adjusting entry was required:
Sept. 30 Accrued interest receivable 5.00
Interest income 5.00
One month's interest on mortgage.
34 ADJUSTMENTS AT THE END OF THE PERIOD [Ch. 3
The debit balance in the Accrued Interest Receivable account
will be shown in the balance sheet as an asset. The credit balance
in the Interest Income account will be shown in the statement of
income and expense.
The following general rule may be stated for making adjusting
entries for accrued income: // a company has earned income for
which no transaction entry has been made, debit an asset account and
credit an income account.
Accrued expense. The company had one item of accrued
expense at the end of the month.
Truck rent. The company rented a truck at a rate of ten
cents a mile. The rent for each month was payable on the first
day of the following jnonth. Since there was no rent payment in
September, there was no transaction entry for that month. But
the company drove the truck 2,400 miles during September, and
thus incurred a rent expense of $240 during the month. The fol-
lowing adjusting entry for the accrual was therefore required at the
end of September:
Sept. 30 Truck rent .. 24000
Truck rent payable ... 240 00
Kxpense and liability for use of truck during
September.
The following general rule may be stated for making adjusting
entries for accrued expenses : // a company has incurred an expense
for which no transaction entry has been made, debit an expense account
and credit a liability account.
Adjustments Required for Apportionments
Income apportionments. Collections may be received in pay-
ment for services to be rendered in the future. The accounting
procedures to be used in such cases are stated below :
If the service will be completely performed, and the total income
thereby earned, during the accounting period in which the
collection is received, an income account should be credited
at the time of the collection.
If the service will not be completely performed during the
accounting period in which the collection is received :
The entire amount of the collection should be credited to
an unearned income account ;
At the end of the period, the portion of the income earned
during the period by the performance of service should be
transferred, by an adjusting entry, from the unearned
income account to an income account.
Ch. 3] ADJUSTMENTS AT THE END OF THE PERIOD
35
Community Televisions had one source of income which
required an unearned income account and an adjusting entry.
Inspection service. When a television set is sold, Sloan agrees
to have it inspected within thirty days from the date of sale.
Community Televisions does this work, and Sloan pays the com-
pany $5 for service on each set sold. Regardless of when the
inspection is made, Sloan makes a payment at the middle of each
month for inspection service on all sets sold during the first half
of the month, and another payment on the last day of the month for
service on all sets sold during the last half of the month. Collec-
tions from Sloan during September were :
September 15
30
$100
150
Because Community Televisions has thirty days from the date
of each sale to make the inspection, it is obvious that the total
amount collected during the month will not be earned by the
performance of service during the month. Therefore, the amounts
of the collections are credited to an unearned income account.
Sept. 15 Cash .... . 100 00
Unearned inspection income . . 100.00
For inspection service to be done on 20 sets
sold during the first half of September.
Sept. 30 Cash.. . .
Unearned inspection income . .
For inspection service to be done on 30 sets
sold during the last half of September.
150.00
150 00
By the end of September, Community Televisions had inspected
12 sets, and therefore had earned $60. This $60 is transferred
from the unearned income account to an income account by the
following adjusting entry:
Sept. 30 Unearned inspection income .
Inspection service income . ...
Income earned by inspection of 12 sets.
60 00
60.00
The posting of the transaction entries and the adjusting entry
will produce the following accounts :
Unearned Inspection Income
19-~
Sept.
30
6 60
^19-
Sept.
15
30
5 100
5 150
00
00
Inspection Service Income
~~] 119— j
Sept. 30
6 6000
36 ADJUSTMENTS AT THE END, OF THE PERIOD [Ch. 3
The $60 credit balance in the Inspection Service Income account
will be shown in the statement of income and expense. The $190
credit balance in the Unearned Inspection Income account (some-
times called a deferred income account) will be shown on the
liability side of the balance sheet; it represents an obligation to
render inspection service in the future.
Cost apportionments. An expenditure is a payment, or the
incurring of an obligation to make a future payment, for a benefit
received or to be received. The amount of the expenditure is the
cost of the benefit.
If the expenditure benefits only the period in which it is made,
the cost should be debited to an expense account. This was the
oase with the expenditures for building rent and salaries.
Business concerns often make expenditures for things which are
assets at the date of the expenditure but which are used up during
several periods as the result of operations or the passage of time.
If an expenditure will benefit more than one period, it is properly
chargeable to an asset account, but at the end of each period it is
necessary to determine how much of the cost should be charged as
an expense of the period and what portion of the cost should still be
shown in the balance sheet as an asset. The accounting procedure
to be used in such cases is stated below :
At the date of the expenditure, debit the entire cost to an asset
account.
At the end of each period benefited by the expenditure, an
appropriate portion of the cost should be transferred from
the asset account to an expense account.
Illustrations applicable to Community Televisions are pre-
sented below.
Insurance. On September 1, the company bought a one-year
fire insurance policy at a cost of $120. This $120 is the cost of an
asset — a very valuable right to collect from the insurance com-
pany in the event of a fire. Therefore, an asset account, Unexpired
Insurance, was debited.
Sept. 1 TTncxpirod insurance .. 12000
Cash . 120 00
Cost of one-year fire insurance policy.
One-twelfth of this asset expires each month. The cost
expiration is an expense, and the following adjusting entry is
required :
Sept. 30 Insurance expense 1000
Unexpired insurance 10 00
Insurance expense for the month.
Ch. 3] ADJUSTMENTS AT THE END OF THE PERIOD
37
The posting of this entry will affect the two accounts as
follows:
Unexpired Insurance
19—
Sept.
120
lltt-
00 Sept
I
Insurance Expense
6 1000
19—
Sept
H
10 00
The $10 debit balance in the Insurance Expense account will
appear in the statement of income and expense. The $110 debit
balance in the Unexpired Insurance account will be shown on the
asset side of the balance sheet.
Installation and repair parts used. In July the company pur-
chased antennas and other parts at a cost of $3,800, which was
debited to an asset account called Installation and Repair Parts.
In its installation and repair work during September, the company
used antennas and parts which cost $270. To give recognition to
the expense and the reduction in the asset, the following adjusting
entry is required at the end of September :
19—
July
Sept. 30 instji Hat ion and repair parts expense
Installation and repair parts
Expense for the month
Installation and Repair Parts
Tio-
270 00
270.00
I
. 800 00 Sept
27000
19
Sept.
H
Installation and Repair Parts Expense
270
00]
i!
The $3,530 debit balance in the Installation and Repair Parts
(asset) account will appear on the asset side of the balance sheet.
The $270 debit balance of the Installation and Repair Parts
Expense account will appear in the statement of income and
expense.
Depreciation of equipment. To conduct its operations, Com-
munity Televisions purchased equipment on September 1, at a
cost of $2,400. Payment was made in cash and the purchase
was recorded by the following entry:
Sept. 1 Equipment
Cash
Purchase of equipment.
2,100 00
2,400.00
38
ADJUSTMENTS AT THE END OF THE PERIOD fCfc. 3
The equipment is an asset, with an expected useful life of ten
years. Since its cost will become an expense during the ten-year
period, a portion of the cost should be recognized as an expense
during each accounting period. In other words, there is a monthly
cost expiration of -fa of $2,400, or $20. This cost expiration,
which is called depreciation, is recorded by an adjusting entry.
The monthly adjusting entry for depreciation includes a debit to
Depreciation of Equipment — an expense account. The credit
might be made to the Equipment (asset) account. However, it
usually is desirable to have the balance of such an asset account
show the original cost of the asset. Therefore, it is customary to
credit a separate account. Reserve for Depreciation has long been,
and is here, used as. the title of this account. Some accountants
prefer the account title, Allowance for Depreciation.
Following is the September 30 adjusting entry:
Sept. 30 Depreciation of equipment 20 00
Reserve for depreciation — Equipment . 20 00
Depreciation for September.
Equipment
19—1
Sept.
^ 2, 400 00
- ^ II
Reserve for Depreciation — Equipment
19—
Sept.
H
2000
Depreciation of Equipment
19—
Sept.
30
6 2000
The asset and reserve account balances will appear in the balance
sheet, thus:
Equipment
Less reserve for depreciation
*2,400 00
20.00 $2,380 00
The balance in the Depreciation of Equipment account will
appear as an expense in the statement of income and expense.
It should be noted that the balance of the Depreciation of
Equipment (expense) account is transferred to Profit and Loss
when the books are closed, but the reserve account remains open
and its balance is increased by the periodic adjusting entries
for depreciation.
Journal— Transaction entries. On page 39 is the journal of
Community Televisions containing all of the entries for September
transactions previously mentioned and an entry to record the
payment of a dividend.
Ch. 3] ADJUSTMENTS AT THE END OF THE PERIOD 39
Journal (Page 5)
19—
Sept.
1
Cash . .
500
00
Mortgage receivable
1,000
00
Land .... . .
1 ,500
00
To record the sale of land
1
Building rent . ....
250
00
Cash . . ...
250
00
Payment of rent for September.
1
Equipment ....
2,400
00
Cash. ...
2,400
00
Purchase of equipment.
1
Unexpired insurance
120
00
Cash . . .
120
00
Cost of insurance policy
3
Cash...
750
00
George Sloan
750
00
Collection of commission billing for last half of
August.
15
Cash..
100
00
Unearned inspection income .
100
00
For inspection service to be done on 20 sets sold
during the first half of September.
16
Cash..
625
00
Commissions earned
625
00
Collection of commissions for first half of Sep-
tember.
27
Cash ..
160
00
Repair job income
160
00
For repair work done Sept. 1 through Sept. 26.
30
George Sloan
700
00
Commissions earned
700
00
Commission billing for last half of September.
30
Cash
825
00
Installation income
i
825
00
For television set and antenna installations dur-
ing September.
30
Cash ...
150
00
Unearned inspection income ....
150
00
For inspection service to be done on 30 sets sold
during the last half of September.
30
George Sloan . .
35
00
Repair job income
35
00
Amount billed Sloan for repair work done from
Sept. 27 to Sept. 30, inclusive.
30
Salaries expense .
1.150
00
Cash .. .
1,150
00
Paid salaries for the month.
30
Dividends
80
00
Cash
80
00
Payment of dividend.
40
ADJUSTMENTS AT THE END OF THE PERIOD [Ch. 3
Trial balance after posting transaction entries. The following
trial balance shows the balances of the accounts after the com-
pletion of the posting of the entries for the September transactions.
COMMUNITY TELEVISIONS
Trial Balance
September 30, 19
Cash
G. E. Button
George Sloan
Installation and repair parts
Unexpired insurance
Mortgage receivable'
Equipment..
O. E. Maltby
Unearned inspection income
Capital stock
Earned surplus
Dividends
Commissions earned
Repair service income
Installation income
Salaries expense ....
Building rent ...
2,005.00
500 00
735 00
3,800 00
120 00
1,000 00
2,400 00
1 ,300 00
250 00
8,000 00
145 00
80 00
,150 00
250 00
,325 00
195 00
825 00
12,040 00 i2_,(Mgj)0
Journal — Adjusting entries. Following is the journal of
Community Televisions containing all of the September 30
adjusting entries. The first entry is for an accrued income; the
second entry is for an accrued expense ; the third entry is for an
income apportionment; the last three entries are for cost apportion-
ments.
Journal
19—
Sept.
30
30
30
30
Accrued interest receivable
Interest income
One month's interest on mortgngo.
Truck rent .
Truck rent payable
Expense and liability for use of truck during
September.
Unearned inspection income . . .
Inspection service income
Income earned by inspection of 12 sets.
Insurance expense
Unexpired insurance .
Insurance expense for the month.
Installation and repair parts expense
Installation and repair parts
Expense for the month.
Depreciation of equipment
Reserve for depreciation —Equipment
Depreciation for September.
5001
24000
00
1000
27000
2000
['age 6)
500
240 00
6000
i
10
00
27000
2000
Ch. 3] ADJUSTMENTS AT THE END OF THE PERIOD 41
Trial balances before and after adjustments. Below are
shown the trial balances of the company before and after the post-
ing of the adjusting entries.
COMMUNITY TELEVISIONS
Trial Balances
September 30, 19
Before Adjustments After Adjustments
('ash ... 27005 2,005
G. E. Button 500 500
George Sloan 735 735
Accrued interest receivable 5
Installation and repair parts . 3 , 800 3 , 530
Unexpired insurance 120 110
Mortgage receivable 1,000 1,000
Equipment .. . 2,400 2,400
Reserve for depreciation — Kquipment . 20
O. E. Maltby . 1,300 1,300
Truck rent payable 240
Unearned inspection income 250 190
Capital stock 8 , 000 8 , 000
Karned surplus \ 45 145
Dividends 80 80
Commissions earned 1 , 325 1 , 325
Repair service income 195 195
Installation income 825 825
Inspection service income 60
Interest income 5
Salaries expense 1 , 1 50 1 , 150
Building rent 250 250
Truck rent 240
Insurance expense 10
Installation and repair parts expense 270
Depreciation of equipment 20
12,040 12.040 12,305 12,305
Locating errors. If a trial balance docs not balance, the
amount of the difference should be determined; the following steps
may be taken to locate the error:
(1) Refoot the trial balance.
(2) See that the balances have been carried correctly from the
ledger to the trial balance. Watch for:
(a) Differences between the balances in the accounts
and the balances shown in the trial balance.
(6) Debit balances in the accounts entered on the
credit side of the trial balance, and vice versa.
(c) Ledger balances omitted from the trial balance.
(3) Recompute the ledger balances; this will involve the fol-
lowing steps:
(a) Refooting the debit, side and the credit side of each
account.
(6) Recomputing the difference between the two sides
of each account.
42 ADJUSTMENTS AT THE END OF THE PERIOD [Ch. 3
(4) Check the postings from the journal to the ledger. Begin-
ning with the first journal entry, see whether each debit
and credit has been correctly posted. Watch for :
(a) Errors in amounts.
(6) Postings to wrong accounts.
(c) Posting a journal debit to the credit side of the
ledger, or a journal credit to the debit side of the
ledger.
As each entry in the journal is traced to the ledger, place a
check mark (vO beside the amount in the journal and also
beside the amount in the ledger. A check mark usually is
placed at the right of an amount. After the checking of the
postings has been completed, look for:
(a) Unchecked entries in the journal — see whether these items
have been posted.
(6) Unchecked entries in the ledger- see whether these items
belong in the ledger; it is possible that a journal entry
has been posted twice, that one ledger entry has been
checked, and that the unchecked ledger entry is a
duplicate posting.
(5) See that the debit and credit amounts in each journal entry
are equal.
In looking for errors, be constantly on the watch for:
Transpositions — such as $79.85 posted as $78.95.
Slides — such as $.75 ported as $75.00.
Erasures should not be made in accounting records. When an
error is discovered, the incorrect amount or other item in the entry
should be struck out by drawing a line through it, and the correct
entry should be inserted above the incorrect one.
CHAPTER 4
Working Papers and Their Uses
Working papers. Working papers are a columnar device
employed by accountants as a convenient and orderly way of
organizing the accounting data to be used in the preparation of
adjusting entries, periodic statements, and closing entries.
If the ledger contains only a few accounts, working papers are
not necessary, and the accounting procedures are performed in the
following order:
Make and post the entries for transactions.
Take a trial balance.
Make and post the adjusting entries.
Take an adjusted trial balance.
Prepare the statement of income and expense, the statement of
earned surplus, and the balance sheet.
Make and post entries to close the books.
Take an after-closing trial balance.
If the ledger contains a considerable number of accounts, work-
ing papers are very useful. Since one of their purposes is to
indicate the adjusting entries which should be made, the above-
stated sequence of procedures is changed as follows :
Make and post the entries for transactions.
Take a trial balance.
Prepare working papers.
Prepare the statement of income and expense, the statement of
earned surplus, and the balance sheet.
Make and post adjusting and closing entries.
Take an after-closing trial balance.
These procedures, in total, constitute an accounting cycle. In
actual business, this cycle, including closing the books, usually
is completed only once a year, because the books ordinarily are not
closed more frequently. In the illustrations and problems in this
text it is often assumed, for convenience and simplicity, that the
cycle is completed monthly.
Illustrative working papers. The account balances of Com-
munity Televisions at the end of September and the related
adjustment data, presented in the preceding chapter, will be used
43
44 WORKING PAPERS AND THEIR USES [Ch. 4
for purposes of illustration. There are so few accounts that an
experienced accountant probably would not consider it worth while
to prepare working papers; but in a textbook it is advisable to
begin with a relatively simple illustration.
The steps in the preparation of the working papers are stated
and illustrated below.
First step. Headings were written; the ledger account balances
before adjustments were entered in the Trial Balance columns;
and these columns were totaled to determine their equality.
The working papers after the completion of this step are
shown on page 45.
Second step. The required adjustments were entered in the
Adjustments columfas. These adjustments are the same as those
mentioned in Chapter 3. Observe that the nature of each adjust-
ment is stated at the bottom of the working papers, with a key
letter referring to the debit and credit entries in the Adjustments
columns. These letters not only key the debit and credit entries
to the explanatory data but also make it easier to match an entry
in the Adjustments debit column with its related credit. The
Adjustments columns were totaled as a check against errors.
The working papers after the completion of this step are shown
on page 46. Read the explanation of each adjustment at the
bottom of the working papers, and observe the related debit and
credit entries in the Adjustments columns. Also observe that, if
the adjustment requires the use of an account which does not
appear in the trial balance, the name of the account is written
below the trial balance.
Third step. The account balances (after the application of
adjustments, if any) were entered in the Adjusted Trial Balance
columns. Observe how the adjustments were applied. For
instance, on the Installation and Repair Parts line, the $3,800 in
the Trial Balance debit column minus the $270 in the Adjustments
credit column is $3,530, the amount entered in the Adjusted Trial
Balance debit column.
The Adjusted Trial Balance columns were totaled as a test of
accuracy. The working papers after the completion of this step
are shown on page 47.
Fourth step. Each account balance appearing in the Adjusted
Trial Balance columns was entered in a column at the right
corresponding to the statement in which it should appear.
Debit balances were entered in debit columns; credit balances
were entered in credit columns.
The working papers after the completion of this step are on
page 48. (Continued on page 51.)
Ch.4]
WORKING PAPERS AND THEIR USES
45
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WORKING PAPERS AND THEIR USES
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September
e — Cost of parts used during Sei
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tember.
48
WORKING PAPERS AND THEIR USES
[Ch.4
Ch.4]
WORKING PAPERS AND THEIR USES
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50
WORKING PAPERS AND THEIR USES
[Ch.4
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Ch. 4] WORKING PAPERS AND THEIR USES 51
Fifth step. The net income for the month, amounting to $470,
was determined by computing the balance of the Income and
Expense columns. The $470 was entered in the Income and
Expense debit column as a balancing figure; and, since the net
income increases the earned surplus, it was also entered in the
Earned Surplus credit column. The Income and Expense columns
were then totaled. The working papers after the completion of
this step are on page 49.
Final step. The earned surplus balance at the end of the
month, in the amount of $535, was determined by computing the
balance of the two Earned Surplus columns. The $535 was
entered as a balancing figure in the Earned Surplus debit column;
and, since the earned surplus also appears in the balance sheet, the
$535 was also entered in the Balance Sheet credit column.
The Earned Surplus columns were totaled.
The two Balance Sheet columns were totaled and found to be
in agreement. If the Balance Sheet columns did not have the
same totals, an error some place in the working papers would be
indicated.
The completed working papers are on page 50.
Statements prepared from working papers. The working
papers furnish in a convenient form the information required for
the periodic statements.
Statement of income and expense. The following statement
shows the amounts which appear in the Income and Expense col-
umns of the working papers.
COMMUNITY TELEVISIONS
Statement of Income and Expense
For the Month of September, 19 -
Income:
Commissions earned $1 ,325.00
Repair service income 195 00
Installation income* . 825 00
Inspection service income 60 00
Interest income 5 00
Total. $2,410 00
Deduct expenses:
Salaries expense $1 , 150 00
Building rent 250 00
Truck rent 240 00
Insurance expense 10 00
Installation and repair parts expense . . . 270 00
Depreciation of equipment. . . 20 00
Total 1,940.00
Net income $ 470 . 00
52 WORKING PAPERS AND THEIR USES [Ch. 4
Statement of earned surplus. The following statement shows
the amounts which appear in the Earned Surplus columns of the
working papers.
COMMUNITY TELEVISIONS
Statement of Earned Surplus
For the Month of September, 19 -
Kurncd surplus, August 31, 19— $M5 00
Add net income for the month — Per statement of income and
expense . 470 00
Total $015 00
Deduct dividends ... . 80 00
Earned surplus, September 30, 19 — $.535 00
Balance sheet. The following statement shows the amounts
which appear in the Balance Sheet columns of the working papers.
COMMUNITY TELEVISIONS
Balance Sheet
September 30, 19 —
Assets
Cash ... $ 2,005 00
Accounts receivable 1 , 235 00
Accrued interest receivable 5 00
Installation and repair parts 3 , 530 00
Unexpired insurance 1 10 00
Mortgage receivable 1 , 000 . 00
Equipment $2 , 100 00
Less reserve for depreciation 20 00 2 , 380 00
$To,2G5 00
Liabilities and Owners' Equity
Liabilities:
Accounts payable $| ,300 00
Truck rent payable • 240 00
Unearned inspection income 190.00
Total . S 1,730 00
Owners' equity:
Capital stock $8,000 00
Earned surplus — Per statement of earned surplus 535 00
Total . . 8,535.00
$10,265 00
A balance sheet in which the assets appear at the left and the
liabilities and owners' equity at the right is sometimes called an
account form balance sheet. The term report form is sometimes
applied to a balance sheet in which the liabilities and owners'
equity appear below the assets.
Adjusting entries. The amounts in the Adjustments columns
of the working papers, together with the information in the key
to adjustments at the bottom of the working papers, furnish the
information for the following adjusting entries to be recorded in
the journal and posted to the ledger.
Ch. 4]
WORKING PAPERS AND THEIR USES
53
Journal
(Page 6)
19- -
Sept.
30
30
30
30
30
30
Accrued interest receivable . .
Interest income
One month's interest on mortgage.
Truck rent
Truck rent payable .
Expense and liability for use of truck during
September.
Unearned inspection income
Inspection service income
Portion of income earned.
Insurance expense
Unexpired insurance
Insurance expense for the month.
Installation and repair parts expense
Installation and repair parts
Expense for the month
Depreciation of equipment .
Reserve for depreciation -Equipment
Depreciation for September.
500
24000
0000
1000
27000
2000
500
240100
OOiOO
10100
270100
2000
Closing entries. The closing entries can be prepared from the
data in the Income and Expense columns and the Earned Surplus
columns of the working papers.
Journal (Page 7)
19—
!
Sept.
30
Commissions earned
1,325
00!!
Repair service income
105
00
Installation income
825
ooj
Interest income
5
ool
Inspection service income .
60
00'
Profit and loss
2,410
00
To close the income accounts
30
Profit and loss
1,91000"
Salaries expense ' 1 , 150
00
Building rent 250
00
Truck rent , 210
00
Insurance expense 10
00
Installation and repair parts expense 270
00
Depreciation of equipment
1 20
00
To close the expense accounts.
. r
30
Profit and loss
470
ooi
Earned surplus
470
00
To transfer the net income to Earned Surplus.
;
30
Earned surplus
80
00
Dividends
80
00
To close the Dividends account.
In the illustrative closing entries in Chapter 2, a separate
journal entry was made for the closing of each income and expense
54
WORKING PAPERS AND THEIR USES
[Ch.4
account. This was done for purposes of clear explanation. The
closing procedure can be greatly simplified by making compound
journal entries. The foregoing closing entries, prepared from data
in the working papers, are illustrative of compound entries.
The Profit and Loss and Earned Surplus accounts after the
posting of the closing entries will appear as follows:
Profit and Loss
19-
Sept.
1,940
470
00
00
19--
Sept.
30
2,410
00
(55)
2,41000
~27410()6
Earned Surplus
19-
Aug.
Sept.
31
30
3
7
80
80
119-
OOAug.
00 Sept.
31
30
J[6l)
22500
47000
Accrual adjustments and entries in subsequent periods. If an
expense accrual is made in the books at the end of a period, it. must
be remembered when payment is made in a subsequent period.
For instance, in Chapter 3 the following adjusting entry was made
for an expense accrual:
Sept. 30 Truck rent
Truck rent payable
Expense and liability for use of truck during
September.
240 00
210 00
Assume, first, that payment is made on October 10; the entry
should be:
Oct. 10 Truck rent payable
Cash
Payment of truck rental for September.
240 00
240 00
Assume, second, that payment is made on October 15, at which
date another $150 of truck rent has accrued, and that the entire
$390 is paid; the entry should be:
Oct. 15 Truck rent payable 240 00
Truck rent . 150 00
Cash 390.00
Payment of September truck rent, and $150
of October rent accrued to date.
Assume, third, that no payment is made in October, that the
rent accrual for use of the truck during October is $270, and that
the $510 total for September and October rent is paid on Novem-
ber 5.
Ch. 4] WORKING PAPERS AND THEIR USES 55
An adjusting entry should be made at the end of October for
the rent accrued during that month, as follows:
Oct. 31 Truck rent 270 00
Truck rent payable 270 00
Expense and liability for use of truck during
October.
The entry for the payment of the rent would be :
Nov. 5 Truck rent payable 5 1 0 00
Cash 510 00
Payment of truck rent for September and
October.
If an income accrual is made in the books at the end of a
period, it should similarly be borne in mind when the collection
is received in a subsequent period.
CHAPTER 5
Merchandise Operations — Perpetual Inventory Method
Illustrative statement of income and expense. In the illustra-
tions in the preceding chapters, the business operations consisted
of rendering services. Many businesses, however, derive all or a
large portion of their earnings from selling merchandise. A state-
ment of income and expense for a company whose entire income
is derived from selling merchandise is presented below.
THE MORTON COMPANY
Statement of Income and Expense
For the Month of April, 19 -
Sales $3,000 00
Cost of goods sold 2,700 00
Gross profit on sales . . $ 900 00
Deduct expenses:
Advertising expense . . $ 25 00
Depreciation expense — Equipment 10 00
Rent expense* . 75 00
Salaries expense 500 00
Total expenses _ 610 00
Net income for the month $ 290 00
Notice the new feature introduced by the merchandising opera-
tions: namely, the appearance in the statement of income and
expense of the " gross profit on sales." The gross profit is the
excess of the selling price over the cost of the goods sold.
Some accountants, perhaps because of the appearance of the
"gross profit," prefer to give the above statement the heading
" Statement of Profit and Loss" or "Profit and Loss Statement."
All of these statement headings are acceptable, and all are used in
this text in order to familiarize the student with such variations.
Perpetual and periodical inventory methods. There are two
basic accounting methods for the determination of the cost of
goods sold and the cost of goods remaining on hand : The perpetual
inventory method is described in this chapter; the periodical
inventory method is described in the next chapter.
Basis of illustration. For purposes of illustration, it is assumed
that The Morton Company deals in room air-conditioners, which
it buys at wholesale for $300 and sells at retail for $400. The com-
pany has been in business for some time ; its account balances after
the books had been closed on March 31 are shown on page 57.
Ch. 5]
PERPETUAL INVENTORY METHOD
57
Account Balances — March 31, 19
Cash 3,700 00
Inventory (4 units costing $300 each) 1 ,200 00
Equipment 1 ,200 00
Reserve for depreciation — Equipment 300 00
Capital stock 5,000 00
Harnerl surplus 800 00
6,100 00 fl/lOOJX)
Included in the above list of accounts is an Inventory account.
When used as an account title, the term "inventory" refers to
the merchandise which a business purchases for resale to its cus-
tomers. Such merchandise is recorded at cost.
The illustration covers the month of April.
Inventories, purchases, sales, and cost of goods sold. The
procedures, by the perpetual inventory method of accounting for
inventories, purchases, sales, and the cost of goods sold, are
described below.
Inventory at beginning of period. The inventory at the begin-
ning of April was shown in the Inventoiy (asset) account as
follows :
Inventory
(3)
19—
March
31
Balance
1,200
00
Purchases. Purchases increase the merchandise asset and are
therefore debited to the Inventory account. One purchase trans-
action occurred during April :
April 3 — Ten air-conditioning units costing $300 each were purchased
from George White on account.
The journal entry to record this transaction was:
Journal
(Page 11)
19—
April
Inventory
George White
Purchased ten air-condi turning units on ac-
count.
3,000
00
3,00000
After this entry was posted, the Inventory account appeared
as follows :
Inventory
(3)
19—
March
31
Balance
1,200
00
April
3
11
3,000
00
58
MERCHANDISE OPERATIONS
[Ch.5
Sales. A sale of merchandise is recorded in the same way as a
"sale" of service —that is, by a credit to an income account. The
Sales account is used for this purpose. One sale occurred during
April:
April 18 — Nine air-conditioning units were sold to Bailey Apartments
on account, for $400 each.
The journal entry to record the sale was:
Journal
(Page 11)
19—
April
18
Bailey Apartments . . .
Sales
Sale of nine units on account.
3,600
00
3,600
00
After this entry was posted, the Sales account appeared as
follows :
Sales
(13)
1
19—
April
H
11
3,60000
Cost of goods sold. When the perpetual inventory method is
used, entries for sales are followed by companion entries for the
cost of the goods sold. These entries transfer the cost of the goods
sold from the Inventory account to a Cost of Goods Sold account.
The transfer entry for the sale mentioned above was:
Journal
(Page 11)
19—
April
18
Cost of goods sold
Inventory .
Cost of nine units sold transferred from Inven-
tory to Cost of Goods Sold. $300 X 9.
2,70000
2,70000
After this entry was posted, the accounts affected appeared as
follows:
Cost of Goods Sold
(14)
19—
April
18 11
2,700
Im
00
irentory
19—
March
April
31
3
Balance
11
1,200
3,000
00
00
19—
April
18
11
(3)
2,70000
Ch.5]
PERPETUAL INVENTORY METHOD
59
Inventory at end of period. The inventory on April 30, to
appear in the balance sheet, is the balance of the Inventory
account, $1,500. Since, under the perpetual inventory method,
all purchases of merchandise are debited to the Inventory account
and the cost of all goods sold is credited to the Inventory account,
the Inventory account balance should show the cost of goods in
the inventory at the end of the period, provided that no merchan-
dise has been lost or stolen.
Detailed inventory records. In most instances where the per-
petual inventory method is in use, a running record in terms of
quantities is maintained for each of the various types of goods
held for sale. Cost data may also be included. In the case of
The Morton Company, which sells only one type of merchandise,
such a supplementary record, in terms of quantities, can be illus-
trated as follows :
INVENTORY CARD
Description Room air-conditionors
Date
19
April
Quantity
Purchased Sold
Balance
10
4
14
<) I, 5
As a check on the accuracy of these detailed records, it is
advisable and customary to make occasional counts of merchandise
on hand.
April journal. In addition to the transactions already men-
tioned, the following transactions occurred in April:
April 1 —The store rent for the month, $75, was paid in cash.
15 — Salaries for the first half of April, $250, were paid in cash.
26 — A cash payment of $1,500 was made to George White, to
apply on account.
27 — A cash collection of $1,750 was received from Bailey
Apartments, to apply on account.
30 — A cash dividend of $50 was declared and paid.
The complete journal is on page 60. Observe that the sales
entry is immediately followed by the related entry for the cost of
goods sold.
60
MERCHANDISE OPERATIONS
Journal
[Ck 5
(L'age 11)
19—
April
15
18
18
26
27
30
Rent expense
Cash
Payment of store rent for April.
Inventory
George White
Purchase of merchandise? on account. Ten units
at $300 each.
Salaries expense
Cash
Salaries for the first half of April paid in cash.
Bailey Apartments
Sales
Sale of merchandise on account. Nine units at
$400 each.
Cost of goods sold
Inventory
Cost of nine units sold transferred from Inven-
tory to Cost of Goods Sold. $300 X 0.
George White
Cash
Payment to White to apply on account.
Cash
Bailey Apartments
Collection from Bailey Apartments to apply on
account.
Dividends .
Cash
Payment of dividend to stockholders.
75
3,000
00
00
250 00
3, 00000
2,70000
1,50000
1,75000
5000
75
00
3,00000
250 00
3,00000
2,70000
1,50000
1,75000
5000
Trial balance. The trial balance in the working papers on page
61 shows the balances that would appear in the ledger as of April
30 after the preceding journal entries were posted.
Completed working papers. Completed working papers for
The Morton Company are presented on page 62. Adjustments
were made for the following matters:
(a) Salaries for the last half of April have not been paid; there
are accrued salaries in the amount of $250.
(6) Accrued advertising; there was an unrecorded liability for
April newspaper advertising in the amount of $25.
(c) Depreciation for April ; the depreciation rate for the equip-
ment is 10 per cent per annum. The depreciation for
one month is therefore $10.
Equipment
Depreciation rate per year.
Depreciation per year . .
$1,200
10%
$ 120
Depreciation per month . . . $__
10
Ch. 5]
PERPETUAL INVENTORY METHOD
61
$
^
!
0> X1
l-s
«s
s B
g I
<e o>
^•N —J
E MORTON COMP
Working Papers
the Month of April, :
Adjusted
, Trial Balance
so
« I
H fe
I
Is
flj
62
MERCHANDISE OPERATIONS
lCh.5
*
1
O O O O »*5 O »O
;H O O 10 N ~ij <N
^H 10' ^ 00
Balance
eo"^^^ »
02
*o *2
ll
rH
Statem
Earned
i— 1 rH
* TJ
CO CO
1 1
Statem
Income an
ci co
i Jj
i«i
1
u od
o 2
rH IO CO '"'
;w
> JfiJ
in
IS
1
10000 oo»ob 10 °i2
I'- »O O O *O O I* O <N ^28
rH
' i2 ^
:**
' r8
ments 1
03 pC
£ o ^ J5
^ »O 0s! 00
ts
•i-*
o »o o »o
0
rH 10" CO" rn' ^ ^
rH «4_ •£"
0 r
I
0 100 0 ^ ^
loSioS "° i-1' 8 8 ^ J:
CO^-HrH (N -H g ^
^? ^ fl
"~ I - * K H P
1 rk ° ff5 C
o; JI? co S • ^
d ••S S 1 . -C L- boT
•3 : . t.; i • • i iiis
I 1 2 &|:S 1 : "' ^IP
'S S, a • 8 '1 .§&| 8 ' S l-Sj
1 ^lllt ils. |i-S §1 s & -S^.1
:5-bl^|SSN iia "-a- ?| 1 a • gg
Iflif! J Ji jj|
Ch. 5]
PERPETUAL INVENTORY METHOD
63
Statements prepared from working papers. After the working
papers are completed, the accountant has the information he needs
for purposes of statement preparation. The financial statements
of The Morton Company, prepared from the preceding working
papers, appear below:
THE MORTON COMPANY
Statement of Income and Expense
For the Month of April, 19—
Cost of goods sold
Gross profit on sales
Deduct expenses:
Advertising expense
Depreciation expense
Rent expense
Salaries expense
Total expenses
Net income
$3,600 00
2,700 00
$ 900 00
Equipment
$ 25 00
10 00
75 00
500 00
610 00
$ 290 00
THE MORTON COMPANY
Statement of Earned Surplus
For the Month of April, 19 —
Karned surplus, March 31, 19 —
Net ineome for the month
Total
Deduct dividends
Earned surplus, April 30, 19 -
$ 800.00
290 00
$1,090 00
50 00
$1,010.00
Assets
Cash
Accounts receivable
Inventory.
Equipment $1 ,200 00
Less reserve for
depreciation 310 00
THE MORTON COMPANY
Balance Sheet
April 30, 19—
Liabilities and Owners' Equity
$3,575 00 Liabilities:
1,850 00 Accounts pay-
1,500 00 able $1,500 00
Accrued salaries
payable.
890 00 Accrued adver-
tising payable
Owners* equity:
Capital stock. $5 , 000 00
Earned surplus 1,0*000 6,04000
250 00
25 00 $1,775 00
$7,815 00
$7,815 00
Recording the adjusting and closing entries. Adjusting and
closing entries for a merchandising company using the perpetual
inventory method are made in the same manner as those for a
service enterprise, which were illustrated in the preceding chapters.
In the case of The Morton Company, the adjusting journal entries
on the following page are required.
64 MERCHANDISE OPERATIONS [Ch. 5
Journal 0'iw 12)
19—
April
30
Salaries expense
250
00
Aecured salaries payable . ...
250
00
Accrued salaries for the last half of April.
30
Advertising expense . .
25
00
Accrued advertising payable
25
00
To record liability for April newspaper adver-
tising not recorded before the trial balance was
prepared.
30
Depreciation expense — Equipment . . .
10
00
Reserve for depreciation — Equipment
10
00
To record depreciation for one month. $1,200
X 10% •*- 12 = $10.
The following entries close the accounts of The Morton Com-
pany. The closing entries are based on the information in the
working papers.
19—
April
30
30
30
Journal
Sales
Profit and loss
To close the income account.
Profit and loss
Cost of goods sold
Rent expense
Salaries expense
Advertising expense
Depreciation expense- -Equipment
To close the expense accounts.
Profit and loss
Earned surplus
To close the Profit and Loss account.
Earned surplus . . .
Dividends
To close the Dividends account .
(Page 12)
3,000
00
3,600
00
3,310
00
2,700
00
75
00
500
00
25
00
10
00
290
00
290
00
50
00
50
00
Ledger accounts after adjusting and closing. The following
ledger accounts are those of The Morton Company after the
entries for the transactions for April and the adjusting and closing
entries have been posted.
Cash
(1)
19—
March
April
Balance
19—
3,700
00
April
1
11
1,750
00
15
26
30
7500
250 00
1,50000
5000
Ch. 5] PERPETUAL INVENTORY METHOD 65
Bailey Apartments (2)
19--
April
18 11
H19-
April
27
11
1,750
00
Inventory (3)
19—
19—
March
31
Balance
1,200
00
April
18
11
2,700
00
April
3
11
3,000
00
Equipment (-1)
19—
March
31
1,200
Reserve for Depreciation Equipment (5)
i
19—
March
31
Balance
300
00
April
30
12
10
00
George White (6)
19 -
•I
19—
I)
April
20
11
1,500
00
April
3
11
3,000
00
Accrued Salaries Payable (7)
i
19—
April
30
12 250
00
Accrued Advertising Payable (8)
!
19-
April
30
12
2500
Capital Stock (9)
i .
in
1 *7
March
31
Balance j
j 5,000
00
Earned Surplus (10)
19—
April
30
12
50
00
19—
March
April
31
30
Balance
800
12 290
00
00
Dividends (11)
19~ 1 1 1 1
April |30| |ll| 50
00
19—
April
3o|
12
50
00
66 MERCHANDISE OPERATIONS [Ch. 5
Profit and Loss (12)
19—
April
30
30
12
12
3,310
290
00
00
19—
April
les
30
12
3,(>00
00
00
3,600
00
3,000
Sa
00
(13)
19—
April
30
12
3,000
19 —
April
•J
)ld
11
3,000|00
00
Cost of Goods S(
19- 1 I
April J18J
Dej
11
2,700
00
19-
April
ense — 1
30
Eqi
iipment
12|| 2,700
(
00
5)
00
jreciation £xp<
19—
April
30
12
10
00
19- 1 1
April J30|
g Expense
12
10
Advertisin
(1«)
19—
April
30
IH
1 *
119
00||April
30
12
25
00
L
Renjt Expense
(17)
19-
April
1
11
75
00
119—
[April
30
n
75|00
(18)
Salaries
Expense
19—
April
15
30
11
12
250
250
00
00
19-
April
30
12
500
00
00
500
00
500
Net loss for period. If the expenses exceed the gross profit for
the period, the statement of profit and loss will appear as illus-
trated below:
THE A B COMPANY
Statement of Profit and Loss
For the Month of February, 19
Sales
Deduct cost of goods sold
Gross profit on sales
Deduct expenses
Net loss
$5,000.00
4,500 00
$ r>00 00
600 JH)
s 160" oo
Since the operations resulted in a loss, the Profit and Loss
account will have a debit balance, and will be closed by an entry
debiting Earned Surplus and crediting Profit and Loss.
Ch. 5] PERPETUAL INVENTORY METHOD 67
In the working papers, the Income and Expense columns will
be balanced by entering the net loss in the credit column. The
net loss will also be entered in the debit Earned Surplus column.
Loss on sales. If the cost of goods sold exceeds the sales, the
operations will result in a loss on sales instead of in a gross profit,
and the statement will be prepared as follows:
THE X Y COMPANY
Statement of Profit and Loss
For the Month of July, 19
Sales . $10,000.00
Deduct cost of goods sold . . 10,200 00
Loss on sales $ 200 00
Add expenses . . . 500 00
Net loss . . . . .... S _ 700. 00
Deficit. The occurrence of net losses may cause the Earned
Surplus account to have a debit balance. Should the Earned
Surplus account have a debit balance, it is described in the balance
sheet as a Deficit and is deducted from the capital stock as follows:
Owners' equity:
Capital stock $40,00000
Deduct deficit 10,000 00 $30,000 00
Two principal sources of income. If a company has two
principal sources of income, one from merchandising operations
and the other from rendering services, its statement of income
and expense may be presented as follows :
THE M N COMPANY
Statement of Income and Expense
For the Month of August, 19 —
Sales. . . . $8,000 00
Deduct cost of goods sold 5,000 00
Gross profit on sales $3,000 00
Income from services 2,000 00
Total .. . $5,000 00
Deduct expenses 4,000.00
Net income $1 ,000 00
CHAPTER 6
Merchandise Operations — Periodical Inventory Method
Determining cost of goods sold and ending inventory. The
sum of the inventory at the beginning of the period and the pur-
chases during the period is the cost of goods available for sale.
To prepare a statement of income and expense and a balance sheet
for a merchandising- company, it is necessary to divide this total
into two portions:
The cost of goods sold during the period -to be shown in the
statement of income and expense.
The cost of goods remaining in the inventory at the end of the
period — to be shown in the balance sheet.
There are two methods for making this division.
Perpetual inventory method. This method, which was de-
scribed in the preceding chapter, can be used when it is practicable
to determine and record the merchandise cost applicable to each
sale. Using the data in Chapter 5, we may express the procedures
as follows:
Bookkeeping procedure:
Inventory Cost of Goods Sold
Inventory at beginning of period 1 ,200
Purchases during period 3,000
Cost of goods sold
2,700 2,700
Statement procedure:
The $1,500 balance in the Inventory account is shown in the
balance sheet as an asset.
The $2,700 balance in the Cost of Goods Sold account is shown
in the statement of income and expense, as illustrated below :
Statement of Income and Expense
Sales S3, 600 00
Deduct cost of goods sold 2,700 00
Gross profit on sales $ 900 00
Periodical inventory method. When it is impracticable,
because of the large number of small sales or for any other reason,
to determine and record the merchandise cost applicable to each
sale, the procedures stated on page 69 are used.
68
Ch. 6] PERIODICAL INVENTORY METHOD 69
Bookkeeping procedure:
Inventory
Inventory at beginning of period 1 , 200
Purchases
Purchases during period 3 , 000
Statement procedure:
The end-of-period inventory is determined by counting and
listing all merchandise on hand held for sale, and pricing
such merchandise in terms of cost. This is called " taking
a physical inventory."
The inventory thus determined is shown in the balance sheet
as an asset.
The end-of-period inventory is also shown in the income and
expense statement as a deduction from the cost of goods
available for sale, to determine the cost of goods sold, as
illustrated below:
Statement of Income and Expense
Sales .. $3,600.00
Deduct cost of goods sold:
Inventory at beginning of period $1 ,200 00
Add purchases 3,000 00
Total goods available for sale $4,200 00
Deduct inventory at end of period 1 ,500 00
Cost of goods sold 2,700 00
Gross profit on sales $ 900 00
Comparative summary of bookkeeping procedures. As indi-
cated in the preceding paragraphs of this chapter, the bookkeeping
procedures for recording transactions by the perpetual inventory
method and the periodical inventory method are identical, with
the following exceptions :
By the perpetual inventory method:
Purchases are debited to the Inventory account.
The cost of goods sold is recorded by a debit to Cost of
Goods Sold and a credit to Inventory.
By the periodical inventory method:
Purchases are debited to the Purchases account.
No entry is made for the cost of goods sold.
Comparative trial balances. The trial balances on the following
page show the account balances under each inventory method.
Asterisks appear where differences in methods affect the account
balances.
70 MERCHANDISE OPERATIONS [Ch. 6
THE MORTON COMPANY
Trial Balances (Before Adjustments)
April 30, 19 -
Perpetual Periodical
Inventory Method Inventory Method
Cash 3J375 ~00 ;37575~00
Bailey Apartments 1 ,850 00 1 ,850 00
"•Inventory . . 1 ,500 00 1 ,200 00
Equipment . 1,20000 1,20000
Reserve for depreciation —Equipment 300 00 300 00
George White . . 1 ,500 00 1 ,500 00
Capital stock . 5,00000 5,00000
Earned surplus 800 00 800 00
Sales. . 3,(500 00 3,000 00
*Purchases . 3,000 00
*Cost of goods sold 2 , 700 00
Rent expense 7500 75.00
Salaries expense 250 00 250 00
Dividends. 50 00 50 00
ll,20p_0g 11,200 00 U, 20(^00 11,200 00
Working papers — Periodical inventory method. Working pa-
pers in various stages of completion appear on pages 72, 73, and
74. They are based on the data of The Morton Company shown
on the preceding pages of this ^chapter.
Observe the following features in the working papers:
(1) The term Profit and Loss has been used in place of Income
and Expense as a column heading. As noted earlier,
either terminology is considered acceptable.
(2) Columns for the Adjusted Trial Balance have been omitted.
Many accountants prefer to extend the trial balance
amounts, as modified by the data in the Adjustments
columns, directly to the statement columns.
(3) All of the accounts in the ledger, except the Profit and Loss
account, have been listed in the trial balance, including
accounts having no balances when the trial balance was
prepared. In the ledger of an established business, there
may be several accounts that normally have no bal-
ances when the trial balance is prepared but acquire bal-
ances from the adjusting entries. Depreciation expense
accounts and accrued accounts are examples. The
accountant may find it desirable to list such "no bal-
ance" accounts in their statement order in the trial
balance in the working papers; this procedure, by avoid-
ing the addition of account titles below the trial balance,
results in having the working-paper information more
nearly in statement order.
Ch. 6] PERIODICAL INVENTORY METHOD 71
Stage 1. The working papers identified as Stage 1 (see page
72) show the condition of the papers after the following steps
have been taken:
(1) All working-paper headings entered.
(2) The trial balance entered.
(3) The adjustments entered.
Stage '2. Page 73 shows how the working papers appear after
the completion of the following additional steps:
(1) The balances in the (beginning) Inventory and Purchases
accounts appearing in the trial balance have been
extended to the Profit and Loss debit column. The
sum of these two debits, $4,200, is the cost of goods
which were available for sale during the period.
(2) The ending inventory, $1,500, which does not appear in
the trial balance, has been entered in the working papers
in two places:
(a) Tn the Profit and Loss column, because it will
appear in the profit and loss statement as an
element of the computation of the cost of goods
sold. It is entered in the credit column because
it is a deduction from the opening inventory and
purchases, which are debits. The Profit and
Loss columns now have a debit balance of
$2,700, the cost of goods sold.
(6) In the Balance Sheet debit column, because the
ending inventory will be shown in the balance
sheet as an asset.
Stage 3. Page 74 shows the completed working papers.
72
MERCHANDISE OPERATIONS
[Ch.6
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Ch.6]
PERIODICAL INVENTORY METHOD
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MERCHANDISE OPERATIONS
[Ch.6
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Ch.6]
PERIODICAL INVENTORY METHOD
75
$1,200 00
3,000 00
$4,200 00
1,500 00
Financial statements — Periodical inventory method. The fol-
lowing profit and loss statement was prepared from the preceding
working papers. It is presented in order to show the computation
of the cost of goods sold.
THE MORTON COMPANY
Statement of Profit and Loss
For the Month of April, 19—
Sales ... $3,00000
Deduct cost of goods sold:
Inventory, March 31, 19
Purchases
Cost of goods available for sale.
Deduct inventory, April 30, 19 —
Cost of goods sold 2 , 700 00
Gross profit on sales $ 900 00
Deduct expenses:
Advertising expense $ 25 00
Depreciation expense — Equipment 10 00
Rent expense 75 00
Salaries expense 500 00
Total 010 00
Net income $ 290 00
The statement of earned surplus and the balance sheet would
be identical with those on page 63 of Chapter 5.
Adjusting journal entries -Periodical inventory method. The
adjusting entries are not affected by the inventory method. They
are the same as those in the preceding chapter.
Closing entries -Periodical inventory method. The closing
entries under the periodical inventory method are presented below.
Observe that, in these entries, the beginning inventory is removed
from the Inventory account by a credit, and the ending inventory
is debited to the Inventory account.
Journal
(Page 12)
19—
April
30
Sales
Inventory
Profit and loss . . .
To close the Sales account and set up the ending
inventory.
Profit and loss. . .
Inventory
Purchases
Advertising expense
Depreciation expense- Equipment
Rent expense
Salaries expense
To close the expense accounts and to remove the
beginning inventory from the Inventory ac-
count.
3,600
00
1,500
00
ding
5,100
00
1,810
00
1,200
00
3,000
00
25
00
10
00
75
00
^ tViP
500
00
I lit.
ac-
76
MERCHANDISE OPERATIONS [Ch. 6
Journal (Page 12 Concluded)
19—
April 30
30
Profit and loss
Karned surplus
To close the Profit and Loss account.
Kurnc*d surplus
Dividends
To close the Dividends account.
290 00
5000
290 00
5000
After the above entries are posted, the Inventory account will
appear as follows :
Inventory
19—
r
19—
March
31
10
1^200
00
April
30
April
30
12
1,500
do
12
1,20000
Special note regarding a newly organized business. A newly
organized business may start operations without a beginning
inventory. The cost of goods sold during its first accounting
period will be computed by simply deducting the ending inventory
from the purchases.
- •»
Office Routines; Documents
Duties of the accounting department. The work of the
accounting department includes:
(1) Writing up various documents, such as sales invoices,
checks, and notes. Most of these documents are deliv-
ered to the parties with whom the company does busi-
ness; duplicates of some of them (duplicate sales invoices,
for instance) may be retained in the company's files for
future reference and as evidence of the propriety of the
entries for the transactions.
(2) Checking similar documents received from the parties with
whom the company does business, to determine whether
or not they have been prepared in accordance with the
facts of the transactions. After having been checked,
the documents are filed as evidence of the transactions.
(3) Recording the transaction facts indicated by the documents
written up in the office or received from other parties.
Internal control. The office and accounting procedure should
be so organized that errors will be prevented so far as possible,
and that, if errors are made (by the company's employees or in
documents received from people with whom the company does busi-
ness), they probably will be discovered. Moreover, the work of
Ch. 6] PERIODICAL INVENTORY METHOD 77
the various members of the organization should be so interrelated
and checked that fraud cannot be committed and concealed with-
out the collusion of two or more persons. The method of effecting
these safeguards is called the system of internal check or internal
control.
It should be understood that the discussion in this chapter
relative to office routines is intended to indicate methods which
may be used to provide for internal control. It is not intended to
describe procedures used in every business.
The number of copies of each document prepared in any given
business may be more or less than the number stated in the follow-
ing comments. Also, the office routines depend on the size of the
business and on the ideas of the company's accountant regarding
the relative advantages of different procedures.
Purchase Routine
Purchase requisitions. All purchases may be made by the
purchasing agent, who obtains information concerning require-
ments from purchase requisitions sent to him by other members
of the organization. Requisition forms are of various kinds; the
following is illustrative.
R.
E. JOHNSON &
COMPANY
Requisition No.
Please purchase
M135
Date
July 2, 19—
£ j 1- b^forp
for nf»li vf»r y u c i u i e
July 6
Quantity
Description
10 cases
15 cases
10 cases
XXXX Strawberry preserves
Acorn Peanut butter
Acorn peas
Requisitioned fr
SI £> "\^^ jfi
\j L* Cs vlr6l&Ce/l<dS
Approvec
!hy Q.fiWJLfa,
"> pu..rr-nwr
Purchasing Agent's Memorandum of Order
Ptirchn** OrrW Nn 1705 TCC,,^ tn The Osborne Co.
Date of Order
July 2
Chicago
Purchase Requisition
78 MERCHANDISE OPERATIONS [Ch. 6
Purchase requisitions may be filled out by various persons,
depending on the nature and size of the business.
In the case of staple merchandise, the merchandise manager
may fix a minimum quantity below which the stock must not be
allowed to fall without reordering. When the stock is reduced
to the minimum quantity determined by the merchandise manager,
the stock clerk enters the description of the article on a requisition ;
he may also enter the quantity to be ordered (if a standard quantity
to be purchased has been established), or the quantity may be
entered on the requisition by the merchandise manager.
In the case of non-staple merchandise, the requisition may be
prepared in the office of the merchandise manager after consulta-
tion with the sales manager regarding quantities which probably
will be required.
Purchase order. The purchasing agent places the order by
filling out a purchase order. Purchase orders vary in form; the
following is illustrative.
Purchase Order No 1705
R. E, JOHNSON & COMPANY
2913 North Western Avenue
Chicago
The Osborne Company nato July 2, 19--
Before July 6
215 Wost Canal Street • Your truck
g^ • vja
F. O. B
Chicago _ Tftrmq 1/10; n/60
Quantity
Description
Price
10 cases
XXXX Strawberry Preserves
27.80
15 cases
Acorn Peanut Butter
9 20
10 cases
Acorn Peas
12.40
R. E Johnson & Company
Req. Nn _ Ry
Purchasing Agent
Purchase Order
Ch.6]
PERIODICAL INVENTORY METHOD
79
Three copies of the purchase order may be made, and disposed
of as follows:
Original -sent to the supplier from whom the goods are being
purchased.
First carbon — retained in the purchasing department files.
Second carbon— sent to the receiving department.
The uses subsequently made of the first and second carbon copies
of the purchase order are described in a subsequent section of this
chapter.
Invoice. The purchaser receives an invoice from the seller.
The invoice describes the merchandise shipped, shows the amount
charged therefor, and gives other important information. An
illustrative invoice appears below.
THE OSBORNE COMPANY
215 West Canal Street
Chicago, Illinois
Invoice Nn 2397
Customer's
Order No 1705
Date of Order 7/2/19— Tnvnice Date July 3 . 19* -
Sold to R-
E. Johnson & Company Term*;
1/10; n/30
2913 North Western Ave.
Chicago, 111. F. O. B.
Shipped to
Same Dafi, RWp
^ July 3
How Ship
Car. No. I
prf Truck
fc Initials
Quantity
Description p
?i Amount
iCG
10 cases
15 cases
10 cases
XXXX Strawberry Preserves 27.
Acorn Peanut Butter 9
Acorn Peas 12
80 278.00
.20 138.00
.40 124.00
540.00
Invoice
80 MERCHANDISE OPERATIONS (Ch. 6
Purchaser's verification of invoice. When the invoice is
received, it is sent to the purchasing department, where a check
sheet in the following general form is pasted to it, or a rubber
stamp imprint of the same form is made on it.
Goods checked to invoice
Invoice checked to purchase order for:
Merchandise
Prices
Discount terms
Freight terms
Invoice footings and extensions checked
Approved for payment
Paid by Check No Date.
Check Sheet
Before the purchase is recorded, the purchasing company
should know that :
(1) The goods invoiced have been received.
The second carbon of the purchase order was sent to the
receiving department. When the goods are received, the
receiving clerk:
Inspects the merchandise to see that it is in good
condition.
Counts, weighs, or otherwise determines the quantities
received, and enters these quantities 011 his copy of
the purchase order. This copy was made with a
narrow carbon, so that the quantities ordered were
not typed on it; such a practice assures a careful
count by the receiving clerk instead of a perfunc-
tory checking of typed quantities.
Initials the copy of the purchase order and sends it to
the purchasing department, where it is filed in a
binder called a receiving record.
A clerk in the purchasing department compares the quanti-
ties received (shown by the receiving record) with the
quantities billed (shown by the invoice). If they agree,
he initials the check sheet on the " Goods checked to
invoice" line.
(2) The invoice agrees with the purchase order.
The first carbon of the purchase order was retained in the
purchasing department files. A clerk checks the invoice
Ch. 6] PERIODICAL INVENTORY METHOD 81
against this carbon of the purchase order to see that the
merchandise invoiced is the same as the merchandise
ordered, and that the prices, the discount terms, and the
freight terms are correct. He indicates the accuracy of
these matters by initialing the check sheet on the four
lines provided therefor.
(3) The extensions and footings of the invoice are correct.
The computations are checked by a clerk in the accounting
department, and their accuracy is indicated by his
initials on the " In voice footings and extensions checked"
line of the check sheet.
After the invoice has been checked, an entry is made to record
the purchase.
Payment of the invoice. The terms of the invoice received
from The Osborne Company were 1/10; n/30. This is read as
follows: 1% in 10 days; net 30*. It means that 1% cash discount
will be allowed if the invoice is paid within ten days from its date,
July 3, and that the invoice is due in thirty days without discount.
To be sure that all invoices are paid within the discount period,
they may be filed in a tickler, which is a card file with index cards
bearing dates. The Osborne invoice will be filed in front of the
card for July 12, the date on which the check should be mailed
to reach the creditor before the expiration of the discount period.
When the payment date arrives, the invoice is taken from the
tickler and sent to the treasurer. If funds are available for the
payment of the invoice, the treasurer signs or initials the check
sheet on the "Approved for payment " line and sends the invoice
to the cashier, who:
(1) Draws a check;
(2) Enters the check number and date of payment on the
check sheet attached to the invoice;
(3) Sends the check to the treasurer for his signature. The
check is clipped to the invoice so that the treasurer can
be sure that the check he is signing is in payment of an
approved invoice.
The treasurer signs the check and sees that it is mailed to the
creditor. The invoice is sent to the bookkeeper, who records its
payment. The invoice is then filed for future reference as evidence
of the propriety of the entries for the purchase and the payment.
* The expression net is a misnomer, because the gross amount of the invoice (not
the net amount) is payable after 10 days.
82 MERCHANDISE OPERATIONS [Ch. 6
Checks, advices, and receipts. When a remittance is sent to
a creditor, it is important that the creditor be given information
which will indicate the particular invoice which is being paid. A
debtor may owe several bills; he has a legal right to specify that
his remittance shall apply to a certain bill or certain bills, and the
debtor's and the creditor's records should show which bills are
being paid. It is also desirable to obtain a receipt from the
creditor. Several methods may be used to accomplish these pur-
poses; two methods in common use are described below:
(1) The check form may be a simple one, similar to the follow-
ing illustration :
FIRST NATIONAL BANK 2-1 No 1668
Chicago, _jdZ2__ 19 ~
Pay to the order of _ The Osborne Company _ $£54.60
_ EXACTLY £55^^6OC7-$. _ Doiiars
R E Johnson & Company
/ Treasurer
Check
When the purchaser sends the seller the check, he may send
with it a letter, stating that the check is sent in payment of
the creditor's invoice 2397 of July 3, in the amount of
$540, less 1 % cash discount.
This method has two disadvantages:
(a) It necessitates writing a letter.
(6) Although the creditor's endorsement of the check is a
receipt for $534.60, it is not an acknowledgment of the
payment of a particular invoice.
(2) Data with respect to the invoice that is being paid may be
shown in a space provided for that purpose at the left
of the check, as illustrated on page 83.
The back of the left end of the check contains the following or
similar words: " Endorsement of this check by the payee shall
constitute a receipt for the items described on the face
thereof." A receipt for specific items is thus obtained from
the creditor.
Ch. 6]
PERIODICAL INVENTORY METHOD
83
FIRST NATIONAL BANK 2-1 No 1668
Date
Invoice
Amount
rw~ « Juiy 12>
7/3/19 --
2397
540.00
order of The Osborne Company $ 534.60
EXACT LV $5 34;M COCT*. Dollars
Total
Discount
540.00
5 40
R E Johnson & Company
\jjCtGMj {LJ^^&Lsfr'LrfL'Pt'L/
Net
534 60
TreasuriT
Check with Space for Data at Left
Sales Routine
Sales. The office and accounting procedures with respect to
sales differ in retail and wholesale businesses; they also depend on
the nature and size of the business. The procedures described in
the following paragraphs are typical and illustrative; but you
should understand that, although they are indicative of methods
of establishing internal control, other procedures may be used with
equal effectiveness.
In retail stores, where the orders in most cases are oral, the
clerk may merely ring up the sale on the cash register. If it is a
charge sale, the salesman may make out a sales ticket in duplicate,
showing the name and the address of the customer and the items
purchased; one copy will be given to the customer, and the other
copy will be sent to the bookkeeping department for entry in the
records. If the order is to be filled from stock in the storeroom, a
third copy may be made for use in filling the order.
In wholesale businesses, most orders are received in written
form from the company's salesmen or customers, the sales are made
on account, and the goods are shipped or otherwise delivered to the
customers. The procedure may be somewhat as follows:
(1) The order goes to the credit department for approval of
the customer's credit rating. If the approval is given,
(2) The order goes to a billing clerk who types an invoice in
triplicate. The three copies are used as follows:
The second carbon is sent to the stock room for order
filling, and thence (with the merchandise) to the
shipping room for packing and shipment. After the
goods have been shipped, this copy of the invoice
is initialed by the shipping clerk and sent to the
accounting department, where it is filed, in invoice-
number sequence, in a binder which serves as a
shipping record. Maintaining a record relative to
84
MERCHANDISE OPERATIONS
[Ch.6
the shipment of goods is important. In the first
place, it serves as evidence of the propriety of the
entry debiting the customer and crediting the Sales
account; in the second place, if the goods are delayed
or lost in transit, it furnishes information which may
be of assistance in tracing the shipment or in sub-
stantiating a claim for loss.
The first carbon remains in the accounting depart-
ment, where it is checked to determine that it is in
agreement with the order, and that the prices, terms,
and computations are correct. After the second
carbon is returned to the accounting department
(thus showing that the goods have been shipped),
the first carbon is filed in a sales binder and used by
the bookkeeper in making his entries.
The original is mailed to the customer after the goods
are shipped.
Statements. In many lines of business, merchants send their
customers monthly statements. Such statements show :
(1) The balance owed by the customer at the beginning of the
mouth.
(2) Charges to the customer during the month, for sales.
(3) Credits to the customer during the month, for cash remit-
tances, returns and allowances, and so forth.
(4) The balance owed by the customer at the end of the month.
Statement
July 31, 19--
R. E. JOHNSON & COMPANY
2913 North Western Avenue
Chicago
J. K. Larson,
Whitney, Oklahoma
Date
Charges
Credits
Balance
June 30
39.85
July 7
47.88
87.73
9
59.85
47.88
18
40. 5C
88.38
CHAPTER 7
Additional Income and Expense Accounts —
Classified Statements
Introductory note. Starting with this chapter, it will be
assumed in all instancies that the periodical inventory method is
the one in use. Any differences in accounts and procedures
necessitated by the use of the perpetual inventory method in place
of the periodical inventory method are presented in Chapter 28.
Expense classification. The expense accounts kept by each
business depend upon the kinds of expenses which the business
incurs and the amount of detailed information desired by the
management. Frequently it is possible to distinguish between
those expenses incurred in connection with selling activities and
those incurred in the general administration of the business.
Whenever such a classification can be made, it may increase the
informative value of the profit and loss statement to so classify
the expenses. Such a classification is illustrated below.
Partial Profit and Loss Statement
Gross profit on sales $29 ,000 00
Deduct expenses:
Selling:
Store rent $5,000 00
Advertising; . 2,000 00
Delivery expense 500.00
Salesmen's salaries y.OOO 00
Miscellaneous selling expenses 750 00
Total selling expenses 77 $17 , 250 00
General :
Insurance . , $ 450 00
Taxes . . 125 00
Office salaries . 2,50000
Office expenses ... 3,200 00
Miscellaneous general expenses 400 00
Total general expenses . . . . 0,735 00
Total expenses . 23,98500
Transportation charges. Freight, express, and other transpor-
tation costs applicable to goods purchased are part of the cost of
obtaining the goods; therefore, they are added to the purchases
in the statement of profit and loss, as shown in the illustration
on the following page.
85
86 ADDITIONAL INCOME AND EXPENSE ACCOUNTS [Ch. 7
Partial Profit and Loss Statement
Sales .. $60,500.00
Deduct cost of goods sold:
Inventory, June 30, 19— $1 15,700 00
Purchases . . $50,100 00
Freight in . 525 00 50,625 00
Cost of goods available for sale . $166,325 00
Deduct inventory, July 31, 19— . 117,320 00
Cost of goods sold . 49,005 00
Gross profit on sales $1 1 ,495.00
Freight, express, and other expenses incurred in delivering
goods to customers should be shown in the profit and loss state-
ment under the Selling Expenses caption.
Freight terms. Freight terms are expressed thus :
F. o. b. destination. This means free on board cars at destina-
tion. In other words, the seller bears the freight charges.
F. o. b. shipping point. This means that the seller bears the
cost of putting the merchandise on board the cars, but the
purchaser pays the freight charges.
Returned sales and allowances. Customers, after receiving
merchandise sold to them, may:
(1) Return the goods because they are not of the kind or
quality ordered. When the returned goods are received,
the selling company should make entries as follows:
// the customer has paid for the goods, and cash is
returned to him:
Returned sales and allowanc.es 500 00
Cash 500 00
// the customer is given credit for the returned goods:
Returned sales and allowances. 500 00
Customer's account . . 500 00
(2) Request and receive an allowance on the price. If an
allowance is granted, the seller should make entries as
follows :
// cash is sent to the customer for the amount of the
allowance:
Returned sales and allowances 40.00
Cash . 40 00
// the customer is given credit for the allowance:
Returned sales and allowances 40.00
Customer's account 40.00
Ch. 7] CLASSIFIED STATEMENTS 87
The notice sent to the customer that his account has been
credited for a return or an allowance may be in the form of a letter,
or a credit memorandum may be issued to him. A form for a
credit memorandum is illustrated below :
R. E. JOHNSON & COMPANY
2913 North Western Avenue
Chicago
Credit Memo No.
Date
We credit your account as follows:
Reason for Credit
Amount
R. E. Johnson & Company
Per
Credit Memorandum
Credit memorandums should be made in duplicate. The orig-
inal is usually signed by an officer or an employee of the company
and is sent to the customer. The carbon copy, which should be
initialed by the person who signed the original (as evidence that
the credit was properly authorized), should be filed in a credit
memo binder to give the bookkeeper the information he will need
in recording the allowance. The initialed copies of the credit
memorandums also serve as evidence of the propriety of the entries
crediting the customers' accounts and debiting Returned Sales and
Allowances.
The debit balance in the Returned Sales and Allowances
account should be shown in the profit and loss statement as a
deduction from the gross sales, as illustrated in the following partial
profit and loss statement:
Partial Statement of Profit and Loss
Gross sales $5,00000
Deduct returned sales and allowances 350 00
Net sales $1,650.00
88 ADDITIONAL INCOME AND EXPENSE ACCOUNTS [Ch. 7
Returned purchases and allowances. Goods purchased may
be found unsatisfactory and may be returned. Or the goods may
be kept if the concern from which they were purchased grants an
allowance from the purchase price. Entries for purchase returns
or allowances are illustrated below:
Davis and Company. . 375 00
Returned purchases and allowances . ... 375 00
To charge1 Davis and Company for goods returned.
or,
Cash 50 00
Returned purchases and allowances 50 00
To record return of goods to Oshorne Corporation and
cash received therefor.
The credit balance of the Returned Purchases and Allowances
account should be deducted in the profit and loss statement from
the debit balance of the Purchases account, as illustrated below:
Cost of goods sold:
Inventory, August 31, 19 — . $ <i,!)00 00
Add net cost of purchases:
Purchases $3,215 00
Deduct returned purchases and allowances 122 00
Net purchases V. $3,093 00
Add freight in .. . .. 275 00 3,308 00
Cost of goods available for sale. . . $10,208 00
Trade discounts. Trade discounts are deductions from the
list price allowed for various reasons, such as :
(a) To avoid frequent publication of catalogues; the prices can
be changed merely by changing the discount rates.
(6) To allow dealers a deduction from an advertised retail
price; this practice is followed, for instance, by pub-
lishers whose advertisements state the retail prices of
their books, dealers being allowed a discount from the
published, or list, price.
Trade discounts may be stated as a single rate or as a series of
rates. For instance, assume that the list price of merchandise is
$1,200 and that a trade discount of 35% is allowed; the net price is
computed as follows :
List price
Less trade discount -35% of $1,200 ..
Net price . .
Or, assume that the list price is $2,000, and that trade dis-
counts of 30% and 10% are allowed; the net price is computed on
the following page.
Ch. 7] CLASSIFIED STATEMENTS 89
List price $2,000
First discount--30% of $2,000. 600
Remainder after first discount . . $1 , 400
Second discount— 1 0 % of $ 1 ,400 140
Net price $1 260
No entries are made in the accounts for trade discounts; entries
for sales and purchases are made at the net price. For instance,
assume that Wharton and Company sold goods to James Benton
at a list price of $2,000, subject to trade discounts of 30% and
10%. Wharton and Company would make the following entry:
.lames Benton . 1 ,260 00
Sales 1,260 00
and Benton's entry would be:
Purchases .... 1 ,260 00
Wharton and Company ... 1 ,260 00
Cash discounts. Cash discounts are deductions allowed to cus-
tomers to induce them to pay their bills within a definite time.
Cash discount terms are stated on the invoice in the following
manner: 2/10; n/30.
Discount on sales. If we refer to the preceding illustration and
assume that Benton paid the bill within the ten-day discount
period and deducted the two per cent cash discount, Wharton and
Company's entry would be:
Cash . 1 ,234 80
Discount on sales 25.20
James Henton 1 ,260.00
To record collection of invoice of June 19, less 2%
cash discount.
Since discounts on sales reduce the amount received for sales,
they are shown in the profit and loss statement as a deduction from
sales, thus:
Partial Profit and Loss Statement
Gross sales . . . . . $23,560 00
Deduct:
Returned sales and allowances $365 00
Discount on sales 197 00 562 00
Net sales . .. . $22,9981)0
Discount on purchases. Benton' s entry would be:
Wharton and Company . . . 1 ,260 00
Discount on purchases 25.20
Cash 1,234.80
To record payment of invoice of June 19, less 2%
cash discount.
90 ADDITIONAL INCOME AND EXPENSE ACCOUNTS [Ch. 7
Because purchase discounts reduce the amount paid for mer-
chandise, they are shown in the profit and loss statement as a
deduction, thus:
Partial Profit and Loss Statement
Net sales . . . . $22,998.00
Deduct cost of goods sold:
Inventory, May 31, 1953 $ 5, -150 00
Add net cost of purchases:
Gross purchases $17,50000
Deduct:
Returned purchases and allow-
ances . $235.00
Discount on purchases . 315.00 550.00
Net purchases $10,950.00
Add freight in .... 415 00 17,305 00
Cost of goods available for sale $22,815 00
Deduct inventory, May 31, 1954 7,815.00
Cost of goods sold 15,000 00
Gross profit on sales . $7,998.00
Accounting for bad debts. At the end of 1953 (the first year
of operations), a company prepared the following statements:
THE X~Y COMPANY
Statement of Profit and Loss
For the Year Ended December 31, 1953
Sales . $100,000 00
Deduct cost of goods sold 80,000 00
Gross profit on sales $T20,000 00
Deduct expenses 12,000 00
Net income $ 8,000~QO
THE X Y COMPANY
Balance Sheet
December 31, 1953
Assets Liabilities and Owners' Equity
Cash . $6,00000 Accounts payable $5,00000
Accounts receivable . 13,000.00 Owners' equity:
Inventory 19,000.00 Capital ^ $25 000 Q()
Earned sur-
plus . . . 8,000 00 33,000 00
$38,000.00 $38/000 00
Both the statement of profit and loss and the balance sheet are
incorrect because no consideration has been given to the probable
loss from bad debts.
The balance sheet shows that there are $13,000 of accounts
receivable on the books. But it is a rare thing for merchants to
collect all their accounts receivable; some losses are almost certain
to occur. Therefore, if the balance sheet is to present fairly the
financial position of the company, it should show the net amount
Ch. 7] CLASSIFIED STATEMENTS 91
which probably will be collected from the accounts receivable; this
will be less than $13,000.
Moreover, the statement of profit and loss for each period
should include all losses and expenses applicable to the period.
Bad debt losses should therefore be deducted in the statement of
profit and loss for the period in which the losses are incurred. In
what period are they incurred? Bad debt losses result from selling
merchandise to customers who do not pay their accounts; such
losses are therefore incurred in the period in which the sales are
made. If goods were sold in 1953 to customers whose accounts
were found in 1954 to be worthless, the loss was incurred in 1953.
The loss was not incurred in 1954; it was merely discovered in
that year.
Thus it is evident that both the balance sheet and the state-
ment of profit and loss will be incorrect unless recognition is given
to probable losses on accounts receivable.
If it is estimated that only $12,000 will be collected from the
receivables totaling $13,000, the bad debt losses are estimated at
$1,000, and the following journal entry should be made at the end
of 1953:
Bad debts 1 ,000 00
Reserve for bad debts . . 1 ,000.00
To provide for the estimated losses on uncollectible
accounts.
The Bad Debts account, which was debited in the foregoing
journal entry, is an expense account; in a statement in which the
expenses arc classified, bad debts may be shown in the general
expense section, because passing on credits is usually an adminis-
trative function rather than a function of the sales force. The
Bad Debts account, like other expense accounts, should be closed
to Profit and Loss.
Nature of bad debt reserve. The estimated loss from bad
debts cannot be credited to accounts receivable because, at the
time the estimate is made, the particular customers' accounts
which will finally prove worthless are unknown. Since we cannot
credit any particular customers' accounts, we credit the reserve,
which thus stands as a sort of blanket deduction from all of the
accounts receivable. In other words, the total of the debit bal-
ances in the customers' accounts minus the credit balance in the
Reserve for Bad Debts represents the estimated realizable value
of the accounts receivable asset. Therefore, in the balance
sheet, the credit balance in the Reserve for Bad Debts should be
deducted from the total of the debit balances in the customers5
accounts, as illustrated on page 92.
92 ADDITIONAL INCOME AND EXPENSE ACCOUNTS [Ch. 7
THE X Y COMPANY
Balance Sheet
December 31, 1953
Assets
Cash $ 6,000 00
Accounts receivable $13,00000
Deduct reserve for bad debts 1,000 00 12,000 00
inventory . 19,000 00
$37,000.00
Liabilities and Owners' Equity
Liabilities:
Accounts payable $ 5 , 000 . 00
Owners' equity:
Capital stock $25,000 00
Earned surplus ' 7,000 00 32,000 00
$37,000 00
The Reserve for Bad Debts is called a valuation account, or
valuation reserve. Valuation reserves are sometimes called contra
accounts or offset accounts. The nature of the reserve might be
more clearly understood if some title such as Estimated Deduction
for Bad Debts were used. The word Reserve, as used in account-
ing terminology, carries the same meaning.
Writing off bad accounts. * After the adjusting journal entry
shown on page 91 is made, the ledger contains the following
balances:
Accounts receivable (total) $13, 000 . 00
Reserve for bad debts . .. . $1,000.00
Let us now assume that an account with P. K. Lane, with a
balance of $75, is determined to be uncollectible; it should be
written off by the following journal entry:
Reserve for bad debts 75 00
P. K. Lane 75 00
To write off the uncollectible account.
It should be noted that the loss is charged to the reserve and
not to the Bad Debts (expense) account. If we debited the Bad
Debts account with estimated losses when the reserve is set up and
later with ascertained losses, a double charge to expense would
result.
After Lane's account is written off, the ledger contains the fol-
lowing balances :
Accounts receivable (total) $12,925 00
Reserve for bad debts $925 00
Methods of estimating bad debt provisions. The amount to
be debited to Bad Debts and credited to the Reserve for Bad Debts
at the end of a period is frequently computed as a percentage of the
Ch. 7] CLASSIFIED STATEMENTS 93
net sales for the period. For example, assume that the ledger con-
tains the following balances on December 31 :
Accounts receivable (total) $20,000 00
Reserve for bad debts $ 31500
Sales . 215,000 00
Returned sales and allowances 1 , 500 00
Assume, further, that experience shows that the reserve should be
credited with a provision for bad debts equal to £ of 1% of the
sales for the year less returns and allowances. The provision is
computed as follows:
Sales $215,000
Deduct returned sales and allowances 1 , 500
Sales less returns and allowances . $213,500
Reserve provision - \ of 1 % of $213,500 = $1,067.50
This amount is debited to Bad Debts and credited to the
reserve.
The total reserve is now $315.00 + $1,067.50, or $1,382.50, and
the accounts receivable will be shown in the balance sheet as
follows :
Accounts receivable $20,000 00
Less reserve for bad debts . 1,382 50 $18,61750
The amount to be added to the reserve is sometimes computed
by giving consideration to the probable collectibility of each cus-
tomer's account, and thereby estimating the total probable reserve
requirement. The Bad Debts account is then debited and the
reserve is credited with an amount sufficient to increase the reserve
to the required balance. For example, suppose that the manage-
ment reviewed the accounts receivable totaling $20,000 (see the
preceding illustration) and decided that a $1,500 reserve might be
required. The provision to be made at the end of the year would
be computed as follows:
Total reserve required . . . $1,500
Present balance in the reserve 315
Amount to be debited to Bad Debts and credited to the reserve $1 , 185
The accounts receivable would appear in the balance sheet as
follows :
Accounts receivable . . $20,00000
Less reserve for bad debts ... ... 1 ,500.00 $18,500.00
Payroll and Sales Taxes
Payroll taxes and employees' income taxes withheld. The
subject of payroll taxes is presented in considerable detail in
94 ADDITIONAL INCOME AND EXPENSE ACCOUNTS [Ch. 7
Appendix 1. The subject is introduced here in an abbreviated
form; the objective is to present the basic debit-credit procedures
for recording such taxes.
Old Age Benefits Taxes:
If covered by social security, employees are taxed* at li%
of the first $3,600 of their annual wages or salaries. The
taxes levied on employees are withheld by the employers.
The employers' tax is equal to the amount of tax withheld
from the employees' pay.
The taxes assessed against the employer and the amount the
employer h$s withheld must be remitted monthly or
quarterly, depending on the amount.
Unemployment Insurance Taxes:
Taxes are levied against employers (but not against employees)
under the Federal Unemployment Tax Act to obtain funds required
to meet the provisions of the Social Security Act relative to unem-
ployment insurance, sometimes called unemployment compensation.
The federal unemployment insurance tax rate is 3%; wages in
excess of $3,000 paid to any one individual during any one calendar
year are not subject to the tax. Although the tax rate is 3%, the
employer is entitled to a credit for taxes paid to the states and
territories under their unemployment compensation laws. This
credit cannot be more than 90% of the tax assessed by the federal
government at the 3% rate. Because of this provision in the
federal law, the states have generally established a 2.7 % unemploy-
ment compensation tax rate. Since taxable wages are generally
(although subject to some minor exceptions) computed in the same
manner for both federal and state taxes, the tax rates are usually
considered to be as follows:
Federal tax — Payable after close of year . 3 %
State tax — Payable after close of quarter 2^7
Total . .. 375%
Income taxes withheld:
As a general rule, employers are required to withhold federal
income taxes from the wages and salaries of employees.
The amount withheld from each employee depends on the
amount earned, the applicable income tax rates, and the
number of the exemptions of the employee.
The amounts withheld must be remitted either monthly or
quarterly, depending on the amount.
* At the date of this writing.
Ch. 7] CLASSIFIED STATEMENTS 95
The entries in connection with income and payroll taxes are
presented below.
Entries at payroll date:
Wages expense 400.00
Salaries expense . . . 600 00
Federal O. A. B. taxes withheld 15 00
Federal income taxes withheld 120 00
Wages and salaries payable . . 865 00
To record wages and salaries and withholding taxes
thereon.
Wages and salaries payable . . 865 00
Cash 865 00
To record payment of wages and salaries.
Payroll taxes . 45 00
Federal O. A. B. taxes payable . . 15 00
Federal unemployment taxes payable . 3 00
State unemployment taxes payable . . 27 00
To record liability for payroll taxes.
Entries when taxes arc paid:
Federal income taxes withheld 120 00
Cash 120.00
To record payment of income taxes withheld from
employees' pay.
Federal O. A. B. taxes withheld 15 00
Federal O. A. B. taxes payable 15 00
Cash 30 00
To record payment of O. A. B taxes withheld from
employees' pay and our O. A. B. liability
Federal unemployment taxes payable 3 00
Cash 3 00
To record payment of federal unemployment tax.
State unemployment taxes payable . . 27 00
Cash . 27.00
To record payment of state unemployment tax.
Statement presentation. The Moving accounts are liability
accounts and their balances are shown in the balance sheet:
Federal Income Taxes Withheld, Federal O. A. B. Taxes Withheld,
Federal O. A. B. Taxes Payable, Federal Unemployment Taxes
Payable, State Unemployment Taxes Payable.
The tax expense is presented in the profit and loss statement,
either classified as a general expense or apportioned among the
expense classifications according to the payroll apportionment.
In other words, the payroll tax on a salesman's salary may be
classified as a selling expense and the payroll tax on a bookkeeper's
salary may be classified as a general expense.
Sales taxes. A number of taxes that are levied on the con-
sumer are collected by the business man. The business man, in
96 ADDITIONAL INCOME AND EXPENSE ACCOUNTS [Ch. 7
turn, remits such collections to the unit of government levying the
tax. Such taxes include sales taxes, luxury taxes, transportation
taxes, and gasoline taxes. The accounting for such taxes can be
illustrated by an example based on a 2% retail sales tax.
Entries for sales include credits to Liability for Sales Taxes for
the amount of the tax collected or charged to the customer.
When the tax is remitted to the government, the liability
account is debited and Cash is credited. If the tax law specifies
that the amount to be remitted is to be computed by multiplying
the sales for the period by 2%, the amount due may differ from
the amount collected from customers and credited to Liability for
Sales Taxes. Any excess due is a tax expense; if the amount due
is less than the amount collected, a miscellaneous income is realized.
Miscellaneous Matters
Income tax expense. Income taxes should be charged to an
expense account in the period in which the taxable income was
earned. As a general rule, the balance of the Income Tax Expense
account is shown as the last expense item in the profit and loss
statement in the manner illustrated on page 97.
Other income. Merchandising companies sometimes earn inci-
dental income from transactions other than sales of merchandise.
Such earnings may be shown in the profit and loss statement under
the caption Other Income, after the net income from merchandising
operations. Examples include interest income, rent income, and
dividend income on shares of stock owned by the business.
Other expense. Expenses may be incurred which cannot
properly be classified either as selling expense or as general expense.
Interest expense is an example. Such expenses are presented in
the profit and loss statement under the caption Other Expense, as
illustrated on page 97.
Illustrative statements. The accounts introduced in this chap-
ter are included in the financial statements presented on pages
97 to 99.
Exhibit letters. It will be noted that the balance sheet is called
Exhibit A, the earned surplus statement is called Exhibit B, and
the profit and loss statement is called Exhibit C.
The balance sheet shows the earned surplus at the end of the
year, and refers to Exhibit B, where further details regarding the
earned surplus can be found.
The earned surplus statement shows the earned surplus at the
beginning of the year, the net income and the dividends for the
year, and the earned surplus at the end of the year. The net
income shown in this statement carries a reference to Exhibit C,
where details of income and expense can be found.
Ch. 71 CLASSIFIED STATEMENTS 97
THE POTTER COMPANY Exhibit V
Statement of Profit and Loss
For the Year Ended December 31, 1963
Gross sales . $103 ,500 00
Deduct:
Returned hales and allowances $ 900 00
Discount on sales 1 ,800 00
Total deductions from sales 2,700 00
Net sales . $100,800 00
Deduct cost of goods sold:
Inventory, December 31, 1952 $25,000 00
Add net cost of purchases:
Purchases . . $65,00000
Deduct:
Returned purchases and
allowances $1 ,000 00
Discount on pui chases 1,200 00
Total deductions from purchases 2,200 00
N et purchases $02 , 800 00
Add freight in. 2,000 00
Total ". (54,800 00
Cost of goods available for sale $89,800 00
Deduct inventory, December 31, 1953 20,000 00
Cost of goods sold 63,800 00
Gross profit on sales $ 37,000 00
Deduct selling and general expenses:
Selling:
Store rent.. $ 6,000 00
Advertising 2,500 00
Depreciation expense- -Dclrvery equip-
ment 500 00
Other dehverv expense 2,200 00
Freight out .... 1 ,800 00
Salesmen's salaries 8,000 00
Miscellaneous selling expenses 600 00
Total selling expenses. . $21 ,600 00
General :
Bad debts . . $ 504 00
Insurance 300 00
Taxes, other than income and payroll 596 00
Payroll taxes 495 00
Office salaries 3,000 00
Office expenses 2,130 00
Total general expenses 7,025 00
Total selling and general expenses. . . 28,625 00
Net operating income $ 8,375 00
Add other income:
Rent income from land $ 1 ,200 00
Interest income . . 930 _00
Total other income $ 2, 130 00
Deduct other expense:
Interest expense 30 00
Other income less other expense 2 , 100 00
Net income before income taxes $ 10 ,475 00
Income taxes. 3,200 00
Net income . ... .... $ 7,275 00
98 ADDITIONAL INCOME AND EXPENSE ACCOUNTS [Ch. 7
Some accountants prefer to omit the words Add and Deduct and
such lines as "Cost of goods sold" and "Total selling expenses/'
A statement illustrating such omissions is shown below.
THE POTTER COMPANY Exhibit C
Statement of Profit and Loss
For the Year Ended December 31, 1953
Gross sales . $ JOS, 500 00
Returned sales and allowances . . $ 000 00
Discount on sales 1,800,00 2,700.00
Net sales . . $100,800.00
Cost of goods sold:
Inventory, December 31, 1952 $25,000 00
Purchases . . t $65 , 000 00
Returned purchases and
allowances $ 1 , 000 . 00
Discount on purchases . . 1,200 00 2,200 00
Net purchases $62,800 00
Freight in .... . . 2,000 00 61,800 00
Cost of goods available for sale $89,800 00
Inventory, December 31 , 1953 26,000 00 _63 ,800 00
Gross profit on sales $37,00000
Selling expenses:
Store rent . . .. $ 6,000 00
Advertising "% . 2,500 00
Depreciation expense — Delivery equipment 500 00
Other delivery expense. . 2,200 00
Freight out . 1,800 00
Salesmen's salaries 8,000 00
Miscellaneous selling expenses. . . _JW?-22 *21 >(50° °°
General expenses:
Bad debts $ 504 00
Insurance 300 00
Taxes, other than income and payroll. . . 596 00
Payroll taxes . 495 00
Office salaries 3,00000
Office expenses . 2,130 00 7,025 00 28,625 ^K)
Net operating income $ 8,375 00
Other income:
Rent income from land $ 1 ,200.00
Interest income. . ... _ 930 00 $ 2,130 00
Other expense:
Interest expense . . . 30 00 2,100.00
Net income before income taxes $ 10,475 00
Income taxes . 3 , 200 00
Net income. . $ 7,275~00
THE POTTER COMPANY Exhibit B
Statement of Earned Surplus
For the Year Ended December 31, 1953
Earned surplus, December 31, 1952 $ 25,950.00
Add net income, per Exhibit C 7 ,275 .00
Total.... $ 33,225.00
Deduct dividends 5,000 00
Earned surplus, December 31, 1953 $^8,225.00
Ch. 7] CLASSIFIED STATEMENTS 99
In the following balance sheet, "net worth" has been used
instead of "owners' equity." The term "net worth" was in
general use for many years. Although it has been supplanted to
a very considerable extent by "owners' equity" and other similar
expressions, the term "net worth" is still frequently used, and
therefore it is desirable that accounting students be familiar with it.
THE POTTER COMPANY Exhibit A
Balance Sheet
December 31, 1953
Assets
Current assets:
Cash ......................... $18,32500
Securities . . . . . 8,000 00
Notes receivable . . ...... 3,000 00
Accounts receivable ........... $16,120 00
Less reserve for bad debts ____ 62000 15,500.00
Accrued interest receivable 100 00
Inventory 26,000 00
Prepaid rent 500 00
Unexpired insurance . . 50 00 $71,475.00
Other assets:
Land (Held for future use) $15,000 00
Securities J^WO 00 27 , 000 . 00
Fixed assets:
Delivery equipment ...... $ 3,000 00
Less reserve for depreciation . 1 ,500 00 1 ,500 00
$99,975 00
Liabilities and Net Worth
Current liabilities:
Accounts payable ..... $6,19000
Notes payable ..... 1 ,000 00
Accrued salaries ..... 400 00
Accrued income taxes ...... 3,200 00
Liability for sales taxes ......... 600 00
Federal income taxes withheld ... 180 00
Federal O.A.B. taxes withheld 45 00
Federal O.A.B. taxes payable ........ 45 00
Federal unemployment taxes payable 9 00
State unemployment taxes payable 81 00 $11 ,750 00
Ixmg-term liability :
Liability for pensions . ............... 15,000.00
Net worth:
Capital stock . . . $45,000 00
Earned surplus, per Exhibit B ...... 28,225.00 73,225.00
&99» 975 .00
Balance sheet classifications. The balance sheet illustrated
above is called a classified balance sheet. The classifications used
in a balance sheet depend upon the nature of the business and the
types of balance sheet accounts appearing in the ledger. The
principal balance sheet categories are stated on the next page.
100 ADDITIONAL INCOME AND EXPENSE ACCOUNTS [Ch. 7
Assets :
Current assets: Cash and other assets, such as temporary invest-
ments in securities, accounts receivable, inventory, and pre-
paid expense, that presumably will be converted into cash
or used during a normal operating cycle. Such items are
held to be indicative of short-run debt-paying ability.
An operating cycle can be described as follows: business
operations consist of a round of conversions — cash to inven-
tories and prepaid expenses, to receivables, to cash; the
average time required to complete this round is an operating
cycle. The time period of an operating cycle varies, depend-
ing on the nature of the business.
The current assets are customarily listed in the following
order: cash, securities, receivables, accrued receivables,
inventories, and prepaid expenses. Prepaid expenses are
regarded as current assets because, from the standpoint of
ability to pay current debts, a company with, say, $950 of
cash and $50 of unexpired insurance is in essentially the same
position as a company with $1,000 of cash but faced with the
necessity of immediately ^spending $50 for insurance.
Other assets: Any assets, such as land held for future use or
permanent investments in securities, which do not fall into
the other classifications.
Fixed assets: Property of a relatively permanent nature, such
as land, buildings, furniture and fixtures, office equipment,
and delivery equipment, used in the operations of the busi-
ness and not intended for sale. Accounts listed under the
fixed assets caption are customarily listed according to their
use-life, assets with the longest use-life being listed first,
assets with the shortest use-life being listed last.
Liabilities and net worth:
Current liabilities: The debts or obligations that will, according
to reasonable expectations, be settled by the use of assets
properly classifiable as current assets. Items of income col-
lected in advance, which are to be earned by the future
performance of services or delivery of merchandise, are
properly classifiable as current liabilities, because the earn-
ing of such income normally requires the utilization of cur-
rent assets.
The relative amounts of current assets and current liabili-
ties are indicative of the ability of a business to pay its
currently maturing obligations.
Ch. 7] CLASSIFIED STATEMENTS 101
Long-term liabilities: Bonds, mortgages, and other debts not due
in the near future.
Net worth: The capital stock and earned surplus.
Depreciation for fractional periods. If fixed assets are acquired
(hiring an accounting period, depreciation must be computed and
recorded for a fractional period. Since depreciation is an estimate,
it seems unnecessary to compute fractional-period depreciation in
terms of days. Depreciation is not that precise. As a general
rule, fractional-period depreciation is computed in terms of months
or fractions of months. This is illustrated below, where it is
assumed that the company's accounting period ends on Decem-
ber 31.
Annual Months
Charge Asset Frac- Depre-
Depre- for in UbC tion elation
nation Depre- First of Charge for
Asset Date Acquired Cost Rate nation _Year Year First Year
Deliveiy equipment MurriTsT $4.000 20% $800 9"" 9/12 $600
machine September 17 (treated 1,200 10% 120 3-1/2 7/24 35
ah Sept. 15 for fiac- (7half-
tumal-peuod pur- months)
poses)
CHAPTER 8
Individual Proprietorships. Partnerships
This chapter deals with accounts and procedures peculiar to a
business owned by an individual proprietor and with some ele-
mentary matters applicable to partnership accounting. More
advanced material relative to partnerships appears in Chapter 16.
The asset, liability, income, and expense accounts of an indi-
vidual proprietorship or a partnership may be the same as those
of a corporation in the same line of business. The books of an
individual proprietorship or a partnership necessarily differ from
those of a corporation only in the net worth accounts.
Individual Proprietorships
Capital and drawing accounts. In place of the Capital Stock,
Earned Surplus, and Dividends accounts kept by a corporation, the
books of an individual proprietor contain the following accounts:
Capital account:
This account is credited with the proprietor's original
investment and with any additional investments; by
transfer from Profit and Loss, it is credited with the net
income or debited with the net loss for the period.
Drawing account :
Although all changes in a proprietor's net worth could be,
and sometimes are, recorded in his capital account, it is
a rather general custom to also have another account,
variously called the drawing account, the personal
account, or the current account.
When such an account is kept, it is debited with:
(a) Withdrawals of cash or other business assets.
When a proprietor takes merchandise for his own
use, it is customary to charge him for it at cost.
Debiting the proprietor at sales price and cred-
iting the Sales account would be illogical; a with-
drawal of merchandise is not a sale. The debit
to the proprietor's drawing account is offset by
a credit to Inventory (if the perpetual inventory
method of accounting is used) or to Purchases (if
the periodical inventory method is used).
102
Ch. 8]
INDIVIDAUL PROPRIETORSHIPS
103
(b) Disbursements of business cash for the benefit of
the proprietor — as, for instance, a purchase made
for him.
Other entries in the drawing account are described under
the caption "Closing the books."
The following accounts are illustrative:
James White, Capital
19—
1!
i1
Jan.
1
Investment
if 7,500
00
Fob.
15
Additional invest-
ji
ment
2 1,500
1
00
James White, Drawings
19—
Mar
25
3
900
00
July
8
7
400
00
Sept
5
9
750
00
Dec.
17
12
GOO
00
Closing the books. The procedure of closing the income and
expense accounts to Profit and Loss is exactly the same in an indi-
vidual proprietorship as in a corporation. Assume that the net
income for the year is $4,500; the Profit and Loss account is closed
to the proprietor's capital account by the following entry:
Profit and loss
James White, eapital
To close the Profit and Loss account and transfer
the net income for the year to the proprietor's
capital account.
4,500 00
4,500 00
The closing procedure is completed by transferring the balance
of the drawing account to the capital account by the following
entry :
James White, capital . .
James White, drawings
To close.
2,650 00
2,650 00
Proprietor's accounts after closing the books. After the books
are closed, the capital account and the drawing account appear as
follows:
James White, Capital
19 -
Dec.
31
Drawings
19—
13
2,650
00
Jan
1
Investment
1
7,500
00
Feb
15
Additional invest-
ment
2
1 ,500
00
Dee.
31
Net income
12
4,500
00
104
INDIVIDUAL PROPRIETORSHIPS
James White, Drawings
[Ch. 8
19—
19—
Mar.
25
3
900
00
Dec.
31
To capital
13
2,650
00
July
8
7
400
00
Sept.
5
9
750
00
Dec.
17
12
600
00
2,650
00
2,650
00
Working papers. Instead of a pair of Earned Surplus columns,
the working papers of an individual proprietorship contain a pair
of Capital columns.
The working papers on page 105 do not contain Adjustment
columns; it is assumed that no adjustments are required.
Statements. The profit and loss statement of an individual
proprietorship does not necessarily differ from that of a corpora-
tion in the same line of business.
JAMES WHITE
Statement of Profit and Loss
For the Year Ended December 31, 19 —
Sales . . .
Loss returned sales and allowances
Net sales "*
Less cost of goods sold:
Purchases $35 ,000 00
Less returned purchases and allowances 500 00
Net purchases .. . $34,500 00
Less inventory, December 31, 19 — 4,000 00
Cost of goods sold
Gross profit on sales
Less expenses
Net income
Exhibit C1
$48,000 00
i ,000 00
$47,000~00
30,500 00
$16,500 00
12,000 00
$ 4,500 00
No income tax is shown because the proprietor's total tax is
usually affected by other matters not related to the business.
Instead of the earned surplus statement prepared for a corpora-
tion, a statement of the proprietor's capital is prepared.
JAMES WHITE Exhibit B
Statement of Proprietor's Capital
For the Year Ended December 31, 19 —
Investment, January I, 19— $ 7,500 00
Add:
Additional investment $1 ,500 00
Net income for the year— Exhibit C 4,500 00 6,000 00
Total $13,500 00
Deduct withdrawals 2,650 00
Balance, December 31, 19 — 810,850.00
The investment at the beginning of the year and the additional invest-
ment during the year were determined from the capital account.
Ch. 8]
INDIVIDUAL PROPRIETORSHIPS
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106 PARTNERSHIPS [Ch. 8
The balance sheets of an individual proprietorship and a cor-
poration do not necessarily differ except in the net worth section.
The balance sheet of an individual proprietorship shows the pro-
prietor's capital in one amount, whereas the balance sheet of a
corporation shows the capital stock and surplus.
JAMES WHITE Exhibit A
Balance Sheet
December 81, 19 —
Assets Libalities and Net Worth
Current assets: Current liabilities:
Cash . $3,85000 Accounts payable $6,00000
Accounts receivable 9,000.00 Notes payable 2,000 00
N otes receivable " 2 , 000 00 Total current liabilities $ 8 , 000 . 00
Merchandise inventory. 4,000.00
Net worth:
James White, capital —
Exhibit B 10,850 00
$18,850 00 $18,850 00
Partnerships
Nature of a partnership. "A partnership," as defined by the
Uniform Partnership Act, "is ati association of two or more persons
to carry on, as co-owners, a business for profit/'
The partnership and the corporation are the two most common
forms of organization by which two or more persons can join in a
business enterprise. The partnership form is usually employed
in comparatively small businesses requiring no more capital than
can be contributed by a few partners; or in professional practices,
such as law, medicine, and accounting, in which the relations of
the firm to its clientele should involve a personal responsibility.
Some of the significant characteristics of the partnership form
of business organization are briefly discussed below. For a com-
prehensive treatment of these matters, a text on the law of partner-
ships should be consulted.
No separate legal entity. Generally, a partnership has no legal
status as an entity. The assets are owned, and the liabilities are
owed, by the partners collectively. However, this common-law
concept of the partnership has been somewhat modified by the
Uniform Partnership Act, which, for instance, enables a partner-
ship to hold real and personal property in its own name. The
Uniform Partnership Act has not been adopted by all of the states.
Mutual agency. Each partner is an agent for all of the other
partners in matters coming within the scope of partnership activi-
ties. Therefore, outsiders have a right to assume that the partner-
ship is bound by the acts of any partner relative to the affairs of
the partnership.
Ch. 8] PARTNERSHIPS 107
Unlimited liability. Each partner is individually liable for all
of the debts of a partnership incurred during his membership in
the firm; he may assume a liability for debts incurred before his
admission to the partnership; and, unless proper notice of with-
drawal is given to the public, he may be liable for partnership debts
incurred after his retirement. If a partner pays partnership debts
from his personal assets, he is entitled to reimbursement.
Limited partnerships are permissible in some states. A limited
partner has no personal liability to creditors, but he must maintain
his investment at the amount contributed at the time of organiza-
tion. There must be at least one general partner who is liable to
creditors for debts which cannot be paid from firm assets.
Limited right to dispose of interest. A partner has a legal right
to assign his partnership interest to another person, although he
may be subject to a suit for damages for any loss incurred by his
partners as a consequence of such an assignment. But he cannot
compel the other partners to accept the assignee as a partner.
Division of profits. Partnership profits may be divided among
the partners in any manner to which they agree. Consequently,
the division of profits is more flexible in a partnership than in a
corporation.
Withdrawal of assets. Because the stockholders of a corpora-
tion generally have no personal liability for corporate debts, the
law places limitations 011 the amounts of dividend payments or
other asset distributions which may be made to corporate stock-
holders. There are no similar legal restrictions on partners'
withdrawals of cash or other assets; the individual liability of the
partners for the payment of partnership debts makes such creditor
protection unnecessary. However, the partners may make agree-
ments among themselves placing limitations on the amounts which
they may withdraw.
Effect of part7ier9s death. The death of a partner automatically
dissolves the partnership of which he was a member. His heirs
have a right to be paid the amount of his partnership interest, but
they have no right (except by consent of the other partner or
partners) to succeed him as a member of the firm.
The partnership contract. The partnership relation is created
by a contract. The contract may be oral, but it is much better
to have it in writing, because partners have been known to forget
the features of oral agreements which prove ultimately to be tc
their disadvantage. A partnership contract is sometimes called
the partnership agreement, and sometimes the articles of partnership
Among the more important things to be covered by the contrad
are those mentioned on the following page.
108 PARTNERSHIPS [Ch. 8
(1) The names of the partners and the name of the partner-
ship.
(2) The date when the contract becomes effective.
(3) The nature of the business.
(4) The place where operations are to be conducted.
(5) The amount of capital to be contributed by each partner,
the assets to be invested and the valuations to be placed
on them.
(6) The rights and duties of the partners.
(7) The dates when the books are to be closed and the profits
ascertained and divided.
(8) The portion of the profits to be allowed to each partner.
(9) The drawings to be allowed each partner and the penalties,
if any, to be imposed because of excess withdrawals.
(10) The length of time the partnership is to continue.
(11) Conditions under which a partner may withdraw or may
be compelled to withdraw ; the bases for the determina-
tion of his equity in the event of withdrawal; and agree-
ments regarding the payment of his equity in full or in
installments.
(12) Procedures in the event of the death of a partner.
(13) Provision for arbitration in the event of disputes.
(14) The rights and duties of the partners in the event of
dissolution.
Capital and drawing accounts. The capital and drawing
accounts of a partnership are similar to those of an individual pro-
prietorship. They are discussed below.
Capital account:
A capital account is kept with each partner and is credited
with the amount of his original investment and the
amounts of any additional investments. Other entries
which may be made in the capital accounts are described
under the caption "Closing the books."
Drawing account:
All changes in a partner's share of the net worth may be
recorded in his capital account, but it is customary to
use also a drawing (sometimes called a personal or
current) account.
When such an account is kept, it may be debited with:
(a) Withdrawals of cash or other partnership assets.
As a general rule, all such withdrawals are charged
to the drawing account. However, partners
sometimes agree that each partner may draw a
Ch.8]
PARTNERSHIPS
109
stipulated amount each month as his share of
the estimated earnings, and that any with-
drawals in excess of this amount shall be
regarded as withdrawals of investments and
shall be debited to his capital account.
What was said about withdrawals of merchandise
by a single proprietor applies equally here.
(6) Disbursements of business cash for the benefit of a
partner.
Other entries which may be made in the drawing accounts
are described under the caption " Closing the books."
The following accounts are illustrative:
D. £. Snyder, Capital
19—
Jan.
1
Investment
1
9,000
00
June
1
Additional invest-
ment
10
1,000
00
D. E. Snyder, Drawings
19—
Apr.
Oct.
5
14
200
800
00
00
J. O. Long, Capital
19—
Jan
1
Investment
1
15,000
00
July
1
Additional invest-
ment
11
4,000
00
J. O. Long, Drawings
4
15
500
700
d
19—
Mar.
Nov.
Loan accounts. A partnership may he in need of funds, which
a partner is able to supply but which he is willing to furnish only
temporarily. In such instances, the credit to the partner may be
made in a loan account. Such loans should not be shown in the
balance sheet as part of the net worth ; they should be shown among
the liabilities, but clearly distinguished from liabilities to outsiders.
On the other hand, a partner may wish to make a temporary
withdrawal of funds in the form of a loan. A loan receivable
account will then appear on the partnership books. In the balance
sheet, such a loan should be shown separately from receivables
from outsiders.
110 PARTNERSHIPS [Ch. 8
Opening the books. If all capital contributions are in the form
of cash, no problems arise; the Cash account is debited and eacli
partner's capital account is credited.
If non-cash assets are invested, it is extremely important that
they be recorded at their fair values at the date of the investment.
Assume, for instance, that a partner invests land and a building
which he is carrying on his books at $20,000, which was the cost to
him less depreciation. At the date when he invests this property
in the partnership, it is worth $25,000. If the property were
recorded on the partnership books at $20,000 and later sold for
$25,000, all of the partners would share in the gain ; this would not
be fair to the partner who invested the property and who should
have received a $25,000 credit for it.
If any liabilities of a partner are assumed by the partner-
ship, they should, of course, be credited to liability accounts, and
the partner's capital account should be credited with the net
investment.
Goodwill. If a partner's investment consists of a going busi-
ness, it may be equitable to give the partner a capital credit for the
goodwill of the business. A business may have goodwill if it has
exceptionally good earnings. The valuation of the goodwill is a
matter of agreement among the partners, and should be based on
the probable future amount of profits attributable to the business
brought in by the partner. The amount, if any, agreed upon
should be debited to a Goodwill account, with an offsetting credit
to the partner's capital account.
The profit and loss ratio. The ratio in which partners divide
their profits or losses is called the profit and loss ratio. In the
illustration in this chapter, it is assumed that the partners have
agreed to divide profits and losses equally. Other methods of
dividing partnership profits and losses are discussed in Chapter 16.
If partners make no agreement regarding the division of profits
and losses, the law assumes an agreement to divide them equally.
If partners make an agreement regarding the division of profits,
without any mention of losses, the agreed method for the division
of profits applies also to the division of losses.
Closing the books. Income and expense accounts are closed
to the Profit and Loss account in the same manner as those of an
individual proprietorship or a corporation. The remaining closing
entries depend upon whether the partners' capitals are to be main-
tained at fixed amounts.
Capitals maintained at fixed amounts. Partners sometimes
agree that their capitals shall be maintained at fixed amounts, to
be shown by the balances of their capital accounts. If there is
Ch. 8] PARTNERSHIPS 111
such an agreement, the Profit and Loss account should be closed
by transfer of the net income or loss to the partners' drawing
accounts. The total or net amount of the balances in the capital
and drawing accounts of each partner is the amount to be included
in the net worth section of the balance sheet.
No agreement for fixed capitals. If there is no agreement with
respect to fixed capitals, the Profit and Loss account is closed to
the partners' capital accounts, and each partner's drawing account
is closed to his capital account. This is the more customary
procedure and it is illustrated below. It is assumed that the net
income for the year was $8,000.
Profit and loss . ... 8,000 00
D. K Snyder, capital 4,000 00
J. O. Long, capital 4,000 00
To divide the net income for the year equally
D. K. Snyder, capital I ,000 00
D K. Snyder, drawings 1,000 00
To close the drawing account
J. O. Long, capital 1 ,200 00
J. O. Long, drawings 1 ,200.00
To close the drawing account
Working papers. The working papers of a partnership con-
tain a pair of columns for each partner, as shown in the illustra-
tion on page 112.
Profit and loss statement. The profit and loss statement of a
partnership will be similar to that of an individual proprietorship
or a corporation in the same line of business.
SNYDER AND LONG Exhibit C
Statement of Profit and Loss
For the Year Ended December 31, 19 —
Sales $W),000 00
Less discount on sales 200 00
Net sales . $8«) , 800.00
Less eost of goods sold:
Purchases $60,000 00
Less diseourit on purchases 700 00
Net purchases $59,300 00
Less inventory at the end of the year . 5,000.00
Cost of goods sold 54,^00 00
Gross profit on sales *35^k)(fO()
Less expenses:
Selling expenses $13 ,000 00
General expenses 14,500.00 27,500 00
Net income | 8,000.00
This statement does not show any deduction for income taxes.
A partnership, as such, does not pay any federal income taxes, but
it is required to file an information return showing the results of its
112
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Ch. 8] PARTNERSHIPS 113
operations and each partner's share of the net income or net loss.
Each partner is subject to income tax on his share of the partner-
ship net income, regardless of the portion thereof which he has
withdrawn.
Statement of partners' capitals. In order to prepare the fol-
lowing statement, it was necessary to refer to the capital accounts
to determine the investments at the4 beginning of the year and the
additional investments during the year.
SNYDER AND LONG Exhibit B
Statement of Partners' Capitals
For the Year Ended December 31, 19 —
D. E. Snyder J. O. Long Total
Investments, January 1, 19— ~$ 9,000 00 $15,000 00 $24,000.00
Add:
Additional investments .. ... 1,00000 4 , 000 00 5,000.00
Net income for the year— Exhibit C 4,000 00 4,000 00 8,000 00
Totals.. .. ... .$14,00000 $23,000 00 $37,000 00
Deduct withdrawals .. . . 1 ,000 00 1,200 00 2,200 00
Balances, December 31, 19— . . $13,000.00 $21,800 00 $34,800.00
Balance sheet. The balance sheet of a partnership usually
shows the capital of each partner, with a reference to the state-
ment of partners' capitals, where details can be found.
SNYDER AND LONG Exhibit A
Balance Sheet
December 31, 19 —
Assets
Current assets:
Cash . $14,800.00
Accounts receivable 18,000.00
Merchandise inventory . 5,000.00
$37,800 00
Liabilities and Net Worth ""^ "
Current liabilities:
Accounts payable . . $3,00000
Net worth— Exhibit B:
D. E. Snyder, capital . . . $13,00000
J. O. Long, capital 21,800 00 34,800 00
$37,800 00
CHAPTER 9
Promissory Notes— Bills of Exchange
Notes
Definition. The following definition is quoted from the Uni-
form Negotiable Instruments Act:
A negotiable promissory note within the meaning of this act is
an unconditional promise in writing made by one person to another,
signed by the maker, engaging to pay on demand or at a fixed or
determinable future time a sum certain in money to order or bearer.
$100.00 Chicago. Illinois. July 25, 19--
One month afterdate
, * „ promise to pay to
th* order of * • *. Hamilton
— — Dn^ TTiinri v*£*ri —no /"I OO— — — — .. — -. — — — -
Dollars
Payable at First National Bank
of Chicago
Value received, with interest at &*
-L9- Ctfmaifiw
No 17 ni1p August 25,
The original parties to a note are :
The payee — In the above illustration,
F. K. Hamilton.
The maker— -In the above illustration,
C. H. Mather.
Every promissory note is a note receivable from the standpoint
of the payee (since he expects to receive money) and a note payable
from the standpoint of the maker (since he expects to pay money).
Maturity. Notes may be drawn to mature:
(1) On a date named in the note, thus: "On June 30, 19 — , I
promise to pay."
(2) On demand, thus: "On demand, I promise to pay."
(3) Upon the expiration of a stated period of time; the time
may be stated in several ways, as indicated on the follow-
ing page.
114
Ch. 91 PROMISSORY NOTES— BILLS OF EXCHANGE 115
(a) Years, thus : " One year after date, I promise to pay."
Such notes will mature in a subsequent year on the
same day of the same month as the date of issue,
except that notes issued on February 29, payable
in a year having only 28 days in February, will
mature on February 28.
(b) Months, thus: "Three months after date, I promise
to pay." Such notes will mature in a subsequent
month on the same day of the month as the date of
issue, except that: (1) notes dated on the 31st of a
month and maturing in a month having only 30
days will mature on the 30th of the month; and
(2) notes dated on the 29th, 30th, or 31st of a
month and maturing in February will mature on
the last day of February.
(c) Days, thus: "One hundred and twenty days after
date, I promise to pay." The method of deter-
mining the maturity of such notes is illustrated by
the following computation of the maturity of a
120-day note dated December 15, 1954:
Remaining days in December 16
Days in January 31
~47
Days in February . 28
"75
Days in March . . ... 31
106
Days in April . . 14 Maturity
120
Interest
Computing interest -General formula. The general formula
for computing interest may be expressed thus :
Principal X Interest Rate X Time = Interest
Interest rates, unless specifically qualified to the contrary, are per
annum rates. If a note is described as a 6% note, the interest is
at the rate of 6% per year.
If time is expressed in terms of months, interest is computed in
terms of months. For example, the interest 011 a $1,000, 6% note
for three months is computed as follows:
$1,000 X .06 X t^ = $15
If time is expressed in terms of days, the exact number of days
is used in the interest computation. However, for interest com-
putation purposes, it is commonly assumed that there are 360 days
116 PROMISSORY NOTES— BILLS OF EXCHANGE [Ch. 9
in a year. For example, the interest on a 45-day 6% note for $1,000
is computed as follows:
$1,000 X .06 X •#& = $7.50
In the determination of the number of days between two dates,
for purposes of computing interest, exclude the first day and include
the last. For instance, the time of a note dated June 17 and due
August 4 would be computed as follows :
Remaining days in June ...... 13
July .................... 31
August ....................... _4
48
Computing interest — Short methods. There are several meth-
ods of computing simple interest. Some of the shortest are
explained below. At 6% per annum,
The interest on $1.00 for 1 year is. . $ 06
The interest on 1.00 for 2 months (60 days) is 01 (i of $.06)
The interest on 1.00 for 6 days is 001 (/o of $.01)
It is evident that interest on $1.00 for sixty days can be com-
puted by moving the decimal point in the principal two places to
the left, and that interest on $1.00 for six days can be computed
by moving the decimal point in the principal three places to the
left. If this is true of $1.00, it is true of any principal, and a
general rule may be developed in the manner shown below:
Given any principal, to find the interest at 6%:
For
Thus,
Multiples and fractions. The time, stated in days, may be
separated into parts that are multiples or fractions of 6, 60, 600,
or 6,000, and the interest for partial time periods may be added.
What is the interest on $137.65 for fifteen days?
Interest for 60 days - $1.3765
« « 15 " = J of $1.3765, or $.3441
What is the interest on $137.65 for eighty-eight days?
Interest for 60 days = $1.3765
" 20 " - .4588 (J of $1.3765)
" 6 " - .13765
" " _2 " * .04588 (j of $.13765)
" " 88 " - $2.01883 or $2 02.
60 "
" " two " " " "
600
t
" " one place " " "
6,000
t
the interest is the same as the principal.
6 da
ys
interest on $1,230.00 is $ 1.23
60 '
" 1,230.00 " 12.30
600 '
" 1,230.00 " 123.00
6,000 '
" 1,230.00 " 1,230.00
Ch. 9] PROMISSORY NOTES-BILLS OF EXCHANGE
117
Interest for any number of days. When the time cannot easily
be divided into fractions or multiples of 6, 60, 600, or 6,000,
Point off throe places. (Amount is interest for six days.)
Multiply by the numbers of days. (Product is interest for six times the
stated number of days.)
Divide by 6. (Quotient is interest for the stated number of days.)
What is the interest on $137.65 at 6% for seventy-seven days?
Point off three places
Multiply by
Interest for 6 X 77 days
.13765
77
$10. 59905
Divide by 6: $10.59905 -^ 6 = $1.7665 = $1.77, interest for 77 days.
Interchanging principal and time. The principal and time may
be interchanged if this procedure will simplify the computation.
What is the interest on $1,000 for thirty-eight days?
Interchanging, what is the interest on $38.00 for 1,000 days?
Interest for 6,000 days = $38.00
Divide by 6: $38.00 -*- 6 - 6.33
Interest at other rates. When the rate is other than 6%, it is
convenient to compute the interest at 0%, and make the adjust-
ments for the difference between 6% and the actual rate.
What is the interest on $360 for thirty days at 7%?
Compute the interest at 6%:
Interest for 60 days = $3 60
Interest for 30 days = $1 80
Add one sixth of $1 80 30
Interest at 7 % $2.10
What is the interest on $3,500 for forty-five days at 5j-%?
Compute the interest at 6%:
Interest for 60 days = $35.00
Interest for 45 days « J of $35.00 $26.25
Deduct (for } of 1 %) & of $26.25 2.19
Interest at 5i % $24 06
Notes Receivable
Notes Receivable account. Although it is customary to keep a
separate account with each debtor who owes the business on open
account, notes receivable from all debtors may be recorded in one
account, thus:
Notes Receivable
19—
July
J. B. Gates 60 da.
C. L. Peters 30 da.
IT. N. Burt 30 da.
J. F. Cole 10 da.
19—
1
a 1,000
00
Aug.
1
J. F. Cole
1
d 1,000
00
1
b 1,500
00
1
c 1,000
00
1
d 1,000
00
118 PROMISSORY NOTES— BILLS OF EXCHANGE [Ch. 9
Each debit entry shows the name of the maker and the time the
note is to run. The credits are identified with the debits by names
and cross-reference letters ; thus, the credit records the collection of
the Cole note, as evidenced by the reference d.
The number of days shown in each entry is the number of days
the note runs. Since the note may bear a date earlier than that of
the entry, the maturity of the note is not necessarily the stated
number of days after the date of the entry.
Entries for note receivable transactions. Let us assume that
we receive from Peter Dunlap a note for $1,000 due in 60 days.
Illustrative entries for the receipt of the note and for its collection
or dishonor at maturity are shown below :
(A) Entries for the receipt of the note:
In studying the following illustrative entries, you will
observe that the entry to be made wben a note receivable
is received always includes a debit to the Notes Receiv-
able account ; the credit depends upon other facts about
the transaction.
You will observe also that the following illustrative debit
and credit entries for the receipt of a note are not affected
by the fact that the note bears interest or does not bear
interest. The only difference is in the explanation,
which states whether the note is interest-bearing or non-
interest-bearing.
(1) Assume that the note is received for a cash loan to
Dunlap (and that it bears 6% interest):
Notes receivable. .. . 1,00000
Cash 1 ,000 00
Received a 60-day, 6 % note from Peter Dunlap for
a loan.
(2) Assume that Dunlap is indebted to us on an account
receivable, and that we obtain the note from him to
apply on account (and that it does not bear interest) :
Notes receivable. 1 ,000 00
Peter Dunlap .. . . 1,00000
Received a 60-day note, without interest, to apply
on account.
(3) Assume that we sell merchandise to Dunlap and
receive a note immediately for the amount of the
invoice (and that the note bears 6% interest).
The transaction might be recorded in the manner
shown on the following page.
Ch. 9] PROMISSORY NOTES— BILLS OF EXCHANGE 119
Notes receivable 1 ,000.00
Sales . ... 1 ,000 00
Received a 60-day, 6 % note from Peter Dun lap for
amount of sale today.
However, it is considered better practice to make two
entries, as illustrated below, so that all the facts will
be shown in our account with Dunlap :
Peter Dunlap . . 1 ,000 00
Sales .. .... 1,000 00
Sale of merchandise.
Notes receivable 1 ,000 00
Peter Dunlap . 1,000 00
Received a 60-day, 6% note for amount of sale
today.
(B) Entries for the collection of the note:
The entries for the collection of a note are affected by the
fact that it bears interest or does not bear interest.
(1) Assume that the note mentioned in the preceding illus-
trations does not bear interest; we will collect the
face of the note, $1,000.
Cash . 1,00000
Notes receivable. . 1,00000
Collection of 60-day note from Peter Dunlap.
(2) Assume that the note bears 6% interest; we will collect
the face of the note and $10 interest.
Interest is a fee charged for loaning money or extend-
ing credit; it is income to the payee of the note,
and should be credited by him to the Interest Income
account.
Cash 1,010 00
Notes receivable . . 1 ,000 00
Interest income. 10 00
Collection of 60-day note and interest at 6 %, from
Peter Dunlap.
If an adjusting entry was made for accrued interest
during the life of the note, the amount of the accrual
should be credited to Accrued Interest Receivable
when the interest is collected, and the remainder
should be credited to Interest Income.
(C) Entries if note is dishonored:
If the maker of a note does not settle for it at maturity, the
note is said to be dishonored. Some bookkeepers make
120 PROMISSORY NOTES— BILLS OF EXCHANGE [Ch. 9
no entry whatever to show that a note receivable has
been dishonored, and continue to carry it in the Notes
Receivable account, with the hope that eventually it
will be collected.
This is not the best practice. If we hold a note receivable
and do not collect it at maturity, we should transfer the
amount from the Notes Receivable account to an
account receivable with the debtor, so that our account
with the debtor will show, for credit information pur-
poses, the fact that he has dishonored his note.
Illustrative entries to record the dishonoring of notes are shown
below :
(1) Assume that Dunlap' s note does not bear interest, and
that he dishonors it:
Peter Dunlap 1 ,000 00
Notes receivable 1 ,000 00
Non-interest-hearing note dishonored
(2) Assume that Dunlap's note bears 6% interest, and
that he dishonors it:
Peter Dunlap ... J , 010 00
Notes receivable 1 ,000 00
Interest income 10 00
Dishonor of 6 % note.
Observe that the Interest Income account is credited,
even though the interest is not collected. The
interest has been earned, and Dunlap owes us the
interest as well as the face of the note.
(D) Entries if note is partially collected:
If at the maturity of a note we make only a partial collec-
tion, we should charge the maker's account with only
the uiicollected portion of the amount due, because the
note is only partially dishonored.
(E) Entries for a renewal note:
At the maturity of a note, the maker may dishonor it and
give us a new note for the full amount; or we may
receive a partial collection in cash and a new note for
the balance.
(1) Assume that Dunlap's note does not bear interest, and
that, at maturity, he dishonors it and gives us a new
note for the amount of the dishonored note. Our
entries are as shown on the following page.
Ch. 9] PROMISSORY NOTES— BILLS OF EXCHANGE 121
Peter Dunlap 1 ,000 00
Notes receivable 1 ,000 00
Dishonor of 60-day note due today.
Notes receivable 1 ,000 00
Peter Dunlap 1 ,000 00
New 60-day note received.
(2) Assume that Dunlap's note bears interest, and that, at
maturity, we collect the interest and $700 on the
principal, and that we receive from Dunlap a new
60-day, 6% note for the balance. Our entries are:
Cash 710 00
Notes receivable 700 00
Interest income. . . 10 00
Collection of portion of $1,000 note, and the interest.
Peter Dunlap.. 300 00
Notes receivable 300 00
Dishonor of portion of 60-day note due today.
Notes receivable 300 00
Peter Dunlap . . 300 00
New 60-day, 6% note for balance of note due today.
Notes Payable
Notes Payable account. Notes payable are also recorded in
one account. Each credit entry shows the name of the payee and
the time the note is to run. The debits recording payments are
identified with the credits by writing the names of the payees and
by using cross-reference letters, in the manner illustrated in the
Notes Receivable account on page 117.
Entries for note payable transactions. Let us assume that we
give George Weaver a note for $2,500, due in 60 days. Illustra-
tive entries for the issuance and for the payment or dishonor of this
note are shown below:
(A) Entries for the issuance of the note:
The entry to record the issuance of an interest-bearing
note or a non-interest-bearing note always includes a
credit to the Notes Payable account for the face amount
of the note; the debit depends on other facts about the
transaction, as illustrated below:
(1) Assume that the note is issued to Weaver for a cash
loan (and that it bears 6% interest):
Cash . . . 2,500.00
Notes payable . . . . 2,500.00
Issued 60-day, 6% note to George Weaver for a
loan.
122 PROMISSORY NOTES— BILLS OF EXCHANGE [Ch. 9
(2) Assume that we are indebted to Weaver on an account
payable, that we give him the note to apply on
his account payable, and that the note does not bear
interest:
George Weaver . 2,500 00
Notes payable .... 2,500 00
Issued a 60-day note, without interest, on account.
(3) Assume that we purchase merchandise from Weaver
and issue a note immediately for the amount of the
invoice, and that the note bears 6% interest.
The transaction might be recorded by a single journal
entry as follows:
Purchases. 2,500 00
Notes payable . . . . 2 , 500 . 00
Issued a 60-day, 6% note to George Weaver for
amount of purchase today.
However, it is considered better practice to make two
entries, as illustrated below, so that all the facts will
be shown in our account with Weaver :
Purchases . . 2,500 00
George Weaver 2,500.00
Purchase of merchandise.
George Weaver 2,500 00
Notes payable 2,500.00
Issued a 60-day, 6 % note for purchase today.
(B) Entries for the payment of the note:
(1) Assume that the note does not bear interest; we will
pay the face of the note, $2,500.
Notes payable . . 2,500.00
Cash 2,500.00
Payment of 60-day note to George Weaver.
(2) Assume that the note bears 6% interest; we will pay
the face of the note and $25 interest.
Notes payable. . ... . . . . 2,500 00
Interest expense . 25 00
Cash . 2,525.00
Payment of 60-day note and 6 % interest to George
Weaver.
If an adjusting entry was made for accrued interest during the
life of the note, the amount of the accrual should be debited to
Accrued Interest Payable when the interest is paid, and the
remainder should be debited to Interest Expense.
Ch. 9] PROMISSORY NOTES— BILLS OF EXCHANGE 123
(C) Dishonor of a note payable:
If we hold a note receivable and it is dishonored at matu-
rity, we should charge it back to the maker's account,
so that his account will show, for credit information pur-
poses, that he has dishonored his note.
If we dishonor our note payable, we have no similar
reason for transferring the amount of the note from the
Notes Payable account to an account payable with the
payee. Therefore, we will make no entry to show that
we have dishonored the note.
If the note bears interest and we do not pay it, we should
make an entry to record the interest expense and the
liability for the interest. Thus, if our note to Weaver
bears interest and we make no payment at maturity,
we should make the following entry to record the accrued
interest :
interest expense 25 00
Accrued interest payable . . 25 00
Interest accrued at 6% for 60 days on note payable to
George Weaver, due today.
(D) Entries if note is partially paid:
If, at the maturity of our note payable, we pay a portion
thereof, our only entry will be for the amount of the
payment.
(1) Assume that the note to Weaver does not bear interest,
and that we make a partial payment of $1,200 at
maturity :
Notes pay able .. . . 1,20000
Cash. .. 1,200.00
Partial payment to George Weaver on note due
today.
(2) Assume that the note to Weaver bears 6% interest,
and that we make a partial payment of $1,200 at
maturity. Since Weaver will presumably regard
$25 as payment of interest, and will regard the
remainder as a payment on the principal, our entry
will be:
Interest expense . 25 00
Notes payable... .. 1,175.00
Cash . . 1,200.00
Payment of portion of principal of note to George
Weaver, due today, and interest.
124 PROMISSORY NOTES-BILLS OF EXCHANGE [Ch. 9
(JB) Entries for a renewal note:
At the maturity of our note payable, we may give a new
note for the full amount, or we may make a partial pay-
ment and give a new note for the balance.
(1) Assume that the Weaver note does not bear interest,
and that, at maturity, we give him a new note due
in 60 days for the amount of the old note. Our
entry will be:
Notes payable 2,500.00
Notes payable. .... . 2,50000
Issuance of a new 60-day note to George Weaver
for face of 60-day note due today.
(2) Assume that the Weaver note bears 6% interest, and
that, at maturity, we pay him the interest on the
note and $1,000 on the principal, and give him a
new 60-day, 6% note for the balance.
Notes payable. . 1 ,000 00
Interest expense 25 00
Cash 1,025 00
Payment of portion of note due today, and total
interest.
Notes payable . . 1 , 500 00
Notes payable . 1,50000
Issuance of a new 60-day, 6% note to George
Weaver for unpaid portion of note duo today.
Discounting a note payable. When a note payable is issued
to a bank for a loan, the note usually does not bear interest, but
the interest is deducted in advance. For instance, assume that
we give a bank a 60-day note for $1,000, and that the bank charges
discount at 6%. The discount is $10, and we will receive the
proceeds of $990.
Entry if note matures before the end of the accounting period:
Cash 990 00
Interest expense 10 00
Notes payable. 1 ,000 00
Note due in 60 diiys, discounted at bank.
Entry if note matures after the end of the accounting period:
Cash . 990 00
Prepaid interest expense 10 00
Notes payable. . . 1 ,000 00
Note due in 60 days, discounted at bank.
If the Prepaid Interest Expense account is used, an adjusting
entry is required at the end of the accounting period to transfer
the expense portion to Interest Expense.
Ch. 9] PROMISSORY NOTES— BILLS OF EXCHANGE 125
Bills of Exchange
Definition. The following definition is quoted from the Uni-
form Negotiable Instruments Act:
A bill of exchange is an unconditional order in writing addressed
by one person to another, signed by the person giving it, requiring
the person to whom it is addressed to pay on demand or at a fixed or
determinable future time a sum certain in money to order or to
bearer.
The parties to a bill of exchange are:
The drawer- the person who signs the order.
The drawee the person to whom the bill is addressed and
who is ordered to make the payment.
The payee the person to whom the required payment is to
be made.
Classification. Bills of exchange, often called drafts, may be
classified as follows:
(A) As to the nature of the parties:
(1) Bills drawn on banks; a bank check is an illustra-
tion of such a bill of exchange.
(2) Bills drawn on parties other than banks; these are
known as commercial bills. They are the only
bills of exchange with which we are concerned in
this chapter.
(B} As to the number of parties:
(1) Three-party drafts -in which A orders B to pay C.
Three-party commercial bills are now so rarely
used in business that they are not discussed in
this chapter.
(2) Two-party drafts — in which A orders B to pay A.
In such a draft, A is both the drawer and the
payee.
Since there are always three parties to a draft
(drawer, drawee, and payee), it would be more
precise to use the expression two-person draft when
one person is both drawer and payee. However,
two-party draft is the customary terminology.
(C) As to the time when payment is to be made :
(1) Sight drafts — payable immediately upon presenta-
tion to the drawee.
(2) Time drafts — payable after a lapse of time. Since
we are concerned in this chapter with time paper,
we shall deal only with time drafts.
126 PROMISSORY NOTES— BILLS OF EXCHANGE [Ch. 9
Two-party time draft. A two-party time draft is illustrated
below:
$100.00 Chicago, Illinois, July 20. 1911
Thirty days after date pay to the Qrder of OURSELVES
One Hundre d-no/100 Dollars
To George Hill,
Freeport, Illinois
Two-Party Time Draft
Acceptance. A time draft should be presented to the drawee to
obtain his agreement to pay it at maturity. This agreement is
called acceptance of the draft and is expressed by writing across the
face of the draft:
Accepted
(Drawee's signature)
After a time draft has been accepted by the drawee, it is called
an acceptance. Thus the word acceptance has two meanings: the
act of accepting, and an accepted draft.
Time drafts may be payable:
(1) A certain period after the date of the paper; in such cases,
the time is expressed thus :
" Thirty days after date, pay to the order of (etc.)."
A draft drawn on June 15, payable thirty days after date,
will be due on July 15, regardless of the date on which it is
accepted. Since the date of acceptance has no bearing
on the maturity of the draft, the date of acceptance need
not be shown.
(2) A certain period after the date when the draft is accepted
by the drawee ; the time may be expressed thus :
"Thirty days after sight, pay to the order of (etc.)," or
"At thirty days' sight, pay to the order of (etc.)."
A draft drawn on June 15, payable thirty days after sight,
and accepted on June 20, will be due on July 20. Since
Ch. 9] PROMISSORY NOTES— BILLS OF EXCHANGE 127
the date of acceptance of such a draft determines the date
of its maturity, the date of acceptance should be shown,
thus:
Accepted
June 20, 19—
(Drawee's signature)
Accounts with notes and acceptances. An accepted time draft,
like a promissory note, is a debtor's written agreement to pay a cer-
tain sum of money at a fixed or deter minable future date. There-
fore, most accountants record acceptances receivable in the Notes
Receivable account, and acceptances payable in the Notes Payable
account.
Although a few accountants prefer to keep separate accounts
with Notes Receivable and Acceptances Receivable, and separate
accounts with Notes Payable and Acceptances Payable, this dis-
tinction is usually considered unnecessary.
Two-party time draft for collection purposes. Two-party time
drafts are occasionally used to reduce a past-due account to a
written promise to pay. If a debtor will not pay his account, he
may consent to give a promissory note or accept a time draft. If
a time draft is used, it is drawn by the creditor and sent to the
debtor for acceptance.
If the debtor accepts the draft, the following entries are made
by the two parties:
Drawee's journal entry:
Creditor's name 100 00
Notes payable 100.00
To record acceptance of draft.
Drawer's journal entry:
Notes receivable 100 00
Debtor's name 100 00
To record receipt of acceptance.
Two-party time draft per terms of sale. Sometimes the terms
of sale require the purchaser of merchandise to accept a time draft
for the amount of the invoice. If the purchaser has established
a credit standing with the seller, the merchandise is shipped on a
straight bill of lading and the draft is sent to the purchaser for
acceptance. To assure obtaining acceptance of the draft before
delivery of the goods, a draft with an order bill of lading attached
may be sent to a bank in the purchaser's city. The purchaser
must accept the draft before the bank will release the bill of lading.
128 PROMISSORY NOTES— BILLS OF EXCHANGE [Ch. 9
Sequence of Entries
Seller's entry at time of sale:
Customer's name . 300 00
Sales 300 00
Sale of merchandise; terms, 30-day acceptance.
Purchaser's entry at time of receipt of goods and acceptance of
draft:
Purchases . 300 00
Creditor's name .... 300 00
Purchase of merchandise; terms, draft due 30 days after
sight.
Creditor's name 300 00
Notes payable . . 300 00
Acceptance of 30-day draft for amount of purchase
today.
Seller's entry when acceptance is received:
Notes receivable 300 00
Customer's name 300 00
Acceptance received
A time draft drawn by the seller on the purchaser of goods sold,
accepted by such purchaser, and bearing on its face the evidence
that the draft arose from a sale of merchandise, is called a trade
acceptance.
No.
of the acceptor hereof adits
The obligation
O
III
T. i
O
O
of us pur feast of foods frocs cht drawer.
iy to the order of OURSELVES
«^_^__— Dofltra
Trade Acceptance
Trade acceptances are used in connection with transactions of
the nature just described.
Registers
Notes receivable register. If many notes and acceptances are
received, it is desirable to keep a supplementary record called a
Notes Receivable Register, where spaces are provided for more
detailed information about the notes and acceptances than can be
entered in the Explanation columns of the Notes Receivable
Ch. 9] PROMISSORY NOTES— BILLS OF EXCHANGE 129
account. This register is a supplementary book; the entries in it
do not take the place of those in the journal and the ledger, but
details can be omitted from the Explanation columns of the
account.
An illustration is presented below. It shows (1) the illustrative
transactions, (2) the entries (in journal form) to record them, (3)
the Notes Receivable account, and (4) the notes receivable register.
Peterson note:
On May 12, a 30-day, non-interest note for $1,000, dated
May 12, payable at our office, was received from O. B.
Peterson, to apply on account.
Notes receivable 1 ,000 00
O. B. Peterson 1,000 00
On June 11, the note was collected.
Cash J ,000 00
Notes receivable 1 ,000 00
Smith note:
On May 21, a 60-day, 6% note for $1,500, dated May 20,
payable at the State Bank, was received from H. D. Smith
to apply on account.
Notes receivable . . 1 ,500 00
H. D. Smith . 1,500 00
On July 19, when the note matured, the maker dishonored
it, and it was charged back to his account.
H. D. Smith . J ,515 00
Notes receivable I ,500 00
Interest income 1500
On July 21, Smith paid us $315 in cash, and gave us a new
6% note, payable in three months at our office, for $1,200.
Cash 315 00
H. D. Smith 315 00
Notes receivable 1,20000
H. D. Smith 1,200 00
Norton acceptance:
On July 24, we drew a $900 draft on Henry Norton, payable
60 days after date. Norton accepted the draft, and
returned it to us. We received it on July 25.
Notes receivable 900 00
Henry Norton 900.00
The acceptance has not yet matured.
130
PROMISSORY NOTES— BILLS OF EXCHANGE [Ch. 9
Notes Receivable
19—
19—
May
12
1,000
00
June
ll
1,000
00
21
1,500
00
July
19
1,500
00
July
21
1,200
00
25
900
00
The notes receivable register appears on page 131. The letters
in the first column indicate whether the paper is a note or an
acceptance. The letters J, F, M, and so forth, at the head of the
narrow columns indicate months of maturity, and the numbers in
these columns indicate the dates of maturity.
The Notes Receivable account has a debit balance of $2,100.
This balance is the total of the last two items in the register.
Notes payable register. An illustration of notes and accept-
ances payable transactions is presented below.
Bank loan:
On March 1, we discounted at the First National Bank our
60-day note for $5,000; discount rate, 6%.
Cash....
Interest expense..
Notes payable
. 4,950 00
50.00
. . .. 5,00000
Slocum acceptance:
On March 10, we accepted a 30-day sight draft for $1,150,
drawn by Frank Slocum on March 9, payable at his office.
... 1,150 00
1,15000
On April 9, the acceptance was paid.
1,15000
1 , 150 00
Bailey note:
On March 17, we gave George Bailey a 6%, two-month
note for $750.
750.00
. . . 750.00
Notes Payable
Frank Slocum
Notes payable
Notes payable
Cash
George Bailey
Notes payable
19—
19—
Apr,
9
1,150
00
Mar.
1
5,000
00
10
1,150
00
17
750
00
The notes payable register appears on page 131.
Ch. 9] PROMISSORY NOTES— BILLS OF EXCHANGE
131
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CHAPTER 10
Columnar Journals. Controlling Accounts
Columnar Journals
Special columns to reduce postings. Accountants have given
a great deal of thought to the development of accounting records
which reduce labor. ' One of the simplest labor-saving devices is
a journal in which special columns are provided for accounts fre-
quently debited and credited. Such a journal is illustrated on
page 133.
Observe that posting labor is saved because the individual
entries in the special columns are not posted; only the column
totals are posted. For instance:
The three debits to Cash, entered in the first debit column,
are not posted; instead, the $10,800 column total is posted.
The two debits to Purchases, in the second column, are not
posted; instead, the $4,000 column total is posted.
The account number at the foot of a column shows that a
posting has been made. The only items individually posted are
those for which special columns are not provided; these are in
the Sundry columns. Since the individual entries in these columns
are posted, the column totals are not posted.
Cross-footing columnar books of original entry. Before post-
ing column totals of a book of original entry containing several
debit and credit columns, you should always make sure that the
sum of the debit-column totals agrees with the sum of the credit-
column totals by a computation (which may be made on scratch
paper) similar to the following proof of the equality of the debits
and credits in the journal on page 133.
Debits Credits
10,800.00 4,050.00
4,000.00 800.00
3,550.00 13,500.00
18,350 00 18,350.00
Determining the equality of the debit and credit totals of col-
umnar books of original entry should never be omitted; if they
are not in balance, the trial balance will not balance, and a great
amount of work may have to be done before the error is located.
132
Ch. 10]
COLUMNAR JOURNALS
133
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134 CONTROLLING ACCOUNTS [Ch. 10
Controlling Accounts
Division of the ledger. If a business has numerous accounts
receivable and accounts payable, it is advisable to divide the
ledger into three sections, as follows :
Accounts receivable ledger — containing all accounts with
customers.
Accounts payable ledger — containing all accounts with trade
creditors.
General ledger — containing all other accounts.
When this is done, the accounts receivable ledger and the
accounts payable ledger are called subsidiary ledgers.
Controlling accounts. When the two subsidiary ledgers men-
tioned above are used, it is customary to keep the two following
accounts in the general ledger:
Accounts Receivable -the balance of this account shows the
total amount receivable from all customers.
Accounts Payable- the balance of this account shows the
total amount payable to all trade creditors.
Posting to the subsidiary ledgers and also to the controlling
accounts does not involve any great amount of extra work. The
journal is provided with debit and credit columns for Accounts
Receivable and Accounts Payable. The individual entries in
these columns are posted to the accounts in the subsidiary ledgers,
and the column totals are posted to the controlling accounts in the
general ledger.
Controlling accounts help in locating errors. Without con-
trolling accounts, it would be necessary to take a combined trial
balance of the general ledger and the subsidiary ledgers. If they
did not balance, it might be necessary to chock all of the postings
in search for errors. With controlling accounts, the three ledgers
can be proved separately, as follows:
General ledger— by taking a trial balance.
Subsidiary ledgers- -by seeing that the totals of their balances
are in agreement with the balances of their related con-
trolling accounts.
The sum of the balances in the accounts receivable
ledger should be equal to the balance of the Accounts
Receivable controlling account; and
The sum of the balances in the accounts payable ledger
should be equal to the balance of the Accounts Pay-
able controlling account.
Ch. 10]
CONTROLLING ACCOUNTS
135
Subsidiary ledger rulings. The ledger form most frequently
used for personal accounts in the two subsidiary ledgers is pro-
vided with a column to show the balance after each transaction.
Two illustrations are given below. Hudson's account is in the
accounts receivable ledger; Murphy's account is in the accounts
payable ledger. The purpose of each column may be indicated
in a box heading, as in the first illustration; or the box headings
may be omitted, as in the second illustration.
C. E. Hudson
Date
Explanation
Folio
Debit
Credit
Balance
Juno
2
1
600
00
600
00
11
1
600
00
—
19
2
760
00
760
00
23
2
35
00
725
00
28
3
725
00
—
July
6
! 4
495
00
495
00
T. O. Murphy
19—
Oct.
Nov
17
975
00
975
00
17
! 975
00
—
18
856
00
856
00
18
! 20
00
836
00
19
836
00
—
20
425
00
425
00
If a balance appears in an account in the accounts receivable
ledger, it is assumed to be a debit balance; if an account has
a credit balance, this fact may be indicated by writing "Cr."
after the amount of the balance. An account in the accounts
payable subsidiary ledger is assumed to have a credit balance; a
debit balance may be indicated by writing "Dr." after the balance.
If the balance in an account is composed of unsettled balances
from more than one invoice, the bookkeeper may use letters to aid
him in determining the elements of the account balance. The
procedure is illustrated below :
B. R. Riiey
19—
Nov.
20
a 295
00
295
00
21
a 15
00
280
00
21
b 300
00
580
00
22
c 179
00
759
00
22
c 13
00
746
00
23
b 300
00
446
00
136 CONTROLLING ACCOUNTS [Ch. 10
The $446 balance in the account with B. R. Riley on the pre-
ceding page consists of the following elements:
Invoice, November 13 . $295 00
Less credit on November 16 . 15 00 $280 00
Invoice, November 24 $ 1 79 . 00
Less credit on November 26. . 13.00 166 00
Total. . ~.~ $446.00
Illustration. The use of controlling account columns in the
journal and the procedure of posting to the three ledgers and
determining that they are in balance are illustrated on the follow-
ing pages. You should trace all the postings from the journal on
pages 137 and 138 to the three ledgers, which appear on the pages
indicated below:
General ledger . .... ... . 139
Accounts receivable ledger . 1 40
Accounts payable ledger 1 40
During the month, the entries in the Sundry columns were
posted to the general ledger and the entries in the Accounts Receiv-
able and Accounts Payable columns were posted to the subsidiary
ledgers. The accounts in the subsidiary ledgers usually are
arranged in alphabetical order and are not numbered. Since there
are no subsidiary ledger account numbers, the bookkeeper indicates
that postings have been made by entering check marks (\/) in the
L. F. column of the journal.
At the end of the month the column totals, including the totals
of the controlling account columns, but excluding the totals of the
Sundry columns, were posted to the general ledger.
i.10
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CONTROLLING ACCOUNTS 1
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CONTROLLING ACCOUNTS
[Ch. 10
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Ch. 10] CONTROLLING ACCOUNTS 139
General ledger. The general ledger accounts appear below:
Cash (1)
19—
July
31
2 26,686
II19-
00 July
HI
2 9,750
00
19—
July
Accounts Receivable (10)
31
2 1 ,350
II19-
00 July
31
2 820
00
Accounts Payable (20)
19—
July
31
2 2,150
H19—
July
31
2 4,80000
Capital Stock (30)
119—
July
I
1
1 25,000
00
Sales (40)
I19~l 1
July 31
2 2,250
00
Returned Sales and Allowances (41)
19—
July
H
1
20
oo|
1
Discount on Sales (42)
19—
July
23
2
14
00
Purchases (50)
19—
July
31
2
12,300
00
I
Returned Purchases and Allowances (51)
119—
July
11
1 150
00
Store Rent (60)
July 5
1
250
*
140
CONTROLLING ACCOUNTS
[Ch. 10
Accounts receivable ledger. The accounts receivable sub-
sidiary ledger appears below:
Peter Mason
19—
July
15
23
2
2
700
00
700
700
00
00
John Nolan
19-1
July 31
.
2 350
00
350
00
John Phelps
19—
July
10
1
300
00
300
00
12
1
20
00
280
00
22
2
100
00
180
00
Accounts payable ledger. Following is the accounts payable
subsidiary ledger:
Bacon & Company
19—
July
19—
July
19
1
3,000
00
3,000
00
1
150
00
2,850
00
2
2,000
00
850
00
White and Davis
2t
1,800
00 1,800
00
Proving the ledgers. Following is the trial balance of the
general ledger :
General Ledger Trial Balance
July 31, 19—
Cash 16,936.00
Accounts receivable 530.00
Accounts payable . . 2 , 650 . 00
Capital stock . 25,000.00
Sales 2,250.00
Returned sales and allowances 20 .00
Discount on sales. . . ... . . . . 14.00
Purchases .... . 12,300.00
Returned purchases and allowances. . . 150.00
Store rent 250 00
30,050.00 30,050.00
The subsidiary ledgers are proved by preparing the following
schedules of their balances and finding that the totals thereof
Ch. 10] CONTROLLING ACCOUNTS 141
are in agreement with the balances of the respective controlling
accounts in the general ledger.
Schedule of Accounts Receivable
July 31, 19 -
John Nolan 350.00
John Phelps ... 180 00
Total (per balance of controlling account) . . . 530 00
Schedule of Accounts Payable
July 31, 19—
Bacon & Company .... 850 00
White and Davis . ] ,800 00
Total (per balance of controlling account; 2,650 00
CHAPTER 11
Specialized Books of Orisinal Entry
Division of labor. The columnar journal illustrated in the pre-
ceding chapter saves posting labor, but it does not provide for a
division of labor. In a large business it is utterly impracticable to
use a single book of ..original entry. To enable several bookkeepers
to work at the same time, it is necessary to have several books of
original entry. And, as we shall see in this chapter, by using
specially designed books of original entry for different classes of
transactions, the labor of journalizing can be greatly reduced.
Books to be illustrated. The special books to be used in any
business will depend upon the nature of its operations, and upon
whether transactions of a particular kind occur often enough to
warrant having a special book of original entry in which to record
them. The special books to~he illustrated in this chapter are:
Sales book.
Purchase book.
Cash receipts book.
Cash disbursements book.
These books are sometimes called the sales journal, the purchase
journal, and so forth. Since some transactions cannot be recorded
in the special books of original entry, it is necessary also to have a
journal in which to record these transactions; this book may be
called the general journal or merely the journal.
If a transaction is recorded in one of the specialized books of
original entry, it is not recorded in the general journal also; only
those transactions which cannot be recorded in a specialized book
of original entry are recorded in the general journal.
Sales book. A sales book is illustrated below.
Sales Book
(Page 1)
Dat
e
V
Name
19—
May
2
7
V
v
R. E. West
G. O. Davis
1?
V
S. E. Bates
18
V
R. E. West
23
V
(i. O. Davis
30
V
II. E. West
Invoice No.
Amount
1
800
00
2
450
00
3
600
00
4
850
00
5
280
00
6
300
00
3,280
00
142
(10) (40)
Ch. 11] SPECIALIZED BOOKS OF ORIGINAL ENTRY 143
The sales book is used for recording sales on account. It has
the following advantages:
Saving of labor:
In recording transactions:
Each entry records a debit to a customer and a credit to
Sales; but the credit to Sales need not be written; it
is implied because the entry is in the sales book.
The sales book need not contain an explanation of each
entry. A numbered invoice is given to the customer,
and a carbon copy thereof is retained and filed. The
sales book shows the number of the invoice. Infor-
mation about the kinds of merchandise sold can be
obtained by referring to the filed duplicate of the
invoice indicated by the number.
In posting:
A separate book of original entry for sales, like the
special Sales column in the journal in Chapter 10,
saves posting labor because, instead of posting the
amount of each sale separately to the Sales account,
the bookkeeper posts the total of all entries to the
Sales account. The column total is also posted to the
Accounts Receivable controlling account.
Division of labor:
In recording transactions:
One bookkeeper can be engaged in recording sales while
other bookkeepers are recording other kinds of
transactions.
In posting:
An assistant bookkeeper can post to the accounts receiv-
able subsidiary ledger, and the head bookkeeper can
post to the general ledger.
The other special books of original entry described in this
chapter have similar advantages.
Postings have been made from the illustrative sales book on
page 142. The postings of the individual debits to customers
were made during the month. The postings of the debit to
Accounts Receivable controlling account (account 10) and the
credit to Sales (account 40) were made at the end of the month.
Purchase book. Savings in journalizing and posting can be
effected by using a special book of original entry for recording
purchases on account. The entries in the purchase book on page
144 are equivalent to five entries debiting Purchases and crediting
the parties from whom the merchandise was purchased.
144 SPECIALIZED BOOKS OF ORIGINAL ENTRY
Purchase Book
Date
V
19—
May
1
V
Price and Holmes
9
V
Henderson's, Inc
13
V
Osborne Company
18
V
Price and Holmes
24
V
Henderson's, Inc
Name
NTRY [Ch. 11
(Page 1)
Invoice
Date
Amount
May
1
8
10
16
23
2,000
3,500
2,600
650
1,300
00
00
00
00
00
10,050
00
~~(50j~(20)
Postings were made as follows:
During the month, the individual entries were posted to the
credit of the creditors' accounts in the subsidiary ledger.
At the end of the month, the column total was posted to
general ledger accounts as follows:
To the debit of Purchases.
To the credit of Accounts Payable.
Cash receipts book. The cash receipts book on page 145 con-
tains entries for the following transactions :
May 1 — Issued capital stock for cash, $25,000.
3— Sold merchandise for cash, $150.
5— Collected from R. E. West amount of invoice of May 2, $260.
12 — Sold merchandise for cash, $500.
15 — Collected from G. O. Davis amount of invoice of May 7, $450, less 1 %
cash discount.
20- -Collected a non-interest-bearing note from R. E. West, $500.
24 — Collected from R. E. West amount of invoice of May 18, $850, less 1%
cash discount.
31 — Sold merchandise for cash, $400.
The illustrative cash receipts book contains two credit columns:
General Ledger- -In this column are entered the amounts of the
credits to all accounts other than accounts receivable.
Accounts Receivable— This column serves two purposes:
The accounts receivable subsidiary ledger bookkeeper can
easily find the items that are to be posted to the accounts
receivable subsidiary ledger.
The general ledger bookkeeper can post the total of the
column to the Accounts Receivable controlling account.
The cash receipts book also contains two debit columns, to
facilitate the recording of collections from customers who take a
deduction for cash discounts. The amount of the discount is
Ch. 11] SPECIALIZED BOOKS OF ORIGINAL ENTRY
145
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146 SPECIALIZED BOOKS OF ORIGINAL ENTRY [Ch. 11
entered in the Discount on Sales debit column ; the amount of cash
received is entered in the Cash debit column; and the total is
entered in the Accounts Receivable credit column.
Each of the entries in the cash receipts book records a receipt
of cash. The debits to Cash are not written (as they would have
to be in the journal), but are indicated by the fact that the amounts
are in the Cash debit column. The debits to Discount on Sales
are indicated by the fact that the amounts are in the Discount on
Sales debit column.
Postings were made as follows:
During the mbnth:
The head bookkeeper posted the entries in the General
Ledger column to the credit of the accounts named
under "Account Credited."
The assistant bookkeeper posted the entries in the Ac-
counts Receivable column to the credit of the accounts
named under "Account Credited. "
At the end of the month:
The head bookkeeper posted column totals to accounts in
the general ledger, as follows:
Accounts Receivable column- -to the credit of the
Accounts Receivable controlling account, No. 10.
Discount on Sales column — to the debit of the Dis-
count on Sales account, No. 42.
Cash column — to the debit of the Cash account, No. 1 .
It will be observed that the two debit columns in the cash
receipts book on page 145 are at the right of the two credit columns.
In columnar books of original entry, any column sequence may be
adopted so long as the headings clearly identify the debits and
credits. The column arrangement shown above was adopted so
that the columns in the cash receipts and cash disbursements books
would be in the same sequence: general ledger, subsidiary ledger,
discount, and cash.
Cash disbursements book. The cash disbursements book on
page 147 contains two debit columns:
General Ledger— In this column are entered the amounts of the
debits to all accounts other than Accounts Payable.
Accounts Payable- -This column serves two purposes:
The accounts payable subsidiary ledger bookkeeper can
easily find the items that are to be posted to the accounts
payable subsidiary ledger.
The general ledger bookkeeper can post the total of the
column to the Accounts Payable controlling account.
Ch. 11] SPECIALIZED BOOKS OF ORIGINAL ENTRY
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148 SPECIALIZED BOOKS OF ORIGINAL ENTRY [Ch. 11
The cash disbursements book also contains two credit columns,
to facilitate the recording of payments to creditors with a deduc-
tion for cash discounts.
Postings were made as follows:
During the month :
The head bookkeeper posted the entries in the General
Ledger column to the debit of the accounts named under
"Account Debited."
The assistant bookkeeper posted the entries in the Accounts
Payable column to the debit of the accounts named
under "Account Debited."
At the end of the month:
The head bookkeeper posted column totals to accounts in
the general ledger, as follows:
Accounts Payable column - to the debit of the
Accounts Payable controlling account, No. 20.
Discount on Purchases — to the credit of the Discount
on Purchases account, No. 52.
Cash — to the credit of the Cash account, No. 1.
Journal. To facilitate the postings to the controlling accounts,
it is desirable to use a six-column journal with special debit and
credit columns for each controlling account. See page 149.
Postings from the journal were made as follows:
During the month:
Entries in the Accounts Receivable columns were posted
to accounts in the subsidiary accounts receivable ledger.
Entries in the Accounts Payable columns were posted to
accounts in the subsidiary accounts payable ledger.
Entries in the General Ledger columns were posted to
accounts in the general ledger.
At the end of the month, totals of the Accounts Receivable
and Accounts Payable columns were posted to the con-
trolling accounts — Accounts Receivable, No. 10, and
Accounts Payable, No. 20.
References to books of original entry. When several books of
original entry are used, the ledger accounts must indicate the books
from which the entries were posted. Thus,
CR1 means cash receipts book, page 1.
GDI " cash disbursements book, page 1.
81 " sales book, page 1.
PI " purchase book, page 1.
Jl " journal, page 1.
Ch. 11] SPECIALIZED BOOKS OF ORIGINAL ENTRY
149
150
SPECIALIZED BOOKS OF ORIGINAL ENTRY [Ch. 11
You should trace all the postings from the foregoing books of
original entry to the following ledger accounts, beginning with the
first entry in the sales book and continuing to the last entry in the
journal.
General ledger. The general ledger accounts appear below :
Cash
(1)
19—
May
31
GUI
28,097
119-
00 May
31
GDI
12,318
00
Accounts Receivable (10)
19—
May
31
r
81
3,280
00
19—
May
31
31
Gill
Jl
1,560
540
00
00
Notes Receivable (16)
19—
May
5 R. E. West
Jl 500
119-
00 May
20
R. K. West
GR1
500
00
Accounts Payable
PI
(20)
19—
May
31
31
GDI
Jl
4,856
1 , 150
00
00
19—
May
31
10,050
00
Notes Payable
(21)
19—
May
25 Price and Holmes
GDI
1,000
119-
00 May
II
7
Price and Holmes
Jl
1,000
00
Capital Stock
GR1
(2
25,000
K»
19—
May
1
00
Sales (40)
19—
May
3
12
31
31
GR1
GR1
GRl
SI
150
500
400
3,280
00
00
00
00
Returned Sales and Allowances (41)
19—
May
\
Jl
40
H
Discount on Sales (42)
19—
May
31
CR1
13
00
Ch. 11] SPECIALIZED BOOKS OF ORIGINAL ENTRY 151
Purchases (50)
19—
May
1
10
26
31
GDI
GDI
GDI
PI
5,000
500
350
10,050
00
00
00
00
Returned Purchases and Allowances (51)
19—
May
4
Jl
150
00
Discount on Purchases (52)
1
19—
May
31
GDI
52
00
19—
May
1
GDI
Store Rent
300 (
Salesmen's Salaries
(61)
(62)
19—
i 1
May
16
GDI
200
00
31
GDI
200
00
Accounts receivable ledger. After postings from the books of
original entry are completed, the subsidiary accounts receivable
ledger appears as follows :
S. £. Bates
19—
May
19--
May
-
SI
600 00
60000
G. O. Davis
SI
450
00
450
00
cm
450
00
—
si
280
00
280
00
R. E. West
19—
May
i
SI
800
00
800
00
Jl
40
00
760
00
GUI
260
00
500
00
Jl
500
00
—
SI
850
00
850
00
cm
850
00
—
si
300
00
300
00
152
SPECIALIZED BOOKS OF ORIGINAL ENTRY [Ch. 11
Accounts payable ledger. The subsidiary accounts payable
ledger appears as follows:
Henderson's, Inc.
19—
May
9
PI
3,500
00
3,500
00
16
CD I
3,500
00
-
24
PI
1,300
00
1,300
00
Osborne Company
19—
May
19—
May
PI
GDI
Price and Holmes
50000
2,00000
2,60000
2,10000
PI
2,000
00
2,000
00
.11
150
00
1,850
00
GDI
850
00
1,000
00
Jl
1,000
00
— .
PI
050
00
050
00
Proving the ledgers. Following are the trial balance of the
general ledger and the schedules of the subsidiary ledgers.
General Ledger Trial Balance
May 31, 19—
Gash .... 15,719 00
Accounts receivable . 1 , 1 80 00
Accounts payable . ... 1,05000
Gapital stock . 25,00000
Sales . 4,330 00
Returned sales and allowances . . 40 00
Discount on sales 13 00
Purchases . . . 15,900 00
Returned purchases and allowances ...
Discount on purchases
Store rent 300 00
Salesmen's salaries 400 00
150 00
52 00
33,582 00 33,582 00
Schedule of Accounts Receivable
May 31, 19—
S. E. Bates
G. O. Davis.
II. E. West. .
Total (per balance of controlling account)
Schedule of Accounts Payable
May 31, 19—
Henderson's, Inc
Osborne Company
Price and Holmes
Total (per balance of controlling account)
000 00
280.00
300.00
1,180.00
1,300.00
2,100.00
650 00
4,050 00
Ch. 11] SPECIALIZED BOOKS OF ORIGINAL ENTRY 153
Providing controlling account columns in books of original
entry. It is desirable to provide special controlling account
columns in the various books of original entry so that the postings
to the controlling accounts, so far as practicable, will consist only
of column totals.
Suppose, for example, that customers are frequently credited
with returned merchandise after having paid their accounts in full.
Their accounts will then have credit balances which may have to
be paid in cash. If there are many such cash disbursements
requiring debits to customers' accounts, it will be desirable to have
an Accounts Receivable debit column in the cash disbursements
book, as illustrated in the cash disbursements book on page 154.
The accounts receivable bookkeeper posted the two items in
the Accounts Receivable column, and the general ledger book-
keeper posted the column total.
Posting to subsidiary ledgers from General Ledger column.
Transactions of the nature mentioned in the preceding section may
be too infrequent to justify providing a special column for them in
the cash disbursements book; if it is not desired to have a special
column, the amounts of the entries may be put in the General
Ledger column and each entry will be posted twice: once by the
accounts receivable bookkeeper to the subsidiary ledger, and once
by the general ledger bookkeeper to the controlling account in the
general ledger. See illustrative cash disbursements book on
page 155.
The method illustrated in the cash disbursements book with no
Accounts Receivable column (page 155) may be applied whenever
entries affecting subsidiary ledgers and controlling accounts must
be made in a book of original entry which does not have a special
column for the controlling account affected. Great care should
be exercised to see that items of this nature are posted to both the
general ledger and the subsidiary ledger; if only one posting were
made, the subsidiary ledger would be thrown out of agreement
with its control.
154 SPECIALIZED BOOKS OF ORIGINAL ENTRY [Ch. 11
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156 SPECIALIZED BOOKS OF ORIGINAL ENTRY [Ch. 11
Other Special-Purpose Columns in the Cash Receipts Book
A cash receipts book with several additional special columns
appears on page 157. The additional columns and their uses are
described below.
Interest Income. The cash receipts book shows that, on
June 23, a $600 note and $1 of interest were collected from Oscar
White. The entry for the transaction includes credits to Notes
Receivable and Interest Income, and a debit to Cash. The
special Interest Income credit column makes it possible to record
the transaction on one line of the cash receipts book.
Sales. This cohimn was provided because the Sales account
is frequently credited. The special column reduces posting work.
Prepaid Interest Expense. On June 25, a $2,000 note payable
was discounted at the bank. The entry for the transaction
includes a credit to Notes Payable and debits to Prepaid Interest
Expense and Cash. The special Prepaid Interest Expense debit
column makes it possible to record the transaction on one line of
the cash receipts book.
Collection and Exchange. On June 26, a $600 check was
received from J. B. Turner to apply on account. When the check
was deposited, the bank charged an exchange fee of $.25. The
entry for the transaction includes a credit to J. B. Turner and
debits to Collection and Exchange and Cash. The special Collec-
tion and Exchange debit column makes it possible to record the
transaction on one line. This special column was also used to
record the fee charged by the bank for the collection of the Peter-
son note.
Ch. 11] SPECIALIZED BOOKS OF ORIGINAL ENTRY
157
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158 SPECIALIZED BOOKS OF ORIGINAL ENTRY [Ch. 11
Other Special-Purpose Columns in the Cash Disbursements
Book
A cash disbursements book with several additional special
columns appears on page 159.
Interest Expense. The Interest Expense debit column makes
it possible to record the payment of a note payable and interest on
one line.
Purchases, Freight In, and Freight Out. These special
columns were provided because the accounts are frequently
debited in the cash disbursements book.
Special columns to be used. You should understand that the
special columns shown in this chapter are purely illustrative.
The special columns to be used in the cash books of a business will
depend on the nature of the business and the frequency of certain
types of cash transactions.
Ch. 11] SPECIALIZED BOOKS OF ORIGINAL ENTRY
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Transactions Recorded on Two Lines of a Cash Book or in a Cash
Book and the General Journal
It is theoretically desirable to have enough columns in the cash
books so that each cash transaction can be recorded on a single
line, but it is impracticable to provide columns for accounts which
are infrequently used. Two procedures for dealing with situations
in which special columns would be helpful but are not provided are
discussed below and illustrated in the cash receipts book and
journal on pages 161 and 162. Similar procedures can be used for
recording cash disbursements.
Two entries in tfre General Ledger column. For purposes of
illustration, assume that, on June 5, land which had been acquired
as a building site at a cost of $12,000 was sold for $15,000 cash.
The entry for the transaction requires a $15,000 debit to Cash, a
$12,000 credit to Land, and a $3,000 credit to Gain on Sale of Land.
The transaction is recorded on two lines of the cash receipts book
on page 161; the two credits are entered in the General Ledger
column.
Entry in a cash book and the general journal. Assume the
same transaction except that $5,000 cash and a $10,000 mortgage
were received. It is inconvenient to record the $10,000 debit to
Mortgage Receivable in the cash receipts book because there is no
General Ledger debit column. The accounting procedure follows.
The entire transaction is recorded in the general journal, in
the manner illustrated on page 162. Observe that an
"X" is placed beside the Cash debit to indicate that it is
not posted.
The cash receipt is recorded in the cash receipts book.
Observe that the cash amount appears in the General
Ledger credit column as well as in the Cash debit column ;
this is necessary in order to make the debits and credits in
the cash book equal. But no account name appears in the
Account Credited section, and an "X" appears in the
L.F. column at- the left of the General Ledger credit,
column, to indicate that no credit is posted from the cash
receipts book.
Observe that postings were made as follows:
Debit Credit
From the general journal:
Mortgage receivable . 10, 000
Land .. ... 12,000
Gain on sale of land . 3 , 000
From the cash receipts book:
Cash (included in column total) 5,000
Ch. 11] SPECIALIZED BOOKS OF ORIGINAL ENTRY
161
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General Journal
CREDITS
tn
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Ch. 11] SPECIALIZED BOOKS OF ORIGINAL ENTRY 163
Locating errors. When subsidiary ledgers and controlling
accounts are used, it usually is possible to determine which ledger
contains an error and which bookkeeper should be charged with
the responsibility of locating it. For example :
If the general ledger is in balance, and the accounts receivable
schedule agrees with its control, but the accounts payable
schedule does not agree with its control, an error is indicated
in the accounts payable ledger.
If the general ledger is in balance, and the accounts payable
schedule agrees with its control, but the accounts receivable
schedule does not agree with its control, an error is indicated
in the accounts receivable ledger.
If the general ledger is not in balance, but the subsidiary ledgers
are in agreement with their controls, an error is indicated in
the general ledger, and this error is presumably not in the
controlling accounts.
If the general ledger is not in balance, and the subsidiary ledgers
are not in agreement with their controls, it usually is advis-
able to look for errors in the general ledger first. When these
errors are located and the general ledger is in balance, it may
be found that corrected balances in the controlling accounts
will be in agreement with the subsidiary ledgers; if not, a
search must be made for errors affecting the subsidiary
ledgers.
Following is an outline of the procedures to be applied for the
purpose of locating errors.
(A) When the general ledger trial balance does not balance,
perform the following operations, in the order indicated :
(1) Refoot the general ledger trial balance.
(2) Compare the balances shown by the trial balance
with those shown by the accounts in the general
ledger.
(3) Check the computation of the balances of the
general ledger accounts.
(4) Check the postings to the general ledger.
(5) Refoot the books of original entry which have
only one column.
(6) See whether the sum of the totals of the debit
columns is equal to the sum of the totals of the
credit columns of the columnar books of original
entry; if they are not in balance, refoot each
column. If this does not disclose the error, see
164 SPECIALIZED BOOKS OF ORIGINAL ENTRY [Ch. 11
whether the debits and credits in each entry
are equal.
See whether any amounts are entered in wrong
columns of columnar books of original entry.
(B) When the general ledger is in balance but a subsidiary
ledger is out of agreement with its control :
(1) Refoot the schedule of the subsidiary ledger.
(2) See that the balances were carried correctly from
the subsidiary ledger to the schedule.
(3) Recompute the balance of each subsidiary ledger
account.
(4) Check the postings to the subsidiary ledger.
CHAPTER 12
Departmental Operations
Departmental profits. If a merchandising concern operates two
or more departments, it is advisable for it to keep the accounts in
such a way that a statement of profit and loss can be prepared
showing the results of operations by departments.
Determining gross profits by departments. To determine the
gross profits by departments, as shown in the illustrative profit and
loss statement on page 168, the following departmental merchan-
dise accounts were kept:
Inventory -Department A
Inventory— Department B
Sales — Department A
Sales — Department B
Returned Sales and Allowances — Department A
Returned Sales and Allowances- Department B
Discount on Sales Department A
Discount on Sales — Department B
Purchases -Department .1
Purchases — Department B
Returned Purchases and Allowances Department .1
Returned Purchases and Allowances- Department B
Discount on Purchases- Department A
Discount on Purchases Department B
The trial balance in the working papers on pages 106 and 167
shows that only one Freight In account was kept. If, in a business
with departments, it is practicable to analyze the freight bills to
determine the freight costs applicable to each department, depart-
mental Freight In accounts may be kept. In the illustration in
this chapter it is assumed that the management prefers to make an
approximate apportionment of the cost of freight in, rather than to
incur the expense of analyzing the freight bills. The apportionment
was made on the basis of purchases.
Department Purchases Per Cent Freight In
A. .............. $ 00,000 40% $~~72<r
B ........... 90,000 00
_
Total ........ S15p,QOO 100% $^800
165
166
DEPARTMENTAL OPERATIONS
[Ch. 12
Ch. 12]
DEPARTMENTAL OPERATIONS
167
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168
DEPARTMENTAL OPERATIONS
[Ch. 12
8
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Ch. 12]
DEPARTMENTAL OPERATIONS
169
Columnar sales and purchase records. When departmental
sales and purchases accounts are kept, it is advisable to use
columnar books of original entry for sales and purchases. The
sales book, for example, may have columns such as those illus-
trated below.
Sales Book
DKBIT
CREDITS
Date
Name
Invoice
No
...
Ifi
Accounts
Sales
Sales
j.F.
Receivable
Dept. A
Dept. B
19—
Jan.
7
C. H. Holmes
1001
V
1,500
00
1,000
00
500
00
11
D. K. Whitfly . .
1002
V
2,550
00
2,000
00
550
00
19
D. 11. Long
1003 V
1 ,250
00
750
00
500
00
?,9
G. K. Jones
1004 V
2,525
00
525
00
2 000
00
00
00
7,825
00
4,275
3,550
(1120) (4001)
(4002)
The general ledger postings from this book were made as
follows:
Debit: Accounts Receivable controlling account, for the total
of the Accounts Receivable column.
Credits: Sales- -Department A.
Sales — Department B.
For the totals of the Department A and Depart-
ment B Sales columns.
The purchase book should have three columns :
Credit: Accounts Payable.
Debits: Purchases —Dept. A.
Purchases- Dept. B.
Cash sales and cash purchases. Chapter 11 showed how7
special columns for cash sales and cash purchases may be included
in the cash receipts book and the cash disbursements book. If a
business has only two or three departments, the cash receipts book
may contain a Sales column for each department, and the cash
disbursements book may contain a Purchases column for each
department. The totals of these columns can then be posted to
the departmental sales and purchases accounts.
But if the business is divided into a great many departments,
Sales and Purchases columns cannot be provided in the cash books
without making these books so wide as to be inconvenient. Under
170
DEPARTMENTAL OPERATIONS
[Ch. 12
such conditions it is advisable, in place of a Sales column for each
department in the cash receipts book, to add a Cash debit column
to the sales book and to have only one Sales column in the cash
receipts book. Cash sales will then be recorded in the two books
thus:
Sales Book
Date
Name
r
DEBITS
CKEDITS
Accounts
Receivable
Cash
Sales
Dept. A
Sales
Dept. B
V
Amount
19-I
Jan.|16
Cash sales
600 00
(Column tota
35000
250 00
nut
Cash Receipts Book
Date
Account
Credited
CREDITS
DEBITS
Sundry
Accounts
Sales
Accounts
Recievable
Discount
on Sales
Casl
L.F.
Amount
V
Amount
19—
Jan.
16
Sales... .
600
00
60(
(Column total
not posted)
The debit to Cash (in the sales book) and the credit to Sales
(in the cash receipts book) are not posted. The posted entries
are, therefore:
From the cash receipts book: The debit to Cash.
From the sales book: The credits to the two
Sales accounts.
The illustrations on pages 172 and 173 show a sales book and a
cash receipts book after the completion of footing and posting at the
end of the month. The bookkeeper put an X at the foot of each
of the two columns (Cash in the sales book, and Sales in the cash
book) which were not to be posted. It will be noted that the
totals of these two columns are equal, and the bookkeeper should
always be sure that this is the case.
Ch. 1 2] DEPARTMENTAL OPERATIONS 1 71
Cash purchases may be recorded in a similar manner. That is :
The purchase book will contain a Cash credit column, the
total of which will not be posted.
The cash disbursements book will contain a Purchases debit
column, the total of which will not be posted.
Entries for cash purchases will be made in both books, the
debits to the departmental Purchases accounts being posted from
the purchase book, and the credits to Cash being posted from the
cash disbursements book.
Cash discounts. If a business has only a few departments, a
Discount on Sales column for each department can be provided
in the cash receipts book, and a Discount on Purchases column for
each department can be provided in the cash disbursements book.
If there are so many departments that it is impracticable to pro-
vide a column for each in both of the cash books, the cash receipts
book may have a single Discount on Sales column (as in the illus-
tration on page 173) and the cash disbursements book may have a
single Discount on Purchases column. Supplement ary records
may then be provided with discount columns for each department,
postings being made from these supplementary records instead of
from the cash books. Or 110 supplementary records may be
maintained, postings being made from the cash books to a Discount
on Sales account and a Discount on Purchases account, and
approximate apportionments of the balances of these accounts
may be made for statement purposes.
Departmental inventories in the balance sheet. In the balance
sheet of a business with departments, the inventories may be set
out separately, thus:
Inventories:
Department A $13 , 000 00
Department B 31 ,,000 00
Total " $4 I, 000 00
If there are very many departments, it is impracticable to
detail the inventories in the balance sheet; hence, they may be
shown in total.
172
DEPARTMENTAL OPERATIONS
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1 74 DEPARTMENTAL OPERATIONS [Ch. 1 2
Gross profit less selling expenses by departments. If it is
desired to have the profit and loss statement show gross profit less
selling expenses by departments (as in the illustration on page 177),
departmental selling expense accounts should be kept to the
extent practicable. The trial balance in the working papers shows
that, in this illustration, only the following departmental expense
accounts were kept:
Salesmen's Salaries- -Department A
Salesmen's Salaries — Department B
In many cases if is not practicable to identify selling expenses
by departments at the time they are incurred; in such cases, one
account is kept for each type of expense and some basis of appor-
tionment for statement purposes is adopted. The balances of
such accounts are frequently apportioned to departments in the
ratio of sales by departments; but this is only a " rough and ready"
method and is not likely to be very accurate because the depart-
mental expenses are rarely, if ever, proportionate to the depart-
mental sales.
If possible, some accurate basis of apportionment should be
used for each expense. In the illustration, it is assumed that the
store rent was apportioned by departments on the basis of floor
space occupied, and that the advertising was apportioned on the
basis of advertising space occupied. In some businesses it may be
possible to apportion delivery expenses on the basis of the number
of deliveries made for each department, with proper consideration
of differences in weight and bulk of the merchandise of the various
departments. In this illustration it is assumed that such a pro-
cedure is impracticable, and the apportionments were made on the
basis of sales, as follows:
Depreciation —
Delivery Delivery
Department Sales Per Cent Expense J^iigment^
A $75,000 37.5%" "$1,500 ~~ ~$ ~S75~ ~
B J^«LL?OO 62 5 2,500 625
Total §200,000 100J>% §4,000 *M>00
Dangers of approximations. To the extent that items of
expense or income are allocated to departments by some method
of approximation, the departmental profit and loss statement
is affected by estimates and guesswork; judgments based on such
a statement may be erroneous and misleading; and, unless manage-
ment maintains a constant awareness of this element of guesswork
and possible error, unwise policies may be adopted.
Ch. 12]
DEPARTMENTAL OPERATIONS
175
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Ch. 12]
DEPARTMENTAL OPERATIONS
177
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1 78 DEPARTMENTAL OPERATIONS [Ch. 1 2
Net income by departments. A profit and loss statement
carried to the final point of net income or net loss is illustrated on
page 179. It is assumed that:
(a) The bad debt losses by departments were determined by
analyzing the accounts receivable.
(b) The office salaries, officers' salaries, and miscellaneous
general expenses were apportioned to departments on
the basis of sales, for want of a better basis.
Interest income was apportioned on the basis of sales, on
the assumption that the interest was earned on notes
received from customers.
Interest expense was apportioned on the basis of purchases
on the assumption that funds were borrowed to finance
purchases.
It is obvious that most of the foregoing assumptions are of
doubtful validity and that the apportionments are sub-
ject to question. The computations are shown below:
Apportionments on Basis of Sales
Total Dept. A Dept. B
Sales . ^ $200,000 $75,000 $125,000
Percent. . 1000% 37.5% 625%
Office salaries . . $2,400$ 900 $ 1,500
Officers' salaries 1 0 , 000 3 , 750 6 , 250
Miscellaneous general expense . . 1 , 200 450 750
Interest income . . 80 30 50
Apportionment on Basis of Purchases
Total Dept. A Dept. B
Purchases $150,000 $60,000 $ 90,000
Percent . . ... 100% 40% 60%
Interest expense . . $ 125 $ 50 $ 75
(c) The insurance was apportioned to departments in the ratio
of the average inventories on the assumption that the
premiums were paid for insurance on the merchan-
dise. (Automobile insurance was charged to Delivery
Expense.) The computation is shown below:
Total Dept. A Dept. B
Inventories, December 31, 1953 $ 46,000 $17,000 $ 29,000
Inventories, December 31, 1954 44,000 13,000 31,000
Total | » 90,000 $30,000 $ 60,000
Average inventories $ 45,000 $15,000 $^30,000
Fractions % %
Insurance ... $ 600 $ 200 $ 400
Special attention is directed to the treatment of income tax in
the profit and loss statement. On the assumption of the correct-
ness of the expense and income apportionments to departments,
Department A suffered a loss, which reduced the income tax.
Ch. 12]
DEPARTMENTAL OPERATIONS
179
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DEPARTMENTAL OPERATIONS
[Ch. 12
Although this assumption is of doubtful validity, consistency
requires that Department B be charged with income tax in the
amount which would have been payable on its net income, and
that Department A be given credit for the tax reduction resulting
from its net loss.
Significance of the statement. Because the apportionments
of expenses are to such a large degree based on assumptions which
may not be valid, complete reliance should not be placed on the
amounts shown as net loss for Department A and net income for
Department B.
Moreover, even if no assumptions had been made in the alloca-
tion of expenses to departments, the fact that Department A shows
a loss should not be accepted as a conclusive reason for discontinu-
ing the department. The discontinuance of Department A would
result in eliminating all the gross profit resulting from its opera-
tions, but it would not result in eliminating all the expenses which
were charged to it. Before reaching any decision with respect to
the advisability of discontinuing Department A, the management
should make a study of the expenses and the miscellaneous income
for the purpose of determining the probable reductions which
would result from such a discontinuance. The following state-
ment is assumed to be the result of such a study.
Probable Reduction in Expenses and Miscellaneous Income Which Would Result
from Discontinuance of Department A
Charged
to
j Department A
KFFKCT OF
DISCONTINUANCE OF
DEPARTMENT A
Eliminated
Not
Kliminated
Selling expenses:
Store rent
Advertising
Salesmen's salaries
Delivery expense
Depreciation — Delivery equipment
$ 2,400 00
1,600 00
6,000 00
1,500 00
375 00
$1,600 00
6,000 00
$2,400 00
1,500 00
375 00
Total selling expenses
General expenses:
Office salaries . . .
Officers' salaries
Insurance
Miscellaneous general expense
Bad debts.
Total general expenses
$11,875 00
$7,600 00
$4,275.00
$ 900 00
3,750 00
200.00
450 00
150.00
$ 200 00
150 00
150 00
$ 900.00
3,750 00
300.00
$ 5,450.00
$ 500 00
$4,950.00
Interest income
$ 30 00
$ 30 00
« *ft nn
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Ch. 12] DEPARTMENTAL OPERATIONS 181
The first column shows the items of expense and income which
appear in the Department A columns of the profit and loss state-
ment on page 179. The second column shows the items which, in
the opinion of the management, would be eliminated if Depart-
ment A were discontinued. The third column shows the items
which the management believes would not be eliminated. The
management's conclusions were reached as follows:
The store rent would not be reduced, because the entire space
would have to be retained under the lease. The advertising and
salesmen's salary charges could be eliminated. The delivery
equipment and the driver would have to be retained to make
deliveries for Department B. There is only one office employee,
and no portion of her salary could be eliminated. The officers'
salaries would not be reduced. Since the merchandise inventory
of Department A would be eliminated, the insurance cost applica-
ble to it would be eliminated. It is estimated that one-third of
the miscellaneous general expense apportioned to Department A
could be eliminated. With the discontinuance of sales by Depart-
ment A, there would be no bad debt losses in that department.
Without Department .4 , the interest income on receivables arising
from Department A sales, and the interest expense incurred to
make purchases for that department, would disappear.
The consequences of discontinuing Department A can now be
estimated as follows:
Estimated Effect on Net Income Which Would Result from Discontinuance of
Department A
Net income of Departments A and B before income tax . . . $3.285 00
Net income which would be lost by discontinuing Department .1 :
Income lost:
(Jross profit on sales $10,270 00
Interest income 30 00
Total income lost $10,300 00
Expense reductions:
Selling expenses $7 . 600 00
General expenses 500 00
Interest expense _ 50 00
Total expense reduction 8,150 00
Net income lost 2,150 00
Resulting net income before income tax . $1,135 00
Surprising as it may at first seem, the foregoing statement
indicates that, although the departmental profit and loss state-
ment on page 179 shows that Department A's operations resulted
in a net loss of $7,075 before income tax adjustment, the elimina-
tion of that department would not increase the net income of the
business as a whole but would reduce it from $3,285 to $1,135 before
income taxes.
1 82 DEPARTMENTAL OPERATIONS [Ch. 1 2
Contribution to overhead. Some accountants now prepare
statements in which no attempt is made to show the net income,
or even the gross profit less selling expenses, by departments.
Instead, each department is credited with the income and charged
with the expenses which, in the opinion of the management, would
disappear if the department were discontinued. The excess of
such income over the " direct" departmental expenses represents
the contribution of the department to what may be called the
overhead of the business as a whole, or non-departmental over-
head. Such a statement is illustrated on page 183.
Adjusting and closing entries. The adjusting entries indi-
cated by the working papers are :
(a) Insurance . . 600 00
Unexpired insurance . 600 00
Insurance expired during the year.
(b) Office salaries . 90 00
Accrued salaries payable 90 00
Unpaid salaries at the end of the year.
(c) Accrued interest receivable . ... 30 00
Interest income . .... 30 00
Accrued interest on notes receivable.
(d) Bad debts 420 00
Reserve for bad debts . 420 00
To increase the reserve to 5% of the accounts
receivable.
(e) Depreciation— Delivery equipment 1 ,000 00
Res. for depr. — Delivery equipment . 1 ,000 00
To provide for depreciation at the rate of 25%
per annum.
(f) Federal income tax 1 ,000 00
Federal income tax payable 1 ,000 00
Tax for 1954.
The closing procedure need not be affected by the fact that the
business is departmentalized. Below and on page 184 are the
closing entries :
1954
Dec. 31 Inventory— Dept. A .13,00000
Inventory— Dept. B 31 ,000 00
Sales— Dcpt. A . . ... 75,00000
Sales— Dept. B . . 125,00000
Returned purchases and allowances — Dept. A 600 00
Returned purchases and allowances — Dept. B 850 00
Discount on purchases — Dept. A 390 00
Discount on purchases— Dept. B . . . 81000
Interest income . . 80.00
Profit and loss .. 246,73000
To record the December 31, 1954 inventories and
close accounts with credit balances.
Ch. 12]
DEPARTMENTAL OPERATIONS
183
II.
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1 84 DEPARTMENTAL OPERATIONS [Ch. 1 2
Dec. 31 Profit and loss 244,445.00
Inventory— Dept. A .... 17,000 00
Inventory— Dept. B 29,00000
Returned sales and allowances — Dept. A 400 00
Returned sales and allowances — Dept. B . 900 . 00
Discount on sales — Dept. A . . 600.00
Discount on sales — Dept. B . 1,000 00
Purchases- Dept. A . 60,000 00
Purchases— Dept. B 90,000 00
Freight in . . 1,800 00
Store rent . 6,000 00
Advertising . 4,000.00
Salesmen's salaries — Dept. A 6,000 00
Salesmen's salaries — Dept. B 7,000 00
Delivery expense 4,000 00
Depreciation — Delivery equipment 1,000 00
Officers' salaries 10,000 00
Office salaries 2 , 400 00
Insurance 600 00
Bad debts 420 00
Miscellaneous general expenses 1,200 00
Interest expense 125 00
Federal income tax . . 1,000.00
To close the accounts with debit balances.
31 Profit and loss .2,28500
Earned surplus 2,285 00
To close the Profit and Loss account.
31 Earned surplus. .. . 5,00000
Dividends . . 5,00000
To close the Dividends account.
CHAPTER 13
Manufacturing Accounts
Manufacturing costs. A merchandising concern buys its
goods ready for resale; its books, therefore, contain a Purchases
account which shows the cost of merchandise purchased. A manu-
facturing concern buys raw materials, but the process of manu-
facture also involves expenditures for labor and for a great variety
of manufacturing expenses; its books must, therefore, contain
accounts in which to record all these manufacturing costs.
The following statement indicates the elements which enter
into the computation of the cost of goods manufactured. Payroll
taxes have been omitted to simplify the illustration.
THE ABC COMPANY Exhibit D
Statement of Cost of Goods Manufactured
Year Ended December 31, 1954
Materials:
Inventory, December 31, 1953. . $ 12,000
Purchases $94,000
Deduct:
Returned purchases and allowances $1 ,500
Discount on purchases. . 1,200 2,700
Net purchases $91 , 300
Freight in 800
Total. 92 , 100
Total inventory and purchases . . . $104,100
Deduct inventory, December 31, 1954. . . 9,000
Cost of materials used . . . . $ 95 , 100
Direct labor .. 80,750
Manufacturing expenses:
Indirect labor. $ 9 , 125
Heat, light, and power 3,500
Building and machinery repairs 300
Depreciation :
Buildings.. 3,500
Machinery and equipment . 6 , 000
Insurance . . ... 950
Taxes . 1,400
Factory supplies . . 3 , 500
Miscellaneous factory expense. 2,500
Total manufacturing expenses . . 30 , 775
Total cost of manufacturing. . ... $206,625
Add goods in process, December 31, 1953 .... 15,000
Total .... . $221,625
Deduct goods in process, December 31, 1954 11,000
Cost of goods manufactured $210,625
185
1 86 MANUFACTURING ACCOUNTS [Ch. 1 3
" Materials" include only those things which enter into and
become a part of the finished product; supplies used in the opera-
tion of the factory are not classified as materials because they do
not become part of the finished product.
The nature of direct labor can best be shown by distinguishing
it from indirect labor. Employees who work on the product with
tools, or who operate machines in the process of production, are
direct laborers; but superintendents and foremen, who supervise
the work of production, and engineers and janitors, whose services
are incidental to the process of production, are indirect laborers.
Manufacturing expense, or manufacturing overhead, includes
all costs incurred in production which cannot be classed as mate-
rial or direct labor. Manufacturing expense includes, among
other things, indirect labor, depreciation of the factory building
and equipment, power, supplies, taxes and insurance on the assets
used in manufacture, and repairs and upkeep of the factory.
The cost of finished goods manufactured during a given period
cannot be determined, however, merely by adding the costs incurred
during the period for ^materials, direct labor, and manufacturing
expense. There may be unfinished goods, called goods in process,
on hand at the end of the period, and the cost of these unfinished
goods must be deducted to determine the cost of goods finished.
Similarly, there may have been goods in process at the beginning
of the period, and these must also be taken into consideration.
Operating statements. The operating statements of manu-
facturing companies do not necessarily differ from those of trading
companies except in one particular: the statements of manufac-
turing companies show the cost of goods manufactured (as deter-
mined in the statement of cost of goods manufactured), whereas
the statements of trading companies show the cost of goods
purchased. The profit and loss statement follows.
THE ABC COMPANY Exhibit C
Statement of Profit and Loss
Year Ended December 31, 1954
Gross sales.. . .. $300,000
Deduct:
Returned sales and allowances $ 2,000
Discount on sales 2,500 4,500
Net sales . . ... . 7 ~ $295,500
Deduct cost of goods sold:
Finished goods inventory, December 31, 1953 $ 20,000
Cost of goods manufactured — per Exhibit D 210,625
Total . . . $230,625
Deduct finished goods inventory, December 31, 1954 17,000
Cost of goods sold 7771 213,625
Gross profit on sales (forward) $ 81,875
Ch. 13] MANUFACTURING ACCOUNTS 187
Gross profit on sales (brought forward) $ 81 ,875
Deduct expenses:
Selling expenses:
Advertising $ 9,000
Salesmen's salaries 20,360
Salesmen's traveling expense 8,000
Miscellaneous selling expense 2,500 $ 39,860
General expenses:
Officers' salaries $18, 000
Office salaries 3,040
Stationery and printing 400
Office supplies 300
Depreciation of furniture and fixtures 750
Bad debts 800
Miscellaneous general expense 700 23 , 990
Total expenses 7. . . . 63,850
Net income before federal income tax . . .. . $ 18,025
Federal income tax 5 , 500
Net income . $ 12,525
Statement of cost of goods sold. Some accountants prepare
a statement of cost of goods sold instead of a statement of cost of
goods manufactured. Such a statement would be similar to the
statement of cost of goods manufactured, on page 185, except that
the title would be changed from "Cost of Goods Manufactured"
to "Cost of Goods Sold/7 and would appear as follows:
THE ABC COMPANY Exhibit D
Statement of Cost of Goods Sold
Year Ended December 31, 1964
and the finished goods inventories would appear in the statement,
as shown below:
Cost of goods manufactured $210,625
Add finished goods inventory, December 31, 1953 20 . OOP
Total $230,625
Deduct finished poods inventory, December 31, 1954 . . . 17,000
Cost of goods sold. . . S2T3.625
The matter thus included in the statement of cost of goods
sold would be excluded from the profit and loss statement, which
would then show the computation of the gross profit as follows:
THE ABC COMPANY Exhibit C
Statement of Profit and Loss
Year Ended December 31, 1954
Gross sales .. . . $300,000
Deduct :
Returned sales and allowances . . ... $2,000
Discount on sales . 2,500 4,500
Net sales . . . $295,500
Deduct cost of goods sold — per Exhibit D 213,625
Gross profit on sales $ 81 ,875
1 88 MANUFACTURING ACCOUNTS [Ch. 1 3
Surplus statement. There are no unusual features in the
earned surplus statement of a manufacturing company. The
statement of The ABC Company appears below.
THE ABC COMPANY Exhibit B
Statement of Earned Surplus
Year Ended December 31, 1954
Balance, December 31, 1953. . . $71 ,450
Net income for the year, per Exhibit C 12,525
Total $83,975
Less dividends . . . 6,000
Balance, December 31, 1954 . $77,975
/ ' "
Balance sheet. The balance sheet of a manufacturing com-
pany will usually contain three inventory accounts (finished goods,
goods in process, and raw materials) and certain factory fixed
asset account balances. The balance sheet of The ABC Com-
pany is shown on page 189.
Working papers. The illustrative statements were prepared
from the working papers on pages 190 and 191. These working
papers have a new pair of columns headed Manufacturing, which
contain all of the amounts used in determining the cost of goods
manufactured.
Adjusting and closing entries* Following are the adjusting
entries; the closing entries are on pages 192 and 193.
Dec. 31 Bad debts 800 00
Reserve for bad dcjbts . ... 800.00
To increase the reserve to $1,000.
31 Depreciation of buildings . . 3,50000
Reserve for depreciation — Buildings 3 , 500 00
To provide for depreciation at 5% per annum.
31 Depreciation of machinery and equipment 0,000.00
Reserve for depreciation — M. & E. 0,000 00
To provide for depreciation at 10% per annum.
31 Depreciation of furniture and fixtures 750 00
Reserve for depreciation — K. & F. 750 00
To provide for depreciation at 15% per annum
31 Direct labor 750 00
Indirect labor 1 25 00
Salesmen's salaries 360 00
Office salaries . . 40 00
Accrued salaries and wages payable 1 , 275 00
Salaries and wages accrued and unpaid at end of year.
31 Insurance.. . . 95000
Unexpired insurance . 950.00
Insurance expired during year.
31 Federal income tax 5,500 00
Federal income tax payable 5,500.00
Tax for 1954.
Ch. 13]
MANUFACTURING ACCOUNTS
189
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Ch. 13]
MANUFACTURING ACCOUNTS
191
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The procedure for closing the books of a manufacturing con-
cern involves setting up a Manufacturing account and debiting
and crediting it with the totals of all of the items appearing in the
Manufacturing columns of the working papers.
Dec. 31 Manufacturing 233,32500
Haw materials inventory (12/31/53) . . 12,000 .00
Goods in process inventory (12/3 1 /53) . 15, 000 . 00
Purchases— Raw materials 94 , 000 . 00
Freight in. . 800 00
Direct labor .. 80,750.00
Indirect labor . 9 , 125 . 00
Heat, light, and power. 3,500 00
Building and machinery repairs 300 00
Depreciation — Buildings . 3,500.00
Depreciation — Machinery and equipment 6 , 000 . 00
Insurance . . 950.00
Taxes 1,400 00
Factory supplies . 3 , 500 00
Miscellaneous factory expense 2 , 500 00
To close manufacturing accounts with debit-
balances.
31 Returned purchases and allowances 1 ,500 00
Discount on purchases. 1,200 00
Raw materials inventory (12/31/54) 9,000 00
Goods in process inventory (12/31 /54) 1 1 ,000 00
Manufacturing 22 , 700 . 00
To close manufacturing accounts with credit bal-
ances and record end-of-year inventories.
The closing procedure is completed by debiting and crediting
Profit and Loss with all of the items appearing in the Profit and
Loss columns of the working papers and transferring the net
income and the balance of the Dividends account to Earned
Surplus.
Dec. 31 Profit and loss . .210,625 00
Manufacturing .. . 210,62500
To close the Manufacturing account.
3 1 Profit and loss 93 , 850 00
Finished goods inventory (12/31/53) 20,000 00
Returned sales and allowances 2,000 00
Discount on sales 2 , 500 00
Advertising . 9 , 000 . 00
Salesmen's salaries . 20 , 360 00
Salesmen's traveling expense 8,000 00
Miscellaneous selling expense . 2,500 00
Officers' salaries 18,000 00
Office salaries. 3,040 00
Stationery and printing . . 400 00
Office supplies 300 00
Depreciation — Furniture and fixtures 750 00
Bad debts . 800 00
Miscellaneous general expense 700 00
Federal income tax 5,500.00
To close accounts with debit balances.
Ch. 13]
MANUFACTURING ACCOUNTS
193
Dec. 31 Sales ... . 300,000 00
Finished goods inventory (12/31 /54) . 1 7 , 000 00
Profit and loss . 317 , 000 . 00
To close the Sales account and record end-of-
year inventory of finished goods.
31 Profit and loss. . 12,52500
Earned surplus ... 12,525 00
To transfer net income to learned Surplus.
31 Earned surplus . 6 , 000 00
Dividends . 6,000 00
To close the Dividends account.
Apportioned items in the working papers. If an expense
charged to one expense account is to be apportioned (as between
manufacturing and selling expenses, or among manufacturing,
selling, and general expenses), the apportionment may be indi-
cated in the working papers in the manner illustrated below.
Observe that, when a portion of an expense is classified as Selling
Expense and another portion of the same expense is classified as
General Expense, the two portions are identified by the letters
S and G. These letters may also be used if an expense is not
apportioned between Selling and General but the title of the
account does not clearly indicate whether the items should be
classified as Selling or General.
Trial Balance
Manufacturing
Profit and Loss
Taxes
Rent of building
3,000
6,000
2,000
5,000
f 600 S
I 400 G
1.000 G
If an account balance is apportioned in part to manufacturing
and in part to selling and /or general expense, the journal entries
closing the books should give recognition to the apportionment.
A portion of the account balance should be transferred to the
Manufacturing account and the remainder should be transferred
to Profit and Loss.
CHAPTER 14
The Voucher System
Vouchers. In a small business the proprietor may check
every invoice before it is recorded and sign every check. He is
thus in a position to satisfy himself of the propriety of each entry
recording a liability, 'and the propriety of drawing a check in pay-
ment of the liability. In large businesses this work must be
delegated to others, and the system of office procedure and internal
control should be such as to give assurance that responsible
employees satisfy themselves as to the propriety of recording a
liability and issuing a check in payment thereof. Also, there
should be documents indicating which members of the organiza-
tion satisfied themselves of the propriety of recording the liability
and the propriety of issuing a .Qheck.
When the voucher system is used, the propriety of recording
liabilities and issuing checks in payment thereof is evidenced by a
voucher and supporting papers attached to it.
Preparing the voucher. The office procedures for the prepara-
tion of vouchers vary in different businesses. The procedures
described below are indicative of the desired objectives and of one
acceptable method of achieving them.
Chapter 6 contains a description of the method of checking
invoices received from creditors. The illustration in that chapter
was based on an invoice which is repeated on page 195.
It will be remembered that a check sheet in the following form
was attached to the invoice, and was initialled by employees in
the purchasing and accounting departments to show that they
had made the indicated verifications.
Goods checked to invoice ^'Q'
Invoice checked to purchase order for: «
Merchandise
Prices
Discount terms
Freight terms
Invoice footings and extensions checked
Approved for payment V
Paid by Check No.-
194
Ch. 14]
THE VOUCHER SYSTEM
195
THE OSBORNE COMPANY
215 West Canal Street
Chicago, Illinois
Invoice No *™7
Customer's Order No 1705
Date of Order V2/19-- TnvnW T>tf> Jul? 3» 19"
Sold to R- E- Johnson & Company TArmc
1/10; n/30
2913 North
Western Ave.
Chicago, 111. P. O. B.
Shipped to Same n*t*Shinnprf July 3
How Ship]
Car. No. t
r*rf Truck
fe Initials
Quantity
Description p }
ke *«»*
10 cases XXXX Strawberry Preserves 27.
15 cases Acorn Peanut Butter 9.
10 cases Acorn Peas 12,
80 278.00
20 138.00
40 124.00
540 . 00
Invoice
If a voucher system is in use, the checking of the invoice is
followed by the preparation of a voucher. The face and back of
a voucher are illustrated on page 196.
The steps in the preparation of this voucher were as follows:
(a) Using the information shown by the invoice (with check
sheet attached), a voucher clerk typed the information
shown on the face of the voucher and in the Summary
section on the back of the voucher.
(b) The voucher clerk attached to the face of the voucher the
invoice and any other documents related to the trans-
action. He then sent the voucher to the controller.
196
THE VOUCHER SYSTEM
[Ch. 14
R. E. JOHNSON & COMPANY
2913 North Western Avenue
Chicago, Illinois
Payee The Osborne Company,
Voiirhcr No l693
nofo July 6, 19—
Term* 1/10; V30
n,10 July 12
215 West Canal Street,
Oh** No.
Chicago, Illinois.
Invoice Date '
Invoice No. Amount
July 3, 19—
Cash Discount
Net
2397
540.00
5.40
534.60
Approved fi.di&LfatMAJ PA ftsp.04 for Payment
* Controller Treasurer
Face of Voucher
Distribution
Summary
purchases .
1 fiQ*3!
Freight In
nnfo July 6, 19 -
Freight Out •••
r ,
T)*itp Duo u.Ly -L«j | _Ly— —
Advertising * • •
PatA PfliH
Delivery Expense
^ rh^rk NA
Misc Selling Expense . . -
43
^-j Arpoiint of ohnnW
Office Salaries
2 Tn The Os"borne Company,
Officers Salaries . . .
Oflfio** Rnr>r»1ip<!
.52 215 W. Canal Street,
Stationery & Printing . .
JS Chicago, Illinois.
o K/II^ r\r\
> Amount 540.00
Discount 5'40
N-t 534.60
"
Total
Back of Voucher
Ch. 14]
THE VOUCHER SYSTEM
197
(c) The controller examined the voucher and the documents
attached to it, and assured himself that the checking of
the invoice, as described in Chapter 6, had been per-
formed, and that R. E. Johnson & Company actually
owed the amount of the voucher. The controller's
signature on the voucher indicates that he made this
examination.
Recording the voucher. In a large business, much of the book-
keeping work may be done by assistant bookkeepers who must
be told what accounts to debit and credit. Therefore, the back
of the voucher may be printed with the names of accounts most
frequently debited, and blank lines may be left on which to write
the names of other accounts which may be debited. Before the
voucher was given to the assistant bookkeeper to be recorded, the
head bookkeeper (or some other employee competent to do so)
filled in the Distribution section on the back of the voucher to
indicate the debit to be made by the assistant bookkeeper. The
name of the account to be credited is not stated on the back of
the voucher, because all credits arc made to a liability account called
Vouchers Payable. After the Distribution section was completed,
the back of the voucher appeared as follows:
Distribution
Summary
PnrviifleM 5*0.00
VniinliPr Nn 1695
Freight In .
Hat* July 6, 19--
Freight Out* . , ... .— —
nAteiw July 12, 19—
Advertising
Salesmen's Salaries _ - . _ _
Hal* Paid
Delivery Expense . , . ,
7? rtiprfr ISJn
Misc, Selling Expense ,
3
.J-t Amount of eheric
Office Salaries,
Oflfioorc* QilariPQ
2 T.O The Osborne Company,
Office Supplies
.8 215 W. Canal Street,
Stationery & Printing . . .
Ji Chicago. Illinois.
x
> Amount 540.00
Discount, , , M°
N*t 654.60
Total 5+0. 00
Back of Voucher
198 THE VOUCHER SYSTEM [Ch. 14
When a voucher system is in use, all vouchers are recorded in
a special book of original entry called a voucher register, which con-
tains numerous columns for accounts to be debited, thus provid-
ing many of the advantages of the columnar books of original
entry discussed in preceding chapters.
Note the following facts with respect to the voucher register
on page 199:
Numerous explanatory columns are provided at the left for
miscellaneous information about the transactions.
The Vouchers Payable column is a credit column ; the amount
of each voucher is recorded in this column, and the column
total is posted at the end of the month to the credit of
Vouchers Payable.
All the other columns are debit columns. Special columns
are provided for all accounts frequently debited. (Later
illustrations contain many more special columns.) Debits
to accounts for which special columns are not provided
are recorded by entries in the Sundry Accounts debit sec-
tion at the right of ths register, where space is provided
to write the names of the accounts debited as well as the
amounts.
The entry in the voucher register to record voucher No. 1693
debits Purchases and credits Vouchers Payable.
Filing the voucher until payment. After the voucher was
recorded in the voucher register, it was folded (at the line indi-
cated in the illustration, on page 196, of the back of the voucher)
with the documents inside and was filed in a tickler. A tickler
is a file divided into sections by months, with a subdivision for each
day.
The illustrative voucher shows that a 1% discount can be
taken if payment is made within 10 days from the date of the
invoice. It also shows (on the Due line) the date when payment
should be made so that the remittance will reach the creditor in
time to justify taking the discount. This date is July 12. There-
fore, the voucher is filed in the July 12 space of the tickler so that
it will receive attention on that date.
You can now see the purpose of the Summary section on the
back of the voucher. This section shows most of the important
facts relative to the voucher. The voucher is filed with this sec-
tion facing to the front; anyone looking through the voucher file
for a particular voucher can locate it without being obliged to
open the vouchers to read from the face.
Ch. 14]
THE VOUCHER SYSTEM
199
g
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s
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111
^,25
c
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200
THE VOUCHER SYSTEM
[Ch. 14
Paying the voucher. On July 12 the voucher was taken from
the tickler and sent to the treasurer for approval of payment.
The treasurer examined the documents and authorized the pay-
ment by signing the voucher on the line " Passed for Payment."
R. E. JOHNSON & COMPANY
2913 North Western Avenue
Chicago, Illinois
Payee The Osbo^ne Company,
Voucher No. l693
Date July 6, 19 —
Terms VlO; n/30
ni1^ July 12
215 West Canal Street,
Check No.
Chicago , Illinois .
Invoice Date
Invoice No. Amount
July 3, 19--
Cash Discount
Net
2,597
540.00
5.40
534.60
Approved 6.A<D2UteAJ POCSM* for Payment &&3&fa&*
* Controller Treasurer
Face of Voucher
The cashier then performed the following operations:
(a) Drew a check.
(b) Entered in the Summary section, on the back of the
voucher, the date of payment, the number of the
check, and the amount of the check. The Summary
section then appeared as shown on page 201.
(c) Sent the check to the creditor.
(d) Sent the voucher to the bookkeeper, to record payment.
Recording the payment. The notations made by the cashier
in the Summary section on the back of the voucher (on the lines
for Date Paid, Check No., and Amount of check) furnished the
bookkeeper with all of the information that he required to record
the payment. The recording of the payment included:
(a) Making an entry in a check register.
A check register is a cash disbursements book under another
name. Because every voucher is recorded in the
voucher register with a credit to Vouchers Payable,
Ch. 14]
THE VOUCHER SYSTEM
201
Distribution
54-0.00
Freight In
Freight Out .
Advertising
Salesmen's Salaries
Delivery Expense
Misc. Selling Expense
Office Salaries
Officers' Salaries
Office Supplies
Stationery & Printing
Total
5*0. 00
Summary
Voucher No.
Date
1693
19--
Date rw July 13, 19 —
Date Paul Ujutstof /2.S4--
Amount of check.
The Osborne Company,
215 w. Canal Street.
Chicago . Illinois .
> Amount.
Net
540 . 00
5.40
534.60
Back of Voucher
every entry in the check register to record the payment
of a voucher includes a debit to Vouchers Payable.
The entries in the voucher register and the check register
for the recording of a voucher and its payment are:
Entry in voucher register:
Debit the account (or accounts) chargeable with
the expenditure. Credit Vouchers Payable.
Entry in the check register:
Debit Vouchers Payable. Credit Cash (and Dis-
count on Purchases, if a discount is taken).
The check register on page 202 shows how the payment of
voucher No. 1693 was recorded. The entry shows the
number of the check issued and the number of the
voucher paid. Vouchers Payable account is debited and
Discount on Purchases and Cash are credited.
(b) Writing notations in the Date Paid and Check No. col-
umns of the voucher register. Observe the notations
in these columns in the voucher register on page 202.
Filing the paid voucher. After the entry was made in the
check register arid the notations were made in the voucher register,
the voucher was filed in a paid voucher file. Paid vouchers usu-
ally are filed in numerical order, so that they can be found easily.
202
THE VOUCHER SYSTEM
[Ch. 14
3
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8
3
i
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I
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1!
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Ch. 14] THE VOUCHER SYSTEM 203
Since each voucher is signed by persons having authority to
approve the expenditure and has attached to it the creditor's
invoice and any other supporting documents, it furnishes evidence
of the propriety of the entries in the voucher and check registers.
Vouchers for immediate disbursements. The preceding dis-
cussion shows the procedure to be followed if some time elapses
between the drawing of the voucher and its payment. The pro-
cedure is the same for transactions involving the immediate
payment of a voucher except that the filing of the voucher in a
tickler to await the payment date is omitted. The other steps are :
Preparing the voucher.
Recording the voucher in the voucher register.
Paying the voucher.
Recording the payment.
Filing the paid voucher.
Observe that an entry is made in the voucher register crediting
Vouchers Payable even though the voucher is immediately paid.
There are two reasons why this is done:
(1) When a voucher system is in operation, no check can be
drawn without a voucher, and each voucher should be
recorded in the voucher register so that all vouchers
(which are prenumbered) will be accounted for.
(2) It is advantageous to use the special debit columns which
are provided in the voucher register.
Extended illustration. A voucher register and a check register
containing the record of a month's transactions appear on pages
206, 207, and 208. To provide a large number of distributive
debit columns, the voucher register extends across two facing
pages. (In the illustration, the left page is printed above the
right page.) Observe how the following transactions are recorded
in the voucher register and in the check register.
Summary of August Transactions and Entries
Aug. 1 — Received merchandise from Barnard & Co. :
VOUCHER REGISTER CHECK REGISTER
Purchases
Vouchers payable (Later)
3 — Paid freight on merchandise purchased :
VOUCHER REGISTER CHECK REGISTER
Freight in Vouchers payable
Vouchers payable Cash
The date paid and check number are entered in the voucher
register. (This should be done each time a voucher is paid.)
204 THE VOUCHER SYSTEM [Ch. 14
Aug. 4 — Paid Daily News for advertising:
VOUCHKR REGISTER CHECK REGISTER
Advertising Vouchers payable
Vouchers payable Cash
4- Paid freight:
VOUCHER RKGISTKR CHECK REGISTER
Freight in Vouchers payable
Freight out Cash
Vouchers payable
5- — Paid Davis Supply Co. for office supplies and stationery:
VOUCHER REGISTER CHKCK REGISTER
Office supplies Vouchers payable
Stationery and printing Cash
Vouchers payable
7— Paid G. E. Wilson for note and interest:
VOUCHER REGISTER CHECK REGISTER
Notes payable Vouchers payable
Interest expense - Cash
Vouchers payable
The debit to Notes Payable was entered in the Sundry Ac-counts
section.
8— Paid Barnard & Co. voucher 1 :
VOUCHER REGISTER CHECK REGISTER
(Notations in Date Paid and Vouchers payable
Check Number columns) Discount on purchases
Cash
1O Received merchandise from L. N. Whitely:
VOUCHER REGISTER CHECK REGISTER
Purchases
Vouchers payable (Later)
15 — Paid store rent for the month:
VOUCHER REGISTER CHECK REGISTER
Store rent Vouchers payable
Vouchers payable Cash
The debit was entered in the Sundry Accounts section.
17 — Received merchandise from F. R. Mason & Co. :
VOUCHER REGISTER CHECK REGISTER
Purchases
Vouchers payable (Later)
Ch. 14] THE VOUCHER SYSTEM % 205
Aug. 19- Paid L. N. Whitely voucher 7:
VOUCHER REGISTER CHECK REGISTER
(Notations in Date Paid and Vouchers payable
Check Number columns.) Discount on purchases
Cash
23 Paid Acme Garage for August rent:
VOUCHER REGISTER CHECK RKGISTER
Delivery expense Vouchers payable
Vouchers payable Cash
20- Received merchandise from (Jeorge Martin:
VOUCHKR RKGISTER CHECK REGISTER
Purchases
Vouchers payable (Not paid in August)
26— Paid F. R. Mason & Co. voucher 9:
VOUCHER RKGISTER CHECK REGISTER
(Notations in Dale Paid and Vouchers payable
Check Number columns.) Discount on purchases
Cash
28-- Purchased postage stamps:
VOUCHER REGISTER CHECK REGISTER
Postage Vouchers payable
Vouchers payable Cash
30 Received merchandise from Dalton & Doane:
VOUCHER REGISTER CHKCK REGISTER
Purchases
Vouchers payable (Not paid in August)
31 Paid salaries for the month:
JOITRNAL,
Salesmen's salaries 500 00
Delivery expense . 350 00
Office salaries 250 00
Officers' salaries 600 00
Federal income taxes withheld ;H(> 00
Federal O A. B. taxes withheld 25 50
Accrued payroll ... 1 ,358 50
To record salaries expense, tax withholding*, and net
payroll liability.
Payroll taxes . . 76 50
Federal () A. B taxes payable 25 50
State unemployment taxes payable 45 90
Federal unemployment taxes payable 5 10
To record employers' taxes.
VOUCHER REGISTER CHECK REGISTER
Accrued payroll 1,358 50 Vouchers payable 1,358 50
Vouchers pay- Cash .... 1,35850
able 1,358.50
206
THE VOUCHER SYSTEM
[Ch. 14
You should understand that the illustration on these two pages represents two wide
facing sheets of a voucher register. The left side of the register appears at the top of
pages 206 and 207. The right side of the register appears at the bottom of the two
pages.
Left page
Line
No.
Voucher
No.
Dat
e
Payee
Explanation
Terms
Dat
Pai(
e
1
1
2
3
4
5
1
2
3
4
5
19—
Aug.
1
3
4
4
5
Barnard & Co
C. N. W. Ry
Daily News
C. N. W. Ry.
Davis Supply Co
Invoice, Aug. 1
Bill dated Aug. 3
Invoice 317
2/10,11/30
Cash
Cash
19—
Aug.
8
3
4
4
5
6
7
8
9
10
6
7
8
9
10
7
10
15
17
23
G. E. Wilson
L. N. Whitely .
B. N. Haines
F. R. Mason & Co
Acme Garage
Noto dated July 8
Invoice, Aug. 9
Rent for August
Invoice 2425
Rent for August
1/10; n/30
2/10; n/30
7
19
15
26
23
11
12
13
14
11
12
13
14
26
28
30
31
George Martin
Postmaster
Dalton & Doane
Payroll . . . r ."*
Invoice 1372
Invoice 3639
•
1/10; n/30
2/10; n/30
28
31
15
16
Register
D KB ITS
Line
No.
Miscella-
neous Sell-
ing Expense
Accrued
Payroll
Office
Supplies
Stationery
and
Printing
Postag
i
r
Interest
Expense
1
2
3
4
5
30
00
75
00
6
7
8
9
10
1,358
—
5
00
11
12
13
14
15
16
50
25
00
1,358
50
30
00
75
00
25
00
5
00
(15) (53) (54) (55) (61)
Ch. 14]
THE VOUCHER SYSTEM
207
Voucher
Check
No.
Credit
Vouchers
Payable
DEBITS
Line
No.
Purchases
Freight
In
Freight
Out
Adver-
tising
Delivery
Expense
6
1
2
3
4
1,500
18
150
35
105
00
00
00
00
00
1,500
00
18
20
00
00
15
00
150
00
1
2
3
4
5
5
8
7
10
9
1,005
3,500
200
2,600
25
00
00
00
00
00
3,500
2,600
00
00
00
00
25
00
6
7
8
9
10
11
12
1,750
25
1,875
1,358
00
00
00
50
50
1,750
1,875
00
00
00
00
11
12
13
14
15
16
14,146
11,225
00
38
15
150
25
(11) (31) (35) (41) (42) (45)
Right page
Sundry Accounts
Name of Account
L.F.
Amount
Notes payable
Store rent
12
43
1,000
200
00
00
00
1,200
Remarks
Line
No.
1
2
3
4
J
6~
7
8
9
10
11
12
13
14
15
16
208
THE VOUCHER SYSTEM
Check Register
[Ch. 14
('RED IT
-|-v,.v Ji.
Check
No.
Date
Payee
Voucher
No.
Debit
Vouchers
Payable
Discount
on Pur-
Cash
chases
1
19—
Aug.
3
C. N. W. Ry
2
18
00
18
00
2
4
Daily News
3
150
00
150
00
3
4
C. N. W. Ry
4
35
00
35
00
4
5
Davis Supply Co.
5
105
00
105
00
5
7
G. E. Wilson
6
1,005
00
1,005
00
6
8
Barnard & Co
1
1,500
00
30
00
1,470
00
7
15
B. N. Hames
8
200
00
200
00
8
19
L. N. Whitely
7
3,500
00
35
00
3,465
00
9
23
Acme Garage
10
25
00
25
00
10
26
F. 11. Mason & Co
9
2,600
00
52
00
2,548
00
11
28
Postmaster.
12
25
00
25
00
12
31
Payroll
14
1,358
50
1,358
50
10,521
50
117
00
10,404
50
(11)
(71)
(1)
Posting from the voucher register. The entries in the Sundry
Accounts debit section should be posted during the mouth. At the
end of the month, the columns of the voucher register are footed.
The total of the footings of the debit columns should be compared
with the footing of the Vouchers Payable credit column to see that
the debits and the credits in the voucher register are equal. Post-
ings are then made as follows:
Credit: Vouchers Payable — column total.
Debits: Totals of all special debit columns.
Posting from the check register. At the end of the month, the
columns of the check register are footed, and the total of the Vouch-
ers Payable debit column is compared with the sum of the totals of
the two credit columns (Discount on Purchases and Cash). Post-
ings are then made as follows:
Debit: Vouchers Payable- column total.
Credits: Discount on Purchases —column total.
Cash—column total.
Use the letters Ch R in the ledger accounts to indicate postings
from the check register.
Elimination of accounts payable ledger. When a voucher sys-
tem is in use, a subsidiary ledger with accounts payable is not
required; it is possible to determine the individual liabilities at any
Ch. 14]
THE VOUCHER SYSTEM
209
date by merely noting the unpaid items in the voucher register.
To illustrate, posting the totals of the Vouchers Payable column
in the voucher register and the Vouchers Payable column in the
check register in the preceding illustration will produce the follow-
ing controlling account:
Vouchers Payable
19—
AUK.
31
OhRl
10,521
I19-
50Aug.
31
VR1
14,146
50
This account has a credit balance of $3,625. The individual
liabilities making up this total are the items in the voucher register
with no notations in the Date Paid and Check Number columns.
A schedule of the unpaid vouchers can be prepared as follows :
Schedule of Vouchers Payable
August 31, 19 —
Voucher
No. Payee
Amount
11 George Martin
13 Dalton & Doane
Total
1,750 00
1,875 00
3,625 00
The elimination of the accounts payable subsidiary ledger is a
major advantage of the voucher system, as a great deal of posting
labor is thereby avoided.
Some companies like to be able to determine the purchases
made from each creditor by keeping a file, with a card for each
creditor, on which are listed the date and the number of each
voucher payable to him. Such a card might appear as follows:
J. B. Henderson,
1357 North Calumet Avenue,
Chicago, Illinois
Date
Vo. No.
Date
Vo. No.
Date
Vo. No.
;*--
J*f3 15
135
Jw.zr
/*/
t
This card can be referred to when it is desired to determine the
numbers of the vouchers payable to each creditor, and the vouchers
can be obtained from the file.
Or, carbon copies of all vouchers may be made, and carbon
copies of the vouchers payable to each payee may be filed together.
210 THE VOUCHER SYSTEM [Ch. 14
Balance sheet title for liability. When a voucher system is in
use, the total liability on open vouchers is sometimes called
"Vouchers payable7' in the balance sheet. The better-known
title "Accounts payable" is probably preferable.
Partial payments. If, when an invoice is received, it is known
that it will be paid in installments, a separate voucher should be
made and recorded for each installment. If installment payments
are decided upon after one voucher for the entire invoice has been
made and recorded, a new voucher for each installment must be
prepared and recorded.
To illustrate, assume that voucher number 200 was prepared on
July 7 in the amount of $2,000, and recorded as shown in the
voucher register on page 211. On July 20 it was decided to make
an installment payment of $500; two new vouchers, numbers 255
and 256, were prepared and recorded in the register with a notation
"See Voucher 200 " in the Explanation column; the credits were
recorded in the Vouchers Payable column; the debit was also to
the Vouchers Payable account, and it was entered in the Sundry
Accounts debit section. A notation "See 255 and 256" was made
in the Date Paid and Check Number columns of the voucher regis-
ter on the line for voucher 200, thus indicating how the liability on
voucher 200 was cancelled. A check (number 945) was drawn in
payment of voucher 255; it was recorded in the check register, and
the date of payment and the check number were recorded in the
voucher register on the line for voucher 255.
The voucher and check registers are shown on page 211.
Exchange charges. If, at the time a voucher is drawn and
recorded, it is known that the payment will be made by a bank
draft or in some other manner which will involve an exchange
charge, the voucher may be made for the full amount of the pro-
spective disbursement, including the exchange, and Collection and
Exchange can be debited either in a special column of the voucher
register or in the Sundry Accounts section.
If the exchange charge is riot known until the disbursement
is made, at some date after the recording of the voucher, an entry
can be made in the journal, debiting Collection and Exchange and
crediting Vouchers Payable. For instance:
On June 10, merchandise was purchased for $500; voucher 27
was prepared, and an entry was made in the voucher reg-
ister debiting Purchases and crediting Vouchers Payable.
On June 25, a bank draft for $500 was purchased and mailed
to the creditor; the bank draft was paid for by a check to
the bank in the amount of $500.25, the $.25 being an
exchange charge. (Continued on page
Ch. 14)
THE VOUCHER SYSTEM
211
1
02
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212
THE VOUCHER SYSTEM
[Ch. 14
An entry should be made in the journal as follows:
Collection and exchange ....
Vouchers payable (No. 27)
Exchange charged by bank on bank draft for $500 purchased
for payment of voucher 27.
25
25
And an entry should be made in the check register debiting
Vouchers Payable and crediting Cash, $500.25.
If exchange charges are frequently incurred, the journal entry
procedure just described can be avoided by providing a Collection
and Exchange debit column in the check register.
Returned purchases and allowances. Assume that a purchase
of merchandise, on invoice A1316, costing $500, with terms of
2/10; n/30, is made from Keith & Co. on November 5, and that
voucher No. 2324 is prepared and recorded in the voucher register,
as shown in the first voucher register on page 213.
Assume, further, that some of the merchandise is returned to
Keith & Co. and that a credit memorandum for $45 is received
on November 9. An entry in the journal is made as follows:
Nov. 9 Vouchers payable (No. 2324)
Returned purchases and allowances
Credit memo No. 239.
45 00
45 00
A notation is made on the face of the voucher, so that,
when it is taken out of the tickler for payment, the cashier will
draw a check for only the net amount. The credit memo is
attached to the voucher.
The list of open vouchers prepared at the end of the month
should show the net liability on each voucher. To make it easy
for the bookkeeper to prepare the list, the voucher register may be
provided with Deductions columns in which a memorandum
notation (not to be posted, because postings are made from the general
journal) may be entered in the manner illustrated in the second
voucher register on page 213.
If there are enough returns and allowances to warrant it, a
returned purchases and allowances book may be used. The entry
in such a book would be made as follows :
Returned Purchases and Allowances Book
Date
Name
Explanation
Voucher
No.
Amount
19—
Nov.
9
Keith & Co
Cr. Memo 239
2324
45
00
Ch. 14]
THE VOUCHER SYSTEM
213
£
I
&&
«T5 I
22 r
00
§
o
0;
e
o
.2
"S
Cj
13L
K
o
X
a;
-s
3
214 THE VOUCHER SYSTEM [Ch. 14
At the end of the month, the column total would be posted to
the debit of Vouchers Payable and to the credit of Returned Pur-
chases and Allowances. Memorandum notations, of the nature
previously described, would be made on the face of the voucher
and in the Deductions columns of the voucher register.
Notes payable. Several methods are available for dealing with
notes payable issued for merchandise or other purchases. The fol-
lowing method will usually be found satisfactory:
(1) Record the purchase in the usual way in the voucher regis-
ter, debiting Purchases (or another appropriate account)
and crediting Vouchers Payable.
(2) Make a journal entry for the issuance of the note, debiting
Vouchers Payable and crediting Notes Payable. In the
voucher register, indicate the issuance of the note by a
memorandum, " Canceled by note," in the Deductions
section, and by entering the date of the issuance of the
note in the Date Paid column.
(3) At the maturity of the note, make a new voucher and
record it in the voucher register, debiting Notes Payable
(and Interest Expense, if the note bears interest) and
crediting Vouchers Payable.
(4) Record the payment of the note by an entry in the check
register, debiting Vouchers Payable and crediting Cash.
Journal entries charging Vouchers Payable should show the
number of the voucher, thus:
Vouchers payable (No. 3)
Notes payable
CHAPTER 15
Alternative Adjustment Procedures
Chapter 3 contains a discussion of adjustments for accruals of
unrecorded income and expense, and for apportionments of
recorded income and costs. On page 54 of Chapter 4 there is a
statement of the procedures to be followed when income that had
accrued and had been recorded by an adjusting entry at the end
of one period is collected in a subsequent period, and when an
expense, accrued and recorded by an adjusting entry at the end
of one period, is paid in a subsequent period. For the sake of
simplicity, no intimation was given in those chapters that alterna-
tive procedures are sometimes used. We shall now consider alter-
native procedures.
Accrued Income
Procedures previously described. The procedures described
in Chapters 3 and 4 for recording adjustments for accrued income
and the subsequent collection thereof were as follows:
Adjusting entry:
If a business has earned income for which no transaction
entry has been made, debit an asset account and credit
an income account.
Entry for collection:
When the income is subsequently collected, credit the asset
account (set up by the adjusting entry) with the amount
of the recorded accrual, and credit an income account with
any amount collected in excess of the recorded accrual.
For instance, assume that a company receives a 60-day, 6%
note for $1,000 on December 21, 1953, and collects the note and
interest on February 19, 1954.
Adjusting entry- December 31, 1953:
Accrued interest receivable 1.67
Interest income . . 1.67
Accrued interest for 10 days on $1,000 note.
Entry for collection- -February 19y 1954'
Cash ... . . 1,010.00
Accrued interest receivable . 1 . 67
Interest income 8 33
Notes receivable 1 ,000 00
Collection of note and interest.
215
216
ALTERNATIVE ADJUSTMENT PROCEDURES [Ch. 15
Alternative procedure. An alternative procedure is described
and illustrated below :
Adjusting entry — December 31, 1963 (Same as by the method
previously described) :
Accrued interest receivable
Interest income
Accrued interest for 10 days on $1,000 note.
1 67
1 67
Reversing entry- January
entry) :
Interest income
Accrued interest receivable
To reverse adjusting entry.
1954 (Reverses the adjusting
i 67
1 67
Entry for collection- February 19, 1954 (No apportionment of
income necessary) :
Cash
Interest income .
Notes receivable. .
Collection of note and interest.
1,010 00
10 00
1,000 00
When this procedure is used, the Accrued Interest Receivable
account and the Interest Income account appear as follows:
Accrued Interest Receivable
1953
Dec.
31
Adjustment
1
11954
67|Jan.
1
Reversal
1
67
Interest Income
1953
Dec.
31
To Profit and Loss
Reversal
1
67
1953
Dec.
31
19
Adjustment
Collection
—
1
67
1954
Jan.
1
1
67
1954
Feb.
10
00
Observe that the Interest Income account now has a credit
balance of $8.33, the amount of the interest income applicable to
1954.
Why reversing entries are desirable. The above illustration
shows that the two procedures produce identical results. Many
accountants believe that it is desirable to reverse the accruals,
because subsequent transactions can then be recorded without any
need to refer to prior accruals. In the preceding illustration, for
instance, if the accrual is not reversed, it is necessary, on February
19, when the note and interest are collected, to look up the amount
of interest accrued on December 31 in order to make the credit to
Accrued Interest Receivable. If there are many notes receivable,
this will be quite an inconvenience.
Ch. 1 5] ALTERNATIVE ADJUSTMENT PROCEDURES 21 7
Accrued Expense
Procedures previously described. The procedures described
in Chapters 3 and 4 for recording adjustments for accrued expenses
and the entries for the subsequent payment thereof may be sum-
marized as follows:
Adjusting entry:
If a business has incurred an expense for which no trans-
action entry has been made, debit an expense account and
credit a liability account.
Entry for payment:
When the expense is subsequently paid, debit the liability
account (set up by the adjusting entry) with the amount
of the recorded accrual, and debit an expense account with
any amount paid in excess of the accrual recorded by the
adjusting entry.
For instance, assume that a company issues a 60-day, 6%
note for $1,000 on December 21, 1953, and pays the note and
interest on February 19, 1954.
Adjusting entry December 31, 1953:
Interest expense . . 1 67
Accrued interest payable 1.67
Accrued interest for 10 days on note payable
Entry for payment — February 19, 1954:
Accrued interest payable 1 67
Interest expense ... 8 33
Notes payable 1 ,000 00
Cash 1,010 00
Payment of note and interest
Alternative procedure. The alternative procedure is described
and illustrated below:
Adjusting entry — December 31, 1953 (Same as by method pre-
viously described) :
Interest expense . I 67
Accrued interest payable 1 .67
A<!CTue,d interest for 10 days on note payable.
Reversing entry -January 1, 1954 (Reverses the adjusting
entry) :
Accrued interest payable 1 .67
Interest expense 1 .67
To reverse adjusting entry.
218
ALTERNATIVE ADJUSTMENT PROCEDURES [Ch. 15
Entry for payment — February 19, 1954 (No apportionment of
expense necessary) :
Interest expense 10 00
Notes payable 1 ,000 00
Cash 1,01000
Payment of note and interest.
When this procedure is used, the Accrued Interest Payable
account and the Interest Expense account appear as follows:
Accrued Interest Payable
1954
Jan.
1
Reversal
1
67
1953
Dec.
31
Adjustment
1
67
Interest Expense
1953
1953
Dec.
31
Adjustment
1
67
Dec.
31
To Profit and Loss
1
67
1954
1954
Feb.
19
Payment
10
00
Jan.
1
Reversal
1
67
Observe that the Interest Expense account now has a debit
balance of $8.33, the amount of the interest expense applicable
to 1954.
The words Adjustment, Payment, Reversal, and To Profit and
Loss are included above for explanatory purposes only, and need
not appear in the accounts.
Desirability of reversing entries. The remarks made in the
comparable paragraph in the discussion of accrued income are
equally applicable here.
Apportionments of Recorded Costs
Procedure previously described. The following procedure
was described in Chapter 3 :
If an expenditure benefits only the period in which it is made,
the cost should be debited to an expense account.
If an expenditure will benefit more than one period, it is prop-
erly chargeable to an asset account; at the end of each period
benefited by the expenditure, the portion of the cost expired
during the period should be transferred, by an adjusting
entry, from the asset account to an expense account.
Alternative procedure. An alternative procedure is stated
below:
Charge all expense expenditures to expense accounts, regard-
less of the number of periods that will be benefited.
Ch. 15] ALTERNATIVE ADJUSTMENT PROCEDURES 219
At the end of each period, the portion of the cost unexpired at
the end of the period should be transferred, by an adjusting
entry, from the expense account to an asset account.
At the beginning of the next period, reverse the adjusting
entry.
The two procedures illustrated. Assume that a three-year fire
insurance policy is purchased on January 2, 1954 at a premium
cost of $300. Entries by the two procedures are shown below:
Original Debit to Asset Account Original Debit to Expense Account
January %, 1954 entry for expe?iditure:
Unexpired insurance 300 Insurance expense ... . 300
C1ash 300 Cash 300
Three-year fire policy. Three-year fire policy.
December 31, 1954 entry for apportionment:
Insurance expense 100 Unexpired insurance . . 200
Unexpired insurance . .. 100 Insurance expense. 200
To transfer one-third of pre- To set up as an asset the un-
miuni to expense. expired (two-thirds) portion
of the three-year premium.
January 1, 1955 reversing entry:
None. Insurance expense 200
Unexpired insurance 200
To reverse the adjusting
entry.
The acceptability of the above alternative procedures is evi-
dent when it is noted that the periodical statement results for
1954 by both procedures are identical. In both cases $100 is
shown in the profit and loss statement as an expense, and $200 is
shown in the balance sheet as an asset.
Reason for the reversing entry. To understand why the
reversing entry is desirable, let us assume that no reversing entry
was made and that another insurance policy was purchased in
1955 and charged to Insurance Expense. At the end of 1955,
when it came time to make the annual adjusting entry, part of
the apportionable costs would be in the Unexpired Insurance
account and part would be in the Insurance Expense account.
This would be a confusing situation, which the reversing entry
avoids.
A second alternative procedure. A second alternative pro-
cedure for dealing with costs which are apportionable is described
on page 220:
220 ALTERNATIVE ADJUSTMENT PROCEDURES [Ch. 15
Charge all of the expenditures to a prepaid expense (asset)
account, regardless of the number of periods benefited.
At the end of each period benefited by the expenditure, the
portion of the cost expired during the period should be trans-
ferred, by an adjusting entry, from the prepaid expense
account to an expense account.
This procedure has the advantage of the first alternative
method, described on page 219, because it results in charging all
expenditures of the same nature to a single account, instead of
charging part to a prepaid expense account and part to an expense
account on the basis of the number of periods benefited. And it
has the advantage of the method described in Chapter 3, because
it avoids the necessity of making a reversing entry.
The procedure is illustrated on page 221, and is contrasted
with the first alternative procedure. Observe that the expendi-
tures consist of a premium for a three-year policy and premiums
for one-year policies. Observe also that the procedure of charg-
ing all of these expenditures to the Unexpired Insurance account
makes reversing entries unnecessary.
Custom and convenience affect choice of method. When
should an expenditure be charged to an asset account, and when
should it be charged to an expense account? For certain trans-
actions, the answer is apparent.
Use an asset account if there is no expectation that any por-
tion of the expenditure will ever be chargeable to expense;
an expenditure for the purchase of land is an example.
Use an expense account if no portion of the expenditure will
benefit a future period; income tax expense is an example.
For other expenditures, when some or all of the cost will sooner
or later be assigned to expense, custom and convenience are the
factors which determine the selection of the account for the debit.
It is customary, for example, to debit an asset account at acqui-
sition for all items properly classifiable as fixed assets. Amounts
invested in fixed assets, if ultimately assignable to expense, reach
expense accounts by way of depreciation entries. It would not
be sensible to charge the cost of a fixed asset to a depreciation
expense account at acquisition and later by adjusting entries
remove the portion applicable to future periods.
It is sometimes impracticable for the person recording trans-
actions to determine, with a reasonable degree of accuracy at the
time of making the expenditure, whether the expenditure will
benefit more than one period. For instance, how long will store
Ch. 15] ALTERNATIVE ADJUSTMENT PROCEDURES
221
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222 ALTERNATIVE ADJUSTMENT PROCEDURES [Ch. 15
supplies last? In such cases the choice of procedure is largely a
matter of accounting policy; some accountants would charge the
expenditure to an asset account and make end-of-period transfers
to expense; others would charge the expenditure to an expense
account and make end-of-period transfers to an asset account, with
reversing entries at the beginning of the succeeding period.
Even when the apportionment of an expenditure to periods to
be benefited can be accurately made at the date of the expenditure,
a strict application of the rule stated in Chapter 3 may be undesir-
able. For example, during any given year some expenditures for
insurance might benefit only the current year whereas others
might benefit a longer period of time. If the tentative rules
stated in Chapter 3 were followed, some premiums (those on
policies expiring before the end of the accounting period) would
be charged to Insurance Expense and other premiums (those on
policies not expiring before the end of the accounting period)
would be charged to Unexpired Insurance. Such a procedure
would result in the use of two insurance accounts for current trans-
actions, which might cause some confusion. To avoid such con-
fusion, it might be preferable to charge all premiums to either the
asset or the expense account, and to make the adjusting and
reversing entries consistent with the method adopted.
It is of some significance to recognize that, even if, at the time
of making an expenditure, a determination were made of the period
or periods affected by the transaction, adjusting entries would not
necessarily be avoided nor would their number always be mini-
mized. Referring to the immediately preceding paragraph, the
use of both an Insurance account and an Unexpired Insurance
account for the payment of premiums would not avoid the neces-
sity of making an adjusting entry for the expired portion of the
premiums charged to Unexpired Insurance.
Failure to adhere strictly to either the procedure stated in
Chapter 3 or the alternative procedure stated in this chapter for
recording expenditures cannot be considered to be wrong so long
as the transaction entry and the adjusting and reversing entries
together effect a correct apportionment of costs to the periods
benefited. For instance, it would not be a mistake to charge
insurance premiums to Unexpired Insurance, an asset account,
even though the policies expired during the current accounting
period. It would be wrong to leave the premium in the asset
account at the end of the period and show it in the balance sheet
as an asset when in fact the policy and the premium had expired.
The considerations noted above have created a situation in
accounting practice where it is considered acceptable to charge an
Ch. 15] ALTERNATIVE ADJUSTMENT PROCEDURES 223
expense expenditure to either a prepaid expense (asset) account
or an expense account, regardless of the number of time periods
affected, provided that adjusting and reversing entries are made
in such a way as to effect a proper apportionment of cost, for
periodical statement purposes, between expired cost (expense) and
unexpired cost (asset).
Apportionments of Recorded Income
Procedure previously described. Collections may be received
for services to be rendered in the future. The following procedure
for dealing with such collections was described in Chapter 3 :
If the service will be completely performed, and the total
thereby earned, during the accounting period in which the
collection is received, an income account should be credited
at the time of the collection.
If the service will not be completely performed during the
period in which the collection is received, the entire amount
should be credited to an unearned income account; at the
end of each period during which service is performed, the
portion of the income earned during the period should be
transferred by an adjusting entry, from the unearned income
account to an income account.
Alternative procedure. An alternative procedure is stated
below :
Credit all income collections to income accounts, regardless of
the number of periods over which the income will be earned.
At the end of each period, the portion of the income unearned
at the end of the period should be transferred, by an adjusting
entry, from the income account to an unearned income
account.
At the beginning of the next period, reverse the adjusting entry.
The two procedures illustrated. Assume that, on December 1,
1953, cash in the amount of $300 is collected as rent of a portion
of our building for three months. Entries by the two procedures
are shown below:
Original Credit to Unearned Income Original Credit to Income
December 1, 1953 entry for collection:
Cash 300 Cash. 300
Unearned rent income 300 Rent income 300
Collection of rent for three Collection of rent for three
months. months.
224 ALTERNATIVE ADJUSTMENT PROCEDURES [Ch. 15
December 31, 1953 entry for apportionment:
Unearned rent income 100 Rent income. 200
Rent income . 100 Unearned rent income 200
To transfer December rent To transfer January and
from unearned income ac- February rent to an un-
count to income account. earned income account.
January 1, 1954 reversing entry:
None. Unearned rent income 200
Rent income 200
To reverse the adjusting
entry.
The acceptability of the above alternative procedures is evi-
dent when it is noted that the periodical statement results for 1953
are identical. In both cases, $100 is shown in the profit and loss
statement as income, and $200 is shown in the balance sheet as
unearned income (under the current liabilities caption).
What was said in the discussion of apportionments of recorded
costs, under the captions " Reason for reversing entry" and
"Custom and convenience affect choice of method," is equally
relevant in relation to apportionments of recorded income.
Second alternative procedure. An alternative procedure for
dealing with income which is apportionable, comparable to the
second alternative procedure described for dealing with appor-
tionable costs, is described below:
Credit all income collections to unearned income accounts,
regardless of the number of periods over which the income
will be earned.
At the end of each period during which service is rendered and
income thereby earned, the portion of the income earned
during the period should be transferred, by an adjusting entry,
from the unearned income account to an income account.
This procedure has advantages comparable to those discussed
in connection with the second alternative method of dealing with
the apportionment of recorded costs: (1) it avoids the confusion
of credits to income accounts and unearned income accounts for
income collections of the same nature; and (2) it avoids the neces-
sity of making reversing entries.
Determining When Adjustments Are Required and the
Amounts Thereof
An inspection of the trial balance of the general ledger will
usually indicate the nature of the required adjustments. The
existence of balances in certain classes of asset accounts may sug-
Ch. 15] ALTERNATIVE ADJUSTMENT PROCEDURES 225
gest the necessity for adjustments. For instance, an Accounts
Receivable account suggests an adjustment for had debts; fixed
asset accounts suggest provisions for depreciation; a Notes Receiv-
able account suggests the possibility of a required adjustment
for accrued interest receivable.
The appearance of certain classes of liability accounts may call
the accountant's attention to the necessity for an adjustment.
For instance, a Notes Payable account suggests the possibility
of a required adjustment for accrued interest payable.
If any prepaid expense accounts or unearned income accounts
appear in the trial balance, they should immediately draw the
accountant's attention to the fact that adjustments for cost or
income apportionments may be required.
The accountant will do wisely to consider each income and
each expense account and ask himself whether there is any possi-
bility that an adjustment may be in order, either for an accrual or
for an apportionment.
Although an inspection of the trial balance may suggest the
nature of the required adjustments, it usually is necessary to have
recourse to other sources of information to determine the amounts
of the adjustments. For instance, the amount of the provision
for bad debts may be based on loss experience or a review ol the
receivables; provisions for depreciation are governed by the
established rates and the accounting policy with respect to depre-
ciation for fractional periods; insurance premium apportionments
may be determined by an inspection of policies or of an insurance
register; and interest adjustments may be determined by an in-
spection of notes or of note registers.
CHAPTER 16
Partnerships (Concluded)
Chapter 8 dealt with some of the fundamentals of partnership
accounting. This chapter deals with the following more advanced
material: miscellaneous methods of dividing profits and losses;
changes in personnel; and liquidation of the partnership.
Miscellaneous Methods of Dividing Profits and Losses
Determinants of an equitable division. Some of the things
which should be given consideration in the determination of an
equitable division of partnership profits are :
The relative amounts of capital furnished by the partners.
The relative values of the services rendered by the partners.
These may differ because of differences in business ability
and/or time devoted to partnership affairs.
Various matters, such as seniority, business contacts, profit
potential of a going business contributed by a partner, and
the degree of risk-taking. The degree of risk-taking depends
on the dangers of loss and the relative amounts of the part-
ners' capitals, as well as their outside assets to which the firm
creditors may have recourse for the payment of partnership
debts.
Methods of dividing profits and losses. Various methods of
dividing partnership profits and losses are discussed below, under
the following captions:
(1) In a fractional ratio.
(2) In a capital ratio.
(3) Interest on capitals, and the remainder in a fractional
ratio.
(4) Salaries to partners, and the remainder in a fractional
ratio.
(5) Salaries, interest, and the remainder in a fractional ratio.
Any agreement with respect to the division of profits applies
also to the division of losses. In the absence of an agreement with
respect to the division of profits, the law assumes an agreement to
divide them equally.
226
Ch. 16]
PARTNERSHIPS (CONCLUDED)
227
Basis of illustrations. For purposes of illustration we shall
assume that the capital accounts of two partners appear as follows :
J. L. Lane, Capital
1954
Juno
Nov
1954
CD 6
500
00
Jan.
1
CD11
1,500
00
Aug.
1
OR 1
10,
CR 8
2,
'
00000
00000
D. K. Burton, Capital
1954
1
1954
Apr.
1
CD 4 1,000
00
Jan.
1
CR 1
20,000
00
Dec.
1
CD 12 2,000
00
July
1
CR 7
2,000
00
The debit balances in the drawing accounts at the end of the
year were: J. L. Lane, $3,000.00; D. K. Burton, $4,000.00.
The balances in the drawing accounts represent the totals of
the agreed monthly drawings; the debits in the capital accounts
record withdrawals in excess of the agreed monthly amounts.
The income and expense accounts have been closed, and the
Profit and Loss account has a credit balance of $12,000, the amount
of the net income for the year.
The illustrative closing entries are based on an assumption
that there is no agreement to maintain fixed amounts of capitals;
therefore, the Profit and Loss and drawing accounts are closed to
the capital accounts.
(1) Divisions in a fractional ratio. The equal division of profits
in Chapter 8 is an illustration of a division in a fractional ratio.
To illustrate another fractional-ratio division, let us assume
that the partners, Lane and Burton, after consideration of the
determinants of an equitable division of profits, agree that ade-
quate recognition can be given to all of the determinants by
dividing the profits in the ratio of one-fourth to Lane and three-
fourths to Burton. The entries to close the books are:
Profit and loss 12,000 00
J. L. Lane, capital 3,000 00
D. K. Burton, capital 9,000 00
To divide1 the net income in the ratio of 25% and
75%.
J. L. Lane, capital ... 3 ,000 00
J. L. Lane, drawings. ... . 3,000 00
To close Lane's drawing account.
D. K. Burton, capital . 4 , 000 00
D. K. Burton, drawings. . 4,000 00
To close Burton's drawing account.
The entries closing the drawing accounts are omitted from the
remaining illustrations. They would be the same as those above.
228 PARTNERSHIPS (CONCLUDED) [Ch. 16
(2) Divisions in a capital ratio. If the capital investments are
the major source of income and the other determinants of an
equitable division of profits are not pertinent, the total profits may
be divided in a capital ratio. Two illustrations are given below :
Division in ratio of capitals at beginning of period. The capital
accounts on page 227 show the following balances on January 1 :
J. L. Lane . ... $10,000 00
D. K. Burton. 20,000 00
The net income division on this basis is shown below:
Capitals at
Partner * Beginning Fraction Amount
Lane .................. $10,00000 i$ $4,00000
Burton . . 20,000.00 2<j 8,000 00
Total $30,000 00 $12,000 00
Division in ratio of capitals at end of period. As an inducement
for partners to refrain from making withdrawals of material
amounts during the period for which income is being divided, and
to encourage them to invest additional capital as needed, it may
be preferable to divide the net% income in the ratio of the capitals
at the end of the period, thus:
Capitals
Partner at End Fraction Amount
................. $10,000.00 l%9 $ 4,137.93
Burton .......... 19,000.00 *%* 7,862 07
Total $29,000 00 $12,000 00
(3) Interest on capitals; remainder in fractional ratio. Suppose
that the partners agree that some consideration should be given to
capital investments, but that consideration should also be given to
other determinants of an equitable division of the net income.
Therefore, they agree to divide a portion of the net income in the
capital ratio by allowing 6% interest on the capitals, and to divide
the remainder in some other fractional ratio — say, equally. The
interest may be computed on the capitals at the beginning or at
the end of the year, as agreed ; in the following entries, the interest
is computed on opening capitals.
Profit and loss. . . ...................... 1 ,800 00
J. L. Lane, capital ................... 600 00
D. K. Burton, capital .... 1 ,200 00
To allow interest on opening capitals.
Lane: 6% on $10,000 = $ 600
Burton: 6% on $20,000 = $1,200
Profit and loss ................................. 10,200.00
J. L. Lane, capital .......................... 5,100.00
D. K. Burton, capital ....................... 5,100.00
To divide remaining net income equally.
Ch. 16] PARTNERSHIPS (CONCLUDED) 229
(4) Salaries to partners, and remainder in a fractional ratio.
Partners may agree to make a partial division of the net income in
the form of salaries in order to give recognition to the difference in
the value of their services. The remaining net income may be
divided equally or in any other ratio to which the partners agree.
One illustration will be sufficient : salaries and an equal division of
the remainder.
For purposes of illustration, assume that Lane is allowed a
salary of $3,600 a year and Burton is allowed a salary of $4,800.
They are permitted to draw such amounts during the year as they
desire, and at the end of the year their salaries are to be credited
to them. The following entries will be made:
Profit and loss . 8,400 00
J. L. Lane, capital 3,600 00
D. K. Burton, capital 4,800.00
To credit the partners with their agreed salaries.
Profit and loss . . 3,600 00
J. L. Lane, capital. . 1 ,800 00
D K Burton, capital 1,80000
To divide the remaining net income equally.
(5) Salaries, interest, and remainder in a fractional ratio.
Assume that Lane and Burton agree to make the following income
division :
Salaries:
Lane S3, 600 00
Burton 4,800 00
Interest on capitals — 6% on January 1 balances
Remainder equally.
Following are the entries to close the Profit and Loss account:
Profit and loss . 8, 400 00
J. L. Lane, capital 3,600 00
D. K. Burton, capital 4,800 00
To credit the partners with their agreed salaries
Profit and loss. 1 ,800 00
J. L. Lane, capital 600 00
D. K. Burton, capital 1 ,200 00
To credit the partners with 6% interest on their
January 1 capitals:
Lane -—6 % of $ 1 0,000.
Burton— -6% of $20,000.
Profit and loss .. . . . 1,80000
J. L. Lane, capital .... 900 00
D. K. Burton, capital 900 00
To divide the remaining net income equally.
The methods of showing this division of profits in the working
papers and in the statement of partners' capitals are illustrated on
pages 230 and 231.
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Ch. 16) PARTNERSHIPS (CONCLUDED) 231
LANE AND BURTON Exhibit B
Statement of Partners' Capitals
For the Year Ended December 31, 1954
J. L. Lane D. K. Burton Total
Balances, January 1, 1954 .... $10,000 00 $20,000 00 $30,000 00
Add:
Additional investments . . 2,00000 2,00000 4,00000
Net income for the year (Ex-
hibit C):
Salaries .3,600.00 4,800.00 8,400 00
Interest on capitals 600 .00 1 , 200 .00 1 , 800 00
Remainder equally 900.00 900.00 1,800 00
Total. $17,100 00 $28,900 00 $46,000.00
Deduct withdrawals 5,000 00 7,000 00 12,000 00
Balances, December 31, 1954 < 12"," 100 00 $21,900 00 $34,000 00
Interest on partners' capitals and salaries to partners are not
expenses but are divisions of profits; therefore, they do not enter
into the computation of the net income shown by the profit and
loss statement, but are shown in the statement of partners'
capitals.
Salaries and/or interest in excess of net income. The salaries
and interest in the preceding illustration totaled $10,200. Suppose
that the net income had been only $9,000; how should it have been
divided?
The entries for the salaries and the interest must be made in
accordance with the agreement, thus:
Profit and loss 8,400 00
J. L. Lane, capital . 3,600 00
D. K. Burton, capital ... 4,800 00
To credit the partners with their agreed salaries.
Profit and loss 1,800 00
J. L. Lane, capital . 600 00
D. K. Burton, capital . . 1 ,200 00
To credit the partners with 6% interest on their
capitals.
After these entries are posted, the Profit and Loss account will
have a debit balance of $1,200, because the salary and interest
credits to the partners total $10,200, whereas the net income was
only $9,000. Because the partners agreed to an equal division of
the balance after salaries and interest, the $1,200 debit balance in
the Profit and Loss account will be divided equally by the following
entry :
J. L. Lane, capital 600 00
D. K. Burton, capital ... 600 00
Profit and loss. 1,200 00
To divide the debit balance in the Profit and Loss
account equally, as agreed.
232 PARTNERSHIPS (CONCLUDED) [Ch. 16
The entries on the preceding page divide the $9,000 net income
between the partners as follows:
Lane Burton Total
Credits:
Salaries $3,600.00 $4,800.00 $ 8,400.00
Interest on capitals .... 600 00 1,200 00 1,800 00
Total credits .... . . . . $4 , 200 00 $6,000~. 00 $10 , 200 . 00
Less debit for remainder . . 600 00 600 00 1,200 00
Distribution of net income . . $3,600 00 $5,400 00 $ 9,000.00
If partners' salaries and interest on their capitals are agreed
upon, entries therefpr must be made even though the operations
of the business result in a loss. For instance, assume that the
operations result in a loss of $5,000, and that salaries and interest
are to be allowed as in the preceding illustration; the credits to
the partners for salaries and interest, and the debits to them for
the final balance of the Profit and Loss account, will be as indicated
in the following tabulation:
Lane Burton Total
Credits to partners:
Salaries $3,600 00 $4,800 00 $ 8,400 00
Interest on capitals 600 00 J .200 00 1 ,800 00
Total credits to partners for
salaries and interest $4,200 00 $6,000 00
Offsetting debit to Profit and Loss $ 10 , 200 00
Net loss 5,000 00
Debit balance in Profit and Loss $15,200 00
Debits to partners to close Profit and
Loss 7,600 00 7,600.00
Net debits to partners — equal to net
loss $3,400 00 $1,600 00
The journal entries to close the Profit and Loss account are as
follows :
Profit and loss .. 8,40000
J. L. Lane, capital. . 3,600 00
D. K. Burton, capital. . 4,800 00
To credit the partners with their agreed salaries
Profit and loss . . 1 ,800 00
J. L. Lane, capital . 600.00
D. K. Burton, capital 1 ,200 00
To credit the partners with 6% interest on their
capitals.
J. L. Lane, capital 7 ,600 00
D. K. Burton, capital 7,60000
Profit and loss 15,20000
To divide the debit balance in the Profit and Loss
account equally, as agreed.
Ch. 16] PARTNERSHIPS (CONCLUDED) 233
Changes in Personnel
Procedures generally applicable to changes in personnel.
Changes in the personnel of a partnership may be caused by the
admission of a partner, or by the retirement or death of a partner.
It is important to realize that, in all such cases, the old partner-
ship is dissolved. Therefore, the first of the following steps should
usually be taken, and the second step may also be required.
(1) Close the books, to determine the capital of each partner.
(2) Make entries to adjust the asset valuations in accordance
with any agreements with respect thereto. Asset valua-
tions which are proper from the standpoint of a going
concern may not be proper valuations to be used when
changes occur in partners' interests. For instance, from
the standpoint of a going concern, the proper valuation
of a fixed asset is cost less depreciation; but if a partner
dies or is withdrawing or a new partner is being admitted,
there is, in effect, a transfer of assets from one group of
people to another group, and equity requires that
recognition be given to the market values of the fixed
assets at the date of such transfer.
Any gains or losses reflected by such adjustments should be
divided among all persons who were partners before the
change in personnel, in their profit and loss ratio.
For example, assume that a change is to occur in the per-
sonnel of the partnership of .4, B, and C, who share
profits and losses equally, and that the following adjust-
ments of asset valuations have been agreed upon:
Increase in Land account $5,000 00
Increase in Building account . 8,000 00
Increase in Reserve for Bad Debts . 1,000 00
The adjustments are made by the following journal entry:
Land .... o. 000 00
Building 8,000 00
Reserve for bad debts 1 ,000 00
.4, capital . 4,000.00
7?, capital 4,000 00
C, capital. 4,000 00
To adjust the asset valuations in accordance with
the agreement, crediting the partners in their
profit and loss ratio.
If numerous adjusting entries are made, the gain or loss
shown by each entry may be credited or debited to a Cap-
ital Adjustment account, and the final balance of this
account will be closed to the partners' capital accounts.
234 PARTNERSHIPS (CONCLUDED) [Ch. 16
In connection with asset valuations, it may be proper to give
recognition to goodwill. The recognition of goodwill is
illustrated later in the chapter.
It is also important to realize that, since a change in personnel
dissolves the old partnership, the old articles of partnership no
longer govern. New articles should be drawn up and signed.
It is particularly important to realize that the old agreement
regarding the division of profits is no longer in effect, and that,
unless a new agreement is reached, the profits and losses of the
new partnership will legally be divisible equally. For instance,
if A, By and C shared profits in the ratio of 60, 25, and 15, and C
withdrew, it would be important for A and B (if they continued
the business as a new partnership) to make a new agreement
regarding the sharing of profits. In the absence of such an agree-
ment, A might claim that the profits of the new partnership should
be divided in the ratio of 60 and 25, whereas B could maintain that
the profits were legally divisible equally.
Admission of a partner by purchase. A new partner may be
admitted to the firm by purchase from an old partner or by pur-
chases from two or more partners.
Purchase from one partner. Assume that A has a $10,000
capital interest in the partnership of A, B, and C. D desires to
enter the partnership; A, with the consent of B and C, sells his
interest to D. The price is a private matter between A and D and
is not recorded on the firm's books. Regardless of the price paid,
the entry on the partnership's books is :
A, capital 10,00000
D, capital. . 10,000 00
To record the transfer of A's capital interest
to D.
Purchase from more than one partner. Assume that three
partners had capital account balances as follows:
E . $10,000 oo
F.. 15,000.00
G 20,000.00
H purchases one-quarter of the capital interest of each partner.
H's payment goes to E, F, and G personally, and not into the firm's
cash; the prices paid are not recorded on the firm's books; and the
entry for fiT's admission is:
E, capital 2,500 00
F, capital 3,750 00
G, capital 5,000.00
tf, capital 11,250.00
Admission of H by purchase of one-fourth of
capitals of E, F, and G.
Ch. 16] PARTNERSHIPS (CONCLUDED) 235
Admission of a partner by investment. A new partner may
gain admission to a partnership by making a contribution to the
firm's capital. The assets contributed are placed on the firm's
books. A goodwill allowance may be made to the old partners in
recognition of the profitability of their business. Or, if the new
partner is turning over a profitable going business, an allowance
may be made to him for his goodwill.
In the illustrations which follow, it is assumed that two part-
ners, A and B, have capitals of $10,000 and $20,000, respectively,
and that they share profits equally; C obtains a one-fourth interest
in the firm's capital by making an investment. Although he
obtains a one-fourth interest in the capital, he does not necessarily
obtain a one-fourth interest in the profits; that is a matter for
separate agreement.
No goodwill. Assume that C is to invest $10,000 in cash, and
that no goodwill is to be allowed to the old partners or the new
partner. The entry to record the admission of C is :
Cash . . 10,000 00
C, capital. 10,000 00
To record C's investment and his admission to
the partnership with a one-fourth interest in the
capital.
Goodwill to old partners. A and B are allowed a goodwill of
$3,000, making their total capitals $33,000; to obtain a one-fourth
interest, C is required to invest $11,000. The required entries are:
Goodwill 3,00000
A, capital. . . 1 ,500 00
.#, capital . 1,500 00
To record the agreed goodwill valuation, with
credits to the old partners in their profit and loss
ratio.
Cash .... 11,000 00
C, capital. 11,000 00
To record C's investment and his admission to
the partnership with a one-fourth interest in the
capital.
Goodwill to new partner. C has been conducting a profitable
business, which is to be brought into the partnership. It is agreed
that he is to be allowed a goodwill of $2,000, and that the goodwill
plus $8,000 of miscellaneous assets is to entitle him to a one-fourth
interest in the partnership capital.
Goodwill 2,000.00
Miscellaneous assets 8,00000
C, capital . . . . 10,000 00
To record C's investment, including his goodwill,
and his admission to the partnership with a one-
fourth interest in the capital.
236 PARTNERSHIPS (CONCLUDED) [Ch. 16
Retirement of a partner. When a partner is to retire, it may
be desirable, as previously indicated, to give recognition to the
existence of unrecorded goodwill. There are two theories with
respect to the proper procedure for recording partnership goodwill
at the time of the retirement of a partner:
Place the entire goodwill on the books, with credits to all of the
partners in their profit and loss ratio.
Record only the retiring partner's profit and loss percentage of
the goodwill, with a credit to his capital account only.
To illustrate, assume that A and B are in partnership, sharing
profits equally. It is agreed that the goodwill of the business is
worth $5,000. B wishes to retire. If the entire goodwill is placed
on the books, the entry is:
Goodwill 5,000 00
A, capital.. . ... . 2,500 00
B, capital.. 2,50000
To record the goodwill, prior to the retirement of B.
If only the retiring partner's share of the goodwill is recorded,
the entry is :
Goodwill . 2,50000
B, capital.. . . 2,500 00
To record B'a share of the goodwill, prior to his
retirement.
It is more conservative to record only the retiring partner's
share of the goodwill.
A partner may retire from a partnership in the following ways :
By sale of his capital interest:
To an outsider;
To his partner or partners.
By payment from the partnership assets.
Sale to an outsider. Assume that H, 7, and J are partners,
sharing profits equally. Each capital account, after all adjust-
ments prior to the retirement of J, has a balance of $10,000. With
his partners' consent, J sells his capital interest to K. This is
essentially the same situation as that in the first illustration on
page 234 under the caption, " Admission of a partner by purchase."
Regardless of the price paid by K to /, the entry is:
/, capital 10,000 00
K, capital 10,000.00
To record J's sale of his capital interest to K.
Ch. 16] PARTNERSHIPS (CONCLUDED) 237
Sale to other partners. Assume that / sells his capital interest,
in equal amounts, to H and I. Regardless of the price, the entry
is:
J, capital 10,000.00
H, capital . 5,000 00
/, capital .. ... . 5,000 00
To record the purchase of «/'s capital interest by
H and 7.
Payment from partnership assets. When a partner retires and
is paid from partnership assets, he may receive the amount of his
capital balance, or more or less than his capital balance.
If he receives the amount of his capital account balance, the
only entry required is a debit to his capital account and a credit to
Cash, or credits to the accounts with whatever assets he accepts
in settlement. Referring to the preceding illustration, assume
that J is paid $10,000 from partnership cash. The entry is:
J, capital 10,000 00
Cash 10,000 00
To record the retirement of J.
If a retiring partner receives more than the balance in his
capital account, it may be because the accounts have not been
adjusted for asset revaluations and /or goodwill, and the remaining
partners prefer to treat the excess payment as a bonus. Oi the
remaining partners may be willing to pay a bonus in order to get
rid of an undesirable partner. Continuing the illustration,
assume that J is paid $12,000 from partnership cash. As shown
by the following entry, the bonus is debited to the remaining
partners in their profit and loss ratio:
H, capital . .. 1,000.00
/, capital ... 1,000 00
J, capital 10,000 00
Cash ... 12,000.00
J retires, receiving the amount of his capital
and a $2,000 bonus.
A retiring partner may receive less than the balance of his
capital account because downward revaluations of assets have
not been recorded, or because the retiring partner is willing to
take a loss in order to get out of an unprofitable, or otherwise
undesirable, partnership. Assume, for instance, that J settles
for $9,000. The entry is:
J, capital 10,00000
Cash 9,000.00
H, capital 500 00
/, capital . 500 00
J retires, accepting $1,000 less than his capital
credit.
238 PARTNERSHIPS (CONCLUDED) [Ch. 16
If a retiring partner is not paid in full immediately, the unpaid
balance of his capital account should be transferred to an account
payable or note payable account, which should be shown as a
separate item in the balance sheet, with a clearly descriptive title,
such as " Account payable to former partner." The unpaid
balance of a retired partner's capital should not be allowed to
remain in his capital account, because he is no longer a partner.
Death of a partner. The death of a partner dissolves the
partnership; therefore, the surviving partners should take such
action as is necessary for the determination of the net income from
the date of the last preceding closing of the books to the date of the
partner's death. If the articles of partnership provide for adjust-
ments of asset values and a recognition of goodwill in the event
of a partner's death, entries therefor should be made.
The immediate payment of the entire capital interest of a
deceased partner might deplete the current assets of the business
and seriously handicap it in its operations. Partners sometimes
provide against such a contingency by carrying insurance on the
lives of the partners, the firm being named as beneficiary; the
collection of the insurance .provides funds with which to make
settlement with the deceased partner's estate. The articles of
partnership may contain a provision that payments shall be made
in installments; in the absence of such a provision, the surviving
partners and the estate may reach such an agreement.
Liquidation of the Partnership
A partnership is terminated whenever there is any change in the
members of the firm; the change in personnel creates a new
partnership.
A partnership is liquidated when the business is discontinued or
the assets are transferred to other parties.
Basis of illustration of liquidation. Assume the following bal-
ance sheet of a partnership :
A AND B
Balance Sheet
October 31, 19—
Assets Liabilities and Net Worth
Cash $5,000 Accounts payable . $9,000
Accounts receivable $25 , 000 A , loan 5 , 000
Less reserve for bad A, capital 25,000
debts 1,000 24,000 #, capital 20,000
Inventory 30,000
S59,000 $59,000
In addition to investing $25,000, A has loaned the business
$5,000.
Ch. 16] PARTNERSHIPS (CONCLUDED) 239
Disposal of assets. Assume that X desires to acquire the busi-
ness of A and B, and that the partners sell their inventory and
accounts receivable to X for $52,000. A and B retain the $5,000
of cash shown in the foregoing balance sheet and are to pay the
$9,000 of accounts payable. The sale of the inventory and
receivables will be recorded as follows:
x. 52,000 oo
Loss on sale of business 2,000 00
Reserve for bad debts 1 ,000 00
Inventory... . 30,000.00
Accounts receivable 25 , 000 00
To record the sale of the assets to X.
Cash 52,000 00
X 52,000 00
To record collection for assets sold.
Division of the profit or loss. Any profit or loss on the disposal
of the assets should always be divided between the partners before
any cash distribution is made to them, because the amounts of cash
to which the partners are entitled cannot be determined until their
shares of the profit or loss have been credited or charged to them.
The profit or loss should be divided between the partners in their
profit and loss ratio. Assuming that .4 and B share profits equally,
the $2,000 loss on the sale of the assets to X will be divided by
the following entry:
A, capital . 1,000 00
/*, capital . 1,000 00
Loss on sale of business . 2,000 00
Distribution of cash. After the disposal of the inventory and
the receivables, the collection of the cash, and the division of the
loss between the partners, the balance sheet of the firm is as
follows :
A AND B
Balance Sheet
November 3, 19 —
Assets Liabilities and Net Worth
Cash $57,00000 Accounts pnyabh $9,00000
A, loan 5,000 00
.1, capital 24,000 00
/?, capital 19,000 00
$57,000 00 $57,1300^00
The distribution of cash should be made in the following; order:
(1) In payment of liabilities to outside creditors:
Accounts payable . 9,00000
Cash . . 9,000 00
240 PARTNERSHIPS (CONCLUDED) [Ch. 16
(2) In payment of partner's loan:
A , loan . 5,000.00
Cash . 5,000.00
(3) In payment of partners' capitals:
A, capital . . 24,000 00
B, capital 19,00000
Cash . . 48,000 00
Partner with a debit balance. It sometimes happens that a
partner has a debit balance in his capital account as a result of
operating losses, drawings, and losses on the disposal of assets
during liquidation/ Three illustrative cases are now presented.
Case 1. Assume that, after the sale of all assets and the payment of
liabilities, the trial balance of a partnership shows the following balances:
Cash 20,000 00
M, capital. . . 5,000 00
N, capital 25,000 00
25,000 00 25,000 00
The entire cash balance should be paid to AT; this payment
would reduce his capital credit to $5,000. He has a right to
collect $5,000 from M .
Case 2. Assume that, after the sale of all assets and the payment of
liabilities to outside creditors, the trial balance of a partnership shows the
following balances:
Cash 25,000 00
0, capital 2,000 00
0, loan . . 3,000 00
P, capital 24,000 00
?L9po"oo 27^000^)0
Enough of the credit in O's loan account should be transferred
to his capital account to make good the debit balance in his capital
account; this is accomplished by the following entry:
0, loan 2,000.00
Q, capital 2,000 00
To apply the right of offset, by transferring $2,000
of O's loan to his capital.
The payments to partners will then be made as indicated by
the following entries:
O, loan.. . . . ... 1,000 00
Cash 1,000 00
To record the payment of 0's loan.
P, capital 24,00000
Cash 24,000 00
To record the payment of P's capital.
Ch. 16] PARTNERSHIPS (CONCLUDED) 241
Case 3. In this case it is assumed that, after the sale of all assets and
the payment of all liabilities, a partnership's trial balance appears as
follows :
Cash . 20,000.00
R, capital 5,000 00
S, capital 15,000.00
T7, capital 10 , OOP. 00
25,000 00 25,000 00
Profits and losses were divided as follows: R, 20%; S, 40%; T, 40%.
R should pay $5,000 cash into the partnership to make good the
debit balance in his capital account; if he does so, there will be
$25,000 cash on hand, which will be sufficient to pay S and T in
full.
But suppose that it is desired to distribute the $20,000 of cash
on hand to S and T before it is known whether or not R will pay in
the $5,000. In determining how to divide the cash between S
and T, we should remember that, if R fails to pay in the $5,000,
this loss will have to be borne by S and T in their profit and loss
ratio. In the past, S and T each had 40% of the profits or losses;
that is to say, their shares of profits or losses were equal. There-
fore, if R should fail to pay in the $5,000, S and T would share the
loss equally. Accordingly, they should be paid down to &2,500
each, thus leaving each of these partners with a capital balance
sufficient to absorb his share of the loss if R fails to pay in the
$5,000. The entry to record the payment is:
.S, capital 12,500 00
1\ capital 7,500 00
Cash 20,000.00
To record the distribution of cash to S and T.
The resulting trial balance will be :
tf, capital 5,00000
S, capital 2,500 00
T, capital 2,500 00
5,000.00 5,000 00
CHAPTER 17
Corporations
Nature of the corporation. Probably the most famous defini-
tion of the corporation is the one given in 1819 by Chief Justice
Marshall in the Dartmouth College case decision, in which he
described a corporation as "an artificial being, invisible, intangible,
and existing only in contemplation of law."
This definition Emphasizes the basic characteristic of the cor-
poration-its separate legal entity. It is not a group of separate
persons, as is the case with a partnership; it is itself a legal "per-
son." It can make contracts in its own name; it can sue and be
sued, even by its own stockholders; and it can own real estate.
Within the limits of its charter, it can perform any business act
which could be performed by a natural person.
Because a corporation is a legal entity, a stockholder usually is
not liable for its debts unless- his shares have a par value and were
issued at a discount, and even under such circumstances he is liable
only for the amount of the discount. Stockholders of certain
classes of corporations, such as banks organized under the laws of
some of the states, may have a personal liability in an amount not
in excess of the par value of their shares. Although relief from
personal liability is an advantage to the stockholders, it sometimes
operates to the disadvantage of the corporation by limiting its
borrowing power: banks frequently refuse to loan money to a
corporation unless stockholders of means endorse the notes.
The separate legal entity of a corporation gives it a continuity
of life. A partnership is dissolved by the death, insanity, insol-
vency, or withdrawal of a partner; therefore, the continued life of a
partnership is constantly in jeopardy. A corporation can be dis-
solved only by agreement of the stockholders, by forfeiture of the
charter by the state, by judicial decree, or by the expiration of the
period stated in the charter. A charter may give a corporation
an unlimited life; if the life is limited by the charter, a renewal
usually can be obtained.
Continuity of corporate life notwithstanding changes in
ownership is effected by the issuance of transferable shares. This
transferability of interest gives a stockholder several advantages
not enjoyed by a partner. (1) A partner cannot withdraw from a
partnership or sell his interest without the consent of the other
partners; if he undertakes to do so without their consent, he
242
Ch.17] CORPORATIONS 243
renders himself liable to a suit for damages. Unless there is an
agreement among the stockholders to the contrary, a stockholder
can sell his stock to any willing purchaser whenever he desires to do
so; the consent of the other stockholders is not required. (2) If
a partner dies, his heirs have a right to be paid the amount of his
capital interest, but they have no right to enter the business as
partners without the consent of the other partners. If a stock-
holder dies, his stock passes to his heirs, who thus acquire an
interest in the business. (3) A stockholder can pledge his stock
as collateral to a loan; a partner cannot easily pledge his partner-
ship interest. Therefore, a stockholder is in a better position than
is a partner to borrow needed funds.
These characteristics of the corporation make it an attractive
form of business organization even for small enterprises. In large
businesses, in which the capital requirements make it necessary to
obtain funds from many investors, the adoption of the corporate
form is virtually imperative. A partnership with hundreds of
partners, subject to termination upon the death of any one of them,
would be in an intolerable chaos of repeated dissolution and
reorganization; the orderly conduct of business would be impossi-
ble, and capital could not be attracted.
On the other hand, the corporation has certain disadvantages,
the chief of which are mentioned below.
Corporations are required to pay income taxes and the stock-
holders are required to pay income taxes on the dividends which
they receive. This "double taxation " has induced a number of
relatively small corporations to reorganize as partnerships.
The state requires the payment of a fee at the time the corpora-
tion is organized, and imposes an annual franchise tax for the privi-
lege of continuing operations. Numerous reports, not required
of partnerships, must be furnished to the state of incorporation and
to other states where business is transacted.
A corporation has a right to conduct only the kind of business
authorized in its charter; to engage in other lines of business, it
must obtain an amendment of its charter.
Each state regards corporations organized in other states as
foreign corporations. If a corporation desires to do business in
states other than the one from which it obtained its charter, it may
be required to obtain licenses from those states and pay a license
fee to each of them. Failure to obtain such licenses may result in
losses of far greater amount than the fees. For instance, a state
may refuse unlicensed foreign corporations the privilege of bringing
actions in its courts, and heavy losses may be incurred because of
the inability to enforce claims by actions at law.
244 CORPORATIONS [Ch. 17
Restrictions of various kinds are placed upon corporations by
the states. In some states, a corporation cannot own the stock of
another corporation; in some states, it cannot own its own stock; in
some states, its liabilities cannot exceed a certain percentage of its
capital stock. Also, corporations frequently are prohibited from
owning more real estate than they require for business uses.
Organization of a corporation. If a corporation is to be organ-
ized, an attorney should be consulted, because the laws of the
various states differ regarding the rights and duties of corporations
organized under their laws and the procedure for organizing cor-
porations. Since the procedure differs in the various states, arid
since the organization of corporations is the work of an attorney
rather than that of an accountant, the subject will not be discussed
in detail here.
In general, and subject to the exceptions incident to the diver-
sity of laws, the organization of a corporation involves steps some-
what as follows:
(1) An application, signed by a required number of incorpora-
tors, is filed with a designated state officer. This appli-
cation states, among other things:
(a) The name of the corporation.
(b) The nature of the business which it is desired to
conduct.
(c) The amount of the authorized capital stock, and the
number of shares into which it is to be divided.
(d) The names and the addresses of the original sub-
scribers to the stock.
(e) The assets paid into the corporation by these
subscribers.
(2) If the application is approved, a charter (which is often the
approved application itself) is received from the state
officer with whom the application was originally filed.
This charter evidences the fact that the corporation has
been organized and is authorized to conduct business.
(3) A meeting of the incorporators (or stockholders) is held for
the purpose (among other things) of electing directors.
(4) A meeting of the directors is held, and officers are elected.
(5) Capital stock certificates are issued.
Organization costs. The organization of a corporation involves
expenditures for attorneys' fees, the fee paid to the state at the
time of incorporation, and other costs. Without organization
expenditures, a corporation could not come into being and conduct
operations ; therefore, organization expenditures are the cost of an
Ch.17] CORPORATIONS 245
intangible asset which presumably will benefit the company during
the entire period of its existence. This is the position taken by the
Committee on Accounting Procedure of the American Institute of
Accountants. In its bulletin on intangible assets, the committee
mentions organization costs as one of the assets "as to which there
is, at the time of acquisition, no indication of limited life," and
which, therefore, need not be written off unless "it becomes rea-
sonably evident that their term of existence has become limited.'9
The committee further takes the position that, if such assets are
written off, the write-off should be accomplished by periodical
charges to income rather than by a charge to Earned Surplus. So
long as organization expense remains on the books, it should be
shown in the balance sheet as an asset, preferably as a separate
item below the fixed assets.
Corporate management. If a business is organized as a cor-
poration, the stockholders are its owners, but they have no author-
ity to transact its business. The stockholders elect directors, to
whom the general management of the business is committed. In
most states, a person cannot serve as a director of a corporation
unless he is one of its stockholders.
Although the directors are charged with responsibility for the
general management of the business, their duties are to a con-
siderable extent supervisory, since most of the work of manage-
ment is performed by officers elected by them. The officers usually
include a president, a vice-president, a secretary, and a treasurer.
Sometimes one individual holds more than one office ; for instance,
one person may be secretary and treasurer. On the other hand,
there may be several vice-presidents, an assistant secretary, and an
assistant treasurer. The president usually is the ranking officer,
but in some corporations there is an officer called the "chairman
of the board," whose rank is superior to that of the president.
The secretary is the official custodian of the corporate records and
seal. The treasurer is the chief financial officer.
Although the officers have general control over the various
functions of the business, other employees are charged with the
responsibility of performing much of the detailed work. The
kinds and number of employees differ in every business, and it
is impossible, therefore, to draw up a standard personnel chart; the
chart on page 246 is merely one illustration of the flow of authority.
Elements of net worth. Corporate accounts need not differ
from the accounts of other types of business organization except
in the manner of reflecting the elements of net worth. In account-
ing for the elements of net worth of a corporation, the emphasis
is placed on source. How much of the net worth was produced by
246
CORPORATIONS
[Ch. 17
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Ch. 17] CORPORATIONS 247
stockholders' capital contributions? How much consists of
retained earnings? How much, if any, was produced in other
ways?
Proper accounting for the elements of net worth according to
their source requires a knowledge of the nature of capital stock and
of the various classes of surplus. These matters are discussed in
this and the following chapters.
Capital stock. The two principal classes of capital stock are
common and preferred. Capital stock may have a par value or
be without par value.
Recording the Issuance of Par Value Stock
Although $100 is a customary par value, any par may be
authorized by the charter. Thus, a corporation with an authorized
capital of $100,000 might have 100 authorized shares of $1,000 par
value, or 100,000 authorized shares of $1 par value, or its shares
might have any other desired par.
In the illustrations under this caption, it is assumed that a
corporation's charter authorizes it to issue 1,000 shares of $100 par
value common stock, and no preferred shares. The number of
shares authorized may be shown by a memorandum in the Capital
Stock account, thus:
Capital Stock
(Authorized issue, 1,000 shares of $100 par value.)
Group A illustrations — Immediate collection of subscriptions.
In the four following illustrations it is assumed that the stock
subscriptions are received and collected on the same day, and that
the stock is immediately issued.
First illustration- All stock issued at par. In this illustration
it is assumed that all of the authorized stock is subscribed for and
issued at par. The entry for the issuance is:
Cash 100.000 00
Capital stock. .. 100,00000
Issuance of 1,000 authorized shares at their
par value of $100.
When this entry is posted, the Capital Stock account appears
as follows:
Capital Stock
(Authorized issue, 1,000
shares of $100 par value.)
Date 100,000 00
248 CORPORATIONS [Ch. 17
Second illustration — Part of stock issued at par. In this illus-
tration it is again assumed that subscriptions arc taken at par, but
that only half of the stock is subscribed, paid for, and issued.
The entry is:
Cash . 50,000 00
Capital stock 50,000 00
Issuance of 500 of the authorized shares at their
par value of SI 00.
Third illustration — All stock issued at a premium. In this illus-
tration it is assumed that the stock is issued at $110 per share.
The entry is :
Cash ' 110,000 00
Capital stock 1 00 , 000 00
Premium on stock 10,000 00
Issuance of 1,000 authorized shares at a
. premium of $10 per share.
Stock may be issued at a premium at the time of the organiza-
tion of the corporation, as illustrated above. Stock premiums are
probably more common, however, when additional shares are
issued at a subsequent date. For instance, assume that a com-
pany with 1,000 outstanding shares of capital stock with a total
par value of $100,000 has been successful in its operations and
has accumulated, over several years, an earned surplus of $50,000,
thus giving the stock a book value of $150 per share. It might not
be fair to the old stockholders to allow new stockholders to acquire
stock at par. Moreover, because of the book value of the out-
standing stock and the company's earnings record and prospects,
its stock might be so attractive that investors would willingly pay
a premium to obtain it.
Fourth illustration — All stock issued at a discount. We shall
now assume that all of the stock is issued at $90 per share. The
entry is:
Cash 90,000 00
Discount on stock . . 10,000 00
Capital stock . 1 00 , 000 . 00
Issuance of 1,000 authorized shares at a dis-
count of $10 per share.
Stock is rarely issued at a discount. In many states the issu-
ance of stock at a discount is illegal. In states where it is legal, a
discount may be allowed as an inducement to prospective investors.
However, such an inducement is of doubtful value because, if stock
is issued at a discount and the company becomes unable to pay its
debts, the holders of such stock at the time of the corporation's
insolvency (whether they be the original subscribers or subsequent
transferees) may he held personally liable to the corporation's
Ch. 1 7] CORPORATIONS 249
creditors for amounts equal to the original discount on the shares
which they hold.
Group B illustrations — Stock issued before collection of sub-
scriptions. We shall now assume that time elapses between the
date when the stock subscriptions are received and the date when
the subscriptions are collected. When the subscriptions are
received, Subscriptions Receivable should be debited. What
account should be credited? In general, it may be said that a
person legally becomes a stockholder as soon as a valid stock
subscription by him is accepted by the corporation. The law
makes a distinction between a subscription to stock and a contract
for the purchase of stock; we are here dealing only with stock
subscriptions.
If a subscriber is immediately a stockholder, and if (as fre-
quently happens) stock certificates arc issued to subscribers before
their subscriptions are fully collected, an immediate credit to the
Capital Stock account appears to be justified.
In this chapter we shall show the entries to be made if stock
certificates are issued when subscriptions are received although not
yet collected. In the next chapter we shall show the entries to be
made if the issuance of certificates is postponed until the subscrip-
tions are collected.
First illustration — All stock subscribed for at par. If all of the
authorized stock is subscribed for at par, and the subscriptions are
subsequently collected, the entries are:
At date of subscription:
Subscriptions receivable . 100,000 00
Capital stock 100 , 000 . 00
Subscriptions for 1,000 authorized shares at
their par value of $100.
At date of collection of subscriptions:
Cash . 100,000.00
Subscriptions receivable . . . . 100,000 00
Collection of subscriptions in full.
Second illustration — Subscriptions at a premium. This illus-
tration is the same as the preceding one, except that it is now
assumed that the subscriptions were at a premium.
At date of subscription:
Subscriptions receivable 110,000 00
Capital stock 100,000 00
Premium on stock 10,000.00
Subscriptions for 1,000 authorized shares at
$110 per share.
250 CORPORATIONS [Ch. 17
At date of collection of subscriptions:
Cash . . . 110,000.00
Subscriptions receivable . 110, 000 . 00
Collection of subscriptions in full.
It should be observed that the premium is recorded at the date
of the subscriptions, rather than at the date of collection. This is
the correct procedure because the amount receivable is the par
of the stock plus the premium.
Uncollected subscriptions in the balance sheet. If it is
expected that the subscriptions will be collected in the near
future, they may be' shown in the balance sheet under the Current
Asset caption, but they should be clearly shown as subscriptions
to capital stock. The balance sheet will then appear as follows:
Balance Sheet
Current assets: Net worth:
Cash . $ 60,000 00 Capital stock— $100 par
Subscriptions receivable 40,000 00 value. Authorized,
and issued, 1,000
shares . $100, OOP 00
$100,000,00 $100,000 00
If there is no immediate intention to call on the subscribers for
the uncollected balances of their subscriptions, the subscriptions
receivable may still be shown on the asset side of the balance
sheet, but under the caption of Other Assets.
Premium and discount in the balance sheet. The balances of
Premium on Stock and Discount on Stock accounts should be
shown in the Net Worth section of the balance sheet in the manner
illustrated below:
Net worth:
Capital stock — $100 par value; authorized and issued,
1,000 shares $100,000 00
Premium on stock 10,000 00
Earned surplus. . 25,000 00
or thus:
Net worth :
Capital stock — $100 par value; authorized and issued,
1,000 shares . $100 , 000 00
Discount on stock 10,000 00*
Earned surplus . 25,00000
* Deduction.
If some shares are issued at a discount while other shares are
issued at a premium, the amount of discount should be shown in a
Discount on Stock account and the amount of premium should be
Ch. 17] CORPORATIONS 251
shown in a Premium on Stock account. They should not be offset,
because the stockholder who acquired his stock at a discount is not
relieved of his discount liability merely because some other stock-
holder acquired his stock at a premium.
Disposition of stock premium and discount accounts. Stock
premiums have customarily been carried indefinitely in the Pre-
mium on Stock account, and this procedure is correct. The avail-
ability of such a credit for dividends depends on the laws of the
state of incorporation.
In the past, many accountants advocated writing off stock
discount as rapidly as possible, by charges to surplus. This pro-
cedure was probably adopted because, although stock discount
was customarily shown on the asset side of the balance sheet, it was
realized that it had no valid asset status. When stock discount
was recognized for what it is — not an asset, but an item to be
deducted in the net worth section of the balance sheet to show
the net amount of the funds paid in by the investors — it became
apparent that there was no particular reason for writing it off. In
fact, it appears definitely improper to write off stock discount.
For one reason, the write-off beclouds the record of the capital
investment and creates a confusion between the original invest-
ment and the accumulated earnings. For another reason, v,rriting
off the discount against surplus does not relieve the stockholders
of their discount liability, but merely conceals it.
Recording the Issuance of No-Par Stock
Prior to 1912, the capital stocks of all corporations in this
country had a par value. In that year, the first American law
permitting the issuance of stock without par value was enacted in
New York. Other states have since passed similar laws, but,
unfortunately, they are not uniform.
Advantages and disadvantages of no-par stock. The par value
of a share of stock is usually of little significance compared to the
book value and the market value. Printing a par value on a
certificate has made it easy for promoters to extract money from
the uninformed and the unsuspecting. There is an inevitable
attraction about a $100 share of stock offered for $50, and many
people find it impossible to resist such an offer. The omission of a
par value may cause some prospective buyers to make inquiries
regarding the issuing company's net assets and earnings.
No par value stock has another great advantage : it avoids the
discount liability. If a share of stock with a par value of $100 is
issued for $90, the purchaser incurs a discount liability of $10, and
252 CORPORATIONS [Ch. 17
may be required to furnish that amount of cash for the payment
of the corporation's debts. But if a no par value share is sold for
$90, there is no discount liability. Discount is the difference
between a par value and a lower issuing price; if there is no par
value, there can be no discount and, therefore, no discount liability.
No-par stock has some disadvantages. Transfer fees, organi-
zation fees, stock taxes, fees for operation in foreign states, and
other taxes may be based on an arbitrary valuation of the stock
very much in excess of its fair value. Laws not uncommonly pro-
vide that no-par shares shall, for tax purposes, be assumed to have
a par of $100 ; such, a provision might entail a very inequitable
expense if the shares were issued at, say, $5.
Accounting procedures. The methods described above for
recording issuances of par value stock can be used for recording
issuances of no-par stock. But, in the absence of a par, this
question arises: At what amount should the shares be recorded in
the capital stock accounts? The answer depends on the law of the
state of incorporation and on any resolution which the directors,
with the permission of the law, may have passed.
The laws of some states require that the entire amount received
for no-par stock shall (like the par of par value shares) be regarded
as stated, or legal, capital, not to be impaired by distributions to
stockholders; if a corporation is organized in a state with such a
law, the entire amount received for its no-par stock should be
credited to a capital stock account.
Some states allow corporations to credit a surplus account
with a portion of the proceeds of the issuance of no-par stock, and
some states even allow corporations to use such surplus for divi-
dends. If a corporation is organized in a state which permits the
crediting of a surplus account with a portion of the proceeds
of the issuance of no-par shares, and if the directors pass
a resolution stating the amount which is to be credited to the
capital stock account, the accountant should be governed by the
resolution; he should credit the capital stock account with the
amount stated by the resolution, and should credit a paid-in
surplus account with any excess of the proceeds over the stated
capital amount. If the law permits such a division of the proceeds
but the directors do not pass a resolution establishing a stated
value for the stock, the entire proceeds of the stock issuance should
be credited to the capital stock account.
Basis of illustrations. In all of the following illustrations of
entries recording the issuance of no-par stock, it is assumed that
the corporation is authorized to issue 1,000 shares of no par value.
The number of shares authorized is recorded by a memorandum in
the caDital stock account, in the manner previously illustrated.
Ch.17] CORPORATIONS 253
Group A illustrations — Immediate collection of subscriptions.
In the three following illustrations it is assumed that the sub-
scriptions were collected on the day they were received and that
the shares were immediately issued.
First illustration. In this illustration it is assumed that the
corporation was organized in a state which requires that the entire
proceeds of the issuance of shares be regarded as stated capital,
and that all of the authorized shares were issued at $60 per share.
The entry to record the issuance is:
Cash .. 60,00000
Capital stork 60,000.00
Issuance of 1,000 authorized shares at $60 per
share.
After this entry is posted, the Capital Stock account appears
as follows :
Capital Stock
(Authorized issue, 1,000
shares of no par value.)
Date 1,000 shares issued 60,000 00
Second illustration. It is now assumed that the laws of the
state of incorporation permitted the company to credit a portion
of the proceeds of the issuance of no-par stock to a surplus account,
but that the directors did not pass any resolution making an
apportionment between capital stock and surplus. It is also
assumed that all of the shares were issued for $60,000. The entry
to record the issuance would be the same as the one shown in the
immediately preceding illustration.
Third illustration. It is again assumed that all of the author-
ized stock was issued for $60,000, that the laws of the state of
incorporation permitted the company to credit a surplus account
with a portion of the proceeds, and that the directors established a
$50 stated value for the shares. The entry to record the issuance
is:
Cash . 60.000 00
Capital stock 50,000 00
Paid-in surplus 10,000 00
Issuance of 1,000 shares at $60 per share.
Stated value of $50 per share established by the
directors.
Paid-in surplus in the balance sheet. If only a portion of the
proceeds of no-par stock is credited to a capital stock account,
and the remainder is credited to a paid-in surplus account, the
facts may be shown in the balance sheet in the manner illustrated
on the following page.
254 CORPORATIONS [Ch. 17
Net worth:
Capital stock — No par value; authorized and
issued, 1,000 shares $50,000 00
Paid-in surplus 10,000.00 $60,000 00
Earned surplus . 15,00000
Or as follows :
Net worth:
Capital stock — no par value; authorized and
issued, 1,000 shares. $50,000 00
Surplus:
Paid-in . $10,000 00
Earned . . .. 15,000 00 25,00000
,'
Group B illustrations — Stock issued before collection of sub-
scriptions. As stated in connection with par value stock, certifi-
cates may be issued to subscribers before the subscriptions are
collected in full, and an immediate credit to Capital Stock appears
to be justified in such cases.
First illustration. If all of the authorized shares are subscribed
for at $60 per share, the certificates are issued, the subscriptions are
subsequently collected, and the law requires that the entire pro-
ceeds be regarded as stated capital, the entries are:
At the date of subscription:
Subscriptions receivable . . . .. 60,00000
Capital stock. ... . 60,00000
Subscriptions for 1 ,000 authorized sharos at $60
per share.
At the date of collection of subscriptions:
Cash . . 60,000 00
Subscriptions receivable 60,000 00
Collection of subscriptions in full.
Second illustration. This illustration is the same as the pre-
ceding one except that it is now assumed that the law permits the
company to credit a surplus account with part of the proceeds of
issuance, and that the directors establish a stated value of $50 per
share. The entries are:
Subscriptions receivable ... . . 60,00000
Capital stock . . 50 , 000 . 00
Paid-in surplus 10 , 000 . 00
Subscriptions, at $60 per share, for 1,000 author-
ized shares; stated value established by direc-
tors, $50 per share.
Cash 60,000.00
Subscriptions receivable 60,000.00
Collection of subscriptions in full.
Ch. 1 7] CORPORATIONS 255
Stock issued for property. When par value stock is issued for
property other than cash, the question arises whether the property
is really worth the par of the stock issued. If it is not worth the par
of the stock, a Discount on Stock account should be debited with
the excess of the par of the stock over the value of the property.
Such a debit to Discount on Stock is not likely to be made, how-
ever, because directors are disposed to value the property at the
par of the stock, and in so doing they are acting within their legal
powers, for the law allows directors great latitude in exercising
their discretion regarding the valuation of property acquired by
issuance of shares of stock.
One of the advantages of no-par stock is that it reduces the
incentive to overvalue assets, because it is not necessary to inflate
the valuation of property received for stock in order to balance
the par value of the stock. If stock without par value is issued,
the property can be recorded at its fair value, and a capital stock
account can be credited with the same amount. However, the
use of no-par stock has not done away entirely with the overvalua-
tion of assets issued for stock.
CHAPTER 18
Corporations (Continued)
Stock not issued until collection of subscriptions. Stock
certificates may not be issued when the subscriptions are received.
The subscriber may not acquire the status of stockholder until his
subscription is paid in full; or, even though he acquires the legal
status of stockholder when his subscription is received, the corpora-
tion may adopt the policy of deferring the issuance of certificates
until subscriptions are collected.
If certificates are not issued until subscriptions are collected in
full, it is advisable to keep two accounts, as follows:
Capital Stock Subscribed :
When subscriptions are received, this account is credited with
the par or stated value of the shares subscribed for.
When stock certificates are issued, this account is debited
and Capital Stock Issued is credited.
The credit balance in this account shows the par or stated
value of the shares subscribed for but not issued.
Capital Stock Issued:
The number of shares authorized is shown by a memorandum
entry in this account. When certificates are issued, this
account is credited with the par or stated value of the
shares represented by the certificates.
Illustrations — Par value stock. In the two following illus-
trations it is assumed that the corporation has an authorized issue
of 1,000 shares of stock of $100 par, and that all of these shares are
subscribed for at par. Shares of stock are not issued to a sub-
scriber until he has paid his subscription in full.
First illustration- All subscriptions collected in full. The
authorized issue is shown by a memorandum entry, as follows :
Capital Stock Issued
(Authorized issue, 1,000 shares of $100 par value.)
The subscriptions are recorded by the following entry:
Subscriptions receivable . . 1 00 , 000 . 00
Capital stock subscribed 100,000.00
Subscriptions for 1,000 authorized shares at
par.
256
Ch. 1 8] CORPORATIONS (CONTINUED) 257
When the subscriptions are collected, the following entries are
made:
Cash . 100,000 00
Subscriptions receivable 100 , 000 . 00
Collection of subscriptions in full.
Capital stock subscribed 100,000 00
Capital stock issued 100,000.00
Issuance of 1,000 shares after collection of
subscriptions in full.
Second illustration — Some subscriptions fully, others partially,
collected. The authorized issue should be recorded by a memoran-
dum entry in the Capital Stock Issued account, as in the preceding
illustration, and the same entry as in the preceding illustration
should be made for the subscriptions:
Subscriptions receivable 100,000 00
Capital stock subscribed 100,000 00
Subscriptions for 1,000 authorized shares at
par.
It is now assumed that, at a subsequent date, half of the
subscriptions are collected in full. The following entries are made :
Cash 50,000 00
Subscriptions receivable ... 50,000 00
Collection in full of subscriptions for 500 shares.
Capital stock subscribed .... 50,000 00
Capital stock issued ... 50 , 000 00
Issuance of 500 shares for which subscriptions
have been fullv collected
It is further assumed that $10,000 is collected on the other
subscriptions. An entry is made to record the collection, but the
certificates are not issued.
Cash 10,000 00
Subscriptions receivable 10,000 00
Collection on subscriptions for 500 shares.
Illustrations No-par stock. If certificates for no-par stock
are not issued until the subscriptions arc collected in full, the
Capital Stock Subscribed and Capital Stock Issued accounts may
be used in the same manner as just described in connection with
par value stock. It is assumed, in the two following illustrations,
that the company has an authorized issue of 1,000 shares of no
par value.
First illustration — All subscriptions collected in full. It is
assumed that all of the authorized shares are subscribed for at $60
per share, and that they are given a stated value of $50. The
authorized issue is shown by a memorandum in the Capital Stock
258 CORPORATIONS (CONTINUED) [Ch. 18
Issued account. The entries for the subscriptions, the collection
of the subscriptions, and the issuance of the certificates are shown
below:
Subscriptions receivable 60,000 00
Capital stock subscribed . . 50,000 00
Paid-in surplus.. . 10,00000
Subscriptions for 1 ,000 authorized shares at $60.
Stated value, $50.
Cash . . 60,000 00
Subscriptions receivable 60,000 00
Collection of subscriptions in full.
Capital stock subscribed 50,000 00
Capital stock issued 50,000 00
Issuance of fully paid shares.
Second illustration — Some subscriptions fully 9 others partially,
collected. Assume that subscriptions were received as in the
immediately preceding illustration. Also assume that, at a later
date, subscriptions for half of the shares were collected in full and
the certificates were issued.
Subscriptions receivable 60,000 00
Capital stock subscribed. 50,000 00
Paid-in surplus. ... 10,00000
Subscriptions for 1,000 shares at $60. Stated
value, $50.
Cash 30,000 00
Subscriptions receivable 30 , 000 00
Full collection of half of the subscriptions.
Capital stock subscribed 25,000 00
Capital stock issued 25,000 00
Issuance of 500 shares for which subscriptions
have been fully collected.
Assume further that $10,000 is collected on the remaining
subscriptions. The following entry is made to record the collec-
tion, but the certificates were not issued.
Cash . . . 10,000 00
Subscriptions receivable 10,000 00
Collection of portion of subscription price on
500 shares.
Records Peculiar to Corporations
Subscribers' ledger. If stock subscriptions are not imme-
diately collected, the Subscriptions Receivable account in the
general ledger should be supported by a subsidiary ledger contain-
ing an account with each subscriber. The subscriber's account is
debited with the amount of his subscription, and is credited with
the amounts collected from him.
Ch. 18]
CORPORATIONS (CONTINUED)
259
Stock certificate and stub. Blank stock certificates are bound
in books with stubs, like check books. The certificate illustrated
on page 3 (Chapter 1) appears again 011 page 260, still attached to
its stub. The certificate has been signed by the secretary and the
president of the corporation, and is ready to be detached, stamped
with the corporation's seal, and given to Dobson. The stub,
which will remain in the certificate book, shows the essential facts
about the certificate.
The important facts shown by the certificate and the stub are:
Certificate No . .
Number of shares. ,
Authorized capital ,
Number of authorized shares.
Par value per share. .
Issued to
Transferred from . .
Date of issuance of certificate
Shown by Certificate Shown by Stub
1
10
$5,000 00
50
$100 00
Henry Dobson
July 20, 19—
1
10
Henry Dobson
Original
July 20, 19—
The word "Original" appearing on the " Transferred from"
line means that Dobson obtained the certificate by making an
investment in the corporation, and not by purchase from another
stockholder.
The use of the blank spaces in the stub is explained later.
Stockholders' ledger. A stockholders' ledger should be kept
by corporations with numerous stockholders, and may be kept by
any corporation. It contains an account with each stockholder,
showing the number of shares issued in his name.
The issuance of the certificate to Henry Dobsoii is recorded in
his account in the stockholders' ledger in the manner illustrated
below :
Name Henry Dobson ^
Address ^73 Hickory Street , Chicago ^0, Illinois
CERTIFICATES CANCELLED
CERTIFICATES ISSUED
Balance
10
Date
Ref.
Certificate
Number
Number
of Shares
Date
Ref
Certificate
Number
Number
of Shares
19-f
July | 20
1
10
Transfer of shares. Assume that Henry Dobson wishes to
sell two of his shares to Robert Dawson. Dobson will fill in the
assignment form which is printed on the back of the certificate, as
shown on page 261.
260
CORPORATIONS (CONTINUED)
[Ch. 18
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Ch. 18]
CORPORATIONS (CONTINUED)
261
For Value Received,.
.hereby sell,
transfer and assign to.
Robert Daws on
-Two-
Shares of stock within mentioned and hereby authorize
J. B. Hudson
to make the necessary transfer on the books of the Corporation.
WITNESS my hand and seal this 3rd day of
August f 19
Witnessed by:
(Seal)
For
Assignment Form on Back of Certificate
When the stock certificate is presented to the corporation for
transfer of the stock, the cer-
tificate is canceled and at-
tached to the stub from which
it was originally taken. The
open stubs (stubs to which
no unissued or canceled cer-
tificates are attached) will
indicate the certificates still
outstanding.
In accordance with the
terms of Dobson's assign-
ment, two new certificates
will be issued : one certificate
to Robert Dawsonf or the two
shares which Dobson sold to
him, and another certificate
to Dobson for the eight shares
which he retained. At the
right is the stub of the new
certificate issued to Dawson;
the stub of the certificate for
eight shares issued to Dobson would be similarly filled in.
A record of the transfer is made in the transfer journal, in the
manner illustrated on page 262.
Certificate No L
2 Shares
Issued to
Robert Davson
Transferred from
Henry Dobson
Date August 3*
Original
Certificate
No.
Number of
Original
Shares
10
Number of
Shares
Transferred
262
CORPORATIONS (CONTINUED)
[Ch. 18
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Ch. 18]
CORPORATIONS (CONTINUED)
263
After the entry in the transfer journal is posted, the stock-
holders' ledger accounts affected appear as shown below.
Name Robert Dawson
Address 1369 Fortunata Street, Chicago 6l, Illinois
Certificates Cancelled
Certificates Issued
Balance
Date
Ref.
Certificate
Number
Number
of Shares
Date
Ref.
Certificate
Number
Number
of Shares
19—
Aug.
3
TJ 1
5
2
2
Name Henry Dobaon
Address 173 Hirkory Street, Chicago fcO, Illinois
Certificates Cancelled
Certificates Issued
Balance
Date
Ref.
Certificate
Number
Number
of Shares
Date
Ref
Certificate
Number
Number
of Shares
19-
Aug.
3
TJ 1
1
10
19—
July
Aug.
?0
3
TJ 1
i
6
10
8
10
8
Transfer agent and registrar. Large corporations, particularly
those whose stock is listed on a stock exchange, may (either by
requirement of the stock exchange or voluntarily) engage a trans-
fer agent and a registrar to perform the duties incident to the
issuance and transfer of shares and the keeping of records showing
the names and addresses of stockholders and the number of shares
owned by each stockholder. A bank or trust company usually is
engaged to perform the duties of transfer agent, and another bank
or trust company is engaged to perform the duties of registrar.
The employment of a transfer agent and a registrar serves as a
safeguard to the stockholders. When certificates are to be trans-
ferred, they are delivered to the transfer agent, who cancels the
old certificates, signs the new certificates, and passes them to the
registrar, who also signs them. Records of the stockholders are
kept by the transfer agent. The registrar's chief function is to act
as a control against any possible overissuance of stock, and for
this purpose the registrar maintains a record showing the aggregate
number of shares outstanding.
264 CORPORATIONS (CONTINUED) [Ch. 18
Minute book. A record of all the actions taken by the stock-
holders and directors at their meetings is kept by the secretary of
the company in a minute book. This book does not contain debit
and credit entries; it contains a record of events written in narra-
tive form, or in the form of resolutions.
The minute book contains information which may be required
by the company's accountant for purposes of making entries in
the books, and by the public accountants when they audit the
company's accounts. For instance, reference to the minutes may
be necessary to validate the stated value of no-par stock, the
amounts of officers7 salaries, the valuations assigned to non-cash
assets acquired for "stock, and liabilities for dividends.
The minute book usually contains a copy of the company's
by-laws. The rights and duties of the stockholders, directors, and
officers are in general governed by the state corporation law; in
many particulars, however, they are stipulated by the corpora-
tion's own by-laws. The by-laws contain other stipulations with
respect to the management of the corporation, such as the dates
on which the regular meetings of the stockholders and directors
shall be held, the formalities to be complied with in calling special
meetings, and any transactions (such as the issuance of new stock
with special privileges) that require the approval of the stock-
holders. The by-laws are usually passed by the stockholders, but
in some states they may be passed or amended by the board of
directors.
Changing from Partnership to Corporation or Vice Versa
Basis of illustration. To illustrate the entries to be made to
effect a change from partnership organization to corporate organ-
ization, let us assume that A and B are partners sharing profits and
losses equally, and that their balance sheet appears as follows:
A AND B
Balance Sheet
December 31, 19 —
Assets Liabilities and Net Worth
Cash ... . . $5,000 Accounts payable $9,000
Accounts receivable $25 , 000
Less reserve for bad Net worth:
debts . 1,000 24,000 A, capital $30,000
Merchandise inventory ... 30,000 B, capital 20,000 50,000
$59,000 $59,000
It is decided to incorporate. The corporation, to be known
as The A B Company, is to obtain a charter authorizing the
issuance of $100,000 of capital stock, consisting of 1,000 shares of
$100 par value.
Ch. 1 8] CORPORATIONS (CONTINUED) 265
A and B expect to sell a portion of this stock later to other
parties; in anticipation thereof, they make the following adjust-
ments in the valuation of their assets :
The goodwill of the business is to be valued at $6,000.
The merchandise inventory is to be written down $2,000.
The reserve for bad debts is to be increased $500.
After making these adjustments, the two partners are to make
additional cash investments sufficient to bring their capitals to
$35,000 for A and $25,000 for B, and are to take capital stock in
these amounts.
Adjustment of asset values ; additional investments. The fol-
lowing entries will be made on the partnership books to adjust the
asset values in accordance with the agreement, and to record the
additional cash investments by the partners:
Goodwill 6,000 00
Merchandise inventory 2,000 00
Reserve for had dehts 500 00
A, capital 1,750 00
B, capital . 1,750 00
To make the adjustments indicated.
Cash 6,500 00
/I, capital 3,250 00
£, capital 3,250 00
To record additional cash investments prior to
incorporation.
After these entries are posted, the balance sheet of the partner-
ship immediately prior to the incorporation will be:
A AND*
Balance Sheet
December 31, 19 —
Assets Liabilities and Net Worth
Cash . $11,500 Accounts payable $9,000
Accounts receivable $25,000
Less reserve for bad Net worth:
debts . . 1,500 23 ,500 A, capital $35 , 000
Merchandise inventory 28,000 B, capital . . 25,000 60,000
Goodwill . . .... 6,000
$69,000 $69,000
Alternative procedures. The remaining entries to record the
change from the partnership to the corporation will depend upon
whether:
(1) The partnership books are to be retained for use by the
corporation.
(2) The partnership books are to be closed and new books are
to be opened by the corporation.
266 CORPORATIONS (CONTINUED) [Ch. 18
Partnership books retained. If the partnership books are to
be retained as the books of the corporation, it is only necessary to:
Set up a Capital Stock account and make a memorandum nota-
tion of the number of authorized shares.
Make and post the following journal entry to close the partners'
capital accounts and record the issuance of the stock:
A, capital . 35,000 00
B, capital 25,000 00
Capital stock.. . 60,000.00
To close the parners' capital accounts and
record the issuance of 600 shares of stock to A
and By in exchange for the net assets of the
partnership.
Partnership books closed; new books opened for corporation.
If a new set of books is to be used by the corporation, the partner-
ship books must be closed and the new books must be opened.
This is accomplished as follows:
(1) Entries closing the partnership books by recording the
transfer of the assets and the liabilities to the corpora-
tion, in exchange for stock of the corporation, as shown
below :
The A B Company . 69 ,000 00
Reserve for bad debts 1 , 500 00
Cash.. . 11,50000
Merchandise inventory 28,000 00
Accounts receivable 25 , 000 00
Goodwill 6,000 00
To record the transfer of the partnership's
assets to The A B Company.
Accounts payable 9,000 00
The A B Company . . 9,000 00
To record the assumption of our liabilities by the
corporation.
Stock of The A B Company . .... 60,000 00
The A B Company 60,000 00
To record the receipt of 600 shares of the corpo-
ration stock in payment for the net assets
transferred.
A, capital . 35,000.00
B, capital . 25,00000
Stock of The A B Company . 60 , 000 . 00
To record the division of the stock between the
partners, and to close their capital accounts.
(2) A memorandum entry in the corporation's Capital Stock
account showing the number of shares authorized and
their par value, and the j ournal entry on the following page.
Ch. 18] CORPORATIONS (CONTINUED) 267
Cash. 11,500.00
Merchandise inventory 28,000.00
Accounts receivable ... . 25,00000
Goodwill ... 6,000 00
Reserve for bad debts .... 1 , 500 . 00
Accounts payable ... 9 , 000 . 00
Capital stock ... . 60,000.00
To record the assets, reserve, and liabilities taken
over from the partnership, and the stock issued.
Changing from a corporation to a partnership. Corporations
with a few stockholders are sometimes changed to partnerships —
usually for the purpose of obtaining a tax advantage, which is some-
times possible. To illustrate the accounting procedure involved,
assume that a corporation's balance sheet immediately before the
change appears as follows:
THE X Y COMPANY
Balance Sheet
June 30, 19—
Assets Liabilities and Net Worth
Cash . $ 6 , 000 Accounts payable $1 5 , 000
Accounts receivable .. $30,000
Less reserve for bad Net worth :
debts 1,000 29 , 000 Capital stock $50 , 000
Merchandise . .... 40,000 Earned surplus 10,000 60,000
$75,000 $75,000
X owns $30,000 of stock, and Y owns $20,000. Hence, X's
interest in the surplus is $6,000, and Y's interest is $4,000.
Entries if corporation books are retained. If the corporation's
books are to be used by the partnership, the only entry is:
Capital stock . . 50,00000
Earned surplus 10,00000
X, capital ... 36,000.00
lr, capital . 24,000 00
To record the change from corporate to partner-
ship form of organization.
New books for the partnership. If a new set of books is to be
used by the partnership, the corporation's books must be closed
and new books must be opened. This is accomplished as follows:
(1) Entry on the corporation's books:
Capital stock 50 , 000 . 00
Earned surplus 10 , 000 00
Accounts payable 1 5 , 000 00
Reserve for bad debts 1 ,000 00
Cash 6,000 00
Accounts receivable 30 , 000 . 00
Merchandise . 40,00000
To record the dissolution of the corporation
and distribution of the assets, subject to liabil-
ities and reserve, to the stockholders.
268 CORPORATIONS (CONTINUED) [Ch. 18
(2) Entry to open the partnership books:
Cash . 6,000.00
Accounts receivable 30 , 000 . 00
Merchandise 40 , 000 . 00
Reserve for bad debts 1 ,000 00
Accounts payable 15,000 00
X, capital 36,000 00
V, capital . . 24,000 00
To open the books of the partnership.
Preferred Stock
Classes of stock. Shares of stock entitle their holders to four
basic rights, namely:
(1) To share in the management; that is, to vote at the stock-
holders' meetings.
(2) To share in the profits; that is, to receive dividends when
they are declared by the directors.
(3) To share in the distribution of the assets of the corporation
if it is dissolved.
(4) To subscribe to any additional issues of stock of the class
held. This is known as the pre-emptive right.
If there is only one class of stock, these four fundamental rights
are enjoyed proportionately, share and share alike, by all stock-
holders.
If there are two or more classes of stock, one class may enjoy
more than its proportionate share of some right, or may have
some right curtailed. Thus, preferred stock may enjoy special
privileges in the matter of dividends or in the distribution of
assets in liquidation; on the other hand, the preferred stockholders
may have no right to vote, or may have a right to vote only under
certain conditions, such as the failure of the corporation to pay
preferred dividends for a stated period of time.
Stock preferred as to dividends. Stock which is preferred as
to dividends entitles its holders to a dividend at a stipulated rate
on par, or to a stipulated amount per share in the case of no-par
stock, before any dividend is paid on the common stock. Pre-
ferred stockholders have no right to dividends unless the directors
declare them. Directors may decline to declare dividends on pre-
ferred as well as common stock on the ground that the funds are
needed in the business; the stockholders then have no recourse
except to elect a board which will pay dividends, or to bring action
in the courts in the hope of proving that the retention of the funds
is not justifiable.
Ch. 1 8] CORPORATIONS (CONTINUED) 269
Cumulative and non-cumulative stock. Stock which is pre-
ferred as to dividends may be :
(a) Cumulative, in which case all dividends in arrears on pre-
ferred stock must be paid before dividends can be paid
on the common stock.
To illustrate, assume $100,000 par value of 6% cumulative
preferred stock, $100,000 par value of common stock,
and earned surplus of $30,000; no dividends have been
paid on the preferred stock for four years- -three prior
years and the current year. Since the preferred stock
is cumulative, the preferred stockholders are entitled to
dividends of $24,000 before any dividends can be paid
to the common stockholders.
(6) Non-cumulative, in which case a dividend lost in one year
is lost forever.
Non-cumulative preferred stock is not a desirable invest-
ment because of the danger that dividends may be lost.
This is particularly true if the preferred stock is non-
voting, or if the voting power of the common stock
exceeds that of the preferred stock and the directors are
elected by the common stockholders.
Participating and non-participating stock. Stock which is pre-
ferred as to dividends may be:
(a) Fully participating, or entitled to dividends at as high a
rate as the dividends paid on the common stock.
To illustrate, assume $100,000 par value of 6% fully par-
ticipating preferred stock, $200,000 par value of com-
mon stock, no preferred dividends in arrears, and earned
surplus of $27,000.
The preferred stock is entitled to a 6% dividend, or
$6,000.
A 6% dividend (or $12,000) may then be paid to the com-
mon stockholders without any additional dividend pay-
ment being made to the preferred stockholders.
But if a 9% dividend ($18,000) instead of a 6% dividend
is paid to the common stockholders, an extra 3% must
be paid to the preferred stockholders.
(6) Partially participating, or entitled to participate with the
common stock, but only to a limited degree. For
instance, the preferred may carry a 6% preference rate,
with a right to participate to 8%.
270 CORPORATIONS (CONTINUED) [Ch. 18
(c) Non-participating, or entitled to receive its stipulated pre-
ferred dividend but no more, regardless of the rate paid
on the common stock.
Rights under various conditions of preference. If the preferred
stock is non-cumulative and non-participating, its holders have a
right to only the stipulated rate of return, regardless of the profits
earned; and if a dividend is not paid in one year, the right to it is
forever lost. On the other hand, if the stock is participating and
cumulative, the preferred stockholders will receive as high a rate
of dividend as the Common stockholders receive, and the preferred
dividend for every year must be paid before anything can be paid
to the common stockholders.
If a corporation is successful, and its preferred stock is non-
participating, the common stockholders may receive larger divi-
dends than those paid to the preferred stockholders. As a con-
sequence, the common stock may have a much higher market
value than the preferred stock.
Stock preferred as to assets. In the event of dissolution and
liquidation, stock that is preferred as to assets is entitled to pay-
ment in full (the par value of par stock or a stated liquidation
value for no-par stock) before any distribution is made on the com-
mon stock.
To illustrate, assume $100,000 par value of preferred stock,
$100,000 par value of common stock, and assets of only $150,000
after paying all liabilities. If the preferred stock is preferred as
to assets, $100,000 should be paid to the preferred stockholders,
and only $50,000 to the common stockholders. If the preferred
stock is not preferred as to assets, the assets should be divided
between the common and the preferred stockholders in the ratio
of the par value of the two classes of stock — in this case, in equal
amounts.
The preference as to assets may extend only to the par of the
stock, or the preferred stockholders may have a right to receive
par and all dividends in arrears. Just what the preferred stock-
holders' rights are must be determined in each case by reference
to the stock certificate or the charter.
The fact that stock is preferred as to dividends does not make
it preferred as to assets also, nor is stock which is preferred as to
assets necessarily preferred as to dividends also.
Reasons for classes of stock. Different classes of stock with
differing rights have been devised to meet the desires of manage-
ment and to make the shares sufficiently attractive to investors.
This fact can best be indicated by an illustration.
Ch. 18] CORPORATIONS (CONTINUED) 271
Assume that a group of men had an opportunity to buy a going
business at a cost of $500,000, and that, on the basis of its past
operations, the business could be expected to earn about $50,000
a year. They decided to organize a corporation to acquire the
business. We shall assume that they wanted to keep their own
investment down to about $250,000, perhaps because that was all
they had available, or because they wanted to make other invest-
ments, or because they wanted to obtain a " leverage" on net
income (this term is explained later).
If they obtained a charter which authorized the corporation
to issue only common stock, they would not have control, because
outsiders would have equal votes with them. They therefore
decided to issue $250,000 par value of common stock and $250,000
par value of non-voting preferred stock.
The next matters which required their consideration were the
rights and preferences to be given to the preferred stock. Would
it be necessary to make the stock preferred as to assets as well as
to dividends? Or was the business sufficiently safe to make pref-
erence as to assets unnecessary? What dividend rate would be
necessary to make the stock attractive to investors? Could the
stock be marketed without making it cumulative? Could it be
marketed without making it participating?
We shall assume that the organizing group believed that the
hazards of the business were so few and slight that preference as
to assets would be unnecessary, and that a 7% cumulative pre-
ferred stock could be marketed without the participating feature.
The organizing group wanted to avoid making the preferred stock
participating, because non-participating preferred stock would give
their common stock a leverage on the net income. To illustrate:
If the preferred stock were participating and if the company earned
$50,000 on the $500,000 investment, both the preferred and the
common stocks would earn ten per cent ; but if the preferred stock
was non-participating, the allocation of earnings would be as
follows:
Total net income . $50 ,000
Applicable to preferred stock — 7% of $250,000 . ... 17,500
Remainder — applicable to common stock — equal to 13% of
$250,000 . $32^500
This illustration should serve to indicate the matters to which
management gives consideration when planning the capital struc-
ture of a corporation.
Accounts with various classes of stock. The methods of
recording the issuance of preferred stock are the same as those
applicable to common stock, previously discussed.
272 CORPORATIONS (CONTINUED) [Ch. 1 8
If several classes of stock are issued, the account titles for each
class should clearly indicate its nature. Thus, a ledger might con-
tain accounts with titles similar to the following:
Capital Stock— Common.
Subscriptions Receivable- -Common.
Paid-in Surplus — Common Stock.
Capital Stock Subscribed — 7% Preferred.
Capital Stock Issued — 7% Preferred.
Subscriptions Receivable — 7% Preferred.
Premium on Stock — 7% Preferred.
If only one class of stock is authorized by the charter, it is
common stock; the account titles need not include the word
"Common."
Common and preferred stock in the balance sheet. If there
are two classes of stock, the amounts thereof should be shown
separately in the balance sheet, and the special rights of the pre-
ferred stock should be described briefly. No attempt need be
made to divide the surplus in order to show the rights of the two
classes of stock therein. The balance sheet presentation of the
facts may, therefore, be as follows:
Net worth:
Capital stock:
Preferred, 6% participating, cumulative;
par value, $100; authorized and issued,
1,000 shares .. .$100,00000
Common, no par value; stated value, $10;
authorized and issued, 10,000 shares. .. 100,000.00 $200,000 00
Surplus:
Premium on stock . $ 2,00000
Paid-in surplus.. . . 10,000 00 12,00000
Karned surplus. . ... 75,000.00
Total ... . $287.000.00
Stock Values
The following terms are used in expressing different bases for
the valuation of stock:
Par value. This is a nominal value, printed on the certificate.
For instance, if a corporation is authorized to issue $100,000 of
capital stock, represented by 1,000 shares, the par value of each
share is $100.
Book value. The book value of a share of stock of a certain
class is computed by dividing the total amount of capital stock
and surplus applicable to the class by the number of shares of the
class outstanding.
Ch. 18] CORPORATIONS (CONTINUED) 273
For instance, if a corporation has 1,000 shares of common stock
(and no preferred stock) outstanding, and its balance sheet shows :
Capital stock. . ... $100,00000
Earned surplus . 30,000 00
Total .... .. . ""$130,00000
the book value of each share is $130,000 ~ 1,000, or $130.
If there is preferred stock outstanding, the preferred stock-
holders' interest in the surplus will depend upon whether the stock
is participating, and also upon whether the preferred stock is
cumulative and there are preferred dividends in arrears.
Market value. This is the price at which a share of stock can •
be sold. It depends partly on the book value of the stock and
partly on the corporation's earning record and the prospects of
future earnings and dividends.
Liquidation value. This is the amount which a stockholder
will be entitled to receive if the corporation goes out of business,
disposes of its assets, pays its liabilities, and distributes the residue
among its stockholders. If common stock only is outstanding, its
liquidation value will depend only on the amount available for
distribution to the stockholders after the realization of the assets
and the payment of liabilities. If common and preferred stocks
are outstanding, the liquidation values of both classes will also
depend upon whether the preferred stock is preferred as to assets.
Redemption value. Corporations sometimes issue preferred
stock with a right to redeem it. The redemption price may be
stated in terms such as: par, par and dividends in arrears, or par
and a premium of $5.00 per share.
Stated value. The concept of stated value is discussed at some
length in Chapter 19.
CHAPTER 19
Corporations (Concluded)
The nature of surplus. Surplus may be broadly defined as the
portion of a corporation's net worth not represented by its capital
stock. Formerly, one surplus account was regarded as sufficient,
ind it was credited not only with the net income from operations,
but with many other kinds of increments in net worth. During
recent years accountants have come to believe that two general
classes of surplus should be recognized:
Earned surplus- -the portion of the owners' equity represented
by retained earnings produced by operations and by extra-
neous transactions such as the sale of fixed assets and
investments.
Paid-in surplus*- including elements of the following nature:
(A) Surplus resulting from transactions in the company's
own stock, such as:
(1) Premiums on par value stock.
(2) Excess of amounts received for no-par stock
over amounts credited to capital stock
accounts.
(3) Reissuance of treasury stock at an amount
greater than its acquisition cost.
(B) Surplus resulting from stockholders' contributions :
(1) Donations by stockholders.
(2) Assessments on stockholders.
(C) Surplus resulting from contributions by outsiders,
including gifts of assets- -such as the gift of a plant
to a company to induce it to locate in the donor
city.
Special points on paid-in surplus. The term paid-in surplus
is a generic term applicable to all surplus elements of the nature
* When the desirability of classifying the surplus was first recognized, the words
earned surplus and capital surplus came into use. There was, however, considerable
coufusion as to the meaning of capital surplus; some accountants used the term to
include items such as those here listed in the Paid-in Surplus category and also the
credits resulting from writing up assets to an appraised valuation, credits which are
now regarded as not properly to be considered as surplus. There has been a growing
tendency, in the interest of clarity of terminology, to discontinue the use of the term
capital surplus and to use the term paid-in surplus.
274
Ch. 19] CORPORATIONS (CONCLUDED) 275
mentioned above, but the student should not get the impression
that all paid-in surplus elements should be recorded in a single
Paid-in Surplus account. To do so would result in an inadequate
classification of paid-in surplus according to source and a failure
to maintain the detailed records necessary for proper accounting
and statement-preparation purposes. Therefore, the ledger may
contain several paid-in surplus accounts, in which the words
" paid-in " may or may not appear, such as:
Paid-in Surplus — No-par Common Stock.
Premium on Preferred Stock.
Paid-in Surplus—From Treasury Stock Transactions.
As one illustration of the importance of keeping separate
accounts with the various elements of paid-in surplus, assume that
preferred stock is issued at a premium of $50,000, and that com-
mon stock is issued at a discount of $20,000. There is a net paid-in
surplus of $30,000; but separate accounts should be used so that
the books will show that the common stockholders are subject to a
discount liability.
Another reason for setting up detailed paid-in surplus accounts
is that some elements of paid-in surplus may be legally available
for dividends whereas other portions are not. Writers have some-
times expressed the opinion that dividends should never be
charged to paid-in surplus. This is incorrect. Paid-in surplus
may or may not be available for dividends, depending on how it
was created and on the law of the state in which the company was
incorporated. It probably would be better to say that stock-
holders should have a right to assume that dividends come from
earned surplus unless they are informed to the contrary, and that,
if dividends are charged to paid-in surplus, disclosure of that fact
should be made to them. There have been instances in which a
corporation has been given a false appearance of prosperity by
crediting a portion of the proceeds of stock issuances to a paid-in
surplus account and by charging dividends to such surplus, thus
merely giving back to the stockholders a portion of their invest-
ment but creating the impression that they are receiving dividends
out of earnings.
Paid-in surplus should never be charged with asset write-
downs and losses which normally would be charged to income or
earned surplus. This rule was laid down in the first bulletin
issued by the American Institute of Accountants' Committee on
Accounting Procedure. Following are two illustrations of the
application of the rule. If a reserve for bad debts is found to be
inadequate, it should not be increased by an offsetting charge
276 CORPORATIONS (CONCLUDED) [Ch. 19
against paid-in surplus; to do so would relieve current income of a
charge which normally should be made to it. Fixed assets should
not be written down by charges to paid-in surplus; to do so would
relieve future periods of depreciation charges which normally
should be made against income.
Recommended discontinuance of use of the word "surplus."
In 1949, the Institute's Committee on Accounting Procedure
authorized the publication of a report of its subcommittee on
terminology, in which the discontinuance of the use of the word
" surplus " was recommended. Words indicating source, such as
" retained income/' " retained earnings/' or " accumulated earn-
ings" were suggested as suitable replacements for " earned sur-
plus." No substitutes were suggested for " capital surplus" or
" paid-in surplus." At the date of this writing, insufficient time
has elapsed to determine the extent to which the recommendations
of the Committee may modify traditional terminology.
Appropriated surplus. Corporations sometimes transfer, by
journal entries, portions of their surplus to special-purpose reserves.
Such appropriations of surplus may be classified as follows :
(A) Made in compliance with contracts:
(1) With creditors.
For instance, bond indentures may place a limita-
tion on the amount of dividends which can be
paid while the bonds are outstanding. To
reflect this limitation in the accounts, the por-
tion of the surplus not available for dividends
may be transferred to a reserve. Such a
reserve is still a part of the surplus, but is
temporarily not available for dividends.
(2) With preferred stockholders.
If, under the terms of issuance, the preferred
stock of a company is to be retired (periodically
or otherwise) out of funds provided by the
profits, the charter provisions for the retire-
ment of the preferred stock may require the
creation of an appropriated surplus reserve.
Although not available for dividends until the
preferred stock is retired, such a reserve is still
a part of the surplus.
(B) Made by voluntary action of the directors:
(1) To indicate that dividends will be limited in order
to permit the accumulation of funds for general
Ch. 19] CORPORATIONS (CONCLUDED) 277
purposes or for some specific purpose, such as the
acquisition of additional plant assets. Such a
segregation of surplus does not, of course, give
any assurance that cash will be available for the
expenditure to which the reserve is related.
(2) To provide a reserve for possible losses of so uncer-
tain and contingent a nature that the creation of
a reserve by charge to income would not be
justified.
If such appropriations have been made from earned surplus,
the earned surplus should be detailed in the balance sheet in some
manner similar to the following:
Earned surplus:
Appropriated:
Bond sinking fund reserve $ 60 ,000
Reserve for retirement of preferred stock 50,000
Reserve for plant extensions ... . 75,000
Reserve for contingencies . ... 10,000
Total appropriated surplus . ... $195,000
Free 115,000
Total earned surplus $310,000
The statement is sometimes made that appropriations of sur-
plus should always be made from earned surplus and never from
paid-in surplus. In most cases this probably is true; but, since
an appropriation of surplus is usually intended to place a limita-
tion on dividends, and since dividends are sometimes payable from
paid-in surplus, occasions might arise in which an appropriation
from paid-in surplus would not be improper.
Appraisal increments. Prior to 1940 it was not an uncommon
practice for companies to write up their fixed assets to appraised
values. The offsetting credit frequently was made to Capital
Surplus, Appraisal Surplus, or Appreciation Surplus; but many
accountants, believing that the word "surplus" should not be
used in connection with unrealized increments in value, preferred
an account title such as " Unrealized Increment in Valuation of
Fixed Assets."
In 1940 the Institute's Committee on Accounting Procedure
issued a bulletin containing the following statement: " Accounting
for fixed assets should normally be based on cost, and any attempt
to make property accounts in general reflect current values is both
impracticable and inexpedient." As a consequence of the issuance
of this bulletin, the practice of writing up fixed assets to appraised
values has greatly diminished.
278 CORPORATIONS (CONCLUDED) [Ch. 19
Stated capital. Among the advantages of the corporate form
of business organization is that of limited liability: the stock-
holders cannot be held personally liable for the debts of the cor-
poration. Since the law gives the stockholders this protection, it
is only fair that the creditors should be given some assurance that
the corporation will not make payments to its stockholders, either
as dividends or for the acquisition or retirement of stock, which
will reduce the net worth below a stipulated amount.
Originally the corporation laws placed restrictions only on divi-
dends. Before the advent of no-par stock, the dividend restric-
tion usually consisted of a prohibition against any dividend pay-
ment which would reduce the net worth below the par value of the
shares outstanding. With the advent of no-par stock, such a
basis of restricting dividends became inapplicable; obviously it
could not be applied to distributions to the holders of no-par
stock.
More recently it has been recognized that the protection of
creditors was inadequate unless, in addition to a restriction on
dividends, there was a restriction on the amount which could be
paid to stockholders for the acquisition or retirement of their
stock.
For the reasons indicated above, a definition of stated capital
has been included in the laws of many states. Unfortunately, the
concepts of stated capital are not uniform in all states. In some
states, the stated capital includes the total amount received for
par or no-par shares issued, including any amount credited to a
premium or paid-in surplus account. In other states, the stated
capital is measured by the par value of par shares or, with respect
to no-par shares, the amount per share which the directors elect to
establish as stated capital and credit to a capital stock account.
In some states, the amount which the directors elect to establish
as stated capital per share cannot be less than a minimum fixed
by law.
Since it has come to be realized that a restriction as to dividends
is only a partial protection to creditors, many state statutes pre-
scribe that the stated or legal capital must not be impaired either
by the payment of dividends or by disbursements for the acquisi-
tion or retirement of shares.
Since stated capital is a legal concept, and since there is a con-
siderable variation in the state laws with respect thereto, it is
impracticable to deal exhaustively with the subject here. It
must suffice to call attention to the fact that dividends and trans-
actions in the company's stock are usually restricted by the law
of the state of incorporation.
Ch. 19] CORPORATIONS (CONCLUDED) 279
Dividends. Dividends distributed by corporations to their
stockholders may be classified as follows:
(A) Dividends out of surplus:*
(1) Decreasing net worth.
The customary dividend of this nature is a peri-
odical distribution of cash. However, other
assets may be distributed, or the company
may issue scrip, which is an obligation to make
payment at a later date.
(2) Not decreasing net worth.
This classification covers stock dividends. A
stock dividend does not change the net worth
of the corporation; it merely decreases the sur-
plus element and increases the capital stock
element.
(B) Dividends out of capital :
The principal dividends of this nature are liquidating
dividends which are intended to return all of the capi-
tal to the stockholders because the company is dis-
continuing operations, or to return a portion of the
capital because the scope of the business is being
reduced and the total capital is no longer required.
In this chapter we shall be concerned only with dividends out
of surplus.
Legality of dividends. Under what conditions does a com-
pany have a legal right to declare a dividend? It is difficult to
state general rules which are not subject to exceptions because the
laws of the various states differ in their regulations, especially with
respect to dividends on no par value stock. In general, it may
be said that a corporation has a right to pay a dividend if it has a
surplus which has been produced by income from operations or
from extraneous activities. Dividends must not reduce the net
worth below the amount of the stated capital.
Financial policy with respect to dividends. In making their
decisions with respect to the amounts of dividend payments, direc-
tors give consideration not only to the amount of surplus legally
available for the payment of dividends, but also to matters of
* The expression "dividends out of surplus'1' is an abbreviation of "dividends
paid out of surplus." These expressions are in common use and are therefore used
in this text. However, they are subject to criticism. Since surplus is not an asset,
nothing can literally be paid out of it. To avoid confusing the layman, it might be
better to say "dividends which reduce surplus."
280 CORPORATIONS (CONCLUDED) [Ch. 19
financial policy. A dividend payment may be undesirable because
the available cash is inadequate; but if there is only a temporary
shortage of cash, the directors may consider it advisable to borrow
money for dividend purposes in order to maintain a continuity of
dividend payments. Even when adequate cash is available, the
directors may consider it advisable to pay no dividends, or divi-
dends of only limited amounts, in order to conserve the funds for
expansion of the business.
Significant dates applicable to dividends, and related entries.
In the case of corporations with only a few stockholders and with
infrequent transfers of shares, it may be practicable to declare and
pay a dividend on the same day. But for large corporations with
many stockholder^ and frequent transfers of shares, such a pro-
cedure would be impracticable. Under such conditions there are
three significant dates applicable to dividends: the date of declara-
tion, the date of record, and the date of payment.
Date of declaration. On the date when the dividend is declared,
the following entry is made:
Dividends .. . . 100,00000
Dividends payable . . 100,00000
To record the declaration of a dividend.
Date of record. The directors' resolution authorizing the pay-
ment of a dividend states a date as of which the corporation, by
an examination of its stock records, will determine the "stock-
holders of record." For instance, a dividend may be declared on
January 5, payable on January 30 to stockholders of record on
January 20. Between January 5 and January 20, the purchaser
of stock obtains a right to the dividend; after January 20, the
stock is sold "ex-dividend" — that is, the seller of the stock, rather
than the purchaser, is entitled to receive the dividend payment.
No entry need be made by the company on the date of record.
Date of payment. A period of time is usually required between
the date of record and the date of payment because of the work
involved in the determination of the stockholders of record and
the preparation of the dividend checks. When the checks are
mailed, the following entry is made :
Dividends payable . ... 100,00000
Cash 100,000 00
Payment, to stockholders of record on January
20, of dividend declared on January 5.
Unpaid declared dividends. After a dividend has been legally
declared and notice of the declaration has been given to the stock-
holders, by publication or otherwise, the unpaid dividend ranks
as a liability and should be shown as such in the balance sheet,
usually under the current liability caption. The directors may
Ch. 19] CORPORATIONS (CONCLUDED) 281
rescind the declaration of a dividend, but they can do so only in
case no one else has knowledge of the declaration.
Scrip dividends. When it is desired to declare a dividend but
to defer the payment thereof, a corporation may issue scrip to its
stockholders. "Scrip" is a certificate stating the rights of the
holder— usually to receive payment therefor with interest at a
stated future date. Such scrip should be shown in the balance
sheet as a current liability, with some title such as "Dividend
Scrip Payable." Issuance of scrip as a dividend is very rare.
Dividends in arrears on preferred stock. Since even a pre-
ferred stockholder has no right to a dividend until it is declared,
preferred dividends do not accrue; no entry for them should be
made until the date of declaration.
But if dividends on cumulative preferred stock are in arrears,
there is an obligation to pay these arrearages before paying divi-
dends to the common stockholders. The amount of the cumula-
tive dividends in arrears should, therefore, be shown in the balance
sheet. This is usually done by adding a footnote below the bal-
ance sheet totals, thus:
Note: Cumulative dividends on preferred stock were in arrears on (the balance sheet
date) in the amount of $12,000.00.
Stock dividends. Dividends are sometimes paid in capital
stock instead of in cash. To illustrate, assume that a company
has 1,000 authorized shares of common stock of $100 par, of which
600 shares are outstanding; also assume that a 10% stock dividend
(60 shares) is declared and immediately issued. The Committee
on Accounting Procedure of the American Institute of Accountants
has taken the position that, when such stock dividends are declared,
earned surplus in an amount equal to the fair value of the shares
issued as a dividend shall be capitalized by transfer to the Capital
Stock and Paid-in Surplus accounts. Assuming that the shares
issued in this illustration have a fair value of $120 each, the entry
to record the distribution of the dividend is:
Stock dividends (to be closed to Earned Surplus) . 7,200 00
Capital stock 6,00000
Paid-in surplus — From stock dividend 1 , 200 . 00
Issuance of a 10% dividend: 60 shares of $100 par
value stock having a fair value of $120 each.
Assume that the stock was without par value and that it had
been given a stated value of $75 per share; the entry would be:
Stock dividends (to be closed to Earned Surplus) . . . 7,200 00
Capital stock 4,500 00
Paid-in surplus — From stock dividend 2,700 00
Issuance of a 10% dividend: 60 shares of no-par
stock (stated value, $75 per share) having a fair
value of $120 each.
282 CORPORATIONS (CONCLUDED) [Ch. 19
If time intervenes between the declaration and payment of the
stock dividend, the entries (for the dividend on par value stock,
for instance) should be:
At date of declaration:
Stock dividends 7,200 00
Stock dividend payable . . 6,000.00
Paid-in surplus — From stock dividend. . . 1 ,200.00
Declaration of 10% stock dividend to stockholders
of record on December 31, 1953; shares to be issued
February 1, 1954.
At date of issuance:
Stock dividend payable 6,000.00
Capital stock 6,000.00
To record issuance of 60 shares as a stock dividend.
If a balance sheet is prepared between the date of declaration
and the date of distribution of a stock dividend, the net worth
section should appear as illustrated below :
Net worth:
Capital stock — $100 par value; authorized,
1,000 shares.
Issued, 600 shares $60,000 00
To be issued February 1 , 1954 as a stock
dividend— 60 shares 6,000 00 $66,000.00
Surplus:
Paid-in — Karned surplus capitalized in con-
nection with a stock dividend . $ 1 , 200 00
Earned 11,000 00 12,20000
Observe that an unpaid stock dividend is not shown as a liability.
Treasury stock. Treasury stock is a corporation's own stock
which has been issued, reacquired, and not canceled in accordance
with a formal procedure specified by law. It will be noted that
there are three important elements of this definition:
(1) Treasury stock must be the company's own stock; holdings
of the stocks of other companies are not treasury stock.
(2) The stock must have been issued.
(3) The stock, although reacquired, must not have been can-
celed. Cancellation of stock is effected by a procedure
prescribed by law, and places the stock in the status of
unissued, or even unauthorized, shares.
Unissued and treasury stock — Purchaser's liability for dis-
count. A stockholder who acquires unissued stock at a discount
assumes a contingent liability for the amount of the discount.
This means that, if the corporation is unable to pay its debts, the
Ch. 19] CORPORATIONS (CONCLUDED) 283
creditors may demand that stockholders who acquired unissued
stock at a discount pa'y the corporation the amount of the discount.
If a person acquires from a company, at a discount, par value
treasury stock which was originally issued at par or more, he has
no contingent liability for the discount.
Treasury stock is not an asset. Treasury shares may have a
ready marketability and may be reissued; but so may unissued
stock be issued; and it seems obvious that treasury stock, like
unissued stock, is not an asset but is merely a possible source of
additional funds.
Although treasury stock has been shown in balance sheets as
an asset (sometimes even combined with securities which are
assets, under some title such as " Government Bonds and Other
Securities"), accountants now generally recognize that the acquisi-
tion of treasury stock causes a reduction in the corporation's net
worth.
Treasury stock in the balance sheet. Since the acquisition of
treasury stock causes a reduction of the corporation's net worth
to the extent of the cost of the stock, the cost should be shown as a
deduction in the net worth section of the balance sheet. There
are several ways of showing the deduction; the method illustrated
below is generally regarded as acceptable. The illustration is
based on the following facts with respect to the capital stocK:
The authorized issue is 1,000 shares of $100 par value.
All the authorized stock has been issued.
The corporation has reacquired 100 shares at a cost of $12,000.
You should note the distinction between " issued" and "out-
standing." All of the 1,000 shares have been issued, and are so
shown. The number of outstanding shares is not stated in the
balance sheet, but can be easily determined; there are 900 out-
standing shares: the difference between the 1,000 issued shares
and the 100 treasury shares.
Net worth:
Capital stock — $100 par value; authorized
and issued, 1,000 shares, of which 100
shares are in the treasury . . . $100,000.00
Earned surplus . ... 25,000.00
Total .. $125,000 00
Deduct cost of treasury stock _ 12,000 00 $113,000.00
If a company has a paid-in surplus as well as an earned surplus,
the facts may be shown in the balance sheet in the manner illus-
trated on the following page.
284 CORPORATIONS (CONCLUDED) [Ch. 19
Net worth:
Capital stock — $100 par value; authorized
and issued, 1,000 shares, of which 100
shares are in the treasury . $100,000.00
Paid-in surplus . 10,00000
Earned surplus . . 25,000.00
Total . . $135,000.00
Deduct cost of treasury stock . . 12,000 00 $123,000 00
If a company suffers a deficit after the acquisition of treasury
stock, the facts may be shown as follows:
Net worth:
Capital stock — $100 par value;
authorized and issued, 1,000
shares, of which 100 shares
are in the treasury . . . . $1 00 , 000 . 00
Deduct:
Deficit $ 5,000 00
Cost of treasury stock 12,000.00 17,000 00
Net worth ... " $83,000 00
If treasury stock is acquired by donation, there is no cost to
deduct; the facts may be shown as follows:
Net worth:
Capital stock — $100 par value; authorized
and issued, 1,000 shares, of which 100
shares, acquired by donation, are in the
treasury .. . . $100,00000
Earned surplus . . ^ 25,000 00
Net worth 7." $125,000 00
Recording treasury stock acquisitions Cost basis. As indi-
cated above, the cost of treasury stock may properly be shown in
the balance sheet as a deduction in the net worth section. To
provide the information for this balance sheet presentation, it is
considered proper to debit the Treasury Stock account with the
cost of the stock acquired. If this procedure is adopted, an
acquisition of treasury stock is recorded as follows:
Treasury stock .. 12,00000
c»sh . . . 12,000 00
To record the acquisition of 100 shares of $100
par value stock at a cost of $12,000.
An entry of this nature should be made regardless of whether
the shares have a par value or are without par value, and regardless
of the amount which was received for the shares when they were
issued. The treasury stock account title should indicate the
nature of the stock if there is more than one class of issued stock.
If the company has only one class of stock, the account title may
be merely Treasury Stock; otherwise, it might be Treasury Stock
Preferred, or Treasury Stock — Common, or Treasury Stock-
Common — No Par Value.
Ch. 19] CORPORATIONS (CONCLUDED) 285
Stockholders sometimes donate shares to the company; this
may be done because the company is in a poor financial condition
and the stockholders do not wish to invest additional funds; they,
therefore, donate portions of their stock which possibly can be
reissued to obtain additional funds. Since donated shares are
acquired without cost, no debit and credit entries are made to
record the acquisition. A memorandum notation is made in the
Treasury Stock account, as shown below :
Treasury Stock
Date! | 50 shares donated |
I I i
Reissuance of treasury shares. When treasury stock is
reissued, the Treasury Stock account should be credited with the
acquisition price. Entries under various conditions are shown
below.
Reissuance at cost. Assume that the treasury stock acquired
for $12,000 is reissued for $1 2,000; the entry is:
Cash 12,000 00
Treasury stock 1 2 , 000 . 00
Reissuance at a price in excess of cost. Assume that the shares
were reissued for $13,500; the entry is:
Cash . . . . 13,500 00
Treasury stock 1 2 , 000 00
Paid-in surplus — From treasury stock trans-
actions 1,500 00
Reissuance at a price less than cost. The method of recording
reissuances of treasury stock at a price less than the original cost
depends on the law of the state of incorporation and the kinds of
surplus accounts on the company's books. Assume that shares
acquired for $12,000 are reissued for $11,500. If a paid-in surplus
exists as a result of treasury stock reissuances at more than cost,
the entry may he:
Cash 11,50000
Paid-in surplus — From treasury stock transactions 500 00
Treasury stock . " . .. 12,00000
If the company has a paid-in surplus resulting from the issuance
of shares of the same class as those acquired as treasury stock, and
if this paid-in surplus is not a part of the legal stated capital, the
excess of the acquisition price over the reissuance price of the
treasury shares may be charged to this paid-in surplus, thus:
Cash 11,50000
Premium on stock (or Paid-in surplus) 500.00
Treasury stock 12,000.00
286 CORPORATIONS (CONCLUDED) [Ch. 19
In the absence of any applicable paid-in surplus accounts, the
excess should be charged to Earned Surplus, thus:
Cash 11,500.00
Earned surplus 500.00
Treasury stock 12,000.00
Reissuance of donated shares. If donated treasury stock is
reissued, the entire proceeds of the reissuance should be credited
to Paid-in Surplus — From Treasury Stock Transactions.
Recommended departure from the cost basis. In 1948 the
executive committee of the American Accounting Association, in
Accounting Concepts and Standards Underlying Corporate Financial
Statements, expressed the following opinion:
"An outlay by a corporation for shares of its own stock should be
treated as a reduction of paid-in capital up to the pro-rata amount
represented by the acquired shares, whether or not such shares are
reissuable. If the outlay for the reacquired shares exceeds the pro-rata
reduction in paid-in capital, the excess should be treated as a dis-
tribution of retained income. The reissue of acquired shares should
be accounted for in the same manner as an original issue of corporate
shares."
As an illustration of the recommended procedure, let us assume
that a company's no-par stock was originally issued at $80 per
share, of which $75 was credited to Capital Stock and $5 was
credited to Paid-in Surplus. Also assume that a share of treasury
stock is acquired at a cost of $85. If the recommended procedure
is used, the entry is :
Treasury stock (Amount originally credited to Capital
Stock) 75 00
Paid-in surplus (Amount originally credited to Paid-in
Surplus) . 5 00
Earned surplus ... . . . . 5 . 00
Cash . ... 85 00
It is believed that this procedure is followed much less fre-
quently than the cost-basis procedure.
Surplus restrictions resulting from treasury stock acquisitions.
Assume that a company has issued capital stock of $100,000 par
value and has an earned surplus of $25,000, but that it is holding
treasury stock which it acquired at a cost of $12,000. Assume
also that the law of the state of incorporation provides that
dividend payments and treasury stock acquisitions, together, must
not impair the stated capital* which, in this illustration, is
* The state laws differ with respect to the effect of a treasury stock acquisition
on earned surplus. In at least one state, the earned surplus is reduced; more com-
monly, it is merely restricted.
Ch. 19] CORPORATIONS (CONCLUDED) 287
assumed to be the par value of the issued shares, including the
treasury shares. In effect, this means that $12,000 of the earned
surplus is restricted so long as the treasury stock is retained, and
that, so long as this restriction exists, future dividends and dis-
bursements for treasury stock acquisitions must not, together,
exceed the $13,000 unrestricted earned surplus. The balance
sheet should be prepared in such a way as to disclose this restric-
tion. The following net worth section of the balance sheet illus-
trates a method of making the disclosure:
Net worth:
Capital stock-— $100 par value; authorized and issued,
1,000 shares, of winch 100 shares are in the treasury $100,000.00
Earned surplus:
Not available for dividends — Kqual to
cost of treasury stock $12,000.00
Free J^,000 00 25,000 00
Total $125,000 00
Deduct cost of treasury stock 12,000.00
Net worth $113,000 00
CHAPTER 20
Miscellaneous Matters
Purpose of the chapter. This chapter deals with a number
of accounting devices and procedures with which the student
should be familiar. They are presented in this chapter because
they are used in a practice set of which the first transactions
appear in the assignment material for this chapter.
Numerical Chart of Accounts
Account numbers. Most ledgers are kept on cards or in loose-
leaf binders. Each account is given a number, and the cards or
sheets are kept in numerical order.
It is advisable to number accounts in a systematic manner so
that the account numbers indicate classifications and relationships.
Numbering systems differ, but the following chart of accounts
illustrates the general principle.
Observe that each account number contains four digits, and
that the first digit at the left indicates a main classification, a?
shown below:
1 — Assets and related reserves.
2 - Liabilities and deferred credits.
3—- Net worth.
4 Sales and related accounts.
5 Accounts with manufacturing costs: materials, labor,
and manufacturing expenses.
6- - - Selling expenses.
7 General expenses.
8 Other income and expense.
9 Closing accounts: Manufacturing and Profit and Loss.
The second digit indicates a main subclassifieation, thus :
1 1 - - Current assets and related reserves.
12- Other assets.
13- - Fixed assets and related reserves.
14 Long-term deferred charges.
The third and fourth digits indicate further subelassifieations
and relationships, thus:
1130 Notes Receivable.
1135 Accrued Interest on Notes Receivable.
288
Ch. 20] MISCELLANEOUS MATTERS 289
The third and fourth digits are not assigned haphazardly, hut in
many instances are selected for reasons of consistency, or to show
relationships.
As illustrations of numbers chosen for purposes of consistency,
observe the following account numbers. The first digit indicates
whether the account represents an asset or a liability ; the fact that
the item is current is indicated by the second digit; the final 20
indicates an account receivable or payable; the final 30 indicates a
note.
1120 Accounts Receivable.
2120 Vouchers Payable.
1130 Notes Receivable.
2130 Notes Payable.
Also observe that offset accounts, representing deductions from
related accounts, are numbered with a final 8 or 9:
1120 Accounts Receivable.
1 129 Reserve for Bad Debts.
1331 Machinery and Equipment.
1339 Reserve for Depreciation — Machinery and Equipment.
4001 Sales.
4008 Discount on Sales.
4009 Returned Sales and Allowances.
As an illustration of account numbers assigned to show rela-
tionships, observe the following:
The account with bonds payable is:
2350 6</c First Mortgage Bonds.
Observe the numbers of the related accounts:
1250 Sinking Fund Cash.
1251 Sinking Fund Securities.
2150 Accrued Bond Interest.
2550 Bond Premium.
3250 Sinking Fund Reserve.
8250 Bond Interest.
Another illustration of account numbers assigned to show rela-
tionships is:
1184 Unexpired Insurance.
5384 Insurance (manufacturing expense).
6084 Insurance (selling expense).
7084 Insurance (general expense).
290 MISCELLANEOUS MATTERS [Ch. 20
Illustrative chart of accounts. The following chart of accounts
will be used in the practice set:
CURRENT ASSETS:
1111 Cash.
1112 Petty Cash.
1120 Accounts Receivable.
1129 Reserve for Bad Debts.
1130 Notes Receivable.
1135 Accrued Interest on Notes Receivable.
1139 Notes Receivable Discounted.
1151 Finished Goods.
1101 Goods in Process.
1171 Raw Materials.
1181 Factory Supplies.
1182 Postage.
1183 Salesmen's Traveling Expense Advances.
1184 Unexpired Insurance.
OTHBR ASSETS:
1250 Sinking Fund Cash.
1251 Sinking Fund. Securities.
1271 Subscriptions to Capital Stock.
FIXED ASSETS:
1311 Land.
1321 Buildings.
1329 Reserve for Depreciation — Buildings.
1331 Machinery arid Equipment.
1339 Reserve for Depreciation- -Machinery and Equipment.
1341 Tools.
1349 Reserve for Depreciation — Tools.
1351 Delivery Equipment.
1359 Reserve for Depreciation — Delivery Equipment.
1361 Furniture and Fixtures.
1369 Reserve for Depreciation - Furniture and Fixtures.
1371 Patents.
1379 Reserve for Patent Expiration.
1381 Goodwill.
GUURKNT LIABILITIES:
2120 Vouchers Payable.
2130 Notes Payable.
2133 Dividends Payable.
2135 Accrued Interest on Notes Payable.
2137 Accrued Interest on Mortgages Payable.
2150 Accrued Bond Interest.
2161 Accrued Payroll.
Ch. 20] MISCELLANEOUS MATTERS 291
2162 Federal Income Taxes Withheld.
2103 Federal O. A. B. Taxes Withheld.
2171 Federal O. A. B. Taxes Payable.
2172 State Unemployment Taxes Payable.
2173 Federal Unemployment Taxes Payable.
2180 Accrued Taxes Payable — General.
2181 Accrued Federal Income Taxes Payable.
2191 Kent Collected in Advance.
LONG-TEUM LIABILITIES:
23 10 Mortgage Payable -6 %.
2320 Mortgage Payable— 5%.
2350 5% First Mortgage Bonds.
LONG-TEHM DEFERRED CREDITS:
2550 Bond Premium.
NET WORTH:
3171 Capital Stock.
3201 Earned Surplus.
3233 Dividends.
3250 Sinking Fund Reserve.
SALES AND RELATED ACCOUNTS:
4001 Sales.
4008 Discount on Sales.
4009 Returned Sales and Allowances.
PURCHASES AND RELATED ACCOUNTS:
5171 Purchases — Raw Materials.
5172 Freight In.
5174 Discounts Lost.
5179 Returned Purchases and Allowances.
DIRECT LABOR:
5201 Direct Labor.
MANUFACTURING EXPENSES:
5300 Manufacturing Expense Control.
5301 Indirect Labor.
5302 Superintendence.
5315 Heat, Light, and Power.
5328 Repairs to Buildings.
5329 Depreciation — Buildings.
5338 Repairs to Machinery and Equipment.
5339 Depreciation — Machinery and Equipment.
5349 Depreciation — Tools.
292 MISCELLANEOUS MATTERS [Ch. 20
5370 Payroll Taxes.
5379 Patent Expiration Expense.
5380 Taxes— General.
5381 Factory Supplies.
5384 Insurance.
5390 Miscellaneous.
SELLING EXPKNSES:
0000 Selling Expense- -Control.
6001 Sales Salaries.
6004 Delivery Salaries.
6051 Delivery Expense.
6059 Depreciation — Delivery Equipment.
6061 Freight Out.
6070 Payroll Taxes.
6075 Advertising.
6083 Salesmen's Traveling Expenses.
6084 Insurance.
6090 Miscellaneous.
GENERAL EXPENSES:
7000 General Expense — Control.
7001 Officers' Salaries.
7002 Office Salaries.
701 1 Office Supplies.
7012 Printing and Stationery.
7029 Bad Debts.
7069 Depreciation -Furniture and Fixtures.
7070 Payroll Taxes.
7080 Taxes— General.
7082 Postage.
7084 Insurance.
7090 Miscellaneous.
OTHER INCOME:
8135 Interest Income.
8151 Delivery Income.
8191 Rent Income.
OTHER EXPENSES:
8235 Sundry Interest Expense.
8250 Bond Interest.
8281 Federal Income Tax.
CLOSING ACCOUNTS:
9001 Manufacturing Account.
9002 Profit and Loss.
Ch. 20]
MISCELLANEOUS MATTERS
293
Organization of ledger. If the chart of accounts is well
planned, the accounts will be arranged in the ledger in the sequence
in which their balances will appear in the statements at the end of
the period. For instance, all current asset accounts will be in one
section of the ledger, arid they will be arranged in the order in which
they appear in the balance sheet. It is desirable to leave several
unassigned numbers in each group, to provide for other accounts
which may be added later in the sequence in which their balances
will appear in the statements.
Use of account numbers instead of account names. Space can
frequently be saved in the books of original entry by providing a
narrow Account Number column instead of a wide Account Name
column. The following paragraphs show the use of such Account
Number columns in the voucher register, the cash disbursements
book, and the cash receipts book.
Voucher register. Special columns are pro-
vided in the voucher register for accounts
frequently debited. Previously it has been
necessary to write (in the Sundry Accounts
Debited section) the names of other accounts
debited. The writing of these account names
can be avoided by using an Account Number
column instead of an Account Name column.
Since the bookkeeper has used the account
number to indicate the account to which the
posting is to be made, it will be confusing to use
the account number also to show that the post-
ing has been made. Therefore, a check mark
is used for that purpose. After the entries
have been posted, the Sundry Accounts Debited
section will appear as shown at the left.
The only credit column in the voucher registers previously illus-
trated was Vouchers Payable. Occasionally it is necessary to
credit some other account,
and in such cases entries might
be made in red ink in the
Sundry
section.
SUNDRY AC-
COUNTS DEBITED
Acrt.
No.
V
Amount
1321
8235
1,000
25
00
00
SUNDRY AC-
COUNTS DEBITED
Aoct.
No.
1321
8235
Amount
T76oo bo
2500
Accounts Debited
To avoid such red
ink entries, a Sundry Credit
section as well as a Sundry
Debit section may be pro-
vided in the voucher register,
as illustrated at the right.
SUNDRY ACCOUNTS
Debits
Aoct.
No.
Amount
Credits
Acct.
No.
Amount
294
MISCELLANEOUS MATTERS
[Ch. 20
Ch. 20]
MISCELLANEOUS MATTERS
t
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295
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296
MISCELLANEOUS MATTERS
[Ch. 20
Expense Controls
Controlling accounts. In studying controlling accounts with
customers and creditors, you learned that controlling accounts are
introduced into the accounting system when the work becomes so
heavy that it must be divided.
In a very large business, the controlling account procedure can
also be applied to expense accounts, thus providing for further sub-
division of the bookkeeping work. Controlling accounts with
various classes of expense can be kept in the general ledger, and
the details can be kept in a subsidiary expense ledger or other
record.
Referring to the chart of accounts, it will be observed that
expense controlling accounts are provided in the general ledger for
Manufacturing Expense, Selling Expense, and General Expense,
and detail accounts are in a subsidiary record.
When such a system of controlling accounts and subsidiary
records is used, the voucher register may contain a debit section
for each of the three controlling accounts (Numbers 5300, 6000,
and 7000), and each of these controlling account sections will be
provided with three subcolumns: Account Number, (V)> and
Amount, as shown at the bottom of page 297.
During the month, the bookkeeper in charge of the subsidiary
expense record should post the individual entries from the expense
control columns, and indicate by check marks in the (\/) column
(between the account number and the amount), that the postings
were made. Thus, the check marks in the part of the register
shown indicate that the bookkeeper has posted to accounts as
shown at the top of page 297.
(Left page) Voucher
DEBITS ,
PAID
- -
Credit
i!
Vo.
No.
Date
Payee
Explanation
Terms
Vouchers
Payable
Pur- 1
Freight
2120
chases
In
5171
.r>172
Date
Ck,
No
1
19—
July
1
J. B. White
Invoice, July I
2/10, n/30
19—
July
11
12
3,000
00
3,000
00
2
2
C. N. W. Ry
2
1
8
00
8
00
3
3
Payson & Co
Invoice 1361
Cash
3
2
65
00
4
3
C. R. Maynard
Circulars
3
3
200
00
5
3
Basset & Co .
Note and interest
3
4
510
00
6
3
Osbornc & Co
Invoice, July 2
1/10, n/30
12
14
850
00
850
00
7
5
C. N. W. Ry
5
5
25
00
00
00
18,222
00
14,590
375
V
Ch. 20]
MISCELLANEOUS MATTERS
297
5381 Factory Supplies.
6075 Advertising
6061 Freight Out
$ 65.00
200.00
25 00
The general ledger bookkeeper posts from the voucher register
as follows:
AT THE END OF TI1K MONTH COLUMN TOTALS'.
Credits:
Vouchers payable
Debits:
Purchases — Raw materials
Freight in
Manufacturing expense (Control)
Selling expense (Control)
General expense (Control)
2120 $18,222.00
5171
5172
5300
6000
7000
$14,590.00
375.00
995.00
882 00
870 00
DITRIN(J THE MONTH ENTRIES IN SUNI>RY ACCOUNTS SECTION:
Debits:
Notes payable
Interest expense
2130
8235
500 00
10.00
$18,222 00
Since the subsidiary ledger bookkeeper posts all the items in
the Manufacturing Expense column, the sum of the balances in the
subsidiary manufacturing expense accounts should equal the bal-
ance in the Manufacturing Expense controlling account. The same
agreement should exist between the Selling Expense controlling
account and the subsidiary selling expense record, and between the
General Expense controlling account and the subsidiary general
expense record.
Register
(Right page)
DhBITfl
SUNDRY ACCOUNTS
Manufacturing
'
Selling General
Expense
5300
Expense Expense
6000 7000
Debit I Credit
Remarks
i
I
Aort.
No.
V
Amount
Aoet.
No.
V
Amount
Acct.
No.
V
Amount
Acct.
No.
\'
Amount
Acct.
No.
\ !]Amount
I
5381
V
65
00
6075
V
200
00
2130
V
500
00
8235
V
10
00
6061
V
25
00
—
00
005
00
882
00
870
00
510
298
MISCELLANEOUS MATTERS
[Ch. 20
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Ch. 20] MISCELLANEOUS MATTERS 299
The bookkeeper who posts to the subsidiary expense ledger or
analysis record prepares a summary of the selling expense account
balances at the end of the month in the following form:
Selling Expenses, July, 19 —
6001 Sales salaries $ 900.00
6004 Delivery salaries . . 350 00
6051 Delivery expense 290 00
6059 Depreciation — Delivery equipment 25.00
6061 Freight out 102 00
6070 Payroll taxes 56 25
6075 Advertising . 200 00
6083 Salesmen's traveling expenses . .... 265 00
6084 Insurance . . . 35 00
6090 Miscellaneous. . __ 25 00
$2,218 25
This summary is prepared for two reasons : first, to prove that
the subsidiary record is in agreement with the controlling account;
second, for use in connection with the periodic statements.
Posting from vouchers. If desired, the postings to the sub-
sidiary expense records can be made directly from the vouchers
instead of from the voucher register. If this is done, the Account
Number and the (\/0 columns will not be needed in the expense
controlling account sections of the voucher register.
Use of account numbers on vouchers. In the voucher illus-
trated on page 196, the names of the accounts most frequently
debited were printed on the back of the voucher, and spaces were
left in which to write the names of other accounts as required. It
may be desirable to print account numbers instead of names on the
back of the voucher. Since so much less space is required for num-
bers than for names, the back of the voucher can contain more
printed account numbers than account names.
Note Registers as Books of Original Entry
Notes receivable register. If there are many transactions
involving notes and drafts, the Notes Receivable and Notes Pay-
able accounts may be controlling accounts and the note registers
may be designed for use as books of original entry and subsidiary
records rather than as merely supplementary memorandum records.
The illustration on page 301 shows how the notes receivable
register may be used as a book of original entry in which to record
the receipt of notes and acceptances receivable.
The total of the Accounts Receivable column is posted to the
credit of the Accounts Receivable controlling account; postings to
the credit of individual accounts in the subsidiary ledger are made
as indicated by the check marks at the left of the names, and as
more fully explained later.
300 MISCELLANEOUS MATTERS [Ch. 20
The total of the Notes Receivable column is posted to the debit
of the Notes Receivable controlling account. Since there are occa-
sional interest and discount adjustments to be made in settling
accounts by notes, Sundry Accounts sections are provided.
The entries in the notes receivable register are explained below.
The debits and the credits in the register take the place of entries
which would otherwise be made in the general journal.
First entry:
On July 2 we received a 30-day, 6% note dated July 1 from A. R.
Lukins, the maker. We credited Lukins (the check mark in the
L.F. column indicates the posting to his account) and Accounts
Receivable control; Notes Receivable account was debited.
Second entry:
On July 6 we received a 60-day note from G. C. Walker with interest
for 60 days at 6% included in the face. The note was received to
apply on account. The entry in the register for the receipt of
this note contained the following debits and credits:
Debit: Notes receivable. . . .... 1,010.00
Credit: Accounts receivable (and Walker)... 1,000 00
Interest income (account 8135) .. 10.00
Third entry:
James Hudson purchased merchandise from us on July 14. We
allowed him to deduct 1% discount in consideration of his giving
us a 30-day, interest-bearing note. The entry in the register for
the receipt of the note was:
Debit: Notes receivable. . 495 00
Discount on sales (account 4008) 5.00
Credit: Accounts receivable (and Hudson) 500.00
Fourth entry:
On July 21 we sold merchandise to C. F. Wilson under terms requiring
him to accept a 30-day draft. The acceptance was received on
July 25; it had been accepted on July 23 and was payable 30 days
after sight. The acceptance was made payable at the Home
National Bank of Atlanta. The entry was:
Debit: Notes receivable 300.00
Credit: Accounts receivable (and Wilson) 300.00
The postings to the general ledger from the register were :
Debit Credit
During the month — entries in Sundry Accounts columns:
Discount on sales — account 4008 $ 5.00
Interest income — account 8135 $ 10.00
At the end of the month :
Notes receivable — account 1130 2,305.00
Accounts receivable — account 1120 2,300.00
Total debits and credits to general ledger $2,310.00 $2,310.00
Ch. 20]
MISCELLANEOUS MATTERS
301
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302 MISCELLANEOUS MATTERS [Ch. 20
Accounts in the accounts receivable subsidiary ledger were
credited as indicated by the check marks at the left of the names.
Entries for the collection of notes receivable would be made in
the cash receipts book in the usual way, with notations in the Date
Collected column of the register. The cash receipts book should
have a Notes Receivable credit column to facilitate posting to the
controlling account.
Notes payable register. The entries in the notes payable
register on page 303 are explained in the following comments:
First entry:
On November \ we gave a 60-day, 6% note for $5,000 to Sidney
Welch to apply on account.
Debit: Vouchers payable (No. 316) 5,000 00
Credit: Notes payable 5,00000
Second entry:
On November 3 we accepted a 30-day sight draft for $1 ,000, without
interest, drawn by George Mason, payable to himself.
Debit: Vouchers payable (No. 321) 1,000 00
Credit: Notes payable* 1 ,000 00
Third entry:
On November 7 we gave a note to James Snowden, to whom \\o
owed $2,000; the note was due in 30 clays, and the face included
interest at 6% for 30 days.
Debit: Vouchers payable (No. 330) 2,000 00
Sundry interest expense (account 8235) . . 10 00
Credit: Noted payable 2,01000
Fourth entry:
On November 25 we borrowed from the bank, issuing a (50-day, non-
interest note for $5,000, and receiving $4,950 as the proceeds.
This transaction required a cash receipts book entry as well as a
note register entry. These entries were as follows:
Entries Entries Posted
Not
JPosted Debits Credits
Notes payable register:
Debit: Memo in Sundry Accounts column 4,950.00
Sundry interest expense (account 8235) . . 50.00
Credit: Notes payable . . 5,000 00
Cash receipts book:
Debit: Cash. . . 4,950.00
Credit: Memo in Sundry Accounts column . 4,950.00
The entry in the cash receipts book appears on page 304 (all
columns not required for the entry are omitted).
Ch. 20]
MISCELLANEOUS MATTERS
303
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304
MISCELLANEOUS MATTERS
Cash Receipts Book
[Ch. 20
Dale
SUNDRY
ACCOUNTS
(Credit)
Cash
Account
1 Explanation
(Debit)
Amount
Art*!
f\\J\J\Jm
No.
V
1111
Nov.
25
First National Bank
See notes payable register
X
4,950
00
4,950
00
The postings to the general ledger from the register were:
?
_ Deb it Credit
During the month — entries in Sundry Accounts columns:
Sundry interest expense — account 8235 (two entries) $ 60 00
At the end of the month:
Vouchers payable— account 2120 . 8,000 00
Notes payable — account 2130.
Total postings to general ledger
$13,010 00
$ 8,060 00 $137010 00
Memo entry — not posted — balanced by unposted entry in
cash receipts book 4,950 00
$13,010 00 $13,010. 00
- -\ ' ' " ' •"' ~ • — *" ""
When a voucher is paid by a note, notations should he made in
the Date Paid and Check Number columns of the voucher register.
Date Check
Paid No.
Nov. 1 N.P.R.
These notations indicate that the voucher was paid by a note
issued on November 1 and recorded in the notes payable register.
After the notations are made in the voucher register, a check mark
should be entered in the (V) column of the notes payable register,
after the number of the voucher paid.
Entries for the payment of notes payable will be made in the
voucher register and cash disbursements book in the usual way,
with notations in the memorandum columns of the note register.
Alternative Treatments of Cash Discounts
Treatment as other income and expense. So far throughout
this text, discounts on sales have been shown in the income and
expense statements as a deduction from sales, and discounts on
purchases have been shown as a deduction from purchases. They
are sometimes shown under the captions, respectively, of "other
expense" and "other income." Those who favor this procedure
Ch. 20] MISCELLANEOUS MATTERS 305
argue that, like interest expense and income, cash discounts are
related to the use of money; they further maintain that discounts
on sales are offered as an inducement to customers to pay their
bills promptly, thus reducing the hazard of losses from had debts.
The treatment of cash discounts as deductions from purchases
and sales is coming to be recognized as theoretically preferable.
The treatment of purchase discounts as other income is based on
an absurdity: it assumes that, by purchasing merchandise and pay-
ing for it within the discount period, income is earned, regardless
of whether or not the goods have been sold. With respect to both
purchase and sales discounts, they are somewhat analogous to
returns and allowances: both are deductions to determine the net
cost of purchases and the net proceeds of sales.
Purchase discounts lost. Under the method of recording pur-
chase discounts previously explained in this text, and commonly
used in business, the credit balance in the Discount on Purchases
account shows the amount of discount taken. The accounts do
not show how much discount was lost by failure to pay bills within
the discount period. An alternative method of recording pur-
chases and purchase discounts, to disclose this important informa-
tion, is illustrated below:
(1) Raw material is purchased with a billed price of $1,000, and with
terms of 2/10; n/30. The purchase is recorded in the voucher
register at the net price, by the following debit and credit:
5171 — Purchases — Raw materials . . 080 00
2120 — Vouchers payable 980 00
(2) If the bill is paid within the discount period, the following entry
is made in the rash disbursements book:
2120— Vouchers payable ... ... . 980 00
1111— Cash 980 00
(3) If the bill is paid after the discount period has expired, the follow-
ing entry is made in the cash disbursements book:
2120— Vouchers payable . . 980 00
5174— Discounts lost. . 2000
1111— Cash ,. 1,000 00
Adjusting entries for discounts lost. At the end of each period
for which statements are prepared, an adjusting journal entry
should be made for the discount on all unpaid vouchers for which
the discount period has expired. A memorandum column should
be provided in the voucher register to show the amount of the dis-
count lost, so that the total liability on the voucher will be shown
in the schedule of open vouchers payable. The procedure is illus-
trated on page 306.
306
MISCELLANEOUS MATTERS
[Ch. 20
Ch. 20] MISCELLANEOUS MATTERS 307
Discussion of the method. The method of recording purchases
and purchase discounts lost, just described, is commonly referred
to as the "net price" procedure. Many accountants favor the net
price procedure for three reasons: (1) it discloses very significant
information — namely, the amount of discounts lost; (2) it records
purchases at the price which will secure the goods; and (3) it
results in presenting liabilities more nearly in terms of the amounts
that will be expended for their settlement; if most invoices are paid
before the discount period expires, the recording of purchases and
liabilities in terms of gross invoice price tends to overstate the
liabilities by the amount of the available purchase discounts on
unpaid vouchers. But since the procedure is unusual, if it is fol-
lowed the balance sheet should indicate parenthetically that the
liability on vouchers payable is stated net of available discounts.
There is some difference of opinion regarding the proper posi-
tion of the Discounts Lost account in the periodic statements of
operations. Many accountants believe that, as a matter of theory,
the net price is the correct measure of cost. Following this theory,
they would show the discounts lost in the profit and loss state-
ment as an administrative expense, since, presumably, it is the
responsibility of the administrative officers to see that obligations
of the business are paid within the discount period.
Other accountants believe that cost is equal to the entire
amount paid for an item. Under this theory, the balance of the
Discounts Lost account is added to the purchases. The chart of
accounts in this chapter is in accord with this theory.
CHAPTER 21
Bonds, Sinking Funds, and
Sinking Fund Reserves
Sources of corporate funds. When a corporation finds it neces-
sary or desirable to raise additional funds, it may borrow them on a
short-term note, on a long-term mortgage note, or on bonds, or it
may issue additional stock. It usually is regarded as good business
management to borrow on short-term notes only in case the funds
are needed for current operations and the current operations pre-
sumably will produce the cash with which to repay the loan. If the
funds are to be used for plant additions or permanent investments,
they usually should be obtained by issuance of long-term securities.
Mortgage notes and bonds. If all the desired long-term funds
can be borrowed from one lender, the borrower may issue a note and
a mortgage; the note will recite the terms of the obligation (date,
maturity, interest rate, and so forth) and the mortgage will effect a
pledge of certain property as security. A mortgage originally was
a conveyance of property from a debtor to a creditor or his repre-
sentative, subject to the proviso that, if the debtor met his obliga-
tion, the conveyance would be nullified. In most states the form
of the mortgage has been changed to give it the status of a lien
instead of a conveyance or transfer of title.
If it is impossible to obtain the funds from one lender, an issue of
bonds may be offered to the public. Since the bonds may be held
by many people, who are not known at the time of arranging for the
issue and who will change with each transfer of a bond from one
holder to another, the lenders cannot be named in a mortgage.
Therefore, the borrower selects a trustee, usually a bank or a trust
company, to act as a representative of the bondholders; and a
mortgage, or deed of trust, is executed conveying a conditional title
to the pledged property to the trustee as agent for the bondholders.
This trustee is called the trustee under the mortgage.
Since long-term borrowings by corporations are usually repre-
sented by bonds, the remainder of this chapter deals specifically
with bonds. However, except as indicated above, long-term mort-
gage notes are essentially of the same nature as secured bonds.
Therefore, what is said in the remainder of this chapter with respect
to secured bonds may be regarded as also applying generally to
long-term mortgage notes.
308
Ch. 21] BONDS, SINKING FUNDS, AND RESERVES 309
Stocks and bonds — advantages and disadvantages. Bond
issues have certain advantages over stock issues :
(1) Bondholders have no vote; therefore, the stockholders do
not have to share the management with them.
(2) The money cost may be lower. If common stock is issued,
the contributors of new capital will share prorata with the
old common stockholders in accumulated surplus and earn-
ings. If preferred stock is issued, it may be participating,
in which case the dividends may be greatly in excess of
reasonable interest on bonds; or it may be nonparticipat-
ing, in which case it usually is necessary to give the pre-
ferred stock a dividend rate higher than the interest rate
tit which bonds could be sold, because bonds are a positive,
and usually a secured, liability with a definite maturity,
and also because bond interest is payable unconditionally,
whereas the payment of preferred dividends is dependent
upon earnings and the existence of surplus.
(3) The fact that bond interest is deductible as an expense in the
computation of income taxes, whereas dividends are not,
is frequently a deciding factor in the choice of securities
to be issued, and has sometimes even influenced corpora-
tions to convert preferred stock into bonds.
On the other hand, if interest and principal payments on a bond
issue are not made when due, the bondholders may institute fore-
closure proceedings and the borrowing company may lose fixed
assets which are essential to its operations and may even be forced
into liquidation, with a consequent loss which will leave a very
small equity for the stockholders.
Classes of bonds. It is impossible to discuss all the different
kinds of bonds which have been devised for use in corporate financ-
ing. Some of the more common forms are:
(1) Secured bonds. These differ as to the nature of the prop-
erty which is pledged as security. Three classes of
secured bonds are in common use:
(a) Real estate mortgage bonds. These are secured by
mortgages on land, or on land and buildings.
(b) Chattel mortgage bonds. These are secured by
mortgages on tangible personal property, such
as machinery, equipment of various kinds, and
merchandise.
(c) Collateral trust bonds. These are secured by a
pledge of stocks, bonds, or other negotiable
instruments.
310 BONDS, SINKING FUNDS, AND RESERVES [Ch. 21
(2) Unsecured bonds. Unsecured bonds are sometimes called
debentures. Since they are not secured by a pledge
of any specific property, their marketability depends
upon the general credit of the borrower.
First and second mortgages. Bonds may be secured by first,
second, or even third mortgages on the same property. If the obli-
gations are not met, and foreclosure ensues, the proceeds of the
mortgaged property must go first to the satisfaction of the first-
mortgage bondholders, any residue to the satisfaction of the second-
mortgage bondholders, and so on.
Second-mortgage bonds are thus obviously a less desirable
investment than first-mortgage bonds, because they are secured by
a secondary lien on the pledged assets. First-mortgage bonds are
called prior-lien or underlying bonds; second-mortgage bonds are
called junior bonds.
Registered and coupon bonds. Bonds may be classified in
three groups on the basis of registry, as follows:
(1) Registered as to both principal and interest.
The name of the owner of the bond is recorded on the
books of the issuing company or its fiscal agent, and
the interest is paid by checks drawn to the order of the
bondholders. This method has the advantage of safe-
guarding the owner against loss or theft, but it has
two disadvantages: First, a sale and transfer can be
made only by assignment and registry, instead of
merely by delivery; second, the check method of pay-
ing interest is burdensome.
(2) Registered as to principal only.
By registering the bonds as to principal only, and attach-
ing coupons for the interest, the owner is safeguarded
against loss or theft of principal, and the debtor com-
pany is relieved of the burden of issuing numerous
interest checks.
(3) Unregistered.
Such a bond is transferable by mere delivery ; the owner's
endorsement is not required. The danger from loss or
theft is, of course, much greater than with a bond
which is registered as to principal. The interest is col-
lected by clipping the interest coupons and presenting
them to a bank for deposit or collection.
Recording the bond issue. A separate liability account should
be kept with each bond issue. If there is more than one issue, the
account title for each issue should contain a comprehensive descrip-
Ch. 21] BONDS, SINKING FUNDS, AND RESERVES 311
tion of the issue, such as " First Mortgage, 6%, Bonds Payable,
1 972," or " Collateral Trust, 7 % Bonds Payable, 1975." The year
is the year of maturity.
Assuming that a company has only one bond issue, all of which
is sold for cash at par, the entry to record the issue is:
Cash 100,000.00
Bonds payable . . 100 , 000 . 00
The mortgage, or trust deed, states the amount of bonds which
may be issued. Each bond is signed by the trustee under the mort-
gage to indicate that it is secured by the mortgage; this is called
authentication by the trustee.
Very frequently, the amount of bonds immediately authen-
ticated by the trustee and issued by the borrowing company is less
than the total issue provided for under the trust deed. To illus-
trate, assume that a company's real estate is ample in value to
secure an issue of $100,000 of first-mortgage bonds. Only $60,000
of funds are immediately required, but there may be future require-
ments for $ 40,000 more. If the trust deed were drawn to secure
an issue of only $60,000, a subsequent loan of $40,000 could be
secured only by a second mortgage; a second-mortgage issue, being
less desirable, might require a higher interest rate and might be
difficult to market. In anticipation of its future requirements, the
company may authorize a total first-mortgage bond issue of $100,-
000, drawing a trust deed as security for a loan of that amount. If
$100,000 of bonds are authenticated, but only $60,000 are issued,
the entries are:
Unissued bonds . 1 00 ,000 00
First-mortgage bonds payable 100,000.00
To record the authorized issue of first -mort-
gage, O^t', real estate bonds payable, due
March 1, 1970.
Cash .... . 00,000 00
Unissued bonds 00,000 00
Issuance of $00,000 bonds at par.
The facts with respect to authorized, unissued, and issued bonds
should be shown in the balance sheet as follows:
Long-term liabilities:
First -mortgage, 6^<,, real estate bonds pay-
able, due March 1, 1970:
Authorized $100,000 00
Less unissued 40,000.00 $00,000.00
Or thus:
Long-term liabilities:
First-mortgage, 6%, real estate bonds payable, due
March 1, 1970; authorized, $100,000.00; issued . $00,000 00
312 BONDS, SINKING FUNDS, AND RESERVES [Ch. 21
The amount of unissued bonds should be shown in the balance
sheet, because the bondholders have a right to know that $40,000
of additional bonds can be issued under the same trust deed which
secures their bonds. Thus, if the real estate is carried in the bal-
ance sheet at $150,000, the holders of the $60,000 of issued bonds
would be interested in knowing that an additional $40,000 of bonds
could be issued. On the basis of the issued bonds only, the ratio
of security to debt is 150 to 60; but on the basis of the total author-
ized issue, the ratio of security is only 150 to 100.
If the bonds are registered as to principal or interest, or both,
subsidiary records should be kept, showing the names and addresses
of the holders. '
Issuances between interest dates. Bonds are often issued
between interest dates, in which case the purchaser is usually
required to pay the accrued interest. To illustrate, assume that
$10,000 of 6% bonds are issued two months after the interest date,
at par and accrued interest; the entry will be:
Cash . 10,100 00
Bonds payable. 10,000 00
Bond interest expense 100 00
When the semiannual interest is paid four months later, the
entry will be:
Bond interest expense 300 00
Cash.. 300 00
The $300 debit to Bond Interest Expense made at the time of
paying the interest, minus the $100 credit to Bond Interest Expense
made at the time of selling the bonds, leaves the account with a
$200 debit balance, which is the interest expense for four months.
Payment of interest. Most bonds provide for the payment of
interest semiannually. The methods of paying bond interest
depend upon whether the bonds are registered as to interest. Two
conditions are illustrated:
(1) The bonds are registered as to interest. If there are a
large number of bondholders, it is advisable to draw a
check for the entire amount of the bond interest and
deposit it in a special bond interest bank account. The
entry will be:
The A' Bank— Bond interest account . . . 6,000.00
Cash .. 6,000.00
To record deposit of funds in the account for pay-
ment of bond interest.
Such a procedure has the advantage of simplifying the
reconciliation of the principal bank account; also, the
Ch. 21] BONDS, SINKING FUNDS, AND RESERVES 313
chief disbursing officer can be relieved of the task of
signing a large number of interest checks by delegating
the work of signing interest checks to a subordinate.
Separate checks will then be drawn on the bond interest
account, the total of these checks being debited to Bond
Interest Expense and credited to The X Bank- Bond
Interest Account.
(2) The bonds are not registered as to interest, but bear coupons
which are clipped by the holders and presented for collec-
tion. The bondholder usually deposits the coupons in his
own bank account, and the bank makes the collection.
The coupons usually designate a bank at which collection
can be made; when the semiannual interest is due, the
company deposits the total amount of the interest in a
special account at the bank where the coupons are pay-
able; when coupons are presented for payment, the bank
pays them and charges the amount to the company's
account. The entries by the issuing company are as
follows :
On or before the date when interest is payable:
The -V Bank — Bond interest account 0,000 00
Cash 6,000.00
Transfer of funds to special hank account for pay-
ment of interest.
On the date when interest is pat/able:
Bond interest expense 0,000 00
Accrued bond interest payable 0,000 00
To record the expense and liability for six months'
interest.
At the end of the month or at any other date when the bank reports
the amount of coupons paid:
Accrued bond interest payable 5 , 700 00
The A' Bank — Bond interest account 5 , 700 00
To record the payment of interest coupons pre-
sented to the bank.
Since some bondholders may be dilatory in presenting coupons
for payment, balances may remain in the special bank account and
in the Accrued Bond Interest Payable account. The balance sheet
should show as an asset any balance in the special bank account,
and should show as a liability any balance in the Accrued Bond
Interest Payable account; the mere deposit of funds in a special
bank account to be used for the payment of bond interest does
not constitute payment of the liability.
314 BONDS, SINKING FUNDS, AND RESERVES [Ch. 21
Bond discount. If the bond interest rate is lower than the
market rate for bonds of a similar nature (for instance, similar in
the nature of the borrower's business and credit standing, and in
the nature of the borrower's security), it may be impossible to
obtain par for the bonds. Let us assume, by way of illustration,
that a ten-year, 5% bond issue of $100,000 is disposed of for a net
amount of $98,000. The issuance of these bonds will be recorded
by the following entry:
Cash .. 98,000 00
Bond discount 2,00000
Bonds payable . . . . 100,000 00
Issuance of bond* at 98.
Amortization of bond discount. In the preceding illustration,
$98,000 was received, but $100,000 must be repaid. The $2,000
excess of the amount to be paid over the amount received is an
expense to be spread over the life of the bonds. The total interest
cost over the life of the bonds includes the discount as well as the
semiannual interest payments.
The Bond Discount account should be written off to Bond
Interest Expense in periodic installments ; the write-off commonly
is made in equal amounts each six months, at the semiannual
interest-payment dates. Since there will be twenty semiannual
interest payments during the ten-year life of the bonds, the dis-
count will be written off in twenty equal installments of $100.
The charges to Bond Interest Expense each six months will be as
shown in the following entries:
Bond interest expense 2 , 500 00
Cash . ... 2,500 00
Payment of semiannual interest.
Bond interest expense 100 00
Bond discount .. 100.00
To amortize -fa of the discount.
These semiannual amortizations will completely write off the
Bond Discount account at the end of the tenth year, and will pro-
duce equal total semiannual charges to the Bond Interest Expense
account.
If a semiannual interest-payment date does not coincide with
the end of the issuing company's accounting period, an adjusting
entry will be required for the accrued interest, and another entry
will be required to amortize the portion of the discount applicable
to the period between the last preceding interest date arid the end
of the accounting period. For example, referring to the preceding
illustration, assume that interest was paid and an amortization
entry made on September 30, and that the issuing company's
Ch. 21] BONDS, SINKING FUNDS, AND RESERVES 315
accounting year ends on December 31. The following entries will
be required on December 31 :
Bond interest expense . 1 ,250 00
Accrued bond interest payable . 1 ,250 00
Accrued interest for three months.
Bond interest expense . . . 50 00
Bond discount . . 50 00
Amortization of discount for three months.
Bond premium. If bonds are issued at a premium, the pre-
mium reduces the interest charge. For instance, if the bonds
mentioned in the preceding illustration were sold for $102,000,
the $2,000 premium received when the bonds were sold would not
have to be repaid at their maturity, and should therefore be offset
against the interest payments to determine the net cost of the use
of the money.
The entry at the time of the issuance of the bonds would be
as follows:
Cash . 102,000 00
Bonds payable 1 00 , 000 00
Bond premium 2,000 00
Issuance of bonds at 102
The payment of the bond interest and the amortization of the
bond premium in equal semiannual installments would be recorded
by the entries shown below:
Bond interest expense 2,500 00
Cash 2,500 00
Payment of semiannual interest.
Bond premium . 100 00
Bond interest expense . . . . 100 00
Amortization of bond premium.
If an interest-payment date does not coincide with the end of
the issuing company's accounting period, end-of-period entries
should be made for the accrued interest and for the amortization
of premium for the fractional period.
Bond premium and discount in the balance sheet. It has long
been regarded as correct accounting procedure to show unamortized
bond discount under a deferred charges caption at the bottom of
the asset side of the balance sheet, and unamortized bond premium
on the liability side under a caption of deferred credits, between the
long-term liabilities and the net worth. For instance, assume that
a trial balance contained the following balances:
First-mortgage, 6%, real estate bonds, 1970. 100,000.00
First-mortgage equipment bonds, 6J%, 1965 . 50,000 00
Premium on first-mortgage real estate bonds 3,000 00
Discount on first-mortgage equipment bonds 1,800 00
316 BONDS, SINKING FUNDS, AND RESERVES [Ch. 21
The customary presentation of these facts in the balance
sheet is:
Assets
Deferred charges:
Discount on first-mortgage equipment bonds $ 1 ,800 00
Liabilities and Net Worth
Long-term liabilities:
First-mortgage, 6%, real estate bonds, 1970 $100,000.00
First-mortgage equipment bonds, 5J%, 1965 50,000 00
Total long-term liabilities 150,000 00
Deferred credits:
Premium on first-mortgage real estate bonds. . . 3 ,000 00
There has been some agitation in favor of showing unamortized
premium as an addition to, and unamortized discount as a deduc-
tion from, the par of the bonds, thus:
Liabilities and Net Worth
tang-term liabilities:
First-mortgage, 6%, real estate bonds, 1970. $100,000 00
Add unamortized premium. . ^3,OOOJH) $103,000 00
First-mortgage equipment bonds, 5J%, 1905 S 50,000 00
Deduct unamortized discount . 1,800 00 48,20000
> N
This procedure has not been generally adopted by the account-
ing profession.
Retirement of bonds. Bonds may be retired :
(1) In total at maturity, out of the borrowing company's
general funds. The payment of the bonds under such
conditions is recorded by debiting Bonds Payable and
crediting Cash.
(2) In a series. Bonds retirable in this way are called serial
bonds.
To illustrate, assume that $100,000 is borrowed; nothing
is to be paid off during the first five years; at the end of
the sixth year, and each year thereafter, $20,000 is to
be paid, so that the bonds will be retired serially by the
end of the tenth year. Each retirement is recorded by a
debit to Bonds Payable and a credit to Cash.
(3) In total at maturity out of a sinking fund created by peri-
odic deposits with a sinking fund trustee. This method
is discussed below.
Sinking funds. If bonds are to be retired at maturity through
the operation of a sinking fund, the borrowing company agrees, as
one of the terms of the trust indenture, to make periodic deposits
with a sinking fund trustee, who invests the deposited funds in
securities. The sinking fund trustee may, or may not, be also the
Ch. 21] BONDS, SINKING FUNDS, AND RESERVES 317
trustee under the mortgage. Sinking fund deposit agreements
take various forms, particularly with respect to the amounts of
the periodic contributions. As a simple illustration, we shall
assume that a company borrows $100,000 which is repayable at
the end of ten years. It agrees to deposit $10,000 with the sink-
ing fund trustee at the end of the first year; the trustee is to invest
the fund in securities and add the income earned on these secur-
ities to the fund. At the end of the second year, the company will
deposit enough to bring the total fund up to $20,000. At the end
of the third year, the company will deposit enough to bring the
total fund up to $30,000; and so on to the end of the tenth year.
The annual contributions by the company will decrease because
the interest collected by the trustee on the accumulating fund will
increase each year.
Assume that the trustee is able to earn 5% on the securities in
the fund; the accumulation of the sinking fund may be tabulated
in the manner illustrated below:
End of Year Interest Earned
Deposit
Total Fund
1
§10,000 00 $ 10,000.00
2
* 300 00
9,500 00
20,000 00
3
1,000 00
0,000 00
30,000.00
4
1,500 00
8,500.00
40,000 00
5
2,000.00
8,000.00
50,000 00
6
2,500.00
7,500 00
00,000 00
7
3,000.00
7,000 00
70,000 00
8
3,500.00
6,500.00
80,000 00
9
4,000.00
6,000 00
00,000 00
10
4,500.00
5,500 00
100,000.00
S22.500 00
$77,500 00
Annual entries for the deposit of funds with the trustee and
the collection of interest by the trustee on sinking fund securities
are indicated below:
End of first near:
Sinking fund cash . . 10,00000
Cnsh 10,000 00
Deposit with sinking fund trustee.
End of second year:
Sinking fund cash . 500 00
Sinking fund income . 500.00
Income earned on sinking fund securities. (The
Sinking Fund Income account will he closed to
Profit and Loss.)
Sinking fund cash . . . ft ,500 00
Cash . 9,500 00
Deposit with sinking fund trustee.
318 BONDS,. SINKING FUNDS, AND RESERVES ICh. 21
The trustee is expected to invest the sinking fund deposits in
securities, but there usually will be some uninvested cash in the fund.
The company's records should show what portion of the sinking
fund is represented by cash and what portion is represented by
securities. Therefore, when the trustee reports the purchase of
securities, the company should make an entry debiting Sinking
Fund Securities and crediting Sinking Fund Cash.
The sinking fund cash and securities may be shown in one
total in the balance sheet, or they may be detailed as follows:
Sinking fund:
Cash $ 300 00
Securities ' _19_f700. 00 «20,000 00
The sinking fund may be shown under the other assets caption
or as a separate item.
When the bonds mature, the sinking fund securities will be dis-
posed of by the trustee, who will pay the bonds from the cash in the
sinking fund. Assuming that the entire $100,000 fund was
invested in securities, that the securities were disposed of without
loss, and that the bonds were paid, the trustee would report the
facts to the debtor company, and the company would make entries
as follows:
Sinking fund cash 100,00000
Sinking fund securities 100,000 00
Sale of sinking fund securities.
Bonds payable 100,00000
Sinking fund cash 100,000 00
Retirement of the bonds.
If a loss is incurred in the disposal of the sinking fund securities,
the company will be obliged to make another deposit with the
trustee in an amount sufficient to bring the fund up to the required
balance. Assume that the trustee loses $500 on the disposal of the
securities; the company will be obliged to make up this loss by a
deposit of $500, and its entries will be:
Sinking fund cash . 99,500 00
Loss on sale of sinking fund securities . . . . 500 00
Sinking fund securities .... 100,000 00
Sale of sinking fund securities at a loss.
Sinking fund cash . . 500 . 00
Cash . 500.00
Additional deposit with trustee to cover the
loss from the disposal of the securities in the
fund.
Bonds payable 100,000.00
Sinking fund cash 100,000.00
Retirement of bonds by sinking fund trustee.
Ch. 21] BONDS, SINKING FUNDS, AND RESERVES 319
On the other hand, if the trustee makes a gain of $540 on the
disposal of the sinking fund securities, the residue of the fund will
be returned to the company. The company's entries will be:
Sinking fund cash 100,54000
Sinking fund securities 100,000 00
Gain on sale of sinking fund securities 540 00
Sale of sinking fund securities at a gain.
Bonds payable . 100,00000
Sinking fund cash 100,000 00
Retirement of bonds by sinking fund trustee.
Cash .. . 540.00
Sinking fund cash 540 00
Excess in sinking fund received from trustee.
Sinking fund expense. The service fee charged by the sinking
fund trustee may be paid from the sinking fund cash. If this is
done, the issuing company should debit Sinking Fund Expense
and credit Sinking Fund Cash. Or the trustee's fee may be paid
from the issuing company's general cash; if so, the entry will be:
debit Sinking Fund Expense and credit Cash.
Sinking fund reserves. In addition to requiring sinking fund
deposits, the terms of the bond issue may restrict the amount of
dividends which the borrowing company may pay during the life
of the bonds. One way of making this restriction is by requiring
the establishment of a sinking fund reserve by transfers from
earned surplus.
The sinking fund reserve requirement is intended to prevent
the impairment of the company's working capital. Suppose, for
instance, that the company which issued the bonds mentioned in
the foregoing illustration had a working capital (current assets
minus current liabilities) of $100,000 after issuing its bonds, and
that this amount was considered no more than adequate to carry
on operations. Assume that, during the first year of the life of
the bonds, the company had a net income of $20,000, which
increased the working capital an equal amount; if the company
paid dividends to the full extent of the $20,000 net income and also
paid $10,000 to the sinking fund trustee, the working capital would
be reduced $10,000. If this took place year after year, the com-
pany's working capital might be so impaired that it would not be
able to carry on its operations profitably. A year might soon
come when, because of inadequate working capital, the company's
operations would be so unprofitable that it would not be able to
make its sinking fund deposit.
To restrict the payment of dividends, and thus to avoid a
dangerous impairment of working capital, the terms of the bond
issue may include a provision similar to the following: "In addition
320 BONDS, SINKING FUNDS, AND RESERVES [Ch. 21
to increasing the sinking fund $10,000 each year, the company
shall transfer $10,000 each year from its Earned Surplus account
to a Sinking Fund Reserve account; the surplus set apart in this
reserve shall not be available for dividends until the bonds have
been paid."
Referring to the illustration in the section on sinking funds, and
assuming that the company was obligated to set up a reserve in
accordance with the provision just quoted, the following annual
entries would be made:
End of first year:
Sinking Fund Entry:
Sinking fund cash . . 10,000 00
Cash .. 10,00000
Deposit with the sinking fund trustee.
Sinking Fund Reserve Entry:
Earned surplus 10,000 00
Sinking fund reserve 10,000 00
To transfer a portion of the surplus to a re-
serve.
End of second year:
Sinking Fund Entries :
Sinking fund cash . 500 00
Sinking fund income .500 00
Income collected by sinking fund trustee on
securities in the fund.
Sinking fund cash. . 9,50000
Cash 9,500 00
Deposit with the trustee.
Sinking Fund Reserve Entry:
Earned surplus 10,000 00
Sinking fund reserve 10,000 00
To transfer a portion of the surplus to a re-
serve.
A sinking fund reserve is really a part of the earned surplus; for
the time being, dividends cannot be charged to it, but it is earned
surplus nevertheless. Therefore, it should be shown in the bal-
ance sheet under the net worth caption, as illustrated below:
Net worth:
Capital stock . . $500,00000
Earned surplus:
Sinking fund reserve — Not available for
dividends ... $20,000 00
Free — Available for dividends. 15,000.00
Total earned surplus . . 35,000 00
Total net worth. ... $535,00000
It is sometimes difficult to understand that a sinking fund
reserve is really a part of the earned surplus, because other reserves
Ch. 21] BONDS, SINKING FUNDS, AND RESERVES 321
(such as the reserve for bad debts and the reserves for depreciation)
represent decreases in the assets. The nature of the sinking fund
reserve would be more easily understood if it were called " Surplus
Appropriated for Sinking Fund/' or " Surplus Not Available for
Dividends Until After the Bonds Have Been Paid."
After the bonds have matured and been paid, the bondholders
have no further right to restrict the payment of dividends; there-
fore, an entry can be made debiting the Sinking Fund Reserve and
crediting Earned Surplus. Thus the balance in the Sinking Fund
Reserve is returned to Earned Surplus, and is again free from any
contractual limitations upon the payment of dividends. How-
ever, it might be expedient for the directors to refrain voluntarily
from the payment of dividends from this surplus in order to pro-
tect the company's working capital position.
A sinking fund requirement such as the one quoted on pages 319
and 320 may not be enough safeguard against an impairment of
working capital. If a company is required to deposit $10,000 in a
sinking fund, it may not be sufficient to require that $10,000 also
be transferred from Earned Surplus to a reserve ; even though this
requirement may be met, the borrowing company may still deplete
its working capital by paying dividends and charging them against
earned surplus accumulated before the long-term debt was incurred.
For this reason, some bond indentures provide that, in addition to
the creation of a sinking fund by periodic credits, the earned sur-
plus at the date of the issuance of the obligations (or a stated por-
tion thereof) shall be u frozen" and shall not be available for
charges for dividends until the obligations are retired.
Some bond indentures restrict dividends in ways other than
by a sinking fund reserve requirement. For instance, the issuing
company may agree to refrain from paying dividends which will
reduce the net worth below a stipulated amount, or which will
reduce the working capital below a stipulated amount, or which
will reduce the working capital ratio (a company with $300,000
of current assets and $100,000 of current liabilities has a working
capital ratio of 3 to 1) below the ratio existing when the bonds
were issued.
Dividend restrictions not reflected by a sinking fund reserve
should be stated parenthetically in the balance sheet in the man-
ner illustrated below :
Net worth:
Capital stock . $100,00000
Earned surplus (of which $40,000 is not
available for cash dividends because of
restrictions in the bond indenture) 65,000.00
Total ~ $165,000.00
CHAPTER 22
Cask
What is cash? In accounting usage, coin, paper money, bank
balances, and other media of exchange, such as checks, bank drafts,
cashier's checks, express money orders, and postal money orders,
are referred to as "cash." I. O. U.'s and postage stamps, some-
times found with 'the contents of a cash fund, are not cash. An
I. O. U. is a receivable. Postage stamps are a prepaid expense.
Although a business may have several cash accounts in its
ledger, it is considered acceptable to combine the accounts for bal-
ance sheet purposes, describing the combined accounts as "Cash
on hand and in banks." Or, the cash may be detailed as follows:
Cash on hand $ \xx
Cash in bank x,xx\
If some of the cash has been set aside for a special purpose or is
otherwise not readily available for disbursement, such cash should
be listed separately in the balance sheet.
As a general rule, cash is a current asset. There may be
instances, however, where cash funds become so restricted or
blocked that they should be excluded from the current assets sec-
tion of the balance sheet. Cash in an insolvent closed bank is an
example.
Internal check. The objectives of a good system of internal
check, as it relates to assets, may be summarized as follows:
(1) To safeguard the assets.
(2) To achieve more accurate accounting.
The above objectives stand a greater chance of being achieved
if, whenever it is feasible, the custody of assets and the recording
of transactions affecting assets are assigned to two or more indi-
viduals in such a way that the work of one person is verified by
another person. An irregularity, then, would require collusion.
In broad outline, a basic system of internal check with regard
to cash would include the following:
(1) Establishing a definite routine for accounting for cash
transactions.
(2) Separating the receiving and disbursing of cash from the
recording function.
Ch. 22] CASH 323
(3) Separating the activities associated with the disbursing of
cash from those associated with the receiving of cash.
(4) Requiring that all cash received he deposited daily in the
hank.
(5) Requiring that all disbursements be made by check.
The methods and procedures used to achieve internal check
vary greatly in different organizations. The system described
below is merely indicative of some of the methods and procedures
in use.
Cash receipts. Some receipts may come over the counter as the
proceeds of cash sales or as collections on account; other receipts
may come through the mail. As to the cash received over the
counter, prenumbered invoices should be made out for all cash
sales, and it should be the duty of some person to see that the
duplicates of these cash sales invoices or tickets agree with the
recorded receipts, and that no invoices are missing and unaccounted
for. Prenumbered receipts should be issued for all over-the-
counter collections on account ; if possible, these receipts should be
issued by some person other than the one who receives the cash ;
and a third employee should compare the duplicates of the receipts
with the cash record. All over-the-counter receipts should be
recorded on a cash register, if possible. When this is done, all
cash received over the counter should be counted and the total
compared with the cash register tape by some person other than
the one who collected the cash.
As noted above, the danger of misappropriations of cash is
reduced if the system of internal check makes collusion necessary
to conceal an abstraction of cash receipts. As to cash received
through the mail, a system of internal control can be provided in
which the perpetration and concealment of fraud would require
the collusion of three people, whose records should be required
to agree, as indicated below:
(1) All remittances received through the mail should go to an
employee other than the cashier or bookkeeper for list-
ing on an adding machine; this employee should also
obtain the cash register readings so that his tape will
include the total receipts for the day. After he has
listed the mail receipts, he will turn the cash over to the
cashier and will send the remittance letters to the
bookkeeper.
(2) The cashier will prepare the deposit tickets and will deposit
the funds. Since all funds received should be deposited
daily, the total of the deposit tickets for the day should
324 CASH [Ch. 22
equal the total of the adding machine tape prepared by
the first employee. The cashier should prepare each
deposit ticket in duplicate, request the receiving teller
at the bank to receipt the duplicate, and present the
receipted duplicate to the first employee for comparison
with his tape.
(3) The bookkeeper will record the cash receipts from informa-
tion shown by the remittance letters, cash register tapes,
and other papers; the total recorded receipts for the day,
as shown by the cash receipts book, should equal the
first employee's tape and the cashier's deposit.
With such a system of internal check, fraud cannot be practiced
with the cash receipts and remain undetected even for a day, with-
out the collusion of three persons. The first employee has no access
to the books and cannot falsify the records to conceal a misappro-
priation; he cannot expect to withhold funds received from debtors
without detection, because the debtors will receive statements or
letters from the credit department and will report their remittances.
If the cashier withholds any cash, his daily deposits will not
agree with the first employees list or with the bookkeeper's record
of cash receipts made from the remittance letters arid other sources
of information. The bookkeeper, having no access to the cash, has
no opportunity to misappropriate any of it, and therefore has no
incentive to falsify his records unless he is participating in a three-
party collusion.
Cash disbursements. Since all receipts are deposited daily in
the bank, all disbursements must be made by check. The person
authorized to sign checks should have no authority to make entries
in the cash book; thus a fraudulent disbursement by check could
not be concealed without the collusion of two persons. The col-
lusion of a third person can be made necessary:
(1) Either by requiring that all checks shall be signed by one
person and countersigned by another,
(2) Or by installing the voucher system, allowing the checks to
be signed by one person, but only upon authorization
evidenced by a voucher signed by some other person.
All checks should be prenumbered. All spoiled, mutilated, or
voided checks should be preserved. Some companies even go so far
as to require that such checks be recorded in their proper sequence
in the cash disbursements record, without entry in the money col-
umn, but with a notation to the effect that the check is void.
Bank columns in the cash books. If all cash receipts are
deposited daily and if all disbursements are made by check, the
Ch. 22] CASH 325
Cash columns of the cash books will serve as a record of the deposits
in, and the withdrawals from, the bank. If several bank accounts
are kept, the cash receipts book should be provided with as many
columns as there are bank accounts. This book may then appear
somewhat as shown on page 326.
Instead of a single account with Cash, there should be a sepa-
rate account with each bank, and the monthly totals of the Bank
columns of the cash receipts record should be posted to the debit
of the respective bank accounts.
The cash disbursements book (check register) may be similarly
ruled, in which case the Bank credit columns should be provided
with subcolumns to show check numbers, as shown on page 327.
Instead of a cash disbursements book with several bank col-
umns, as in the illustration, a separate cash disbursements book
may be used for each bank.
Petty, or imprest, cash. In the discussion of the system of
internal check on cash disbursements, the statement was made
that all disbursements should be made by check. How is this pos-
sible when certain disbursements of trifling amounts, for carfares
and postage, for instance, must be made in cash? Although such
petty disbursements may not actually be made by check, their
total can be covered by a check through operating a petty cash
fund. The petty cash fund, which is sometimes called the ''imprest
fund/' is operated as follows:
(1) Establishment of fund :
A check is drawn for a round amount ($10, $50, or such
an amount as will provide for petty disbursements for
a reasonable time) and cashed. The cash is held in
the office for use in making petty disbursements. The
establishment of a fund of $25 is recorded by entries
indicated below.
Voucher register:
Debit Petty Cash, credit Vouchers Payable: $25.
Cash disbursements book:
Debit Vouchers Payable, credit Cash: $25.
These entries record a transfer from the general cash account
to the petty cash account.
(2) Disbursements from fund :
When expenditures are made out of the petty cash fund,
receipts or other memoranda are put into the petty
cash box to show what the money was spent for.
326
CASH
[Ch. 22
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Ch. 22]
CASH
327
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328
CASH
[Ch. 22
In many businesses, the petty cashier is required to fill
out a petty cash voucher for each expenditure. An
example of a completed petty cash voucher is pre-
sented below. Petty cash vouchers usually provide
space for the signature of the person receiving the
cash from the petty cashier; thus, a receipt exists for
each disbursement. Any documents received by the
petty cashier supporting a petty cash disbursement
can be attached to the petty cash voucher.
,'
Nn /
Petty Cash Voucher
Paid to 6fG/ta(j
r d* x^ /*
0sbjtj&LAs C^
^y / 7
t *AIT
7
A^nimt- Nn ^5V JJL
Amoun
Payment Approved
Payment Received
^^ CUfc^ A £W
" 6
In addition, memorandum entries may be made in a
petty cash disbursements book, to show what accounts
will be charged with the disbursements. Such a book
might appear as follows :
Petty Cash Book
Date
July
Voucher
Number
1
2
3
5
6
Sr.Nnm
Freight
Freight.
Adver-
Office ,
Amount
In
(Jut
t ising
Supplies
(5172) !
(6061)
(6075)
(7011)
Acct
\o.
Amount
1
15
1
15
—
3
25
1
10
2
15
7
00
5
00
6051
2
00
1
43
75
68
5
70
1
20
4
00
50
6
20
2
00
1
20
3
00
24
73
6
20
7
35
8
00
1
18
2
00
This Is merely a memorandum book. No postings are made
from it.
Ch. 22] CASH 329
(3) Replenishment of fund:
Whenever the petty cash expenditures have nearly
exhausted the fund, it is necessary to replenish it. In
the above illustration, the petty cash hook is totaled
and ruled because the expenditures (which total
$24.73) have nearly exhausted the fund, and it is
necessary to replenish it. It is replenished by a check
for the exact amount of the expenditures: $24.73.
The issuance of the check is recorded as follows:
Voucher register:
Debit the various expense (or other) accounts;
credit Vouchers Payable: $24.73.
Cash disbursements book:
Debit Vouchers Payable; credit Cash: $24.73.
The expense accounts are debited when the fund is replenished,
and not when the petty disbursements are made. Thus, numerous
small disbursements can be recorded by one entry in the voucher
register.
As a general rule, the petty cash vouchers covering disburse-
ments must be presented by the petty cashier to a designated
accounting officer for his review and approval. Such petty cash
vouchers should equal the replenishment check, and, after being
marked u cancelled," to prevent their re-use, they are filed as sup-
port for the replenishment check.
The foregoing procedure may be summarized as follows:
Expense
Vouchers Petty (or other )
Payable Cash Cash Accounts
Establishment of fund: j I | I
Entry for voucher 25 00 25 OOi
Entry for check 25 00 25 00
Disbursements from fund :
No entries, except perhaps
memorandum entries.
Replenishment of fund:
Entry for voucher. 24 73 ; 24 73
Entry for check 24 73 !24 73
i 1
Ignoring the debits and credits to Vouchers Payable, which
offset one another, we may state the procedure as follows:
Establishment of fund: Debit Petty Cash, credit Cash.
Replenishment for
expenditures made : Debit expense or other accounts.
Credit Cash.
330 CASH [Ch. 22
It will be noted that the only entry in the Petty Cash account
is the one establishing the fund ; other entries will be made in this
account only if the established amount of the fund is increased or
decreased.
The Petty Cash account is not debited for replenish-
ments of the fund or credited for petty cash disbursements. The
person in charge of the petty cash fund should always have cash
or evidence of disbursements in his box equal to the balance of the
Petty Cash account.
The petty cash fund should always be replenished at the end
of a period before the statements are prepared and the books are
closed, so that the' effect of expenditures from the petty cash fund
will be reflected in the accounts of the period in which the expendi-
tures are made.
Cash over and short. In the process of handling cash receipts,
making change, and making disbursements from the petty cash
fund, it is possible that errors may be made, with the result that
cash shortages or cash overages may develop.
Example of cash overage:
A cash register is used for cash sales. At the end of the day,
the cash register shows that cash sales for the day equal
$325.60. However, the cash in the drawer, when counted,
amounts to $325.80. The cash overage of 20 cents is
recorded in the following entry :
Cash . 325 80
Sales 325.60
Cash over and short .20
Example of cash shortage:
A $25 petty cash fund exists. The fund is down to $1.50 and
is being replenished. However, the petty cashier has petty
cash vouchers accounting for the disbursement of only $23.00.
The cash shortage of 50 cents is recorded in the following
entry:
Various expense (or other; accounts. 23 00
Cash over and short ... 50
Vouchers payable 23 50
If the cash shortages exceed the overages during an accounting
period, the Cash Over and Short account will have a debit balance.
A debit balance will show the net expense arising from cash short-
ages and overages. Such an expense may be treated as a general
expense. If the Cash Over and Short account has a credit bal-
ance at the end of an accounting period, it may be treated as an
item of miscellaneous income.
Ch. 22] CASH 331
Dealings with the Bank
Opening a bank account. When an account is opened at the
bank, the persons authorized to draw checks against the account
will be requested to sign cards furnished by the bank, to show the
signatures which they will use on checks. These signature cards
will be filed by the bank, so that a teller who may be unfamiliar
with a depositor's signature can test the authenticity of a check
drawn on his account by comparing the depositor's signature on
the card with the signature on the check.
CORPORATION
To CONTINENTAL ILLINOIS BANK AND TRUST COMPANY
You are hereby authorized to charge to our account all orders or obligations
for payment of money drawn on or payable at. or which shall be paid or hon-
ored by, your Bank, bearing any of th* signatures below. You are also author*
ized to recognise any of said signatures in the transaction of all other business
for our account.
SIQM PRESIDENT
vice.
WILL SIGN PRESIDENT
WILL SION TREASURER
WILL SIGN SVCRETARY
AsST
WILL SIGN TREASI
ASST
WtLL SIQN SECRETARY
PLEASE SIGN FOOTNOTE
It Is hereby certified that the above signatures are the duly authorised signa-
tures of
(TITLE OF CORPORATION)
President . .Secretary
COR OTHER OFFICER)
Date 19!
*.a-ia ORIGINAL
Signature Card
If the depositor is a corporation, the bank will request that the
directors pass a resolution authorizing certain officers or employees
of the corporation to sign checks, and that a copy of this resolution
be filed with the bank.
Deposits. Deposits should be accompanied by deposit tickets
which describe the items deposited. Deposit tickets are of various
forms; an illustration appears on page 332.
It was formerly a general custom for the depositor to be fur-
nished with a pass book in which the bank teller recorded deposits;
the entries in the pass book, initialed by the receiving teller, con-
stituted receipts for the deposits.
332
CASH
[Ch. 22
It is now a more general custom for the depositor to prepare
deposit tickets in duplicate, and for the teller to initial the carbon
copy and return it to the depositor as a receipt.
Maintaining a record of the bank balance. Cash receipts and
deposits are recorded in the cash receipts book, and disbursements
are recorded in the cash disbursements book. At the end of the
month, totals are posted from the two books to the bank account
in the ledger, and the resulting balance in this account should show
the balance in the bank.
But, during the month, how can one ascertain the balance in
the bank? The record may be kept:
,-
(1) On the stubs of the check book, or
(2) In a bank register.
A running record on the check book stub is shown below.
*M
• r^
MM
»*m»i
Y
1 CHAM
••
Balance brought forward &5Q3 . 7J5 ,
flppn^it
CON
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TINEN1
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fNBTHH
m
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MAMfttt
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WITH
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TNB*ACK
AND1
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i «•••«•
f
COMP;
INT
f f
INY
Total
Check No 7,7
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tfts
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PAV^A n%f^^fi^^ &5O.OO
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Balan^A 7,^53. 75
c
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535SV
HlM
Deposit 7/(7/— 23oo 00
r / /
Total I0f 1^.75
Chf ok N^ ^4
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ton
•At MM
HT»* •
Balance carried forward f, 7JJ. 7J?
•
Deposit Ticket
Check Book Stub
If many checks are drawn, the computation of the bank bal-
ance after each deposit and each check is usually regarded as
Ch. 22]
CASH
333
unnecessary. In some cases, unbound checks are used so that
carbon copies can be prepared and handed to the bookkeeper for
his information in recording disbursements. For either of these
reasons, it may be expedient to eliminate the running record on
the check book stubs, and keep a bank register which will not
show the balance after each deposit and each check, but will show
the balance at the end of each day.
The following is an illustration of a bank register:
Bank Register
FIRST NATIONAL BANK
Date
n "
---
Deposits
Withdrawal^
!
Balance
19—
1
Juno
July
30
1
2
3
4
1 ,! !
,000|00'J 2,18000
.fiOOlOO* 3,500|00
5
5
6
,000
,520
,520
00
00
00
FIKST STATE BANK
Deposits
1
Withdrawals!
Balance
1 1
3,638ioO!!
! 3,20000|j
u
4,850
3,712
4,512
00
00
00
4,000|00
This record is kept in the following way:
Each day enter pencil totals of the day's receipts (deposits) in
the Bank debit columns in the cash receipts book (see page
320) and enter these totals in the Deposits columns of the
bank register.
Similarly, enter, in pencil, daily totals of the disbursements in
the Bank credit columns of the cash disbursements book, or
check register (see page 327), and transfer these totals to the
Withdrawals columns of the bank register.
Compute the resulting daily bank balances and enter them in
the Balance columns of the bank register.
Miscellaneous transactions. In addition to providing the serv-
ices of a checking account, with its benefits of a safe depository for
funds and its conveniences in providing for remittances by check,
the bank renders certain other services to its customers which wrill
be merely mentioned here without discussion, since they are com-
mented upon in other chapters. The bank will:
Through correspondent banks, collect sight drafts, notes, and
acceptances, or present time drafts to the drawees thereof
for acceptance; this service may involve a collection fee.
Sell cashier's checks or bank drafts to its customers for their use
in making remittances to creditors who prefer not to accept
personal checks; this service may involve an exchange fee.
334 CASH [Ch. 22
Loan funds to its customers on their own notes payable or on
notes and acceptances receivable owned by them; this serv-
ice involves an interest or a discount charge.
The bank statement. Once a month the bank will render a
statement to the depositor and return the checks which it has paid
and charged to his account. The statement is usually a carbon
copy of the bank's account with the depositor and shows the bal-
ance at the beginning of the month, the deposits, the checks paid,
other debits and credits during the month, and the balance at the
end of the month. A simple illustration of such a statement is
shown on page 335.
The symbols on the statement require some explanation :
N.S.F. On June 27 R. M. Walker Company received a check for
$63.95 from Wm. Barnes; this check was included in the
deposit of June 27. It was returned to The White
National Bank because Barnes did not have a sufficient
balance in his bank account to cover the check. The
White National Bank therefore charged it back to U. M.
Walker Company.
When a returned -'check marked "N.S.F." is received from
the bank, an entry should be made crediting Cash and
debiting the party from whom the check was received.
Such a check should not be regarded as cash, even if it is
redeposited, until it has been paid by the maker, unless
the bank gives credit for it at the time it is redeposited.
Ex. — On June 5 the bank charged $.10 exchange on a check
included in the deposit of that date.
Col. — On June 27 the bank credited the Walker Company with the
proceeds of a note collected by the bank for the company's
account, and charged a collection fee of $.25.
P.S. (Payment stopped)— If the Walker Company received and
deposited with The White National Bank a check from a
customer who, for some reason, stopped payment on the
check, the customer's bank would refuse to pay it and
would return it to The White National Bank, which would
charge it back to the account of the Walker Company.
S.C. - (Service charge) — Because of the expense involved in han-
dling checking accounts, banks cannot profitably handle
accounts with small balances; therefore, they frequently
make a service charge on accounts with balances averaging
less than a certain minimum amount. Instead of making
a service charge if the balance falls below a minimum
amount, many banks now base the service charge on &
number of factors, such as the average balance of the
account during the month, the number of deposits made
and the number of checks drawn.
Ch. 22]
CASH
335
20 Vouchers Returned
June , --
, 19 —
R. M. Walker Company,
135 West State Street,
Chicago, Illinois.
In Account with THE WHITE NATIONAL BANK
N.S F. - Not sufficient funds
Ex. - Exchange
Col - Collection
Int. - Interest on daily balance
PS- Payment stopped
S.C. - Service charge
Date
Checks
Deposits
Balance
1
4
5
6
8
10
11
12
13
15
18
19
20
22
24
26
27
29
30
$100.
96.
Ex.
75.
39
136.
84.
164,
7,
39.
600,
00 /
00 /
10
,00^
.75 '
.50*
.20/
.19v
.25V
50 v
35 v
13.75 V
76.
12,
35 <t
60 V
Balance brought forward
310. 00 /
150.50V
19.50V
123.80^
N.S. P. 63. 95
Col. .25
109.11V
175.00V
425.50V
136.75V
216.80V
310.80V
165.00V
138.20V
Balance end of month
500.17
3,710.17
3,614.17
,789.07
3,563.57
3,989.07
3,949.32
3,812.82
3,949.57
3,865.37
3,917.98
3,910.73
4,221.53
4 , 182 . 03
3,581.68
3,746.68
3,589.63
3,727.58
3,651.23
3,465.57
3,465.57
Please examine at once; if no errors are reported within
ten days, the account will be considered correct.
Bank Statement
336 CASH [Ch. 22
When the bank rendered this statement, it returned all paid
checks to the depositor. Accompanying the statement and the
canceled checks, there were debit memoranda for all charges to the
depositor not represented by checks; these included charges for
exchange, collection, and the check charged back (N.S.F.).
Reconciling the bank account. The balance shown by the bank
statement rarely agrees with the balance shown by the depositor's
books. Items may appear on the depositor's books which have
not yet been taken up on the bank's books, such as:
Outstanding checks not presented to and paid by the bank.
Deposits not yet received by the bank- perhaps in transit in the
mails.
Paper left with the bank and charged to the bank as a deposit,
but taken by the bank for collection only and not credited to
the depositor until collected.
Similarly, items may appear on the bank's books which have
not yet been taken up on the depositor's books, such as:
Service charges.
Charges for collection arid exchange.
Charges for checks returned N .S.F. Although the bank notifies
the depositor immediately of such returned checks, and also of
checks returned because payment has been stopped, entries
may not be made immediately on the depositor's books.
Charges for protest fees.
If a company keeps funds on deposit in several banks, contra
errors are sometimes made in the bank accounts on the depositor's
books. Checks drawn against one bank account may be recorded
as disbursements from another bank, and deposits in one bank may
be charged to another bank. The banks also occasionally make
errors by charging or crediting one customer with another cus-
tomer's checks or deposits, particularly if the customers' names
are similar. For all these reasons, the bank statement should be
reconciled as soon as possible after it has been received.
Illustration. The procedure of reconciling the bank account
will depend to some extent upon the system of accounting and
internal check. In some cases, the bank statement will be checked
against the record of deposits and checks shown by the check book
stubs. If all receipts are deposited daily, the deposits shown on
the bank statement may be checked against the cash receipts book.
In this illustration, we shall reconcile the June bank statement
of R. M. Walker Company (page 335) with the cash books shown
on pages 337 and 338.
Ck. 22]
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[Ch. 22
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Ch. 22] CASH
The bank account in the ledger appears as follows:
The White National Bank
339
19—
May
31
Balance
June
30
3.200 37
CR1
I
19—
3,625
97
Juno
30
16 1,628
55
1 5.254
52
CD23
1,961
15
Steps in the reconciliation. The procedure of reconciling the
hank account involves the following steps:
(1) Arrange in numerical order the paid checks returned from
the bank.
(2) Kefer to the reconciliation at the close of the preceding
month; note the items which were outstanding at that
date. The May 31st reconciliation appears below:
Balance, per hooks
Balance, per bank statement
Add deposit not credited by bank
Total
Deduct outstanding checks:
129
130
Adjusted balance.
Bank Reconciliation
May 31, 19—
S3, 625 97
$3,500 17
310 OOs/
S3, 810 17
$100 00 v*
81 20s/4 181 20
$3,625 97
This reconciliation shows that $310 recorded by the com-
pany as a deposit in May had not been credited by the
bank at the end of the month, and that checks fo/$100
and $84.20 were outstanding. Reference to the bank
statement on page 335 shows that the deposit was cred-
ited by the bank on June 1, and that the checks were
paid 011 June 1 and June 13. These items are now
checked on the May 31st reconciliation and on the June
30th bank statement as follows: ^ . The use of the
special check mark is not essential, but it has the advan-
tage of identifying the items as applicable to May.
(3) See whether the daily totals of receipts (as shown by the
cash receipts book) agree with the entries in the Deposits
column of the bank statement. Place check marks in the
cash receipts book and in the Deposits column of the bank
statement beside the items which are in agreement.
Make a list of unchecked receipts in the cash book;
these represent deposits not taken up by the bank.
By reference to the cash receipts book, it will be
noted that only one of the daily receipts is unchecked :
June 30 $60.50
340 CASH [Ch. 22
This unchecked item is presumably a deposit in trans-
it and must be taken into the bank reconciliation.
Make a list of any unchecked items in the Deposits col-
umn of the bank statement, representing credits by
the bank not taken up by the depositor. It will be
noted that there are no unchecked items in the
Deposits column of the bank statement.
(4) Compare the returned checks (which have been sorted in
numerical order) with the entries in the cash disburse-
ments book. Place a check mark in the cash disburse-
ments book beside the entry for each check that has been
returned by the bank.
Make a list of unchecked items in the cash disburse-
ments book; these are outstanding checks. By
reference to page 338, it will be noted that only one
entry is unchecked: the $300 check drawn on
June 30.
Make a list of any charges by the bank, as shown by
the statement or by debit memos, that do not appear
in the cash -^disbursements book. Such charges
shown by the bank statement are:
Kxchange . . . . $ 10
Collection 25
X.8.F. check returned . . 03 U5
(5) Prepare the reconciliation statement, as follows:
Bank Reconciliation
June 30, 19 —
Balance, per books . . . $3,29037
Deduct bank's charges not on the books:
Exchange . $ 10
Collection . . .25
N.B.F. check— Win. Barnes . 03.95 01.30
Adjusted balance . . $3,220 07
Balance, per bank statement . . S3 , 405 . 57
Add deposit not taken up by the bank . . 00 50
Total $37520 07
Deduct outstanding checks:
140 . _ 300 00
Adjusted balance (as above) $3^220 07
Certified checks. An ordinary check is deducted from the
drawer's account when the check is presented to the drawer's
bank for payment. In contrast, a certified check is deducted
from the drawer's account when it is certified by the drawer's bank.
Therefore, outstanding certified checks need not be included in the
list of outstanding checks in the bank reconciliation.
Ch. 22] CASH 341
Adjustments after reconciliation. The illustrative bank recon-
ciliation discloses the fact that the bank has made certain deduc-
tions from the depositor's account which have not been taken up
on the depositor's books. To take up these items, the company
should debit Collection and Exchange $.35, debit William Barnes
$63.95, and credit Cash $64.30.
The book of original entry to be used for such adjusting entries
depends on whether the cash journals have been footed and posted
prior to the preparation of the bank reconciliation.
Condition: Cash journals not ruled and posted prior to prepara-
tion of bank reconciliation.
Under such a condition, any required adjusting
entry can be entered in the appropriate cash
journal.
Condition: Cash journals ruled and posted prior to preparation
of bank reconciliation.
Any required adjusting entry should be recorded in
the general journal.
Payroll bank account. If a company pays a large number of
employees by check, it is desirable for it to open a special payroll
bank account. At each pay date, a voucher is prepared for the
total payroll, and a check on the regular bank account is drawn
and deposited in the payroll bank account. Individual checks for
the employees are then drawn on this special account, which is
thus immediately exhausted. If the payroll account and the gen-
eral account are kept in the same bank, different-colored checks
should be used.
This procedure has several advantages. In the first place, one
voucher against the general bank account can be drawn for the
entire payroll; the checks on the payroll account can be drawn
without vouchers. In the second place, the officer authorized to
sign checks on the general bank account can be relieved of the
work of signing numerous payroll checks; these can be signed by
some other employee. In the third place, the general bank
account can be reconciled without cluttering the reconciliation
statement with all the outstanding payroll checks. And, in the
fourth place, the labor of recording the payroll disbursements is
reduced: instead of recording all payroll checks in the cash disburse-
ments book, check numbers may be entered in a payroll record.
The payment of the payroll is recorded as follows:
Make a voucher register entry, debiting Payroll Bank
Account and crediting Vouchers Payable, for the amount
needed for the payroll ($1,925).
342 CASH [Ch. 22
Draw a check on the general bank account for the amount
needed for the total payroll; deposit this check in the
special payroll bank account.
Make a cash disbursements book entry, debiting Vouchers
Payable and crediting Cash, $1,925.
Make general journal entries as follows (the amounts are
assumed) :
Salesmen's salaries .... . 875.00
Office salaries 533.44
Officers' salaries 1,05500
Payroll bank account . . 1 ,925 00
Federal O. A. B. taxes withheld 36.95
Federal income taxes withheld . 501 .49
Payroll taxes 110 85
Federal O. A. B. taxes payable 36.95
Federal unemployment taxes payable 7.39
State1 unemployment taxes payable 66 51
Instead of making and posting a general journal entry, the pay-
roll record may be drawn up in such a form that postings to the
various expense accounts and the Payroll Bank Account can be
made directly from it.
When the statement of the payroll bank account is returned
from the bank, the canceled checks are arranged in numerical
order and checked off against the check numbers on the payroll
record. The unchecked items will represent outstanding checks,
and usually will be the only items to be taken into consideration
in reconciling the payroll bank account.
Dividend bank account. If a company has a large number of
stockholders, a special bank account may be used for the pay-
ment of dividends. A voucher for the total amount of the dividend
will be prepared, and a check for that amount will be drawn and
deposited in this special bank account. Checks payable to the
individual stockholders will be drawn on this account.
Bank overdraft. If a bank account is overdrawn, the amount
of the overdraft should be shown as a current liability.
CHAPTER 23
Accounts Receivable. Discounting Notes
and Acceptances Receivable
Accounts Receivable
Accounts receivable in the balance sheet. The amount shown
under the current assets caption as Accounts Receivable (without
any further description) should include only amounts receivable
on open account from trade debtors. Accounts receivable from
stockholders, officers, or employees should be shown separately in
the balance sheet unless the receivables arose from sales and are
collectible in accordance with the company's regular terms;
accounts with such individuals for loans or other advances may
be listed under the current assets caption if the terms of such
receivables and the company's experience with them indicate that
they will be collected as soon as other current assets; otherwise,
they should be shown under the caption of other assets, thus:
Other assets:
Accounts receivable from officers and employees
ftxx.xxx
Accounts receivable and payable with same party. If goods
are purchased from and sold to the same party, it is advisable to
keep two accounts: one in the accounts receivable ledger, thus:
James Smith
Date
19—
Sept.
12
Kxplanation
Folio j Debit
81
CR1
50000
Credit ,' Balance
500
500JOO
and (unless a voucher system is in use) another in the accounts
payable ledger, thus:
James Smith
Date
19—
Sept.
15
Explanation
Folio
Debit
Credit
Balanee
PI
CD1
200
00
375
00
375
175
00
00
343
344 ACCOUNTS RECEIVABLE [Ch. 23
If a voucher system is used, the receivable from Smith will be
shown in the accounts receivable ledger, and the liability will be
recorded in the voucher register.
It is recommended that such receivables and payables should
not be offset when the balance sheet is prepared.
Ledger headings. The headings of the ledger sheets or cards
used for accounts receivable usually are provided with spaces in
which to enter certain general information relating to the debtor
which may be useful for credit or sales purposes. The data will
vary in different businesses, but may include the following:
Sheet No. ^ Name
Rating Address
Credit Limit. .. .
Salesman . Business
The Sheet Number space is needed on active accounts extending
over several pages kept in a loose-leaf binder; if the current sheet is
number 7, it is known that six other sheets must be found, either in
the current binder or the transfer binder, to include the entire
account.
The Rating space is used to show the credit rating given the
customer by rating agencies, such as Dun & Bradstreet, Inc.
The Credit Limit space shows the maximum amount fixed by
the credit department.
The salesman's name may be desired on the account so that the
sales manager can see whether the salesman appears to be neglect-
ing his sales opportunity with the customer, and so that the credit
and collection department can see which salesmen are making sales
on accounts that become delinquent.
Account and statement at one impression. Many concerns
which make a practice of sending monthly statements to their cus-
tomers use bookkeeping machines to keep their accounts receiv-
able. Such machines can be used to type the entries and compute
and enter the balance after each entry. The three-column ledger
ruling with debit, credit, and balance columns is generally used
with these machines.
At the beginning of the month, a statement form is inserted in
the binder with each customer's ledger sheet. When an entry is to
be recorded, the account and the statement are put into the
machine, with a carbon between, so that the ledger account and
the statement are duplicates. At the end of the month, the state-
ment is removed from the binder and mailed to the customer.
C.O.D. sales. Sales made on C.O.D. terms may be recorded in
the sales book in the usual way, but a notation should be made
Ch. 23]
ACCOUNTS RECEIVABLE
345
showing that the terms are C.O.D. This can be done by merely
writing C.O.D. after the name of the customer. From that point,
custom varies. Three methods of procedure may be mentioned:
(1) The debtor's account is kept in its regular alphabetical posi-
tion in the subsidiary accounts receivable ledger, with a
notation in the heading of the account indicating that the
customer is on a C.O.D. basis.
(2) The accounts of all customers who are on a C.O.D. basis are
grouped together in one place in the ledger, where they
can be more closely watched.
(3) Instead of keeping accounts with the debtors, the book-
keeper posts the amounts of all C.O.D. sales to a C.O.D.
accounts receivable register. When the collection is
received, it is recorded in the cash receipts book in the
usual manner, and the date of the collection is entered
in the Date Collected column of the register. Such a
register follows:
C.O.D. Accounts Receivable Register
Date
Invoice
No.
Customer
19—
June 1
1387
J. B.
White
6
1473
R. C.
Luther
7
1489
J. Y.
Hitter
Address
Amount
Date
Collected
Osborne, Iowa
Dayton, Minn.
Ohphant, Tenn.
50
75
GO
00
00
00
June
5
The open items in the register (that is, the entries with 110
notations in the Date Collected column) represent uncol-
lected charges; in balancing the subsidiary records
against the accounts receivable controlling account, the
bookkeeper must include the open items in the register
with the balances in the subsidiary ledger.
Red balances in subsidiary ledgers. The individual accounts
in the accounts receivable ledger normally have debit balances;
some accounts may run into credit balances because of overpay-
ments, credits for returns and allowances after payment of the
account in full, or for other reasons. Such credit balances may be
entered in the accounts in red to distinguish them from the debit
balances; for this reason they are sometimes called red balances
even though written in black ink with a notation Cr. after them.
Assume that the debit balance in the Accounts Receivable con-
trolling account is $6,325, which represents the subsidiary ledger
balances shown on the following page.
346 ACCOUNTS RECEIVABLE [Ch. 23
Debit balances $6,500.00
Credit balances . !!*L?0
Net debit . . $6,325 00
The controlling account balance of $6,325 should not be used
in the balance sheet; instead, the total debit balances and the total
credit balances in the subsidiary ledger should be shown, thus:
Current assets: Current liabilities:
Accounts receivable. $6,500 00 Credit balances in customers'
accounts $175 00
Similarly, if the subsidiary accounts payable ledger contains
some debit balances, the balance sheet should not show the balance
of the controlling account but should show the total credit balances
and the total debit balances of the subsidiary ledger, thus:
Current assets: Current liabilities:
Debit balances in suppliers' Accounts payable $7,800.00
accounts . . . $135 00
Aging the receivables. As noted in Chapter 7, the amount to
be added to the Reserve for Bad Debts is sometimes computed by
giving consideration to the probable collectibility of each cus-
tomer's account, thereby estimating the total probable reserve
requirement. The age-distribution of the receivables is some-
times a reliable indication of collectibility, and may therefore be
useful in estimating the reserve requirement. For example,
experience may indicate that the following reserve balance would
be desirable, considering the age-distribution of the receivables.
Estimated
Per cent Reserve
Accounts Receivable Balances Uncollectible Requirement
1-30 days old $32,000 I $ 320
31-60 days old 21,000 2 420
61-90 days old 14,000 8 1,120
91 days to 6 months old 8,000 20 1 ,600
Over 6 months old 2,000 50 1,000
$77,000 $4,460
However, supplementary information must also be considered ;
some accounts which are not old may be of doubtful collectibility,
whereas accounts long past due may be collectible.
The age-distribution may be obtained by preparing a schedule
of the accounts receivable on columnar paper, with columns headed
to indicate various ages, such as / to 30 days, 31 to 60 days, 61 to
90 days, 91 days to 6 months, and Over 6 months. The balance of
each debtor's account is analyzed to determine the age of the com-
ponent elements, and the aging schedule is filled out by entries
Ch. 23]
ACCOUNTS RECEIVABLE
347
.such as the following (which is based on the account with J. IT.
Boyce, presented below). After all the balances have been aged,
the columns are totaled, thus completing the aging.
Accounts Receivable Aging, November 30, 19 —
Name
Total
775
00
1-30
Days
31-GO
Days
61-90
Days
91 Days to
6 Months
Over 0
Months
J. II. Boyce
525
00
250
00
J. H. Boyce
Date
19—
Sept.
Oct.
Nov.
Explanation
Note Receivable
Note Receivable
1
Folio
Debit
Credit
Balance
SI
a 250
00
250
00
82
b 500
00 \'
750
00
CR1
b 500
oov
250
00
S2
c 800
00 V
1,050
00
J2
c 500
00 v
550
00
CR2
c 300
00 V
250
00
S3
d 750
00V
1,000
00
S3
e 200
oov
1,200
00
CH3
d, e 950
oov
250
00
S4
f 600
00 %
850
00
S4
g 250
00
1,100
00
CIU
f 200
00 V
900
00
J3
f 400
00 v'
500
00
S4
h 375
00
875
00
CR5
K 100
00
775
00
By reference to Boyce's account, it may be seen that the prac-
tice of lettering the entries in receivable accounts is very helpful
in preparing the aging schedule. In this instance, the bookkeeper
has also checked the offsetting items which do not enter into the
balance of the account.
There are four unchecked items in the account, and these are,
therefore, the only ones which enter into the balance ; these items
are:
Date
19—
Sept. 15
Nov. 7
11.
16
Debit
(a) $250 00
(g) 250 00
(h) 375 00
Credit
(g) S100 00
The $775 balance in the account consists of the $250 September
item (which was between 61 and 90 days old on November 30),
and two November debits and one November credit in a net
amount of $525 (which was between 1 and 30 days old on Novem-
ber 30).
348 ACCOUNTS RECEIVABLE [Ch. 23
In addition to being useful in the computation of reserve
requirements, data by age groups may be used by management
to determine whether collections from customers are lagging.
Such a trend would be revealed by a shift in the percentage rela-
tionships among the age groups, with the older balances making
up a larger share of the total receivables than heretofore.
Bad debt recoveries. Suppose that an account receivable
previously written off is collected. If subsequent developments
indicate that the entry writing off the account against the reserve
was an error, the write-off should be reversed. To illustrate,
assume that P. K. Lane's account in the amount of $75 had been
written off. The, reversing entry, at the time of the collection
from Lane, would be as follows:
P. K. Lane 75 00
Reserve for bad debts 75 00
To reverse entry writing off Lane's amount
The cash collection will then be recorded in the cash book by an
entry debiting Cash and crediting Lane.
The proper treatment of partial collections on written-off
accounts is somewhat more difficult to determine because it
depends upon the probability of further collections. To illus-
trate, assume that, after Lane's account was written off, he paid
$30:
If this collection and other facts indicate that the account may
be collected in full, the entries should be:
In the journal: Debit Lane, credit Reserve for Bad I )ebts :
$75.00.
In the cash book: Debit Cash, credit Lane: $30.00.
If no more collections are expected, the entries should bo:
In the journal: Debit Lane, credit Reserve for Bad Debts :
$30.00.
In the cash book: Debit Cash, credit Lane : $30.00.
Reserves for returns and allowances, cash discounts, and freight.
Let us assume that a company has total accounts receivable of
$20,000 on December 31, and has provided a reserve of $1,000
for bad debts. This reserve may be an adequate provision for bad
debt losses, but it does not necessarily follow that the company will
collect $19,000 from the accounts. Customers may demand
credits for returned merchandise and allowances on defective goods ;
many of the debtors will take the cash discounts to which they are
entitled ; and, if the goods are sold on terms which require the cus-
Ch. 23] ACCOUNTS RECEIVABLE 349
tomers to pay the freight but allow them to deduct such payments
in remitting for the merchandise, deductions will he taken for such
freight.
Theoretically, all these prospective deductions should he pro-
vided for by reserves, so that the accounts receivable will be stated
in the balance sheet at the estimated net amount which will be col-
lected after allowing all such deductions. As a practical matter,
however, such adjustments are rarely made, for the following
reasons :
(1) Such prospective deductions are difficult to estimate.
(2) The omission of such adjustments normally will have no
significant effect on net income.
This might not be the case for the first year of a new
business. Its accounts would show a full year's sales
with something less than a full year's deductions from
sales for discounts and returns and allowances. But
in the second and succeeding years, since any deduc-
tions relating to prior years' sales are recorded when
taken, the accounts for discounts and returns and
allowances will show deductions covering a full period.
Hence, unless large fluctuations occurred in sales
deductions, the failure to adjust for prospective returns
and allowances and discounts affects the financial
statements only in that accounts receivable will be
stated at an amount slightly above their cash realiz-
able value. Most accountants feel that this is not
serious, since the amounts involved are so small. If,
in a given case, it should develop that the amounts
involved were significant, then no doubt the account-
ant would make adjusting entries of the type indi-
cated above.
Discounts on returned sales. Assume that a customer buys
merchandise for $1,000 subject to a 2C; discount, and that he pays
the invoice within the discount period with a check for $980.
Subsequently, he returns one-tenth of the goods, which had been
billed to him at $100 and which were paid for at the net amount of
$98. Should he receive credit for $100 or $98?
Although this is largely a matter of policy, it would seem that
the credit should be $98 if he is to be reimbursed in cash, and $100
if the credit is to be traded out. The reasoning may be made
clearer by assuming that the entire shipment is returned. Allow-
ing a credit of $1,000 to be repaid in cash would open the way to
abuses of the cash discount privilege, whereas allowing a credit of
350 ACCOUNTS RECEIVABLE [Ch. 23
only $980 payable in merchandise would cause the customer to lose
the benefit of having paid his bill within the discount period.
Freight paid and discount taken by customer. Assume that a
customer buys merchandise amounting to $1,000. He is to pay
the freight, which amounts to $40, and is allowed to deduct it in
remitting for the merchandise; he is also allowed a 2% discount
for cash within 10 days. Should the 2% discount be based on the
$1,000 invoice, or on this amount less the $40 freight?
The discount should be based on the full amount of the invoice,
because the customer is paying the freight for the seller, and is
entitled to a cash discount for the funds so used. The settlement
should, therefore, be made as follows:
?
Invoice SI ,000 00
Deduct: Freight . $40 00
Discount— 2% of SI ,000.00 20 00 60 00
Net amount of remittance . . .... $__i)40 00
Sales discount on customers' partial payments. Assume that
a customer buys merchandise for $1,000 subject to terms of 2/10;
n/30. Suppose that he is not able to pay the entire invoice, but
does send a check for $588 in partial settlement within the ten-day
discount period. Since the partial payment was made within the
discount period, the seller may, as a matter of policy, allow the dis-
count on the partial payment.
If the discount is granted on partial payments, the amount paid
is the net amount, and therefore it is necessary to determine the
amount of the gross obligation settled by the partial payment.
This can be computed as follows :
S588 -f- .98 - S600
In general journal form, the collection would be recorded as
follows :
Cash . ... 588.00
Discount on sales 12 00
Accounts receivable 600 00
To record partial collection of an account receivable
within the discount period.
Uncollectible notes receivable. If a business has a large num-
ber of notes receivable, a separate reserve for bad debts account
may be used. However, if there are only a few notes receivable,
possible losses thereon are generally combined with the estimate of
losses on accounts receivable. The debit to Bad Debts should
cover estimated losses on both accounts and notes receivable.
When a note is determined to be uncollectible, it should be written
off against the reserve.
Ch. 23] DISCOUNTING NOTES RECEIVABLE 351
Discounting Notes and Acceptances Receivable
Purposes of discounting notes and acceptances receivable.
Instead of borrowing money from a bank by discounting our own
note payable, as discussed in Chapter 9, we may obtain funds from
a bank by endorsing, and transferring to the bank, any notes or
acceptances receivable held by us which are acceptable to the bank.
The payee of a note or an acceptance may endorse it and trans-
fer it to a creditor to apply on account, if the creditor is willing to
take it.
Same methods apply to notes and acceptances. The essen-
tial characteristics of a note and an acceptance are the same: they
are written obligations of a debtor, payable at a fixed or determin-
able date. To simplify the presentation in this chapter, the
illustrations deal only with notes; it should be understood that the
procedures and entries applicable to the discounting of acceptances
are identical with those for notes.
Endorsements. Paper which is payable to the order of a
named payee must be endorsed by the payee if it is to be trans-
ferred by him to some other party; thus, if F. K. Hamilton, the
payee of the illustrative note on page 114, wishes to transfer the
note to John Smith, Hamilton must endorse the note by writing
his name across its back. The party who endorses a note is called
an endorser; the party to whom the note is transferred is called an
endorsee.
By the act of endorsement of a negotiable promissory note or
acceptance, the endorser assumes an obligation (subject to certain
defenses) to pay the paper to a subsequent holder if the maker fails
to pay it at maturity. This obligation is called a contingent lia-
bility. For a complete discussion of the nature of the contingent
liability of an endorser, and the nature of his defenses, you are
referred to any good text on the law of negotiable instruments.
Paper which is payable to bearer can legally be transferred by
delivery without endorsement; however, the party to whom the
paper is to be transferred may require that it be endorsed in order
to make the transferor contingently liable for its payment.
Endorsements are classified and illustrated as follows:
(1) Unqualified endorsements (the transferor assumes the full
contingent liability imposed by law upon an endorser):
(a) In full (shows the name of the party to whom the
paper is transferred) :
Pay to the order of
John Smith
F. K. Hamilton
352 DISCOUNTING NOTES RECEIVABLE [Ch. 23
The paper is still payable to order; that is, Smith
must endorse it in order to transfer it.
(b) In blank (does not show the name of the party to
whom the paper is transferred) :
F. K. Hamilton
The paper is now payable to bearer and can legally
be transferred by subsequent holders without
endorsement.
(2) Qualified endorsement (the endorser limits his contingent lia-
bility by inserting the words Without Recourse):
(a) In full:
Pay to the order of
John Smith
Without Recourse
F. K. Hamilton
(b) In blank:
Without Recourse
1VK. Hamilton
One who endorses without recourse materially lessens his
contingent liability as an endorser. He warrants that
the paper is valid and thai he has a good title to it, but he
does not assume a legal obligation to pay the paper
merely because the primary obligor does not do so.
(3) Restrictive endorsement (which must be in full):
(a) To prevent further transfers:
Pay to John Smith only
F. K. Hamilton
(b) To make the endorsee an agent for a special purpose:
Pay to the order of
First National Bank
For collection
F. K. Hamilton
Proceeds. The proceeds of a discounted note or acceptance
receivable are computed as follows:
First, determine the value of the receivable at maturity (this
is the amount which the holder will be entitled to collect
at maturity).
The maturity value of non-interest paper is the face.
Ch. 23] DISCOUNTING NOTES RECEIVABLE 353
The maturity value of interest-bearing paper is the face
plus the interest for the full period.
Second, determine the discount period, or time from the date
of discount to maturity.
Third, compute the discount at the agreed rate, on the value
at maturity, for the discount period.
Fourth, deduct the discount from the value at maturity.
Let us compute the proceeds of two notes receivable discounted.
Maker B. Bates C. Cole
Date of note . August 1 August 1
Time from date of note to maturity 60 days 60 days
Date of discount. . August 11 August 11
Discount period — or tune from date of discount to
maturity 50 days .50 days
Rate of interest borne by the note None 5J%
Rate of discount charged . _6*i _ 6j^>
Computation of proceeds:
Face of note $6,000 00 $6,000 00
Add interest from date of note to maturity:
The Bates note does not bear interest.
Interest on the Cole note at 5j9r for 60 days is 55 00
Value at maturity tt^000~00 $6,055 00
Deduct discount at 6c/< for 50 days:
50 days' interest on $6,000.00 50 00
50 days' interest on $6,055.00 . 50 46
Proceeds . $5 ,"tWO~Op $6,004.54
Discounting notes receivable at the bank. Let us assume that
we own the Bates and Cole notes, which are recorded in the Notes
Receivable account as follows:
Notes Receivable
19—'
AUR.
B. Hates 60 da. i 6,00000
C. Cole 60 da . 5* % I : 6 , 000 00 1
l i,
Let us now assume that we discount these notes at the hank on
August 11. Since we part with the notes, it may seem that the
Notes Receivable account should be credited. But we should
remember that, in order to transfer the notes to the bank, we must
endorse them, and thus render ourselves contingently liable for
their payment. This contingent liability should be shown in the
accounts. Therefore, we shall credit Notes Receivable Discounted,
as illustrated in the entries* on the following page.
* The illustrative entries throughout this chapter are given in general journal form
for simplicity of explanation ; it will be understood that entries for cash receipts and
disbursements would be made in the cash books.
354 DISCOUNTING NOTES RECEIVABLE
Bates note- for which we receive less than the face:
ICh. 23
Cash
Interest expense
Notes receivable discounted
Note of B. Bates discounted at hank at 6%.
5,950.00
50 00
0,000 00
Cole note -for which we receive more them the face:
Cash. 6,001 54
Notes receivable discounted
Interest income. . ...
C. Cole's 5i% note discounted at bank at 6%.
6,000 00
4 54
The Notes Receivable and Notes Receivable Discounted
accounts now appear as follows:
Notes Receivable
19—
Aug.
1
B. Bates 60 da.
6,000
00
1
C. Cole 60 da. 5|%
6,000
00
Notes Receivable Discounted
19—
Aug
11
11
B. Bat™
C. Cole
6,00000
6,00000
The net balance of the two accounts is zero, showing that we
own no notes receivable.
Discounting notes receivable with a creditor. Let us assume
that, instead of discounting the notes receivable at a bank, \ve
transferred them on August 11 to a creditor, J. B. Houston, to
apply on our account payable liability to him; let us also assume
that they were discounted at 6%; the proceeds, therefore, were the
same as computed above. Our entries to record the discounting
of the Bates and Cole notes with our creditor to apply on account
are shown below :
Bates note — for which we receive less than the face:
5,950.00
50 00
J. B. Houston
Interest expense
Notes receivable discounted
Note of B. Bates transferred on account, discounted
at 6%.
Cole note- -for which we receive more than the face:
J. B. Houston . . . . 6 , 004 . 54
Notes receivable discounted . . . ...
Interest income
C. Cole's 5i% note transferred on account, dis-
counted at 6%.
6,000.00
6,000 00
4.54
Ch. 23]
DISCOUNTING NOTES RECEIVABLE
355
Discounted note paid by maker at maturity. Assume that
Bates and Cole paid their discounted notes at maturity. We no
longer have any contingent liability, and can therefore make the
following entries:
Notes receivable discounted 6,000 00
Notes receivable 6 , 000 . 00
To eliminate the Bates note and contingent liability
from the accounts.
Notes receivable discounted 6,000 00
Notes receivable 6 , 000 . 00
To eliminate the Cole note and contingent liability
from the accounts.
The two ledger accounts appear as follows:
Notes Receivable
19—
111 9—
Aug.
1
B. Bates GO da.
6,000
00 Sept.
30
B. Bates
6,000
00
1
C. Cole* (tt) dti. 5i%
6,000
oof
1
30
C. Cole
6,000
00
Notes Receivable Discounted
19—
Sept.
B. Bates
C. Cole
19—
6,000
00
Aug.
11
B. Bates
6,000
00
6,000
00
11
C. Cole
6,000
00
Discounted note dishonored by maker. An endorser cannot
he held on his contingent liability for the payment of a discounted
note receivable unless the holder (endorsee) has presented it to the
maker at maturity, demanded and not received payment, and given
proper notice of dishonor to the endorser.
Let us assume that Bates and Cole dishonored their notes at
maturity and that the holder took the proper steps to enforce col-
lection from us. Our entries will be:
For payment of Bates note — which did not bear interest:
6,000 00
B. Bates
Cash. ...
Paid (bank or Houston) the Bates note discounted
by us and dishonored by him.
(The payment is charged to Bates because we have
a right to enforce collection from him.)
Notes receivable discounted ...
Notes receivable
To eliminate the Bates note and the contingent
liability from the accounts.
(This entry is made because there is no longer any
contingent liability on the note. The contingent
liability developed into a real liability, and was
paid.)
6,000.00
6,000 00
6,000.00
356 DISCOUNTING NOTES RECEIVABLE [Ch. 23
For payment of Cole note — which bore interest:
C. Cole 6,05500
Cash 6,055.00
Paid (bank or Houston) the Cole note discounted
by us and dishonored by him, and 5J% interest
thereon for 60 days.
Notes receivable discounted 6,000.00
Notes receivable 6,000.00
To eliminate the Cole note and contingent liability
from the accounts.
Disposition of Notes Receivable Discounted account. You
should observe tl^at the entry debiting Notes Receivable Dis-
counted and crediting Notes Receivable is made by the endorser
at the maturity of a discounted note, regardless of whether the note
is paid by the maker or by the endorser. If the note is paid by the
maker, the endorser has no further liability. If the note is dis-
honored, the contingent liability becomes a real liability.
Protest. In some cases, notice of dishonor can be given to the
endorser informally, either orally or in writing. In other cases,
protest and formal notice of dishonor are required.
Protest is a formal declaration in writing by a notary public to
the effect that he has presented an instrument to the person pri-
marily liable thereon and demanded payment, and that the instru-
ment has been dishonored. Notice of protest is sent by the notary
public to the maker and to all the endorsers.
The holder of the paper (the endorsee) engages the services of
the notary public and pays his fee, which he charges to the endorser.
The endorser is obligated to pay the face of the note, the protest
fee, and any accrued interest.
Let us assume that the Cole note, discounted by us, was dis-
honored and protested, and that the protest, fee was $2.04. Our
entries at the time of payment will be:
C. Cole.. . 6,057.04
Cash 6,057 04
Payment of dishonored note, interest, and protest
fee.
Notes receivable discounted . .. 6,00000
Notes receivable. . 6,00000
To eliminate the C. Cole note and the con tin Kent-
liability from the accounts.
Purpose of Notes Receivable Discounted account. It should
be understood that the Notes Receivable Discounted account is
used to show the contingent liability on paper which we have
owned and have transferred to other parties, thus assuming a con-
tingent liability as a result of our endorsement.
Ch. 23]
DISCOUNTING NOTES RECEIVABLE
357
If we discount our own note payable, the transaction should be
recorded by a credit to Notes Payable, to show the direct liability.
Notes receivable and notes receivable discounted in the bal-
ance sheet. Assume that a company's accounts with notes receiv-
able and notes receivable discounted appear as follows:
Notes Receivable
19—
— J^-a—k -
19—
June
1
Smith- -30 da.
Jl
a 1,000
00
July
1
Smith
CR3
a 1,000
00
10
Brown— 30 da.
J2
b 2,000
00
10
Brown
JG
h 2,000
00
20
White*— 00 fla.
J3
c 2,500
00
25
Green — (>0 da.
.M
d 3,000
00
|
Notes Receivable Discounted
19—1 1
July lOl Brown
"T
J<> h 2,000
Jl
00
19—
June
15
25
1
Brown j J2
White J3
I
b 2,00000
e 2,500100
These accounts show the following facts:
The Smith note was received on June 1 and was collected on
July 1.
The Brown note was received on June 10; it was discounted
on June 15; it matured on July 10, and the contingent lia-
bility was eliminated.
The White note was received on June 20; it was discounted
on June 25; it has not yet matured; therefore, there is a
contingent liability of $2,500.
The Green note was received on June 25; it has not yet
matured, and the company therefore has an asset of
$3,000.
The balance sheet, should show the note receivable asset of
$3,000 and the contingent liability of $2,500. The asset, and the
contingent liability can be determined from the balances of the
two accounts, as follows:
Debit balance* of Notes Receivable account $5,500 00
Credit balance of Notes Receivable Discounted account —
amount to be shown as a contingent liability 2,500 00
Net balance of the two accounts — amount to be shown as note
receivable asset.
$3,000 00
The note receivable asset is shown in the balance sheet on the
asset side. The contingent liability on notes receivable discounted
is usually stated in a footnote. The procedure is illustrated on the
following page.
358 DISCOUNTING NOTES RECEIVABLE [Ch. 23
NAME OF COMPANY
Balance Sheet
July 31, 19—
Assets Liabilities and Net Worth
Cash S 75000 Liabilities:
Accounts receivable 2 , 850 00 Accounts
Notes receivable 3,000 00 payable $ 2,000.00
Inventory 6,780.00 Notes pay-
able 1,000 00 $ 3,000.00
Net worth:
Capital stock $10,000 00
Earned sur-
plus 380 00 10,380.00
$13,380 00 ~~ SI 3~, 380 00
Note. On July 31, 19 — , the company was contingently liable on a note receivable
discounted in the amount of $2,500.
Discounted notes taken from debtor on account. Assume that
Fred Button is indebted to us on an account receivable, and that he
wishes to transfer to us, to apply on account, two notes which he
holds and which are described as follows:
Interest-
Maker Date Time Rate Face
James Magee ........... ^N. . June 1 60 days — $3 ,000 00
Horace Heald ...... "10 60 days 6% 6,00000
We are willing to take these notes from Button on June 15 at a
value determined by discounting them at 6%. The proceeds are
computed as follows :
Maker . Magee Tleald
Date of note. . . . . . ...... June 1 .June 10
Period of note . . 60 days 60 days
Maturity . July 31 Aug. 9
Date of discount June 15 .June 15
Discount period 46 days 55 days
Rate of interest on note — 6%
Rate of discount charged by us 6% 6%
Computation of proceeds:
Face of note. $3,000 00 $6,000 00
Add interest on note from date of issuance to
maturity _____ _ _ J?9-°°
_____ _ _
Value at maturity . $3,000 00 SeTOBO 00
Discount at 6% deducted by us:
On $3,000 for 46 days ...... 23 00
On $6,060 for 55 days ....... __ __ 55^55
Proceeds ..................... $2,9^.00 $6,004 45
Entries at acquisition:
Notes receivable ................................ 3,000 00
Interest income .......................... 23 .00
FredDutton ........................... 2,97700
James Magee 60-day, non-interest note due July 31,
taken from Putton on 6% discount basis, to apply
on account.
Ch. 23] DISCOUNTING NOTES RECEIVABLE 359
The $23 credit to Interest Income is the amount we will earn by carry-
ing the note from June 15, the date of discount, to July 31, the
maturity.
Notes receivable ....................... 6,000 00
Interest income ............. . 4 45
Kred Button 6,004 45
Horace Heald 60-day, 6% note due August 9, taken
from Dutton on 6% discount basis, to apply on ac-
count
We charge the $4.45 to Interest Income because, when we collect the
note arid interest, the Interest Income account, will be credited with
$60
The Interest Income account will then appear as follows:
Interest Income
June
4|45JAug.
1
9|f~ " 11
'I I 1
6000
and the resulting credit balance of $55 55 will be the net amount we
will earn by carrying the note from June 15, the date of discount, to
\ugust 9, the maturity
Observe that, when we receive a note on a discounted basis, the debit is
to Notes Receivable — not to Notes Receivable Discounted. The
Notes Receivable Discounted account is used to show the contingent
liabihtv on notes which \\e endorse and transfer to others.
Kiitricx at maturity if note is collected from the maker:
If, at the maturity of the notes, they are collected from the
makers, the entries are as follows:
Cash 3,000 00
Notes receivable 3,000 00
Collection of note from James Ma goo
Cash 6,060 00
Notes receivable 6,000.00
Interest income . 60 00
Collection of Horace Heald note and interest
Entries at maturity if note is not collected from the maker:
If, at. the maturity of the notes, they are not collected from
the makers, but are immediately collected from Fred Dut-
ton, the endorser, the entries will be the same as those
shown just above, except that the explanatory comment will
indicate that the collections were made from the endorser.
If the notes are dishonored by the makers, and are not
immediately collected from the endorser, they should be
charged back to the endorser from whom we received them,
by entries as shown on the following page.
360 DISCOUNTING NOTES RECEIVABLE |Ch. 23
Fred Button 3,000.00
Notes receivable . . ... 3 , 000 . 00
To charge Dutton with the Magee note taken from
Dutton to apply on account, and dishonored by
Magee.
Fred Dutton f>,000 00
Notes receivable . 6,00000
Interest income ..... 60 00
To charge Dutton with principal of, and interest on,
the Heald note taken from Dutton to apply on ac-
count, and dishonored by Heald.
CHAPTER 24
Fixed Assets
Definitions. Fixed assets are assets of a relatively permanent
nature used in the operation of the business and not intended for
sale. A building used as a factory is a fixed asset; it is relatively
permanent property ; it is used in the operation of the business and
it is not intended for sale. A factory building no longer in use is
not a fixed asset because it is not used in operations. Land held
as a prospective factory site is not a fixed asset; it is permanent
property and it is not intended for sale, but it is not used in
operations.
Fixed assets may be either tangible or intangible. An asset
is tangible if it has bodily substance, like a building or a machine.
An asset is intangible if, like a patent or a copyright, its value
resides, not in any physical properties, but in the rights which its
possession confers upon its owner.
Charging fixed asset costs to operations. Most fixed assets
have a limited useful life. The cost of such an asset (less any
scrap or residual value which may be realizable at the end of the
asset's usefulness) should be charged off gradually against income
during the period (known or estimated) of its useful life. The
words most commonly used to describe such systematic assign-
ment of fixed asset costs to expense are:
Depreciation, which is the systematic assignment of the cost of
tangible assets other than natural resources to expense.
Depletion, which is the systematic assignment of the cost of
natural resources to expense.
Amortization, which is the systematic assignment of the cost
of intangible fixed assets to expense.
Classification of fixed assets. Fixed assets may be classified,
with respect to their nature and the type of cost assignment to
which they are subject, as follows:
(A) Tangible:
(1) Plant property:
(a) Subject to depreciation.
Examples: Buildings, machinery, tools and equip-
ment, delivery equipment, furniture
and fixtures.
361
362 FIXED ASSETS ICh. 24
(b) Not subject to depreciation.
Example: Land.
(2) Natural resources, subject to depletion.
Examples: Timber tracts, mines, oil wells.
(B) Intangible:
(1) Normally subject to amortization.
Examples: Patents, copyrights, franchises, lease-
hold improvements.
(2) Not normally subject to amortization.
Examples: Goodwill, trademarks.
These various 'classes of fixed assets will be discussed in the
order in which they are mentioned in the foregoing classification.
Valuation of fixed assets. Fixed assets usually are carried in
the accounts on one of the following bases of valuation:
Cost.
Cost less depreciation, depletion, or amortization.
Appraised value- usually replacement cost new less deprecia-
tion thereon.
(The use of appraisal- data for accounting purposes is con-
sidered acceptable only under certain special conditions.
Such conditions are encountered so infrequently that no gen-
eral discussion of this valuation basis will be given in this
volume; it is discussed in the authors' Principles of Account-
ing, Intermediate.
As a general statement, it can be said that the cost of a fixed
asset includes all expenditures made in acquiring the asset and
putting it into a place and condition in which it can be used as
intended in the operating activities of the business. Thus, the
cost of machinery includes such items as freight and installation
costs in addition to its invoice price.
Separate accounts should be kept with land and buildings,
because the buildings are subject to depreciation, whereas the land
is not. If land and a building thereon are purchased for a lump-
sum price, an appraisal may be necessary to provide a basis for
dividing the cost between the land and the building. For instance,
assume that land and a building are purchased at a lump-sum price
of $50,000. An apportionment of the cost on an appraisal basis
may be made as follows:
Appraisal Cost
Valuation Fraction Apportionment
Land ........................... $15,000
Building ......................... _45,000 % 37_f50p
Total ........... $60^000 $50,000
Ch. 24] FIXED ASSETS 363
If, in order to obtain a desired building site, it is necessary to
acquire land that has an unsuitable building thereon, the Land
account should be charged with the entire purchase price. Under
such circumstances, it will be necessary to demolish or remove the
unsuitable building. Any costs incurred in this connection should
also be charged to the Land account, since the costs were incurred
to make the site suitable for building purposes. Any amounts
received as salvage from the disposal of the building should be
credited to the Land account.
The cost of land purchased without improvements includes the
purchase price, broker's commission, fees for examining and record-
ing title, surveying, draining, clearing (less salvage), and land-
scaping. Any interest accrued at the date of purchase on mort-
gages or other encumbrances, and paid by the purchaser and any
accrued taxes paid by the purchaser are part of the cost of the
land. If land and improvements are purchased, the broker's com-
mission and any accrued interest or tax costs should be apportioned
between the land and the buildings.
Expenditures for land improvements may be charged to the
Land account if the expenditures result in the addition of costs
which are not subject to depreciation. If depreciation must be
considered in relation to such expenditures, an account with Land
Improvements should be opened. Such an account would be
charged with expenditures for fences, water systems, sidewalks,
and paving. Special assessments for local improvements which
benefit the property may be charged to the Land account.
Where a building is purchased, the Building account should be
charged with any repair costs incurred to make good the deprecia-
tion prior to acquisition, and with the cost of any subsequent
improvements.
The cost of a building constructed includes the payments to
contractors, fees for permits and licenses, architects' fees, superin-
tendents' salaries, and insurance and similar expenditures during
the construction period. It is considered permissible to charge
the Buildings account with interest costs incurred during the con-
struction period on money borrowed for the payment of con-
struction costs.
If a machine or other fixed asset is constructed by a company
for its own use, it should be recorded at cost, and not at some
higher price which it might have been necessary to pay if the asset
had been purchased from outsiders.
Depreciation. Plant fixed assets do not last forever. They
either wear out or become obsolete. The wearing out of a fixed
asset is characterized by physical deterioration caused by use or
364 FIXED ASSETS [Ch. 24
the action of the elements. The nature of obsolescence is indicated
by the following illustrations:
A company owns a hand machine capable of making 100 arti-
cles a day. The business has grown so that 1,000 articles
must be made each day. Instead of buying nine more hand
machines, it is better to dispose of the one machine owned
and buy a power machine capable of making 1,000 units a
day. The hand machine is obsolete.
The operation of the power machine requires the services of
five men. A new automatic machine is invented. Because
of the savfng in labor, it may be economical business
management to dispose of the recently acquired power
machine and purchase the new automatic machine. If so,
the power machine is obsolete.
The new automatic machine is capable of producing only one
product. The market for this product suddenly ceases.
The automatic machine is obsolete.
Whether the usefulness jqf a plant fixed asset is terminated by
physical deterioration or by obsolescence, it is the objective of
depreciation accounting to spread the cost of the asset over the
years of its usefulness in a systematic and sensible manner. This
notion of depreciation is supported by the following definition
proposed by the Committee on Terminology of the American
Institute of Accountants: "Depreciation accounting is a system of
accounting which aims to distribute the cost or other basic value
of tangible capital assets, less salvage (if any), over the estimated
useful life of the unit ... in a systematic and rational manner.
It is a process of allocation, not of valuation." It is important to
stress the fact that depreciation, in the accounting sense, does not
consist of measuring the effects of wear and tear. It is a systematic
cost assignment procedure, determined primarily by the use-life
expectancy of assets.
Fixed assets are, of course, subject to decreases in market
value, but accountants do not consider it necessary to record such
decreases, because fixed assets are not intended for sale. The mar-
ket values may be up today and down tomorrow; such fluctuations
in value may be ignored because the value of a fixed asset to a busi-
ness normally lies in its usefulness rather than in its marketability.
Hence, as noted in the above definition, measuring the decline in
value attributable either to use or to obsolescence is not an objec-
tive of depreciation. To repeat, depreciation is not a valuation
process.
Ch. 24] FIXED ASSETS 365
Computing and recording depreciation. There are numerous
methods of estimating depreciation. The straight-line method,
which is the one most frequently used, will be discussed. Other
methods are discussed in Principles of Accounting, Intermediate.
Theoretically, the periodic depreciation charge under this
method should be computed as follows :
Cost of asset .... . $2 , 500
Estimated residual or scrap value — amount which it is estimated
can be realized from the asset \\hen it is 110 longer usable 300
Total depreciation to be* charged to expense during the total use-
ful life of the asset * $2,200
Estimated useful life 10 years
Estimated depreciation per year. $ 220
As a practical matter, the residual value is frequently ignored,
and the depreciation is based on the cost. Ignoring the residual
value and writing off the total cost over a period of ten years
would, in the foregoing illustration, result in an annual charge of
$250.
Depreciation is recorded by :
Debiting a Depreciation account, which is an operating expense
account.
Crediting either :
A Reserve for Depreciation, which will have a credit balance
to be deducted in the balance sheet from the debit bal-
ance of the fixed asset account; or
The fixed asset account. This is called writing down the
asset. This method usually is not desirable for two
reasons :
First, if depreciation is credited to the asset account,
the cost of the fixed asset will be lost sight of.
Second, the provision for depreciation is only an esti-
mate; by crediting it to a reserve, the amount of
depreciation provided can be shown in the balance
sheet, where interested parties can get information on
which to base their own opinions as to the adequacy
of the provision.
Estimates of useful life may be based on the past experience
of a business with assets of the same type, or experience data may
be obtained from manufacturers or trade associations. Probably
the most widely used reference source reporting on commonly
accepted estimates of useful life for various assets is Bulletin F,
366 FIXED ASSETS [Ch. 24
published by the Bureau of Internal Revenue. Presented below
are examples from Bulletin F.
Item Useful life
Office equipment:
Safes . 50 years
Furniture, fixtures, and filing cases 20 years
Mechanical equipment ... 8 years
Depreciation vs. provision for replacement. The nature of
depreciation accounting is often misunderstood. The misunder-
standing arises from a tendency to assume that depreciation entries
somehow produce funds for the replacement of fixed assets; this
false assumption may have been caused by a misunderstanding of
the expression "provision for depreciation " frequently used by
accountants.
Depreciation entries merely charge operations, during a series
of periods, with the cost of an asset previously acquired. Depre-
ciation entries in no way affect the Casli account. If it is desired
to provide a fund for the replacement of the assets, cash may be
set aside in a special bank account or invested in securities to be
held until money is required for replacement purposes. The crea-
tion of such a replacement fund is very unusual, because manage-
ment usually believes that the cash can be more profitably used
in regular business operations.
Expenditures during ownership. An expenditure is the pay-
ment, or the incurring of an obligation to make a future payment,
for a benefit received. Expenditures incident to the ownership of
fixed assets are of two classes:
Capital expenditures, which should be recorded by increasing
the book value of the assets. In most cases, this is done by
debiting the asset accounts; in some cases, it is done by debit-
ing the depreciation reserves.
Revenue expenditures, which should be charged to expense.
A careful distinction must be made between capital and reve-
nue expenditures if a correct accounting for fixed assets and for
net income is to be maintained. If a capital expenditure is
charged to an expense account, the book value of the fixed asset
is understated, and the net income and net worth also are under-
stated. On the other hand, if a revenue expenditure is charged
to an asset account instead of to an expense account, the book
value of the fixed asset is overstated and the net income and net
worth also are overstated.
The proper treatment of some of the more common types of
expenditures is indicated on the following page.
Ch. 24]
FIXED ASSETS
367
Revenue
Capital Kxpenditures
Particulars
Kxpendi-
tures
Book Value of Assets
Increased by Charges to
Charged to
Expense
Accounts
Asset , T>
Account ! Reservc
Acquisition cost:
A 111! 111
A company purchased three second-hand
machines; charge the fixed asset account
Expenditures to make good depreciation
which took place prior to acquisition:
Before the machines were put into use,
they were thoroughly overhauled. This
was a capital expenditure
Installation cost:
This is a capital expenditure
Betterment:
Additional accessories were purchased for
use with the machines; this expenditure
is chargeable to the asset account
Ordinary repair:
At the end of the fm»t month of operations,
a repair bill was paid, this was a revenue
expenditure or expense
Extraordinary repair :
After three years of use, the machines were
again thoroughly reconditioned at a cost
of $400. This was a capital expenditure
because it made good some of the depre-
ciation subsequent to acquisition; it
should not be recorded by a charge to
the asset account because it is not an
addition to cost; it should be recorded
by a charge to the depreciation reserve
because it is a reduction of accrued de-
preciation
! $3,000
400
50
75
$18
$400
lleinstallation expense :
The first cost of installing machinery in a factory is a proper charge to the asset
account. If machinery is rearranged in the factory for the purpose of improving
the routing or otherwise reducing the time and cost of production, a question
arises with respect to the proper treatment of the remstallation expense. Pre-
sumably, the cost of one installation will already have been charged to the1
Machinery account. Theoretically, therefore, the cost, or the undepreciated
remainder of the cost, of the first installation should be removed from the accounts
(by crediting the fixed asset with the original cost and debiting the reserve with
the accumulated depreciation thereon), and the reinstallation cost should be
capitalized by charge to the Machinery account.
Disposal of fixed assets. When a fixed asset subject to depre-
ciation is disposed of, an entry should be made debiting Cash for
the amount received, crediting the asset account with the cost of
the asset, debiting the depreciation reserve with the depreciation
368 FIXED ASSETS [Ch. 24
provided against the asset, and debiting or crediting an account to
show the loss or gain on the disposal. Three illustrations follow :
(1) Price equal to book value:
Assume that, at the date of disposal of a machine, the
asset and reserve accounts had the following balances:
Debit Credit
Machinery $2,50000
Reserve for depreciation — Machinery .. . $2,20000
The asset had a net book value of $300 and was sold for
$300. The entry to record the sale is:
Cash ' . . . .... 300 00
Reserve for depreciation — Machinery ... 2 , 200 . 00
Machinery . 2,500.00
To record the sale of machinery, relieving
the asset account of the cost and relieving
the reserve of the depreciation provided
thereon.
(2} Price less than book value:
Assume that the accounts had the following balances:
Debit Credit
Machinery $2,50000
Reserve for depreciation — Machinery $1,76000
The asset had a net book value of $740 and ,was sold for
$400; hence, there was a loss of $340. The entry to
record the sale is:
Cash 400.00
Loss on disposal of machinery 340 00
Reserve for depreciation — Machinery 1 , 760 . 00
Machinery 2,500.00
To record the sale of machinery.
Price more than book value:
Assume that the accounts had the following balances:
Debit Credit
Machinery. . .. $2,500 00
Reserve for depreciation — Machinery $2,200.00
The asset had a net book value of $300 and was sold for
$500; hence, there was a gain of $200. The entry to
record the sale of the machinery at a gain of $200 is
shown below:
Cash 500 00
Reserve for depreciation — Machinery 2,200.00
Machinery . . 2,500.00
Gain on disposal of machinery 200.00
To record the sale of machinery.
Ch. 24] FIXED ASSETS 369
Losses and gains on the disposal of fixed assets were formerly
charged and credited to the Earned Surplus account. Some
accountants supported this treatment by the following reasoning:
If depreciation were correctly estimated, no losses or gains
would result from the disposal of fixed assets. Therefore,
losses and gains arising from the disposal of fixed assets are
in reality corrections of the earnings of prior years, which
were incorrectly stated because the depreciation was incor-
rectly estimated. The earnings of prior years are now in
the Earned Surplus account; a correction of prior years'
earnings should therefore be debited or credited to Earned
Surplus.
Other accountants justified the charge or credit to Earned
Surplus as follows:
The profit and loss statement should show the results of regular
operations ; a loss or gain from the disposal of a fixed asset is
an extraneous, non-operating item and therefore should be
charged or credited direct to Earned Surplus.
Accountants are not in complete agreement on this matter at
the present time. However, the following position, taken by the
Committee on Accounting Procedure of the American Institute of
Accountants, is widely supported:
There is a presumption that all items of profit and loss recog-
nized during any given period should be used in determining
the figure reported as net income. A possible exception may
be justified in the case of extraordinary charges or credits
resulting from the disposal of fixed assets, where the amount
of such losses or gains is so large in relation to a company's
net income that misleading inferences might be drawn unless
such items were excluded from the profit and loss statement.
Deciding what is " extraordinary " and concluding that a certain
gain or loss is so large that "misleading inferences " might be
drawn from the profit and loss statement are matters of opinion.
Therefore, it seems desirable for purposes of this text to regard all
losses and gains from the disposal of fixed assets as being immate-
rial and hence not to be charged or credited to Earned Surplus.
If a fixed asset is disposed of during the year and it is the
accounting policy to record depreciation for fractional periods, an
entry for depreciation for the fractional period ending with the
date of disposal is required. To illustrate, assume that the
balances on page 370 appear in the accounts on June 30, 1954:
370 FIXED ASSETS [Ch. 24
Debit Credit^
Machinery ............................... $5,000 00
Reserve for depreciation — Machinery — created by
annual credits of $300 . $3,000 00
The asset is disposed of on June 30 for $1,500; no depreciation
has been provided for since December 31, 1953. The following
entries should be made:
Depreciation — Machinery ............... 150 00
Reserve for depreciation — Machinery ____ 150.00
To provide for depreciation as an operating
expense of the six months ended June 30, 1954.
Cash ........ ' ... 1,500 00
Reserve for depreciation— -Machinery ...... 3, 150 00
Loss on disposal of machinery .... . . . 350.00
Machinery .............. 5 ,000 00
To record the sale of machinery.
^ Trade-ins. Frequently, a fixed asset is disposed of by trading
it in on a new asset. Some trade-in allowance is generally granted
by the dealer. The difference between the trade-in allowance and
the book value of the asset being traded in, after recording depre-
ciation to the date of disposal, is the gain or loss on disposal.
Trade-ins are illustrated by using the following data:
Case A Case B
Old asset: ~
Cost ... ........ $5,000 $5,000
Reserve for depreciation ..... ............. 3 ,000 3 ,000
Book value . . ....... 2,000 2,000
Trade-in allowance .... .......... 2 , 300 1 , 800
List price of new asset ...... ............... 6 ,000 6,000
Cash payment. . . ............................ 3 JOO 4^200
lOntrics Case A Case B
Asset account (new asset) 6 ,000 6 ,000
Reserve for depreciation 3 ,000 3 !oOO
Loss on disposal of old asset 200
Gain on disposal of old asset 300
Asset account (old asset) . 5 , 000 5 , 000
Cash 3,700 4,200
To record exchange of assets.
In computing the federal income tax for a business, gains or
losses resulting from trading in one asset on another are not
allowed. Under the tax rule, the cost of the new asset, for pur-
poses of computing depreciation and the gain or loss on subsequent
disposal, is the sum of the book value of the old asset plus the addi-
tional expenditure made in acquiring the new asset. On this basis,
the entry to record the exchange of assets in the foregoing cases
would be as shown on the following page.
Ch. 24] FIXED ASSETS 371
Case_A CaseB _
Asset account (new asset) ........ 5 , 700 6 , 200
Reserve* for depredation ...... 3,000 3,000
Asset account (old asset) . ... . 5,000 ,5,000
Cash . ...... 3,700 4,200
Many accountants, as a matter of convenience, prefer to fol-
low the tax rule in the accounts.
Depreciation program revisions. After an asset has been in
use for some time, it may be found that too much or too little
depreciation has been provided. Such a condition may be due to
an error in estimating the life of the asset or to an incorrect esti-
mate of the residual value. In any event, it would be incorrect
to continue with the existing depreciation program under such
circumstances, unless, of course, the amount involved is so small
that it can be ignored on practical grounds. If a change is war-
ranted, either of the following alternatives is acceptable:
(1) Adjust the Reserve for Depreciation account to the amount
which it would have contained if depreciation had origi-
nally been based on the estimates which now seem cor-
rect, and base subsequent depreciation charges on the
revised useful life.
Data for example:
Asset cost ............. .. $9,000
Kstimated scrap value ..... — 0 —
Estimated useful life .............. 10 years
Depreciation entries to date:
Year
~~T~ ........ $ 900
2 . 900
3 900
4 900
5 900
0.. . 900
Balance in Reserve for Depreciation at the end of the
sixth year ..
During the seventh year, before recording any deprecia-
tion for the seventh year, it is established that the asset
will probably last six more years (revised useful life = 12
years).
Computation of correction, of Reserve for Depreciation:
Depreciation recorded during the first six years ....... $5,400
Revised annual charge for depreciation:
$9,000 -f- 12 - $750.
Revised depreciation for the first six years:
$750 X 6 = .......................................
_
Amount of adjustment ............................... $ 900
372 FIXED ASSETS [Ch. 24
Entry to adjust the Reserve for Depreciation account:
Reserve for depreciation . . . . . . 900 00
Earned surplus, or Correction of prior years' de-
preciation 900.00
To adjust the Reserve for Depreciation to conform
to the; revised estimate of useful life.
Entry for depreciation for seventh and subsequent years:
Depreciation expense 750.00
Reserve for depreciation ... . 750 . 00
Depreciation for the year.
Note: If f the depreciation adjustment is immaterial in
amount, it may be shown in the profit and loss
statement. If the adjustment is material in
amount, some accountants would advocate carry-
ing it direct to Earned Surplus, whereas other
accountants would still favor showing it in the
profit and loss statement.
(2) Spread the undepreciated cost of the asset over the remain-
ing useful life of the asset by " revised" depreciation
provisions, without changing the current balance in the
Reserve for Depreciation account.
Data for example:
Same conditions as above.
Computation of depreciation provision for the seventh and
siibsequent years:
Undepreciated cost:
Cost . . $9,000
Reserve for depreciation 5 , 400 $3 , 600
Revised remaining useful life ... 6 years
Revised annual depreciation provision $ 600
Entry for depreciation for seventh and subsequent years:
Depreciation expense . 600 00
Reserve for depreciation 600 00
Depreciation for the year.
The above illustration dealt with overdepreciation. If under-
depreciation is discovered, the changes will be as follows:
For alternative (1):
The Reserve for Depreciation will be credited for the amount
of the underdepreciation, the debit being assigned either
to Earned Surplus or Correction of Prior Years' Deprecia-
tion, as discussed above.
Ch. 24] FIXED ASSETS 373
The subsequent provisions for depreciation will be larger
than the former annual provisions.
For alternative (2) :
The subsequent provisions for depreciation will be larger
than the former annual provisions.
The second alternative is found more commonly in practice,
possibly for the following reasons:
(a) One reason has been well expressed by the Committee on
Accounting Procedure in its Bulletin 27 :
"Under most circumstances, costs once identified and
absorbed through amortization or depreciation charges
are not considered to be subject to further accounting,
and corrections of estimates affecting the allocations
are commonly reflected in revised charges during the
remaining life of the property."
On another occasion, the committee expressed the same
position in the following words:
"Corrections of (depreciation) estimates should nor-
mally be reflected in revised charges for later years."
(b) Alternative (1) is not acceptable for federal income tax
purposes.
(c) Particularly if the difference between the former annual
depreciation provision and the new annual depreciation
provision is not large in relation to average net income,
accountants are inclined to avoid an adjustment for the
accumulated "error" resulting from past depreciation
entries, since their effect on reported net income was
immaterial. The "approximate" character of deprecia-
tion accounting does not seem to require such a precise
treatment.
Subsidiary records. The general ledger should contain an
account with each class of fixed assets, such as Land, Buildings,
Machinery, Furniture and Fixtures, and Delivery Equipment.
It is also desirable to maintain a subsidiary plant ledger contain-
ing considerable information with respect to the cost, depreciation,
repairs, and so forth, of each unit. Thus, the subsidiary machinery
record might contain a card or page for each machine, showing the
following data:
Name of asset.
Identification number.
Location.
374 FIXED ASSETS [Ch. 24
Manufacturer.
From whom purchased.
Date of installation.
Purchase cost.
Other incidental costs.
Depreciation data:
Estimated life.
Estimated residual value.
Depreciation rate.
Periodic and accumulated provision for depreciation.
Ordinary and extraordinary repairs, with information as to
date, natura, and cost.
Actual life, residual value, and gain or loss on disposal.
Information as to abnormal operating conditions, such as over-
time work, affecting rapidity of depreciation.
Such records furnish a good control over the fixed assets, as
they are virtually a perpetual inventory showing all fixed assets
which should be in the company's possession. The information
regarding the cost and accumulated depreciation of each unit can
be used in making entries -to relieve the asset and depreciation
reserve accounts of the correct amounts when a unit is fully depre-
ciated. The subsidiary records are also useful in connection with
insurance claims.
Natural Resources
Valuation. Natural resources, such as timber tracts, mines,
and oil wells, should be carried in the asset accounts at cost. As
the resources are converted, a portion of their cost is removed from
the fixed asset account and assigned to other accounts, thereby
reducing the book value of the fixed asset. Such cost transfers
give recognition to depletion. Such assets are sometimes called
wasting assets.
Development expenditures, such as those made for the removal
of surface earth for strip mining operations, which do not result in
the acquisition of tangible fixed assets, may be charged to the
wasting asset account. Tangible fixed assets acquired for pur-
poses of developing or extracting the wasting asset should be
recorded in separate accounts; they should be depreciated in
amounts proportionate to the depletion, if the developments will
render service throughout the entire life of the wasting asset ; they
should be depreciated over a shorter period if their useful life will
expire before the wasting asset is completely depleted.
Depletion. Depletion usually is computed by dividing the cost
of the wasting asset by the estimated number of units (tons, bar-
Ch. 24] FIXED ASSETS 375
rels, thousand feet, and so forth) in the asset; thus a unit depletion
charge is computed. The total depletion charge for each period is
then computed by multiplying the unit charge by the number of
units converted during the period.
To illustrate, assume that $90,000 was paid for a mine which
was estimated to contain 300,000 tons of available deposit. The
unit depletion charge is $90,000 ^ 300,000, or $.30. If 60,000
tons are mined during a given year, the depletion charge for the
year is $.30 X 60,000, or $18,000.
The depletion charge will be recorded as follows:
Depletion 18,000 00
Reserve for depletion 18,000 00
If some of the units converted remain unsold at year-end, the
depletion charge relating to such units is assignable to an inven-
tory account. In other words, depletion is a charge against
income when the units converted are sold, not when they are
converted.
The credit balance in the Reserve for Depletion should be
deducted in the balance sheet from the debit balance in the asset
account.
Intangible Fixed Assets Normally Subject to Amortization
Reason for amortization. Some intangible fixed assets are sub-
ject to amortization because their lives are limited by law, regula-
tion, contract, or their nature. Examples are patents, copy-
rights, franchises for limited periods, leaseholds, and leasehold
improvements. It should be understood that the period fixed by
law, regulation, or contract is the maximum period of life, and that
the usefulness of such assets may cease prior to the expiration of
that period ; in such instances, the shorter useful life should be the
period on which the amortization is based.
If the original estimate of useful life is subsequently regarded
as incorrect, the accountant may either (1) adjust the book value
of the asset to the amount which would be reflected by the accounts
if amortization had originally been based on the estimates which
now seem correct, and base the subsequent amortization on the
revised useful life; or (2) spread the unamortized balance over the
remaining useful life, as revised. These are the same alternatives
that were discussed in connection with depreciation revisions, on
pages 371 to 373.
Patents. If a patent is acquired by purchase, its cost is the
purchase price. If it is obtained by the inventor, its cost is the
total of the experimental expense and costs of constructing work-
376 FIXED ASSETS [Ch. 24
ing models and obtaining the patent, including drawings, attor-
ney's fees, and filing costs. Since a patent has no proven value
until it has stood the test of an infringement suit, the cost of a suc-
cessful suit may be charged to the Patents account. If the suit is
unsuccessful, and the patent is thereby proved to be valueless, the
cost of the suit and the cost of the patent should be written off.
A patent is issued for 17 years, and its cost should be amortized
over that period, unless it was acquired after the expiration of a
portion of the 17-year period, in which case it should be written
off over its remaining life. If there is a probability that the
patented device or the product of the device will become obsolete
before the expiration of the patent, conservatism would suggest
writing off the patent during a period shorter than its legal life.
A patent may give its owner a monopoly which enables him to
develop his business to a point where, after the expiration of the
patent, competitors will find it extremely difficult to enter the
field and overcome the handicap. When this happens, a goodwill
is created during the life of the patent. Nevertheless, the patent
should be amortized, and no goodwill should be set up.
Copyrights. A copyright gives its owner the exclusive right
to produce and sell reading matter and works of art. The fee for
obtaining a copyright is only a nominal amount, too small to
justify an accounting procedure of capitalization and amortization.
Costs sufficient in amount to justify such an accounting procedure
may be incurred, however, when copyrights are purchased.
Copyrights are issued for 28 years with a possibility of renewal
for an additional 28 years. However, publications rarely have an
active market for a period as long as 28 years, and it usually is
regarded as advisable to write off copyright costs over a much
shorter period.
Franchises. Franchises should not be set up in the books
unless a payment was made in obtaining them. Franchises are
sometimes perpetual, in which case their cost need not be amor-
tized; usually they are granted for a definite period of time, in
which case their cost should be amortized over that period.
Leaseholds and leasehold improvements. When property is
rented for a period of years, an advance payment may be made
which will apply against future rents ; this payment may be charged
to a Prepaid Rent account or a Leasehold account and amortized
over the life of the lease by charges to Rent and credits to Prepaid
Rent or Leasehold.
Sometimes a company will obtain a long-term lease on real
estate, and property values will so increase that the rents payable
under the lease are much smaller than they would be on the basis
Ch. 24] FIXED ASSETS 377
of current values. The lease may thus become very valuable
because of the saving in rent or because the lease could be sold for
a gain. It is not proper, however, to place this value in the
accounts, because the offsetting credit to surplus would inflate the
surplus by including an unrealized gain.
Leases for long periods frequently provide that the lessee (the
party who acquired the right to occupy the property) shall pay
the cost of any alterations or improvements which he may desire,
such as new fronts, partitions, and built-in shelving. Such altera-
tions and improvements become a part of the real estate and
revert to the owner of the real estate at the expiration of the lease;
all that the lessee obtains by the expenditure is the intangible
right to benefit by the improvements during the life of the lease.
The lessee should therefore charge such expenditures to a Lease-
hold Improvements account; the cost should be amortized over
the life of the lease or the expected useful life of the improvements,
whichever is shorter, by journal entries charging Rent and credit-
ing Leasehold Improvements. The Rent account is, of course,
also charged with the cash payments for rent made to the lessor.
Intangible Fixed Assets Not Normally Subject to Amortization
Some intangible fixed assets are not normally subject to amor-
tization because they are assumed to have an unlimited useful life.
Examples are trademarks, trade names, secret processes and for-
mulas, and goodwill.
Such assets may be carried indefinitely at cost if there is no
reason to believe that their useful lives will ever terminate. How-
ever, their amortization or complete write-off may be proper under
several conditions. First, at the time of its acquisition there may
be good reason to fear that the useful life of such an asset will
terminate, even though there is no conclusive evidence to that
effect; in such instances, periodic amortization charges may be
made against income. Second, at some date subsequent to
acquisition, the asset may be found to be valueless, in which case
it should be written off; or conditions may have developed which
indicate that the life of the asset will terminate, in which case its
cost may be amortized over the estimated remaining life ; or a por-
tion of the cost may be charged off immediately (as representing
amortization for prior periods) and the remainder may be amor-
tized over the estimated remaining life.
Trademarks. The right to the use of a trademark may be
protected by registry; the right does not terminate at the end of a
definite period, and trademarks are, therefore, normally carried
indefinitely in the accounts at cost, without amortization.
378 FIXED ASSETS [Ch. 24
Goodwill. The following statement, intended to indicate the
nature of goodwill, is quoted from a court decision:
"When an individual or a firm or a corporation has gone on for an
unbroken series of years conducting a particular business, and has been
so scrupulous in fulfilling every obligation, so careful in maintaining
the standard of the goods dealt in, so absolutely fair and honest in all
business dealings that customers of the concern have become con-
vinced that their experience in the future will be as satisfactory as it has
been in the past, while such customers' good report of their own experi-
ence tends continually to bring new customers to the concern, there
has been produced an element of value quite as important as — in some
cases, perhaps, far more important than — the plant or machinery with
which the business is carried on. That it is property is abundantly
settled by authority, and, indeed, is not disputed. That in some
cases it may be very valuable property is manifest. The individual
who has created it by years of hard work and fair business dealing
usually experiences no difficulty in finding men willing to pay him for
it if he be willing to sell it to them."
This quotation is interesting because it indicates some of the
ways in which goodwill may be created. However, it does not
adequately indicate the nature of goodwill for two reasons.
In the first place, it implies that goodwill is produced only by
satisfactory customer relations; but since goodwill is dependent
upon earnings, and since many things other than customer satisfac-
tion contribute to earnings, there are many sources of goodwill.
Some of these sources are: location; manufacturing efficiency;
satisfactory relations between the employees and the management,
which contribute to earnings through effective employee service
and the reduction of losses from labor turnover; adequate sources
of capital and a credit standing which is reflected in low money
costs; advertising; monopolistic privileges; and, in general, good
business management.
In the second place, in laying the emphasis on customer rela-
tions, the quotation fails to put the emphasis where it really
belongs : on the relation between earnings and net assets. A com-
pany may be scrupulous, fair, and honest, and its good repute
may tend continually to attract new customers, and yet the com-
pany may have no goodwill. The existence of goodwill depends
upon the earning of excess profits.
"Goodwill" may be defined as the value of the earnings of a
business which are in excess of a normal or basic return on the net
assets exclusive of goodwill. To illustrate, let us assume the con-
ditions shown on the following page.
Ch. 24] FIXED ASSETS 379
Company A Company B
Net assets, exclusive of goodwill. . $100,000 $100,000
Rate of net income which, for the particular
industry, may be agreed upon by the pur-
chaser and seller of a business as normal, or
which a new company entering the field may
reasonably be expected to earn — say 10% 10%
Net income earned $10,000 $ 15,000
Income at "normal" rate on net assets ex-
clusive of goodwill 10 , 000 10 , 000
Excess earnings __ _— $ 5,000
The excess earnings of Company B indicate that it has a good-
will; Company A apparently has none because it has no excess
earnings.
Methods of computing goodwill. The price to be paid for good-
will in connection with the sale of a business may be an amount
arbitrarily agreed upon by the purchaser and seller, without formal
computation. On the other hand, it may be computed on the
basis of past or anticipated earnings of the business. Three
goodwill valuation bases are illustrated below:
(1) Some multiple of the average past annual earnings. For
instance, assume that the average earnings for five years
prior to the sale of the business have been $10,000, and
that the goodwill is to be valued at twice the average
earnings; the goodwill will be valued at $20,000. The
price so computed is said to be "two years' purchase"
of the average annual earnings.
This method is illogical because it fails to give recognition
to the fact that the goodwill is not dependent upon total
earnings, no matter how large, but upon the relation of
the earnings to the net assets exclusive of goodwill, and
that no goodwill exists unless the earnings are in excess
of a normal income on the net assets other than goodwill.
Recognition is given to this fact in the two following
bases of goodwill valuation.
(2) Some multiple of the average past earnings in excess of a
return at an agreed rate on the average investment. For
instance, assume average annual earnings for five years
of $10,000, an average investment of $100,000 and an
agreement to pay for goodwill three years' purchase of
the average earnings in excess of 8% on the average
investment. The goodwill would be computed in the
manner shown on the following page.
380 FIXED ASSETS [Ch. 24
Average earnings. $10,000
Less 8% on average investment 8 , 000
Excess $~2,600
Multiply by number of years1 purchase 3
Goodwill $ 6,000
(3) The capitalized value of excess income. For instance,
assuming the same facts as in (2) with respect to average
income and investment, and assuming an agreement to
compute goodwill by capitalizing, at 10%, the average
annual earnings in excess of 8% on the average invest-
ment, we would compute the goodwill as follows :
Average earnings . $10 ,000
Less 8% on average investment 8,000
Excess to be capitalized $^2,000
Capitalized value: $2,000 -j- .10 = $20,000
Proper book value of goodwill. A Goodwill account can prop-
erly appear on the books only if the goodwill was specifically paid
for. The management of a company may believe that it has
created goodwill by advertising expenditures or otherwise, and
may desire to charge such items to a Goodwill account. Account-
ants do not approve of such charges to Goodwill because of the
practical impossibility of identifying specific expenditures as repre-
senting the cost of goodwill.
It is usually considered good accounting to carry goodwill as
an asset indefinitely at its cost. However, since the price paid
for goodwill is generally based on a belief that better-than-average
earnings will be produced by a given group of assets, what should
the accountant do with the Goodwill account if better-than-average
earnings fail to materialize or if the earnings decline?
As a general rule, accountants do not favor perpetuating an
asset balance when there is no underlying value in support of the
asset. And, where an accountant has convincing evidence that an
asset is significantly overstated, such overstatement should be
removed from the accounts, possibly by direct charge to Earned
Surplus.
As a practical matter, there is no way of determining the " life "
of goodwill. Many accountants believe that it is unlikely that
goodwill will "last" over the entire life of an enterprise. For this
reason, it is considered acceptable to amortize goodwill over a
reasonable period of time. The Committee on Accounting Pro-
cedure has supported this practice in its Bulletin No. 24. The
Committee's opinion is paraphrased below:
Where a corporation decides that goodwill may not continue to have
value during the entire life of the enterprise, it may amortize the
Ch. 24] FIXED ASSETS 381
cost of such intangible despite the fact that there are no present
indications that goodwill will have a limited life. In such cases
the cost may be amortized over a reasonable period of time, by
systematic charges in the income statement.
Fixed Assets in the Balance Sheet
It usually is considered desirable to show the total tangible
fixed assets and the total intangible fixed assets separately in the
balance sheet. One procedure is illustrated below:
Tangible fixed assets:
Land .......... $ 20,000 00
Buildings . . $ 1 50 , 000 00
Less reserve for depreciation 30.000 00 120,000 00
Machinery and equipment $ 90,000 00
Less reserve for depreciation 12,000 00 78,000 00
Tools $ 15,000 00
Less reserve for depreciation 4,000 00 11,00000
Delivery equipment $ 5,00000
Less reserve for depreciation 2 ,000 JX) 3 , 000 00
Furniture and fixtures $" 5,50000
I ,ess reserve for depreciat ion __2 ,200 00 3 , 300 00
Total tangible fixed assets. ~7.~ $235,30000
Intangible fixed assets:
Patents $ 8,000 00
Less reserve for amortiza-
tion 2,000 00 $ 6,000 00
Goodwill . 50,000 00
Total intangible fixed assets . . 56,000 00
If there are many fixed assets, space can be saved by a balance
sheet presentation similar to the following:
Depreciation Cost Less
or Depreciation
Amortization or
Cost Reserve Amortization
Tangible fixed assets:
Land ....... $ 20,000 00 $ 20.000 00
Buildings 150,000 00 $30,000 00 120,000 00
Machinery and equipment 90,000 00 12,000 00 78,000 00
Tools 15,00000 4,00000 11,00000
Delivery equipment . 5 , 000 00 2 , 000 00 3 , 000 00
Furniture and fixtures . 5 , 500 00 2 , 200 00 3,300.00
Total tangible fixed as- _ __
sets . . $,OJO $50,200 00 $235,300 00
Intangible fixed assets:
Patents. . $ 8,000.00 $ 2,000.00 $ 6,000 00
Goodwill. . 50,000 00
Total intangible fixed as-
sets ................. 56,000 00
CHAPTER 25
Inventories
Classes of inventories. The inventory of a concern that buys
its goods in condition for sale is usually called a merchandise inven-
tory. Merchandise inventories are found in wholesale and retail
businesses. These businesses do not alter the form of the goods
purchased for sale.
The following classes of inventories can be found in manufactur-
ing businesses:
Finished goods.
Goods in process.
Raw materials.
The above-mentioned inventories should be classified as cur-
rent assets in the balance sheet, below the receivables and above
the prepaid expenses.
Inventory all goods owned. What should be included in the
inventory, and what should be excluded therefrom? The general
rule is that the inventory should include all goods for which the
company holds title, wherever they may be located.
If a business has received an order for goods but is holding
them for future delivery, it is important to determine whether title
has passed. The mere fact that the goods have been segregated
from other merchandise may or may not mean that title has passed
to the customer. If title has passed, the goods should be excluded
from the inventory; if title has not passed, they should be included.
On the other hand, goods which have been ordered but not
received at the inventory date may properly belong in the inven-
tory. If the goods are in transit, the general rule as to passing of
title is as follows: If the goods were shipped f. o. b. shipping point,
they belong to the purchaser; if they were shipped f. o. b. destina-
tion and have not arrived at the destination, they belong to the
seller.
A consignment is a shipment of merchandise from the owner
(called the consignor} to another party (called the consignee) who
is to attempt to sell the merchandise for the owner. Goods out on
consignment should be included in the inventory of the consignor,
who is the owner.
Importance of accuracy in taking and pricing the inventory.
If the inventory is misstated, both the balance sheet and the profit
and loss statement will be affected. For example, if the December
382
Ch. 25] INVENTORIES 383
31, 1953 inventory is overstated $5,000, the current assets pre-
sented in the December 31, 1953 balance sheet will be overstated
$5,000 and the net income appearing in the profit and loss state-
ment for the year ended December 31, 1953 will be overstated the
same amount. The effect on the profit and loss statement can be
seen by the following illustration, in which two profit and loss state-
ments have been presented; in the first profit and loss statement,
the correct ending inventory, $30,000, has been used; in the second
profit and loss statement, the ending inventory has been over-
stated $5,000.
DEUCE COMPANY
Profit and Loss Statement
For the Year Ended December 31, 1963
Incorrect
Correct (Overstated)
Ending Inventory Ending Inventory
Sales "$106TOOO $l66~666
Cost of goods sold:
Beginning inventory, 12/31 /52 . $20 ,000 $20 ,000
Purchases . 70,000 70,000
Total . $90,000 $90,000
Deduct ending inventory, 12/31/53. . 30,000 60,000 35,000 55,000
Gross profit . . . $40,000 $45,000
Operating expenses 25,000 25,000
Net income . $ 15,000 $ 20,000
Since the ending inventory of one year is the beginning inven-
tory of the next year, a misstatement of an inventory will affect
two profit and loss statements — the statement for the year in
which the inventory error occurred, and the statement for the fol-
lowing year. This can be demonstrated by continuing the preced-
ing illustration through 1954. It is assumed that the correct
inventory for December 31, 1954 is $25,000.
DEUCE COMPANY
Profit and Loss Statement
For the Year Ended December 31, 1964
Incorrect
Correct (Overstated)
Beginning Beginning
Inventory Inventory
$110,000 $110,000
Cost of goods sold :
Beginning inventory, 12/31/53. $30,000 $ 35,000
Purchases. 65,000 65,000
Total .... $95 , 000 $100 , 000
Deduct ending inventory, 12/31/54 25,000 70,000 25,000 75,000
Gross profit ~ $ 40,000 $ 35,000
Operating expenses 27,000 27,000
Net income $ 13,000 $ 8,000
384 INVENTORIES [Ch. 25
If the amounts of net income reported above for the two years
are added, it will be seen that the same total is reported for the
two-year period.
Net Income Computed With
Correct An Inventory Error in
Year Inventories Error Net Income
1953 $15,000 $20,000 ~ S5,000ovor
1954 13,000 8,000 5 ,000 under
Total $28,000 $28,000 — 0—
Although an inventory overstatement causes an overstatement
of net income in the first year, it causes an offsetting understate-
ment of net incomfe in the second year. Thus, inventory errors
are counterbalancing over a two-year period. The net income is
misstated in each of the two years, but not in the aggregate.
If the December 31, 1953 inventory had been understated
instead of overstated, just the opposite results would have occurred ;
the 1953 net income would have been understated and the 1954
net income would have been overstated.
The above observations may be summarized in the following
manner :
If the ENDING inventory is : Net income for the period will be :
Overstated Overstated
Understated Understated
If the BEGINNING inventory is : Net income for the period will be :
Overstated Understated
Understated Overstated
Procedure of inventory taking. There is no universal pro-
cedure for taking an inventory. Probably the simplest procedure
is as follows: Two people work as a team; one person counts,
weighs, or otherwise measures the merchandise and calls the
descriptions and quantities to the other person, who writes them
on inventory sheets. Unit valuations are then entered on the
sheets; extensions are made by multiplying quantities by these
prices; and the sheets are footed.
Although this is a simple procedure, it does not provide safe-
guards against errors, because the work of one person is not checked
by some other person. There are several ways of providing such
safeguards. One such procedure is here described.
A team of two persons is assigned to a department, a section,
or some other unit of space. Each team is provided with prenum-
bered, two-part, perforated inventory tags, which may be printed
as illustrated at the top of the following page.
Ch. 25]
INVENTORIES
385
Tag No. 101
Location No
Article :
Identification
number _ _
Description
Quantity ( )
Taken by
Tag No. 101
Location No
Article:
Identification
number
Description
Quantity ( )_ _
Checked Hv
Each team is furnished with
at least as many tags as there are
different classes of articles that
the team will inventory.
Each member of the team
takes a complete inventory of
the stock assigned to the team.
One member of the team takes
the tags and goes through the
stock systematically, inventory-
ing each class of merchandise,
and entering the data for each
class on the top section of the
tag, which may then appear as
shown below. The "Descrip-
tion" space is used if the article
does not have an identifying
number. The ' ' Taken by " line
may show the person's initials
or his clock number. The per-
Tag No. 101
Location No &I4
Article:
Identification
number
97
Description
Quantity (*&*,)
4
Tftlcen hy
924
son who fills out the top section
of the tag leaves the entire tag
with the merchandise.
The second member of the
team follows the first member,
makes an independent identifi-
cation and count of the articles,
and fills out the bottom section
of the tag. He compares the
top and bottom sections of the
tag and reports any differences to a supervisory employee. He
also watches for any merchandise which the first member may have
overlooked.
To deter the second member of the team from merely copying
the data appearing 011 the top section of the tag without making a
second count and without independently identifying the articles,
the inventory plan frequently provides that supervisory personnel
or members of the audit staff will make test checks of the tags and
the items inventoried as a verification of the work of the inven-
tory team. Such third parties should also check to see that noth-
ing has been overlooked that should be included in the inventory.
After the inventory-taking has been completed, the bottom sec-
tion of each tag is detached; the top section of the tag is left with
the merchandise. The bottom sections are sent to the accounting
386
INVENTORIES
[Ch. 25
office and are sorted in tag-number sequence. Any unused tags
are sent with them, for purposes of control ; if any tags are missing,
they should be found, since they may contain data applicable to
inventoried goods.
After the accounting department has determined that all pre-
numbered tags have been accounted for, the tags are sorted by
article number. This is necessary because the same kind of mer-
chandise may be in several locations : for instance, the main depart-
ment, the basement department, the display windows, the store-
room, and the receiving room. After the tags have been thus
assembled, the data shown by them are entered on inventory
sheets as follows:
INVENTORY
December 31, 19 —
Department No. B
Sheet No.
Quantity
Article No.
Tag No.
Unit of
Measurement
Detail
Total
97
98
101
102
Doz.
Pr.
8
4
98
304
it
16
98
419
{(
31
55
Price
Amount
The inventory sheet shows that No. 98 articles are in three
locations, as indicated by the tag numbers. The total is entered
so that the total inventory valuation of all articles of this num-
ber can be computed by one multiplication and shown in one
amount.
You will remember that the top half of the tag was left with
the merchandise. This was done to provide a further check on the
accuracy of the inventory. This is accomplished by giving all
employees who handle the merchandise instructions to be on the
alert, on the morning following the inventory-taking, for any mer-
chandise not tagged or for merchandise improperly described or
identified on the tag or incorrectly counted.
The unit valuations are then entered on the inventory sheets;
these prices are multiplied by quantities, and the amounts are
entered on the sheets; finally, totals are computed for each sheet,
for each department, and for the inventory as a whole.
Inventory pricing. There are a number of acceptable bases for
pricing inventories. Some are considered acceptable only under
Ch. 25] INVENTORIES 387
special circumstances, while others are widely applicable. The
two bases most widely applicable are:
(1) Cost.
(2) Cost or market, whichever is lower.
Cost. Cost of merchandise or materials purchased includes
not only the purchase price but also any additional costs necessary
to put the goods into condition for sale or for use in manufacturing.
These incidental costs include duties, freight, drayage, storage,
insurance while the goods are being transported or stored, and
costs incurred during any aging period.
Incidental costs frequently are omitted for inventory-pricing
purposes. Such omission is sanctioned by accountants if the
incidental costs are immaterial in amount and the effect of their
exclusion on the financial statements would be negligible.
From a theoretical standpoint, purchase discounts are unques-
tionably cost reductions. However, as a general rule, it is imprac-
tical to attempt to relate discounts taken to the merchandise on
hand. Furthermore, the amount involved is relatively small.
Therefore, it does not seem reasonable for accountants to insist
that purchase discounts be recognized in determining costs for
inventory-pricing purposes.
Cost selection for inventory pricing. It is a readily observable
fact that prices change. Therefore, identical goods may be
acquired at different costs. Consequently, accountants are faced
with the problem of determining which costs apply to the goods
that have been sold, and which costs apply to the goods that
remain in the inventory.
Several of the more widely used methods of selecting the costs
which are to be regarded as applicable to the goods in the inven-
tory are discussed in the following paragraphs.
For purposes of illustration, assume the following facts :
Unit
Units Cost Total
Beginning inventory 2 $10 $20
First purchase 1 11 11
Second purchase 1 10 10
Third purchase .... ... 1 1212
Fourth purchase . J. 13 13
Coat of goods available for sale . . $66
Total quantity available for sale .... . 6
Sold during the period 4
Ending inventory 2
Specific identification. If the goods on hand can be identified
as pertaining to specific purchases, they may be inventoried at the
388 INVENTORIES [Ch. 25
costs shown by the related invoices. Assume, for instance, that
the two units in the ending inventory can be identified as having
been acquired by the second and fourth purchases; the cost for
inventory purposes would be :
Units Unit^Cost Total
" i " $ib~ ~$io~
1 13 _13
Ending inventory . . . . $23
Weighted-average method. The cost of the goods available
for sale is divided by the total units available for sale. The result-
ing average unit cost is used for pricing the ending inventory.
Using the above facts, the weighted-average unit cost and the end-
ing inventory would be computed as follows:
Cost of goods available for sale $66
Total units available for sale 6
Average unit cost ____ $ 1 1
Ending inventory $11X2 $22
The costs determined by the weighted-average method are
affected by purchases early in the period as well as toward the end
of the period; therefore, on a rising market, the weighted-average
unit cost will be less than current unit cost, and, on a falling mar-
ket, the weighted-average unit cost will be in excess of the current
unit cost.
First-in, first-out method. This method is based on the
assumption that the first goods purchased are the first to be sold,
and that the goods which remain are of the last purchases. This
method, referred to as the fifo (initial letters of first-in, first-out)
method, is probably the most commonly used method. Applying
this method to the facts being used for illustrative purposes, the
two units in the ending inventory would be regarded as having
been acquired by the last two purchases. Thus, the ending inven-
tory would be priced as follows:
Units ttut^CciHt Total
" 1 ~~$T2"~ $12
1 13 JL3
Ending inventory $25
The assumption that the older stock is usually the first to be
disposed of is generally in accordance with good merchandising
policy. There are, of course, cases in practice where the assump-
tion does not square with the facts; for instance, the first coal
dumped on a dealer's pile will be the last sold.
This method has also been considered desirable because it pro-
duces an inventory valuation which is in conformity with price
Ch. 25] INVENTORIES 389
trends ; since the inventory is assumed to consist of the most recent
purchases and is priced at the most recent costs, the pricing follows
the trend of the market.
Last-in, first-out method. Under this method, referred to as
the lifo method, the oldest costs are assumed to be applicable to
the goods on hand. In the case assumed here, the two units in the
ending inventory would be priced at the unit cost used in pricing
the two units in the beginning inventory. Thus, the ending inven-
tory would be computed as follows:
Units Unit Cost Total
2 $10 $20
If the ending inventory had been composed of three units, the
third unit would, under lifo, be priced by using the unit cost appli-
cable to the first purchase. Thus, an ending inventory of three
units would total $31 under lifo.
In the minds of the advocates of the lifo method, the expression
"last-in, first-out" does not necessarily refer to an assumption
regarding the flow of goods, but rather to an assumption regarding
the flow of costs. The advocates of lifo maintain that, during
periods of changing costs and selling prices, more meaningful profit
and loss statements are produced if " current " costs are applied
to current sales, thus achieving a better matching of costs and
revenues.
Cost or market, whichever is lower. On the "cost or market,
whichever is lower" basis for the valuation of inventories, cost is
used except under certain conditions, described later, where mar-
ket is lower than cost. The term "market," as used here, means
current replacement cost — that is, the currently prevailing pur-
chase price of merchandise purchased for resale and raw materials
purchased for use in manufacture — and the reproduction cost,
under prevailing conditions, of goods in process and finished goods.
In making the necessary comparisons to see whether market
is lower than cost, the accountant may refer to some of the follow-
ing sources for information regarding market prices.
(1) Current catalogues or other price lists.
(2) Recent invoices.
(3) Market price quotations as published in newspapers or
trade journals.
(4) Specific quotations furnished by suppliers for this
purpose.
(5) Current contracts for the purchase of like goods.
(6) Manufacturing cost data for a short period close to the
inventory date.
390 INVENTORIES [Ch. 25
Prices may vary depending on the quantity purchased. In the
use of market prices for purposes of comparison with cost, if prices
vary for different quantities, the accountant should use, for inven-
tory purposes, the price for the quantity typically purchased by
the business.
The lower-of-cost-or-market basis of inventory valuation was
adopted as one of the earliest applications of an old rule of account-
ing conservatism often stated as follows: Anticipate no profit and
provide for all possible losses. In the days when primary emphasis
was placed on balance sheet conservatism, the cost-or-market rule
required that inventories be priced at market whenever market
was less than cost /regardless of whether the downward trend in
replacement costs had been accompanied, or would probably be
followed, by a decrease in selling prices. It was merely pre-
sumed that, when market purchase prices decreased, a loss of
realizable value in the inventory was inevitable; this presumptive
loss was " provided for " by reducing the inventory valuation to the
market replacement price.
With the increasing emphasis on the income statement and the
proper matching of income and related costs, accountants came to
realize that decreases in replacement costs are not always and
inevitably accompanied by decreases in selling prices, and that,
when decreases in selling prices do occur, they may be proportion-
ately less or greater than the decreases in replacement costs.
Therefore, the old cost-or-market rule was somewhat modified.
The general principles now governing the application of the cost-or-
market rule may be stated as follows:
Inventories may be priced at cost, even though replacement
cost is lower, if it appears probable that the inventory can
be disposed of at a normal profit — that is, if there has been
no decline, and there is no prospect of a decline, in selling
prices.
If a decline in selling prices, actual or prospective, will probably
reduce, but not entirely eliminate, the margin between the
cost and the selling price of the inventory, the inventory may
be priced at an amount, less than cost but greater than mar-
ket, which will permit the realization of a normal gross profit
on its disposal. For instance, assume that goods were pur-
chased for $100 and were marked to sell for $150; that the
market replacement price dropped to $80; and that it is
expected that the goods in the inventory can be sold for $145.
The inventory can properly be priced at $95 per unit, because
its disposal for $145 per unit would yield the normal gross
profit of $50.
Ch. 25] INVENTORIES 391
The inventory valuation should not exceed the prospective sell-
ing price less reasonably predictable costs of completion and
disposal. For instance, assume that goods were purchased
for $100; that the replacement cost is $93; that selling prices
have fallen to such an extent that it is doubtful whether the
goods can be sold for more than $95; and that the costs of
disposal are estimated at $5. The inventory valuation
should be not more than $90.
Application of cost or market. There are three ways of apply-
ing the cost-or-market method:
(1) By comparing the cost and market for each item in the
inventory, and using the lower figure in each instance,
as shown below.
Determination of Lower of Cost or Market
Item-by-Item Method
Extension
at Lower of
Unit Price Cost or
Quantity Cost Market Market
Men's department:
Suits 200 $40 $37 $ 7 ,400
Coats 100 31 35 3,100
Ladies9 department:
Dresses 300 10 12 3,000
Coats 80 30 32 2,400
Inventory at lower of cost or market . $15,900
(2) By comparing the total cost and market for major inven-
tory categories, and using the lower figure.
Determination of Lower of Cost or Market
Category Method
Lower of
Unit Price Extended cost or
Quantity Cost Market Tost Market Market
Men's department:
Suits ... 200 $40 $37 $ 8,000 $ 7,400
Coats ... 100 31 35 _ 3 100 3,500
Total . ... $lQOQ $10,900 $10,900
Ladies' department:
Dresses 300 10 12 $ 3,000 $ 3,600
Coats . 80 30 32 2,400 2,560
Total jj>J5,400 $ 6^ 160 5,400
Inventory at lower of cost or market . . $16,300
(3) By comparing the total cost and market for the entire
inventory, and using the lower figure, as shown on the
following page.
392 INVENTORIES [Ch. 25
Determination of Lower of Cost or Market
Total Inventory Method
Lower of
Unit Price Extended Cost or
Quantity Cost Market Cost Market Market
Men's department:
Suits. 200 $40 $37 * 8,000 $ 7,400
Coats 100 HI 35 3,100 3,500
Ladies' department:
Dresses. 300 10 12 3,000 3,600
Coats... 80 30 32 2,400 2,560
Total.. $16,500 $17,060
Inventory at lower of cost or market . . $1 6 , 500
For many years it was considered imperative to use the item-
by-item method; the category and total inventory methods are
now regarded as acceptable alternatives.
Effect of cost-or-market rule on gross profits. Although the
cost-or-market rule is a conservative one and is generally accepted,
the application of the rule distorts the gross profit of a period in
which the market prices decline.
To illustrate, assume that a company buys goods at a cost of
$10,000 and sells one-half of -them for $7,500. The gross profit on
the goods sold may be determined as follows:
Sales $7,500 00
Less cost of goods sold (i of $10,000) 5,000 00
Gross profit on sales . $2,50000
But assume that the inventory valuation of the remaining half
at the lower of cost or market is only $4,000. The profit and loss
statement would usually be prepared thus :
Sales . . $7,500 00
Less cost of goods sold :
Purchases .. $10,00000
Less inventory at end of period _!».??!? °9 r)'OOQ °°
Gross profit on sales $1 ,500 00
A more comprehensive statement of facts would be:
Sales .. $7,500 00
Less cost of goods sold:
Purchases . .. $10,000 00
Less inventory— at cost 5,000 00 5 ,000.00
Gross profit on sales ... .. $2,50000
Less decline in replacement cost of inventory 1,000 00
Gross profit less inventory adjustment $1 , 500 00
But, to prepare a statement in the latter form illustrated, it
would be necessary to price the inventory at both cost ($5,000)
and the lower of cost or market ($4,000) in order to determine
the reduction. Computing the inventory on two bases would
Ch.25] INVENTORIES 393
involve so much work that the procedure is usually regarded as
impracticable.
Obsolete and damaged merchandise. Regardless of the inven-
tory-pricing basis adopted, merchandise which has become obsolete
or damaged should be excluded entirely from the inventory if it is
unsalable. If it can be sold at a reduced price, a conservative
estimate of realizable value may be assigned to it. Thus, the loss
on goods remaining unsold which have been damaged or have
become obsolete is taken in the period when the loss developed,
not in the period in which the goods are sold.
Valuation basis should be disclosed. Either in the balance
sheet itself or in comments or footnotes accompanying the balance
sheet, the basis of the inventory valuation should be stated.
Gross profit method of estimating inventories. It is sometimes
desired to estimate an inventory. Perhaps it is desired to prepare
financial statements without taking a physical inventory, or to
estimate the value of an inventory which has been destroyed by
fire. The gross profit method is frequently used for this purpose.
To illustrate this method, assume that the goods on hand June
30, 1954 were destroyed by fire; no physical inventory had been
taken since December 31, 1953. The books showed the following
balances at the date of the fire:
Sales $90.000 00
Returned sales and allowances $ 700 00
inventory, December 31, 1953 20,000 00
Purchases 65,000 00
Returned purchases and allowances 1 ,000.00
Freight in . 800 00
Assume, further, that the company's records show that in prior
years it made a gross profit of approximately 25% of net sales.
Therefore, if it may be assumed that the same rate of gross profit
was realized during the six months preceding the fire, the inventory
at the date of the fire can be estimated as follows:
Inventory, December 31, 1953 $20,000 00
Add net purchases:
Purchases . . $65,000 00
Freight in.... 800 00
Total . $05,80000
Less returned purchases and allowances. . . . 1,000 00 64,800 00
Total goods available for sale $84,800.00
Less estimated cost of goods sold:
Gross sales.. .. . $90,000.00
Less returned sales and allowances _ 700 00
Net sales . . . $89,300~00
Less estimated gross profit— 25% of $89,300.00 22,325 00 66,975 00
Estimated inventory, June 30, 1954 $17,825.00
CHAPTER 26
Theory and Principles of Accounting
Purpose of chapter. Some of the principles which govern
accounting have been stated and discussed in the preceding chap-
ters in connection with the valuation of assets and the determina-
tion of income and expenses. Other principles, although not for-
mally stated and discussed, have been implicitly recognized in the
discussions of correct procedures. It is the purpose of this chapter
to present a brief, but comprehensive, statement of generally
accepted fundamental principles.
Accounting principles. What are these basic accounting prin-
ciples? Although reference is frequently made to "generally
accepted accounting principles/' no authoritative compilation or
code of principles exists.
A principle is a fundamental truth, a fundamental law, or a
fundamental assumption which forms the basis of reasoning or con-
duct. But principles cannot be established in accounting, as they
are in the realm of natural sciences, by experimentation. Nor
have they been determined, as in the law, by authoritative pro-
nouncement, although progress in that direction is being made.
The American Institute of Accountants has issued bulletins deal-
ing with matters which may be regarded as principles, but the
opinions expressed in these bulletins are not law, nor have all of
them been generally accepted by the profession. The American
Accounting Association also has done commendable work in for-
mulating statements of accounting standards, but the pronounce-
ments of the Association, as well as those of the Institute, have
not been unanimously accepted. The Securities and Exchange
Commission has issued rules which touch the realm of accounting
principles; these rules are binding only on those persons who are
subject to the authority of the Commission, but they may be
expected to exercise a pronounced influence on the practice of
accounting generally.
Shift in emphasis. For many decades accountants regarded
the balance sheet as of primary importance and the income state-
ment as of secondary importance a reflection of the attitude of
bankers and other grantors of short-term credit. Grantors of
credit were concerned with the margin of security for their loans;
they were primarily interested in two questions: What assets does
the applicant for credit own? What liabilities does he already
394
Ch. 26] THEORY AND PRINCIPLES OF ACCOUNTING 395
owe? The answers to these questions were found in the balance
sheet.
With the increase in the number of investors in corporate
securities, a shift in emphasis, from the balance sheet to the income
statement, has taken place. Investors and speculators are dis-
posed to measure the desirability of securities in terms of the earn-
ings of the issuing company. As net income goes up, security
values tend to increase; as net income goes down, security values
tend to decrease.
When the balance sheet was regarded as of primary importance,
balance sheet conservatism was the accounting principle which out-
ranked all others. As the governing principle, it was responsible,
for instance, for the old (and now somewhat modified) cost-or-
market rule which required writing down the inventory if replace-
ment costs decreased, even though there was no prospect of a cor-
responding decrease in selling prices with a consequent loss of
income.
With the increasing emphasis on the income statement,
accountants are becoming increasingly interested in developing
clear and precise concepts of net income, and in developing criteria
for its determination. Conservatism is one of these criteria, but
accountants are now becoming increasingly concerned with the
problems incident to a "sharp" determination of net income -
with the proper " matching" of income and related costs applicable
to a period.
Periodic statements. The problems related to the matching
of income and costs arise because of the custom of preparing peri-
odic statements. Most businesses are engaged in a continuing
"stream" of activity. Not until a business has ceased to function
as a going concern and has disposed of its assets is it possible to
compute with absolute accuracy the net income earned or the loss
sustained. But it obviously would be undesirable to make no
computations of net income until the business completes its life
span. Unless interim computations of the results of operations
are made, no adequate basis exists for reporting on the success of
a business.
The matching of income and related costs means matching for
a period. Proper matching involves the following:
Determining what income has been earned during the period.
Determining what costs are properly chargeable against the
income.
Matters affecting the determination of periodic income and
related costs are considered in the remainder of this chapter.
396 THEORY AND PRINCIPLES OF ACCOUNTING [Ch. 26
Income
The nature of income. Income is an inflow of assets, but it
must be recognized that there are inflows of assets which are not
income. Obviously, an inflow of capital funds from stockholders
is not income to a corporation, nor should a business regard as
income an inflow of assets which is offset by an increase in liabili-
ties. Income consists of an inflow of assets in the form of cash,
receivables, or other property from customers and clients, and is
related to the disposal of goods and the rendering of services. If
income is earned by selling goods, it may also be called profit; the
term profit is not /properly applied to income derived from the
rendering of services.
When is income earned? A basic criterion for the determina-
tion of the period in which income may be regarded as earned may
be stated as follows: Income should not be regarded as earned until
an asset increment has been realized, or until its realization is reason-
ably assured. There are also auxiliary criteria. The criteria which
determine the period to which income from production and sales
activities should be allocated differ somewhat from the criteria
which govern the period-allocation of income from services. The
two classes of income are therefore considered separately.
Income from production and sales activities. The earning of
income from wholesale and retail operations involves a series of
activities: the purchase of merchandise, the sale of merchandise,
and sometimes the subsequent rendering of service or the fulfill-
ment of guarantees. If a business is engaged in manufacturing,
the series of activities includes the purchase of raw materials and
the fabrication of the product. All of these activities are directed
to the earning of income. At what point in the series should
income be regarded as earned?
The point of sale. The sale is the step in the series of activities
at which income is generally regarded as earned. The earning of
income does not necessarily require a collection in cash, since a
valid receivable from a solvent debtor is an asset in as good stand-
ing as cash.
The point of sale is generally regarded as the point when income
is earned because (1) it is the point at which a conversion takes
place — an exchange of one asset for another — and conversion is
regarded as evidence of realization; and (2) it is the point at which
the amount of the income is, in the normal case, objectively deter-
minable from a sale price.
After the point of sale. The taking up of income at the point
of sale, and before the collection of the resulting receivable, is
justified only if there is a presumption that the receivable will be
Ch. 26] THEORY AND PRINCIPLES OF ACCOUNTING 397
collected promptly and without material collection costs and losses.
This presumption is subject to question in the case of installment
sales in which there are high percentages of collection costs, repos-
sessions, and collection losses. The installment sales accounting
procedure defers the taking of income until collections are received.
To illustrate the procedure, assume that goods which cost $100 are
sold for $150, to be collected in 10 equal installments. If the
installment sales procedure is adopted, the entire $50 difference
between cost and selling price is credited to a deferred profit
account; since one-third of the selling price is prospective profit,
each $15 installment collection is regarded as including a $5 realiza-
tion of profit; therefore, when each installment is collected, $5 is
regarded as realized income to be transferred from the deferred
profit account to an earned profit account.
Before the point of sale. Income is sometimes regarded as
earned before a sale is completed. For instance, if goods are
manufactured under a cost-plus contract and the amounts of
income applicable to completed portions of the contract are deter-
minable, realization of income may be reasonably assured even
though delivery and transfer of title have not been made. But
the taking up of profits on fixed-price contracts in process is of
doubtful propriety, because completion costs usually cannot be
estimated with accuracy; therefore, there is no certainty regarding
an ultimate profit.
When the completion of a contract extends over two or more
accounting periods, there may be a question as to whether the
income statements fairly reflect the results of operations during
these periods if the entire income is reported in the period of com-
pletion, particularly if the major portion of the work was done
prior to the period of completion. Moreover, if the proprietorship
personnel changes while the contract is in process, questions of
equity to the changing partners or stockholders arise, and the
accountant may feel that consideration should be given to these
questions of equity as well as to accounting principles. But if a
portion of the fixed price on contracts in process is taken into
income, it should be evident that the reported income may be
based to a greater degree on estimates and opinion than the
accountant would prefer.
Income from services. When should income from services be
regarded as earned? The theoretically correct answer seems to
be: in the period in which the services are rendered. The account-
ing for service income on this basis frequently requires end-of-
period adjustments for the unearned portion of charges billed in
advance, or adjustments for accruals of unbilled charges.
398 THEORY AND PRINCIPLES OF ACCOUNTING [Ch. 26
Practical considerations may lead to the adoption of a policy
of postponing the taking of any income from services until the
services are completed. The rendering of services may extend
over several periods and the amount to be charged for the entire
service may not be determinable until completion; in such cases,
the income applicable to services rendered during periods prior to
completion cannot be known.
Unrealized appreciation. The accounting principle that in-
come should not be regarded as earned until an asset increment
has been realized, or until its realization is reasonably assured, is
violated if unrealized appreciation is regarded as income.
Let us assume that a company purchases marketable securities
for $50,000 and that, at the end of the accounting period, these
securities have a market value of $60,000. Has $10,000 of income
been realized? No. The securities have riot been sold, and the
market price may decline before they are sold; therefore, no asset
increment has been realized and there is no reasonable assurance
that an increment will be realized.
Income and savings. A saving, but not income, results from
manufacturing a thing at accost less than the price at which it
could have been purchased. To regard such savings as income is
a violation of the accounting principle relative to the realization
of asset increments.
Companies which construct fixed assets for their own use at a
cost less than the market purchase price sometimes desire to record
the fixed assets at a theoretical purchase price and take up a
"profit." The manufacture of fixed assets may increase the future
profits by reducing future depreciation charges, but a present sav-
ing with a prospect of increased future profits should not be con-
fused with realized income.
Ultimate profits on sales of merchandise may be increased by
manufacturing the goods instead of purchasing them; but no
profit should be regarded as realized until the goods are sold.
Costs
Terminology. The word cost is related to expenditure. An
expenditure is a payment, in cash or otherwise, or the incurring of
an obligation to make a future payment, for a benefit received.
Cost is the measure of the expenditure. But when used without
modifying words, cost does not always have a definite meaning.
For precision of expression, we shall use several terms.
The expression cost outlay will be used with reference to expendi-
tures and acquisitions, regardless of whether the benefit received
is chargeable to an asset or an expense account.
Ch. 26] THEORY AND PRINCIPLES OF ACCOUNTING 399
The term cost transformation refers to such changes as the con-
version of material, labor, and overhead costs into finished goods
costs.
Expired costs are those which no longer have any asset status.
Expired costs are of two classes: utilized costs and lost costs. Uti-
lized costs include the cost of merchandise sold and the costs of
services, utilities, and other benefits used for the purpose of pro-
ducing income. Lost costs are costs which have expired without
utilization or without contributing to the production of income.
A cost residue is the unexpired portion of a cost outlay; it may
properly appear on the asset side of the balance sheet of a going
concern.
The cost principle. Cost is the generally accepted basis for
accounting for assets and expenses. Charges to asset and expense
accounts should generally be made on the basis of cost -or, in
other words, on the basis of actual expenditures.
It is a violation of the cost principle to value assets in the
accounts at more than cost, because this would involve an anticipa-
tion of profits. Actual costs should not be surcharged with theo-
retical additions by such practices as including interest on the
investment in plant assets in the cost of goods manufactured,
recording constructed fixed assets in the property accounts at a
theoretical purchase price in excess of construction cost, valuing
goods in process at various stages of completion at theoretical pur-
chase prices, or charging operations with a theoretical rent on
owned real estate in excess of the actual expenses incurred.
It is also a violation of the cost principle to value assets at less
than cost merely for purposes of conservatism, because the profits
and the net worth would thereby be understated. It is, of course,
necessary to give recognition to expired costs and lost costs in
determining asset valuations.
The cost principle requires that assets, in general, shall be
stated in the accounts at cost, or at cost minus the portions of cost
which have been properly charged to operations by depreciation
provisions or otherwise. The cost principle also requires that the
charges to operations for depreciation and other asset expirations
shall be on the basis of cost.
The cost basis is sometimes criticized by people who believe
that reports would be more informative if all assets were stated at
market replacement prices at the date of the report. Market
values of plant and other assets may be information of significance,
but it does not follow that the cost basis of accounting should be
abandoned in favor of an accounting procedure which would
require appraisals and revaluations of all assets at each balance
400 THEORY AND PRINCIPLES OF ACCOUNTING [Ch. 26
sheet date. There are two reasons why such a procedure would
riot be desirable: First, it would introduce unrealized profits and
losses into the accounts. Second, although there are many diffi-
cult problems involved in the determination of cost, there is more
definite and objective evidence for the determination of costs than
for the determination of market values; market or replacement
values are often matters of pure opinion, estimate, and conjecture.
It would seem that whatever benefits might be obtained by a
periodic revision of the accounts to a current price basis could be
obtained by stating such values parenthetically in the balance
sheet.
Departures from the cost basis. Although cost is the generally
accepted basis for accounting for assets and expenses, other bases
are sometimes preferable or acceptable.
The gross amount of accounts receivable can scarcely be said
to represent their cost, because of the profit element in the selling
price of the merchandise for which the receivables were obtained.
Moreover, the estimated realizable value of the receivables is the
only significant basis for their valuation, and they are, therefore,
properly valued at the gross amount less the reserve for losses.
Valuations of other current assets, such as inventories and
temporary investments in marketable securities, at market values
which are less than cost are generally recognized as acceptable
departures from the cost basis. Or perhaps it might be more pre-
cise to say that the reduction from cost to market is a recognition
of lost costs.
Classification of cost outlays. Expenditures chargeable to
asset accounts and those chargeable to expense accounts should be
clearly distinguished. An expenditure need not result in the
acquisition of a tangible asset to justify charging it to an asset
account. In general, it may be said that any expenditure for a
service or other intangible which can reasonably be expected to
benefit the business during at least one period beyond the period
in which the expenditure is made can properly be charged to an
asset account, and the asset, or diminishing portions thereof, may
properly be regarded as continuing to exist so long as benefits are
to be derived from the expenditure.
If it is known at the time of making a cost outlay that the
benefit derived will not extend beyond the current accounting
period (as when a month's rent is paid at the beginning of the
month), it is customary and expedient to charge the cost imme-
diately to an expense account. Although the cost may not have
expired at the time of the outlay, the accounting entries are
reduced by making an immediate charge to an expense account
Ch. 26] THEORY AND PRINCIPLES OF ACCOUNTING 401
rather than charging an asset account and subsequently making a
transfer from the asset account to an expense account.
If a cost outlay will presumably benefit more than one period,
but only a few periods (as in the case of insurance costs), either
of the following accounting procedures is acceptable. The outlay
may be charged to an asset account (such as Unexpired Insurance) ;
if this is done, the expired portions of cost are transferred period-
ically to an expense account (such as Insurance Expense). Or the
cost outlay may be charged to an expense account; if this is done,
cost residues are transferred periodically to an asset account.
If a cost outlay results in the acquisition of an asset which pre-
sumably will benefit a considerable number of periods (as in the
case of the acquisition of a fixed asset), the cost should be charged
to an asset account and the periodic cost expirations should be
charged to expense.
Some of the most difficult problems of classification of cost out-
lays at the time when the outlays are made arise in connection with
fixed assets. Some of these problems of differentiating between
capital and revenue expenditures were discussed in the chapter
dealing with fixed assets.
Determination of asset costs. The cost of an asset includes
not only the basic, or purchase, price but also incidental costs such
as the following: costs of title searches and legal fees incurred in
the acquisition of real estate; transportation, installation, and
breaking-in costs incident to the acquisition of machinery ; storage,
insurance, taxes, and other costs incurred in aging certain kinds of
inventories, such as wine; and expenditures made in the rehabilita-
tion of a plant purchased in a rundown condition.
Cash discount and interest. Although cash discounts on pur-
chases are often shown in profit and loss statements as income, this
procedure is coming to be recognized as a violation of the cost prin-
ciple. Terms of 2/10; n/30 on an invoice dated, for instance,
March 1, mean that 2% discount can be taken if payment is made
on or before March 11, and that the gross amount of the invoice
is payable on March 31. The purchaser gets the 2% discount for
paying the invoice 20 days before it is due for payment. Two per
cent for 20 days is equivalent to an interest rate of 36% a year.
Such a rate is so high that purchase discounts cannot reasonably
be regarded as income for the use of money; moreover, a profit
cannot be made on a purchase. When cash discounts on mer-
chandise purchases are treated in the operating statement as
income rather than as a factor in the determination of the merchan-
dise cost, the procedure is a violation of the cost principle; it is
sanctioned partly because of custom and partly because of the
402 THEORY AND PRINCIPLES OF ACCOUNTING [Ch. 26
difficulty of applying discounts as a reduction of purchase costs for
purposes of inventory valuations. (The discount would have to
be applied to each item in each invoice, to obtain the net price;
and net prices, if accurately stated, would run into fractions of
cents — for instance, the net price of an article purchased for $4.35,
subject to a 1% cash discount, would be $4.3065.) But no such
practical objection can be raised against applying cash discounts
as a reduction in the cost of a fixed asset, and fixed assets should
therefore be charged to the accounts at their net cost.
If time intervenes between the date of purchase and the date of
payment and an interest charge is incurred, the interest should be
recorded as an, expense and not as an addition to the asset cost.
Assets acquired with securities. If assets are acquired by issu-
ance of stocks or bonds, the price at which the securities could have
been issued for cash is the true cost of the assets. For instance, if
land was acquired by issuance of $50,000 par value of bonds which
could have been sold for $55,000 cash, the entry to record the
transaction should be:
I^and . . 55,000 00
Bonds payable . 50,00000
Premium on bonds " 5,000 00
If the cash value of the securities at the date of issuance cannot
be determined, the price at which the asset could have been
acquired for cash is an acceptable measure of cost.
Assets acquired for noncash assets. The determination of the
cost of an asset acquired in a transaction in which some other non-
cash asset is part or all of the consideration may present difficulties.
For instance, assume that a machine is purchased at a price of
$1,500; that $1,000 is paid in cash; and that the seller accepts, as
the remainder of the price, an old machine which is carried at a
depreciated cost of $400 and which could have been sold for $250.
Did the new machine cost $1,500 (the nominal cost), or $1,400 (the
sum of the cash and the undepreciated cost of the old machine),
or $1,250 (the sum of the cash and the cash value of the old
machine)? From a theoretical standpoint, $1,250 appears most
truly to represent cost because it is the sum of cash and cash
equivalent. A $1,500 cost, although commonly regarded as
acceptable, is theoretically questionable because it involves the
taking of a profit of $100; this " profit/' although nominally arising
from the disposal of the old asset, is so related to the purchase
transaction that its realization is debatable. A $1,400 cost has
some theoretical justification, since it is, in a sense, cost on a going-
concern basis; that is, it is a valuation which includes an unexpired
old plant cost plus an additional cost.
Ch. 26] THEORY AND PRINCIPLES OF ACCOUNTING 403
Cost apportionments. If several kinds of assets are acquired by
a cash payment at a lump price, the aggregate cost must be
apportioned to the various assets. This immediately introduces
an element of opinion, and the effects upon current and subsequent
income statements and balance sheets should be recognized.
Thus, if land, buildings, and merchandise are acquired at a lump
price, the apportionment of the cost affects the computation of
merchandising profit during a relatively short period, the building
depreciation charges during a relatively long period, and any gains
or losses which may result from a disposal of the fixed assets.
Cost transformations and expirations. Cost transformations
and cost expirations must be differentiated. During a period of
operations, some costs will be transformed and others will expire;
those which are transformed will remain as assets, although their
nature will have changed; those which have expired should be
charged against income or earned surplus.
Costs are transformed by the process of production. Manu-
facturing costs are incurred initially for materials, labor, and over-
head; by the transformations of the manufacturing process, these
costs become merged into goods in process and finished goods.
Costs expire as a result of utilization; for instance, the cost of
postage stamps expires when the stamps are used. Although
utilization is a cause of cost expiration, it should be clearly under-
stood that utilization does not always result in an expiration of
cost. For instance, the cost of gasoline used in an engine which
furnishes power for a factory becomes transformed into the cost
of the finished goods; the cost of gasoline consumed in the motor of
a truck used to deliver sold goods is an expired cost. Similarly,
the rent of a factory building for a month becomes a transformed
cost ; the rent of a salesroom becomes an expired cost.
Costs are regarded as lost if they disappear without utilization ;
for instance, the cost of stolen merchandise is a lost cost.
Cost favors and exemptions. In the allocation of transformed
costs, no special favors or cost exemptions should be granted. One
application of this principle was mentioned in Chapter 24 in the
discussion of the propriety of including a charge for manufacturing
expenses in the cost of fixed assets constructed. Unless con-
structed fixed assets are charged with a proper portion of manu-
facturing expenses, a special favor or cost exemption is granted to
the fixed assets.
Because of the labor and difficulties involved in the determina-
tion of their material, labor, and overhead costs, by-products are
sometimes charged with only material costs, and sometimes with
no costs at all. This may be a case where departure from an
404 THEORY AND PRINCIPLES OF ACCOUNTING [Ch. 26
accounting principle must be permitted because of the difficulty of
obtaining the information which would be required to comply with
the principle.
Because a certain company's operations were seasonal, its
plant was comparatively idle for several months during the year.
To keep its plant busy during this period, the company accepted
an order for a special product at a price which included the costs of
material and direct labor (but no overhead) and a " profit." The
management requested its accountant to charge all the manu-
facturing expense for the year to the regular products and none to
the special product, defending this procedure on the ground that
no additional overhead was incurred because of the manufacture
of the special product. Although the net income of the business as
a whole presumably was increased by the manufacture and sale of
the special product, a cost exemption was granted to the special
product at the expense of the regular product. As a consequence,
the profit on the regular product was understated and a profit on
the special product was shown although a loss probably was
incurred. That the total profits of a business can be increased by
selling goods at a loss may at first seem anomalous ; but it is obvious
that over-all profits may be increased by the manufacture and sale
(if without interference with the other activities of a business) of
a product at a price sufficient to cover material and labor and a
portion of overhead which otherwise would have to be charged to
other products. Management may, therefore, regard such sales
as good business policy, but they should not expect accountants to
misstate the costs of, and profits on, the various products.
Cost expirations and residues. All costs expired during a
period should be charged against the income for the period (or
perhaps, in special instances, against earned surplus).
The balance sheet and income statement will not present fairly
the financial position of a business and the results of operations
unless a proper differentiation is made between costs which have
expired and those which remain as assets.
In determining the amounts of cost expirations and cost
residues, accountants attack the problem from two directions :
(a) By making decisions as to asset expirations and accepting
the remainder as asset residues.
This is the procedure normally applied to fixed asset and
expense prepayment costs. Provisions for depreciation,
depletion, and amortization, and expense prepayment
write-offs are intended to apportion costs over the periods
benefited; the resulting asset net valuations are consid-
Ch. 26] THEORY AND PRINCIPLES OF ACCOUNTING 405
ered acceptable for balance sheet purposes because they
represent unexpired cost, or value in use, there being no
need for the asset residue shown by the balance sheet to
represent a realizable value,
(b) By making decisions as to asset residues and accepting the
remainders as asset expirations.
This is the theoretically correct procedure to be applied to
most current assets, because, with respect to such
assets, emphasis should be placed upon realization rather
than use. For this reason, accountants apportion total
merchandise costs between residues and expirations by
placing a valuation on the inventory and regarding the
excess of the total merchandise cost over the inventory
valuation as the amount of the asset expiration.
The determination of the amounts of expired costs and cost
residues should be made with the purpose of absorbing costs over
the periods benefited (in the case of fixed assets and expense pre-
payments) or of valuing assets on a realization basis (in the case of
some current assets). The amounts recorded as expirations should
not be determined with the object of arbitrarily and unwarrantably
affecting net income, or on the basis of the amount of ' ' net income "
available for reserve provisions. Depreciation should be recognized
as a cost expiration for which provision must be made regardless of
whether operations for the period are profitable or unprofitable.
Costs of tangible assets, intangible assets, and expense prepay-
ments which will be of no benefit to future periods should be written
off, or written down to realizable values, and should not be carried
along in the accounts for subsequent write-offs; the expired or lost
costs should be immediately recognized.
General Considerations
Matching income and related costs. In the computation of net
income for a period, it is important that:
If income is deferred because it is not regarded as earned, the
related costs should also be deferred.
If future costs may be incurred which are applicable to the
earnings taken into income, provisions for such future costs
should be made by charges against income.
As a simple illustration of the first point, assume that com-
missions are paid to salesmen for sales for future delivery. If the
commissions were charged against income in the period when paid,
instead of being deferred until the period in which the sales are
406 THEORY AND PRINCIPLES OF ACCOUNTING [Ch. 26
taken into income, there would not be a proper matching of income
and related costs by periods.
With regard to the second point, companies sometimes sell
their products with agreements to provide service for a period of
time without cost to the purchaser; goods are sold with guarantees;
a lessee may agree to return the leased property to the lessor at the
end of the lease period in the condition in which it existed at the
beginning of the lease; premium coupons redeemable in merchan-
dise are issued. As a result of these and similar transactions and
contracts, income may be received in one period and costs appli-
cable thereto may be incurred in subsequent periods. Provisions
for such future costs should be made by setting up reserves by
charges to operations in the period in which the related income is
taken up.
Basis of accounts. Accounts and statements should give
expression, so far as possible, to facts evidenced by completed
transactions and supportable by objective data.
For purposes of discussion, the statement of this principle may
be divided into three elements:
(1) "by completed transactions"
For instance, as already pointed out, merchandising profits
are not normally regarded as earned until the realization
of income is evidenced by the completed transaction of a
sale.
(2) "supportable by objective data"
For instance, the selling price in a bargained transaction is
objective data supporting the computation of the profit.
(3) "so far as possible"
Many accounting entries, such as those providing for depre-
ciation, bad debts, and contingencies, cannot be evi-
denced by completed transactions nor wholly supported
by objective data, but must necessarily be based on
estimates.
Fact, opinion, and policy. Audit reports rendered by certified
public accountants formerly contained a "certificate," which was
worded somewhat as follows:
"We hereby certify that, in our opinion, the accompanying balance
sheet and related statements of profit and loss and surplus correctly
reflect the financial condition of The A B Company on December 31,
19 — , and the results of its operations for the year ended that date
yj
Audit reports now customarily contain an "opinion" expressed
in language similar to that on the following page.
Ch. 26] THEORY AND PRINCIPLES OF ACCOUNTING 407
"In our opinion, the accompanying balance sheet and related
statements of profit and loss and earned surplus present fairly the
financial position of The A B Company on December 31, 19 — , and
the results of its operations for the year ended that date ..."
The change in language from " correctly reflect" to " present
fairly" is a recognition that periodic balance sheets and operating
statements can rarely be statements of absolute fact, and therefore
cannot be regarded as " correct" in any absolute sense.
Some of the amounts shown in the periodic statements (such
as cash, sales, rent, and salaries) may be matters of fact. Other
amounts, such as the provision for bad debts, are matters of
opinion. Other amounts are affected by accounting policies; for
instance, while the determination of the quantity of merchandise
sold is a matter of ascertaining facts, the cost to be assigned to it,
if identical goods were acquired at different costs, is affected by the
choice between such methods as first-in, first-out and last-in,
first-out, which is a matter of policy.
Conservatism. Attention was called, earlier in the chapter,
to the fact that balance sheet conservatism was once the account-
ing principle that outranked all others. Accountants still believe
that conservatism is a virtue and that, when matters of opinion or
estimate are involved, it is commendable, in instances of doubt, to
understate the net income and the net worth rather than to over-
state them.
Conservatism may even be regarded as justifying a departure
from procedures which could be defended from the standpoint of
good accounting theory. For instance, in the preceding discussion
of principles applicable to the recording of costs, it was pointed
out that any expenditure for a service which can reasonably be
expected to benefit the business during more than one period can
properly be charged to an asset account, and the asset, or diminish-
ing portions thereof, may properly be regarded as continuing to
exist so long as benefits are to be derived from the expenditure.
This is sound accounting theory. But suppose that large expen-
ditures are made for an advertising campaign, the benefits of which
may be expected to extend beyond the period in which the expen-
ditures are made. It might be theoretically correct to carry for-
ward part of the cost as a prepaid expense; but, because of the
practical difficulty of determining the portion of the cost which
could properly be deferred, most accountants probably would feel
that they would be justified, on the ground of conservatism, in
deferring no portion of the cost.
Although conservatism is still regarded as commendable, there
is a growing tendency to question the time-honored beliefs that
408 THEORY AND PRINCIPLES OF ACCOUNTING [Ch. 26
balance sheet conservatism outweighs all other considerations,
that a conservative balance sheet is a good balance sheet for all
purposes, and that balance sheet conservatism automatically pro-
duces a proper statement of operations. Accountants are becom-
ing increasingly aware that adherence to the doctrine of balance
sheet conservatism may result in income statements which are :
(a) Incorrect.
It may be conservative from the balance sheet standpoint
to charge operations with fixed asset expenditures
s which would more properly be capitalized, or to pro-
vide excessive reserves for depreciation and bad debts,
but the net income is misstated.
(b) Arid sometimes unconservative.
For instance, some accountants have advocated writing
off bond discount, by charge to Earned Surplus, during
the period in which the bonds were issued, in order to
clear the balance sheet of a deferred charge which has
no realizable value. But the effect is to relieve the
income statements of all periods throughout the life
of the bonds of charges for an element of interest cost;
as a result, the net income is overstated and the income
statements are unconservative.
Conservatism can scarcely be regarded as a virtue if, as its
consequence, the balance sheet and income statement do not
"present fairly" the financial position and the results of operations.
Consistency. Increasing emphasis has been placed in recent
years on the importance of consistency. There are many areas
of accounting in which different procedures may be acceptable;
for instance, inventory costs may be determined on a first-ill,
first-out basis or on a last-in, first-out basis. But a change from
one basis to another will affect the net income for the period in
which the change is made. In fact, changes in accounting bases
may so materially affect the stated net income that a comparison
of the operating statements of a company for two periods may be
misleading unless the effect of the changes is known.
A proper regard for consistency need not preclude a desirable
change in procedure; but if a change has a material effect on the
statements, the nature of the change should be disclosed and the
dollar effect thereof on the statements should be indicated, if
determinable.
Disclosure. Statements should make full disclosure of signifi-
cant information. It is the accountant's obligation to disclose all
facts which, if not reported, might make the statements misleading.
Ch. 26] THEORY AND PRINCIPLES OF ACCOUNTING 409
The latitude of a profession. As stated at the beginning of this
chapter, there is no comprehensive code of accounting principles
extending to the ramifications of procedural details. And it
probably is not desirable that accounting procedures should be
reduced to a rigid uniformity by any detailed statement of rules.
Accounting must meet the varying requirements of different
businesses operating under differing conditions, making proper
choices between different procedures which are equally right for
their various purposes, and must be unfettered and prepared to
adjust itself to changes in the economic system. It seems desir-
able, therefore, that members of the accounting profession, like
those of other professions, should exercise individual judgment and
initiative within the framework of general principles.
The "Current Operating" and "Clean Surplus" Concepts
of Net Income
For many years it was standard accounting procedure to show
in the income statement only the results of regular operations for
the current period, and to show in the surplus statement any
corrections of the net income or loss of prior periods and any
unusual, extraordinary, or nonrecurring gains and losses, such as
those resulting from sales of investments and fixed assets. State-
ments prepared in this manner are said to be in accordance with the
current operating concept of net income; they are illustrated below:
THE JONES CORPORATION
Statement of Income and Expense
For the Year Ended December 31, 1953
Net sales . $ 1 , 204 , 960 . 00
Deduct cost of goods sold. . . . 826,940 00
Gross profit on sales . $ 378 , 020 . 00
Deduct expenses . . . 261 ,290 00
Net income . $ 116,730 00
THE JONES CORPORATION
Statement of Earned Surplus
For the Year Ended December 31, 1953
Earned surplus, December 31 , 1952 $ 326,215 00
Add:
Net income for the year . 1 16,730 00
Correction of net income for 1952 — Undervaluation
of inventory on December 31, 1952 . 19,600.00
Total ... . $ 462,545.00
Deduct:
Loss on sale of abandoned plant ... . $15,325.00
Dividends . 90,000 00 105,325 00
Earned surplus, December 31, 1953 $ 357,220.00
410 THEORY AND PRINCIPLES OF ACCOUNTING [Ch. 26
At the present time many accountants advocate the clean sur-
plus concept; that is, they believe that corrections of the net income
or loss of prior periods and extraneous gains and losses should be
shown in the income statement. Statements prepared in accord-
ance with the clean surplus concept of net income are shown below:
THE JONES CORPORATION
Statement of Income and Expense
For the Year Ended December 31, 1963
Net sales $1 ,204,960 00
Deduct cost of goods sold 826,940 00
Gross profit on sales $ 378,020 00
Deduct expenses. . . 261 ,290 00
Net operating income $ 116,730.00
Add — deduct*:
Correction of net income for 1952 —
Undervaluation of inventory on De-
cember 31, 1952 $19,600 00
Loss on sale of abandoned plant 15 , 325 00* 4 , 275 . 00
Net income T. ! $ 121,005 00
THE JONES CORPORATION
Statement of Earned Surplus
For the Year Ended December 31, 1953
Earned surplus, December 31, 1952 $ 326,215.00
Add net income for the year 121, 005 00
Total $ 447,220.00
Deduct dividends. . 90,000.00
Earned surplus, December 31 , 1953 $ 357,220.00
Some of the arguments presented by the two schools of thought
are briefly stated below.
Current operating concept. The proponents of the current
operating concept of net income support their position by the
following arguments:
Investors are more interested in the net income of a business
than in any other one figure shown by the annual statements.
And the net income in which they are interested is that which
resulted from normal operating transactions. If extraneous
gains and losses and corrections of the reported net income of
prior periods are included, it is difficult to determine the
trend of a company's operations.
If the stated net income of one year is affected by a material
correction of the net income of a prior year, the error is com-
pounded— the current year's net income is overstated or
understated to the extent that the net income of the past was
understated or overstated. Indicated trends are therefore
misleading.
Ch. 26] THEORY AND PRINCIPLES OF ACCOUNTING 411
Because of the danger that some readers of accounting reports
are likely to assume that the income statement tells all that is to
be told about profits and losses and are not aware of the significance
of matters disclosed in the surplus statement, a combined state-
ment of income and surplus is sometimes advocated. Such a
statement, prepared in accordance with the current operating
concept, is shown below:
THE JONES CORPORATION
Statement of Income and Earned Surplus
For the Year Ended December 31, 1953
Net sales . . . $ 1 , 204 , 960 00
Deduct cost of goods sold . 826,940 00
Gross profit on sales . $ 378,020 00
Deduct expenses 261,290 00
Net income $ 116,73000
Add:
Earned surplus, December 31, 1952 326,215 00
Correction of net income for 1952 — Under-
valuation of inventory on December 31, 1952 19 ,600 00
Total . ... $" 462,545 66
Deduct:
Loss on sale of abandoned plant $15,325 00
Dividends . . . . 90,000 00 105,325 00
Earned surplus, December 31, 1953 $___357 .220 00
Clean surplus concept. The proponents of the clean surplus
concept present the following arguments:
The total of the amounts shown as net income in the state-
ments for a series of years should be the aggregate net income
for those years ; this will not be the case if corrections of the
reported net income of prior periods are shown in the surplus
statement.
When an accountant charges earned surplus with a loss because
he considers it extraordinary or extraneous, he implies that it
is nonrecurring. But a study of business history indicates
that such losses do recur.
The line of demarcation between operating items and extraor-
dinary and extraneous items is not clear-cut, and is often a
matter of opinion. Studies of annual reports have shown
many inconsistencies in classifications between income and
surplus made by different companies, and by the same com-
pany in different years. Wide variations in net income can
be caused by such inconsistencies.
Many so-called extraordinary or extraneous charges and credits
are closely related to operations — not to the operations of a
single year, but to those of a series of years.
41 * THEORY AND PRINCIPLES OF ACCOUNTING [Ch. 26
They may be regarded as corrections of the stated net
income of a number of prior years; for instance, a gain or loss
on the disposal of a fixed asset may be regarded as a correc-
tion of prior years' charges for depreciation.
Or extraordinary charges may relieve future periods of
operating charges which otherwise would be required; this is
the case when fixed assets are written down or written off,
and future years are thereby relieved of depreciation and
amortization charges.
Concluding note. Accountants have not yet arrived at a una-
nimity of opinion with respect to these conflicting concepts of net
income. Differences exist in practice. The American Accounting
Association, in its official publications, has taken a strong position
in favor of the clean surplus concept. The Committee on Account-
ing Procedure of the American Institute of Accountants has taken
a somewhat modified position; in its Bulletin No. 32, the com-
mittee stated:
"It is the opinion of the committee that there should ho a general
presumption that all items of profit and loss recognized during the
period are to be used in determining the figure reported as not, income.
The only possible exception to this presumption in any case would be
with respect to items which in the aggregate are materially significant
in relation to the company's net income and are clearly not identifiable
with or do not result from the usual or typical business operations of
the period . . . "
In view of the fact that practice and authoritative opinion leave
this matter still in a somewhat controversial state, it is perhaps
undesirable for a textbook to take a firm, definite position on the
question. An accounting student should be familiar with both
points of view, and should be adaptable enough to follow either
approach, as directed. Until the issue is more clearly resolved,
an instructor is justified in suggesting the adoption of either point
of view, if for no other reason than to achieve class uniformity.
CHAPTER 27
The Analysis of Financial Statements
Purpose of the chapter. Financial statements take on addi-
tional meaning when subjected to analytical procedures. It is the
purpose of this chapter to discuss and illustrate some of the most
widely adopted of these procedures and to point out their useful-
ness as well as the limitations inherent in some of them. Whole
volumes have been written on this subject; it is obvious that, within
the limitations of a single chapter of an introductory text, the
treatment of the subject must be restricted to fundamentals.
Basis of the illustrations. The following statements serve as
the basis of the illustrations in the chapter. Since comparison con-
stitutes one of the major features of statement analysis, these state-
ments cover two years.
SPECIALTY PRODUCTS COMPANY Exhibit A
Balance Sheets
December 31, 1954 and 1953
Assets
December 31,
1954~ 1953
Current assets:
Cash .. $ 25,005 $ 25,330
Marketable securities 10 , 000 8 , 000
Accounts receivable 98 , 600 80 , 250
Reserve for bad debts 2,500* 2 ,000*
Inventories :
Finished goods . 38 , 685 33 , 500
Goods in process 15,800 14,000
Raw materials . 25 , 940 22 , 865
Prepaid expenses 3,600 3,400
Total current assets $216,030 $185,345
Fixed assets:
Land $ 40,000 $ 40,000
Buildings 245 , 350 1 98 , 675
Reserve for depreciation 61 ,000* 57 , 700*
Machinery and equipment 90 , 500 75 , 000
Reserve for depreciation . 15 , 200* 1 0 , 050*
Furniture and fixtures ... . 9,450 8,760
Reserve for depreciation 2,700* 1,800*
Total fixed assets $306,400 $252,885
$522,430 $438,230
413
414 ANALYSIS OF FINANCIAL STATEMENTS [Ch. 27
Liabilities and Net Worth
Current liabilities:
Accounts payable $18,225 $12,500
Notes pay able— Bank 40 , 000 25 , 000
Accrued taxes, wages, and other expenses 35,250 24,300
Total current liabilities $ 93,475 $ 61 ,800
Long-term liabilities:
Bonds payable— secured by real estate 100,000 100,000
Total liabilities. $193,475 $161,800
Net worth:
Capital stock — $100 par value:
Preferred— 6% $ 50,000 $ 50,000
Common 250,000 200,000
Earned surplus— Exhibit B. . . 28,955 26,430
Total netrworth $328,955 $276,430
$522,430 $438,230
SPECIALTY PRODUCTS COMPANY Exhibit B
Statements of Income, Expense, and Earned Surplus
For the Years Ended December 31, 1954 and 1953
Year Ended
December 31,
_1954 1953
Gross sales -> , . $970 , 675 $786 ,500
Returned sales and allowances ... . ^1 'J)45 29,650
Net sales . . $949,630 $756,850
Cost of goods sold -Schedule 1 . . 685,320 582 , 700
Gross profit on sales .... $264,310 $174,150
Expenses — Schedule 2:
Selling expenses $145,980 $ 89,050
Administrative expenses 71,405 47 , 01 0
Total $217,385 $136,060
- Net income from operations $ 46,925 $ 38,090
Income from securities . 500 400
Net income before interest and federal income tax $ 47,425 $ 38,490
Interest:
On notes payable . ... $ 900 $ 750
On bonds payable . . .. 6,000 6,000
Total . $ 6,900 $ 6,750
Net income before federal income tax $ 40,525 $ 31 ,740
Federal income tax. . . 15,000 11 ,500
Net income . $25,525 $ 20,240
Earned surplus — Beginning of year 26 , 130 25 , 1 90
Total $ 51,955 $ 45,430
Dividends:
Preferred . $ 3,000$ 3,000
Common 20,000 16,000
Total $ "23, OOP $ 19,000
J&rned surplus— JOnd of ^ear $ 28,955 $ 26,430
Ch. 27] ANALYSIS OF FINANCIAL STATEMENTS 415
SPECIALTY PRODUCTS COMPANY Exhibit B
Statements of Cost of Goods Sold Schedule 1
For the Years Ended December 31, 1954 and 1953
Year Ended
December 31,
Cost of goods manufactured: 1954 .. 1953
Raw materials:
Inventory— Beginning of year $ 22,865 $ 20,850
Purchases 237,150 215,260
Total $260,015 $236,110
Inventory — End of year 25,940 22,865
Materials used $234 ,075 $213 , 245
Direct labor . 316 , 500 253 , 200
Manufacturing expense 141 ,730 121,455
Cost of manufacturing $692 , 305 $587 , 900
Goods in process — Beginning of year 14,000 12,700
Total ... . $706,305 $600,600
Goods in process — End of year 15,800 14,000
Cost of goods manufactured $690 , 505 $586 , 600
Finished goods — Beginning of year 33,500 29,600
Total $724,005 $616,200
Finished goods -Knd of year 38,685 33,500
Cost of goods sold $685,320 $582,700
SPECIALTY PRODUCTS COMPANY Exhibit B
Schedules of Selling and Schedule 2
Administrative Expenses
For the Years Ended December 31, 1964 and 1953
Year Ended
December 31,
1954 1953
Selling expenses:
Salesmen's salaries and payroll taxes. $ 28,000 $17,355
Salesmen's traveling expenses 27 , 610 17 , 690
Advertising . . 80,450 45,375
Freight out 7,865 6,350
Miscellaneous 2,055 2,280
Total $145,980 $89,050
Administrative expenses:
Officers' salaries and payroll taxes. . . $ 26,760 $13,765
Office salaries and payroll taxes ... 22 , 865 20 , 680
Stationery and supplies . 1 ,250 1 , 140
Postage, telephone, and telegraph .. 2,535 1,950
Depreciation of furniture and fixtures 900 900
Bad debts . 15,945 7,050
Miscellaneous . 1,150 1,525
$^71,405 $47 ,,010
Outline of chapter. The analytical procedures discussed and
illustrated in the chapter are presented under the following main
captions: The results of operations; Working capital; General finan-
cial position.
416 ANALYSIS OF FINANCIAL STATEMENTS [Ch. 27
The Results of Operations
Ratio of net income to average net worth. Since capital is
invested and business is conducted with the object of earning
income, a basic measure of business success is the ratio of net
income to the capital committed to the business. Because the
amount of capital changes during the year, the ratio should be
based on the average capital during the year. If the data were
available, it would be desirable to compute the average capital
by using the capital at the beginning of the year and the capital
at each month-end during the year. Working with the available
data, the computation of the ratios for Specialty Products Com-
pany is as follows:
Ratio of Net Income to Average Net Worth
1954 1953
Net income— Exhibit B (a) $ 25,525 $ 20,240
Average net worth:
Net worth — Beginning of year — Exhibit A $270,430 $275,190
Net worth Kiid of year— Exhibit A 328,955 270,430
Average (b) $30^093 $275,810
ttntio (a -*- b) _ 8 43% 7 34";
The ratio shows an improvement (from 7.34% to 8.43%) ; hut,
like most ratios, the ratio of net income to net worth would he
more meaningful if there were some standard for comparison.
How do the ratios for this company compare with the ratios of
other companies in the same line of business? Information for
the answer to this question is sometimes available in the form of
statistics furnished by trade associations, or published in reference
books such as Moody's Manual of Investments and Standard &
Poor's Corporation Records.
Number of times preferred dividend earned. The ratio of net
income to net worth gives no recognition to different classes of
stock. Preferred stockholders, particularly if their shares are non-
participating, are primarily interested, so far as earnings are con-
cerned, in the relation of the net income to the preferred dividend
requirement, which is computed as follows:
Number of Times Preferred Dividends Earned
1954 1953
Net income . . (a) $25 , 525 $20 , 240
Preferred dividend requirement . (b) 3 ,000 3 ,000
Number of times preferred dividend earned (a -*- b) 8.51 6 75
Earnings per share of common stock. Common stockholders
are less interested in the total net income than in the net income
applicable to the common stock — that is, in the net income minus
Ch. 27] ANALYSIS OF FINANCIAL STATEMENTS 417
the preferred dividend requirements. Assuming that the preferred
stock of Specialty Products Company is non-participating, the
earnings per share of common stock are computed as follows:
Per-Share Earnings on Common Stock Outstanding at End of Year
1951 1953
Earnings applicable to common stock:
Not income . . $25 , 525 $20 , 240
Amount required for dividend on 6% non-partici-
pating preferred stock .... 3,000 3,000
Earnings applicable to common stock (a) $22 , 525 $17,240
Number of shares of common stock outstanding at
end of year (b ) 2 ,500 2 ,000
Earnings per share (a -5- b) f9 01 $8 62^
In appraising the significance of the increase in the earnings
per share of common stock, it would be helpful to know how long
the additional shares were outstanding during 1954.
It is, of course, understood that earnings per share are not
always the same as dividends per share; but undistributed earnings
increase the book value of the common stock, and thus tend to
increase the value of the common stockholders' investments.
Earnings per share are often compared with market values of
stock as an indication of the advisability of making or retaining an
investment in the shares. Assume, for example, that the common
stock of Specialty Products Company is quoted on the market at
$150; a common stockholder who is considering the advisability of
retaining his holdings, or a person who is considering investing in
the common stock, will probably ask himself the question: Is $9.01
a satisfactory return on an investment of $150?
Number of times bond interest earned. Bondholders are
interested in the debtor company's earnings as well as in the mort-
gaged security, because current income is the normal source of
funds required for the payment of bond interest. Since the bond
interest is a claim against revenue which takes precedence over
income taxes, and since the earnings available for bond interest
are, of course, the earnings before bond interest, the computation
of the number of times the bond interest is earned is made as
follows:
Number of Times Bond Interest Earned
1954 1953
Net income before bond interest:
Net income before income tax $40,525831,740
Bond interest 6,000 6,000
Income available for bond interest . (a) $46 , 525 $37,740
Bond interest.. .. . (b) S 6,000 $ 6,000
Number of times bond interest earned (a 4- b) 7 . 75 6 . 29
418 ANALYSIS OF FINANCIAL STATEMENTS [Ch. 27
Analysis of the profit and loss statement. Percentage com-
putations are often helpful in the analysis of statements of opera-
tions. There are two classes of percentage analyses:
Vertical analysis.
Horizontal analysis.
Both classes are illustrated in this chapter.
Vertical analysis. Vertical percentage analysis is so called
because the per cents apply to related amounts usually shown in
a column. The illustrative statements below and on page 419,
with vertical analysis, show the per cents of various items to the
net sales. They answer the question: What became of the sales
dollar?
SPECIALTY PRODUCTS COMPANY
Comparative Statements of Profit and Loss
With Per Cents of Net Sales
For the Years Ended December 31, 1954 and 1953
1954 1953
Per Cent Per Cent
of Net of Net
Amount Sales Amount Sales
Gross sales $970,675 102.22% $786,500 103 92%
Returned sales and allowances 21 ,045 2.22 29,650 3 92
Net sales. $949,630 100.00% $756,850 100 00%
Cost of goods sold 685,320 72.17 582,700 76 99
Gross profit on sales $264,310 27.83% $174,150 23.01%
Expenses:
Selling expenses $145,980 15.37% $ 89,050 11 77%
Administrative expenses . 71,405 7.52 47,010 621
Total .... $217,385 22 89% $136,060 17.98%
Net income from operations $ 46,925 4 94% $ 38,090 5 03%
Income from securities 500 .05 400 05
Net income before interest and federal in-
come tax $47,425 4.99% $ 38,490
Interest ... .... 6,900 72 6,750
Net income before federal income tax $ 40,525 4 27% $ 31 ,740
Federal income tax 15,000 1 .58 11 ,500
Net income $ 25,525 2 69% $ 20,210 2 67%
Vertical analysis of a profit and loss statement for a single
period is not very informative -there is no basis for judging the
acceptability of the various per cents. For instance, referring to
the profit and loss statement for 1954, is a 27.83% rate of gross
profit good or bad in the industry? Are 15.37 cents of selling
expenses per dollar of sales too high? Is a net income of 2.69 cents
per sales dollar in line with the net income of other concerns in the
same kind of business?
Ch. 27] ANALYSIS OF FINANCIAL STATEMENTS 419
SPECIALTY PRODUCTS COMPANY
Comparative Schedules of Selling and Administrative Expenses
With Per Cents of Net Sales
For the Years Ended December 31, 1954 and 1953
1954 1953
Per Cent Per Cent
of Net of Net
Amount Sales Amount Sales
Selling expenses:
Salesmen's salaries and payroll taxes $28,000 295% $17,355 2.29%
Salesmen's traveling expenses 27,610 291 17,690 2.34
Advertising. .. . .. 80,450 8.47 45,375 6.00
Freight out . 7,865 .83 6,350 .84
Miscellaneous 2,055 .21 2,280 .30
Total $145,980 15.37% $89,050 11.77%
Administrative expenses:
Officers' salaries and payroll taxes $ 26 , 760 2 . 82 % $13 ,765 1 . 82 %
Office salaries and payroll taxes 22 , 865 2.41 20 , 680 2 . 73
Stationery and supplies 1 , 250 .13 1 , 140 .15
- Postage, telephone, and telegraph . 2,535 .27 1,950 .26
Depreciation of furniture and fixtures 900 .09 900 .12
Bad debts 15,945 1.68 7,050 .93
Miscellaneous 1,150 .12 1,525 .20
Total $ 71,405 _7 jg% $47,010 6 21%
Vertical analysis takes on more meaning when applied to a
comparative statement. For instance :
It is interesting to observe that the per cent of returns and
allowances has decreased; returns and allowances mean
wasted sales effort and dissatisfied customers.
It is encouraging to note that the rate of gross profit has
increased from 23.01% to 27.83%; the cause of the increase
cannot be known without information about comparative
volume, sales prices, and costs of goods sold.
It is disturbing to see that the selling and administrative
expenses have increased from 17.98% of net sales to 22.89%
of net sales. An inspection of the expense schedules shows
material increases in the per cents of salesmen's salaries,
salesmen's traveling expenses, advertising (indicating that
the increased sales effort has been relatively unproductive),
officers' salaries, and bad debt losses.
A word of caution is in order in connection with the vertical
analysis of a comparative statement. Per cents are computed by
dividing one number, called the percentage (for instance, the gross
profit), by another number, called the base (the net sales in the
foregoing statements). A change in a per cent can be caused by a
change in the percentage, a change in the base, or changes in both.
Therefore, changes in vertical analysis per cents have to be care-
420 ANALYSIS OF FINANCIAL STATEMENTS [Ch. 27
fully interpreted. For instance, the foregoing statement shows
that the per cent of administrative expenses increased from 6.21 %
to 7.52%; this might be thoughtlessly interpreted as indicating an
inconsequential increase; actually, the administrative expenses
increased about $25,000. This increase was nearly offset, per-
centage-wise, by the increase in net sales. The vertical analysis
per cents in the foregoing statement do not bring forcefully to the
attention of the management this really significant question: Was
the dollar increase in administrative expenses justified by the dollar
increase in sales? Unless administrative expenses should normally
increase in proportion to an increase in sales (an unusual situation),
the per cent of administrative expenses to sales should have
decreased in 1954.
Horizontal analysis. The determination of per cents of
increase and decrease, as shown in the following statement, is
sometimes called horizontal analysis, because the amounts used in
the computation are usually shown on the same line of a statement.
SPECIALTY PRODUCTS COMPANY
Comparative Statements of Profit and Loss
With Per Cents of Increase and Decrease
For the Years Ended December 31, 1954 and 1963
Increase-Decrease *
1954 1953 Amount Per Cent"
Gross sales $970,675 $786,500 $184, 175 23 42%
Returned sales and allowances . 21,045 29,650 8,605* 29 02*
Net sales . . $949 , 630 $756 , 850 $ 1 92 , 780 25 47
Cost of goods sold . 685,320 582,700 102,620 17.61
Gross profit on sales . $264^310 $174,150 $ 90,160 51 77
Expenses:
Selling expenses $145,980 $ 89,050 $ 56,930 63 93
Administrative expenses . 71,405 _ 47,010 21,395 51 89
Total .. ... $217,385 $136,060 $81,325 59.77
Net income from operations . $ 46,925 $ 38,090 $ 8,835 23 20
Income from securities 500 400 100 25 00
Net income before interest and federal in-
come tax $ 47,425 $ 38,490 $ 8,935 23.21
Interest . . 6,900 6,750 150 2.22
Net income before federal income tax.. . $ 40,525 $ 31 ,740 $ 8,785 27.68
Federal income tax . . ... 15,000 11,500 3,500 30 43
Net income ... . . $ J5,525 $ 20,240 $ 5,285 26. 11
The per cents shown in this statement seem to be more infor-
mative than the per cents of net sales shown in the statement on
page 418. They show a number of interesting changes:
Although the gross sales increased 23.42%, the returned sales
and allowances decreased 29.02%; as a result of both of
these changes, the net sales increased 25.47%.
Ch. 27]
ANALYSIS OF FINANCIAL STATEMENTS
421
Although the net sales increased 25.47%, the cost of goods sold
increased only 17.61%; as a result, the gross profit increased
51.77%. We cannot tell from the statement why the per
cent of increase in cost of goods sold was less than the per
cent of increase in sales; it was, of course, due to a change in
the relationship between unit selling prices and unit costs,
or a shift in sales from low-profit merchandise to high-profit
merchandise, or perhaps both.
Although the net sales increased 25.47%, the selling and admin-
istrative expenses increased 63.93% and 51.89%, respec-
tively; as a consequence, the 25.47% increase in net sales
was accompanied by an increase of only 23.20% in net
income from operations.
Computation of per cents of increase and decrease. Following
are illustrations of some problems which arise in the determination
of per cents of increase and decrease; the asterisks indicate entries
in red ink.
Cases in which them \\ere, positixe
amounts last year:
Statement item
Thib Year
$1 ,500 00
500 00 !
500 00*
1,500.00
500.00*
1 ,500 00*
500.00
Last Year
SI, 000 00
1 ,000 00
1,000.00
1 ,000 00
—
1 ,000 00*
1,000 00*
1,000 00*
I ncrease — Decrease *
Amount
Per Cent
* 500 00
500 00*
1 ,000 00*
1,500.00*
1,500 00
500 00*
500 00*
1,500 00
1,000 00
50 ro
50*
100*
150*
A
B
C
D
Cases in which
last year:
Statement
there were no amounts
item
K
F
Cases in which there were negative
amounts last year:
Statement item
G. ..
H.
I
The computations of the per cents for items A, B, C, and D
are obvious. No per cents can be computed for items E and F
because, in each instance, there is no last-year amount to serve as
a base ; and none can be computed for items G, H, and I because
the last-year amounts are negative.
422
ANALYSIS OF FINANCIAL STATEMENTS
[Ch. 27
Positive and negative (black and red) amounts sometimes
appear on the same line (as in item H) in comparative statements
which, for reasons of condensation, show only differences between
certain debit and credit balances. For instance, assume that a
complete profit and loss statement shows the following items:
Net income from operations
Add interest income
Net income from operations and other income. .
Deduct interest expense
Net income
This Year Last Year
$31,500 00 $29,860 00
3,700 00 3,000.00
$35,200 00 $32,800 00
2,950 00 3,900 00
$32,250 00 $28,960 00
A condensed statement might show the net amounts of interest
income and expense, thus:
This Year Last Year
Net income from operations $31 ,500 00 $29,860 00
Interest income (expense*) — net 750 00 900 00*
Net income. $32^250 00 $28,960 00
Comparison of more than two statements. If comparative state-
ments include data for more than two periods or as of more than
two dates, there are two available bases for computing amounts of
increases and decreases.
(1) Comparisons may be made with data for the immediately
preceding period or date, thus:
Sales
Year Ended December 31,
1954
1953
1952
$205,000
$180,000
$210,000
Increase — Decrease *
1954
1953
$257000"
1953
1952
$30,000*
(2) Or comparisons may be made with data for the earliest
date or period, thus:
Sales...
Year Ended December 31,
Increase — Decrease *
1954
1953
1952
1954
1952
1953
1952
$205,000
$180,000
$210,000
$5,000*
$30,000*
It might seem that the same two bases of comparison could
also be used to show per cents of increase and decrease. That is:
Ch. 27]
ANALYSIS OF FINANCIAL STATEMENTS
423
(1) The per cents might be based on data for the immediately
preceding date or period, thus:
Salon
Year Ended December 31,
Per Cent of
Increase — Decrease *
1954
1953
1952
1954
1953
1953
1952
$205,000
$180,000
$210,000
14%
14%*
(2) Or the per cents might be based on data for the earliest date
or period, thus:
Sales
Year Ended December 31,
1954
1953
1952
$205,000 $180,000 $210,000
Per Cent of
Increase — Decrease *
1954
1952
1953
1952
14%"
Per cents of increase and decrease based on the data for the
immediately preceding date or period are likely to be misleading.
For instance, the statement prepared by method 1 above shows
that the sales decreased 14% in 1953 and increased 14^ in 1954;
if one considered only the per cents, he might jump to the incorrect
conclusion that the increase in 1954 offset the decrease in 1953.
The method 2 statement shows that, although some of the 1953
decrease was recovered in 1954, the sales for 1954 were still 2%
below those for 1952.
The confusion which may result from the use of method 1
arises, of course, from the fact that the per cents were computed
on two bases: the per cent of decrease in 1953 was computed on a
base of $210,000, whereas the per cent of increase in 1954 was com-
puted on a base of $180,000.
Ratios expressed decimally. The relation of an amount for a
later date or period to an amount for an earlier date or period may
be expressed decimally, as shown in the comparative statements
on the next page. The ratios are computed by dividing the
amounts for the later period by the amounts for the earlier period.
Although such ratios are less commonly used than per cents
of increase and decrease, they have some advantages. In the
first place, per cents of decrease must be shown in red ink or in
some other manner to distinguish them from per cents of increase;
424 ANALYSIS OF FINANCIAL STATEMENTS [Ch. 27
this fact somewhat increases the work of preparing the statement
and may cause some confusion in interpreting it. In the second
place, it is probably difficult for many persons to grasp the signifi-
cance of large per cents, such as a 1,400% increase; it is much
easier to understand that one item is 15 times as large as another
item.
SPECIALTY PRODUCTS COMPANY
Comparative Profit and Loss Statement
For the Years Ended December 31, 1954 and 1963
Increase Ratio,
1954 1953 Decrease* 1954 to 1953
Gross sales $970 , 675 $786 ,500 $ 1 8 \ , 1 75 ~1 23
Returned sales and allowances 21,045 29,650 8,605* .71
Net sales ' $949,630 $756,850 $192,780 1 25
Cost of goods sold 685,320 582,700 102,620 1 18
Gross profit on sales $264,310 $174,150 $ 90,160 1 52
Expenses :
Selling expenses ... $145,980 $ 89,050 $ 56,930 1 64
Administrative expenses 71,405 47,010 24,395 1 52
Total . $2J7~,385 $136,060 $81 ,325 1 60
Net income from operations . $ 46,925 $ 38,090 $ 8,835 1 23
Income from securities ... . 500 400 100 1 25
Net income before interest and federal
1 23
1 02
1 28
1 30
^ 1 26
SPECIALTY PRODUCTS COMPANY
Comparative Schedules of Selling and Administrative Expenses
For the Years Ended December 31, 1964 and 1963
Amounts Hatio,
Increase 1954
1954 1953 Decrease* to 1953
Selling expenses:
Salesmen's salaries and payroll taxes ....$28,000 $17,355 $10,645 1.61
Salesmen's traveling expenses .... 27,610 17,690 9,920 1.56
Advertising 80 , 450 45 , 375 35 , 075 1.77
Freight out 7,865 6,350 1,515 124
Miscellaneous 2,0")5 2,280 225* .90
Total $145^980 $,89,050 $56,930 1.64
Administrative expenses:
income tax
Interest
Net income before federal income tax. ,
Federal income tax
Xet income ...
$ 47,425 $ 38,490 $ 8,935
6,900 6,750 150
. $ 40,525 $ 31,740 $ 8,785
15,000 11,500 3,500
, $ 25,525 $ 20,240 $ 5,285
Officers' salaries and payroll taxes
$ 26
,760
$13
,765
$12,995
1
94
Office salaries and payroll taxes
,865
,680
2,185
1
11
Stationery and supplies . .
1
1
,140
110
1
10
Postage, telephone, and telegraph
,535
1
,950
585
1
30
Depreciation of furniture and fixtures
Bad debts
15
900
,945
7
900
,050
8,895
1
2
00
26
Miscellaneous
1
,150
1
,525
375*
.75
$ 71
,405
$ 47
,010
$24,395
1
.52
Net sales
$949
,630
$756
,850
1
.25
Ch. 27] ANALYSIS OF FINANCIAL STATEMENTS 425
Working Capital
In the analysis of the statements of a business, great stress is
laid on the analysis of working capital. Some of the applicable
analytical procedures are discussed below.
Amount of working capital. The working capital of a business
is the excess of its current assets over its current liabilities. The
following schedule shows the working capital of Specialty Products
Company at two dates and the changes in the elements thereof in
the interval.
Schedule of Working Capital
December 31 , Increase
1954 _ 1953 Decrease*
Current assets:
Cash $ 25,905 $ 25,330 $ 575
Marketable securities 10,000 8,000 2,000
Accounts receivable 98,000 80,250 18,350
Reserve for bad debts 2 , 500* 2 , 000* 500*
Inventories:
Finished Roods . 38,685 33,500 5,185
Goods in process . 15 , 800 14 , 000 1 , 800
Raw materials . 25 , 940 22 ,865 3 , 075
Prepaid expenses 3,600 3,400 200
Total current assets (ti) $2167630 $185,345 $30,685
Current liabilities:
Accounts payable $ 18,225 $ 12,500 $ 5,725
Notes payable— Bank 40 , 000 25 , 000 1 5 , 000
Accrued taxes, wages, and other expenses ^^SO _ ? 10,950
_
Total current liabilities (I)) * 937475 JTriTTsOO $31,675
Working capital (a - b) S122T555 $[23,545 $ 990*
The working capital is an indication of the ability of a business
to pay its current liabilities as they mature. It is sometimes called
a measure of short-term solvency. The schedule shows that the
working capital decreased slightly, but not significantly, during
the year.
Working capital ratio. The working capital should be suffi-
cient to provide for the payment of current- liabilities as they
mature and for the financing of current operations. But the
amount of working capital is not an adequate measure of suffi-
ciency; this fact can be demonstrated by comparing the working
capital positions of two companies, as follows:
Company A Company B
Current assets... ............... $10,000 $100,000
Current liabilities ................. 5ji950 95,000
Working capital . ........... $ 's^OOO $ 5,000
Both companies have the same amount of working capital, but
their current positions differ radically. Any test of the adequacy
426 ANALYSIS OF FINANCIAL STATEMENTS [Ch. 27
of working capital must give consideration to the possibility of
shrinkages in the realizable values of the current assets; in the
event of forced liquidation, the inventory may have to be disposed
of at a loss, and in the event of a general business recession, it may
be difficult to dispose of the inventory and to collect the receiv-
ables. The current assets of Company A, even with a 50% shrink-
age, are sufficient to pay the current liabilities; Company B can
suffer only a 5% shrinkage.
For the reasons indicated above, it is important to know, not
only the amount of the working capital, but also the ratio of cur-
rent assets to current liabilities. These ratios, for Specialty Prod-
ucts Company, Are computed below:
Working Capital Ratio
December 31,
1054 1953
Total current assets (a) $216,030 $185,345
Total current liabilities .. . (b) 93,475 61,800
Working capital ratio — Dollars of current assets per
dollar of current liabilites (a -s- b) 231 3 00
Although the decrease in the amount of working capital did
not appear significant, the decrease in the ratio may be significant.
Window dressing. Since businessmen know that banks are
interested in the working capital ratio, they sometimes conduct
their affairs just prior to the statement date in such a manner as to
increase the working capital ratio. To illustrate, assume that
Specialty Products Company, late in December of each year, had
done three things :
(1) Sold the marketable securities at their carrying value and
applied the proceeds to the payment of the accounts
payable.
(2) Used $10,000 of cash to reduce the bank loans.
(3) Postponed $10,000 of raw material purchases on account
until the following January.
By these procedures, the current assets and current liabilities
were reduced by equal amounts, as follows:
December 31,
1954 1953
Reduction in current assets:
Sale of marketable securities for payment of accounts
payable $10,000 $ 8,000
Use of cash to reduce bank loans 10,000 10,000
Postponement of raw material purchases 10,000 10,000
Offsetting reduction in liabilities. . $30,000 $28,000
Ch. 27] ANALYSIS OF FINANCIAL STATEMENTS 427
The effect of the window dressing is shown below; observe that
the amounts of working capital are not affected, but that the work-
ing capital ratios are increased:
December 31,
1954 1953
Current assets.. $186,0308157,345
Current liabilities.. .... . . 63,475 33,800
Working capital $122,555 $123,545
Working capital ratio . 2 93~ 4 66
Instead of.. . . . 2 31 3.00
Effect of seasonal business. If business activities vary radically
during different seasons of the year, the working capital ratio is
likely to vary also. During a relatively active season, the inven-
tories, accounts receivable, and accounts payable are apt to be
large, and bank loans may be needed to finance the operations;
during a relatively slack season, the inventory may be reduced,
the accounts receivable should be relatively small, and there should
be a corresponding reduction in the accounts payable and any
bank loans. The amounts of working capital may be approximately
the same during both periods; but since, as we have seen, an equal
increase in current assets and current liabilities reduces the work-
ing capital ratio, the ratio is likely to be smaller during the rush
season than during the slack season. For this reason (and because
it is easier to take a small inventory during the slack season than a
large inventory during a busy season), many concerns close their
books and prepare statements at the close of the slack season,
which is known as the close of the natural business year.
Effect of good and bad times. Periods of boom and periods of
depression affect the working capital ratio in the same manner
that it is affected by seasonal activity. A boom period is a busy
period, and the working capital ratio tends to be relatively low; a
depression period, with slack business, tends to increase the ratio.
Therefore, an increase in the working capital ratio of a given busi-
ness is not necessarily a good sign; the increase may have been
caused by a slump in business.
Distribution and movement of current assets. For many years
the appraisal of the working capital position was pretty much
limited to a rule of thumb: a working capital ratio of 2 to 1 was
generally considered satisfactory. Reliance on this ratio as an
adequate measure of short-term credit standing is rapidly dis-
appearing. Analysts now recognize that the working capital ratio
alone is not sufficiently informative; information is also needed
with respect to the two matters mentioned on the following page.
428
ANALYSIS OF FINANCIAL STATEMENTS
[Ch. 27
The distribution of current assets — What kinds of current assets
does the business own?
The movement of current assets How rapidly are the current
assets converted from raw materials to finished goods to
accounts receivable to cash?
Distribution. Two computations which give consideration to
the distribution of current assets are discussed below, under the
captions :
Acid-test ratio.
Percentage distribution.
T
Acid-test ratio. In the computation of the acid-test ratio, a
distinction is made between quick current assets (cash, temporary
investments in marketable securities, and accounts and notes
receivable) and other current assets. The acid-test ratios for
Specialty Products Company are computed below. A ratio of at
least 1 to 1 is considered desirable.
Acid-Test Ratio
Quick current assets:
Cash
Marketable securities .
Accounts receivable — Less reserve for bad debts
Total quick current assets (a)
Current liabilities . (b)
Excess of quick current assets over current liabilities
Acid-test ratio — Dollars of quick current assets per
dollar of current liabilities (a -s- b)
December 31,
1954
25,905
10,000
90,100
1953
25,330
8,000
78,250
Increase
Decrease*
& 575
2,000
17,850
$132,005 $111,580 $20,425
93,475 01,800 31 ,075
$"38,530 $ 49,780 $11,250*
1 41
1.81
40*
Distribution of current assets. The acid-test ratio is sometimes
supplemented by a list of the current assets showing what per cent
each current asset is of the total. Such a statement for Specialty
Products Company appears below:
Distribution of Current Assets
December 31,
Cash
Marketable securities
Accounts receivable — Less reserve.
Finished goods
Goods in process
Raw materials
Prepaid expenses
1954
1953
Per Cent
Amount of Total
Per Cent
Amount of Total
$25,905 11.99%
10,000 4 63
96,100 41 48
38,685 17.91
15,800 7 31
25,940 12 01
3,600 1.67
$ 25,330 13 67%
8,000 4 32
78,250 42 22
33,500 18 07
14,000 7 55
22,865 12 34
3,400 1 83
$216,030 100.00% $185,345 100.00%
Ch. 27] ANALYSIS OF FINANCIAL STATEMENTS 429
This schedule shows that there have been no shifts of material
consequence in the percentage distribution of current assets. But
the per cents, like all vertical analysis per cents, must be carefully
interpreted to avoid unwarranted conclusions. The per cents
applicable to the inventories have all decreased, and the per cent
applicable to accounts receivable has increased. At first glance,
this may be interpreted as an improvement in distribution. But
we should remember that the change in a vertical-analysis per cent
applicable to an item is the result of the change in that item and
the change in the total of all items; and we should observe that
the amounts of the inventory items have increased although the
per cents have decreased, and that the total of the current assets
was affected by the increase in the accounts receivable — an
increase which may have been caused in part by a slowing up of
collections.
An increase in inventories may be good or bad. It is good if
the increased inventories are necessitated by an increase in sales
volume or if larger-thaii-normal purchases have been made in
advance of price rises; it is bad if the increase is not justified by
increased volume or if it is due to an accumulation of unsalable or
obsolete items.
Movement. In the following sections we shall consider tests
of the movement of accounts receivable, finished goods, and raw
materials.
Accounts receivable. The question with which we are concerned
here is: How rapidly are the accounts receivable collected, or how
old are the accounts?
The ideal source of information for the answer to this question
is found in an aging schedule of the accounts. Following is such a
schedule for Specialty Products Company:
Age of Accounts Receivable
December 31, 1954 December 31 , 1953
Per CVnt ~ Per (Vnt
Amount of Total Amount of Total
30 days or less $38,05900 386% $32,34075 403%
31 to 00 days 20,917 80 27 3 20,402 25 32 9
01 to 90 days 10,307 00 10.0 13,803 00 17 2
91 to 120 days 14,494 20 14.7 0,500 25 8 1
Over 120 days 2,700 80 2 8 1,203 75 1 5
$98,000.00 100 0% $80 ,250 00 100 0%
This schedule shows that the accounts on December 31, 1954
were relatively older than those on December 31, 1953.
The preparation of an aging schedule requires access to the
accounts. Outsiders, who do not have access to the accounts,
430 ANALYSIS OF FINANCIAL STATEMENTS [Ch. 27
sometimes compute the ratio of accounts receivable at the end of
the year to the net sales during the year. The following ratios
for Specialty Products Company show that a smaller per cent of
the year's sales remained uncollected at the end of 1954 than at the
end of 1953, but they give no indication of the relative ages of the
uncollected balances.
Per Cent of Year's Sales Uncollected
-H^LL - l^L
Accounts receivable at end of year . . . (a) $ 98,600 $ 80,250
Net sales for the year ..... . . . . (b) 949,030 750,850
Per cent of year's sales uncollected (a -4- b). . 10 38% 10 60%
r
Theoretically, the ratio should be computed by dividing the
accounts receivable by the charge sales, rather than by the aggre-
gate sales, for the period. Usually this information is not available
in published statements. The use of aggregate sales will still dis-
close trends, unless there is a shift in the relative amounts of
charge sales and cash sales.
Finished goods. The movement of finished goods is measured
by their turnover. The following computation for Specialty Prod-
ucts Company is illustrative of the procedure.
Finished Goods Turnovers
(Data Obtained from Exhibit B— Schedule 1)
1954
Cost of goods sold .............. (a) $685320 $5_82f700
Average finished goods inventory:
Inventory at beginning of year ............ $ 33,500 $ 29,(>00
Inventory at end of year ............... 38,685 33,500
Average inventory .............. (b) $ 3(5,093 $[31,550
Turnovers (a 4- b) ................... (c) ~18799 }S~47~
Average number of days per turnover (365 -s- c). 19 20
If there is a seasonal variation in inventories, a more accurate
turnover computation can be made by the use of the average of
the inventory at the beginning of the year and all month-end
inventories during the year.
A high turnover of finished goods is desirable because it
increases the liquidity of the inventory; moreover, given a certain
per cent of gross profit, the total amount of gross profit earned
during a year increases as the turnovers increase. However,
increasing the turnover by reducing the inventory may ultimately
have the disastrous effect of alienating customers who become dis-
satisfied with the assortment.
Raw materials. The movement of raw materials is measured
by their turnover, as is illustrated by the computation for Specialty
Products Company shown on the following page.
a. 27] ANALYSIS OF FINANCIAL STATEMENTS 431
Raw Materials Turnovers
(Data Obtained from Exhibit B— Schedule 1)
1954 1953
Haw materials used . (a) $234,075 $213,245
Average raw materials inventory:
Inventory at beginning of year $ 22,8(>5 $ 20,850
Inventory at end of year . 2,") ,940 22,865
Average inventory . (b) jfe 24,403 $ 21,858
Turnovers (a -f- b) . . . . . . (c) 9 59 9.76
Average number of days per turnover (365 -s- c) 38 37
What was said about the use of an average of monthly
inventories of finished goods if there are seasonal variations
in the inventories applies equally to the use of an average of
monthly inventories of raw materials in the raw material turnover
computations.
General Financial Condition
Some balance sheet analysis procedures in addition to those
concerned with working capital are discussed in following sections
of this chapter.
Ratio of worth to debt. The ratios of the net worth of Specialty
Products Company to its total liabilities at the two year-ends are
computed below:
Ratio of Worth to Debt
December 31,
1951 1953 "
Net worth (a ) $328 , 955 *27G , 430
Total liabilities (b ) 1 93 , 475 161 , 800
Ratio of \\orth to debt (a + b) 1 70 1 71
From the creditors' standpoint, a high ratio of worth to debt
is desirable; since, in the event of trouble, the stockholders stand
to lose their investment before the creditors suffer any loss, a high
ratio means a large capital cushion of protection to the creditors of
the business.
From the stockholders' standpoint, a high ratio may not be
desirable. To the extent that a company can obtain creditors'
funds at an interest cost lower in rate than the per cent of net
income on total assets, the stockholders benefit by an increased
rate of return on their investment.
While a low ratio of worth to debt may be advantageous to
stockholders from the standpoint of the rate of income on the
investment, too low a ratio is hazardous; in a period of business
recession, a shrinkage of assets and the pressure of creditors may
be disastrous.
432 ANALYSIS OF FINANCIAL STATEMENTS [Ch. 27
Analysis of equities. More detailed information about the
equities of various classes of creditors and stockholders is furnished
by a statement similar to the following:
Analysis of Equities
December 31, 1954 December 31, 1953
Per Cent Per Cent
Amount of Total Amount of Total
Current liabilities $ 93,475 T/ 89% $ 61 ,800 ~14 10%
Long-term liabilities 100,000 19. 14 100,000 22 82
Preferred stock ... 50 ,000 9 57 50 ,000 1 1 . 41
Common stock equity 278,955 53 40 226,430 51 67
$522,430 100 00% $438,230 1100 (HV%
The most significant trend disclosed by this statement is shown
by the ratios of current liabilities and common stock equity. The
common stock equity increased from 51.67% to 53.40%- an
increase of 1.73 percentage points. However, the current liabilities
increased from 14.10%, to 17.89% — an increase of 3.79 percentage
points. Thus, notwithstanding the issuance of common stock of
$50,000 par value during the year, the claims of current creditors
increased percentagewise as well as in amount.
Security for long-terrii debt. A ratio which once had more
significance than it has now is computed in the manner illustrated
below, using data of Specialty Products Company:
Ratio of Pledged Fixed Assets to Long -Term Debt
December 31,
1954 11)53
Pledged fixed assets — Book value:
Land. .. $40,000 K 40,000
Buildings 245,350 198,075
Reserve for depreciation . jil ,000* 57,700*
Total (a) »22TL350 $180,975
Long-term debt (b)
Ratio of pledged fixed assets to long-term debt
(a 4- b)
The change in the ratio shows an increased degree of protec-
tion, but the ratio has no positive significance because the security
is governed by market values rather than by book values.
Possible overinvestment in fixed assets. Investments in fixed
assets impose upon a business fixed charges such as depreciation,
insurance, and taxes. Although many expenses can be reduced
in a period of business depression, fixed charges often cannot be
reduced. Hence, the greater the amount of fixed expenses, the
greater the danger that a business may not be able to ride out a
business recession. This can be shown by an illustrative " break-
even point" computation. Assume the facts stated on the
following page.
Ch. 27] ANALYSIS OF FINANCIAL STATEMENTS 433
Company A Company B
Sales .. 8500,000 $500,000
Costs and expenses:
Fixed expenses:
Incident to ownership of fixed assets $60,000 $ 10,000
( )t her fixed expenses 20 , 000 20 , 000
Total . . * 80,000 $30,000
Variable costs and expenses (Assumed to vary
in direct proportion to sales):
Merchandise costs $350 , 000 $350 , 000
Other variable expenses 20,000 70,000
Total So7J),000 $420,000
Per cent of variable expenses to snles 74 ('t 84 r[
The sales points at which the companies will break even (have
neither a net income nor a net loss) are computed below; S repre-
sents the sales at the break-even point.
For Company A :
For Company B:
N = $80,000 + .748
.2(iN = $80,000
S = $307,602
tf = $30,000 + .84N
16S = $30,000
ft = $187,500
Company A, in order to avoid a net loss, must keep its sales up
to a level of $307,692. Company #'s sales can drop to $187,500
before it will incur a loss.
An overinvestment in fixed assets is also dangerous because, in
a period of depression, fixed assets are likely to become frozen
assets.
Obviously there can be no standard per cent or ratio to mark
the danger point in investments in fixed assets; the fixed asset
requirements of different businesses vary. Two ratios which indi-
cate trends are illustrated.
Ratio of worth to fixed assets. The computation of this ratio is
illustrated below:
Ratio of Worth to Fixed Assets
December 31,
~J954 1953
Net worth . . (a) $328,955 $276,430
Fixed assets (W 306 , 400 252 , 885
Ratio of worth to fixed assets (a -f- b) . . 1 07 I 09
Ratio of sales to fixed assets. Changes in the ratio of sales to
fixed assets are an indication (but not a conclusive one) of whether
sales are moving toward or away from the break-even point.
434 ANALYSIS OF FINANCIAL STATEMENTS [Ch. 27
Only a major decrease in the ratio would be a cause for immediate
concern.
Ratio of Sales to Fixed Assets
December 31,
1954 1953~
Net sales. . . .... (a) $949,630 $756,850
Fixed assets ... . . (b) 306,400 252,885
Ratio of sales to fixed assets (a 4- b) 3.10 2.99
Horizontal and vertical analysis of the balance sheet. The
comparative balance sheets on pages 43.5 and 436 illustrate the
application of both horizontal and vertical analysis.
The horizontal analysis shows increases and decreases in dollar
amounts, and the ratios of 1954 amounts to 1953 amounts. Sales
data are included so that the analyst can compare the sales ratio
with the ratios of changes in assets and liabilities. For instance,
with a sales ratio of 1.25, are a cash ratio of only 1.02 and a total
current liability ratio of 1.51 matters for concern?
The vertical analysis discloses much the same information.
Probably the most significant change disclosed is the increase in
current liabilities from 14.10% to 17.89% of the balance sheet
totals.
Conclusion
Several words of caution need to be expressed before closing
the discussion of statement analysis:
(1) Avoid meaningless ratios. With the increasing interest
in statement analysis during recent years, there has been a tend-
ency to develop a multiplicity of ratios, some of which have little
or no significance. If two dollar amounts have little or no signifi-
cance in relation to each other, a ratio expression of their relation
is no more significant. For instance, it is claimed by some that
the ratio of current assets to long-term debt is meaningful, but it
is difficult to see any reason for regarding it as significant.
(2) Avoid ratios which may be misinterpreted. The turnover
of working capital, often regarded as a very significant ratio, is a
good example. It is computed by dividing the net sales by the
working capital; an increase in the ratio is usually interpreted as
desirable. But an increase in turnover may be caused by either
an increase in the sales or a decrease in the working capital. An
increase in working capital turnover caused by a decrease in work-
ing capital may be an undesirable trend.
(3) Appraise related ratios. For instance, the comparative
balance sheet on page 435 shows that, with a 25% increase in sales,
the accounts receivable increased 23%. Instead of jumping to the
conclusion that the receivables have the same collectibility at the
Ck. 27]
ANALYSIS OF FINANCIAL STATEMENTS
435
OT-H
05
CO
rH
Oi
ss
IS
8
3
00
COCO
co~co~
CO
O 10
)O5
CM
CO
CO
8*O
t>
oor
O5 t
!3
iC CO(
C5 I^C
00 ^H
«"
^«
436
ANALYSIS OF FINANCIAL STATEMENTS
[Ch. 27
g
o
o
CO
H
gs
II
II
O ^ iO
•-s Ss
O> QS rH
a
§
&
•3
!S
II
0) *"*
1s"
I
» s
.fc <J
•s«
530
I
<S
<N »0 10
CO I- «
2 S
3 2
l~ OS
3 8 '
s
§
t^. o -i*
iO 00 »O
35 I- >0
O Oi
<N
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S
i
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a*
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cd .
§
5
2-*-» 'S <^H C 'C O2
TH S aJ H a> 4-
O O • FH £ o c C
rcs
Ch. 27] ANALYSIS OF FINANCIAL STATEMENTS 437
end of 1954 as they had at the end of 1953, observe that the sched-
ule of administrative expenses (page 419) shows that bad debt
charges in 1954 were 1.68% of net sales in 1954 as compared with
.93% in 1953. This suggests a greater degree of possible loss in
the receivables at the end of 1954 than in the receivables at the
end of 1953. Then observe that, although the bad debt losses
doubled in 1954 ($15,945 compared with $7,050), the reserve for
bad debts has not been increased proportionately. Then consider
the possibility that an additional loss provision should have been
made in 1954, and note the effect of such an additional provision
on the net income for 1954.
(4) Be aware that undesirable business operations or condi-
tions may account for apparently favorable ratios, and vice versa.
For instance, it was pointed out earlier in the chapter that a higher
working capital ratio is more likely to exist in a period of poor
business than in a period of good business.
(5) Be aware that facts not disclosed by the statements might
affect the interpretation placed on the statements. For instance,
assume that the management informed you that the large bad debt
charge in 1954 was principally the result of the bankruptcy of one
customer; the line of reasoning in (3) above would be affected.
(6) Bear constantly in mind the fact that changes in vertical-
analysis per cents are affected by changes in the items being
measured and changes in the base- -for instance, changes in
expense items and a change in net sales. Changes in vertical-
analysis per cents cannot safely be interpreted without a constant
awareness of this fact.
(7) Remember, also, that horizontal-analysis per cents and
ratios must often be interpreted in the light of supplementary
information. For instance, if net sales increased 25^ , it does not
necessarily follow that any expense increases of 25 °c or less are
satisfactory. The propriety of that conclusion depends on whether
the expense is relatively fixed or relatively variable.
(8) Weigh the results of the analysis of a given business against
the trends in the industry and in business in general. It may be
that, although conditions in the specific business have worsened,
they are better than the average.
(9) Give consideration to changes in price levels and in the
purchasing power of the dollar. For instance, if sales have been
uniform for two years and there has been no change in the dollar
amount of the inventory, but there has been a 25% increase in
unit purchase costs, a 20% decrease in inventory quantities is
indicated. But before accepting such a conclusion, find out
whether the business uses fifo or lifo.
CHAPTER 28
Manufacturing Cost Controls
Perpetual Inventories
Under the method of accounting for manufacturing concerns
described in Chapter 13, it is necessary to take physical inventories
before the statements can be prepared. Because of the labor
involved in taking these physical inventories, it may be impracti-
cable, under this method, to prepare statements more frequently
than once a year. The following pages contain a description of
methods of keeping perpetual inventories of raw materials, goods
in process, and finished goods, and the related controlling accounts.
RAW MATERIALS
Materials purchased. Let us assume that a company, at the
beginning of its operations, purchased the following materials: 500
units of Material A at $4 per unit, and 1,500 units of Material B
at $2 per unit.
Material A
Dafp
Quantity
Price
Cost
In
Out
Balance
In
Out
Balance
19—
Feb.
— '
3
X
500
500
_^*~^
4
^N
00
2,000
00
^-
•»»»•
2,000
00
^
Material B
Date
Quantity
PnVpk
Cost
In
Out
Balance
JTriCC
In
Out
Balance
19—
Jet.
^
3
*x
1,500
1,500
^— — *
2
L"-~^
00
•• *•
3,000
'
00
^^
s^
3,000
^^.
00
•»•.
^•^ 1
Ch. 28]
MANUFACTURING COST CONTROLS
439
The perpetual inventory of raw materials will contain a page or
a card for each kind of material. After the invoice has been
recorded in the voucher register, it may be used by the perpetual
inventory clerk to make entries on the cards as shown on page 438.
Materials used. Materials should not be taken from the store-
room for use in the factory without a written order, called a requisi-
tion, approved by some person in authority. Let us assume that
the two following material requisitions were issued in February:
Material Requisition M^ i
For Prodiirt.irm Dr<W Nr> * .„_ Date 2/5/19 --
Material
Number of Units
Cost per Unit
Amount
A
B
200
700
4
2
00
00
800
1,400
00
00
2,200
00
Approved Q. If 7.
e
Material Requisition
Mo 2
For Production Order No 2
nate 2/16/19-
Material
Number of Units
Cost per Unit
Amount
A
B
150
100
4
2
00
00
600
200
00
00
800
00
Approved (7 If}.
0
The unit costs and the extended amounts were entered on the
requisitions by the perpetual inventory clerk.
The material items shown by these requisitions were entered by
the inventory clerk in the Out columns of the raw materials perpet-
ual inventory records, and the balances were computed and
entered on the cards by the perpetual inventory clerk, as shown
on page 440.
440
MANUFACTURING COST CONTROLS
[Ch. 28
Material A
Date
Quantity
Price
Cost
In
Out
Balance
In
Out
Balance
19--
Feb.
3
500
500
4
00
2,000
00
2,000
00
5
200
300
800
00
1,200
00
-^ — '
16
^
-*-•*
150
4 -J
150
-*^
^\
600
^^
00
600
^
00
^
Material _5_
r^of A
Quantity
Prirp
Cost
uaie
In
Out
Balance
In
Out
Balance
19--
Feb.
3
1,500
1,500
2
00
3,000
00
3,000
00
5
700
600
1,400
00
1,600
00
k.
16
100
700
^_ -
200
00
1,400
00
GOODS IN PROCESS
Production orders. The perpetual inventory of goods in proc-
ess is kept on sheets called production orders. A production order
is kept for each job or kind of product going through the factory.
Let us assume that the company worked on two products dur-
ing February: Product X and Product F. Product X was started
first, and is represented by production order 1 ; Product Y is repre-
sented by production order 2. The method of recording the mate-
rial, labor, and overhead costs on these production orders is
explained in the following paragraphs.
Raw materials. The cost of materials used is shown by the
material requisitions. Copies of the requisitions are given to cost
clerks for entry on the production orders.
Requisition Number 1 (page 439) shows that materials costing
$2,200 were taken from stock on February 5, for use on
production order 1. This amount was entered in the Raw
Materials column of production order 1 (page 441).
Requisition Number 2 shows that materials costing $800 were
taken from stock on February 16, for use on production order
2. See entry on production order 2.
Ch. 28]
MANUFACTURING COST CONTROLS
441
PrnHijot-ion Order ^
pnr 800 Product X
Dale Coir
ipletoH
Date
Raw Materials
Direct Labor
Overhead
19 —
Feb.
*
5
**"*- -
2,200
00
•*• ~
1 — ^
^--— ^
Production Order 2
por 200 Product Y
Date Corr
ipleted
Date
Raw Materials
Direct Labor
Overhead
19 —
Feb.
^- *.
Id
L- — _
800
00
^>
^ -~
^— — ^
Direct labor. Each factory workman keeps a record of the time
spent on each production order, by punching time cards. He uses
a separate card each day for each production order on which he is
engaged. When the card is turned in at the office, it shows the
workman's number, the production order number, and the time
worked. Clerks compute the elapsed time, enter the hourly wage
rate, and compute the total labor cost. Following are two cards
turned in by one workman.
Date
Employee's Number
Hour In
Hour Out
Elapsed Time
Hourly Rate
Amount
Production Order
FEB20
Date
Employee's Number
Hour In
Hour Out
Elapsed Time
Hourly Rate
Amount
Production Order
FEB20
zi
2.1
BBS
\ 00
400
3iOO
12°°
U: oo
#2.25
#2.25
#9.0O
#6.7S
, 1
SL
442
MANUFACTURING COST CONTROLS
[Ch. 28
These cards are used in making up the payroll. The cards are
then sorted according to the production order numbers, and a
summary is prepared showing the total direct labor cost applicable
to each production order. The summary shows the direct labor
cost incurred during February on each production order.
Production Order Direct Labor Cost Summary
Production Order
r
Payroll Periods
Feb. 1
to 15
Feb. 16
to 28
I
2
1,000
00
200
800
00
00
1,000
00
1,000
00
The direct labor costs shown by the labor cost summary were
entered on the two production orders as shown below:
Production Order
For
800 Product X
Date Completed .
Date
Raw Materials
Direct Labor
Overhead
19-
Feb.
5
15
28
2,200
00
1,000
200
00
00
For.
200 Product Y
Production
Date
Date
Raw Materials
Direct Labor
Overhead
19--
Feb.
16
28
800
00
800
00
Ch. 28]
MANUFACTURING COST CONTROLS
443
Production order 1 was charged with $1,000 and $200 of direct
labor.
Production order 2 was charged with $800 of direct labor.
Manufacturing expense, or overhead. The material and labor
costs applicable to each production order can be definitely deter-
mined by the methods just explained. Overhead expenses must
be estimated. This may be done as follows: If, in the past, the
annual manufacturing expense has been about 50% of the annual
direct labor cost, it may be assumed (unless conditions indicate
otherwise) that this ratio will continue. Therefore, when the
labor cost is entered on the production orders, the manufacturing
expense may be estimated as 50% of the labor cost.
It is assumed that 50% is a fair overhead rate for the concern
under illustration. Therefore, the cost clerk, after entering the
direct labor cost on the production orders, enters overhead charges
equal to 50% of the direct labor costs, as shown below:
Production Order •*•
pnr 800 Product X
Date Con
ipleted
Date
Raw Materials
Direct Labor
Overhead
19 —
Feb.
5
15
28
2,200
00
1,000
200
00
00
. '— . •—*
500
100
^_ .
00
00
--^__ '
Production Order.
For
200 Product Y
Date Completed .
Date
19--
Feb.
16
28
Raw Materials
800
00
Direct Labor
800
00
Overhead
400
00
Product X has been completed, and the production order is
removed from the work in process binder. Product Y is still in
MANUFACTURING COST CONTROLS
[Ch. 28
process at the end of February; production order 2 shows the total
cost of work in process — $2,000.
FINISHED GOODS
Completed production orders. After Product X (see produc-
tion order 1) was completed, the production order was sum-
marized to determine the total cost and the unit cost, as shown
below:
Production Order ^
por 800 Product X
Date Cc
3mplGtecl 2/20
Date
Raw Materials
Direct Labor
Overhead
19 —
Feb.
5
2,200
00
15
1,000
00
500
00
28
200
00
100
00
Total
2,200
00
1,200
00
600
00
Summary :
Material
2,200
00
Direct Labor
1,200
00
Overhead
Total
f'OU
00
4,000
00
Unit cost (Quantity produce
rf 800 ,
I
f)
00
This production order furnishes the information for the follow-
ing entry on the perpetual inventory card for Product X:
Product X
Date
Quantity
Unit
Cost
In
Out
Balance
Cost
In
Out
Balance
19--
Feb.
-^- —
20
k^
800
•»._
800
5
00
4,000
00
.,
•*••• ^
4,000
»»i
00
Ch. 28]
MANUFACTURING COST CONTROLS
445
Finished goods sold. On February 27, a sale of 500 units of
Product X was made. The carbon copy of the invoice is provided
with a Cost column at the right of the Amount (selling price)
column. The carbon copy is sent to the inventory clerk, who per-
forms the following operations:
(1) Looks up the unit price on the finished goods inventory card.
(2) Computes the total cost of the goods sold and enters this cost
in the Cost column of the carbon copy of the invoice,
thus:
(Heading of the Invoice)
Number
Description
Unit Price
Amount
Cost
500
*-^ '
Article X
^_
7
00
-•" .»
3,500
•^
00
2,500
00
(3) Makes entries in the Out columns of the inventory card,
showing the number and the cost of the articles sold, and
computes the new quantity and cost balances. (See
below.)
(4) Sends the carbon copy of the invoice bark to the office for
entry in the sales book.
The inventory card for Product X now appears as follows:
Product _JL_
Date
Quantity
Unit
Cost
Cost
In
Out
Balance
In
Out
Balance
19--
Feb.
20
800
800
5
00
4,000
00
1 , 000
OL
^-^_
27
^v.
— —
500
— ^
300
^-
.
, •**
* — ^
- *^
8,500
_— ^
00
1.5CD
— -~~_
oc
>-— _ «
Since Product X is the only article of finished goods on hand,
this one card shows the total cost of the finished goods inventory at
the end of February $1,500.
Inventory Controlling Accounts
The raw material inventory cards show the units and costs of
raw materials on hand ; the production orders show the units and
446 MANUFACTURING COST CONTROLS [Ch. 28
accumulated costs of goods in process ; the finished goods inventory
cards show the units and costs of finished goods on hand.
In a large business there may be thousands of these inventory
cards and production orders, and the preparation of monthly state-
ments will be greatly facilitated if the following controlling accounts
are kept in the general ledger:
Raw Materials with a balance equal to the sum of all the bal-
ances on the raw material inventory cards.
Goods in Process with a balance equal to the sum of all the bal-
ances on the production orders for goods
r still in process.
Finished Goods with a balance equal to the sum of all the bal-
ances on the finished goods inventory
cards.
Such controlling accounts not only facilitate the preparation of
the monthly profit and loss statements and balance sheets but also
serve as checks upon the accuracy of the subsidiary perpetual
inventory records of raw materials, goods in process, and finished
goods.
We shall now see how such accounts can be produced. For
purposes of illustration, we shall begin with expenditures for mate-
rial, labor, and overhead, and trace the flow of these costs through
goods in process into finished goods. The illustration will be based
on the same assumed facts as those used on the preceding pages in
illustrating the perpetual inventory records.
Material, labor, and overhead accounts. Assume that the
expenditures during February for material, labor, and manufactur-
ing expenses were:
(a) Raw materials . . . $5,000 00
(b) Direct labor . . 2,00000
(c) Manufacturing expenses:
Indirect labor . . . . $500 00
Factory supplies. 300 00
Power . 22(^00 1 ,020 00
These expenditures are recorded exactly as they were under the
method of accounting described in Chapter 13, with one exception:
one Raw Materials account is used instead of a Raw Materials
Purchases account and a Raw Materials Inventory account. The
accounts showing charges for these costs appear below :
Manufacturing Expense
Raw Materials Direct Labor (Control)
(a)Cost 5,000
(b)Paid 2,000
(c) 1,020
Ch. 28]
MANUFACTURING COST CONTROLS
447
Raw materials used. The raw materials taken from stock for
use in the factory are shown by the material requisitions. (See
illustrative requisitions on page 439.) These requisitions should be
listed in a requisition register, as follows:
Requisition Register
Date
Requisition
No.
Amount
19--
Feb.
5
1
2,200
00
16
2
800
00
^**~~~ ' ~ "*-**-•• — ~
3,000
00
' • — .
^-*— •
The requisition register is footed at the end of the month, and
the following journal entry is made:
(d) Goods in process
Raw materials
To transfer the cost of raw materials used
during the month out of the Raw Materials
account and into Goods in Process
3,000 00
3,000 00
Direct labor spent on goods in process. The production order
direct labor cost summary (see page 442) shows the amount of
direct labor charged to each production order. The totals of the
summary show that $2,000 of direct labor was charged to the pro-
duction orders during the month. Therefore, at the end of the
month, the following journal entry is made transferring the labor
cost shown by the summary into the Goods in Process account:
(e) Goods in process .
Direct labor
To charge Goods in Process with the total
direct labor cost entered on the production
orders.
2,000 00
2,000.00
Manufacturing expenses charged to goods in process. This
company is using an overhead rate of 50%; that is, the estimated
overhead charged to each production order is 50% of the direct
labor. Since $2,000 of direct labor was charged to the production
orders, the total overhead charge was $1,000. This amount is
charged into Goods in Process by the following journal entry:
(f) Goods in process ... ..
Manufacturing expense applied
To charge Goods in Process with the total over-
head applied to the production orders.
1,000 00
1,000.00
448
MANUFACTURING COST CONTROLS
[Ch. 28
Ledger accounts after transfer of costs into goods in process.
After the material, labor, and applied overhead costs for the month
are charged to the Goods in Process account, the accounts affected
contain the following amounts:
Raw Materials
Direct Labor
Manufacturing Expense
(Control)
(a)CoHt 5,000|(d) Used 3,000 (h)Paid 2,000
(o) Used 2,000 (c)
1,020
Manufacturing
Expense Applied
(f)
1,000
Goods in Process
(d) Raw materials 3 , 000 . 00
(e) Direct labor.. 2,000.00
(f) Manufacturing expense 1 ,000 00
The Raw Materials account has a debit balance of $2,000,
representing the cost of all raw materials on hand at the end of
February. The costs of the individual items of raw material are
shown by the perpetual inventory cards (see page 440) : Material A ,
$600; Material B, $1,400.
The Direct Labor account has no balance. All of the direct
labor has been applied to the cost of goods in process.
The Manufacturing Expense account ha* a debit balance of
$1,020; the Manufacturing Expense Applied account has a credit
balance of $1,000. Twenty dollars of expense has not been applied
because of a slight error in the estimated burden rate of 50 c'<.
Methods of disposing of this $20 are discussed on page 455.
The Goods in Process account (produced by posting the three
journal entries illustrated) shows the total material, labor, and
overhead charged to production during the month.
Cost of goods finished. When goods are finished, the produc-
tion order is summarized (see production order No. 1, page 444)
and taken from the goods in process binder. The total cost is
entered in a register of completed production orders, thus :
Register of Completed Production Orders
Date
Production
Order Number
Total Cost
19—
Feb.
^~~^
20
• ii •*
1
— •*— - — ' — —
4,000
*• — -^
00
Ch. 28]
MANUFACTURING COST CONTROLS
449
At the end of the month, the register is totaled, and the cost of
goods finished during the month is transferred out of Goods in
Process into Finished Goods by the following journal entry:
(g) Finished goods
Goods in process .
Total cost of goods completed during the
month.
4,000 00
4,000.00
After this entry is posted, the two accounts affected contain the
following amounts:
Goods in Process
(d) Raw materials .
(e) Direct labor
(f ) Manufacturing expense
3,000.00
2,000 00
1 ,000 00
(g) Finished goods
4,000 00
Finished Goods
Manufactured
4,000 00
The Goods in Process account has a debit balance of $2,000,
representing the cost of goods in process at the end of February.
Details are shown on production order 2, which is the only order in
process at the end of the month.
Cost of goods sold. As shown on page 445, the carbon copies
of the invoices are provided with a column in which a clerk enters
the cost of the goods sold. Invoices are recorded in the manner
shown in the following sales book:
Sales Book
Date
Name
Invoice
Number
Selling
Price
Cost
19--
Feb.
2V
Henderson & Riley
^~~~ " -^.
1
5,500
00
2,500 00
i
At the end of the month the two columns are totaled, and the
totals are posted as follows:
Total of Soiling Price column :
(h) Debit Accounts Receivable controlling account
Credit Sales
Total of Cost column:
(i) Debit Cost of Sales
Credit Finished Goods
450 MANUFACTURING COST CONTROLS [Ch. 28
The accounts affected (except Accounts Receivable) will con-
tain the following amounts :
Finished Goods
(g) Manufactured 4,000 00
(i) Sold 2,500 00
The debit balance of this account shows the cost of finished
goods still on hand. Details are shown on the finished goods per-
petual inventory cards.
Sales
|(h) 3,500 00
Cost of Sales
(i) . ... 2,500 001
The difference between the debit balance in the Cost of Sales
account and the credit balance in the Sales account is the gross
profit for the month. Thus, the gross profit on sales can be deter-
mined from the books, without taking physical inventories.
Freight In, Discount on Purchases, and Returned Purchases
and Allowances
For purposes of simplicity, no consideration has been given in
the preceding pages to the problems of accounting for freight in,
purchase discounts, and returned purchases and allowances in the
raw materials perpetual inventory and controlling account. These
matters will now be considered.
Freight in. Since freight in is part of the cost of raw materials
purchased, the freight cost should be charged to the Raw Materials
controlling account and included in the cost entered on the inven-
tory card. Also, the unit costs entered in the Price column of
the raw material perpetual inventory cards should include the
freight element. Assume, for instance, that the freight on
Material A (see page 438) was $50; the unit cost would be com-
puted as follows:
$2,000 (purchase cost) + $50 (freight) -= $2,050 (total cost)
$2,050 -h 500 (units purchased) - $4.10 (unit cost)
Purchase discounts. Cash discounts on purchases may or
may not be reflected in the raw materials perpetual inventory and
controlling account, depending on the general accounting policy
adopted. Three policies are considered on the opposite page.
Ch. 28] MANUFACTURING COST CONTROLS 451
(1) Discounts taken may be shown in the profit and loss
statement as income. If this procedure is followed,
cash discounts do not affect the raw material perpetual
inventory records or the Raw Materials controlling
account.
(2) Discounts taken may be regarded as a deduction from the
gross costs of raw materials. If this procedure is fol-
lowed, cash discounts taken are credited to the Raw
Materials controlling account. But an awkward situa-
tion arises in connection with the perpetual inventory
records. Since, at the time of the purchase, it presum-
ably is not known whether the discount will be taken,
the purchase will be entered at the gross amount and
the unit cost will be computed at the gross amount.
Later, if the discount is taken, the unit cost and the
amount in the Cost Balance column will have to be
adjusted. The necessity for these adjustments may
make this accounting procedure impracticable if per-
petual inventories are maintained.
(3) Discounts available are regarded as a cost deduction; the
net price is debited to the Raw Materials controlling
account and entered on the perpetual inventory card,
and the unit cost is computed on the basis of the net
price. (This is the procedure discussed in Chapter 20.)
To illustrate the computation of the net unit cost, assume
that Commodity B was purchased subject to a 2% cash
discount; then,
98% of $3,000 (gross price) = $2,940 (net price)
$2,940 -J- 1,500 (units purchased) = $1.96 (unit cost)
To avoid the necessity of making adjustments for dis-
counts lost, such discounts should not be debited to the
Raw Materials controlling account (as a cost correction)
but should be debited to Discounts Lost, which should
be shown in the profit and loss statement as an expense.
Returned purchases and allowances* Returns and allow-
ances should be credited to the Raw Materials controlling account.
The entry in the perpetual inventory record is a simple matter if
the transaction is a return of materials; it is recorded in the Out
columns, and new quantity and cost balances are computed; the
unit cost is not affected. If the credit is for an allowance, it is
recorded in the Out column of the Cost section of the inventory
card, and an adjusted unit cost and cost balance are entered on the
card.
452
MANUFACTURING COST CONTROLS
[Ch. 28
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MANUFACTURING COST CONTROLS
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MANUFACTURING COST CONTROLS
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Ch. 28] MANUFACTURING COST CONTROLS 455
Underabsorbed and Overabsorbed Burden
To illustrate the various methods of dealing with underabsorbed
and overabsorbed manufacturing expense, let us assume that the
manufacturing expense accounts at the end of the year have the
following balances:
Manufacturing expense (control) . SI 1 ,000 00
Manufacturing expense applied . . $10,50000
The actual expenses were $11,000; the amount applied to the
production orders was only $10,500.
The $500 balance of unabsorbed burden may be treated in two
ways, as follows:
(1) Theoretically, it should be apportioned to finished goods
manufactured and sold during the period, finished goods
on hand, and goods in process, by a journal entry similar
to the following:
Cost of sales 425 00
Finished goods ... . . f»0 00
(Joods in process ... . . 15 00
Manufacturing expense applied 500 00
(2) If the greater portion of the finished goods manufactured
has been sold, it is reasonably correct to charge the entire
unabsorbed burden to Cost of Sales, as follows:
Cost of sales . . 500 00
Manufacturing expense applied . 500 00
Adjustments for overabsorbed burden may be made similarly;
that is, (1) by credits to Cost of Sales, Finished Goods, and Goods
in Process ; (2) by credit to Cost of Sales.
After one of the foregoing entries has been made at the end of
the year to bring the credit balance of the Manufacturing Expense
Applied account into agreement with the balance in the Manu-
facturing Expense control account, these accounts are closed by an
entry similar to the following:
Manufacturing expense applied . . 11,00000
Manufacturing expense 1 1 ,000 00
To close the manufacturing expense accounts
The two entries may be combined, thus:
Cost of sales ,500 00
Manufacturing expense applied . .. 10,50000
Manufacturing expense . . 11,00000
To close the manufacturing expense accounts
and assign the unapplied expense to cost of
sales
456 MANUFACTURING COST CONTROLS [Ch. 28
Working Papers
Adjustments for accrued and deferred items are made in the
working papers on page 457 in the manner with which you are
already familiar. (See entry a.) The Adjustments columns also
contain the debits and credits of the entries:
(h) Applying the unahsorbed manufacturing expense against
the cost of sales.
(c) Closing the Manufacturing Expense account against the
Manufacturing Expense Applied account.
, Closing the Books
The procedure of closing the books at the end of the period is
illustrated below:
The adjusting and closing entries follow:
(1) Make adjustments for any deferred and accrued items.
Salesmen's salaries in the amount of $200 are accrued and unpaid
at the end of the year.
Selling expense 200 00
Accrued salaries payable 200 00
To set up accrual
(2) Write off the unabsorbed manufacturing expense. For
purposes of illustration we shall write off the entire
unabsorbed manufacturing expense to Cost of Sales.
Cost of sales 1 ,000 00
Manufacturing expanse applied. . . 1 ,000 00
To apply the unabsorbed manufacturing expense to
cost of goods sold
Close the Manufacturing Expense account and Manufacturing
Expense Applied account.
Manufacturing expense applied 11,000 00
Manufacturing expense ... 1-4,000.00
To close
(3) Make the general closing entries:
Sales ... . . .. 100,000 00
Profit and loss . . 100,00000
To close the Sales account.
Profit and loss 93,200 00
Cost of sales 76 , 000 . 00
Selling expense 12,200 00
General expense 5,000 00
To close debit-balance accounts.
Profit and loss 6 ,800 00
Earned surplus (5 ,800 00
To transfer the net income to Earned Surplus.
Ch. 28]
MANUFACTURING COST CONTROLS
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458 MANUFACTURING COST CONTROLS [Ch. 28
Statements
The following statement of profit and loss, statement of earned
surplus, and balance sheet were prepared from the working papers.
THE X Y Z COMPANY Exhibit C
Statement of Profit and Loss
For the Year Ended December 31, 19—
Sales . $100,000 00
Cost of goods sold . . 7(5 , 000 00
Gross profit on sales $ 24 ,000.00
Deduct expenses:
Selling . $12,200.00
General * . . 5,000 00 17,200 00
Net income $ 6,80000
THE X Y Z COMPANY Kxhihit B
Statement of Earned Surplus
For the Year Ended December 31, 19—
Balance, December 31 , 19— $43 ,500 00
Net income, per Exhibit C. . . 0,800 00
Balance, December 31, 19— . $50,300 00
THE X Y Z COMPANY Kxhibit A
Balance Sheet
December 31, 19-
Assets Liabilities and Net Worth
Cash $ 75 , 000 . 00 Vouchers payable $ 6 , 000 00
Accounts receivable 10,000.00 Accrued salaries pay able 20000
Finished goods . 15,000.00 Capital stock . 50,00000
Goods in process 1 ,500 00 Karned surplus, per Kxhibit
Raw materials .... 5,000 00 B 50,300 00
$106,500.00 $106,500 00
APPENDIX 1
Matters Related to Payrolls
Federal old age benefits taxes. The Social Security Act of
1935, as amended, provides for federal government disbursements
called, variously "old age benefits/' "old age and survivors' bene-
fits," "old age insurance," and "old age annuities." These pay-
ments include monthly benefits to workers who retire at age sixty-
five, supplementary benefits to their wives and dependent chil-
dren, benefits for survivors of wage earners who die, and lump-sum
payments in some cases.
The funds required for these disbursements are obtained from
taxes (generally called "O. A. B. taxes") levied under the Federal
Insurance Contributions Act on employers and employees, in
amounts based on wage payments for services performed in the
United States, Alaska, and Hawaii, and on American vessels.
Certain services are excepted. Payments made to an independent
contractor for services performed are not wages.
The taxes levied on employees are withheld by the employers
from wage payments; these tax withholding**, as well as the taxes
levied on the employers, are remitted by the employers to the
Director of Internal Revenue for the district in which the principal
place of business of the employer is located. At the time of this
writing, the rate is 1|%, to increase to 2% in 1954, to 2J % in 1960,
to 3% in 1965, and to 3J% in 1970. Because of possible revisions
in the law, you should ascertain the rate currently in effect.
The tax is not levied on wages in excess of $3,600.00 paid to a
worker by one employer during a calendar year. However, if an
individual works for two or more employers during a calendar year,
each emplojrer is required to pay the tax on his wage payments
to the employee up to $3,600, and to make similar deductions from
the employee's wages. The employee can obtain a refund from
the government for deducted taxes on his aggregate wages for the
year in excess of $3,600; the employers cannot obtain a refund.
Each employer must apply to the Social Security Administra-
tion for an "identification number," to be shown on his tax return.
Each worker must apply to the Administration for an "account
number" — often referred to as his social security number; the
employer must be informed of the account number of each of his
employees, for use in his records and reports.
459
460 APPENDIX 1
The law specifies that every employer withholding taxes must
furnish the employee with an annual statement on or before Janu-
ary 31 of the succeeding year which shows the total social security
tax withheld.
If employment is terminated, the employer must give a final
statement to the employee on the date of the final wage payment.
Many employers find it convenient to report the tax deduction at
the time of making each wage payment; methods of making such
reports to employees are illustrated on pages 468 and 470.
The employer is required to maintain records which show, as to
each employee, his name, address, and social security number; the
total compensation due him at each pay date; any portion thereof
not subject to tax; the period covered by the payment; and the
amount of old age benefit insurance tax deducted. The employer
must also keep copies of all returns and reports filed by him with
government authorities.
Self-employed persons. Self-employed persons other than
farmers and certain professional groups became covered by the old
age and survivors' insurance program on and after January 1, 1951.
The tax on self-employffient income is handled in all particulars as
an integral part of the federal income tax.
Federal unemployment insurance taxes. Taxes are levied
against employers (but not against employees) under the Federal
Unemployment Tax Act to obtain funds required to meet the pro-
visions of the Social Security Act relative to unemployment insur-
ance, sometimes called unemployment compensation. Unemploy-
ment compensation payments are not made by the federal govern-
ment directly to unemployed persons; the funds obtained by the
collection of federal unemployment insurance taxes are used to
make grants to the various states to assist them in carrying out
their own unemployment compensation programs. Laws provid-
ing for unemployment compensation payments have been enacted
by all the states and territories.
Unlike the federal old age benefit tax, which is assessed against
an employer with one or more employees in covered employment,
the federal unemployment insurance taxes are assessed against only
certain employers, as defined in the law, as follows :
"The term 'employer' does not include any person unless on each
day of some twenty days during the taxable year, each day being in a
different calendar week, the total number of individuals who were
employed by him in employment for some portion of the day (whether
or not at the same moment of time) was eight or more."
The expression " employed by him in employ ment" has the
significance of employed by him in covered employment, or, in other
MATTERS RELATED TO PAYROLLS 461
words, not employed in the performance of exempt services. A
person is not subject to the federal unemployment insurance tax
unless he has employed at least eight individuals for the perform-
ance of nonexempt services on at least one day during at least
twenty different weeks of the taxable year; and an employer who is
subject to the tax is assessed on the basis of wages paid to only
those employees who are engaged in the performance of nonexempt
services.
The federal unemployment insurance tax rate is 3%; wages in
excess of $3,000 paid to any one individual during the taxable
year are not subject to the tax. Although the tax rate is 3%, the
employer is entitled to a credit for taxes paid to the states and ter-
ritories under their unemployment compensation laws. This
credit cannot be more than 90% of the tax assessed by the federal
government at the 3% rate. Because of this provision in the
federal law, the states have generally established a 2.7% unem-
ployment compensation tax rate. Since taxable wages are gener-
ally (though subject to some minor exceptions) computed in the
same manner for both federal and state taxes, the tax rates are
usually considered to be as follows:
tax 3%
State tax 2 7
Total 3~0 < <
Although the basic rate for state taxes is 2.7%, the tax actually
payable to a state may be computed at a lower rate. Since one of
the purposes of state unemployment legislation is to stabilize
employment, the state laws contain provisions for merit-rating
plans; under these provisions, an employer who establishes a good
record for stable employment (thus reducing the claims upon state
funds for unemployment compensation) may obtain the benefit of a
state tax rate much lower than 2.7%. In order to assure the
employer of the enjoyment of the tax saving resulting from the
reduced state rate, the federal law provides that an employer pay-
ing a state tax at a rate less than 2.7%, as a result of the state's
merit-rating plan, may deduct as a credit an amount computed at
the 2.7%, rate or at the highest rate applicable to any taxpayer in
the state, whichever is lower; the amount of the credit cannot, of
course, be more than $0% of the federal tax.
The employer must file his federal unemployment tax return
with the Director of Internal Revenue on or before January 31
following the taxable calendar year. To assure himself of obtain-
ing the credit for state taxes, he should pajr these taxes not later
than January 31.
462 APPENDIX 1
The federal tax may be paid at the time the return is filed, or
in four equal installments on January 31, April 30, July 31, and
October 31 of the year following that for which the tax is assessed.
The employer's records should contain all information required
to support his tax return.
State unemployment compensation taxes. Stimulated by the
enactment of the federal unemployment insurance legislation,
which provided for federal grants to the states as an aid in financ-
ing their unemployment compensation programs, all the states and
territories have passed laws which have, in general, the following
principal objectives:
(1) The payment of compensation, of limited amounts and for
limited periods, to unemployed workers.
(2) The operation of facilities to assist employers in obtaining
employees, and to help workers obtain employment.
(3) The encouragement of employers to stabilize employment ;
the inducement offered is a reduction in the tax rate,
through the operation of merit-rating systems.
Since the laws of the several states differ in many particulars,
it is possible here to give only a general discussion. All the states
levy a tax on employers; a very few also levy a tax on employees.
The list of exempt services in the federal law is rather closely fol-
lowed in most of the state laws. Whereas the federal unemploy-
ment insurance tax is assessed against only those employers who
have eight or more employees, many of the states assess taxes on
employers of a smaller number of individuals— even as few as one.
In most states the tax is not assessed on salaries in excess of $3,000.
In general, the state tax rate is basically 2.7%, but provision is
made in some of the laws for increased rates if they are essential to
meet disbursement requirements. All state laws include a merit-
rating plan of some kind; these plans are intended to effect lower
taxes by a reduction of the tax rate or by a credit against taxes for
employers who have established (during an experience period,
usually of three years) a favorable record of stable employment.
The reserve ratio plan is typical; in principle it operates as follows:
Assume that an employer's average annual payroll for three
years has been $100,000.
Assume, also, that the balance in the state's reserve account
with this employer is $5,000; this is the excess of the taxes
paid by this employer over the amounts of benefits paid by
the state to his former employees.
The reserve ratio ($5,000 -^ $100,000) is 5%.
The higher the reserve ratio, the lower the tax rate.
MATTERS RELATED TO PAYROLLS 463
Most states require employers to file returns quarterly and to
pay the tax by the end of the month following the close of the
quarter. Since the amount of taxable wages paid to an individual
is usually one of the factors determining the amounts of benefits
payable to him when he is unemployed, employers are required to
file information returns showing the amount of compensation paid
to each employee during the period.
The states require employers to maintain a compensation record
for each employee, showing, among other things, the period of
employment, the reason for termination of employment, the cause
of lost time, and the amounts of periodical payments of compensa-
tion to him during the period of employment. The specific
requirements of each state are shown in its published regulations.
Federal income tax withholding. Employers of one or more
employees are required to withhold federal income taxes from the
wages of employees, except certain exempt wage payments.
The amount withheld from an employee's wages is affected by
the amount of his income and the number of exemptions ($600
each).
An individual is entitled to:
(1) An exemption for himself.
(2) An additional exemption if he is over 65 or will become 65
on or before January 1 of the following year.
(3) An additional exemption if he is blind.
If the employee is married, he can claim any of the above
exemptions which his spouse could claim if she were employed —
unless, of course, she is employed and claims them herself.
(4) An exemption for each dependent. No additional exemp-
tions are allowed for aged or blind dependents.
A dependent is a person who is closely related to the tax-
payer, who has a gross income of less than $600 for the year, and
who received more than half of his support for the year from the
taxpayer.
In order to determine the amount of tax which he should with-
hold from an employee's compensation, the employer must know
the number of exemptions claimed by the employee. Therefore,
the employee is required to furnish an Employee's Withholding
Exemption Certificate to his employer.
If the employee's status as to exemptions changes during the
year, he should give his employer an amended certificate; he is
required to do so if the number of exemptions decreases, and he is
permitted to do so if the number of exemptions increases.
464 APPENDIX 1
The employer's report and payment procedures are summarized
below :
Each employer must file a quarterly combined return for O. A.
B. taxes and withheld income taxes. Except as noted in the
following paragraph, the return and taxes are due and pay-
able on or before the last day of the month following the
calendar quarter covered by the return.
If the combined O. A. B. taxes and withheld income taxes of any
employer exceed $100 in any month other than the last
month of a quarter (March, June, September, or December),
the employer is required to deposit them in an authorized
depositary bank by the 15th of the following month. For
March, June, September, or December, the employer may
deposit the taxes in an authorized bank on or before the end
of the following month. If all these monthly deposits have
been made on time, the due date for the quarterly return is
extended to the 10th day of the second month following the
calendar quarter covered.
On or before January 31, the employer should give each of his
employees a withholding receipt showing the employee's
total wragcs for the preceding year and the amount of income
tax arid social security tax withheld therefrom. If an
employee's employment is terminated, the employer should
give him, at the time of the last wage payment, a withholding
receipt covering the portion of the year during which he was
employed.
With the return for the last calendar quarter, each employer
should file with the Director of Internal Revenue a Recon-
ciliation of Quarterly Returns, which summarizes the
amounts of taxes shown by the quarterly returns. It should
be accompanied by carbon copies of all withholding receipts
given to employees, and by a listing (which may be in the
form of an adding machine tape) of the amounts of withheld
taxes as shown by the copies of the withholding receipts.
Other payroll deductions. Employers may make other deduc-
tions from payrolls, such as the following: deductions for premiums
for group hospital insurance, deductions for purchases of govern-
ment bonds for the employees, and deductions for payment of
union dues.
Requirements of Federal Fair Labor Standards Act. This act
establishes a minimum hourly wage rate and maximum hours of
work per week for certain classes of employees engaged directly or
indirectly in interstate commerce, and provides that payment for
MATTERS RELATED TO PAYROLLS 465
overtime hours in excess of 40 hours during any work week shall
be at the rate of 1^ times the regular hourly wage. The act also
requires that employers subject to it shall maintain a record for
each subject employee showing his name, address, date of birth (if
under 19), occupation, work week, regular rate of pay per hour,
basis of wage payment (hour, week, month, piecework, and so on),
hours worked per day and per work week, daily or weekly wages at
his regular rate, weekly excess compensation for overtime worked,
miscellaneous additions to or deductions from wages, total period-
ical wage payments, and date of payment.
Following are some illustrations of the application of the
requirement for the payment of wages at l£ times the regular
hourly rate for hours of work in excess of 40 hours during any work
week :
( 1 ) A 's regular hourly rate is $2.00. He works 45 hours during
one week. His wages are computed as follows:
45 hours tit $2 00. $90.00
f> hours at 1 00 . . . 5.00
Total .. $95 00
(2) B's wages are $58.50 a week for a regular work week of
39 hours (7 hours a day for 5 days, and 4 hours on Satur-
day). He works 45 hours during one week.
$58.50 -s- 39 = $1.50 regular hourly rate
45 hours at $1.50 = $67.50
5 hours at .75 = 3.75 (Excess payment for hours over 40)
Total $7T~25
(3) C accepts a position with the understanding that he is to
work 7 hours per day during each of the 6 days of his
work week, and is to receive a weekly wage of $86. He
works 50 hours during one week. To determine his regu-
lar hourly rate, we must remember that his regular work
week consists of 42 hours, and that for 2 of these hours he
is being paid 1| times the regular hourly rate; in other
words, for the 2 hours regularly worked in addition to
40 hours, he is given the equivalent of 3 hours' pay.
Therefore,
$86.00 -f- 43 - $2.00, the regular hourly rate.
If he works the regular 42 hours, his wage is (theoreti-
cally) computed as follows:
42 hours at $2.00 = $84 00
2 hours at 1.00 - 2.00 (Excess for hours over 40)
Total $86.00
466 APPENDIX 1
For the week that he works 50 hours, his wage is:
50 hours at $2.00 - $100.00
10 hours at 1.00 « 10.00 (Excess for hours over 40)
Total $110.00
If wages are paid monthly or semimonthly, recognition must be
given to the fact that the time-and-one-half requirement applies
to each work week separately. To illustrate, assume that an
employee, whose regular hourly rate is $2.00, was paid for the half-
month ended Wednesday, July 15, and that he was entitled to no
overtime payment for that period. We are now to compute his
wage payment for the last half of July; we require the following
information as to hours worked:
In prior payroll period :
Monday, July 13 ... . . 8
Tuesday, "14 .... . . 8
Wednesday, " 15 8
In current payroll period :
Thursday, July 16 8
Friday, "17 . . 7
Saturday, " 18 5
Monday,
20.
Tuesday, 21 . . 7
Wednesday, 22 7
Thursday, 23 8
Friday, 24 6
Saturday, 25 7
Monday, 27 ... 8
Tuesday, 28 .... 8
Wednesday, 20 8
Thursday, 30 . 8
Friday, 31 8
His total wage payment for the semimonthly period is com-
puted as follows:
(a) For the portion of the work week ended July 18:
Considering that work week as a whole, he worked 44
hours. Since, at the time of making the payment for the
period ended July 15, it was not known whether he would
work over 40 hours during the entire week, he was paid
for the first 3 days at the regular rate. We now find that
he worked 44 hours during that week, 20 of them during
the current payroll period. Therefore, the payment to
him now should be:
20 hours at $2.00 - $40 00
4 hours at 1.00 4.00
Total $44.00
MATTERS RELATED TO PAYROLLS 467
(b) For the work week ended July 25:
During this week he worked 41 hours. For it he should be
paid:
41 hours at $2.00 - S82 00
1 hour at 1.00 = 1 00
Total $83 00
(c) For the portion of the work week ended July 31 :
Although he had already worked 40 hours during the week,
there was no certainty on Friday night that he would
work on Saturday. Therefore, he should be paid an
amount computed as follows:
40 hours at $2.00 - S80.00
His total wage payment for the semimonthly period is the
total of the items shown below:
For partial work week ended July 18 $ 44 00
For work week ended July 25 83 00
For partial work week ended July 31 80 00
Total . . . $207 00
Payroll procedures. The payroll summary on page 469
furnishes information required for the entries in the ledger accounts
applicable to wages and payroll deductions. Postings of column
totals may be made directly from the payroll summary to the
ledger; the debits and credits are shown below.
Wages (if it is desired to debit various accounts for
amounts of wages payable for different services, an
analysis must be made to obtain the information for
this purpose) . 3,265 20
Federal O. A. H. taxes withheld from employees 45 86
Federal income taxes withheld from employees 381 80
Wages payable . ' 2,83754
Some companies consider it satisfactory to use one account,
"Federal Taxes Withheld from Employees/' for both the O.A.B.
arid the income tax withholdings. If this is done, the entries in the
account should be identified, so that the liability on each class of
tax can be determined.
It will be observed that the amount shown in the payroll sum-
mary for O.A.B. withholdings is not exactly \\% of the payroll;
this is presumably because some of the wage payments represented
excesses over $3,600, which therefore were not subject to the social
security taxes.
The employer should compute his own liability for social secur-
ity taxes in the manner shown on page 469.
468
APPENDIX 1
Total wages. $3,265 20 83,265 20
Wages not subject to social security taxes 208 10
Wages (in excess of $3,000) not subject to unem-
ployment taxes . .... 608 . I 0
Wages subject to taxes. $376577lO $2^,657 10
Taxes:
Federal O.A.B.— 1J% of $3,057.10 $ 4586
Federal unemployment — 0.3% of $2,657.10 7 97
State unemployment — 2.7% of $2,657.10 . ... 71 74
$"~I25 57
The entry to record the expense and the liabilities for these
taxes may be as follows:
.*
Payroll taxes (separate expense accounts may be used if
desired) 125 r>7
Federal O.A.B. taxes payable 15 86
Federal unemployment taxes payable 7 97
State unemployment taxes payable . . 7 1 74
THE BROWN COMPANY
Employee's
name
Employee's number
Date paid __10_
Hours Wages
To meet the require-
ments of the social secu-
rity legislation, it is also
desirable to keep, for each
employee, an individual
employment and com-
pensation record, similar
to that illustrated on
page 469.
To comply with legal
requirements, payroll rec-
ords, with supporting
data, should be retained
for four years.
Wage payment re-
ports to employees. As
previously stated, many
employers make reports
to employees of payroll
deductions at the time of
each wage payment.
If wages are paid by
check, a stub may be at-
tached to the check and
the data may be shown
on the stub, as illustrated on page 470.
If wages are paid in cash, the pay envelope may be printed as
in the illustration above.
Regular
Overtime
Total
Deductions:
O.A.B. tax
U. S. Inc. tax
Savings bonds
Insurance
I
Total deductions
Cash enclosed
MATTERS RELATED TO PAYROLLS
469
%
s
s
g
d
O
470
APPENDIX 1
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APPENDIX 2
Locating Errors
It is impracticable to attempt to state a procedure which can
invariably be followed, step by step, in locating errors in the general
ledger or in the subsidiary records. Experience is the best guide,
but the following suggestions may be helpful.
Checking the general ledger. It is usually advisable to locate
any errors in the general ledger before looking for errors in the
subsidiary records. Until the general ledger is in balance, there
can be no assurance that the controlling accounts are correct.
Suppose, for instance, that the general ledger is out of balance and
that the accounts receivable ledger is not in agreement with its
control; it may be that the Accounts Receivable controlling
account is incorrect and that, after the error in that account has
been located, the subsidiary ledger and the controlling account
will be in agreement.
If the general ledger is out of balance, the following procedure
may be followed by the bookkeeper:
(1) Refoot the general ledger trial balance.
(2) See that the ledger balances have been correctly transcribed
to the trial balance, watching for errors in amounts, for
debit balances entered on the credit side of the trial bal-
ance or vice versa, and for ledger balances omitted from
the trial balance.
(3) Recompute the ledger balances and refoot the debit and
credit sides of the accounts.
(4) Check the postings from the books of original entry to the
ledger, watching for errors in amounts and for postings to
the wrong side of an account. As mentioned in Chapter
11, entries affecting controlling accounts are sometimes
made in books of original entry which do not contain
special columns for the controlling accounts affected ; the
amounts are entered in the General Ledger column and
are posted twice: to the controlling account and to the
subsidiary ledger. In checking the postings, give special
attention to such items to be sure that they have been
properly posted.
As each item in a book of original entry is traced to the
ledger, place a check mark beside the amount in the book
471
472 APPENDIX 2
of original entry and also beside the amount in the ledger.
After this work has been completed, look for unchecked
items in the books of original entry (indicating items
which have not been posted), and for unchecked items in
the ledger (indicating entries which have been posted
twice, or which, for some other reason, do not belong in
the ledger).
(5) Refoot the books of original entry. If a book contains
debit and credit columns (as in the voucher register,
which contains a Vouchers Payable and a General Ledger
credit column and numerous debit columns), cross-foot
the column totals to see that the sum of the debit column
totals is equal to the sum of the credit column totals.
Posting to work sheets. If the procedure described above does
not result in locating the error, it may be necessary to post all the
entries to work sheets. Using sheets as large as can easily be
handled, head up skeleton accounts, thus:
Cash Accounts Receivable Notes Receivable
Provide skeleton accounts for all the accounts in the ledger,
putting as many accounts as possible on one page, and allowing
only as much space as is necessary in each account. Copy into the
skeleton accounts all the ledger balances at the beginning of the
period; take a trial balance of the skeleton accounts, thus proving
that the accounts were in balance at the beginning of the month or
the year. Post all the entries from the books of original entry,
entering only the reference to the book of original entry and the
imount, thus:
Accounts Receivable
Bal
10,000
US
1,000
8.
30,000
CR
.... 27,000
J.
. 1 ,500
After completing the posting to the work sheets, compute the
balance of each work sheet account and compare it with the balance
3f the corresponding ledger account. If the balance of a work
sheet account does not agree with the balance of the corresponding
ledger account, compare the entries in the ledger account with the
entries in the work sheet account.
This procedure is called abstracting the books of original entry,
Mid will often locate an error after all other methods have failed.
LOCATING ERRORS
473
Checking the subsidiary ledgers. After the general ledger has
been balanced, if a subsidiary ledger does not agree with its control:
(1) It may be tentatively assumed that the general ledger is
correct and that the error lies in the subsidiary ledger.
(a) Refoot the schedule of the subsidiary ledger.
(b) See that the balances of the subsidiary ledger ac-
counts have been correctly transcribed from the
ledger to the schedule, watching for errors in
amounts and for balances omitted from the
schedule. In some cases, subsidiary ledgers which
normally contain only debit balances (as the
accounts receivable ledger) have a few credit
balances, and ledgers which normally contain only
credit balances (as the accounts payable ledger)
have a few debit balances; such exceptional bal-
ances should be watched for.
(c) Recompute the ledger balances and refoot the two
sides of the accounts.
(d) Trace all postings from the books of original entry to
the subsidiary ledgers, place check marks beside
the entries in the books of original entry and the
accounts, and look for unchecked items.
(2) The assumption that the error is in the subsidiary ledger
may be incorrect. Suppose, for instance, that a sales
book appears as follows:
Sales Book
Date
19—
July
Name
Amount
John Smith
William Brown
Fred White
V
500
00
V
600
00
V
300
00
1,500
00
(10) (501)
This sales book has been incorrectly footed ; the total should
be $1,400 instead of $1,500. The error in footing
resulted in an excess debit to Accounts Receivable con-
trol and a similar excess credit to Sales, and left the
general ledger in balance -but incorrect. The sub-
sidiary accounts receivable ledger will not agree with its
control; but the error is in the general ledger, notwith-
standing the fact that the general ledger is in balance.
474 APPENDIX 2
Because of such possibilities, all column totals posted
to controlling accounts should be refooted.
Checking other subsidiary records. The voucher register is a
subsidiary record, but postings are not made to it as they are to a
subsidiary accounts receivable or accounts payable ledger. The
open or unpaid items consist of those entries which have no nota-
tions in the Date Paid column. If the schedule of open items in the
voucher register does not agree with the balance of the Vouchers
Payable account:
(1) Refoot the Vouchers Payable column to see that the total
posted to the controlling account is correct.
(2) See whether there are any debits to Vouchers Payable in the
Sundry Accounts column, recording cancellations of
vouchers on account of partial payments or other adjust-
ments; if any such debits to Vouchers Payable are found,
see that they have been correctly posted.
(3) The cash disbursements book shows the numbers of all paid
vouchers; working from the cash disbursements book, see
that notations have been made in the Date Paid column
for all paid vouchers.
(4) Vouchers are sometimes canceled by the issuance of notes,
with entries in the journal or the notes payable register
debiting Vouchers Payable arid crediting Notes Payable;
in such cases, notations should be made in the Date
Paid column of the voucher register. See that all such
notations have been made.
(5) Other journal entries, such as for purchase returns and
allowances, may affect the balance of the Vouchers Pay-
able account; be sure that they were given proper recog-
nition when the schedule of open vouchers was prepared.
The note registers may be subsidiary records; if so, the open
items should agree with the balances in the Notes Receivable and
Notes Payable accounts. If the notes receivable register is out of
agreement with the controlling account:
(1) See that there is an entry in the register for each note
received and recorded in the journal (notes received on
account) or in the cash disbursements book or voucher
register (notes received for money loaned).
(2) See that a notation in the Date Paid column of the register
has been made for each note collected (recorded in the
cash receipts book) or otherwise canceled (recorded in
the journal or elsewhere).
LOCATING ERRORS 475
If the notes payable register is out of agreement with its control,
similar procedures may be followed.
Expense ledgers or analysis records are also subsidiary records.
If they do not agree with their controls:
(1) Refoot the summaries prepared at the end of the month, or
recompute the balances of the accounts (if accounts are
kept).
(2) Check all postings from the voucher register (or from the
vouchers, if postings are made from the vouchers) and
watch particularly for charges or credits to expense con-
trols from other books, seeing that entries have also been
made in the subsidiary records. For instance, deprecia-
tion charges will be recorded in the journal, expense
adjustments may also be made in the journal, and
refunds credited to expense accounts may be recorded in
the cash receipts book.
Special tests. Certain special tests may be applied in locating
errors in the general ledger or in finding differences between the
subsidiary ledgers and the controls. These tests, which are illus-
trated below, may be applied before beginning the routine already
described.
(1) Determine the exact difference to be located; for instance,
assume that the debit total of the general ledger trial bal-
ance is $50,200 and that the credit total is $50,000;
the difference is $200 — too little credit or too much
debit.
(a) Look for a credit balance of $200 in the ledger; it
may have been omitted from the trial balance.
(b) Look for a $200 error in transcribing the balances
from the ledger accounts ; for instance, a debit bal-
ance of $2,000 entered in the trial balance as
$2,200, or a credit balance of $2,200 entered in
the trial balance as $2,000.
(c) Look for an entry of $200 in the books of original
entry; if it is a credit, it may not, have been posted;
if it is a debit, it may have been posted twice.
(2) Treating a debit as a credit (or vice versa) either in posting
or in transferring balances to the trial balance will pro-
duce a trial balance difference of twice the amount of the
item incorrectly treated. Therefore, divide the trial
balance difference by two; in the foregoing illustration,
476 APPENDIX 2
the quotient will be $100. Since we have too much
debit (or too little credit) :
(a) Look for a credit balance of $100 in the ledger and
see whether it may have been entered on the debit
side of the trial balance.
(b) Look for a credit entry of $100 in the books of
original entry and see if it may have been posted to
the debit side of the ledger.
(3) Transpositions of figures (for instance, $78.50 posted as
$75.80) are errors frequently and easily made; they
should be constantly guarded against and may be sought
for if the books are out of balance. A transposition of
two figures will produce an error of an amount exactly
divisible by nine; if the transposed figures are in adjacent
decimal positions, the significant figure of the quotient
after dividing by nine will be the difference between the
figures transposed; and the decimal position of this sig-
nificant figure will be that of the right of the two numbers
transposed.
As an illustration:
An entry of ftTS 50
Posted as 75 #0
VV ill cause a difference of $ 2 70
Dividing this difference by ?) will product* a quotient of 30
Since the difference ($2.70) is exactly divisible by 9, a transpo-
sition is indicated, the difference* between the figures trans-
posed appears to be 3; and these* figures appear to bo in the
dimes column and the column at its Left Hence we may look
for items (ledger balances or entries) when* the difference
between the two figures in the dunes and dollars places is 3,
as in the number $78.50.
As another illustration:
An entry of $613.50
L'osted as 163 50
\\ ill produce a difference of $450 00
The quotient after dividing by <) is 50 00
Suggesting a transposition (in the tens and hundreds col-
umns) of two figures with a difference of 5.
These special tests for transpositions are sometimes helpful in
locating errors, but the other methods described are more likely to
be effective.
Correcting errors. Erasures in accounting books should be
avoided, since they tend to discredit the records. Corrections
LOCATING ERRORS 477
should be made by drawing a line through the incorrect entry and
making the correct entry above it, or by a journal entry, thus:
Machinery and equipment 500 00
Buildings 500 00
To correct improper posting of voucher register entry
of June 15. Debit was posted to Buildings account,
should have been posted to Machinery and Equip-
ment.
APPENDIX 3
Preparation of Monthly Statements When Books
Are Closed Annually
On pages 480 and 481 are working papers prepared at the end of
January, 1954. The books of the company were closed on the
preceding December 31. They were not closed on January 31
Therefore, in the February 28, 1954 working papers (pages 4S2
and 483),
The Inventory account balance shows the amount of the
inventory on December 31.
The Earned Surplus account balance shows the balance on
December 31.
The balances of the income and expense accounts show results
of operations for the two months ended February 28.
The asset and liability account balances show assets (other
than inventory) and liabilities at the end of February.
If it is desired to prepare statements for the two months ended
February 28, the working papers can be prepared in the manner
with which you are already familiar.
However, if it is desired to prepare operating statements for
February, the account balances will not show operating results for
that month, and it will be necessary to deduct January 31 balances
of operating accounts from February 28 balances to determine the
changes in the account balances during February. Refer to the
working papers on pages 482 and 483 and observe the following:
The trial balances after adjustment, on January 31 and
February 28, are entered in the first two pairs of columns.
The balances in the income and expense accounts (beginning
with Sales and ending with Federal Income Tax) on Janu-
ary 31 are deducted from the balances on February 28, and
the differences (resulting from February transactions) are
extended to the February Profit and Loss columns.
The inventory on December 31 is not extended to any
column.
The inventory at the end of January (which was shown in the
January working papers) is entered in the Profit and Loss
debit column; and the inventory at the end of February is
478
MONTHLY STATEMENTS 479
entered in the Profit and Loss credit and the Balance Sheet
debit columns.
The balance in the Profit and Loss columns then shows the
net income for February. This is entered as a balancing
figure in the Profit and Loss debit column and is extended
to the Earned Surplus credit column.
The balance of the Earned Surplus account as of December 31
is entered in the Earned Surplus credit column. The net
income for January, shown by the working papers for that
month, is also entered in the Earned Surplus credit column.
The balance of the Earned Surplus columns then shows the
surplus at the end of February; the amount is entered in
the Earned Surplus debit column as a balancing figure, and
is extended to the Balance Sheet credit column.
The February 28 balances in the asset, liability, and capital
stock accounts are extended to the Balance Sheet columns,
and these columns are footed.
The statements for January and February are not shown; they
would be prepared from the working papers in the usual manner.
480
APPENDIX 3
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ASSIGNMENT MATERIAL
ASSIGNMENT MATERIAL
Ruled forms especially adapted to the solutions of all Group A problems are
provided in the envelopes of laboratory material accompanying the text.
Journal, ledger, and analysis paper is suitable for solutions to most of the
Group B problems. A pad of such paper, as well as some ruled forms more spe-
cifically adapted to the solutions of some problems, is available
If no year is stated in the questions, problems, and practice sets, use the cur-
rent year.
ASSIGNMENT MATERIAL FOR CHAPTER 1
Questions
1. Define assets, liabilities, and owners' equity.
2. What are the sources of owners' equity?
3. What facts are shown by the heading of a balance sheet?
4. Should the amount receivable from each debtor and the amount payable
to each creditor be shown in the balance sheet? Why?
6. Give rules for debiting and crediting: (a) asset accounts; (b) liability
accounts; (c) owners' equity accounts.
6. In what way or ways is a trial balance useful?
7. Describe posting.
8. Mention transactions that would cause the changes set forth below:
(a) Assets increased; owners' equity increased.
(b) Assets increased ; liabilities increased.
(c) Assets decreased ; liabilities decreased.
(d) Asset total unchanged; liabilities and owners' equity total un-
changed.
Problems — Group A
Problem A-l. Prepare a balance sheet for Acme Corporation after each of
the following transactions.
1954
May 1 — The corporation was organized and $10,000 par value capital stock was
issued for cash.
3 — Repair supplies were purchased for $1,000 cash.
6 — The corporation issued $2,000 additional par value stock for cash.
6 — The corporation acquired a tract of land for $5,000, paying $2,000 in
cash and promising to pay the remaining $3,000 within thirty days.
Problem A-2. The following transactions relate to the affairs of The Mosher
Company, a newly organized corporation.
April 1 — $15,000 par value capital stock was issued for cash.
2 — Service parts costing $1,200 were purchased on account from ARC
Company.
8 — Paid $600 to A B C Company to apply on account.
10 — Purchased additional service parts for $500 cash.
18 — Paid the balance owed to A B C Company.
24 — Purchased a U. S. Government bond for $1,000.
30 — Acquired land for a building site, paying $3,000 in cash and giving a
note payable for $10,000.
Required:
Enter the above transactions in skeleton (T) accounts.
487
488 ASSIGNMENT MATERIAL-CHAPTER 1
Problem A-3. Enter the following transactions of the E Z Company in
skeleton (T) accounts.
May 1- -$8,000 par value capital stock was issued for cash.
13 — Paid $800 to American Supply Company for service supplies.
19— Purchased land for $5,000 cash.
24 — Service supplies costing $600 were purchased on account from McVee
Corporation.
27— The land was sold for $5,000 cash.
29 — Additional par value capital stock in the amount of $7,000 was issued
for cash.
31 — A larger tract of land was acquired for $9,000 cash.
31 — Paid $300 on account to McVee Corporation.
Problem A-4. The transactions listed below are those of the Smith Do-all
Company, which r was organized on August 1, 1954. Journalize these trans-
actions and post to ledger accounts. Take a trial balance.
1954
August 1 — Capital stock of a par value of $10,000 was issued for cash.
3 — Land was acquired for $3,000 cash.
5 — Repair parts costing $900 were purchased on account fiom James
Brown.
8 — A more suitable piece of land was purchased for $4,000 cash.
14 — The land acquired on August 3 was sold for $3,000. No cash was
received on this date. The buyer, R. S. Jones, agreed to pay for
the land within ten days.
18- $900 was paid to James Brown for the repair parts purchased on
August 5.
21- — The company received $3,000 tiom R. S. Jones, the buyer of the
land.
27— Additional repair parts \\ere purchased tor $000 cash.
31 — $2,000 was invested in T. S. Government bonds
Problem A-5. The following chart of accounts is planned for the Arbana
Company.
Account
\umbor
Assets:
Cash . 1
Parts and supplies 10
Land 15
Patont 20
Liabilities:
General Supply (1o . 3 1
Notes payable tffi
Owners' equity:
Capital stock . 50
Perform the following- (a) Journalize the transactions, (fc) post to ledger
accounts, (c) take a trial balance, and (d) prepare a balance sheet as of December
31, 1954.
1954
December 3 — The company was organized and $20,000 of cash was received
for the issuance of the same amount of par value capital stock.
ASSIGNMENT MATERIAL— CHAPTER 1
489
1954
December
5 — The company paid $3,000 to an inventor for a patent.
8 — Purchased on account from General Supply Co. parts and sup-
plies costing $3,000.
12— Purchased land for $4,500.
16 — Paid $1,500 to General Supply Co. to apply on account.
18 — Purchased for cash parts and supplies costing $850.
24 — Paid the balance owed to General Supply Co.
26 — Purchased additional parts and supplies on account from General
Supply Co.; cost, $1,800.
29 — Purchased additional land for $6,000, paying $1,000 in cash and
giving a $5,000 note payable for the balance.
Problems — Group B
Problem B-l. Using the following data, prepare the balance sheet of Pierpont
Service Enterprises as of December 31, 1954.
$3,000
2,000
1,000
500
4,000
1,500
Accounts payable
Accounts receivable
Repair parts
Capital stock
Land.
Problem B-2. Balance sheets have been prepared for Iowa Company alter
each transaction. From an analysis of the balance sheets, prepare a list of the
transactions that occurred.
IOWA COMPANY
Balance Sheet
November 1, 1963
Assets Owners' Equity
Cash #4,00000 Capital stock $4,00000
#4,000 00
$4,000 00
Cash
Repair parts
Assets
IOWA COMPANY
Balance Sheet
November 2, 1953
Liabilities and Owners' Equity
$1,000 00 Liabilities.
1,000 00 Accounts payable $1,000 00
Owners' equity:
Capital stock
4,000 00
$5,000 00
Cash .
Repair parts
Land
Assets
$5,000 00
IOWA COMPANY
Balance Sheet
November 3, 1963
Liabilities and Owners1 Equity
$2,000 00 Liabilities:
1 ,000 00 Accounts payable $1 ,000 00
5,00000 Notes payable 3,00000
Owners' equity:
Capital stock 4,000 00
$8,000 00 $8,000 00
490
ASSIGNMENT MATERIAL— CHAPTER 1
IOWA COMPANY
Balance Sheet
November 4, 1953
Assets Liabilities and Owners' Equity
Cash $1,50000 Liabilities:
Repair parts 1,00000 Accounts payable $ 50000
Land. 5,00000 Notes payable 3,00000
Owners' equity:
Capital stock. .
$7,500 00
4,000 00
$7,500 00
IOWA COMPANY
Balance Sheet
f November 5, 1953
Assets Liabilities and Owners* Equity
Cash $3,500 00 Liabilities:
Repair parts 1,00000 Accounts payable $ 50000
Land. . 5,00000 Notes payable 3,00000
Owners' equity :
Capital stock.
$9,500 00
6,000 00
$<),500~00
IOWA COMPANY
% Balance Sheet
November 6, 1953
Assets Liabilities and Owners' Equity
Cash $3 , 000 . 00 Liabilities :
Repair parts 1,50000 Accounts payable $ 50000
Land, 5,00000 Notes payable 3,00000
Owners' equity:
Capital stock
$9,500 00
6,000 00
$9,500 00
Problem B-3. Record the following transactions in skeleton (T) accounts.
Allow five lines for each ledger account.
May 1 — O. N. Sterling and R. N. Dunne organized a corporation known as the
Midwest Motor Company. Sterling paid in $30,000, Dunne paid
in $40,000, and shares of capital stock were issued.
2 — Land was bought for use as a used-car lot for $15,000, paid in cash.
3 — A small frame building was purchased and moved to the lot to serve
as an office building. Cost, $3,500, paid in cash.
4 — Automobiles were purchased at auction for $40,000 cash.
5 — A building was purchased to serve as a repair shop. The cost was
$10,000. $3,000 cash was paid down and the Midwest Motor Com-
pany owed the balance of $7,000 to John R. Hicks on account. The
land on which the building was located was purchased for an addi-
tional $2,000 cash. (Use separate accounts for the building and
the land.)
8 — Two automobiles costing $2,000 each were traded for service equip-
ment worth $4,000.
ASSIGNMENT MATERIAL-CHAPTER 1 491
May 9— Title to an automobile was transferred to James West, a competitor,
at cost, $2,100. Mr. West did not pay any cash, but agreed to pay
the full amount in thirty days.
11 — John R. Hicks agreed to accept capital stock in the amount of $7,000
in payment of the amount due him. The stock was issued.
Problem B-4. John A. Burke and William R. Hutchins completed the
organization of the Good Housekeeping Service Store on June 17, 1954.
Record the following transactions, which occurred during the remainder of
June, in a journal, post the entries to a ledger, and take a trial balance. Allow
seven lines for the Cash account and four lines each for all other ledger accounts.
1954
June 17 — Capital stock of $35,000 in total was issued to Burke and Hutchins
for cash.
18 — A building was acquired for $27,000 cash. The land on which the
building was located was purchased for an additional $3,000 cash.
(Make two entries and use separate accounts for the building and
the land.)
19- Service equipment was purchased from the Whirlaway Company on
account for $8,500.
20 — Store equipment was purchased for rash in the amount of $3,000.
23- Borrowed $15,000 from the First, National Bank, giving a note pay-
able. (Credit Notes Payable.)
25- Paid $5,000 cash to the Whirla\\ay Company as part payment on the
purchase of June 19.
27— Additional capital stock was issued to John A. Burke for $10,000 cash.
30- Repair parts with a wholesale list price of $18,500 were purchased from
the Better View Company for $17,000 cash. The Better View Com-
pany, currently short on storage space, was giving liberal terms in
order to move existing inventories.
Problem B-5. Enter the following transactions occurring during the latter
part of March, 1954, in a journal; post to ledger accounts; take a trial balance;
and prepare a balance sheet.
March 20 — J. B. Webster and A. 0. Snyder completed the organization of the
Economy Service Company, and each invested $12,500 cash;
$25,000 of capital stock was issued.
23— Purchased land for $4,000 cash.
24 — Issued additional capital stock to J. R. Derby for $5,000 cash.
25 — Service supplies costing $2,000 were purchased from the Dunham
Company on account.
30 — $5,000 cash was invested in U. S. Treasury notes.
31 — Building and land were acquired for $20,000. A cash payment of
$16,000 was made and a mortgage payable was given for the
remainder. The land was valued at $5,000.
31 — Land acquired on March 23 was exchanged for service equipment
costing $4,000.
31 — Paid the Dunham Company $1,200 on account.
31 — Additional service supplies were acquired for $800 cash.
ASSIGNMENT MATERIAL FOR CHAPTER 2
Questions
1. How does the trial balance differ from the balance sheet?
2. What is meant by "closing the books"?
3. What is the purpose of closing the books?
4. What accounts are closed to Earned Surplus?
5. What is tlfe function of the Profit and Loss account?
6. What are dividends?
7. Give a rule for debiting and crediting income and expense accounts.
8. What facts appear in the heading of a statement of income and expense?
Does the heading of a balance sheet differ in any particular from the heading of a
statement of income and expense?
9. What are the rules for the use of dollar signs?
10. What is the purpose of taking a trial balance after closing the books?
11. After the books are closed:
What classes of accounts have no balances?
What classes of accounts have balances?
Problems — Group A
Problem A-l. The transactions listed below are those of Landscapes, Incor-
porated, which was organized on May 1, 1954. Journalize these transactions.
1954
May 1 — Capital stock of a par value of $8,000 was issued for cash.
2 — $100 was paid for the use of office facilities for May.
5 — A landscaping job was finished today and $250 was collected.
6 — Paid $60 for materials used on the landscaping job.
10 — A bill was delivered to 0. A. Smith in the amount of $500 for land-
scaping work completed today. Smith agreed to pay in ten days.
11 — Paid $90 for materials used on the Smith job.
15 — Paid wages in the amount of $225.
17 — Purchased land as a future building site, paying $3,000.
19 — Received $500 from 0. A. Smith for the work completed on May 10.
22 — A landscaping job was finished today; the bill was $600. The cus-
tomer, R. J. Blank, promised to pay half of the bill before the end
of the month and the balance within thirty days.
23 — Paid $95 for materials used on the Blank job.
27— Received $300 from R. J. Blank.
31 — Paid wages in the amount of $350.
31 — Stockholders were paid a dividend of $80.
31 — Purchased a tractor for $1,000 cash.
498
ASSIGNMENT MATERIAL-CHAPTER 2 493
Problem A-2. The Ad Corporation was organized on April 1, 1954. The
corporation is a service enterprise, prepared to help clients with their advertising
programs. The corporation's primary source of income will be from fees. The
following transactions occurred during the month of April.
1954
April 1- -Par value stock in the amount of $6,000 was issued to the organizers for
cash.
3 — Office facilities were rented. Rent, for the balance of April, was
paid, $195.
6 — A bill in the amount of $75 was mailed to The Corner Store for work
performed on its advertising program.
8 — The Mid-town Drug Company, another client, was billed $225 foi
work performed on its advertising progiam.
12 — $75 was collected from The Corner Store.
15 — Salaries of the corporation's employees for the fiibt half of April \\ere
paid, $325.
18 — The plans for an extensive advertising campaign for Tri-State Stores
wore completed. According to the terms of the agreement, the bill,
amounting to $600, was to be paid within thirty days from the date
of the completion of the plans.
24- Received $100 from Mid-to\\n Drug Company, in part payment of
their account.
25— Paid miscellaneous expenses in the amount of $24.75.
29 — Submitted a bill to The Corner Store for work performed on its adver-
tising program, $225.
30- -Paid salaries for the last half of April, $325.
30 — Paid miscellaneous expenses, $75.82.
(a) Journalize the above transactions.
(b) Post to ledger accounts.
(c) Take a trial balance.
Problem A-3. The following trial balance was taken from the ledger of
Moon Corporation, a corporation which was oiganized on June 1, 1954. Jour-
nalize the closing entries.
MOON CORPORATION
Trial Balance
June 30, 1954
Cash ......... 3,302 20
U. S. Government bonds 1 ,000 00
J. U. Richards 532 50
Installation and repair parts 647 25
Land ..... .3,00000
Brown Supply ( 'ompany 327 25
Capital stock . 8,000 00
Dividends 60 00
Selling commissions earned 925 00
Miscellaneous expense . . 185 30
Office facilities expense ..... 125 00
Wages expense ...... ................ _ 400 00 _
9,252 25 9,252 25
Problem A-4. Brown Corporation was organized on January I, 1954. The
trial balance presented below was taken after one month of operations. The
accounts are presented in alphabetical order.
BROWN CORPORATION
Trial Balance
January 31, 1964
Black Coal Co 115 25
Capital stock . . 7 , 000 00
Cash ... . 3,005 00
Commissions earned ... 2 , 100 00
Dividends 140 00
Land . . 3,550 00
Miscellaneous expense. . 31225
O & C Company 228 80
Ohio Corporation 319 20
Rent expense 280 00
Repair parts on hand. 925 50
Wages expense ... 1 , 100 00
White Company . . . . 220 00
9,lJ48l)0 0,648 [OO
Required:
(a) Present the January 31, 1954 trial balance in more useful order.
(b) Prepare the statement of income and expense, the statement of earned
surplus, and tha balance sheet.
(c) Journalize the closing entries.
Problem A-6. The following transactions are those ot King Company, a
newly organized business, during its first month of operations.
1954
November 1 — $4,000 of par value stock was issued for cash.
2 — Paid office rent for November, $150.
10 — Received $750 in commissions.
12 — Paid miscellaneous expenses of $35.65.
20 — Received $600 in commissions.
28 — Paid miscellaneous expenses of $43.22.
30 — Paid salaries for the month, $800.
30 — Billed Acme Brokers per agreement for commissions earned dur-
ing last ten days of November, $650.
30— Paid a dividend, $80.
30— Received a bill for $17.50 from the State Telephone Co. for
telephone service for November.
Required:
(a) Journalize the transactions.
(b) Post.
(c) Take a trial balance.
(d) Prepare the statement of income and expense, the statement of earned
surplus, and the balance sheet.
(e) Make and post the journal entries necessary to close the books. Rule
the income and expense accounts.
(f) Take an after-closing trial balance.
ASSIGNMENT MATERIAL-CHAPTER 2 495
Problems— Group B
Problem B-i. Journalize the following transactions of Borders Company.
1954
August 1 — Repair parts costing SI ,400 were purchased on account from A. K.
Wilson.
10 — Paid J. R. Swanson, a creditor, $800 on account.
15 — Miscellaneous expenses paid, $300.
17 — Paid A. K. Wilson $700 on account.
25 — A non-interest-bearing note receivable was accepted irom D. R.
Meeks, a customer, in lieu of payment on his account. The note
was for $600. (Debit Notes Receivable.)
31 — Salaries and wages paid in cash for August amounted to $2,500.
31 — Paid a cash dividend of $150 to stockholders.
31 — Miscellaneous expenses paid, $250.
31— Commissions collected for services performed, $4,000.
Problem B-2. Cascade Laundry, Inc., was organized on November 1, 1954,
by E. M. Sowell and R. II. Gregory. Transactions occurring during November
are given below. Journalize, post, and take a trial balance.
November 1 — Sowell and Gregory each invested $5,000 for capital stock.
1- An agreement was made whereby laundry equipment and facili-
ties were rented on a monthly basis. Rent of $1,100 was paid
for November. Cascade assumed responsibility for repairs.
5 — Capital stock of $4,000 par value was issued to C S. Davis for
land of equal value.
10 — Paid $80 for a newspaper advertisement.
15— Billed City Restaurant $300 and Exclusive Hotel $2,500 for
laundry work performed during first half of month.
18 — Received bill for $12 from the Electrical Fixit Shop for repairs
to equipment.
20 — Received $2,000 from the Exclusive Hotel on account.
25 — Paid miscellaneous expenses of $60.
30— Billed City Restaurant $400 and Exclusive Hotel $2,600 for
laundry work performed during last half of month.
30— Salaries and wages of $3,800 were paid in cash.
30— Invested $6,000 in U. S. Treasury notes.
Problem B-3. Statements of income and expense and earned surplus are
given below. Journalize the closing entries as they would appear in the books
of the company on July 31.
KOLDAIR FROZEN FOOD LOCKERS, INC.
Statement of Income and Expense
For the Month of July, 1954
Income:
Locker rentals earned . . . $1,650 00
Expenses:
Salaries expense $800.00
Other expense 300 00 1,100 00
Net income . $ 550 00
496 ASSIGNMENT MATERIAL-CHAPTER 2
KOLDAIR FROZEN FOOD LOCKERS, INC.
Statement of Earned Surplus
For the Month of July, 1954
Earned surplus, June 30, 1954 $1,800 00
Add net income for the month — per statement of income and
expense 550 00
Total $2,350.00
Deduct dividends ..... . . 400 00
Earned surplus, July 31, 1954 ... . . $1,950 00
Problem B-4. The balance sheets of the Gem Servicing Company as of
October 31, 1954, and November 30, 1954, are given below.
The company earns its income entirely from services performed. Its expenses
for the month of November consisted of salaries and wages of $4,000, office
expenses of $300, /and miscellaneous expenses of $1,700. A cash dividend of
$800 was paid in November.
GEM SERVICING COMPANY
Balance Sheet
October 31, 1954
Assets Liabilities and Owners' Equity
Cash $ 5,000.00 Liabilities:
Accounts receivable 10,400 00 Accounts payable $ 400 00
Owners' equity:
Capital stock 10,000 00
_J __ Earned surplus 5,000.00
$15,400 00 $15,400 00
GEM SERVICING COMPANY
Balance Sheet
November 30, 1964
Assets Liabilities and Owners' Equity
Cash $ 4,800 00 Liabilities:
Accounts receivable . 12,00000 Accounts payable $ 60000
Owners1 equity:
Capital stock 10,000 00
_ _ Earned surplus 6,200 00
$16,800 00
Prepare the statement of income and expense and the statement of earned
surplus of the company for the month of November.
Problem B-6. The transactions occurring during June, 1954, in the business
of Roofing Repair Company, organized June 1, are given below:
1954
June 1 — Issued capital stock for cash, $8,000.
5 — Paid $100 for two days' rental of a derrick and pulley assembly used
on a repair job.
10 — Paid $200 for repair materials used on a job.
17 — Collected $1,100 upon completion of roofing repair work.
22 — Purchased repair materials costing $180 on account from 0. P. Adams.
These materials were used immediately on a job.
24 — Paid cash dividend of $125 to stockholders.
25 — Collected $2,000 for roofing repair work completed on this date.
ASSIGNMENT MATERIAL-CHAPTER 2 497
1954
June 30 — Paid salaries and wages of $2,700.
30 — Completed roofing repair work for G. B. Armstrong in the amount of
$500. Mr. Armstrong promised to pay for the work on July 10.
30 — Purchased government bonds for $5,000 cash.
Required: (a) Journalize the transactions; (b) post to ledger accounts; (c) pre-
pare a trial balance; (d) prepare a statement of income and expense, a statement
of earned surplus, and a balance sheet; (e) journalize and post closing entries;
(/) rule the accounts having no balances; and (g) take an after-closing trial
balance.
Suggested account titles are:
Cash Dividends
G. B. Armstrong Profit and Loss
Government Bonds Repair Service Income
0. P. Adams Salaries and Wages
Capital Stock Repair Materials Expense
Earned Surplus Rental Expense
ASSIGNMENT MATERIAL FOR CHAPTER 3
Questions
1. Is the following statement correct? Adjusting entries, since they do not
record transactions, are entered directly in the ledger accounts without being
journalized.
2. When are adjusting entries made?
3. Does the depreciation expense account balance always equal the balance
in the reserve for depreciation account?
4. Discuss the validity of the following statement: The net income of a busi-
ness equals the increase in its Cash account balance.
5. Depreciation reserves have credit balances. Then why are they not
shown on the right side of the balance sheet where other balance sheet accounts
with credit balances are shown?
6. Assume that, when an income transaction is being recorded, the accountant
is justified in believing that the amount will be earned before the end of the cur-
rent accounting period, and that he accordingly credits it to an income earned
account. Suppose, however, that a delay is experienced, and that, at the end of
the current accounting period, a portion of the amount has not been earned.
What should the accountant do under such circumstances?
7. Will the column totals of the after-closing trial balance always equal the
totals appearing in the balance sheet for the same date?
8. Do accounts with the word accrued in their titles appear in the profit and
loss statement or the balance sheet?
Problems— Group A
Problem A-l. From the trial balance and other data provided below, pre-
pare adjusting entries for the Blanding Company at the end of operations for the
month of March, 1954. The books were closed on February 28, 1954.
BLANDING COMPANY
Trial Balance
March 31, 1964
Cash .. 2,400.17
Parts . 1,600.50
Prepaid rent . 1 f 800 . 00
Equipment 18,000 00
Reserve for depreciation — Equipment. . . . 6,000 00
Accounts payable ... . 2,300.00
Unearned fee income . . 3,00000
Capital stock 10,00000
Earned surplus . . 1,621 .50
Commissions earned. . 4,000.00
Salaries and wages expense 3,015 . 50
Miscellaneous expense. . 105 .33
26,921.50 26,921.60
498
ASSIGNMENT MATERIAL— CHAPTER 3 499
Data for adjustments:
(1) The equipment had an expected useful life of six years when purchased
new.
(2) Parts on hand at the end of March totaled $1,100.50.
(3) Rent expense for March was $200.
(4) Salaries and wages earned by employees but not paid amounted to $105.
(5) Of the balance in the Unearned Fee Income account, $1,500 has not been
earned.
(6) No entry had been made to record the rental of equipment by the Bland-
ing Company to J. M. White on March 1. One month's rent of $200 was due.
(Credit Rent Income.)
Problem A-2. The trial balance of the ledger of Waring Renovators, Inc.,
on September 30, 1954, was as follows:
WARING RENOVATORS, INC.
Trial Balance
September 30, 1954
Cash 1,50000
Government bonds 5,000 00
Prepaid insurance 600 00
Land 3,000 00
Building.. . . 12,000.00
Reserve for depreciation — Building 1 , 500 00
Mortgage payable 6,000 00
Capital stock . 1 2 , 000 00
Earned surplus 1 , 334 . 00
Service income . 4,350 00
Wages expense . 2,884 00
Equipment rent expense 200.00
25,184 00 25,184.00
Adjustments were required for the following:
(1) The government bonds were acquired on September 1 as an investment,
and interest in the amount of $7 has accrued.
(2) On September 1 insurance was prepaid for twelve months.
(3) Depreciation of building for September was $50.
(4) The mortgage was signed on September 15 and accrued interest payable
as of September 30 was $15.
(5) Accrued wages payable totaled $95.
(6) On September 29, $150 cash was collected for work to be performed in
October. This amount was erroneously credited to the Service Income account;
Unearned Service Income should have been credited.
Prepare adjusting entries.
Problem A-3. J. W. Dewing and A. R. Gray completed the organization of
the Resort Motels Company on June 1, 1954, and engaged in the following trans-
actions during June.
1954
June 1 — Dewing and Gray each paid in $30,000. Capital stock of $60,000 par
.value was issued.
1 — A motel was purchased for $51,000 cash, including land and supplies.
The land was valued at $10.000 and the sunnlies At £1 .000.
500 ASSIGNMENT MATERIAL— CHAPTER 3
acquired, the motel was fully occupied by guests who had reserved
space for the entire summer season.
June 17 — Purchased supplies on account from the Davis Company for $500.
20 — Received $2,000 cash for a portion of the land, sold at cost.
30 — Laundry expense for the month was $110, paid in cash.
30 — Rent earned during June totaled $2,400, all collected in cash on this
date.
30 — Salaries and wages amounted to $1,400, all paid in cash.
30 — A dividend of $200 was paid in cash.
Adjustments were required on June 30 for the following:
(1) Depreciation of motel, $180.
(2) Supplies expense, $300.
(3) Salaries arfd wages earned by employees but unpaid, $90.
(4) A floor-sanding machine was rented on June 28 at a rate of $10 per day.
Three days' rent was unpaid on June 30.
Required:
(a) Journalize the transactions and post.
(b) Take a trial balance.
(c) Journalize and post adjusting entries.
(d) Prepare a statement of income and expense, a statement of earned
surplus, and a balance sheet.
(e) Journalize and post closing entries.
(f) Rule ledger accounts having no balances.
(g) Take an after-closing trial balance.
Problem A-4. The after-closing trial balance of the Merriam Company at
the end of October, 1954, was as follows:
MERRIAM COMPANY
After-Closing Trial Balance
October 31, 1964
Cash 4,00000
Supplies . 800 00
Prepaid rent. 1,20000
Equipment ... 15, 000 00
Reserve for depreciation — Equipment . 4,500 00
Capital stock.. 15,000 00
Earned surplus 1,50000
2MJOO~00 21 ,000 00
Transactions during November were as follows:
1954
November 1 — Paid advertising expense of $60 in cash.
8 — Issued capital stock for land, $2,000.
15 — Purchased supplies costing $400 on account from R. N. Devoe.
18 — Billed R. M. Bain $250 for commissions earned.
20— Paid dividend of $150 in cash.
28— Paid R. N. Devoe $200 on account.
30 — Collected $4,800 in commissions from a transaction completed
today.
30 — Salaries expense paid in cash amounted to $950.
ASSIGNMENT MATERIAL-CHAPTER 3 501
The following data were available for adjustments at the end of November:
(1) Rent expense for November was $1,000.
(2) Depreciation of equipment amounted to $1,500.
(3) Supplies used during November totaled $500.
(4) Salaries earned by employees but not paid amounted to $88.
Required: (See note below.)
(a) Journalize the November transactions and post.
(b) Take a trial balance.
(c) Journalize and post adjusting entries.
(d) Prepare a statement of income and expense, a statement of earned
surplus, and a balance sheet.
(e) Journalize and post closing entries.
(f) Rule ledger accounts having no balances.
(g) Take an after-closing trial balance.
Note. Students using the forms prepared for the solution of the "A" prob-
lems will find the after-closing balances as of October 31, 1954, entered in the
appropriate ledger accounts.
For those students not using the prepared forms, it will be necessary to enter
the after-closing balances as of October 31, 1954, in appropriate ledger accounts.
An example showing how this should be accomplished is given belo\\ :
Cash No 1
1954
Oct.
Balance 4,000m
:. I ;
Problems — Group B
Problem B-l. The trial balance of the Libby Printing Company at the end
of October, 1954, was as follows:
LIBBY PRINTING COMPANY
Trial Balance
October 31, 1954
Cash . 500.00
Supplies 700 00
Mortgage receivable . 2,00000
Land 2,500 00
Building 10,000 00
Reserve for depreciation — Building 500 00
Accounts payable 300 00
Capital stock . 10,000 00
Earned surplus . ... .... 3,90000
Printing service income 4,000 00
General expenses . 2,500 00
Selling expenses __5_?9__29
18,700_00 18,700 00
Supplementary data:
(1) Depreciation of building, $10.
(2) Supplies used during month, $350.
(3) Wages accrued at end of month, $75.
502 ASSIGNMENT MATERIAL-CHAPTER 3
(4) The mortgage was received on October 15. Interest accrued for the half-
month, $6.67.
(5) A section of the building was rented on October 10 to L. R. Smith.
Smith owed $90 rent on October 31.
Prepare adjusting entries.
Problem B-2. Prepare adjusting entries from the following information per-
taining to the accounts of the Larry Motor Freight Lines at the end of June, 1954:
(1) Accrued wages payable, $350.
(2) Depreciation of trucks and vans during June, $1,600.
(3) Accrued interest on U. S. Government bonds owned, $110.
(4) Two-year insurance coverage was purchased on June 1 for $480 and
entered as an asse^.
(5) A tow truck was rented during June from the Wescott Company at the
rate of fifteen cents a mile. This truck was driven 1500 miles during the month
and no rental had been paid as of June 30.
(6) Supplies used during June totaled $970.
(7) On June 1 a trailer was rented to the Gilbert Company for a two-month
period at a rate of $200 per month. No cash had been received as of June 30
and no entry had been made.
(8) Accrued interest payable, $20.
Problem B-3. The Hammond Plumbing Company, engaged in inspection
and repair work only, has been in business several years. It closes its books on
December 31. The company's trial balance at the end of the year 1954 was:
HAMMOND PLUMBING COMPANY
Trial Balance
December 31, 1954
Cash 1,200 00
Note receivable . . . 1,00000
Prepaid insurance ... . . 800 00
Land 7,300 00
Building. .... 14,400 00
Reserve for depreciation — Building 2 , 160 . 00
Automotive equipment 5,000 00
Reserve for depreciation — Automotive equipment . 1,000 00
Accounts payable . 300.00
Unearned inspection income .. . ... 6,00000
Capital stock . 15,000.00
Earned surplus ... 3 ,290 00
Dividends . . 2,00000
Repair service income 13,250 00
Salaries and wages expense 8 ,000 .00
Miscellaneous expense 1,300.00
41,000"00 41,000 00
The building had an expected useful life of twenty years when new, and the
automotive equipment an expected life of five years when new. The accrued
interest on the note receivable amounted to $5 as of December 31, 1954. The
insurance coverage was acquired on January 1, 1954, and the policy was effective
for two years. Half of the balance in the Unearned Inspection Income account
had been earned on December 31.
Prepare adjusting and closing entries.
ASSIGNMENT MATERIAL-CHAPTER 3 503
Problem B-4. The trial balance given below was taken from the ledger of
the Willet Company before adjusting entries were posted at the end of operations
for the year 1954.
WILLET COMPANY
Trial Balance
December 31, 1964
Cash . 800 00
Notes receivable. 2,500 00
Supplies . . 750 00
Land 3,000.00
Building 18,000.00
Reserve for depreciation — Building. . . 2, 160 00
Unearned service income 3,50000
Mortgage payable • . 5,000.00
Capital stock .... 10,00000
Earned surplus . . . 2,590 00
Commissions income . . 9,000.00
Salaries and wages expense. . . . 6,500 00
Miscellaneous expense. . 700 00
32,250 00 32,250 00
The following adjusted trial balance was taken from the ledger after adjusting
entries had been posted but before closing entries were recorded.
WILLET COMPANY
Adjusted Trial Balance
December 31, 1964
Cash .. . 800.00
Notes receivable. .. . 2,50000
Accrued interest receivable. . 12 50
Supplies... . 275.00
Land 3,000 00
Building . ... 18,000 00
Reserve for depreciation — Building 2,880.00
Accrued interest payable . . 100 00
Salaries and wages payable . . .... 10000
Unearned service income 700 00
Mortgage payable. . . 5,000 00
Capital stock ... 10 , 000 00
Earned surplus . 2,590 00
Commissions income. . ... 9,00000
Salaries and wages expense 6,600 00
Miscellaneous expense 700 00
Interest income . 12.50
Supplies expense . 475 00
Depreciation of building 720.00
Service income 2,800.00
Interest expense 100 00
33,182 50 33,182.50
Make the adjusting entries which were entered in the journal of the Willet
Company at the end of 1954.
504 ASSIGNMENT MATERIAL-CHAPTER 3
Problem B-6. Statements of the Whittaker Company are presented below:
WHITTAKER COMPANY
Statement of Income and Expense
For the Month of January, 1954
Income:
Commissions income ......... ........... $6,200 00
Service income, . ...................... 1,800.00 $8,000 00
Expenses:
Salaries and wages expense .......................... $5,900 00
Supplies expense .............. 800 00
Depreciation of service equipment ...... . .... 167 00
Rent expense ......... 150 00 7,017 00
Net income ..... . $ 983 po
WHITTAKER COMPANY
Statement of Earned Surplus
For the Month of January, 1964
Earned surplus, December 31, 1953 ...... . $ 650 00
Add net income for January, 1954 — per statement of income and expense 983 JOO
Total . . $r,63300
Deduct dividends 250 00
Earned surplus, January 31, 1954 $1 ,383 JO
WHITTAKER COMPANY
Balance Sheet
January 31, 1964
Assets Liabilities and Owners' Equity
Cash $ 1,200.00 Liabilities:
Supplies 100 00 Accrued salaries and
Servicing equip- wages $ 200 00
ment $16,000.00 Accrued rent payable 150 00
Less reserve Unearned service income 1 ,400 00
for depreci-
ation. . 4,167 00 11,83300 Owners' equity:
Capital stock. . 10,00000
_ Earned surplus 1 ,383 00
$KM33 00 $13,133 00
The data from which adjusting entries were made before the above state-
ments were prepared are summarized below :
(1) Supplies used during January, $800.
(2) Depreciation of servicing equipment, $167.
(3) Of the unearned service income, $1 ,800 was earned during January.
(4) Salaries and wages earned by employees but unpaid on January 31, $200.
(5) Rent payable for use of building during January, $150.
Required: Reconstruct the January 31, 1954 trial balance of the ledger of the,
Whittaker Company before adjusting entries were made.
ASSIGNMENT MATERIAL FOR CHAPTER 4
Questions
1. What are working papers?
2. Is it always desirable to prepare working papeis before preparing the
financial statements?
3. After entering the account balances in the Adjusted Trial Balance col-
umns of the working papers, to what column would you extend the balance of
each of the following accounts?
Capital stock.
Income from services.
Prepaid insurance.
Dividends.
William Hill (an account receivable).
Salaries expense.
Accrued interest receivable.
Unearned rent income.
4. In what columns is the net income entered in the working papers?
5. In what columns is the earned surplus entered in the working papers?
6. Give the sequence of procedures for the accounting cycle.
7. Describe the type or types of debit entries that normally will appear in an
accrued expense payable account.
8. Are accrued receivable and payable accounts ever closed?
Problems — Group A
Problem A-l. A trial balance after the journal entries for the August
transactions had been posted was as follows:
FIELDING BALER COMPANY
Trial Balance
August 31, 1964
Cash 4,800 00
Prepaid insurance 1,00000
Prepaid rent . 4,000 00
Equipment . 24,00000
Reserve for depreciation — Equipment 4 , 800 . 00
J. K. Morten . 875.00
Capital stock . . 21 , 000 . 00
Earned surplus . . 4 , 825 . 00
Dividends. ... . . 500 00
Service income.. 9,800.00
Salaries expense 6,000.00
Miscellaneous expense 1,000.00
41,300.00 41,300.00
505
506 ASSIGNMENT MATERIAL-CHAPTER 4
Adjustments were required as follows:
(1) Insurance expense for August, $188.50.
(2) The equipment had an expected useful life of five years when new.
(3) Prepaid rent on August 31 was $3,150.35.
(4) Accrued salaries payable, $115.08.
Prepare working papers.
Problem A-2. The trial balance of the Oil Well Servicing Company at the
end of the calendar year 1954 was as follows:
OIL WELL SERVICING COMPANY
Trial Balance
December 31, 1964
Cash . 9 5,700 00
U. S. Treasury notes 30,000 00
Chemicals 200,000 00
Prepaid insurance 3 , 200 00
Land . 9,000.00
Building. . 50,000.00
Reserve for depreciation — Building 10,000 00
Equipment. 560,000 00
Reserve for depreciation — Equipment 10*5,200 00
Note payable 18,000 00
Capital stock 400,000 00
Earned surplus ^ 27,70000
Dividends 30,000 00
Oil-well servicing income. 775,000 00
Salaries expense 440,000 00
Gasoline and oil 8,000 00
1,335,900 00 1 ,"335, 900. 00
Adjusting data at the end of the year comprised the following:
(1) The treasury notes were purchased in November. Interest of $85 has
accrued.
(2) Chemicals used during the year, $180,000.
(3) Insurance expense for the year, $2,600.
(4) The building had an expected useful life when new of twenty-five years ;
the equipment, an expected life of ten years.
(5) The note payable was given on December 1. Interest accrued for one
month amounts to $90.
Prepare working papers.
Problem A-3. The organization of Excavators, Inc., was completed on
April 1, 1954. The following transactions occurred during the first month of
operations:
1954
April 1 — Issued $90,000 par value capital stock to W. J. Jenness and T. J.
Wagner for cash.
1 — Equipment with an expected useful life of five years and costing
$80,000 was purchased for cash.
15 — Rent was paid for the use of land and building from April 15, 1954 to
April 15, 1955, $1,800.
19 — Paid repair expense on equipment, $170.85.
23 — Received bill from W. K. Alexander for supplies which had been used
on jobs, $217.15.
ASSIGNMENT MATERIAL-CHAPTER 4 507
1954
April 28— Paid dividend of $800.
30 — Paid salaries and wages of $6,112.18 for the month.
30 — Completed an excavation contract for Downing Corporation, earning
$10,014.22 from the job. Of this amount, $6,000 was collected in
cash and the Downing Corporation has agreed to pay the balance
within thirty days.
Adjustments were required, in addition to those indicated above, as follows:
(1) Accrued salaries and wages, $104.80.
(2) Unreimbursed traveling expenses, paid from peisonal funds by an officer
of Excavators, Inc. while negotiating for one of the jobs completed in April,
amounted to $125.30. (Credit Traveling Expenses Payable.)
Required:
(a) Journalize transactions and post to ledger accounts.
(b) Take a trial balance.
(c) Prepare working papers.
(d) Prepare statements.
(e) Make and post journal entries for adjustments.
(f) Make and post journal entries to close the books.
(g) Rule ledger accounts having no balances,
(h) Take an after-closing trial balance.
Problem A-4. Bowlanes Corporation was organized on June 1, 1954, to
acquire and operate a bowling center. June transactions follow.
1954
June 1 — $80,000 par value of capital stock was issued to R. H. Marshall and
B. W. Chamberlin for cash.
1 — Bowling equipment, building, and land were acquired for $75,000 cash.
The cost was apportioned as follows:
Bowling equipment $50 , 000
Building... 20,000
Land 5,000
5 — A bill was received from C. M. Whiting for supplies costing $510.25.
It is estimated that these supplies will last two months.
12 — Paid advertising expense, $75.
24— Paid C. M. Whiting $300 on account.
30 — Wages for the month were paid in cash, $2,102.50.
30 — Dividends in the amount of $100 were paid.
30 — During June the bowling facilities were used exclusively by the State
Bowling Club for a regional tournament. Bowlanes Corporation
received $3,720 today from the club for the use of the facilities
during June.
Adjustments were required as follows:
(1) Bowlanes is required to pay the city an operator's tax of one per cent of
its gross bowling income earned each month. (Credit Accrued Taxes Payable.)
(2) The bowling equipment has an expected useful life of five years.
(3) The building has an expected useful life of twenty years.
7H
508 ASSIGNMENT MATERIAL-CHAPTER 4
Required:
(a) Journalize the transactions and post to ledger accounts.
(b) Take a trial balance.
(c) Prepare working papers.
(d) Prepare a statement of income and expense, a statement of earned
surplus, and a balance sheet.
(e) Make and post journal entries for adjustments.
(f) Make and post journal entries to close the books.
(g) Rule ledger accounts having no balances,
(h) Take an after-closing trial balance.
Problems — Group B
Problem B-l. Drive-in Movies, Inc., had the following trial balance at the
end of August, 1954:
DRIVE-IN MOVIES, INC.
Trial Balance
August 31, 1954
Cash ... 1,875 00
Prepaid rent 4,400 00
Equipment 15,000 00
Reserve for depreciation — Equipment .. 2,50000
Capital stock 1 0 , 000 00
Earned surplus 705 45
Dividends.. 300 00
Admissions income 1 1 , 000 00
Salaries expense 2,030 45
24,205.45 24,205 45
Adjustments were required as follows:
(1) Film rental expense amounted to 60% of admissions income. No pay-
ments had been made on August rental.
(2) Depreciation of equipment, $250.
(3) Rent expense, $400.
(4) Accrued commissions income on refreshment stand amounted to $75.08
for the month.
Required:
(a) Working papers.
(b) Adjusting entries.
(c) Closing entries.
Problem B-2. The Johnson Company's trial balance as of April 30, 1954,
is given on the following page.
Data for adjustments:
(1) Service income in the amount of $1,200 has been earned.
(2) Supplies used during April, $600.
(3) Depreciation of building was $75.
(4) Equipment was rented on April 1. One month's rental was $300 and no
payment had been made as of April 30.
Prepare working papers.
ASSIGNMENT MATERIAL— CHAPTER 4 509
JOHNSON COMPANY
Trial Balance
April 30, 1954
Cash ... . 500 00
A. B. Hunt 1,200.00
Supplies 750.75
Land 4,000.00
Building 18,000 00
Reserve for depreciation — Building. 5,400.00
R. C. Holt 1,20000
Unearned service income 1,600.00
Capital stock 15,000 00
Earned surplus 1 ,286 58
Dividends 225.00
Fee income 6,300 00
Wages expense 6,000 00
Other expense 110 83
30,786_58 30,786 58
Problem B-3. Using the trial balance and the data for adjustments given
below, prepare working papers for Bauer Laundry, Inc., for the month of August:
BAUER LAUNDRY, INC.
Trial Balance
August 31, 1954
Cash 1,520.00
Note receivable 2 , 000 . 00
Supplies 2,660.00
Land 11,000.00
Building . 20 ,000 00
Reserve for depreciation — Building 12,000 00
Laundry equipment 56,00000
Reserve for depreciation — Laundry equipment 14,000 00
Ebb Soap Company 5,500 00
Capital stock 50,000 00
Earned surplus 7 , 550 00
Dividends 500 00
Laundry income 9,00000
Salaries expense 4,220 00
Advertising expense 150 00
98,050 00 98,050 00
Data for adjustments:
(1) Accrued interest on the note receivable, $10.
(2) Supplies costing $625 were on hand.
(3) Depreciation of building was $90, and depreciation of laundry equipment
was $583.
(4) Salaries accrued, $60.
(5) On August 1 Barton Delivery Service was engaged at the rate of $30
per day used. The service was employed eight days in August and no payments
were made.
Problem B-4. The Rotary Drilling Company was organized on September
1, 1954, to drill for oil on a contract basis. Transactions occurring during Sep-
tember are stated on the following page.
510 ASSIGNMENT MATERIAL-CHAPTER 4
1954
September 1 — A. R. Southworth and J. K. Silk each paid in 850,000. Capital
stock of $100,000 par value was issued to them.
1 — Drilling equipment costing $160,000 and having an expected use-
ful life of five years was purchased from the Oil Well Equip-
ment Company. $90,000 cash was paid.
1 — Insurance coverage for two years was purchased for $1,440 cash.
5 — Received $60,000 as an advance payment on footage to be drilled
for the Mid-State Oil Company. (Credit Unearned Drilling
Income.)
8 — Paid cash for drilling supplies costing $11,000.
17 — Paid Oil Well Equipment Company $50,000 on account.
25 — Completed a shallow well for the Devonian Production Com-
pany at a contract price of $9,000. Devonian paid $7,500
cash.
30— Paid dividend of $600.
30 — Paid salaries and wages for the month, $6,200.
Information for adjustments, in addition to that provided above, was as
follows:
(1) One-sixth of the payment advanced by Mid-State Oil Company had been
earned.
(2) Drilling supplies costing $3,000 were on hand.
Required:
(a) Journalize the transactions and post the journal entries to ledger
accounts.
(b) Take a trial balance.
(c) Prepare working papers.
(d) Prepare a statement of income and expense, a statement of earned
surplus, and a balance sheet.
(e) Make and post journal entries for adjustments.
(f) Make and post journal entries to close the books.
(g) Rule ledger accounts having no balances,
(h) Take an after-closing trial balance.
Problem B-5. Following is the after-closing trial balance of The Lee Com-
pany.
THE LEE COMPANY
After-Closing Trial Balance
December 31, 1953
Cash . 3,600.00
Note receivable . . . 1,200.00
Accrued interest receivable 30.00
Prepaid insurance 60.00
Equipment 18,000 00
Reserve for depreciation — Equipment 4,500.00
J. A. Mohr.... 720.00
Accrued rent payable 120 00
Capital stock 16,000.00
Earned surplus 1,550 00
22,890.00 22,890 00
ASSIGNMENT MATERIAL— CHAPTER 4 511
Journalize the following transactions that occurred during January, 1954.
1954
January 2 — Paid $720 to J. A. Mohr.
4 — Paid the December, 1953 rent, $120.
7 — Collected $1,000 in fees for work completed today.
15 — Paid January rent, $120.
20 — Collected the note receivable, which matured today, principal and
interest amounting to $1,233.
22— Paid wages, $700.
Problem B-6. The after-closing trial balance of Hilldale Corporation
appears below.
HILLDALE CORPORATION
After-Closing Trial Balance
December 31, 1953
Cash 8,900.00
Accrued rent receivable 200 00
Land 2,000.00
Building . . . 7,000.00
Reserve for depreciation — Building 3,500.00
Accrued salaries payable . . 400 00
Accrued taxes 105 00
Capital stock . .. 12,00000
Earned surplus ... . 2,095 00
18,100 00 18,100 00
Journalize the following transactions and adjustments for January, 1954.
1954
January 3 — Paid the accrued taxes of $105.
7 — Collected $800 in cash for repair services completed today.
11 — Paid salaries for the month ending January 10, 1954, $600.
18 — Received $900 cash for repair services completed today.
27 — Paid miscellaneous expenses, $120.
31 — Data for adjustments:
Accrued taxes, $9.
Depreciation, $12.
Accrued salaries, $410.
Repair services performed, not billed, $310.
Accrued rent receivable, $300.
(Storage space in the building is rented for $100 a month. As of
January 31, 1954, three months' rent is uncollected.)
ASSIGNMENT MATERIAL FOR CHAPTER 5
Questions
1. How is the gross profit computed?
2. State an alternative heading for the statement of income and expense.
3. Describe the entries normally appearing in the Inventory account.
4. When are^ntries made in the Cost of Goods Sold account?
5. Are the adjusting and closing entries for a merchandising company using
the perpetual inventory method made in the same manner as those for a service
enterprise?
6. How does a deficit arise?
7. How is a deficit shown in the balance sheet?
8. If there is a net loss for the period, where will it appear in the working
papers?
9. In what ways are the following accounts similar?
Inventory
Prepaid insurance
Problems — Group A
Problem A-l. Journalize the following transactions of Central Television
Sales Corporation, a newly organized corporation.
1954
July 1 — Issued $10,000 par value stock for cash.
2 — Paid rent for July, $110.
3 — Purchased from Wholesale Supply Company, on account, five television
sets for $200 each.
7 — Sold one television set for $300 cash.
8 — Paid $40 as commission to the salesman.
10 — Sold a television set for $300 to R. S. Brown on account.
15— Paid $1,000 to Wholesale Supply Company.
18 — Purchased for cash four television sets for $200 each.
20 — Paid $30 for newspaper advert sing.
24— Collected $300 from R. S. Brown.
24 — Paid $40 commission to the salesman.
28 — Cash sale of three television sets to Local Hospital for $860.
Problem A-2. The after-closing trial balance of Air Distributors, Inc., is
presented on the following page.
The inventory on December 31, 1953, consisted of two airplanes costing
$3,500 each.
(a) Journalize the January, 1954 transactions listed after the trial balance
on the following page.
512
ASSIGNMENT MATERIAL— CHAPTER 5 513
AIR DISTRIBUTORS, INC.
After-Closing Trial Balance
December 31, 1953
Cash . 7,105 20
Inventory.... 7,00000
Prepaid rent 300.00
Accrued commissions payable .... 400 00
Accrued taxes . . . 135 80
Capital stock .... 15,00000
Earned surplus (Deficit) 1,130 60
15,535 80 15,535 80
1954
January 2 — Sold an airplane and collected cash for the sales price, $4,800.
5 — Purchased from Willow Aircraft Company on account two air-
planes costing $3,600 each.
7 — Paid the taxes accrued on December 31, 1953.
10 — One of the salesmen sold the remaining airplane that was on hand
December 31, 1953. He collected $4,800 from the customer.
He deducted his commission on this sale and the commission
owed to him as of December 31, 1953, and turned in $4,000 to
the company.
15 — Delivered one of the airplanes acquired from Willow Aircraft Com-
pany to a customer and collected the sales price, $4,950.
18 — Paid the amount owed to Willow Aircraft Company.
31 — Purchased from Willow Aircraft Company on account three air-
planes costing $3,650 each.
(b) Compute the balance in the Inventory account as of January 31, 1954.
Problem A-3. Following is the trial balance of the Johnson Tractor Sales
Company at the end of operations for the month of October, 1953:
JOHNSON TRACTOR SALES COMPANY
Trial Balance
October 31, 1953
Cash . 6,000 00
Inventory 22,000 00
Prepaid insurance 300 00
Land.. . 19,000 00
Building 60,000 00
Reserve for depreciation — Building 1 8 , 000 . 00
Earth-Mover Tractor Company 10,000 00
Capital stock 60,000 00
Earned surplus 1 4 , 600 00
Dividends 3,000 00
Sales ... . 61,00000
Cost of tractors sold . 43,000 00
Advertising expense 2,10000
Miscellaneous expense 2,200 00
Salaries and wages expense . . , . 6,000 00
163,600 00 r63,6bo"OQ
Accrued salaries and wages amount to $400. The building when new had
an expected useful life of forty years. Insurance premium unexpired at the end
of October is $250.
Prepare adjusting and closing entries as of October 31, 1953, and a profit and
loss statement for the month of October, 1953.
514 ASSIGNMENT MATERIAL-CHAPTER 5
Problem A-4. Using the following information, prepare working papers for
the year ended June 30, 1954.
ARBORVIEW CORPORATION
Trial Balance
June 30, 1954
Cash . . 3,200 00
U. S. Government bonds 5,000 00
Inventory. . 9,500 00
Land 2,750 00
Building. 9,000 00
Reserve for depreciation — Building 3 , 000 00
Equipment. 2,800 00
Reserve for depreciation — Equipment J , 200 00
Accrued taxes 500 . 00
Capital stock. 25,000 00
Earned surplus (Deficit) 3,750 00
Sales 35,000 00
Cost of goods sold. 25,000 00
Advertising expense. 350 00
Salaries expense 2,400 00
Miscellaneous expense 950 00
64,700 00 64",W6~00
Depreciation:
(a) Depreciation of building, $225.
(b) Depreciation of equipment, $140.
Accrued amounts as of June 30, 1954:
(c) Accrued interest receivable, $25.
(d) Accrued salaries, $300.
(e) Total accrued taxes, $750.
Problem A-5. The following adjusted trial balance was prepared at the end
of the company's fiscal year.
PARKSIDE COMPANY
Adjusted Trial Balance
August 31, 1954
Cash . . 7,000.00
A.B.Jones. .. 2,10000
R. W. Bird . 800 00
Inventory. 4,450 00
Land. . 2,800.00
Building. 10,500 00
Reserve for depreciation — Building . 4,800 00
Equipment 4 , 000 00
Reserve for depreciation — Equipment. 1,150 00
Accrued salaries payable. . . 7500
Accrued taxes. 150 00
Capital stock . 30 , 000 00
Earned surplus (Deficit) 2 , 765 . 00
Sales .. ... 34,000 00
Cost of goods sold . . 26 , 000 00
Salaries expense . . . 8 , 000 . 00
Taxes. . 900 00
Advertising. 250 00
Depreciation of building , 210 . 00
Depreciation of equipment 400 00
70,175 00 70,175.00
ASSIGNMENT MATERIAL— CHAPTER 5 515
Required:
(a) Profit and loss statement, earned surplus statement, and balance sheet.
(b) Journal entries to close tbe books.
Problems— Group B
Problem B-l. Determine the cost of goods purchased by Central Stores,
Inc., from the following data:
Inventory at the beginning of the period $12,113.98
Sales 19,769 40
Sales returns 425 . 60
Cost of goods sold 1 2 , 430 . 24
Selling commissions 1,97694
Inventory at end of period 12,498 33
Problem B-2.
TONE COMPANY
Trial Balance
December 31, 1953
Cash . 18,000 00
Accounts receivable 42 , 400 . 00
Notes receivable 22,500 00
Inventory. . 55,000 00
Advertising. 6,300 00
Insurance 2,400 00
Building. 60,000 00
Reserve for depreciation — Building 5,000 00
Delivery equipment . .. 15,00000
Reserve for depreciation — Delivery equipment 5 , 500 00
Notes payable 1 5 , 000 . 00
Accounts payable 25,000 00
Mortgage payable 25,000 00
Capital stock . 100 , 000 . 00
Earned surplus 32 , 000 . 00
Sales 143,000 00
Cost of goods sold 88,500 00
Selling expense 20,800 00
Administrative expense 19,600 00
350,500 00 350,500 00
Adjustment information for the year ended December 31, 1953:
Depreciation of building, 4% of cost.
Depreciation of delivery equipment, 20% of cost.
Unexpired insurance, $800.
Advertising paid in advance, $1,350.
Interest accrued on the mortgage, $1,000.
Interest accrued on the notes receivable, $1,350.
Wages payable to office workers amounted to $483 on December 31, 1953.
Required:
Working papers.
Problem B-3. The trial balance on the following page was taken from the
books of The Newton Company at the close of business for the year 1954.
516 ASSIGNMENT MATERIAL-CHAPTER 5
THE NEWTON COMPANY
Trial Balance
December 31, 1954
Cash.... 5,438.00
Accounts receivable 12,720 00
Inventory 6,500 00
Materials and supplies 2,250 00
Prepaid insurance 270 00
Land. 5,000 00
Buildings . 50,000 00
Allowance for depreciation — Buildings 10,000 00
Equipment . 60 , 000 . 00
Allowance for depreciation — Equipment 32,000 00
Accounts payable . 4 , 450 . 00
Notes payable— 5%, due 12/31/57 . . 16,00000
Taxes payable 2,520 00
Capital stock 60,000 00
Earned surplus... . 12,50000
Dividends 3,600.00
Sales .. 138,430.00
Cost of goods sold 82,400 00
Selling commissions 6,900 00
Delivery expense 2,380 00
Wages and salaries 33 , 500 00
Property taxes. . 4,54200
Interest expense _ 400.00
275", 900 00 275,900 Oj)
The following information was also obtained from the records maintained by
The Newton Company.
(1) The building was put into operation on January 1, 1949, and is expected
to have a useful life of 25 years from that date.
(2) The equipment is to be depreciated at 20% per year.
(3) A count of the materials and supplies shows $460 as the cost of those on
hand.
(4) The insurance policy was purchased on June 30, 1953, and expires on
June 30, 1956.
(5) The notes payable bear interest of 5% per year. Interest was last paid
on July 1, 1954.
(6) Accrued wages payable amount to $110.
(7) Sales commissions payable are $332.
Required:
Working papers.
Problem B-4. On July 31, 1954, Mr. Sam Teed and Mr. John Tokay
received a charter from the State of Wisconsin authorizing the Totee Corpora-
tion to issue five hundred shares of $50 par value stock and to engage in the pur-
chase, sale, and servicing of refrigerators and allied products.
1954
August 1 — The Totee Corporation issued 300 shares of stock to Mr. Teed upon
the investment of $15,000, and 200 shares of stock to Mr. Tokay
upon the investment of $10,000.
1 — A showroom and warehouse-servicing building was rented from the
May Real Estate Agency for $300 per month, payable in advance.
The August rent was paid.
ASSIGNMENT MATERIAL-CHAPTER 5 517
1954
August 3 — Received, per order, 15 O. K. Specials at an invoice price of $175
each, from the O. K. Cooling Equipment Co.
4 — Purchased for cash from Johnstone Hardware Co. tools and light
repair equipment for $600. It is expected that these items will
last approximately two years.
5 — Paid O. K. Cooling Equipment Co. $2,000 on account and ordered
$850 worth of service supplies and parts.
6 — Sales for the day totaled two O. K. Specials. One was sold for $255
cash installed and the other was sold for $273 on credit to J. B.
Stonehue.
8 — Supplies and parts ordered on August 5 from O. K. Cooling Equip-
ment Co. were received.
9- -Collected $15 for repairs of refrigerators.
10 — Billed D. R. Tompkins $28 for general overhaul of his air conditioner.
11 — Paid balance owing O. K. Cooling Equipment Co. and ordered 12
O. K. Specials.
12 — Paid $48 for newspaper advertising for the week ended August b'.
13— Paid employees' wages for the week, $350.
Sales for the day: Cash— three units at $255 each.
Credit — one unit at $273 to Frank Rae.
15- Collected $15 from J. B. Stonehue.
16 — Paid $83 for window posters advertising next week's sale.
17 — Received the 12 O. K. Specials ordered on August 11, at an invoice
price of $175 each.
18 — Collected D. R. Tompkins' account.
19 — Billed the Stuart Hotel $818 for general overhaul of its refrigerator
system.
20— Paid employees' wages for the week, $350.
Sales for the day: Cash — four units at $255 each.
Credit — one unit at $273, to Henry Peel.
— one unit at $273 to H. E. Roberts.
22 — Collected $15 from J. B. Stonehue and $15 from Frank Rap.
23 — Paid newspaper advertising for the week ended August 13, $(>3.
24- -Cash received for servicing of equipment, $38.
25 — Paid O. K. Cooling Equipment Co. $1,000 on account.
26 — Paid Local Drayage Co. $180 for deliveries of refrigerators to cus-
tomers during the first three weeks.
27 — Paid employees' wages for the week, $350.
Sales for the day: Cash — four units at $255 each.
29 — Purchased repair parts and supplies for $2,500 cash.
30--Received ten O. K. Specials from 0. K. Cooling Equipment Co. at
an invoice price of $175 each.
Paid advertising for the week ended August 20, $105.
31 — Paid salaries of $400 each to Mr. Teed and Mr. Tokay.
Collected $15 each from J. B. Stonehue, Frank Rae, Henry Peel, and
H. E. Roberts.
Adjustment data:
(1) The corporation owes $130 for advertising.
(2) The corporation owes one-half week's wages to employees.
(3) The tools and equipment are to be depreciated for one full month. See
transaction of August 4.
518 ASSIGNMENT MATERIAL— CHAPTER 5
(4) The cost of supplies and parts used on repair jobs amounted to $438.
(5) Delivery expense incurred but not yet paid amounts to $60.
Required:
(a) Journalize, post, and prepare a trial balance.
(b) Prepare working papers.
(c) Journalize and post the adjusting and closing entries.
(d) Prepare a balance sheet and a profit and loss statement.
ASSIGNMENT MATERIAL FOR CHAPTER 6
Questions
1. State the differences in the bookkeeping procedures between the perpet-
ual inventory method and the periodical inventory method.
2. How is the cost of goods sold determined under the periodical inventory
method?
3. Why might an accountant find it convenient to list in the trial balance
accounts having no balances?
4. Are adjusting entries affected by the inventory method? Explain.
5. Are the closing entries affected by the inventory method? Explain.
6. Which inventory method is better? Give reasons.
7. The terms of an invoice are: 1/10; n/30. What does this mean?
8. What is meant by internal control?
9. What purpose is served by purchase requisitions?
10. Describe the procedure of checking an invoice for goods purchased.
Problems — Group A
Problem A-l. Journalize the March, 1954 transactions of Motor Sales Com-
pany. The management decides to separate engine sales and repair income in
the accounts but not to keep a perpetual inventory.
1954
March 1 — Issued $10,000 par value stock for $5,000 cash, land valued at $500,
and equipment valued at $4,500.
2 — Paid March rent, $200.
3 — Purchased six factory-rebuilt automobile engines for $68.50 each
from Morris Company, on account.
6 — Purchased shop supplies for $1,800 cash.
8 — Billed A. B. Sneed $100 for one rebuilt engine and $38.75 for repairs
on his car.
9 — Paid shop wages of $85.
13 — Collected $600 for repairs and rebuilding of wrecked car.
15 — Billed J. C. Aster $100 for one rebuilt engine and $39.20 for repairs
on his car.
Collected $95 for one rebuilt engine and $30 for repairs on another job.
16 — Paid shop wages of $85.
17 — Purchased four rebuilt engines for $72.80 each on account from
Morris Company and paid for those received on March 3.
20 — Truck overhauled for $400 cash.
22 — Collected $195 for two rebuilt engines.
23 — Paid shop wages of $85.
27 — Billed R. P. Cutter $104 for one rebuilt engine and $24.75 for repairs.
30 — Paid shop wages of $87.
519
520 ASSIGNMENT MATERIAL— CHAPTER 6
Problem A-2. The balance sheet of Southhold Company as of December 31,
1953, is presented below:
SOUTHHOLD COMPANY
Balance Sheet
December 31, 1953
Assets Liabilities and Owners' Equity
Cash . $ 3,471 40 Liabilities:
Accounts receivable 3,562 18 Accounts pay-
Inventory . ... 4,91920 able $4,468 58
Prepaid insurance 108 00 Accrued taxes
payable. 1,132 92 $ 5,601 50
Owners7 equity:
Capital stock.. $5,000 00
* Earned surplus 1,459 28 6,459 28
$12,060.78 $12,060 78
The accounts receivable and accounts payable totals were made up of the
following individual accounts:
R. T. Wright $ 562 18
W. R. Smith 428 00
X. B. James . 2,572 00
Total accounts receivable $3,562 18
Double Supply ( 'Ompany . . . $ 468 50
Jones and Jones ... 950 08
Over Supply Company. 3,050 00
Total accounts payable $4,468 58
The transactions for the month are presented below.
1954
January 1 — Paid month's rent, $250.
4 — Sale on account to X. B. James, $310.
6 — Paid Double Supply Company $468.50 on account.
9— Cash sales, $215.45.
14 — Purchased merchandise from Over Supply Company on account,
$612.90.
16 — Made payment of $300 on accrued taxes.
18— Cash collected from R. T. Wright on account, $562.18.
20 — Sold merchandise on account to R. T. Wright, $448.19.
24 — Paid $950.08 owed to Jones and Jones.
27— Cash sales, $448.92.
29 — Purchase from Over Supply Company on account, $842.18.
30— Sale on account to W. R. Smith, $562.20.
31 — Received $428 from W. R. Smith on account.
A physical count reveals $5,102.95 of merchandise on hand at the close of
business this date.
Required:
(a) Journalize the above transactions for January.
(b) Present the Cost of Goods Sold section of the statement of income and
expense for January.
ASSIGNMENT MATERIAL— CHAPTER 6 521
Problem A-3. Using the data below, prepare working papers.
HOLDAND CORPORATION
Trial Balance— December 31, 1954
Cash . 1,562.50
Notes receivable 2,000 00
Accounts receivable 5,450 00
Inventory, December 31, 1953 6,000 00
Supplies 1,570 00
Furniture and fixtures 3,500 00
Reserve for depreciation — Furniture and fixtures 800 00
Notes payable 3,000 00
Accounts payable 2,250 00
Capital stock. 8,000 00
Earned surplus 246 00
Sales 53,000 00
Purchases. 34,702 00
Wages 8,627 50
Rent 2,600 00
Taxes 1,214 00
Interest on notes payable 90 00
Interest on notes receivable __ 20 00
67,316 00 67,316 00
Additional information :
(1) Accrued interest receivable, $20.
(2) Supplies on hand, $430.
(3) Depreciation of furniture and fixtures, $2(52.
(4) Accrued interest payable, $90.
(5) Accrued wages payable, $225.
(6) Accrued taxes, $1,262.
(7) End-of-period inventory, $6,245.
Problem A-4. From the trial balance and other information given below,
prepare working papers and closing entries.
THE BARTON CORPORATION
Trial Balance — June 30, 1964
Cash 4,592 40
Accounts receivable 5,351 20
Inventory, June 30, 1953 . 7,849.00
Supplies 2,600 00
Land. 3,500 00
Building 40,000 00
Reserve for depreciation — Building 4,000 00
Equipment. . 15,200.00
Reserve for depreciation — Equipment 4,560 00
Mortgage payable— 6% . 10,000 00
Capital stock . . 30 , 000 00
Earned surplus . 2 , 566 . 1 8
Sales.. 68,863 22
Purchases 27,219 42
Advertising expense , 3 , 1 20 . 00
Wages and salaries 9 , 693 . 18
Interest expense . . . 600 . 00
Taxes 264.20
119,989 40 119,989.40
522 ASSIGNMENT MATERIAL-CHAPTER 6
Other information:
(a) Supplies on hand, $355.
(b) Equipment depreciation, 10%.
(c) Building depreciation, 4%.
(d) Accrued wages payable, $192.63.
(e) Inventory, June 30, 1954, $7,231.50.
Problems — Group B
•
Problem B-l. The entries given below were recorded in the journal of
Mathews Company for September, 1954. The company uses the perpetual
inventory method.
Journal
1954
Sept.
5
Repairs expense.
Cash...
Paid cash for repairs to building.
64
00
64
00
10
Inventory .
Bishop Company
Purchased 8 pumping units on account.
4,800
00
4,800
00
14
D. E. Sells....
Sales.
Sold 5 pumping units on account.
4,000
00
4,000
00
14
Cost of goods sold.
Inventory
Cost of 5 pumping units transferred from Inven-
tory to Cost of Goods Sold.
3,000
00
3,000
00
15
17
Bishop Company
Cash..
Paid on account.
Supplies. . .
4,000
310
00
40
4,000
310
00
40
Cash . .
Purchased supplies for cash.
21
Inventory .
A. N. Mentor
Purchased 7 pumping units on account.
4,200
00
4,200
00
26
Cash..
Sales..
Sold 7 pumping units for cash.
5,600
00
5,600
00
26
Cost of goods sold . . .
Inventory . .
Cost of 7 pumping units transferred from Inven-
tory to Cost of Goods Sold.
4,200
00
4,200
00
30
Dividends
Cash . . ,
200
00
200
00
Paid cash dividend.
Show how the journal of Mathews Company for September would appear if
the company had used the periodical inventory method of accounting instead of
the perpetual inventory method.
ASSIGNMENT MATERIAL-CHAPTER 6
Problem B-2.
523
BAKER COMPANY
After-Closing Trial Balance— July 31, 1954
Cash 760 75
J. E. Dunham . . . 425 60
Inventory. . . . 5,000 00
Equipment .. . 12,50000
Reserve for depreciation — Equipment . 4 , 850 . 00
C. D. Bain .. .. 500 00
Accrued rent payable . . 150 00
Capital stock . . ... 10,00000
Earned surplus . . . . 3,186 35
18,686 35 18,686.35
The Baker Company sells engine units and uses the perpetual inventory
method to account therefor.
Journal entries to record the company's transactions and to adjust and close
the books for August, 1954, are given below:
Journal
1954
August
3
C. D. Bain
Cash ... .
Paid on account
100
00
10
Inventory. .
J. A. Duncan
Purchased 15 engine units on account.
6,000
00
12
Cash . . ...
Golpa
5,000
00
OctlCD ,
Sold 10 engine units for cash.
12
Cost of goods sold
Inventory ....
Cost of 10 engine units sold transferred from
Inventory to Cost of Goods Sold.
4,000
00
15
Accrued rent payable
Rent expense. .
Cash
Paid rent for one month ending August 15.
150
150
00
00
24
Inventory
C. D. Bain
Purchased 13 engine units on account.
5,200
00
27
Johnson Companv
Sales
6,000
00
Sold 12 engine units on account.
27
31
31
Cost of goods sold
Inventory ... ...
Cost of 12 engine units sold transferred from
Inventory to Cost of Goods Sold.
Salaries expense . . . .
4,800
1,194
40
00
79
00
Cash
Paid salaries for month of August.
Dividends
Cash
Paid cash dividend.
100
6,000
5,000
4,000
300
5,200
6,000
4,80000
1,19479
4000
00
00
00
00
00
00
00
524
ASSIGNMENT MATERIAL-CHAPTER 6
Journal
1954
August
31
Depreciation expense — Equipment
230
00
Reserve for depreciation — Equipment
230
00
Depreciation of equipment for August.
31
Rent expense ....
150
00
Accrued rent payable
150
00
Accrual of rent for last half of August.
31
Sales . ...
11,000
00
Front and loss...
11,000
00
To close the income account.
31
Profit and loss .
10,524
79
Cost of goods sold
8,800
00
Salaries expense
1,194
79
Rent expense
300
00
Depreciation expense — Equipment
230
00
To close the expense accotmts.
31
Profit and loss
475
21
Earned surplus
475
21
To close the Profit and Loss account.
31
Earned surplus
40
00
Dividends
40
00
To close the Dividends account.
Show how the journal of Baker Company for August would appear if the com-
pany had used the periodical inventory method of accounting.
Problem B-3. From the closing entries given below, prepare a statement of
income and expense for Perrin Company for October, 1954,
1954
October
31
Sales....
18,750
30
Inventory.
6,063
10
Profit and loss
24,813
40
To close the Sales account and set up the end-
ing inventory.
31
Profit and loss
24,013
60
Inventory.
7,135
00
Purchases
16,005
00
Supplies expense.
30
10
Depreciation expense — Building
170
00
Insurance expense
53
60
Repairs expense.
140
30
Salaries expense . .
479
60
To close the expense accounts and to remove
the beginning inventory from the Inventory
account.
31
Profit and loss . . .
799
80
Earned surplus
799
80
To close the Profit and Loss account.
31
Earned surplus.
75
00
Dividends .
75
00
To close the Dividends account.
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ASSIGNMENT MATERIAL FOR CHAPTER 7
Questions
1. Define current assets.
2. What is an operating cycle?
3. Define current liabilities.
4. Give the meaning of the following: F.o.b. destination.
5. Distinguish between trade discounts and cash discounts.
6. How should depreciation and bad debt charges be classified in the profit
and loss statement?
7. Describe two basic methods of estimating bad debt provisions.
8. Why are accounts receivable not charged to an expense account when
they are found to be bad, instead of being charged to a Reserve for Bad Debts?
9. The account receivable of Paul Smith, amounting to $85, is considered
worthless. Give the journal entry to write it off.
10. The ledger of X Company on July 31, before the books wen* closed for
the month, contained the following data:
Accounts receivable (total) 35,000 00
Reserve for bad debts 800 00
Sales . 50,500 00
Returned sales and allowances 500 00
The $800 in the bad debt reserve is the balance remaining from credits in
previous months.
The company provides for bad debt losses by monthly charges of 1 % of sales
less returns and allowances. Make the July 31 adjustment for bad debts.
What amount will appear in the statement of profit and loss as the bad debt
expense for July, and where will it be shown? How will the accounts receivable
be shown in the balance sheet for July 31?
11. The ledger of Y Company on December 31, before the books were closed
for the year, contained the following data:
Accounts receivable (total) 75,000 00
Reserve for bad debts 1 , 100 00
It was estimated that the total loss to be incurred in Collecting the accounts
would not exceed $1,750. Make the December 31 adjustment for bad debts.
What amount will appear in the statement of profit and loss as the bad debt
expense for the year, and where will it be shown? How will the accounts receiv-
able be shown in the December 31 balance sheet?
12. After year-end adjustments for bad debt losses were made, the ledger of a
certain company contained the following data:
Accounts receivable (total) . 75,00000
Reserve for bad debts. . . . 2,500 00
Bad debts ... 1 ,500.00
526
ASSIGNMENT MATERIAL-CHAPTER 7 527
Why is the credit balance of the reserve greater than the debit balance in the
Bad Debts account?
In which statement (balance sheet or statement of profit and loss) will the
balance of the Reserve for Bad Debts be shown? In which statement will the
balance of the Bad Debts account be shown?
Which account will be closed to Profit and Loss when the books are closed?
13. Describe a system of accounting for sales taxes*
14. Describe a system of accounting for employees' income taxes withheld by
the employer.
Problems— Group A
Problem A-l. Prepare working papers and journal entries to close the books
of The Amican Company as of December 31, 1953.
THE AMICAN COMPANY
Trial Balance
December 31, 1953
Cash .... 9,100 50
Accounts receivable . .11,71950
Reserve for bad debts 28 00
Inventory, December 31, 1952 7,320 00
Equipment 23,000 00
Reserve for depreciation — Equipment 11,200 00
Accounts payable 14,000 00
Capital stock 15,000 00
Earned surplus 1 , 052 . 00
Sales 55,250.00
Returned sales and allowances 250 00
Discount on sales ... 50 00
Purchases 22,190 00
Returned purchases and allo\\ unceb . 19000
Discount on purchases 110 00
Freight in. 420 00
Salesmen's salaries 14 , 500 . 00
Advertising expense 480 00
Rent expense 2,400 00
Office salaries . 4,80000
Property taxes 210 00
Miscellaneous office expense 390 00
96,830 00 96,830.00
Other data:
(a) Provision for bad debt losses, i of 1 % of sales less returns and allow-
ances and cash discount.
(b) The equipment is depreciated at the rate of 8% per annum. $3,000
of the machinery was acquired on June 30, 1953.
(c) Accrued salesmen's salaries, $125.
(d) Unrecorded bill for advertising, $28.
(e) Federal income tax, $3,240.
(f) Inventory, December 31, 1953, $7,545.
528
ASSIGNMENT MATERIAL-CHAPTER 7
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ASSIGNMENT MATERIAL-CHAPTER 7 589
Problem A-3. Following is the summary of the payroll of Acme Corporation
for the payroll period ending February 15:
O.A.B. Tax Income Tax
Gross Pay Withheld Withheld Net Pay
Wages . .
Salaries
Totals
Submit the following journal entries:
(a) To record the liability for wages and salaries and the withholding taxes
thereon.
(b) To record the payment of the wages and salaries.
(c) To record the liability for payroll taxes on the employer. The state
unemployment insurance tax rate is 2.7%. The federal unemploy-
ment insurance tax rate is 0.3%. Assume that all wages and salaries
are subject to unemployment insurance taxes.
$4,319 62
3,000 00
$ 64 79
45 00
$475 16
360 00
$3,779 67
2,595 00
$7,319 62
$109 79
$835 16
$6,374 67
Problems — Group B
Problem B-l. The ledger of X Y Company contains the following data on
December 31 :
Accounts receivable (total) 35,867 80
Reserve for bad debts 918 30
Sales 421,873 80
Returned sales and allowances 2 , 707 00
(a) Assume that the estimated amount of bad debt losses is $3,000. Give
the adjusting entry, and show how the accounts receivable should appear in the
balance sheet.
(b) Assume that bad debts, according to past experience, are adequately
provided for by making provisions of J of 1 % of sales less returns and allowances.
Give the adjusting entry, and show how the accounts receivable should appear in
the balance sheet.
Problem B-2. (a) How would the following items appear in the balance
sheet of Zee Company :
Reserve for bad debts 3,805 50
Accounts receivable , 84,68935
(b) A $315.60 account receivable from D. C. Woods is determined to be
uncollectible and is to be written off. Make the journal entry to write off the
account and show how the accounts receivable should appear in the balance sheet
after such write-off.
Problem B-3. From the following data, determine the purchases made by
Block Company: Sales, $18,748.40; selling expenses, $2,173.38; freight in, $983.59;
purchase returns, $339.60; sales returns, $340.20; cost of goods sold, $11,960.24;
beginning-of-period inventory, $5,984.38; end-of-period inventory, $6,348.87.
Problem B-4. From the following data, determine the discount on pur-
chases taken by Circle Company: Sales, $48,000; purchase returns, $750; selling
expenses, $1,800; freight in, $840; reserve for bad debts, $2,000; beginning inven-
tory, $10,400; ending inventory, $9,730; purchases, $35,700; cost of goods sold,
$35,780; discount on sales, $900.
530 ASSIGNMENT MATERIAL-CHAPTER 7
Problem B-5. Journalize the following transactions of The Neway Cor-
poration, using the periodical inventory method.
1954
July 1 — Purchased merchandise from Andrews Company on account, $1,820;
terms, 2/10; n/30.
3 — Sold merchandise to A. E. Smith on account, $100; terms, 1/10; n/30.
5 — Returned to Andrews Company merchandise billed at invoice price of
$140.
7 — Sold merchandise to R. A. Roth on account, $230; terms, 1/10; n/30.
9 — Paid Andrews Company the balance owing on the purchase of July 1.
13 — Received a check for $99 from A. E. Smith.
15— Cash sales, $828. •
17 — Paid freight bill on purchases, $23.
19 — Purchased merchandise from White Stores on account; $2,300 list
price; trade discounts, 15% and 10%; terms, 3/10; n/30.
20 — R. A. Roth returned merchandise billed to him at $30. The merchan-
dise was defective.
23 — Sold merchandise to B. A. Baker on account, $219; terms, 1/10; n/30.
28 — Paid White Stores in full for purchase of July 19.
30 — R. A. Roth paid his account in full.
30 — B. A. Baker returned defective merchandise billed to him at $45.
Problem B-6. Journalize the following transactions of The Established Cor-
poration, using the periodical inventory method.
1954
April 1 — Purchased merchandise from Black Company, $1,600; terms, 2/10;
n/30.
4 — Sold merchandise to Robert White on account, $300; terms, 2/10;
n/30.
5 — Returned to Black Company merchandise billed at $500.
6 — Wrote off R. R. Lund's account as uncollectible, $75.
8 — Paid Black Company the balance owing on the purchase of April 1 .
13 — Received a check from Robert White, $294.
17 — Purchased merchandise from Corner Supply Company on account,
$2,000 list price; trade discounts of 10%, 5%, and 5%; terms,
2/10; n/30.
20 — Sold merchandise to John Ames on account, $220; terms, 2/10; n/30.
24 — John Ames returned $50 of the merchandise and received credit
therefor.
25 — Paid the amount owing to the Corner Supply Company.
28 — John Ames settled his account by check.
Problem B-7. Using the following data, prepare the adjusting entry for
depreciation for the year ending December 31, 1954.
Equipment
1951
Jan. 1
10,000.00
1952
Julyl
5,000.00
1954
AprUl
4,000 00
Aug. 15
8,000.00
ASSIGNMENT MATERIAL-CHAPTER 7 531
Reserve for Depreciation — Equipment
1951
Dec. 31 1,00000
1952
Dec. 31 1,25000
1953
Dec. 31 1,500 00
Problem B-8. The William Matteson Company operates a retail depart-
ment store. It employs a total of 50 salesmen and saleswomen at a rate of
$1.50 per hour; they work a total of 40 hours per week and are paid weekly.
In addition to the hourly paid sales employees, the company employs four
department heads, called buyers, one general sales manager, ten office clerks, and
one office manager. All employees other than salespersons are paid a monthly
salary as follows:
Buyers . . $300 per month
General manager 500 per month
Office clerks . . . . 220 per month
Office manager . 400 per month
The store is subject to a state unemployment tax rate of 2.7%.
Compute the employer's federal and state unemployment taxes:
(a) For the first week's hourly payroll.
(b) For the January salary payroll.
(c) For the October salary payroll.
(d) For the December salary payroll.
Assume no turnover in salaried personnel during the year.
Problem B-9. (a) Using the data shown in Problem B-8, compute the old
age benefits tax to be withheld from the employees' pay:
(1) For the first week's hourly payroll.
(2) For the January salary payroll.
(3) For the August salary payroll.
(4) For the December salary payroll.
Assume no turnover in salaried personnel during the year,
(b) For each of the four payrolls of part (a) state the amount of old age
benefits tax levied on the employer.
Problem B-10. From the following accounts, select those that would appear
in the December 31, 1954 balance sheet of Max Corporation and prepare a
classified balance sheet.
Cash . .. $ 9,702 20
Sales . . 94,588.00
Earned surplus, December 31, 1954 . . 22,318 00
Accounts receivable (total) . 31 , 700 . 50
Discount on purchases . . 555 . 50
Capital stock .. . 80,000.00
Reserve for bad debts . 2 ,004 . 40
Reserve for depreciation — Equipment . ... 3,33300
Property tax expense. . . . . 84000
Mortgage payable— due December 31, 1960 30,000.00
Accrued taxes 785.60
Accrued rent receivable 100.00
532 ASSIGNMENT MATERIAL— CHAPTER 7
Advertising expense. . 443 70
Accounts payable (total) 7,201.80
Inventory, December 31, 1954 ... . 35,74040
Prepaid insurance . . . . 30 30
Accrued salaries. . . 374 60
Land... . ... 6,000 00
Equipment. . . 18,744 00
Reserve for depreciation — Building. . . 10,000 00
Depreciation of building 2 , 000 . 00
Building. 50,000 00
Land (held for future use). . 4,000 00
Problem B-ll. The following amounts, with the exception of one inventory
amount, were taken from the adjusted trial balance of The Americo Corporation.
The accounts are listed in alphabetical order. Prepare the adjusted trial balance,
with the accounts Jisted in statement order, and classified statements.
Accounts payable (total) $ 7,000 00
Accounts receivable (total) 7,080 00
Accrued federal income taxes. . 6,702 00
Accrued interest receivable . . 40 00
Accrued wages payable . 65 00
Advertising expense . ... 680 00
Advertising materials inventory 30 00
Bad debts 210 00
Building 34,00000
Capital stock .... . 50 , 000 00
Cash . ... 5,646 00
Depreciation of building . 1 , 700 00
Depreciation of equipment. 1 ,400 00
Discount on purchases . . . 580 00
Discount on sales . 300 00
Dividends . . 5 ,000 00
Earned surplus, December 31, 1953 27,611 00
Equipment.... 26,000 00
Federal income taxes . 6 , 702 00
Freight in... 2,000 00
Freight out. . 960 00
Government bonds (temporary investment) 2,000 00
Insurance expense 70 00
Interest income 210 00
Inventory, December 31, 1953 14,800 00
Inventory, December 31, 1954 13,500 00
Investments (long-term). 4,500 00
Land . 3,500 00
Land held for future use. . . 5,000 00
Notes receivable 2,00000
Office expenses 570 00
Office salaries 3,80000
Prepaid insurance. ... 160 00
Property taxes . 380.00
Purchases... . 31,000.00
Reserve for bad debts 270 00
Reserve for depreciation — Building. 6,000 00
Reserve for depreciation — Equipment 2,700 00
Returned sales and allowances. . . 200 00
Sales 62,000.00
Sales salaries and commissions ... 2 , 700 . 00
Salesmen's traveling expenses 710 . 00
ASSIGNMENT MATERIAL FOR CHAPTER 8
Questions
1. Name the accounts used to record the following matters:
(a) Capital investments of •
(i) An individual proprietor,
(ii) Partners,
(iii) Stockholders.
(b) Withdrawals of profits by:
(i) An individual proprietor,
(ii) Partners,
(iii) Stockholders.
2. State the differences in procedure of closing the books of:
(a) An individual proprietorship.
(b) A partnership.
(c) A corporation.
3. James Dudley is in business as an individual proprietor. He takes mer-
chandise from the store for his personal use. The merchandise rost $100 and he
has marked it to sell for $150. What entry should be made0
4. What is one of the chief disadvantages of a partnership as compared with
a corporation?
6. Name the alternative account titles for the drawing account.
6. How is income tax treated in the financial statements of an individual
proprietor?
7. May a partner's drawing account be debited for anything other than a
cash withdrawal? For what purpose is his drawing account credited?
8. Are all accounts with partners presented in the net worth section of the
balance sheet?
Problems — Group A
Problem A-l. The trial balance (see page 534) for Peter Urban as of June 30,
1955, has been set up on working papers provided in the materials for type A
problems. Assume that all year-end adjustments have been made and that the
inventory on June 30, 1955, is $35,000.
The capital account of Peter Urban is reproduced below:
Peter Urban, Capital
1954
July
1
Balance
47,100
00
1955
May
20
Additional invest-
ment
18
10,000
00
533
534
ASSIGNMENT MATERIAL-CHAPTER 8
PETER URBAN
Trial Balance— June 30,
Cash
Accounts receivable
Inventory, June 30, 1954
Fixtures
Reserve for depreciation
Accounts payable
Notes payable .
Peter Urban, capital
Peter Urban, drawings
Sales
Purchases
Returned purchases and allowances
Operating expenses
Interest expense . .
1955
10,000.00
20,000.00
25,000.00
15,000 00
12,000 00
65,000 00
8,000.00
100 00
5,000 00
8,000 00
2,000 00
57,100 00
80,000 00
3,000 00
155,100 00 155,100 00
Complete the working papers and prepare a statement of profit and loss, a
statement of proprietor's capital, a balance sheet, and closing journal entries.
Problem A-2. The following trial balance as of December 31 , 1955, has been
set up on eight-column working papers in the laboratory material. Complete
the working papers; prepare a statement of profit and loss, a statement of pro-
prietor's capital, and a balance sheet. Prepare the journal entries which would
be necessary to close the books. Assume that all adjustments have been made.
TAMES MATSON
Trial Balance— December 31, 1955
Cash 13,000 00
Accounts receivable . 25 , 000 00
Reserve for bad debts 1 , 000 . 00
Inventory, December 31, 1954 15,000 00
Unexpired insurance . 500 00
Equipment . . . 10,000 00
Reserve for depreciation
Accounts payable
Accrued interest payable
Notes payable
James Matson, capital
James Matson, drawings . . . 6,000 00
Discount on sales
Purchases
Freight in..
Discount on purchases
Selling expenses...
General expenses. .
Interest expense
3,000 00
120,000 00
5,000 00
12,000.00
6,000 00
200.00
2,000 00
11,000 00
100 00
5,000 00
45,400 00
150,000 00
1,200 00
215,700.00 215,700 00
James Matson, Capital
1955
Jan.
1
Balance
25,400
00
Apr.
3
Additional invest-
ment
23
20,000
00
The inventory on December 31, 1955, was $20,000.
ASSIGNMENT MATERIAL— CHAPTER 8 535
Problem A-3. The following trial balance was taken from the books after
they were partially closed on December 31, 1955.
ALLMAN AND FERNDON
Trial Balance— December 31, 1965
Cash 125,00000
Notes payable 25,000 00
James Allmaii, capital (including additional investment of
$10,000) 40,000 00
Henry Ferndon, capital (including additional investment of
$8,000) 30,000.00
James Allman, current . 10,000 00
Henry Ferndon, current 15,000 00
Profit and loss . . .... . 55,000.00
150,000.00 150,000 00
Prepare journal entries necessary to complete the closing of the books, post,
and prepare a statement of partners' capitals.
Problem A-4. C. H. Royce and R. P. Smith prepared the following trial
balance after the books were partially closed on June 30, 1955, the end of the
accounting year.
ROYCE AND SMITH
Trial Balance — June 30, 1955
Cash. . . 110,000 00
R. P. Smith, loan 10,000 00
C. H. Royce, capital (including additional investment of
$13,000). . ... . ... 38,000 00
R. P. Smith, capital . . 60,000.00
C. H. Royce, personal ... 3,000 00
R. P. Smith, personal 5,000 00
Profit and loss . 10,000 00
118.000 00 118,000.00
Prepare journal entries needed to complete the closing process, post, and
prepare a statement of partners' capitals. The partners have agreed that profits
and losses shall be shared as follows: RojTce, 50%; Smith, 50%.
Problem A-6. Stanley Judson and Walter Pike, partners, have prepared the
following trial balance as of December 31, 1955.
JUDSON AND PIKE
Trial Balance— December 31, 1955
Cash. . 10,000 00
Accounts receivable 25,00000
Inventory, December 31, 1954 50,000 00
Equipment 10,000 00
Reserve for depreciation . 2,00000
Accounts payable . . 18.00000
Stanley Judson, capital . . 40,000 00
Walter Pike, capital ... 45,000 00
Stanley Judson, drawings. 6,000 00
Walter Pike, drawings 5,000 00
Sales 90,000.00
Purchases 75,000 00
Expenses 14,000 00
195,00^00 195,000 00
536
ASSIGNMENT MATERIAL— CHAPTER 8
The inventory on December 31, 1955, is $69,000. The partners share profits
and losses equally. Neither partner made additional investments during 1955.
Prepare working papers, statement of profit and loss, statement of partners'
capitals, and a balance sheet, and draft the journal entries needed to close the
books. The capital accounts are not kept with a fixed balance.
Problem A-6. Following is the trial balance of Abrams and Hicks as of
March 31, 1955, the end of their accounting year. Assume that all necessary
adjustments have been made. The closing inventory was $15,000.
ABRAMS AND HICKS
Trial Balance
March 31, 1955
Cash 10,000.00
Accounts receivable. . . . 15,000 00
Loan receivablp— J. H. Hicks 5,000 00
Inventory, March 31, 1954 30,000 00
Accounts payable
Loan payable — H. P. Abrams.
H. P. Abrams, capital .
J. H. Hicks, capital
H. P. Abrams, personal ... . 3,00000
J. H. Hicks, personal 2,500 00
Sales. .
Returned sales and allowances 2 , 000 00
Purchases 20,00000
Expenses 18,000 00
6,000 00
4,000 00
20,000 00
25,500 00
50,000 00
105,500 00 105,500 00
The partners agree to share profits and losses as follows: Abrams, 50%; Hicks,
50%.
The partners' capital accounts are reproduced below:
H. P. Abrams, Capital
1
1
1954
Marc
March |3 ill Balance
20,00000
J. H. Hicks, Capital
1954
March
31
Balance
20,500
00
1955
Jan.
25
Additional in vest-
ment
6
5,000
00
Complete the working papers and prepare a statement of profit and loss, a
statement of partners' capitals, a balance sheet, and the journal entries necessary
to close the books.
Problems — Group B
Problem B-l. On page 537 is the trial balance of Adams and Parker on Sep-
tember 30, 1955, the close of their fiscal year, and a reproduction of their capital
accounts showing the changes during the year. Prepare journal entries to close
the books, a balance sheet, a statement of profit and loss, and a statement of
partners' capitals. Assume that no adjustments are necessary. The closing
inventory was $25,000.
ASSIGNMENT MATERIAL— CHAPTER 8
537
ADAMS AND PARKER
Trial Balance — September 30, 1965
Cash 13,000.00
Accounts receivable 1 2 , 000 . 00
Loan— P. K. Adams . . 5,000 00
Inventory, September 30, 1954 30,000 00
Fixtures 15,000 00
Reserve for depreciation
Accounts payable
Notes payable
P. K. Adams, capital
R. A. Parker, capital
P. E. Adams, current
R. A. Parker, current
Sales.
Purchases
Returned purchases and allowances
Operating expenses
Interest expense
3,000 00
12,000 00
10,000 00
23,000 00
33,500 00
7,000 00
6,000 00
50,000 00
25,000 00
500 00 _
103,500 00 163,500 00
80,000 00
2,000 00
P. E. Adams, Capital
1954
Oct.
1
Balance
20,000
00
Dec.
15
Additional invest-
ment
32
3,0001 00
R. A. Parker, Capital
1954
1
Oct.
1
Balance
30.00000
1955
i
Feb.
23
Additional invest-
1
ment
41
3,500)00
i i
Problem B-2. James Rogers lias the following after-closing trial balance.
Cash . . .
Accounts receivable
Inventory
Patent
Accounts payable
James Rogers, capital
JAMES ROGERS
After-Closing Trial Balance
December 31, 1955
20,000 00
30,000 00
10,000.00
25,000 00
15,000.00
70,000 00
85,000 00 85,000.00
At this time a new partnership is formed with Thomas Alf . It is intended
that the books used by Rogers shall be continued in use, but that, before Alf is
admitted, the following changes will be made:
(1) Inventory is to be restated at $11,000.
(2) Patent is to be restated at $15,000.
(3) Goodwill of $5,000 is to be recorded.
After these changes, Alf invests $66,000 cash.
538 ASSIGNMENT MATERIAL-CHAPTER 8
Make the entries that are necessary to record the partnership formation.
Prepare a balance sheet immediately after the partnership is organized on
December 31, 1955.
Problem B-3. J. P. Maynard and R. T. Norton decide to form a partnership
on May 3, 1955. Maynard invests the following assets:
Description Value
Cash $ 27000
Accounts receivable 8 ,000
Notes receivable 1 ,000
Building 15,000
Total $26,000
The partnership also assumes certain of Maynard's liabilities, as follows:
? i
Accounts payable $ 3 ,000
Notes payable 8,000
Total . . . $j_l,000
Norton invests furniture and fixtures valued at $10,000.
It is also decided that Norton's goodwill is worth $5,000, and that this
amount should be entered on the books.
Prepare journal entries to record the formation of the partnership and a bal-
ance sheet as of May 3, 1955, after the partnership is formed.
Problem B-4. The Western Corporation has the following trial balance on
June 30, 1955, after the books are closed.
WESTERN CORPORATION
After-Closing Trial Balance
June 30, 1956
Cash 75,000 00
Accounts receivable 25,000 00
Inventory. . 40,000 00
Fixtures . . 15,000 00
Accounts payable 20,000 00
Capital stock . . 1 00 , 000 00
Earned surplus 85,000 00
155^000 00 155,000 00
The entire capital stock is owned by three individuals, as follows:
Peter Roe 40%
Henry Starr . 40%
William Tucker . . . 20%
On June 30, 1955, an agreement is reached among the stockholders to termi-
nate the corporation's existence and distribute assets as follows :
(1) Tucker will receive $30,000 cash.
(2) Roe and Starr will continue to operate as a partnership, using the same
books as the corporation.
(3) Fixtures will be revalued to $20,000.
(4) Goodwill will be entered on the books at $10,000.
Prepare a balance sheet for Roe and Starr as of June 30, 1955.
ASSIGNMENT MATERIAL FOR CHAPTER 9
Questions
1. What is the maturity of a note dated December 22, 1954, due
(a) Four months after date?
(b) 120 days after date?
2. If the maker of a note dishonors it at maturity, the payee should charge
it to the maker's account. Why?
3. Why is it unnecessary for the maker of a note to make a similar entry, if
he dishonors it, transferring the liability from the Notes Payable account to a
personal account with the payee?
4. We sold goods to James Keegan and received a note; the bookkeeper
recorded the transaction as follows:
Notes receivable 300 00
Sales 300 00
State how you think the transaction should have been recorded, and give
your reason.
5. Interpiet the following journal entries. (The transactions are unrelated.)
(a) Notes receivable 1,000 00
Cash . 1 ,000 00
(b) Cash . 5,050.00
Notes receivable 5,000 00
Interest income. 50 00
(c) Horace Magee 2 , 020 . 00
Notes receivable 2,000 00
Interest income 20 00
(d) Interest expense . 30 00
Accrued interest payable 30.00
(e) Notes payable . 1,500 00
Notes payable 1 ,500 00
(f) Cash .... ... 990 00
Prepaid interest expense ... . . . 10 00
Notes payable. . . 1 ,000 00
6. What is a trade acceptance?
7. Give the sequence of entries on the books of the seller and the purchaser
when the terms of sale require the purchaser to accept a time draft for the amount
of the invoice.
8. When and for what purpose are the following accounts debited and cred-
ited: Accrued Interest Payable and Accrued Interest Receivable?
539
540 ASSIGNMENT MATERIAL-CHAPTER 9
9. Interpret the following entry:
Interest expense 5.00
Prepaid interest expense 5 00
Under what circumstances might the following entry be made at the end of an
accounting period?
Prepaid interest expense 12 00
Interest expense . . 12 00
Problems — Group A
Problem A-l. Journalize the following transactions in the order in which
they are presented,, In all interest computations, use 360 days as a year. The
company closes its books annually on December 31.
(la) July 1 — Borrowed $5,000 from March and Company on a 30-day, non-
interest-bearing note.
(Ib) July 31 — Paid the above note.
(2a) July 3— Borrowed $5,000 from J. R. Barton on a 30-day , 6% note.
(2b) Aug. 2 — Paid the above note and interest.
(3a) July 5 — Borrowed $5,000 from the First National Bank by giving them
our 30-day, non-interest-bean ng note The bank discounted
the note at 6%.
(3b) Aug. 4 — Paid the above* note.
(4a) July 6— Loaned $1,000 to Ralph Smith on a 00-day y non-interest-bear-
ing note.
(4b) Sept. 4 — Smith paid his note due today.
(5a) July 10— Loaned $1,000 to Frank Jones on a tH)-day, t>% note
(5b) Sept. 8 — Jones paid his note due today.
(6a) July 7— Loaned John Black $1,000 on a Mi-day note. We deducted
discount at 6%.
(6b) Sept. 5 — Black paid his note due today.
(7a) July 9 — Sold merchandise to Frank White on account, $800.
(7b) July 11 — White gave us a 30-day, 6% note for the amount of the sale to
him on July 9.
(7c) Aug. 10- -White paid his note due today.
(8a) July 17 — Purchased merchandise on account from Bowen and Com-
pany, $1,200.
(<Sb) July 17 — Gave Bowen and Company a 30-day, <>% note for the amount
of today's purchase.
(8c) Aug. 16 — Paid the above note.
(9a) July 17— Received a 30-day, non-interest-bearing note for $900 horn
George Whitely to apply on account.
(9b) Aug. 16 — Whitely dishonored the note due today.
(lOa) Nov. 10— Received a 30-day, 6% note for $500 to apply on the account
of Henry Cronk.
(lOb) Dec. 10 — Cronk dishonored the note due today.
(1 la) Jan. 9 — Gave Gibbons & Company a 30-day, non-interest-bearing note
for $600 to apply on account.
(lib) Feb. 8 — Dishonored the note due today to Gibbons & Company.
(I2a) Mar. 10— Gave Kelly Brothers a 30-day, 6% note for $500 to apply on
account.
ASSIGNMENT MATERIAL— CHAPTER 9 541
(12b) Apr. 9 — Dishonored the note due today to Kelly Brothers.
(13a) May 6 — Received a 30-day, non-interest-bearing note for $1,500 from
Joseph French to apply on account.
(13b) June 5 — Received a 30-day, non-interest-bearing note from French in
renewal of the note due today.
(14a) June 20 — Gave Victor Burton a 30-day, non-interest-bearing note for
$2,000 to apply on account.
(14b) July 20 — Gave Burton a 30-day, non-interest-bearing note in renewal
of the note due him today.
(15u) Aug. 18 — Received a 30-day, 5% note for $800 from Ixniis Clark to apply
on account.
(15b) Sept. 12 — Clark dishonored his note due today.
(16a) Oct. IS- Gave Charles Norton a 30-day, 4% note for $450 to apply on
account.
(16b) Nov. 17 — Dishonored the Norton note due today.
(17a) Dec. 11 — Received a 45-day, 5% note for $1,500 from Thomas Dutton
to apply on account.
(17b) Jan. 25- -Collected the interest on the Dutton note, collected $500 on
the principal of the note, and received a 45-day, 5% note ten
the balance.
(18a) Feb 2 — Gave a 20-day, 4% note for $440 to Alvin Webster to apply on
account.
(1Kb) Feb. 22 — Paid the interest on the Webster note and $240 of the principal.
and gave him a new 20-day, 4% note for the balance.
(19a) July 2 — Purchased $900 worth of merchandise from Fall Company;
terms, trade acceptance due 30 days after sight. The mer-
chandise was received and the draft was accepted.
(19b) Aug. 1 — Dishonored the draft due today.
( 19c) Aug. 10- Gave a 4%, 30-day note dated August 1 to cover the dishonored
trade acceptance.
(19d) Aug. 31 — Paul the note to Fall Company.
(20a) June 5 — Sold merchandise to K. F. Willow in the amount of $300; terms,
10-day sight draft.
(20b) June 7 — Received accepted draft from K. F. Willow, dated June 6.
(20c) June 16— Received $300 from K. F. Willow.
Problem A-2. Make journal entries to record the following transactions,
and make supplementary entries m note registers. Assume that the books are
closed as of December 31 .
19
June 10 — Received a 30-day, 6% note dated June 8 for $2,500 from Homer Jones
to apply on account.
June 25 — Discounted our $4,000, 60-day note payable at the Second State Bank.
Discount rate, 6%.
June 28 — Our bank notified us that it held a $400, 30-day sight draft drawn on
us by Moss Company, with bill of lading attached. We accepted
the draft and received the bill of lading from the bank. We pre-
sented the bill of lading to the railroad and received the merchandise.
July 2 — We drew a $500, 30-day sight draft on S. L. Ost and mailed it today.
Ost's account is past due.
July 7— Received $500 from S. L. Ost.
July 8 — Homer Jones paid his note in full today.
542 ASSIGNMENT MATERIAL-CHAPTER 9
July 15 — Sold merchandise to D. K. Fuller in the amount of $880; terms, 10-
day sight draft.
July 17 — Received the draft accepted by D. K. Fuller on July 16.
July 23 — Received a 60-day, 4% note dated July 22 for $1,000 from Jackson
Johnson to apply on account.
July 26 — D. K. Fuller dishonored his acceptance.
July 28 — Sent Moss Company $400 in payment of our acceptance.
July 30— Received a 30-day, 3% note dated July 26 for $880 from D. K. Fuller
to cover the dishonored acceptance.
Aug. 24 — Paid Second State Bank for the note due today.
Aug. 29 — D. K. Fuller dishonored his note due today.
Problem A-3. Using the following information,
(a) Journalize, the January, 1954 transactions.
(6) Post to ledger accounts.
(c) Prepare working papers for the month of January, 1954.
(d) Prepare financial statements.
(e) Journalize and post the adjusting and closing entries.
(/) Prepare an after-closing trial balance.
MIDDLE CORPORATION
After-Closing Trial Balance
December 31, 1953
Cash . . 3,450 00
Notes receivable (Balance consists of one 4%, 60-day note
from City Supply Co., dated December 1, 1953.) . 1,200 00
Smith Supply Co . 200 00
Accrued interest receivable . . . 4 00
Merchandise inventory ... 5,70000
Prepaid rent expense (prepaid for six months) . . ... 900 . 00
Equipment (Depreciation rate: 10% per annum) . . 9,000 00
Reserve for depreciation — Equipment . 5 , 400 00
Notes payable (Balance consists of one 6%, 90-day note to
Jarvis Company, dated December 21, 1953.). . . . . 6,000 00
Accrued interest payable ... 10 00
Liability for sales taxes . . . 600 00
Federal income taxes withheld J65 00
Capital stock. . . . . 9,000 00
Earned surplus (Deficit) 721 00
HI • 1Z!L£5 21»175 00
(Note: If the student is not using the laboratory material for the A problems,
the above balances must be entered in ledger accounts.)
Transactions
1954
Jan. 2 — Paid $240 for a two-year fire insurance policy.
4 — Cash sale, $300 plus 3% sales tax.
5 — Purchase from Jones Brothers, Inc., $800; 2/10; n/30.
8 — Paid for advertising, $60.
10— Sale to Smith Supply Co., $1,100 plus 3% sales tax.
Remitted the federal income taxes withheld from employees' pay.
14 — Paid amount owing to Jones Brothers, Inc., less discount.
15 — Paid $2,400 for an additional item of equipment.
ASSIGNMENT MATERIAL-CHAPTER 9 543
1954
Jan. 17 — Cash sale, $400 plus 3% sales tax.
20— Collected $200 from Smith Supply Co.
22— Accepted a 4%, 60-day note for $1,000 from Smith Supply Co. to
apply on account.
25 — Discounted at 6% a 60-day, $2,000 non-interest-bearing note with the
State Bank.
28 — Paid the December 31, 1953 liability for sales taxes.
29-— Cash purchase, $400.
30 — Collected the amount due from City Supply Co. on its note receivable.
31 — Paid January salaries and recorded payroll taxes thereon. (Note:
The corporation is not subject to unemployment taxes.)
Data: Gross salaries $600
O.A.B. taxes withheld $ 9
Federal income taxes withheld 105 114
Amount paid $486
Additional Information
The January 31, 1954 inventory amounts to $5,900.
The Smith Supply Co. account is believed to be fully collectible. All other data
necessary for the adjustments are given in the problem.
Problems — Group B
Problem B-l. Journalize the following transactions in the order in which
they are presented. In all interest computations, use 360 days as a >ear. The
company closes its books annually on December 31 .
(la) Jan. 2 — Loaned $1,600 to Wayne Kasserman on a 30-day, non-interest-
bearing note.
(Ib) Feb. 1 — Kasserman paid the note due today.
(2a) Mar. 10 — Borrowed $300 from Andrew Byrnes on a 60-day, non-interest-
bearing note.
(2b) May 9 — Paid the above note due today.
(3a) Apr. 1 1— Loaned $700 to Ed Moore on a 30-day, 6% note.
(3b) May 11 — Moore paid the note due today.
(4a) Apr. 13 — Borrowed $800 from Henry Oilman on a 60-day, 6% note.
(4b) June 12— Paid the note due to Oilman.
(5a) May 17- -Borrowed $1,000 from the City National Bank on a 30-day,
non-interest-bearing note. The bank deducted discount
at 6%.
(5b) June 16- -Paid the above note.
(6a) June 14 — Loaned $3,600 to Ralph Matus on a 60-day, non-interest-bear-
ing note, deducting discount at 6% and giving him cash for
the proceeds.
(6b) Aug. 13 — Matus paid the note due today.
(7a) July 7 — Purchased a delivery truck from Central Motors Company for
$4,000, on account.
(7b) July 7 — Gave the Central Motors Company a 60-day, non-interest-
bearing note for the cost of the truck.
(7c) Sept. 5 — Paid the above note due today.
544 ASSIGNMENT MATERIAL— CHAPTER 9
(8a) Aug. 15 — Sold merchandise to Robert Johnston on account, 8250.
(8b) Aug. 15 — Johnston gave us a 30-day, non-interest-bearing note for
amount of today's sale.
(8c) Sept. 14 — Johnston paid the above note due today.
(9a) Sept. 8 — Received a 45-day note, bearing 6% interest, for $900 from
William Martin to apply on his account.
(9b) Oct. 23 — Martin paid the above note due today.
(10a) Oct. 18 — Gave a 45-day, 5% note for $700 to Alan Aekerman to apply
on account.
(lOb) Dec. 2 — Paid the above note due today,
(lla) Nov. 13 — Received a 30-day, non-interest-bearing note for $750 from
William Shaw to apply on account,
(lib) Dec. 13 — Shaw dishonored the note due today.
(12a) Nov. 3 — Gave a 45-day, non-interest-bearing note for $550 to Mel
tfoerster to apply on account.
(12b) Dec. 18 — Dishonored the note due to Foerster today.
(13a) Dec. 11 — Received a 60-day, 6% note for $1,800 from Henry Pox to
apply on account.
(13b) Feb. 9 — Fox dishonored the note due today.
(14a) Dec. 21— Gave a 45-day, 6% note for $1,300 to William O'Donnell to
apply on account.
(14b) Feb. 4 — Dishonored the note due to O'Donnell today.
(15a) Jan. 4 — Received a 30-day, non-interest-bearing note for $400 from
Donald Scotton to apply on account.
(15b) Feb. 3 — Received a 30-day, non-interest-bearing note from Scotton in
renewal of the note due today.
(16a) Mar. 2 — Gave a 60-day, non-interest-bearing note for $880 to Henry
Hoffman to apply on account.
(16b) May 1 — Gave a 60-day, non-interest-bearing note to Hoffman in renewal
of the note due to him today.
(17a) Dec. 6 — Received a 90-day, 5% note for $4,400 from Joseph Thompson
to apply on account.
(I7b) Mar. 6 — Received the interest and $1,400 on the principal of the note
due from Thompson today, and a 60-day, 6% note for the
balance.
(18a) Dec. 11— Gave a 45-day, 4% note for $6,300 to Albert Cranston to
apply on account.
(18b) Jan. 25 — Paid the interest and $3,300 of the principal on the note due
to Cranston, and gave him a 30-day, 5% note for the balance.
(18c) Feb. 24 — Paid the note due today.
(19a) June 1 — Purchased $700 worth of merchandise from Cramer Company;
terms, trade acceptance due 45 days after sight. The mer-
chandise was received and the draft was accepted.
(19b) July 15 — Issued our check for $700 in payment of acceptance held by
Cramer Company.
(20a) Jan. 14 — X. P. Henry has owed us $350 for several months. We drew
a draft on Henry today, payable to ourselves 15 days after
sight, for $350, and mailed it to Henry with a request that
he accept it.
(20b) Jan. 16 — The accepted draft was received from Henry today. It was
accepted under date of January 15.
(20c) Jan. 30 — Henry dishonored the acceptance due today.
ASSIGNMENT MATERIAL-CHAPTER 9 545
Problem B-2. Make journal entries to record the following on the books of
State Supply Company and Carl Smith.
19
Aug. 13 — State Supply Company sold merchandise to Carl Smith for $240.
The terms of sale were bill of lading attached to 15-day sight draft.
The goods were shipped today.
16 — Carl Smith accepted the draft and obtained the goods today.
16 — State Supply Company received the accepted draft.
30 — Carl Smith mailed a check for $240 to State Supply Company.
31 — Check from Carl Smith was received today by State Supply Company.
Problem B-3. Make journal entries to record the following on the books of
Aviation Supplies Company and those of Smith and White, a partnership operat-
ing a flying service.
19_
July 7 — Aviation Supplies Company sold supplies to Smith and White for
$304.5(3; terms, trade acceptance due 30 days after date. The
goods were shipped today.
9 — Smith and White received the merchandise. The trade acceptance
was received, accepted, and returned to Aviation Supplies Company.
11 — Aviation Supplies Company received the acceptance.
Aug. 6 — The acceptance was dishonoied.
12 — Smith and White sent a 4%, 30-day note dated August 6 to cover the
dishonored acceptance.
13— The note from Smith and White was received by Aviation Supplies
Company.
31- -Aviation Supplies Company's fiscal year ended today.
Sept. 4 — Smith and White mailed a check to Aviation Supplies Company for
the amount due at maturity on the note.
5 — Aviation Supplies Company received the check from Smith and White.
ASSIGNMENT MATERIAL FOR CHAPTER 10
Questions
1. What is the principal advantage of having special columns in the journal?
2. What are some of the advantages of controlling accounts?
3. If controlling accounts are kept, why is it desirable to have special col-
umns for them in the books of original entry?
4. Before posting the column totals of a book of original entry, what should
be done to check the correctness of these totals?
5. Why is a check mark used in place of an account number to designate that
a posting has been made to a subsidiary ledger?
6. If you were designing a system of accounts, what facts would influence
you in deciding what controlling accounts should be used?
7. What is the procedure for proving subsidiary ledgers?
8. If a business used only a two-column journal, would there be any advan-
tage in using controlling accounts?
Problems— Group A
Problem A-l. The account balances of the Tours Grocery on February 1 ,
1954, follow:
Cash. 850 00
Accounts receivable 1 , 698 00
Inventory 1,561 00
Fixtures 2,800 00
Reserve for depreciation . 450 00
Accounts payable 1 , 238 00
Capital stock 7,500 00
Earned surplus 721 00
9,909^00 9/J09 00
Accounts Receivable ,
A. C. Arturo * 68 92 R. E. Lowler $296 44
D. P. Barker 532 20 J. P. Munfort 182 20
W. T. Colman 319 70 W. R. Ormano 218 25
C. F. Jones 72. 14 T. F. Tulls. . 8 15
Accounts Payable
G. G. Wholesale Company $429 60 Tompkms Products $138 50
Peters & Sons Company. 342 15 Waltham Wholesale Company. 327 75
February transactions were as follows:
Feb. 2— Cash sales, $128.00.
4r— Collected $532.20 from D. P. Barker.
7— Sale on account to T. F. Tulls, $148.60.
ASSIGNMENT MATERIAL-CHAPTER 10 547
Feb. 9 — Paid G. G. Wholesale Company balance of account.
10 — Purchase on account from Tompkins Products, $393.20.
12— Cash sales, $362.00.
14 — Purchase on account from G. G. Wholesale Company, $368.75.
16 — Sale on account to C. F. Jones, $54.80.
18 — Sale on account to J. P. Munfort, $73.20.
23 — Returned damaged goods to G. G. Wholesale Company, $1 5.00.
24 — Made payments to:
Peters & Sons Company, $342.15;
Waltham Wholesale Company, $327.75.
26 — Collections from:
C. F. Jones, $72.14;
J. P. Munfort, $182.20.
27 — Sales on account to:
W. R. Ormano, $129.40;
D. P. Barker, $210.50.
Journalize the transactions for February using a 10-column journal; post,
using subsidiary ledgers for the accounts receivable and accounts payable.
Problem A-2. Trend Corporation was organized during the latter part of
December, 1953, but did not commence operations until January, 1954. The
first month's transactions are listed below.
1954
January 2— Issued $10,000 par value stock for $10,000.
Rented a building, paying $200 for January occupancy.
4 — Paid $3,600 for furniture and fixtures.
5 — Purchased merchandise from Retail Suppliers for $2,200, paying
$1,000 in cash.
7— Sale on account to P. T. Smith, $28.
9— Cash sale, $33.
11 — Sale on account to R. M. Burforth, $47.
14 Purchased merchandise on account from Loft Corporation, $350.
16 --Sale on account to C. F. Toms, $73.
17 — Returned merchandise to Retail Suppliers, $65.
19 — Purchased a delivery truck from Hanson Company for $2,193, cash.
20 -Sale on account to T. P. Ekton, $120.
21 --Cash sale, $29.
23 — Purchased merchandise on account from R and 8 Company, $664.
24 — Sale on account to A. A. Parker, $79.
25 Paid service station bill for gasoline, $18.
26- -Paid Retail Suppliers the balance of account.
27— Sale on account to R. X. Pero, $134.
28- -Purchased merchandise on account from RePeto Company, $465.
30— Sale on account to J. P. Younger, $129.
31- -Paid salaries, $420.
Cash sales, $183.
Journalize the above in a 10-column journal and post. The corporation uses
an accounts receivable ledger and an accounts payable ledger.
Problem A-3. Post from the journal of Topper Company on pages 548 and
549, and submit a schedule proving the subsidiary ledger as of August 31, 1954.
548
ASSIGNMENT MATERIAL-CHAPTER 10
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Problems— Group B
Problem B-l. Zulauf Corporation uses controlling accounts and a columnar
journal similar to the one illustrated on pages 137 and 138. On July 25,
the bookkeeper of Zulauf Corporation made an error in posting a $1,219.72
purchase of merchandise from the Porter Company as $1,217.92. All other
postings during the month and those at the end of the month were made cor-
rectly. The Zulauf Corporation closes its books monthly.
Required:
(a) At what stage, if any, of the bookkeeping cycle would the above error
be discovered?
(b) Would this error cause the trial balance as of July 31 to be out of
balance? Why?
(c) How would this error be corrected when discovered?
Problem B-2. From the following information, secured from the company's
special-column journal, prepare the Accounts Receivable and the Accounts Pay-
able controlling accounts of the Certified Company in T-account form.
Hales on account $10,000
Bad debts charged off 100
Purchases on account 1 6 , 000
Discount on sales. ISO
Discount on purchases 120
Purchase returns. 200
Cash paid to creditors * 4 ,000
Cash received from customers 5,000
Notes issued to creditors 8,000
Notes received from custom era 1 ,000
Annual adjusting entry to provide tor uncollectible accounts. . . 300
Problem B-3. The Short Company uses a 10-column journal and subsidiary
ledgers for accounts receivable and accounts payable. The following data are
taken from page 11 of its journal and relate to the month of January, 1954.
Column totals:
Debit columns:
Cash. $5,021 15
Purchases 3,405 20
Accounts Receivable 5,707 80
Accounts Payable. 2,000 00
Sundry 825 JM) $17,559 15
Credit columns:
Cash. . $2,825 00
Sales. . . 6,707 80
Accounts Receivable 4,321 15
Accounts Payable 3 , 405 20
Sundry. 300.00 17,559 15
Column details:
Date
Debit columns:
Accounts Receivable:
A. J. Brown . ; Jan. 3 $1 ,307 80
R. S. Woods . 7 2, 100 00
T. W. Zan 18 2,30000
Accounts Payable:
Winter Wholesale Co. 21 2,000 00
ASSIGNMENT MATERIAL-CHAPTER 10 551
Sundry:
Rent expenso 2 200.00
Salaries .... 31 600 00
Advertising expense . . 31 25 00
Credit columns:
Accounts Receivable:
R S. Woods 18 2,100 00
T. W. Zan . 30 2,221.15
Accounts Payable:
Winter Wholesale Co 8 2 , 000 . 00
Hepworth Company 28 1,40520
Sundry :
Notes payable 25 300 00
Show all ledger accounts as they would appear at the end of January after
the posting had been completed. Use three-column paper for the subsidiary
ledger.
Problem B-4. Smith Enterprises uses an eight-column journal and a sub-
sidiary ledger for accounts payable. The following data are taken from the
journal and relate to the operations of the first month, July, 1954.
Column totals:
Debit columns:
Cash $14,703 00
Purchases 8,472 00
Accounts Payable 5,372.00
Sundry 4,030 00 $32,577 00
Credit columns:
Cash $ 9.402 00
Sales 8,703 00
Accounts Payable 8,472 00
Sundry 6,000 00 $32,577.00
Column details:
Purchases:
Date Description Amount
July 5 Merchandise purchased from Brown Company $1 , 720 00
8 Merchandise purchased from Red Company 980 00
13 Merchandise purchased from White Company . 2,000.00
17 Merchandise purchased from Brown Company 1,372 00
21 Merchandise purchased from Red Company 1,300 00
28 Merchandise purchased from Brown Company 1 , 100 00
Accounts Payable:
Date I )oscript ion Amount
Debit ^Credit
July 5 Brown Company $1,720 00
8 Red Company . 980 00
10 Brown Company $1,720 00
12 Red Company , 980 00
13 White Company . 2 , 000 . 00
17 Brown Company 1,37200
21 Red Company ... .... 1,300.00
23 Brown Company 1 ,372 00
28 Brown Company . ... 1 , 100 00
31 Red Company, . . 1,300.00
552 ASSIGNMENT MATERIAL— CHAPTER 10
Sundry:
Date Description Amount
Debit Credit
July 1 Capital investment by tho owner, R. D. Smith . $5,000 00
2 Paid rent . . . . . $ 150 00
6 Purchased store equipment 3 , 000 . 00
17 Paid for advertising . 80.00
22 Sales return 100.00
31 Salaries ... 700 00
31 Borrowed money on a note 1 ,000 00
Show the ledger accounts as they would appear at the end of July, 1954,
after the posting had been completed. Use three-column paper for the sub-
sidiary ledgers.
Prepare a trial balance and a schedule of the subsidiary ledger.
ASSIGNMENT MATERIAL FOR CHAPTER 11
Questions
1. In what two ways do the special books of original entry reduce bookkeep-
ing work?
2. When special books of original entry are used, what entries are made in the
general journal?
3. If a business received many notes, do you think it would be desirable to
have a special Notes Receivable credit column in the cash receipts book, so that
the face of each note collected could be entered in the Notes Receivable column
instead of in the Sundry credit column? If you think it would be advantageous,
give your reason. If you do not think such a special column would be de&irable,
state your reason.
4. Assume that a cash receipts book contains a social Accounts Receivable
controlling account column; state the procedure for making postings from it.
5. If the journal were not provided with special controlling account columns
for Accounts Receivable, and you wished to credit .1. S. Smith, a customer, for a
note received from him, how would the credit entry be posted?
6. Under what circumstances would you suggest having an Accounts Receiv-
able debit column in the cash disbursements book?
7. Describe the posting procedure where a given transaction must be journal-
ized in two journals.
Problems — Group A
Problem A-l. The Excello Dry Goods Company has been in business for a
number of years. On December 31, 1953, the books were closed for the calendar
year 1953 and complete financial statements were prepared.
The general and subsidiary ledger accounts and the balances on January 1,
1954, are set up in the ledgers in the accompanying forms. Record the trans-
actions for January, 1954, in the books of original entry listed below.
(a) General journal.
(b) Purchase book.
(c) Sales book.
(d) Cash receipts journal.
(e) Cash disbursements journal.
1954
Jan. 2 — Paid dividends payable- -$1,500.
Purchased merchandise from Edwin Nugent for $3,000 on account.
Invoice dated January 2.
3 — Sold merchandise to Homer Ferris for $3,200. Invoice No. 1063.
Paid $125 express on merchandise purchased from Nugent.
4 — Received a check from James Altman for $7,350 in full payment of his
account. ($7,500 less 2% cash discount.)
553
554 ASSIGNMENT MATERIAL-CHAPTER 11
Jan, 4— Paid Arthur Mooney $1,980 in full of account. ($2,000 less 1% cash
discount.)
Bought office supplies for cash, $120.
7 — Sold securities for $1,300. These common stocks had cost $1,000 and
had been held as a temporary investment.
Recorded and paid weekly sales salaries — $300. Withheld federal
income tax of $70 and federal O.A.B. taxes of $4.50. Employers'
O.A.B. tax is also $4.50.
8— Sold merchandise to Michael Eldridge for $3,600. Invoice No. 1064.
Returned merchandise costing $300 to Edwin Nugent and received
credit on account.
9 — Received checks from Peter Davis, Homer Ferris, and Charles Gant
in full payment of their January 1 balances less 2% discount.
10 — Paid Haury Oren, Robert Quinlan, Alvin Rogers, and Roy Stanton in
full, less 1 % cash discount.
11 — Purchased merchandise from Lawrence Pope, $1,300. Invoice dated
January 10.
Purchased for cash a 3-year fire insurance policy costing $270.
14 — Sold merchandise to John Clark for $3,200. Invoice No. 1065.
Recorded and paid weekly sales salaries — $300. Taxes were the same
as on the January 7 payroll.
15 — Recorded and paid bi-monthly office salaries- -$200. Withheld $53
federal income taxes and $3 federal O.A.B. taxes. Employers'
O.A.B. tax is $3. _
16 — Received a check from James Hawkins, trustee for the creditors of
William Bowman, who had gone bankrupt. The check is for $1,150.
In an accompanying letter, Mr. Hawkins explains that creditors will
receive only 50 cents on the dollar. The remaining balance in Bow-
man's account is written off as uncollectible.
18 — Purchased a bookkeeping machine for $1,200 cash.
21 — Sold merchandise to Charles Gant for $2,200. Invoice No. 1066.
Sold merchandise to Peter Davis for $1,300. Invoice No. 1067.
Paid weekly sales payroll. Amounts identical with other sales payrolls.
22 — Paid $1,275 in settlement of fourth quarter 1953 taxes withheld and
payable.
23 — Received merchandise billed at $500 from Michael Eldridge, who claims
the items are unsatisfactory. It is decided to accept the return.
Eldridge is issued credit memo No. 336 for $500.
24 — Sold merchandise to James Altman for $2,100. Invoice No. 1068.
Purchased merchandise from Alvin Rogers for $7,200. Invoice dated
January 23.
25 — Purchased merchandise from Harry Oren for $1,300. Invoice dated
January 23.
Made a sale for cash — $350.
28 — Recorded and paid weekly sales payroll — same data as for other weeks.
29 — Purchased merchandise from Arthur Mooney for $850. Invoice dated
January 28.
Sold merchandise to Homer Ferris for $1,000. Invoice No. 1069.
30— Paid note payable of $2,000 plus interest of $20. Interest of $10 had
accrued prior to January 1 and $10 interest accrued during January.
Paid monthly gas bill— $120.
Paid monthly telephone bill— $60.
ASSIGNMENT MATERIAL— CHAPTER 11 555
Jan. 31 — Paid $100 on mortgage. Of this amount, $41.67 represents interest and
$58.33 represents principal.
Recorded and paid bi-monthly office payroll. Amounts are same as
on January 15.
Declared a $750 dividend to be paid February 5, 1954.
Post the above entries and prepare a general ledger trial balance as of January
31. Prove the balances in the control accounts by preparing subsidiary ledger
schedules.
Problem A-2. The Arthur Company began operations on July 5, 1954.
Record the transactions for the remainder of the month, post, and take a trial
balance. Prove the balances in the control accounts by preparing schedules of
accounts receivable and accounts payable.
The following books of original entry are used :
General journal
Cash receipts book
Cash disbursements book
Sales book
Purchase book
The accounts to be used are indicated in the ledger in the accompanying
forms.
1954
July 5 — Capital stock of $20,000 was issued for cash.
A store building and site were purchased for $40,000, of which $10,000
is considered land cost. A $5,000 cash payment was made and a
mortgage of $35,000 was given for the balance.
Fixtures were purchased for $6,000 cash.
6 — Merchandise was received from James Bently on account, $5,500.
Invoice date, July 5. Terms, 2/10; n/60.
Merchandise was received from William Burton on account, $7,300.
Invoice date, July 5. Terms, 1/10; n/30.
7 — Office supplies were purchased for cash, $375.
Fire insurance for five years was purchased for cash, $1,000.
8— Merchandise was purchased for cash, $3,000.
Office equipment was purchased from Otis Company for $6,500. Cash
in the amount of $3,000 was paid and a 30-day non-interest note was
given for the balance,
9— Merchandise was sold for cash, $1,000.
Unsatisfactory merchandise was returned to James Bently and full
credit was received on account, $1,200.
12— Merchandise was received from Peter Carlson on account, $5,300.
Invoice date, July 12. Terms, 3/10; n/30.
Merchandise was sold to Wilbur Matson on account, $6,200. Invoice
No. 2. Terms, 1/10; n/30.
13— Merchandise was sold to Roger Simmons on account, $7,900. Invoice
No. 3. Terms, 1/10; n/30.
14 — A $15,000, 15-day, non-interest-bearing note was discounted at the
bank. The discount rate was 6%. (Record in general journal and
cash receipts book.)
James Bently and William Burton were paid the amounts due them
after deduction of the applicable discounts.
556 ASSIGNMENT MATERIAL-CHAPTER 11
July 15 — Merchandise was sold for cash, $1,200.
Merchandise was sold to Henry Tucker on account, $6,500. Invoice
No. 5. Terms, 1/10; n/30.
16 — Recorded and paid salaries for period July 5-15, $1,700. Withholdings
for federal income taxes were $300 and for federal old-age benefits
were $25.50. (Use both the general journal and the cash disburse-
ments book with an X posting procedure.)
Employers' old-age benefits tax was $25.50.
19— Sold merchandise to John Urban on account, $5,700. Invoice No. 6.
Terms, 1/10; n/30.
20 — Received merchandise on account from Jack Dill, $3,600. Invoice
date, July 20. Terms, 1/10; n/30.
Sold merchandise to Samuel Victor on account, $6,500. Invoice No. 7.
Terms, 1/10; n/30.
21 — Purchased a used delivery truck for cash, $1,500.
Purchased new tires for delivery truck for cash, $225.
22 — Paid Peter Carlson for July 12 invoice, less discount.
Received merchandise returned by John Urban. Issued credit memo
No. 1 for $1,000.
Received cash from Wilbur Matson for invoice No. 2, less discount
23 — Received cash from Roger Simmons for invoice No. 3, less discount.
Paid note to bank, $15,000.
26 — Received merchandise from Phillip Edgar on account, $7,600. Invoice
date, July 23. Terms, 3/10; n/30.
Paid freight charges on above order, $375*
27 — Received cash from Henry Tucker, $6,500.
Sold merchandise on account to Wilbur Matson, $2,300. Invoice No.
8. Terms, 1/10; n/30.
28 — Paid electricity bill in cash, $120.
Sold merchandise on account to Henry Tucker, $2,100. Invoice No. 9.
Terms, 1/10; n/30.
29 — Paid Jack Dill for his invoice of July 20, less discount.
Received cash from John Urban for the balance of invoice No. 6, less
discount.
Purchased office supplies for cash, $75.
30 — Received cash from Samuel Victor for invoice No. 7, less discount.
Received merchandise from William Burton on account, $3,100.
Invoice date, July 29. Terms, 1/10; n/30.
Recorded and paid salaries for period July 16-30, $2,000. Withheld
income taxes of $325 and federal O.A.B. taxes of $30.
Employers' federal O.A.B. taxes were $30.
Paid gas and oil bills for delivery truck, $85.
Problem A-3. Howard Walker is the sole proprietor of an electrical appli-
ance distributorship. His accounting system includes the following books of
original entry:
Sales book — in the form illustrated on page 142.
Purchase book— in the form illustrated on page 144.
Cash receipts book — in the form illustrated on page 145.
Cash disbursements book— in the form illustrated on page 147.
General journal— in the form illustrated on page 149.
ASSIGNMENT MATERIAL-CHAPTER 11 557
In the interest of brevity, the following transactions are assumed to be all of
the transactions for the year 1955. Record these transactions in the books of
original entry. Set up whatever accounts are necessary and post these entries,
including column totals, to general ledger and subsidiary ledger accounts. For
purposes of this problem, assume that columns are totaled and posted at the end
of the year and not at the end of each month. Allow five lines for each account.
1955
Jan. 10 — Sold merchandise on account to Patrick Bell, $5,000. Invoice No.
1384. Terms, 1/10; n/30.
Feb. 15 — Purchased for cash 200 shares of the common stock ol Millroad Cor-
poration for $10 per share as a short-term investment.
27 — Accepted a return of merchandise from Patrick Bell and issued credit
memo No. 186 for $1,000.
Mar. 29 — Purchased merchandise for cash, $6,300.
May 30 — Purchased office equipment for $10,000. Paid $1,000 in cash and
gave a 1-year, 6% note for the balance.
June 25 — Borrowed from City Bank by discounting a $20,000, 1-year note at 6%.
Aug. 10— Received a 5%, 60-day note for $4,000 from Patrick Bell on account,
Sept. 25 — Sold 100 shares of Millroad stock for $12 per share, cash.
Oct. 3 — Howard Walker withdrew merchandise costing $250 for his personal
use.
9 — Collected the Patrick Bell note plus interest.
Nov. 28 — Purchased merchandise on account from William Seely, $3,000.
Terms, 3/10; n/30. Invoice date, Nov. 27.
Dec. 7 — Paid William Seely in full less discount.
10 — Sold 100 shares of Millroad stock for $9 per share. Received half of
selling price in cash and half in notes due in 30 days without interest.
31- -Accounting period ends.
Problem A-4. Harrison Mercantile Corporation has the following trial bal-
ance on November 30, 1954, after all posting has been completed for November.
HARRISON MERCANTILE CORPORATION
Trial Balance
November 30, 1964
Cash 10,00000
Securities 5 ,000 00
Accounts receivable . 8,00000
Notes receivable . 2,00000
Inventory 20,000 00
Prepaid interest
Unexpired insurance
Office equipment 5,000 00
Sales equipment 1 5 , 000 00
Accounts payable 6,000 00
Notes payable . 3,00000
Capital stock 25,00000
Earned surplus 32,600.00
Dividends 500 00
Sales 60,000.00
Returned sales and allowances 1 ,000.00
Discount on sales 500.00
Purchases.- 35,000.00
Freight in 1 ,000 00
558 ASSIGNMENT MATERIAL-CHAPTER 11
Returned purchases and allowances 600.00
Discount on purchases — 300 00
Delivery expense .. . . 4,000 00
Rent . . 5,500 00
Salaries. 15,000 00
Taxes
Interest expense
Interest income
Gain on sale of securities .
127, '500 00 127,500 00
The accounts receivable balance of $8,000 represents November 30, 1954
invoices as follows:
James Hawk $3,000.00
r Peter Jenks 5,000.00
Jack Kiel's account in the subsidiary ledger has no balance as of November 30.
The accounts payable balance of $6,000 represents an invoice dated Novem-
ber 25, 1954, payable to William Logan. Creditors' accounts are needed also
for Robert Mass and Henry Opal.
No posting has been done for the month of December, 1954. The entries for
December are summarized below. If the A forms are not used, set up the neces-
sary accounts, allowing five lines each; post to the ledgers; and prepare a trial
balance as of December 31, 1954. Reconcile the control accounts and subsidiary
ledgers.
General Journal (page 9) — column totals:
Accounts receivable (debit) $ -0-
Accounts payable (debit) . 500 00
General ledger (debit) 19,500 00
General ledger (credit) 18,500 00
Accounts payable (credit) -0-
Accounts receivable (credit) . 1 , 500 . 00
General Journal (page 9) — column details:
Accounts payable (debit):
Henry Opal (Dec. 15) . ... $ 50000
General ledger (debit) :
Returned sales and allowances (Dec. 7) . $ 1,500 00
Cash (Dec. 10). . 2,00000
Notes receivable (Dec. 10) 6,000 00
Cash (Dec. 20). 9,900 00
Prepaid interest (Dec. 20) JOO 00
$19,500.00
General ledger (credit) :
Securities (Dec. 10) $ 5,000.00
Gain on sale of securities (Dec. 10). . 3,000 00
Returned purchases and allowances (Dec. 15) 500 00
Notes payable (Dec. 20) 10,000.00
$18,500.00
Accounts receivable (credit):
Jack Kiel (Dec. 7) $ 1,500.00
Sales Hook (page 15) --column total . $11 ,800 00
ASSIGNMENT MATERIAL— CHAPTER 11 559
Sales Book (page 15) — column details:
Jack Kiel (Dec. 4). . . $ 3,500.00
James Hawk (Dec. 15) 2,500.00
Peter Jenks (Dec. 18) ... 3,200 00
Jack Kiel (Dec. 23) ... 2,600.00
$11,800 00
Purchase Book (page 12) — column total $17,500 00
Purchase Book (page 12) — column details:
Robert Mass (Dec. 6) ... $ 3,100 00
Henry Opal (Dec. 10) . 3,000 00
William Logan (Dec. 18) . ... 7,200 00
Robert Mass (Dec. 24) . ... 4,200 00
817,500 00
Cash Disbursements Book (page 16) — column totals:
General ledger . $1 1 , 540 00
Accounts payable . .... 18,80000
Discount on purchases . . 376 00
Cash . ... 29,964 00
Cash Disbursements Book (page 16) — column details'
General ledger:
Rent (Dec. 1). . .... $ 500 00
Unexpired insurance (Doc. 3) ... 250.00
Notos payable (Dec. 5) ... 3,000.00
Interest expense (Dec. 5) 90.00
Taxes (Dec. 18) 700.00
Purchases (Dec. 23) 2,000 00
Dividends (Dec. 31) . . 5,000 00
$11,540 00
Accounts payable:
William Logan (Dec. 4) . $ 6,000.00
Robert Mass (Dec. 16) 3,100.00
Henry Opal (Dec-. 20). . . . 2,500 00
William Logan (Dec. 28). . . ... 7,200 00
$18.800.00
Cash Receipts Book (page 8) — column totals:
General ledger . .. $16,05000
Accounts receivable .... 15,700 00
Discount on sales . 157.00
Cash . . . 31,593 00
Cash Receipts Book (page 8) — column details:
General ledger:
Sales (Dec. 5) * 2, 100.00
No title (Dec. 10) .. 2,000 00
No title (Dec. 20) .... . 9,900 00
Notes receivable (Dec. 21) 2,000 00
Interest income (Dec. 21) ... ... 50 00
$16,050 00
Accounts receivable:
James Hawk (Dec. 8) . $ 3,000 00
Peter Jenks (Dec. 9) . 5,000.00
Jack Kiel (Doc. 14) 2,000 00
James Hawk (Dec. 24) 2,500.00
Peter Jenks (Dec. 28) . . . 3,200.00
$15,700.00
560
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Problem B-3. The Robbins-Hickham Textile Company was organized on
August 3, 1955. A summary of the books of original entry at the end of August
is presented below. No postings have been made to ledger accounts.
Post the entries for the month, allowing five lines for each account, take a
trial balance, and reconcile the controlling account balances with the subsidiary
ledgers.
General Journal — column totals'
Accounts receivable (debit) $ 1,002 50
Accounts payable (debit) 500 00
General ledger (debit) . . 6,750 00
General ledger (credit) . 6,80250
Accounts payable (credit) ... . 250 00
Accounts re9eivable (credit) . . 1,200 00
General Journal — column details:
Accounts receivable (debit) :
James Benson (Aug. 30) $ 1,002 50
Accounts payable (debit) :
Roger Mills (Aug. 20) $ 500 00
General ledger (debit) :
Purchases (Aug. 5) .. $ 5,000 00
Returned sales and allowances (Aug. 12) . 200 00
Notes receivable (Aug. 15) , . 1,00000
Harold Hickham, drawing (Aug. 25) . 300 00
Office supplies (Aug. 28) . . . 250 00
$ 6.750 65
General ledger (credit) :
John Robbins, Capital (Aug. 5) $ 5,000 00
Returned purchases and allowances (Aug 20) 500 00
Purchases (Aug. 25) . 300 00
Notes receivable (Aug. 30) .... 1,000 00
Interest income (Aug. 30) . . . 2.50
$ 6,802 50
Accounts payable (credit) :
Pace Stationery Store (Aug. 28) $ 250 00
Accounts receivable (credit) :
Arthur Call (Aug. 12) $ 200 00
James Benson (Aug. 15) 1,000 00
ST,200 00
Sales Book:
Column total $16,700 00
Column details:
Arthur Call (Aug. 8) . .... $ 2,200 00
Jack Devon (Aug. 10) 6,000 00
William Fair (Aug. 11) 2,50000
James Benson (Aug. 15) 1,000.00
Arthur Call (Aug. 23) 2,00000
Jack Devon (Aug. 25) 3,000 00
$16,700 00
ASSIGNMENT MATERIAL— CHAPTER 11 565
Purchase Book:
Column total . . . $25,000.00
Column details:
Andrew Norton (Aug. 6) . . $10,000 00
Ralph Sill (Aug. 11) 4,00000
Roger Mills (Aug. 16) 3,000 00
Ralph Sill (Aug. 19) 3,00000
Andrew Norton (Aug. 22) 5,000 00
825,000 00
Cash Disbursements Book — column totals'
General ledger $14,575 00
Accounts payable 19 , 500 00
Discount on purchases . 195 00
Cash 33,880 00
Cash Disbursements Book — column details:
General ledger:
Rent expense (Aug. 5) $ 500.00
Store fixtures (Aug 6) ... . 10,00000
Purchases (Aug. 8) 3,000 00
John Robbins, drawing (Aug. 15) 250.00
Freight in (Aug. 20) 175 00
Harold Hickham, dra\\ ing (Aug. 23) . 300 00
Returned sales and allo\\ aiiees (Aug. 25) 350 00
$14.575 00
Accounts Payable:
Andrew Norton (Aug 15) $10,000.00
Ralph Sill (Aug. 21) .... 4,000.00
Roger Mills (Aug. 20) ... 2,500 00
Ralph Sill (Aug. 28) 3,000 00
$19.500.00
Cash Receipts Book — column totals:
General ledger . $48,00000
Accounts receivable . 10 , 500 00
Discount on sales . . 210 00
Cash .. .... 58,29000
Cash Receipts Book- column details.
General ledger:
John Robbins, capital (Aug. 5) ... . ... $20,000 00
Harold Hickham, capital (Aug. 5) 25,000 00
Sales (Aug. 20) 3,000 00
$48,000 00
Accounts receivable:
Arthur Call (Aug. 18) $2,000 00
Jack Devon (Aug. 20) 6 ,000 00
William Fair (Aug. 21) . . . 2,500.00
$10,500.00
Problem B-4. Hendricks Corporation is formed on May 1, 1954. The trans-
actions described below occurred during the first month of operations. Books of
original entry such as are described in this chapter are to be used to record the
month's transactions. Set up general ledger accounts and subsidiary ledger
566 ASSIGNMENT MATERIAL— CHAPTER 11
accounts, allowing five lines to each account, and post these entries. Number
your general ledger accounts. After posting the month's entries, prepare a trial
balance and reconciliations of the accounts receivable and accounts payable con-
trolling accounts.
1954
May 1 — Issued capital stock for cash, $25,000.
3 — Purchased store fixtures for cash, $3,000.
Purchased office fixtures for cash, $1,000.
4 — Purchased merchandise from Able Brothers, Inc., on account, $2,500.
Invoice date, May 2. Terms, 2/10; n/30.
Paid rent for May, $750.
5 — Paid freight on Able Brothers' order, $100.
8 — Purchased merchandise from Jackson Company on account, $3,000.
Invoice'date, May 8. Terms, 2/10; n/30.
9 — Sold merchandise for cash, $300.
Purchased office supplies for cash, $125.
11 — Sold merchandise to Peter Mumford on account, $2,000. Invoice No.
2. Terms, 1/10; n/30.
12 — Purchased for $26,000 the entire inventory of Harrison Company,
which is going out of business. Paid $16,000 in cash and gave a
5%, 2-year note for the balance.
Sold merchandise to Ralph Peters for $3,000 on account. Invoice
No. 3. Terms, 1/10; n/30.
13 — Returned merchandise-costing $350 to Able Brothers and received full
credit on account.
16 — Sent a customer a check for $75 as an allowance to apply on the cash
sale of May 9.
17 — Purchased merchandise from Lanway Co. for $2,700 on account.
Invoice date, May 16. Terms, 2/10; n/30.
18 — Paid Jackson Company $3,000 less 2% cash discount.
19 — Accepted returned merchandise from Peter Mumford and issued him
credit memo No. 1 for $150.
21 — Received a check from Peter Mumford for $1,831.50 representing a
payment of $1,850 less 1%.
22 — Sold merchandise to John Roberts for $7,200 on account. Invoice
No. 4. Terms, 1/10; n/30.
Sold merchandise to James Sanley for $3,200 on account. Invoice
No, 5. Terms, 1/10; n/30.
Received a check for $990 from Ralph Peters. This amount represents
a partial payment of $1,000 on his May 12 purchase less 1 %; the
discount was allowed.
23 — Discounted a 60-day note for $5,000 at the bank; discount rate, 6%.
26 — Received a 30-day, 5% note from Ralph Peters for $2,000, the balance
of his account.
27— Paid Lanway Co. $2,700 less 2% cash discount.
29 — Purchased merchandise from Arthur Leland for $2,300 on account.
Invoice date, May 27. Terms, 2/10; n/30.
30 — Purchased a 3-year fire insurance policy for $630 cash.
31 — Recorded and paid salaries of employees, $1,000. Withholdings for
federal income taxes were $225 and for federal old-age benefits tax
were $15. (Note: Record salaries payable in general journal and
payment in cash disbursements book.)
Employers' federal old-age benefits tax is $16.
ASSIGNMENT MATERIAL-CHAPTER 11
567
Problem B-5. The trial balance and schedules shown below were drawn off
by the bookkeeper before recording adjusting entries after one month of oper-
ations. The general ledger trial balance does not balance and the subsidiary
ledger schedules do not agree with their respective controls.
JOSEPH CORPORATION
Trial Balance— July 31, 19—
Cash 15,749.00
Accounts receivable .... 1,720.00
Accounts payable . .... 3,51000
Capital stock 25,00000
Sales . .... 3,430 00
Returned sales and allowances . . 40 . 00
Discount on sales . . 13 00
Purchases. . 15,900 00
Returned purchases and allowances 150 00
Discount on purchases 52 00
Salesmen's salaries . 220 00
Advertising 100 00
33,742 00 32,152.00
Schedule of Accounts Receivable — July 31, 19 —
S. E. Batts 600 00
G. O. Dana 280 00
R. E. Waterman 350 00
Total 1,230 00
Schedule of Accounts Payable — July 31, 19 —
Harvey's, Inc . 1,30000
Otto Company . 2, 100 00
Rice and Smith 650 00
4,160.00
Following are the ledgers from which these balances were taken:
GENERAL LEDGER
Cash
(1)
19—
July 31
CR1
28,097
119—
1
July 31
Accounts Receivable
19—
July 31
CD1
CR1
Notes Receivable
19—
July
5 R. E.
Waterman
Jl
H19-
July
Accounts Payable
R. E. Waterman
CR1
(15)
50000
(20)
19—
July 31
31
31
GDI
Jl
Jl
4,85000
1,15000
54000
19—
July 31
PI
10,05000
568
ASSIGNMENT MATERIAL-CHAPTER 11
Notes Payable (21)
19—
July
25
Rice and Smith
GDI
1,000
119-
00 July
71 Rice and Smith
Jl
1,000
00
Capital Stock (30)
19—1
July 1
CR1
25,000
00
1
Sales (40)
19—
July
3
CR1
150
00
12
CR1
500
00
f
31
CHI
400
00
31
31
3,280
00
Returned Sales and Allowances (41)
19—
July
3
Jl
40
00
Discount on Sales (42)
19—
July
31
CR1
- 13
H
Purchases (50)
19—
July
1
GDI
5,000
00
10
GDI
500
00
26
GDI
350
00
31
PI
10,050
00
Returned Purchases and Allowances (51)
19—
July
\
Jl
150
00
Discount on Purchases (52)
19—
July
31
GDI
52
00
Store Rent (61)
19—
July
1
GDI
300
00
Salesmen's Salaries (62)
19—
July
16
GDI
20
00
31
GDI
200
00
ASSIGNMENT MATERIAL-CHAPTER 11
569
Advertising
(63)
19—
July
31
GDI 100
H
ACCOUNTS RECEIVABLE LEDGER
S.
£. Batts
19—
July
H
SI
600
•i
1
600
00
6.
O. Dana
19—
July
7
SI
4501
00
450
00
15
(
CR1
450
00
23
SI
280 (
00
280
00
R. E.
Waterman
19—
i
July
2
i S1
800
00
800
00
3
Jl
40
00
760
00
5
CR1
260
00
500
00
5
Jl
500
00
18
SI
850
00
850
00
24
CR1
850
00
50
00
30
81
300
00
350
00
ACCOUNTS PAYABLE LEDGER
Harvey's, Inc.
19—
f
July
9
PI
j 3,500
00
3,500
00
16
CD1
3,500
00
24
PI
1,300
00
1,300
00
Otto Company
19—
July
13
19
PI
GDI
500
00
2,600
^2,600
2,100
00
00
Rice
and Smith
19—
July
1
PI
2,000
00
2,000
00
5
Jl
150
00
1,850
00
7
CD1
850
00
1,000
00
7
Jl
1,000
00
18
PI
650
OG
650
00
On the following pages are the books of original entry from which postings
were made to the foregoing accounts.
570
ASSIGNMENT MATERIAL-CHAPTER 11
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ASSIGNMENT MATERIAL-CHAPTER 11 573
Sales Book (Page 1)
Date
V
Name
Invoice No.
Amount
19—
July
2
7
12
18
23
30
V
V
V
V
V
V
R. E. Waterman.
G. O. Dana
S. E. Batts .
R. E. Waterman
G. O. Dana
R. E. Waterman
Purchase Book
1
2
3
4
5
6
800
450
600
850
280
300
00
00
00
00
00
00
3 ,280
00
(10) (40)
(Page 1)
Date
V
Name
[nvoice Date
Amount
19—
July
1
9
13
18
24
V
V
V
V
V
Rice and Smith
Harvey's, Inc.
Otto Company
Rice and Smith
Harvey's, Inc.
July
1
8
10
10
23
2,000
3,500
2,600
650
1,300
00
00
00
00
00
10,050
00
(50) (20)
Make a list of the errors and prepare a trial balance of the general ledger and
schedules of the subsidiary ledgers showing what the balances in the accounts in
the three ledgers should have been. You are not required to correct the books.
The procedures on page 163 are to be followed.
A suggested form for the solution is on page 574.
574
ASSIGNMENT MATERIAL— CHAPTER 11
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ASSIGNMENT MATERIAL— CHAPTER 11 575
Practice Set
Barker and Carroll, a partnership, sells the office equipment products of
National Brand Co. The partnership has been in operation for about four years.
The firm uses the books of original entry shown on page 576.
The firm uses a general ledger, an accounts receivable ledger, and a notes
receivable register. All purchases on account are made from National Brand
Co., and therefore no subsidiary ledger is needed for accounts payable. A sched-
ule of notes receivable as of March 31, 1954 is presented below:
Int. Due
Date Maker Time Rate Date Amount
1954
Feb. 19
Mar. 16
Mar. 27
Mar. 31
Thomas Roland
August Benson
Philip Hawley
Martin Warner
60 days
60 days
30 days
60 days
6%
6%
6%
6%
Apr. 20
May 15
Apr. 27
May 30
$2,700
1,500
520
340
No register is maintained for notes payable, since the firm issues few notes.
The accounts used by the firm, with their March 31, 1954 balances, are pre-
sented below:
Acct. March 31,
No. Account Title 1954 Balance
~U)TCash . ... . $ 2,275 00
201 Accounts receivable .. . 5,160.00
202 Reserve for bad debts 432 08
203 Notes receivable 5,060 00
204 Accrued interest receivable 32 10
300 Inventory of office equipment . 1,706 00
400 Unexpired insurance . . .317.50
401 Prepaid advertising
402 Sales supplies . 27.00
403 Office supplies . . . 63 00
404 Prepaid interest expense
501 Sales fixtures 9 , 600 00
502 Reserve for depreciation — Sales fixtures 2,220.00
503 Office fixtures . . 2,59200
504 Reserve for depreciation — Office fixtures. 1,151 00
601 National Brand Co 540 00
602 Notes payable
603 Salaries payable .. 239.35
604 Federal OAB taxes withheld . . 28 35
605 Federal OAB taxes payable 28.35
606 Federal income taxes withheld . . 186 20
701 K. L. Barker, capital 9,756 97
702 K. L. Barker, drawings. . .
703 T. J. Carroll, capital. . . . 12,240.30
704 T. J. Carroll, drawings.
705 Profit and loss
801 Sales . .
802 Returned sales and allowances. ... .
901 Purchases
902 Returned purchases and allowances
903 Discount on purchases
904 Freight in
1001 Store rent
576
ASSIGNMENT MATERIAL-CHAPTER 11
(5
1
CREDITS
Notes
Receivable
1
&
Interest
Income
'
+3
— —— .
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^ 53
2 Q; O
v bO y
3
Explanation
Account Credited
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National
rand Co.
ASSIGNMENT MATERIAL-CHAPTER 11 577
1002 Delivery truck rent. . .
1003 Advertising. . .
1004 Depreciation expense — Sales fixtures
1005 Sales salaries . .
1006 Miscellaneous selling expense
1101 Bad debts..
1102 Payroll taxes..
1103 Insurance expense
1104 Office salaries .
1105 Depreciation expense — Office fixtures
1106 Office expense .
1107 General expense ...
1201 Interest income
1202 Interest expense
The accounts receivable to be used will be:
Name March 31 Balance
Anderson Ttoke Co $ 372 1)0
Richard Chamberlain . 832 00
Courtland and Sparks
Richard C. Lawson
Vincent Mercer Grocery
Thomas Outland 1,475 00
Wilson R. Trenach 326 00
Wayne Shops. 730 00
Woiliston Electric Co. 1 ,425 00
Wlseheart Rug Service — 0 —
The firm hires two clerks, who are paid on the 4th of each month for the last
half of the preceding month and on the 18th of each month for the first half of
the cuirent month. The payroll data are scheduled below:
Withholding
Pay Semimonthly Income Net
Name Position Period Gross Wage O.A.B. Tax Wage
TheoTLcwiH Office Semi- $120 00 $1 80~ $13 30 $104.90
dork monthly
Robert Schmidt Sales Semi-* 15000 225 1330 134.45
clerk monthly
The books of Barker and Carroll are closed monthly, and this practice set will
cover the operations of the firm for the month of April, 1954.
Instructions
(1) Journalize the transactions for the month of April, 1954.
(2) Post the journal entries to the ledger accounts; also enter the necessary
information in the notes receivable register.
(3) Prepare the April 30, 1954 trial balance. (Use the Trial Balance columns
of the working papers.)
(4) Complete the working papers.
(5) Prepare the following monthly statements:
Statement of profit and loss.
Statement of partners' capitals.
Balance sheet.
(6) Journalize the adjusting and closing entries.
(7) Post
578 ASSIGNMENT MATERIAL-CHAPTER 11
TRANSACTIONS FOB THE MONTH OP APRIL, 1954
1954
April 3 — An invoice is received from National Brand Co. for the purchase of
office equipment, $2,400; terms, 2/10; n/30.
Freight on the above shipment is paid to the carrier, $68.
Store rent for April is paid, $230.
Sale of office equipment is made on account to Vincent Mercer, $127.
(Start with invoice number 783.)
Cash sales for the day, $327.50.
4 — Semimonthly salaries for the last half of March are paid to the clerks.
(See the payroll schedule for the amounts.)
Collection is received from Thomas Outland, $1,475.
A sales agreement is made with Wayne Shops whereby, during the
next Several weeks, Wayne Shops will purchase equipment for all its
retail outlets on account. When all of the purchases have been
made, a note will be given covering the total purchases under this
agreement. Wayne Shops also agrees that the amount owing
Barker and Carroll on March 31, 1954, shall be paid before April
10. The first sale under this agreement is completed today, $1,300.
5— Telephone bill is paid, $11.25.
Sales supplies are purchased for cash, $64.
An invoice from National Brand Co. dated March 28, in the amount
of $540, is paid. The terms were 2/10; n/30.
Office equipment is- sold to Vincent Mercer, $520.
Cash sales for the day, $125.
6 — Vincent Mercer returns the office equipment purchased on April 3 in
order to get a larger-model machine, which is placed on order. A
credit memorandum is issued.
Cash sales for the day, $296.70.
7 — Federal O.A.B. taxes withheld and payable for the first quarter are
remitted to the federal depositary. The amounts, based on salaries
paid, are $24.30 each.
Federal income taxes withheld for the first quarter are remitted to the
federal depositary. The amount withheld on salaries paid is
$159.60, and this is the amount remitted.
Sale of office equipment to Wayne Shops, $1,235.
Collection of the March 31 balance in the account of Wayne Shops is
received, $730.
10 — Collections are received from:
Welliston Electric Co $1 , 425
Wilson R. Trenach. . . 326
Gas and oil for the delivery truck are purchased for cash, $8.25.
Cash sales for the day, $89.
11 — An invoice is received from National Brand Co. for the purchase of
office equipment, $2,000; terms, 2/10; n/30.
Freight on the above shipment is paid to the carrier, $38.20.
The new machine ordered for Vincent Mercer is delivered to him,
$175.
12— Newspaper advertising for two days is purchased for cash, $25.
Sale of office equipment to Wayne Shops, $936.
Cash sales for the day, $136.
ASSIGNMENT MATERIAL-CHAPTER 11 579
April 12 — Premium on a three-year insurance policy is paid, $180. The policy
date is April 15.
13 — The National Brand Co. invoice of April 3 is paid.
Office equipment is removed from the inventory to be used in the
office of Barker and Carroll; cost, $72.
Cash sales for the day, $286.
14 — Barker withdraws cash for his personal use, $300.
Janitor services are paid, $12.
Sales of office equipment on account:
Richard C. Lawson . . . $832
Wayne Shops ... . . 439
17 — Semimonthly rental for the delivery truck is paid to Argo Rental Co.,
$35.
Carroll withdraws cash for his personal use, $450.
Richard Chamberlain pays $332 on his March balance of $832 and
signs a 60-day, 6% note for the balance.
Office supplies are purchased for rash, $117.
18 — Semimonthly salaries for the first part of April are paid to the clerks.
The semimonthly accrual for the Federal O.A.B. tax liability is
recorded at this time.
An invoice is received from National Brand Co. for the purchase of
office equipment, $3,000; terms, 2/10; n/30.
Freight on the above shipment is paid to the carrier, $63.
Sale of office equipment is made on account to Richard C. Lawson,
$465.
Cash sales for the day, $217.30.
19 — Sale of office equipment is made on account to Courtland and Sparks,
$176.
A defective machine included in the latest shipment is returned to
National Brand Co. Full credit is taken in line with an agreement
with the supplier. The amount is $79.
20 — The National Brand Co. invoice of April 11 is paid.
Thomas Roland's note dated February 19 is collected.
Sales of office equipment on account:
Courtland and Sparks . $1 ,250
Wilson R. Trenach 158
21 — Advertising supplies to be used for the next several months are pur-
chased for cash, $230.
Gas and oil for the delivery truck is purchased for cash, $7.30.
Sale of equipment is made on account to Courtland and Sparks, $375.
24 — Newspaper advertising for three days is purchased for cash, $38.
The firm signs a 60-day, $1,200 note at the bank. The note is dis-
counted by the bank at 5%.
Sale of office equipment on account is made to Wayne Shops, $570.
25 — An invoice is received from National Brand Co. for the purchase of
office equipment, $1,300; terms, 2/10; n/30.
Freight on the above shipment is paid to the carrier, $24.
Sale of office equipment is made on account to Wiseheart Rug Service,
$465.
Cash sales for the day, $169.
580 ASSIGNMENT MATERIAL-CHAPTER 11
April 26 — As per the agreement of April 4, August Wayne signs a 60-day, 6%
note for the sum of the purchases by Wayne Shops.
Cash sales for the day, $147.
27 — Philip Hawley's note dated March 27 is collected.
A defective typewriter is returned by a cash customer and a cash
refund is given for the sales price, $65.
The defective typewriter is returned to National Brand Co. and credit
is taken for its cost, $36. This item was in the April 25 purchase.
28 — The National Brand Co. invoice of April 18 is paid, less the credit for
the equipment returned.
The semimonthly delivery truck rental is paid, $35.
Janitor services are paid, $12.
30— Utilities for April are paid, $15.60.
Cash sales for the day, $182.
Required Adjustments
(a) Accrued salaries for the last half of the month.
(b) Accrued federal O.A.B. tax payable for the last half of the month.
(c) The insurance policies are:
Date Purchased Protection Term Total Premium
April 15, 1951 Fire on merchandise 3 years $180
January 1, 1953 Public liability 3 years 144
January 1, 1954 Fire and theft on fixtures 2 years 264
April 15, 1954 Fire <m merchandise 3 years 180
(d) Accrued interest on the notes receivable outstanding at the end of the month.
(e) Interest expense on the note payable.
(f) The annual depreciation rates are:
Asset Rate
Sales fixtures. . .... 10%
Office fixtures . . 12 \%
Office fixture transferred from inventory to fixed assets during the
month .. . . 12J%
(g) It is estimated that the monthly provision for uncollectible accounts should
be 1% of the net credit sales (total credit sales less credit returns),
(h) The account of Anderson Coke Co. is found to be uncollectible and is written
off.
(i) Inventories of prepaid expenses are:
Sales supplies. . . $41
Office supplies .... 76
Advertising supplies . ... 196
Other Data
The ending merchandise inventory is $2,871.
The partners share profits as follows:
K. L. Barker 40%
T. J. Carroll 60%
ASSIGNMENT MATERIAL FOR CHAPTER 12
Questions
1. Explain what is meant by the phrase " departmental contribution to
overhead."
2. If the method described in this chapter for recording cash sales in a business
with various departments is used, why are the totals of the Sales column in the
cash receipts book and the Cash column in the sales book not posted?
3. What departmental accounts should be kept if it is desired to determine
merely the gross profit on sales by departments?
4. What additional information must be obtained to determine net income
by departments?
5. What is the danger in apportioning selling expenses to departments on the
basis of sales?
6. Describe the journalizing procedure for recording cash purchases if the
business has several departments and maintains a separate Purchases account
for each department. Explain how such entries would be posted.
7. Suggest a basis for apportioning each of the following expenses to depart-
ments, and state your reason for selecting the basis used:
Delivery expense
Rent expense
Advertising expense
Freight in
8. If the operations of a department result, year after year, in a net loss, after
charging the department with reasonable amounts of selling anil general expenses,
could there be any possible reason for continuing its operations?
Problems — Group A
Problem A-l. Using the information in the following adjusted trial bal-
ance, prepare working papers showing the gross profit on sales by departments.
Apportion the freight in on the basis of purchases.
MAX CORPORATION
Adjusted Trial Balance
December 31, 1964
Cash 17,830.00
Accounts receivable 14,600 .00
Allowance for bad debts 690.00
Inventories — December 31, 1953:
Dept. A 15,000 00
Dept. B 27,000.00
Unexpired insurance 640 .00
Store equipment . .. . 4,000.00
Allowance for depreciation — Store equipment ... 1 , 200 . 00
581
582 ASSIGNMENT MATERIAL— CHAPTER 12
Accounts payable. . . ; 11 ,800 00
Federal income tax payable 5,000 00
Capital stock 40,000 00
Earned surplus 8,32500
Dividends . . 2,000.00
Dept. A 72,00000
Dept. B... 118,000 00
Returned sales and allowances:
Dept. A . . . . . 400 00
Dept. B 800 00
Purchases:
Dept. A 56,000 00
Dept. B 84,000 00
Discount on purchases:
Dept. A ! 560 00
Dept. B . 840 00
Freight in 2,00000
Store rent .. 4,80000
Delivery expense 1 , 125 00
Advertising . . 500.00
Depreciation of store equipment . 400 00
Selling commissions . . . 14,00000
Office salaries 6,50000
Bad debts. 410 00
Insurance 285 00
Miscellaneous office expense 1,12500
Federal income tax 5,000 00
258,415 00 258,415 00
Inventories — December 31, 1954:
Dept. A . $17,000 00
Dept. B . . 22,500.00
Problem A-2. Following is the trial balance of the Brighton Company as of
December 31, 1954
BRIGHTON COMPANY
Trial Balance
December 31, 1954
Cash 32,17644
Accounts receivable . 24,914.62
Reserve for bad debts ... . 228 15
Notes receivable 6,000 00
Accrued interest receivable ... ... —0 —
Inventory — Department A. 14,207 50
Inventory— Department B 17 , 108 . 62
Unexpired insurance . 1,200 00
Delivery equipment. . . .... 9,560.00
Reserve for depreciation — Delivery equipment . . 1 , 728 . 00
Accounts payable 14,738 09
Notes payable 15,000.00
Federal income tax payable
Accrued salaries payable
Accrued interest payable
Capital stock 60,000.00
Earned surplus 7,447 .94
Dividends . 3,000.00
ASSIGNMENT MATERIAL— CHAPTER 12 583
Sales — Department A .... . . 75,000.00
Sales— Department B .... 125,00000
Returned sales and allowances — Department A . 1 ,310 . 12
Returned sales and allowances — Department B. 1,129 88
Discount on sales — Department A . 1 , 280 00
Discount on sales — Department B ..... 1 ,892 50
Purchases — Department A ____ 59,712 00
Purchases — Department B ____ 95 , 788 00
Returned purchases and allowances — Depart-
ment A . 750 00
Returned purchases and allowances — Depart-
ment B 1 ,050 00
Discount on purchases — Department A 620 00
Discount on purchases — Department B 1 ,775 00
Freight in 1,55500
Store rent 4,000.00
Advertising . . 5,050 00
Salesmen's salaries — Department A 5,000 00
Salesmen's salaries — Department B 7,000 00
Delivery expense . 2,957.50
Depreciation — Delivery equipment . . . — 0 —
Officers' salaries ........ 5,000 00
Office salaries ...... 3,075 00
Insurance . — 0 —
Bad debts . . -— 0—
Miscellaneous general expenses . 1 , 380 00
Interest income . .... 98.00
Interest expense ............. 138 00
Federal income tax ................... — 0 —
303,435.18 303^435718
Investigation discloses that the following facts have to be taken into con-
sideration before the formal statements can be prepared:
(a) The $1 ,200 in the Unexpired Insurance account is the premium on a fire
insurance policy which was acquired on January 1, 1954, covering a period of
three years.
(b) The following salaries had been earned but were unpaid as of December
31, 1954:
Salesmen of Department A . ....... $ 600 00
Salesmen of Department B ..... 800 00
Deliveryman ........ ........... 50 00
Office clerks ........................... 125 00
Total . . ..... ...... *
(c) The $5,000 in the Notes Receivable account represents a 60-day, 6%
note received from A. Bobbs, a customer, on December 16, 1954.
(d) The $15,000 in the Notes Payable account represents two notes as follows:
(1) A 5%, 60-day note for $7,200, dated December 1, 1954, given to
Champion Corporation.
(2) A 6%, 30-day note for $7,800, dated December 21, 1954, given to
H. R. Davies and Sons.
(e) Bad debts are estimated to be £ of 1 % of sales less returned sales and
allowances.
(f) The delivery equipment is depreciated at the rate of 10% a year.
(g) Federal income taxes are to be recorded at $1,000 for the year 1954.
584 ASSIGNMENT MATERIAL— CHAPTER 12
(h) The inventories on hand on December 31, 1954, as determined by actual
count, were as follows:
Department A . . $11 ,667 02
Department^ 18,62286
(i) The company has decided that the freight in should be allocated on the
basis of purchases.
Required:
(1) Working papers for the year ended December 31, 1954, showing gross
profit on sales by departments.
(2) The statement of profit and loss for the year ended December 31, 1954,
showing gross profit by departments.
Problem A-3.' Supplementing all of the data included in Problem A-2 with
the following data relative to the apportionment of the selling and general
expenses and interest income and expense, prepare (1) a schedule of apportion-
ments, (2) a work sheet showing net income by departments, and (3) a statement
of profit and loss showing net income by departments.
(a) The following expenses are to be apportioned on the basis of sales.
1. Delivery expense.
2. Depreciation of delivery equipment.
3. Officers' salaries.
4. Office salaries.
5. Miscellaneous general expenses.
6. Interest income.
(b) Interest expense is to be apportioned on the basis of purchases.
(c) Insurance expense is to be apportioned on the basis of average inventories.
(d) Store rent should be apportioned on the basis of floor space occupied;
Department A covers 5,200 square feet and Department B covers 7,800 square
feet of floor space.
(e) Advertising expense should be allocated on the basis of advertising space
occupied in the display windows, newspapers, magazines, and so forth. The
statistical department has apportioned the $5,050 of advertising as follows:
$3,000 to Department A, and $2,050 to Department J5.
(f) Bad debts expense should be apportioned on the basis of net sales (exclu-
sive of discount on sales).
(g) The income tax department has stated that $1 ,500 of income tax would
have been levied on the profits of Department B. (On the work sheet, extend
the $1,000 debit for federal income taxes as a $500 credit in Department A's
columns and a $1,500 debit in Department B's columns.)
All apportionments should be carried to the nearest cent.
Problem A-4. The officers of Brighton Company have asked you to deter-
mine whether it would be advisable for them to discontinue the operations of
Department A, since the apportionment of selling and general expenses as per
Problem A-3 has resulted in showing Department A as operating at a loss.
An investigation made by you has disclosed the following facts:
(a) The store has been leased for a period of 25 years; therefore, the entire
space would have to be retained under the lease.
ASSIGNMENT MATERIAL— CHAPTER 12 585
(b) The advertising and salesmen's salaries charged to Department A would
be eliminated if the operations of that department were discontinued.
(c) There would be no reduction of either delivery expense or depreciation of
delivery equipment, since the company has only one delivery truck and employs
only one driver.
(d) Officers' salaries would not be reduced.
(e) Office salaries would be reduced by $1,000, the salary of one part-time
employee.
(f) Insurance costs applicable to inventories presently carried in Department
A would be eliminated.
(g) All bad debt losses charged to Department A would be eliminated.
(h) Approximately 20% of the total miscellaneous general expenses would be
eliminated.
(i) Both the interest received on receivables arising from Department A's
sales and the interest expense incurred to finance the purchases of Department A
would disappear.
Required:
(1) Determine the total amount of expenses that would be eliminated if
operations of Department A were discontinued.
(2) Determine by what amount the expenses eliminated would exceed or
be less than the gross profit on sales made by Department A.
(3) Determine what the net income before federal income tax would be if
Department A were discontinued.
Problems — Group B
Problem B-l. Refer to Problem A-l and prepare journal entries to close the
books as of December 31, 1954.
Problem B-2. Set up the necessary general ledger accounts and make all
postings from the journals on pages 586 and 587 to the general ledger of Arbor
Company.
586
ASSIGNMENT MATERIAL— CHAPTER 12
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588 ASSIGNMENT MATERIAL— CHAPTER 12
Problem B-3. The profit and loss statement of The Hedges Corporation is
shown on page 589.
The following expenses and income are fully variable, meaning that the
portion thereof allocated to each department would be eliminated if the depart-
ment were discontinued: advertising, salesmen's salaries, insurance, bad debts,
miscellaneous general expenses, interest expense, and interest income.
The following expenses are fixed charges, meaning that they would not be
reduced if a department were discontinued: store rent, depreciation of delivery
equipment, officers' salaries, and office salaries.
Determine the effect on net income before income taxes which would result
from a discontinuance of Department I.
Problem B-4. Using the information presented in Problem B-3, prepare a
profit and loss statement for The Hedges Corporation showing each department's
contribution to lion-departmental overhead.
Problem B-5. The officers of Brighton Company are considering the dis-
continuance of the operations of Department A, since the report submitted in
the solution to Problem A-3 showed that Department A was operating at a loss.
An analysis of the expenses charged to Department A was made and the follow-
ing results were obtained:
(a) If Department A were discontinued, all of Department B would be
located on the first floor. The second floor could then be rented out at a yearly
rent of SI, 000.
(b) Most of the advertising expense of the company is for advertisements in
newspapers, whose charges include both a fixed and a variable fee. Advertising
only the merchandise sold in Department B would reduce the total advertising
expense from $5,050 to $2,550.
(c) The salaries of the salesmen of Department A would be eliminated.
(d) The cost of the gas and oil used by the delivery truck in making deliveries
of sales of Department A is estimated to be $200. The other expenses included in
the Delivery Expense account would not be eliminated.
(e) The depreciation expense on the delivery truck would not be reduced.
(f) Officers' salaries would not be affected.
(g) The discontinuance of the operations of Department A would eliminate
the necessity of paying the office clerks overtime pay, which would reduce the
office salaries payroll by $300.
(h) Insurance costs applicable to inventories presently carried in Department
A would be eliminated.
(i) All bad debt losses charged to Department A would be eliminated.
(j) Approximately one-third of the total miscellaneous general expenses
would be eliminated.
(k) Both the interest received on receivables arising from Department A's
sales and the interest expense incurred to finance the purchases of Department
A would disappear.
Required:
(1) Determine the total amount of expenses that would be eliminated if
operations of Department A were discontinued.
(2) Determine by what amount the expenses eliminated would exceed or
be less than the gross profit on sales made by Department A.
(3) Determine what the net income before federal income tax would be if
Department A were discontinued.
ASSIGNMENT MATERIAL-CHAPTER 12
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ASSIGNMENT MATERIAL FOR CHAPTER 13
Questions
1. What are the three elements of manufacturing cost?
2. Distinguish between direct labor and indirect labor.
3. Tell in which element of manufacturing cost the following would be
classified:
(a) Floor-sweeping material.
(b) Wages paid the factory timekeeper.
(c) A machine operator's wages.
(d) Lumber to be used in making desks to be sold.
(e) Lumber to be used in making desks for the office.
(f) First-aid kit for the factory.
(g) Towels for the factory office.
(h) Parts to be used in a machine to be sold,
4. How do the working papers of a manufacturing business and those of a
trading business differ?
6. If you were given the amount for the cost of goods sold, what would you
do to compute the cost of goods manufactured?
6. If an expense account balance is to be apportioned, how is such apportion-
ment handled in the working papers?
7. The X Machinery Co. manufactured a machine for use in its own furnace
room. At what figure should the machine be set up in the fixed asset account:
Materials cost?
Prime cost (materials plus direct labor)?
Total manufacturing cost (materials, labor, and overhead)?
Selling price?
The price at which the X Machinery Co. would be able to purchase the
* machine elsewhere?
Problems — Group A
Problem A-l. Following is the December 31, 1955 trial balance of the
Mulligan Corporation, whose accounting period is the calendar year.
MULLIGAN CORPORATION
Trial Balance
December 31, 1955
Cash . 20,00000
Raw materials inventory— December 31, 1954. . . 30,000.00
Goods in process inventory — December 31, 1954 15,000.00
Finished goods inventory— December 31, 1954 12,000.00
Unexpired insurance 1 ,000 .00
Factory equipment 25,000.00
Reserve for depreciation — Factory equipment 5,000.00
Furniture and fixtures. . 8,00000
Reserve for depreciation — Furniture and fixtures 3,200 00
Accounts payable 16,00000
590
ASSIGNMENT MATERIAL— CHAPTER 13 591
Accrued salaries and wages payable
Capital stock 75,000 00
Earned surplus . 35,30000
Dividends 2,000 00
Sales . ... 200,000.00
Purchases— Raw materials . . .. . 70,000.00
Direct labor . 50,000 00
Indirect labor . . . 10,000 00
Factory rent. . . . 5,000.00
Heat, light, and power . .. . . . 4,000.00
Insurance expense ...
Depreciation — Factory equipment .
Advertising .... . ... . 3,00000
Salesmen's salaries 42,00000
Office supplies 1 ,500 00
Officers' salaries . . . 30,000.00
Office salaries 5,00000
Depreciation — Furniture and fixtures .
333,500.00 333,500.00
•
Information for adjustments and allocations is as follows:
Adjustments*
1. Insurance amounting to $800 has expired.
2. Accrued salaries and wages as of December 31, 1955 are as follows:
Direct labor
Indirect labor
Salesmen's salaries
Officers' salaries
Office salaries
3. Annual depreciation rates are as follows
Factory equipment 10%
Furniture and fixtures 20%
4. Inventories — December 31, 1955:
Haw materials . . . . $25 , 000
Goods in process 23,000
Finished goods 20,000
Allocations:
1. Insurance expense should be allocated 50% to manufacturing, 10% to
selling, and 40% to general.
2. Depreciation of furniture and fixtures should be allocated 40% to selling
and 60% to general.
Required:
(a) Working papers for the year ended December 31, 1955.
(b) Statement of cost of goods sold for the year ended December 31, 1955.
(c) Closing entries.
Problem Ar2. On pages 592 and 593 is a trial balance of The Pardee
Company on December 31, 1954.
592
ASSIGNMENT MATERIAL— CHAPTER 13
THE PARDEE COMPANY
Trial Balance
December 31, 1954
Cash
Notes receivable
Accounts receivable ...
Reserve for bad debts
Accrued interest receivable ...
Raw materials inventory, 12/31/53
Goods in process inventory, 12/31/53
Finished goods inventory, 12/31/53
Unexpired insurance
Land
Buildings . . . ...
Reserve for depreciation — Buildings
Machinery .
Reserve for depreciation — Machinery. .
Furniture and fixtures. .
Reserve for depreciation — Furniture and fixtures
Notes payable .
Accounts payable
Federal income tax payable
Accrued salaries and wages payable
Accrued interest payable .
Capital stock . . .
Earned surplus
Dividends
Sales
Returned sales and allowances
Discount on sales . ....
Purchases — Raw materials
Discount on purchases
Freight in . .
Direct labor .
Indirect labor . .
Depreciation — Buildings
Depreciation — Machinery... .
Insurance — Buildings...
Insurance — Machinery ....
Taxes — Real estate
Heat, light, and power
Repairs — Buildings
Repairs — Machinery..
Factory supplies. . .
Miscellaneous factory expenses. .
Salesmen's commissions and salaries . .
Salesmen's traveling expenses
Advertising ...
Freight out ...
Insurance — Merchandise. . .
Miscellaneous selling expenses
Officers' salaries
Office salaries
Postage
Telephone and telegraph
Stationery and printing
Depreciation — Furniture and fixtures
Bad debts
32,987.50
2,400.00
250,900.00
27,000.00
25,000.00
30,000.00
3,600 00
25,000 00
50,000.00
40,000 00
5,700 00
15,000 00
42,000 00
15,900 00
320,000 00
23,000 00
299,500 00
52,000.00
4,100,00
23,700 00
950.00
1,310.00
12,875.00
3,010 00
43,000.00
17,500.00
19,600.00
11,000.00
900 00
10,250 00
15,000 00
18,000 00
2,000.00
1,800 00
3,950.00
9,400.00
13,000 00
5,250 00
12,500 00
2,500 00
87,000 00
42,800 00
200,000 00
95,327.50
990,000 00
9,700 00
ASSIGNMENT MATERIAL-CHAPTER 13 593
Miscellaneous general expenses 695 .00
Interest expense. . 6,600 00
Interest income . 7,550.00
Federal income tax
M65, 627 JO 1,465,627.50
The following data must also be taken into consideration:
(a) Depreciation rate on buildings is set at 4% per annum.
(b) Depreciation rate on machinery is set at 10% per annum.
(c) Depreciation rate on furniture and fixtures is set at 10% per annum.
(d) The amount shown in the Notes Payable account represents the follow-
ing two notes:
(1) $37,000 — 60-day, non-interest-bearing note, dated November 23,
1954, given to Steel Industries, Inc.
(2) $50,000—6%, 60-day note, dated December 16, 1954, given to the
General Factory Products Co.
(e) The following insurance costs have expired during 1954:
(1) $400 — on policy covering buildings.
(2) $300 — on policy covering machinery.
(f) Accrued wages and salaries on December 31, 1954, were as follows:
Direct labor. . $10,300
Indirect labor . .3,000
Salesmen's commissions . . . 2,500
Total $15,800
(g) The amount in the Notes Receivable account represents a $2,400 note
dated December 1, 1954, received from one of our customers. The note bears
interest at 5% and is due on February 1, 1955.
(h) The bad debts expense is to be adjusted to bring the total expense for bad
debts for the year to equal $12,480.
(i) The liability for the 1954 income tax is to be set up in the amount of
$6,500.
(j) The following apportionments of expenses are to lie made:
Manufacturing Selling General
Insurance — Buildings 95%
Depreciation — Buildings 95%
Repairs — Buildings 95%
Taxes— Real estate.. 95%
Heat, light, and power . 90 % 5 %
Insurance — Merchandise 50% 50%
Telephone and telegraph 50% 50%
Depreciation — Furniture and fixtures . 25% 75%
(k) The inventories on hand December 31, 1954, were as follows:
Raw materials . ... $25,500
Goods in process 20,000
Finished goods 35,000
Prepare working papers, statement of cost of goods manufactured, statement
of profit and loss, statement of earned surplus, and balance sheet.
594 ASSIGNMENT MATERIAL-CHAPTER 13
Problem A-3. Following is a trial balance of the Pareed Corporation as of
December 31, 1954:
PAREED CORPORATION
Trial Balance
December 31, 1954
Cash . . 121,287.43
Accounts receivable 973,912.00
Reserve for bad debts 4,139.00
Notes receivable. 30,40000
Accrued interest receivable
Raw materials inventory 22,000 00
Goods in process inventory 27 , 500 00
Finished goods inventory 31 ,600 00
Unexpired insurance 23,500 00
Prepaid garage rent 3,60000
Land... . ... 50,000.00
Buildings 100,000.00
Reserve for depreciation — Buildings 13,750 00
Machinery . 73,000.00
Reserve for depreciation — Machinery 1 7 , 255 . 00
Delivery equipment ... . 27,00000
Reserve for depreciation — Delivery equip-
ment. 9,870 00
Furniture. 38,000 00
Reserve for depreciation — Furniture . . 7 , 31 5 . 00
Notes payable.. . v 55,00000
Accounts payable 73 , 917 . 72
Federal income tax payable
Accrued wages and salaries payable
Accrued interest payable.
Capital stock 1 , 000 , 000 . 00
Earned surplus 79, 169 26
Dividends. .. 60,00000
Sales . . ... 2,417,318.72
Returned sales and allowances 9,23928
Discount on sales ... 15,312.80
Purchases— Raw materials ... ... 1 , 218 , 738 . 27
Returned purchases and allowances 4 , 294 . 44
Discount on purchases. . ... 11,21638
Freight in. . 17,319 82
Direct labor. . 482,917 00
Indirect labor 58,91700
Depreciation — Buildings. . . ...
Depreciation — Machinery
Insurance — Buildings
Insurance — Machinery
Taxes— Real estate 4,860.00
Heat, light, and power 28,500 00
Repairs — Buildings 12,50000
Repairs — Machinery 39 , 178 . 41
Factory supplies 17, 111 . 11
Miscellaneous factory expenses 9,31900
Salesmen's salaries ... 48 , 917 . 28
Salesmen's traveling expenses 11,975.00
Advertising 39,100.75
Freight out 8,173.92
Insurance — Merchandise
Insurance — Delivery equipment
ASSIGNMENT MATERIAL-CHAPTER 13 595
Repairs — Delivery equipment 1 ,007 . 50
Depreciation — Delivery equipment
Other delivery expenses 7,117.00
Miscellaneous selling expenses 9,182.00
Officers' salaries 25,000.00
Office salaries 28, 190 00
Postage . . . 3,171 00
Telephone and telegraph .... 1,650 00
Stationery and printing. . . ... 2,800 00
Depreciation — Furniture.
Bad debts
Miscellaneous general expenses 9,173 70
Interest expense ... 4 , 148 . 75
Interest income 2,073.50
Federal income tax
3,695,319.02 3,695,319 02
Additional data:
(a) The depreciation rate on buildings is 2|% per annum.
(b) The depreciation rate on machinery is 10% per annum.
(c) The depreciation rate on delivery equipment is 20% per annum.
(d) The depreciation rate on furniture is 5% per annum.
(e) Insurance policies, purchased on January 1, 1954, were as follows:
Property insured Term of policy Premium paid
Buildings 5 years $5,000
Machinery 5 years 15,000
Merchandise . . ... 2 years 1,500
Delivery equipment 4 years 2,000
Unexpired insurance as of 1/1/54 .. $23 , 500
(f) On July 1, 1954, the company entered into a lease for additional garage
space. The lease covered three years and cost $3,600.
(g) The data on the notes receivable are as follows:
From whom received Date of note Time of note Rate Face value
~~BrRTReigel TT " 12/16/54 60 days ~6%" $ 1,000
Wilson and Sons . 9/ 1/54 6 months 6% 15,000
C. R. Creamer 12/1/54 90 days 5% 14,400
Notes receivable on hand 12/31/54 $30,400
(h) The data on the notes payable are as follows:
To whom given Date of note Time of note Rate Face value
Leste7steei~Corp 11/18/54 3 months — $30,000
Truex Products 11/1/54 4 months 6% 25,000
Notes payable outstanding 12/31/54. . . $55,000
(i) Wages and salaries earned but unpaid on 12/31/54:
Assembly-line workers . . $ 8 , 500
Indirect laborers 770
Salesmen 1,420
Deliverymen . . . 345
Office clerks 912
Total . . $11,947
596 ASSIGNMENT MATERIAL— CHAPTER 13
(j) The company estimates that, of the $973,912 of accounts receivable on
12/31/54, only $947,802 will be collected.
(k) Federal income tax for 1954 is estimated at $110,000.
(1) The company has decided on the following apportionments of expenses :
Manufacturing Selling General
All expense on buildings ... 90% 10%
Taxes on real estate .... . 90% 10%
Heat, light, and power 80% 10% 10%
Telephone and telegraph 50% 50%
Depreciation — Furniture . 20% 80%
Insurance — Merchandise . Average inventories
(m) The inventories on hand on 12/31/54 were as follows:
Raw materials . . $18,000
Goods in process . 22 , 500
Finished goods . . 28,400
Prepare:
(1) Working papers.
(2) Statement of cost of goods manufactured.
(3) Statement of profit and loss.
(4) Statement of earned surplus.
(5) Balance sheet.
Problems— Group B
Problem B-l. From the following information, prepare a statement of cost
of goods manufactured for Cramer Creamery Company.
December 31, 1953 inventories:
Raw materials $ 10 ,000
Goods in process 15,000
Finished goods. 5,000
December 31, 1954 inventories:
Raw materials . . 12,000
Goods in process .. .. 9,000
Finished goods .... . 7,000
Raw material purchases . 100,000
Direct labor.. . .... . . 200,000
Freight in. 3,000
Selling expenses. . . 25,000
Freight out... 2,000
Indirect labor. . 15,000
Insurance on factory 12,500
Heat, light, and power — Factory 22,000
Depreciation — Machinery. . .. 3,000
Factory supplies expense 4,000
Returned purchases and allowances 5,000
Sales 350,000
Discount on purchases 800
Discount on sales 2,000
Problem B-2. Using the information given in Problem A-2, prepare (1)
adjusting entries, and (2) closing entries.
ASSIGNMENT MATERIAL— CHAPTER 13 597
Problem B-3. Using the information given in Problem A-3, prepare (1)
adjusting entries, and (2) closing entries.
Problem B-4. The following information pertains to the operations of the
C. L. Moore Company for the fiscal year ended June 30, 1954:
Inventories, June 30, 1953:
Raw materials $ 22,000
Goods in process . . 16,225
Finished goods . . 77,500
Inventories, June 30, 1954:
Raw materials ... 24 , 500
Goods in process 17 , 100
Finished goods 58 , 425
Net purchases . 300 , 000
Freight in. . 4,000
Direct labor 400,500
Total manufacturing expenses 235 , 700
From the information given above, compute the following:
(a) The cost of manufacturing.
(b) The cost of goods manufactured.
(c) The cost of goods sold.
Problem B-6. The account balances of Sun Corporation after year-end
adjustments are presented below.
SUN CORPORATION
Adjusted Trial Balance
December 31, 1954
Cash . 11,000 00
Accounts receivable 56,500 00
Reserve for bad debts 4,500 00
Finished goods inventory 31 ,000 00
Goods in process inventory 12,000 00
Raw materials inventory 20,000 00
Unexpired insurance . 2,80000
Prepaid advertising 1,200 00
Machinery and equipment 50,00000
Reserve for depreciation — Machinery and equip-
ment. 12,500 00
Furniture and fixtures 20,000 00
Reserve for depreciation — Furniture and fixtures 7,500 00
Accounts payable 34,300 00
Accrued interest payable . . . 900 00
Accrued salaries and wages payable 12,600 00
Accnied income tax 8,000 00
Mortgage payable 30 , 000 00
Capital stock . 75,00000
Earned surplus .. . 13,70000
Dividends. 7,500 00
Sales . . 206,500 00
Returned sales and allowances ... 3 , 500 00
Discount on sales 2,300.00
Purchases 54,000.00
Returned purchases and allowances 3 ,000 00
Discount on purchases . . 1 , 100 00
Freight in .. . 2,000.00
598 ASSIGNMENT MATERIAL— CHAPTER 13
Direct labor ................................ 40,000.00
Indirect labor ........................... 14,000.00
Heat, light, and power ..................... 2,000.00
Factory rent. ... ................ 6,000.00
Factory insurance ............... 1 ,200.00
Depreciation — Machinery and equipment. . 5,000.00
Miscellaneous manufacturing expense 1,800 00
Advertising ..... 4 , 000 00
Freight out.. 2,500 00
Salesmen's salaries 12,500 00
Delivery expense 4,000 00
Miscellaneous selling expense 1,000 00
Officers' salaries 18,000 00
Office salaries . 6,000 00
Stationery and supplies expense 1,400 00
Bad debts r. 3,600 00
Depreciation — Furniture and fixtures . 2,000.00
Miscellaneous general expense .. .. 1,00000
Interest expense ..... 1 ,800 00
Income tax ____ ..... 8,00000
g 409,600 00
Inventories, December 31, 1954:
Finished goods . $25,50000
Goods in process 17 , 500 . 00
Raw materials 18,000 00
The heat, light, and power is allocated as follows :
Factory . 70%
Selling ____ 20%
Administration 10%
Prepare entries to close the books.
ASSIGNMENT MATERIAL FOR CHAPTER 14
Questions
1. Name a major advantage of the voucher system.
2. How does a voucher system permit the elimination of the accounts pay-
able subsidiary ledger?
3. If you were designing a voucher system, how would you determine what
debit columns to have in the voucher register?
4. Why is it necessary to have a Sundry Accounts Debited section in the
voucher register? When are the entries in this section posted? When are all
other entries posted?
5. When a voucher system is used, what is the procedure:
(a) When a purchase is made on account?
(b) When a purchase is made for cash?
6. What is the procedure when a voucher is paid by note?
7. If at the time when a liability is incurred it is known that it will be paid
in installments, what is the accounting procedure with a voucher system?
8. Would you recommend the use of a voucher system if a company is in
such a poor financial condition that its liabilities are usually paid in installments?
9. How are the following situations handled when a voucher system is in use?
(a) A voucher is partially paid.
(b) Part of a purchase for which a voucher has been made is returned
and credit is received.
10. What is the purpose of the Deduction columns in the voucher register?
Problems— Group A
Problem A-l. The following are selected transactions of the Pillar Corpora-
tion during January, 1955. The corporation uses the voucher system. Record
these transactions in the books of original entry. Assume appropriate voucher
and check numbers.
1955
Jan. 6 — Merchandise is received from A. Hawk, $3,000. A 6%, 20-day note
is given in payment.
12 — Merchandise is received on account from H. Stell, $5,000. Terms,
2/10; n/30.
15 — Merchandise costing $1,000 is returned to H. Stell and a credit memo
is received.
19 — A machine costing $6,000 is purchased from Beekman Co. Cash in the
amount of $2,000 is paid down, and the balance is payable in monthly
installments of $1,000 each.
20 — H. Stell is paid the amount due, $4,000 less 2% discount.
21 — Merchandise is received on account from P. R. Prince, $1,000. Terms,
n/10.
599
600 ASSIGNMENT MATERIAL-CHAPTER 14
Jan. 26 — The note payable to A. Hawk is paid with interest.
28— A cash customer, R. Williams, returned merchandise for which he had
paid $700. A bank draft for that amount is purchased from the
White Bank and forwarded to him. The bank charged $700.75 for
the draft, the $.75 representing an exchange charge. The voucher
was made for $700.75.
31— A check for $400 is mailed to P. R. Prince in partial payment of his
invoice of January 21.
Problem A-2. The transactions below represent a selection from the July,
1955 transactions of Smith and Smart, partners. The firm uses a voucher sys-
tem. Record these transactions in the books of original entry. Assume appro-
priate voucher and check numbers.
1955
July 6 — A machine costing $8,000 is purchased from Alexander Co. Cash in
the amount of $4,000 is paid and the balance will be paid in four
monthly installments of $1,000 each.
10 — Merchandise is received from J. Peters on account, $3,000. Terms,
n/10.
15 — Merchandise is received on account from L. A. Moore, $2,500. Terms,
2/10; n/30.
18 — Merchandise costing $500 is returned to L. A. Moore and a credit
memo for that amount is received.
20— J. Peters is paid $1,800 cash and a 6%, 10-day note for $1,200 is given
him for the balance owed.
22 — Merchandise is purchased for cash from Rowland Co., $700.
24 — L. A. Moore is paid the amount due, $2,000 less 2% discount. In
order to make the remittance, a bank draft for $1,960 was pur-
chased. The State Bank charged $1,961 for the draft.
30 — The note payable to J. Peters is paid with interest.
31 — Jack Smart withdraws $600.
Problem A-3. J. P. Mast and P. R. Sanders form a partnership on February
15, 1955, to operate a cash-and-carry wholesale hardware business. The trans-
actions for the first two weeks of operations are given below. Record these
transactions in the books of original entry listed below, post, and prepare a trial
balance and a list of unpaid vouchers at the end of the month. The company
uses the following books of original entry:
Journal
Voucher register
Check register
Cash receipts book
1955
Feb. 15— J. P. Mast invests $60,000 cash.
P. R. Sanders invests non-cash assets with values as follows:
Equipment $20 , 000
Merchandise 40 , 000
Rent for a building is paid to Peters Realty Co. for three months in
advance, $600. The partners plan to adopt a calendar year for
accounting purposes.
16— Cash sale— $2,000.
ASSIGNMENT MATERIAL-CHAPTER 14 601
Feb. 16 — A five-year fire insurance policy is purchased from Hitchcock Mutual
for cash, $2,000.
Merchandise is received from A. Punt on account, $4,500. Terms,
2/10; n/30. Invoice date, February 15.
Merchandise is purchased for cash from Abel Bros., $3,000.
17 — Supplies are purchased from Hunt Supply Co. for cash, $300.
Merchandise is received from P. Jenkins on account, $5,000. Terms,
3/10; n/30. Invoice date, February 17.
18 — Additional equipment (storage bins) is purchased from Carter Co.,
$10,000. Cash in the amount of $2,000 is paid and the balance is
payable in four monthly installments of $2,000 each.
19— Cash sale, $5,000.
Merchandise is purchased for cash from Besser Co., $6,000.
Merchandise is received on account from John Regan, $8,300. Terms,
1/10; n/30. Invoice date, February 18.
22 — Transportation charges on an incoming order are paid to the Vulcan
Express Company, $900.
Merchandise is received from Arthur Jackson on account, $7,900.
Terms, 2/10; n/30. Invoice date, February 21.
Merchandise is purchased for cash from Simpson Steel Co., $3,500.
23— Cash sale, $2,000.
Cash in the amount of $800 is refunded to a customer, Jack Bret, who
returned merchandise.
24 — Merchandise is received from Wilson Corp. on account, $2,500. Terms,
1/10; n/30. Invoice date, February 23.
Merchandise is returned to John Regan and a credit memo for $300 is
received (see February 19).
25 — A. Punt is paid $4,500 less 2% for invoice of February 15.
J. P. Mast withdraws cash, $500.
P. R. Sanders withdraws cash, $750.
26 — P. Jenkins is paid $5,000 less 3% for invoice of February 17.
A loan is secured at bank by discounting a one-year, $1,000 note. The
discount rate is 5%.
27 -Cash sale, $2,000.
John Regan is paid $8,000 less 1 % for invoice of February 18.
Problems — Group B
Problem B-l. The Farriday and Johnson Company uses the following books:
Journal
Voucher register (with "Deductions" section)
Check register
Cash receipts book
Sales book
For the following selected transactions, indicate the books in which entries
would be made. If a notation is required to be made in one of the books of
original entry in addition to other entries, state this fact and name the book in
which the notation is made.
Example: Merchandise is returned to a creditor and a credit memo is received.
Answer: Entered in Journal.
Notation in Voucher Register.
602 ASSIGNMENT MATERIAL— CHAPTER 14
1. Made a sale to a customer, accepting part payment in cash and a note for
the balance.
2. Purchased merchandise for cash.
3. Gave a note to a creditor for a past-due balance.
4. Borrowed money by discounting a note at the bank.
5. Purchased equipment on the installment plan. Made a cash down pay-
ment and agreed to pay the balance in equal monthly installments.
6. Collected a customer's note, plus interest.
7. Made a partial payment to a creditor on an invoice which had been
received and recorded previously.
8. Paid a note at bank. (Note bore no interest and had been discounted at
the bank.)
9. Paid a note to a creditor plus interest.
10. Returned merchandise to a vendor and received a credit memo.
r
Problem B-2. Pilot Corporation began operations on October 1, 1955. At
the end of October, no general ledger postings had been made from the books of
original entry, which are presented in summary below. Set up the necessary
general ledger accounts, post, and prepare a general ledger trial balance as of
October 31, 1955.
Journal:
Column totals:
Debit $22,725
Credit $22,725
Column details:
Debits:
Notes receivable (Oct. 7) $ 3 ,000
Vouchers payable (Oct. 12) 4,000
Cash (Oct. 16) 9,900
Prepaid interest (Oct. 16) .... 100
Vouchers payable (Oct. 23) . 500
Salaries (Oct. 31) 5,000
Payroll taxes (Oct. 31) 225
$22^725
Credits:
Accounts receivable (Oct. 7)
Notes payable (Oct. 12)
Notes payable. (Oct. 16)
Returned purchases and allowances (Oct. 23)
Accrued payroll (Oct. 31)
Federal O. A. B. taxes withheld " (Oct. 31)
Federal income taxes withheld (Oct. 31)
Federal O. A. B. taxes payable (Oct. 31)
Federal unemployment taxes payable (Oct. 31)
State unemployment taxes payable (Oct. 31)
Voucher register:
Column totals:
Vouchers payable $64,000
Purchases 42,000
Sundry accounts , 22,000
ASSIGNMENT MATERIAL— CHAPTER 14 603
Column details:
Sundry accounts:
Freight in (Oct. 7) $ 1,000
Rent (Oct. 8) 400
Supplies (Oct. 12) . 500
Equipment (Oct. 12) 10,000
Delivery expense (Oct. 20) 2,000
Unexpired insurance (Oct. 25) . . . 600
Returned sales and allowances (Oct. 30) ... 1,000
Advertising (Oct. 30) ... 2 , 500
Accrued payroll (Oct. 31) 4,000
$22,000
Check register:
Column totals:
Vouchers payable . . $53,000
Discount on purchases . . 750
Cash . 52,250
Cash receipts book:
Column totals:
General ledger $69 , 900
Accounts receivable ... 40,000
Discount on sales . . 400
Cash . ..109,500
Column details:
General ledger:
Capital stock (Oct. 5). . . .. $60,000
Untitled (Oct. 16) . . . 9,900
$69,900
Sales book:
Column total $63,000
Problem B-3. Libby-Westcott and Company, a partnership, uses the
voucher system. Its voucher register has, in addition to other columns, a pro-
vision for noting deductions against the amounts of outstanding vouchers. Two
debit columns, one for Purchases and one for Sundry accounts, are provided.
Below are selected transactions for the month of August, 1955. Construct
the voucher register for Libby-Westcott and Company and record therein all the
entries and notations which would be necessary for these selected transactions.
Assume appropriate voucher, check, and page numbers. You are not required
to prepare any of the other books of original entry, although the company does
use a journal, check register, cash receipts book, and sales book in addition to
the voucher register.
1955
Aug. 4 — Merchandise is received from J. Armin on account, $6,000. Terms,
2/10; n/30.
6 — Office supplies are purchased on account from United Stationers, $700.
Terms, n/30.
7 — Merchandise costing $1,000 is returned to J. Armin (see August 4)
and a credit memo is received.
604 ASSIGNMENT MATERIAL— CHAPTER 14
Aug. 9 — A check for $500 is paid to a customer, Julian Ross, who returned
goods he had bought for cash on August 2.
12 — J. Armin is paid the balance due on the August 4 purchase, less dis-
count.
15 — Merchandise is received from James Eddy on account, $2,000. Terms,
l/10;n/30.
17 — A bookkeeping machine is purchased from Bliss Co. for $3,000. Cash
in the amount of $1 ,000 is paid down and the balance is payable in
four monthly installments of $500 each, beginning on September 17.
19 — A note payable to Arthur Jinks for $3,000 plus interest of $60 is paid.
(This note was given Jinks in June, 1955.)
20 — Merchandise is purchased for cash from Randolph Corp., $2,000.
21 — Merchandise is received from Silver Bros, on account, $4,000. Terms,
n/10.
25 — Ronald Westcott, a partner, withdraws $600 cash.
27 — A check for $500 is sent to James Eddy in partial payment of the
amount owing on the August 15 purchase. The discount period
ended on August 24.
31 — A 4%, 30-day note for $4,000 is given Silver Bros, in settlement of the
August 21 purchase.
Problem B-4. Dixie Corporation is organized on September 4, 1955. The
transactions for September are given below .
The corporation uses the following books of original entry:
Journal
Voucher register
Check register
Cash receipts book
Set up the books of original entry, record the transactions, post to general
ledger accounts, and prepare a trial balance and a schedule of vouchers payable
as of September 30, 1955.
All sales are for cash, and hence the cash receipts book has a credit column
for sales rather than for accounts receivable. The voucher register lias columns
in which deductions may be noted and has debit columns for Purchases, and
Sundry accounts.
1955
Sept. 5 — Capital stock of $50,000 is issued to John Jones. Cash of $30,000 is
collected and a 15-day, 6% note is accepted for the balance.
7 — Rent for the balance of the month of September is paid to J. Regan.
$275.
Equipment costing $5,000 is purchased from the Millward Co. A
$2,000 down payment is made, with the balance payable in monthly
installments of $1,000 each.
8 — Office supplies are purchased from the Efficiency Co. on account,
$300. Terms, n/10.
10 — Merchandise is received from Burt Co. on account, $6,000. Terms,
1/10; n/30.
Merchandise is purchased for cash from Hingle Bros., $2,000.
11 — A three-year fire insurance policy is purchased from Security Insurance
Co. for cash, $630.
12— Cash sale, $2,300.
ASSIGNMENT MATERIAL— CHAPTER 14 605
Sept. 13 — Merchandise is received from Roll, Inc., on account, $4,200. Terms,
2/10; n/30.
15 — Freight is paid to the R. E. Truck Company on Burt and Hingle
orders, $225.
16 — Merchandise costing $1,000 is returned to Burt Co. and a credit
memorandum is received.
Merchandise is purchased from Joten, Ltd., for cash, $3,700.
17 — Efficiency Co. is paid $300 for invoice of September 8.
Freight on Joten order is paid to Chapel Van Company, $340.
18 — A check for $2,970 is sent to Burt Co. in partial payment of the amount
owed. It is Burt's policy to allow discounts on partial payments.
19 — Cash of $700 is refunded to R. Rait, a customer who had purchased
for cash.
20 — The note given by the stockholder is collected, with interest.
22 — Roll, Inc., is paid $4,200 less 2% discount.
Merchandise is received on account from Mendel Mills, $4,900.
Terms, I/ 10; n/30.
24— Cash sale, $1,700.
26— A note for $2,000, bearing interest at 6% and dated September 20,
1955, is sent to Burt Co. in settlement of the balance owed to them.
28- -Delivery charges for the month are paid to the Safe Haul Co., $325.
ASSIGNMENT MATERIAL FOR CHAPTER 15
Questions
1. A business follows the practice of reversing all adjustments for the accrual
of income. Describe an alternative procedure to avoid the use of reversing
entries.
2. When should an expenditure be charged to an asset account, and when
should it be charged to an expense account?
3. Would it be a mistake to charge an expense account for an expenditure
that benefits a three-year period?
4. Describe tWo procedures by which income collected in advance and appli-
cable in part to future periods may be recorded in the accounts.
5. How does an accountant determine when adjustments are required?
6. Is it possible to adopt accounting procedures that will result in making
reversing entries unnecessary?
7. If reversing entries are used, must they be recorded on the first business
day of the new accounting period?
8. Assume that you wish to record all expenses by one or the other of the fol-
lowing methods:
(a) Charge all expense expenditures to expense accounts and set up
prepaid expense accounts at the end of the period, if necessary.
(b) Charge all expense expenditures to prepaid expense accounts and
write off the expired portion of each expense at the end of the
period by a charge to an expense account.
Which method would you adopt?
Problems — Group A
Problem A-l. The trial balance of Ward Company, before adjustments, at
the end of the year 1954, is given below:
WARD COMPANY
Trial Balance
December 31, 1954
Cash 800 00
Accounts receivable 15,700 00
Reserve for bad debts 173.00
Notes receivable. . 7,000 00
Inventory. . . 32,000.00
Unexpirod insurance 600 . 00
Land 17,000.00
Building.. .. . 30,000.00
Reserve for depreciation — Building 12,000.00
Equipment 26,050.00
Reserve for depreciation — Equipment 9 , 625 00
Accounts payable 4,000.00
Notes payable 8,000.00
Capital stock 80,000.00
606
ASSIGNMENT MATERIAL— CHAPTER 15 607
Earned surplus 2,857.00
Sales. 103,000.00
Purchases 71 , 150 00
Salaries . . .. 17,500 00
Advertising expense. . 1 , 125 00
Miscellaneous selling expense. . 3,330 00
Lease income . . 3,500.00
223,155 00 223,155.00
Data required for adjusting the accounts are as follows:
(1) The Reserve for Bad Debts should be increased to $300.
(2) The balance of the Notes Receivable account is the face of a 6%, 60-day
note carrying the date December 1, 1954.
(3) The insurance was purchased on July 1, 1954, to run for 18 months.
(4) The expected useful life of the building when new was 20 years; the
equipment, 7 years.
(5) The balance of the Notes Payable account is the face of a 5%, 90-day
note dated December 16, 1954.
(6) Salaries accrued amounted to $375.
(7) The advertising expense is the cost of printed matter, one-third of which
has been used.
(8) A portion of the building was leased on July 1, 1954, for a two-year
period, at a total rental of $3,500.
Prepare entries required to adjust the accounts on December 31, 1954, and
prepare reversing entries as of January 2, 1955.
Problem A-2. The trial balance before adjustments of the Superior Com-
pany, at the end of operations for the year 1954, is presented below:
SUPERIOR COMPANY
Trial Balance
December 31, 1954
Cash 2,020 00
Accounts receivable ... 21,230.00
Reserve for bad debts ... 180.00
Notes receivable .... 1 1 , 000 . 00
Inventory. 24,70000
Prepaid insurance 450.00
Land 19,000 00
Building . 40,000.00
Reserve for depreciation .... . 9 , 600 00
Long-term equipment rental prepaid 10,000.00
Accounts payable . 6,730.00
Notes payable 5,000.00
Capital stock 90,000.00
Earned surplus 18,340.00
Sales 87,690.00
Purchases 63,400.00
Salaries 16,720.00
General expense 3 ,200 00
Delivery expense 4,320.00
Supplies expense 1 ,700.00
Interest income 200.00
217,740.00 217,740.00
608 ASSIGNMENT MATERIAL-CH AFTER 15
Data required for adjustments follow:
(1) Five per cent of the accounts receivable are estimated to be bad.
(2) The notes receivable bear a 5% rate. Interest on an $8,000 six-month
note was collected in advance and was one-half earned on December 31, 1954.
The remaining notes were dated December 1 , 1954, and mature sixty days from
that date.
(3) One-half of the insurance has expired.
(4) The building had an expected useful life when new of 25 years.
(5) The equipment rental was paid on January 1, 1954, for five years in
advance.
(6) The notes payable are 6%, 90-day notes arid were given December 1,
1954.
(7) Salaries accrued amount to $410.
(8) A delivery service was engaged during the year on a per-mile contract
basis. On December 31, 1954, the company had paid in advance for 400 miles
of service at a rate of 12 cents a mile.
(9) Supplies on hand total $350.
Using a six-column work sheet, enter the trial balance, make the adjustments,
and complete the adjusted trial balance. Also, using journal paper, prepare
reversing entries as of January 2, 19*55.
Problem A-3. The unadjusted trial balance of Clark Publishing Company
on December 31, 1954, follows.
CLARK PUBLISHING COMPANY
Trial Balance
December 31, 1964
Cash 21,850 00
Subscriptions receivable 23 , 780 00
Reserve for uncollectible subscriptions 380.00
U. S. Government bonds 7,500.00
Lease of building and land prepaid 28,290 00
Equipment 69 , 760 . 00
Reserve for depreciation — Kquiprnent 27,440 00
Accounts payahle 15,70000
Unearned subscriptions income 110,000 00
Mortgage payable 20,000 00
Capital stock 60 , 000 00
Earned surplus 1 0 , 578 00
Materials and supplies expense 74 , 600 . 00
Salaries... 14,750 00
Rent expense — Office equipment 936.00
Insurance expense 2 , 632 . 00
244,098 00 244,098 00
Adjustments were required as follows:
(1) Three per cent of the uncollected subscriptions are estimated to be
uncollectible.
(2) The bonds were acquired at par on October 1, 1954, and bear 3% interest.
(3) On January 1, 1954, the lease covering the building and the land had
two years to run.
(4) A rate of 12^% is used in recording depreciation of the equipment.
(5) Subscriptions income earned for the year amounts to $107,500.
(6) The mortgage was given November I, 1954, and carries a 6% rate.
ASSIGNMENT MATERIAL— CHAPTER 15 609
(7) Salaries accrued amount to $427.
(8) The rent expense was paid April 1, 1954, for an 18-month rental of an
addressing machine.
(9) The insurance was acquired on January 1, 1954, for a two-year period.
(10) The company accepted for the first time an advertising contract effective
December 1, 1954, for a two-year period. The contract calls for the payment
to Clark Publishing Company of a monthly fee of $8,750.
Prepare the adjusting entries and indicate, by writing the letter "R" in the
ledger folio column, which of the entries are reversed on January 1, 1955.
Problems — Group B
Problem B-l. Unique Company uses a fiscal year ending June 30 in account-
ing for its operations.
Transactions involving the company's Insurance Expense account were:
July 1, 1953 — Paid a one-year premium, $444, on an equipment policy, and
a three-year premium, $1,548, on a policy covering the
buildings. Both payments \\ere charged to Insurance
Expense.
July 1, 1954 — Paid a one-year renewal premium, $444, on the equipment
policy. Payment was charged to Insurance Expense.
Prepare all entries affecting the Insurance Expense account from July 1,
1953, through July 1, 1955, assuming that no new premiums were paid on July
1, 1955.
Problem B-2. The unadjusted trial balance and the adjusted uial balance
of the Phoenix Company, as of December 31, 1954, are given below.
Prepare the reversing entries as of January 1 , 1955, assuming that the financial
statements for the year 1954 have been completed.
PHOENIX COMPANY
Unadjusted and Adjusted Trial Balances
December 31, 1954
Unadjusted Adjusted
Cash . 1,550 1,550
Accounts receivable .... . 20,000 20,000
Reserve for bad debts . . . 450 850
Accrued interest receivable ... 100
U.S. Government bonds 10 , 000 10. 000
Inventory 18,000 18,000
Prepaid rent ... . ... 1,200 800
Unexpired insurance ... 2 , 700
Land. . . 8,000 8,000
Building . 35,000 35,000
Reserve for depreciation — Building .. 5,500 7,250
Delivery equipment 28 , 000 28 , 000
Reserve for depreciation — Delivery equipment. 6,080 9,580
Notes payable . 5,000 5,000
Accounts payable . ... 12, 560 1 2 , 560
Accrued salaries payable. . . 650
Accrued interest payable 25
Unearned rent income 4 , 500
Capital stock 70,000 70,000
Earned surplus 11 ,760 11 ,760
610 ASSIGNMENT MATERIAL-CHAPTER 15
Unadjusted Adjusted
Sales 125,000 125,000
Purchases 95,000 95,000
Salesmen's salaries . . 10,000 10,300
Rent expense.. . . 400
Depreciation expense — Delivery equipment. . 3,500
Administrative salaries . . . 12,000 12,350
Insurance expense. .... .. . 3,600 900
Bad debts 400
Depreciation expense — Building 1 9 750
Rent income . . 6,000 1,500
Interest income 100
Interest expense 25
242,350 242,350 248,775 248,775
Problem B-3. r Commercial Standard Company purchased a new office
building on January 1, 1954. Rents were collected in advance during a two-
year period as follows:
1954
Term
Rental
Term Collected
January 1
Two years $ 4 800 00
March 1
June 1
. . . Two years 6 000 00
October 1
One year 1 200 00
1955
February 1
Three vears 10 800 00
April 1
Two vears 7 200 00
August 1
Onp vpar 1 500 00
September 1
. . . Six months 600 00
Required:
(a) Assuming that the collections were credited to Rental Income Earned,
make all the entries necessary to account for the rent through January 1, 1956,
except that entries need not be made to record the collections.
(b) Assuming that the collections were credited to Unearned Rental Income,
make the entries for the same period as in (a) above. Entries need not be made
to record the collections.
The company uses the calendar year in accounting for its operations.
Problem B-4. Adjusting and closing entries are given below for the Dawson
Company. The company is on a calendar-year basis.
Adjusting Entries
1954
Dec. 31 Bad debts.. 150.00
Reserve for bad debts 150 00
To provide for estimated uncollectible accounts.
31 Accrued interest receivable 15.00
Interest income 15.00
To record interest income accrued.
31 Store supplies on hand 160.00
Store supplies expense 160.00
To adjust for store supplies on hand.
ASSIGNMENT MATERIAL-CHAPTER 15 611
Dec. 31 Depreciation expense — Equipment 2,500.00
Reserve for depreciation — Equipment. . . 2,500.00
To record depreciation of equipment for the year.
31 Interest expense . ... . 20.00
Accrued interest payable. .... . 20.00
To adjust for unrecorded interest expense.
31 Salaries 276 00
Accrued salaries payable. . . . 276.00
To record accrued salaries.
31 Prepaid rent . 1,20000
Rent expense 1 , 200 . 00
To adjust the Rent Expense account.
31 Insurance expense . . 1,000 00
Uncxpired insurance . .. . . 1,00000
To record insurance expired.
Closing Entries
31 Sales .. . .... 60,000.00
Inventory . . . ... 9 , 300 . 00
Interest income . . 215.00
Profit and loss ... .. 69,51500
To close the Sales and Interest Income accounts
and set up the ending inventory,
31 Profit and loss 63,54600
Inventory 8,000.00
Purchases 35,000.00
Salaries ... 13,07600
Rent expense 3,600 00
Insurance expense 1 ,000 00
Bad debts 150 00
Store supplies expense 200 00
Depreciation expense — Equipment, .. . 2,500.00
Interest expense . . . 20.00
To close the expense accounts and remove the
beginning inventory from the Inventory account.
31 Profit and loss . 5,969.00
Earned surplus 5,969 00
To close the Profit and Loss account/
From the information provided by these entries:
(a) Make reversing entries as of January 1, 1955.
(b) Compute the balances of the accounts given below as they appeared in
the December 31, 1954 trial balance before adjustments:
Bad debts
Interest income
Store supplies expense
Depreciation expense — Equipment
Interest expense
Salaries
Rent expense
Insurance expense
If the trial balance amount cannot be determined, so state.
612
ASSIGNMENT MATERIAL-CHAPTER 15
Problem B-6. Hayes Company rented a store building for five years on
January 1, 1954, for $30,000 paid in advance. On March 1, 1954, the company
started another store, paying in advance rent of $14,400 for a two-year period.
A third store was opened on November 1, 1954, and a rental of $12,600 was paid
in advance for one and one-half years. On July 1, 1955, the company rented a
building for its fourth store, paying a rental of $9,450 for one year.
The company uses the calendar year in accounting for its operations.
Required:
(a) Make all entries in connection with the company's rent beginning Janu-
ary 1, 1954, and carrying through January 1, 1956, assuming that Rent Expense
is charged at the time the rent is paid.
(b) Make all entries in connection with the rent for the same period as in (a)
above, assuming that Prepaid Rent is charged at the time the rent is paid.
Problem B-6. The books of Bonnie Company contained the following accounts
before adjustments, at the end of the year 1954:
Prepaid interest expense
Interest expense
Rent received in advance
Rent income. .
200 00
50 00
1,350 00
2,400 00
The ledger accounts appeared as follows:
Prepaid Interest Expense
1953
Dec.
31
Adjusting entry
200 00
T
(9)
Rent Received in Advance (29)
1953
Dec.
31
Adjusting entry
28 1,350
00
Interest Expense
1953
1953
...
Oct.
15
Interest on 60-day
Dec.
31
Adjusting entry
28
200
00
note
25
150
00
31
To Profit and Loss
29
250
00
Dec.
1
Interest paid in ad-
*
vance on 3-month
note
26
300
00
450
00
450
00
1954
June
30
Interest on 30-day
note
51
50
00
Rent Income
(43)
1953
Dec.
31
31
Adjusting entry
To Profit and Loss
28
29
1,350
450
00
00
1953
Oct.
1
12 mos. rent rec'd
in advance
12 mos. rent rec'd
in advance
23
1,800
00
1,800
00
1,800
00
1954
Oct.
1
72
2,400
00
ASSIGNMENT MATERIAL-CHAPTER 15 613
Required:
(a) What was wrong with the accounts?
(b) What entries should the bookkeeper make on December 31, 1954, in con-
nection with these accounts?
(c) What additional entry or entries should be made to put the accounts in
condition to receive entries for transactions for the year 1955?
ASSIGNMENT MATERIAL FOR CHAPTER 16
Questions
1. Mention some of the things which should be given consideration in the
determination of an equitable division of partnership profits.
2. If partners' salaries and interest on their capitals are agreed upon, must
allowances therefor be made even though the operations of the business result in
a loss? Devise an example to illustrate the procedure which conforms with your
answer. ,
3. How may a change in the personnel of a partnership be caused?
4. If a partner is to withdraw:
(a) Why should the books be closed?
(b) Why may it be proper to revise the valuations of the fixed assets? (In
answering this question, assume that the fixed assets arc carried at cost
in the fixed asset accounts, and that the depreciation reserves have
been computed properly.)
5. If the valuations of partnership assets are revised at the time of a change
in the firm's personnel, how should the increase or decrease in valuation be
divided among the partners?
6. If a partner retires and is not paid in full immediately, should the unpaid
balance be left in his capital account?
7. A new partner may be admitted either by purchase or by investment.
Explain the basic difference in accounting for these alternatives.
8. Why is it imperative to divide all profits or losses between the partners
before distributing any assets to them when the partnership is dissolved?
9. A partnership's books show the following liabilities and partners' capitals:
Accounts payable $15,000 00
J. P. Olive, loan 6,000 00
F. R. Tutt, capital 20,000 00
J. P. Olive, capital. 25,000 00
Total . . |66,000 00
All the assets have been sold for $50,000, and this amount is on hand in cash.
Losses on the disposal of the assets have not been charged to the partners. How
should the cash be paid out?
Problems— Group A
Problem A-l. Following is a trial balance of the ledger of Clark and Foster,
a partnership, on December 31, 1954:
Cash 4,520 00
Accounts receivable 9 ,404 00
Inventory (December 31, 1953) 12 ,400 00
614
ASSIGNMENT MATERIAL— CHAPTER 16 615
Furniture and fixtures 2,200 00
Reserve for depreciation — Furniture and fixtures . 330 . 00
Goodwill ... .... 10,000 00
Accounts payable 4, 100 00
Notes payable. . 5,000.00
K. L. Clark, capital 10,00000
James Foster, capital . . . 5,000 00
K. L. Clark, drawings . . 2,800 00
James Foster, drawings . 3,600 00
Sales . . 55,106 00
Sales returns and allowances . . 280 00
Purchases 30,527.00
Salesmen 's salaries . 2 , 600 . 00
Insurance expense . 36000
Taxes.. 120.00
Office expense . . . 650 00
Interest expense 75 . 00
797536JOO 79,536 00
The inventory on the trial balance date was $5,025.
K. L. Clark invested $5,000 on February 1. The other capital account
remained unchanged throughout the year.
The partnership agreement provided that the profits be shared as follows:
(1) Interest to be allowed partners at 6% per annum on their capital account
balances at the beginning of the year.
(2) Foster to be allowed a salary of $3,200 for his active management of the
business.
(3) The remainder of the profits to be shared in the following ratio: Clark
60%; and Foster, 40%.
Prepare:
Working papers.
Statement of partners' capitals.
Problem A-2. Following is a trial balance of the books of Kelly, Stone, and
Court, a partnership, on June 30, 19 — :
Cash 7,500 00
Accounts receivable 17,500 00
E. Kelly, capital 5,000.00
J. R. Stone, capital 10,000 00
Frank Court, capital 10,000 00
25,000 jjO 25,000 00
Stone decides to withdraw from the partnership, and it is agreed that his
interest shall be disposed of as follows:
One-fourth of his interest to Frank Court for $4,000.
One-half of his interest to E. Kelly for $8,000.
One-fourth of his interest to D. L. Sweeney for $4,500.
Prepare the journal entries to be placed on the partnership books to record
the withdrawal.
616
ASSIGNMENT MATERIAL— CHAPTER 16
Problem A-3. The after-closing trial balance of the firm of W, X9 F, and Z
is presented below:
Cash
Real estate
Accrued taxes payable
Xy loan
Zy loan
W, capital
X, capital
F, capital
£, capital
W> X, Y9 and Z
After-Closing Trial Balance
December 31, 1964
3,000 00
31,000.00
4,200 00
3,000 00
500 00
4,800 00
3,000 00
12,600.00
5,900 00
34,000 00 34,000 00
The partnership is liquidated. Prepare a statement showing the distribution
of cash in eaeh of the following eases.
Case 1. The real estate is sold for $35,000.
Case 2. The real estate is sold for $18,600.
Case 3. The real estate is sold for $8,200.
Problem A-4. Dole, Gorman, and Paine are partners. Their capital
accounts for 1954 appear below:
Ralph Dole, Capital
1954
1953
Aug.
10
2,115
00
Dec.
31
16,000
00
1954
June
13
3,430
00
James Gorman, Capital
1954
11953
May
3
590
OODec.
31
22,000
00
Aug.
9
215
I
J. L. Paine, Capital
1954
1953
May
13
385
00
Dec.
31
12,000
00
Dec.
12
265
00
1954
Feb.
8
-
5,135
00
Make journal entries as of December 31, 1954, to divide the $14,280 of net
income under the following agreements:
(a) The first $6,000 of net income is to be divided in the ratio of 5, 4, and 3,
and the remainder is to be divided equally.
(b) Net income is to be divided in the ratio of the partners' capitals at the
beginning of the year.
(c) Net income is to be divided in the ratio of the partners' capitals at the
end of the year.
ASSIGNMENT MATERIAL-CHAPTER 16 617
(d) Interest at 6% is to be allowed on partners' capitals at the beginning of
the year, and the remainder is to be divided equally.
(e) Remainder is to be divided in the ratio of 5, 4, and 3, after crediting the
partners with salaries of $4,000 each.
(f) Remainder is to be divided equally after allowing salaries as follows:
Dole $5,500
Gorman 6,500
Paine 7,500
Problem A-6. Make journal entries for the distribution of cash in liquida-
tion in the following cases.
Case 1:
Cash 19,000 00
A, loan .... . .. 3,000 00
X, capital... . 1,000 00
B, capital _ 17,000 00
20,000 00 20,000 00
Case 2:
Cash 13,000 00
Accounts payable 2,000 00
C, capital " . . 12,000 00
D, capital . 1,000 00 _
14,000 00 14,000 00
Case 3:
Cash 16,000.00
Notes payable .. .. 10,00000
Accrued interest payable . . . 1 ,000 00
E, loan ... . 5,000 00
E9 capital 3,000 00
F9 capital 3,000 00
G, capital 6,000 00
22,000 00 22,000 00
Case 4:
Cash 21,000 00
Taxes payable 3,000 00
H, loan 3,000 00
tf, capital. 8,000 00
7, capital ... ... __ 7,000 00
2i7ooo.oo 21,000.00
Problems— Group B
Problem B-l. Using the capital accounts given in Problem A-4, make jour-
nal entries as of December 31, 1954, to divide net income of $11,280 under the
following agreements:
(a) The first $9,000 of net income is to be divided in the ratio of 3, 4, and 5,
with any remainder divided equally.
(b) Net income is to be divided in the ratio of the partners' capitals at the
beginning of the year.
(c) Interest at 4% is to be allowed on partners' capitals at the beginning of
the year, with any remainder divided equally.
618 ASSIGNMENT MATERIAL— CHAPTER 16
(d) Salaries of $3,000 each are to be allowed, with any remainder divided in
the ratio of 4, 3, and 3.
(e) Interest at 3% on partners' capitals at the beginning of the year and
salaries of $3,000 each are to be allowed, with any remainder divided
in the ratio of 3, 3, and 4.
(f) Interest at 5% on partners' capitals at the beginning of the year and
salaries of $5,000 each are to be allowed, with any remainder divided
in the ratio of 1, 2, and 1.
Problem B-2. The firm of Ace, Jack, and King earned $2,412 during the
year. The capital account balances as of the beginning of the year are given
below.
Ace . . $25,000
Jack . 20,000
. King 15,000
The profit-sharing agreement provides that the partners shall share profits
in the ratio of 30-30-40 after allowing for salaries and interest on beginning
capital balances at 5%. The salary allowances are as follows:
Ace $4,500
Jack 5,400
King 3,900
Prepare journal entries to close the Profit arid Loss account.
Problem B-3. The Profit and Loss account of the firm of Smith, Nelson,
and Paige shows a net loss of $3,400 for the year. The capital account balances
at the beginning of the year are shown below.
O. E. Smith .... $30,000
P. R. Nelson . 20,000
G.F.Paige .. 15,000
The articles of partnership provide that the partners shall share annual
profits equally after allowing interest at 4% on opening capital account balances
and after crediting the partners with salaries as follows:
Smith $8,000
Nelson 6,000
Paige 4,000
Prepare journal entries to close the Profit and Loss account, and a statement
showing each partner's net participation.
Problem B-4. Three partners, who divide profits in their capital ratio, have
the following balances in their capital accounts:
Raymond Cole $10,000
Arnold Howes 10,000
Harold Smith 20,000
Make journal entries to record Charles Johnson's admission to the partner-
ship under the following conditions:
(a) Johnson buys Cole's interest for $10,000.
(b) Johnson invests $10,000 for a one-fifth interest in the capital of the firm.
(c) Johnson allows $4,000 as goodwill to the old partnership and invests
$11,000 for a one-fifth interest in the capital of the firm.
(d) Johnson is granted goodwill; he invests $8,000 for a one-fifth interest in
the capital of the new partnership.
ASSIGNMENT MATERIAL-CHAPTER 16 619
Problem B-5. The net worth on June 30, 19 — of Jones and Sons, a partner-
ship, is represented by the following balances in the capital accounts:
James Jones $22,000
Henry Jones 20,000
William Jones 18,000
The only asset of the firm is an investment in real estate. There are non-
interest-bearing notes payable of $4,000.
Land Corporation agrees to buy the real estate from Jones and Sons for
$100,000 in cash, after which the partnership is to be dissolved. Give the
entries necessary to record the sale of the real estate and the dissolution of the
partnership.
Problem B-6. Following is a trial balance of the books of Green and Hill, a
partnership, on June 30, 19 — :
Cash 500 00
Accounts receivable . . 3 , 250 00
Reserve for bad debts 125.00
Inventory 5,610 00
Land .... . 4,900.00
Building 3,840 00
Reserve for depreciation — Building. 765.00
Accounts payable. . 450 00
Frank Green, capital . 9,000.00
John Hill, capital . . . 7,760 00
18,100.00 18,100.00
Henry Farmer was admitted as a partner, and a new partnership, known as
Green, Hill, and Farmer, was formed on the following terms:
(1) Certain assets of the old partnership were restated as follows:
Inventory . .... $4,500 00
Land 5,500 00
Buildings (adjust by an entry in the reserve) . . 3,000.00
(2) The old partnership was granted goodwill in the amount of $2,000.
(3) Farmer contributed $10,000 as follows:
Cash ... . $5,000 00
30-day, non-interest note . 2 , 500 . 00
Accounts receivable, of a face value of $3,000, valued at . 2,500.00
(4) John Hill and Frank Green contributed sufficient cash to bring their
capital account balances to $10,000 each.
Prepare the journal entries to record these transactions, and prepare the
opening balance sheet of the new partnership.
Problem B-7. The partnership of A, B, and C, who share profits equally,
closed its books on December 31 ; their accounts on that date had credit balances
as follows:
A, capital $9,000.00
.J3, capital 5,000.00
C, capital 2,000.00
C, loan 500.00
620 ASSIGNMENT MATERIAL-CH AFTER 16
The partnership went into liquidation. All of its assets were turned into
cash, and losses were charged to a Loss on Liquidation account. Prepare a
statement with columns as follows:
A, Capital B, Capital C, Capital C, Loan Total
For each of the following cases, enter the December 31st balances; show
deductions for the loss on liquidation; show any transfers from C's loan account
to his capital account; and show the amounts paid to each partner as a distribu-
tion of cash on hand.
Case 1. Loss on liquidation, $3,300; cash to divide, $13,200.
Case 2. Loss on liquidation, $6,690; cash to divide, $9,810.
Case 3. Loss on liquidation, $8,400; cash to divide, $8,100.
ASSIGNMENT MATERIAL FOR CHAPTER 17
Questions
1. List several characteristics of a corporation that make it an attractive
form of business organization.
2. What are organization costs? How should such costs be recorded in the
accounts?
3. The M Corporation was organized with authorized capital stock of $100,000
divided into 10,000 shares of $10 par value each. Half of the stock was sold at
$9, and the following entry was made: Debit Cash and credit Capital Stock,
$45,000.
Have you any criticism of the above entry?
4. What kind of account is Subscriptions Receivable?
6. Illustrate how premium and discount on capital stock are presented in the
financial statements.
6. Assume that you are appointed chief accountant of a small corporation.
You discover the following account in the ledger: Discount on Capital Stock.
What action, if any, would you take in connection with this account?
7. Does the par value of stock represent its real value?
8. If you purchased a share of no-par capital stock for $25, and two years
later purchased another share of the same stock for $16, would you necessarily
believe that the second acquisition was more advantageous?
Problems— Group A
Problem A-l. Journalize the following transactions of Barton Chemical
Company, a newly organized corporation, in general journal form, and show how
the Capital Stock account would appear in the general ledger after the entries
were posted: (a) assuming that authorization was obtained for the issuance of
10,000 shares of $10 par value stock, and (b) assuming that authorization was
obtained for the issuance of 10,000 shares of no-par stock, with the directors
voting to assign a stated value of $10 a share to the no-par stock.
1954
Nov. 12 — Cash subscriptions were received for 3,000 shares at $10 per share.
The cash was collected and stock certificates were issued.
16 — Subscriptions were received for 2,000 shares at $11 per share. Stock
certificates were issued.
30— The subscriptions of November 15 were collected in full.
Problem A-2. (a) Give entries in general journal form for the following
transactions of Hicks Corporation, a newly organized corporation. Authoriza-
tion was obtained for 5,000 shares of $25 par value stock. Show how the Capital
Stock account would appear in the general ledger after the above entries were
posted.
621
622 ASSIGNMENT MATERIAL— CHAPTER 17
1954
May 1 — 1,000 shares of stock were issued for $24,000 cash.
7 — Subscriptions were received for 1,500 shares at $26.50 per share.
Stock certificates were issued.
9 — Paid organization costs, $3,000.
15 — The subscriptions of May 7 were collected in full.
20 — Subscriptions were received for 100 shares at $26 per share. Stock
certificates were issued.
(b) Complete the above requirements under the assumption that the author-
ized shares had no par value.
(c) Assuming that the corporation had $1,800 of earned surplus after the
books were closed on May 31, prepare the net worth section of the balance sheet
as of May 31, 1954, for (a) and (b).
Problem A-3. Booth Corporation was organized on June 1, 1954, and was
authorized to issue 5,000 shares of $100 par value stock.
Subscriptions were taken on June 1 from M. A. Frederick for 2,000 shares
and from R. B. Booth for 2,200 shares at $110 per share. The stock certificates
were issued.
On June 8 Frederick transferred the following assets and liabilities to the
corporation:
Notes receivable $ 8,000
Accounts receivable . 35,250
Inventory.- . . . 60,370
Accounts payable . 7 , 340
The net assets were accepted in partial payment of Frederick's subscription.
Booth transferred assets to the corporation on June 10 in partial payment of
his subscription as follows:
Land. . $18,000
Building 90,000
A subscription was taken on June 12 from R. B. Wood for 100 shares at $112
per share. The certificate was issued.
Frederick and Booth paid the remainder of their subscriptions on June 13
in cash and Wood paid his subscription in cash on June 14. On June 15, the
corporation paid $7,000 for legal fees and other organization costs.
Prepare entries in journal form to record the subscriptions and issuance of
the shares and prepare a balance sheet of the corporation on June 15.
Problems— Group B
Problem B-l. Acers Corporation was organized on May 1, 1954, and was
authorized to issue 1,000 shares of $100 par value stock. On May 1, A. K.
Powell and C. D. Lockwood paid cash for 150 shares each at $90 per share. By
May 15, the officers had entered into several contracts which were advantageous
to the company, and 400 shares were issued to J. K. Morris for cash at par. By
May 25, the corporation needed additional funds and, because of the favorable
earnings outlook, it secured $110 a share cash for the issuance of 200 shares to
J. A. Taylor.
Journalize the transactions involving the issuance of shares of stock as
indicated above.
ASSIGNMENT MATERIAL— CHAPTER 17 623
Problem B-2. Hughes Paint Company was organized on July 1, 1954, and
was authorized to issue 1,000 shares of no-par stock. The entire issue was sold
for cask on the date of organization for $90 a share.
Make journal entries to record the sale of the stock under the following
conditions:
(a) The company was organized in a state in which the laws require that
the entire amount received for no-par shares shall be regarded as legal capital.
(b) The company was organized in a state in which the laws permit the
crediting of a surplus account with a portion of the proceeds from the sale of
no-par shares, and the directors of the company passed a resolution stipulating
that $75 per share should be credited to the Capital Stock account.
Problem B-3. Great Western Lumber Company was organized on Septem-
ber 1, 1954, and was authorized to issue 3,000 shares of $100 par value stock.
Prepare journal entries to record the issuance of the stock on the organization
date, assuming that (a) all of the authorized stock was issued for cash at par,
(b) all of the authorized stock was issued for cash at 105, and (c) all of the author-
ized stock was issued for cash at 95.
Problem B-4. Federal Sign Company was organized on January 2, 1954.
The company was authorized to issue 10,000 shares of no-par stock. The laws
of the state in which the company was organized require a stated value for such
stork of at least $3 per share. The company issued 8,000 shares at $12 per share
on the date of organization and on January 31 issued 1,000 shares at $15 per
share. The directors did not pass any resolution concerning stated value.
The company paid $5,000 in organization fees.
Assuming earnings of $2,200 for January and the payment of no dividends,
prepare the net worth section of the balance sheet of Federal Sign Company as
of January 31 , 1954.
Problem B-5. Garner Corporation was organized on March 1, 1954, and
was authorized to issue 6,000 shares of $100 par value stock.
On March 1, subscriptions to 3,000 shares at par were received and the cer-
tificates were issued. On March 5, one-half of the subscriptions of March 1
was collected in cash. On March 10 subscriptions were received for 500 shares
at $108 per share and certificates were issued. On March 15 the remainder of
the March 1 subscriptions was collected. Eleven shares were issued to an
attorney on March 17 in payment of $1,210 of costs incurred in the organization
of the corporation. A tract of land costing $8,000 was purchased for cash, and
inventory in the amount of $12,000 was acquired on account on March 22 from
Jones Company. The subscriptions of March 10 were collected in full on
March 29.
Give entries in journal form to record the above transactions, and prepare a
balance sheet as of March 31, 1954.
Problem B-6. J. R. Hadley and A. M. Nelson organized the Arctic Refrig-
eration Company on February 1, 1954, with an authorized capitalization of
4,000 shares of no-par value stock. The state in which the company was incor-
porated allowed a portion of the proceeds of the sale of stock to be credited to a
surplus account. A resolution stipulating that $20 per share would be regarded
as stated capital was passed.
On the date of organization, Hadley subscribed for 1,000 shares and Nelson
subscribed for 1,200 shares at $25 per share. The stock certificates were issued.
On February 10, Hadley transferred land worth $15,000 to the company in
624 ASSIGNMENT MATERIAL-CHAPTER 17
part payment of his subscription and paid cash for the balance. On the same
date Nelson paid cash for his entire subscription.
Fifty shares were issued on February 16 to pay attorneys' costs of $1,250
incurred in connection with the organization of the company.
On February 27, J. N. Wilson paid in $30 per share cash for 100 shares.
Required:
(a) Prepare journal entries to record the subscriptions and the issuance of
the shares.
(b) Assuming that the net income for February was $1,620 and that no
dividends were declared, prepare the net worth section of the Arctic
Refrigeration Company's balance sheet as of February 28, 1954.
ASSIGNMENT MATERIAL FOR CHAPTER 18
Questions
1. Does a Capital Stock Subscribed account normally have a debit or a credit
balance? Where does such an account appear in the financial statements?
What does its balance show?
2. Contrast the accounting under the following circumstances:
(1) Stock certificates are issued when subscriptions are received.
(2) Stock certificates are not issued until subscriptions are collected in
full.
3. Suppose that a stockholder sells a portion of his shareholdings to another
person. Describe how the transfer is recorded by the corporation. What
accounts are debited and credited?
4. A partnership decides to incorporate. Describe the accounting procedure:
(a) If the partnership books are retained by the corporation.
(b) If the corporation opens new books.
5. What basic rights does the ownership of shares of stock confer upon a
stockholder? Are these rights always enjoyed proportionately by all classes of
stockholders?
6. (a) In what two general ways may stock be preferred?
(b) What is meant by the words " cumulative" and " participating" as
applied to preferred stock?
7. Express an opinion on the following statement: "No stock is worth more
than its par value."
8. Give some reasons why a partnership might wish to incorporate. Is there
any reason why the stockholders of a corporation might wish to change to a
partnership?
Problems — Group A
Problem A-l. On November 1, 1954, Crown Corporation was authorized
to issue 3,000 shares of no-par stock. A resolution was passed establishing $12
per share as the stated value. On November 2, subscriptions were received for
1,400 shares at $15 per share. On November 10, subscriptions were received for
800 shares at $16 per share. The subscriptions of November 2 were collected in
full on November 15 and the certificates were issued. On November 24, collec-
tion was made in full for 600 of the shares subscribed for on November 10. The
certificates were issued. There was no immediate intention to call on the sub-
scribers for the uncollected balances of their subscriptions.
Give entries in journal form to record the above transactions, and prepare a
balance sheet as of November 30, 1954, for Crown Corporation.
Problem A-2. A description of the capital stock of the Cobb Corporation
appears on the following page.
625
626 ASSIGNMENT MATERIAL— CHAPTER 18
5% preferred stock: $100 par value; participating to the extent of 2% above
the 5% preference rate, and cumulative; 1 ,000 shares outstanding.
Common stock: $100 par value; 1,000 shares outstanding.
Information concerning the earnings and earned surplus during the first five
years of the company's existence follows:
Net Portion of Year's Total Earned Surplus
Year Income Net Income Retained at End of Year
1950 $25,000 00 "$7,000 00 $ 7,000 00
1951 3,000 00 — 7,000 00
1952 26,000 00 5,000.00 12,000 00
1953 11,000.00 1,000.00 13,00000
1954 18,000 00 6,000.00 19,000 00
Prepare a statement showing the dividend payments of the company for each
of the years shown above.
Problem A-3. On August 31, 1954, the ledger of the partnership of Wingate
and Wilson had the following balances:
Assets
Cash $ 6,500.00
Accounts receivable . ... 31,00000
Inventory 37,000.00
Land... ... 8,000.00
Building 25,00000
Equipment T : . . 22,000.00
$129,500.00
Liabilities and Owners' Equity
Accounts payable $ 15,000 00
Notes payable . 7,500.00
Owners' equity:
Wingate, capital $65,800.00
Wilson, capital . 41,200.00 107,000.00
$129,500.00
The partners had taken action to form a corporation on August 31, to be
known as the W Company. The profit and loss ratio of the partners was:
Wingate, 60 per cent, and Wilson, 40 per cent.
The goodwill of the partnership was valued at $12,000. The valuations of
certain of the partnership assets were to be adjusted, as indicated below:
Accounts receivable (by establishing a reserve) .... . $30,000.00
Building . . .. .. 19,000.00
Equipment , . . . 14 ,000 .00
Cash (Wingate withdrew $4,000) . - . 2,50000
The new corporation was authorized to issue 1,000 shares of $100 stock.
Required:
(a) Prepare journal entries to adjust the partnership's accounts,
(b) Prepare the journal entry to record the change from the partnership to
the corporate form, assuming that the books of the partnership were
to be used by the corporation.
(c) Prepare journal entries to close the books of the partnership and to
open new books for the corporation.
ASSIGNMENT MATERIAL-CHAPTER 18 627
Problem A-4. Dover Corporation was incorporated on June 1, 1954, with
an authorized capital consisting of 5,000 shares of 5% cumulative preferred stock
of $100 par value and 2,000 shares of common stock of $50 par value.
Prepare (a) journal entries to record the transactions and (b) the owners'
equity section of the balance sheet as of June 8, 1954. In making entries for
the subscriptions, show subscribers1 names, number of shares subscribed, the
price, and the amount of the subscriptions in the explanation.
On June 1, shares were subscribed for as follows:
Preferred
Subscriber
Shares
Price Amount
W. H. Prince
A. A. Rainbolt
J. A. Campbell
J. B. Blair
300
.... 700
.. 1,000
200
$100 00 $ 30,000 00
98 00 68,600 00
99.00 99,000 00
102 00 20,400 00
2,200
$218,000 00
Common
Subscriber
Shares
Price Amount
C. R Raley
W. H. Prince
J. A. Campbell
E. L. Odom
500
600
300
50
$48 00 $24,000 00
49.00 29,400 00
48 00 14,400.00
47.00 2,350.00
1,450
$70,150 00
On June 8, the subscriptions were collected as follows:
Rainbolt transferred equipment valued at $50,000 to the corporation and
paid the balance in cash.
Campbell transferred land valued at $50,000 and a building valued at
$40,000, and paid cash for the remainder.
The remaining subscriptions were collected in cash.
Certificates were issued.
Make individual entries for the subscribers who paid in assets other than
cash. Make only one entry for the cash receipts from the other subscribers and
show names of subscribers paying their subscriptions and other details in the
explanation of the journal entries.
Problems— Group B
Problem B-l. It was decided that the Bell Corporation should be liquidated.
The capitalization of the corporation was as follows:
Preferred stock — $100 par value; authorized and issued, 1,000 shares. (Divi-
dends in arrears on preferred stock, $5 per share.)
Premium on preferred stock, $10 per share.
Common stock — $100 par value.
The preferred stock is preferred as to assets. The charter of the corporation
provides that, in the event of dissolution and liquidation, the preferred stock-
holders have the right to receive all dividends in arrears before the common
stockholders receive anything.
After the payment of all liabilities, assets of $1 12,500 remained. Show how
these assets should be distributed to the stockholders.
628 ASSIGNMENT MATERIAL— CHAPTER 18
Problem B-2. Nabors Corporation was organized on May 1, 1954, and was
authorized to issue 4,000 shares of $100 par value stock. On May 3, subscriptions
for 1,500 shares at par were received. On May 10, subscriptions for 1,800 shares
at $110 per share were received. On May 15, two-thirds of the May 3 subscrip-
tions were collected in full and certificates were issued. On May 25, one-half
of the May 10 subscriptions was collected in full and certificates were issued.
Journalize the above transactions and prepare a balance sheet as of May 31
for Nabors Corporation, assuming that the uncollected subscriptions will be col-
lected in the near future.
Problem B-3. Azle Company has 1,000 shares of $100 par value 5% pre-
ferred and 2,000 shares of $50 par value common stock outstanding.
With the understanding that the directors declare all dividends possible each
year, show how profits of $4,000 in 1953, $10,000 in 1954, and $14,000 in 1955
will be distributed to each class of stockholders if the preferred stock is:
(a) Non-cumulative and non-participating.
(b) Cumulative and non-participating.
(c) Cumulative and fully participating.
Problem B-4. Osburn Corporation was organized on October 1, 1954, \\ith
authorization to issue 1,000 shares of 6% participating, cumulative, preferred
stock of $100 par value, and 1,000 shares of no par value common stock.
Subscriptions were received for 300 shares of preferred at par on October 1 .
On the same date, 840 shares of common were issued for assets as follows:
Notes receivable $ 2,500 00
Inventory 14,800 00
Land 10,000 00
Building 30,000 00
Equipment 18,300 00
One-half of the subscriptions was collected in cash on October 15. No sub-
scriptions were collected in full.
Attorneys' fees for organizing the corporation amounted to $1,038. The cor-
poration paid the fees on October 16 by issuing 10 shares of preferred stock at
par and giving cash for the balance.
On October 31 , the directors passed a resolution establishing $75 a share as
the stated value for the common stock. On this date, the preferred subscriptions
were collected in full. Certificates were issued.
Required:
(a) Prepare journal entries to record the stock transactions.
(b) Prepare the corporation's balance sheet as of October 31, 1954.
Problem B-5. The Triangle Company's balance sheet is presented below.
TRIANGLE COMPANY
Balance Sheet — November 30, 1964
Assets
Cash $ 5,400.00
Accounts receivable $8,750 00
Less reserve for bad debts. ... . 1,100 00 7,650.00
Inventory. . . 25,000.00
Land 10,000.00
Building 30,000.00
Equipment 15,800.00
$93,850.00
ASSIGNMENT MATERIAL-CHAPTER 18 629
Liabilities and Owners* Equity
Current liabilities:
Accounts payable . .. $8,740.00
Owners' equity:
Capital stock . $60,00000
Paid-in surplus 10,000 00
Earned surplus 15,110 00 85,110 00
$93,850 00
The stockholders decided to change to the partnership form of organization
on November 30.
The stockholders own shares as follows:
Fain $30,000.00
Farmer 15,000.00
Farley 15,000.00
It was decided that a new set of books would be opened for the partnership.
Give necessary journal entries on the books of the corporation and of the
partnership to record the change.
Problem B-6. Prince and Price, a partnership, received authorization to
establish a corporation on June 30, 1954. Prince has been receiving 60 per cent
of the profits and Price 40 per cent. The balance sheet of the partnership on
June 30 was as follows:
PRINCE AND PRICE
Balance Sheet
June 30, 1954
Assets
Cash $ 7,500 00
Accounts receivable $12,500 00
Less reserve for bad debts 1,800.00 10 , 700 00
Inventory . 30,000.00
Land 8,000.00
Building 27,000 00
$813,200.00
Liabilities and Owners' Equity
Accounts payable . $ 9,350 00
Owners' equity:
Prince, capital . 833,69000
Price, capital 40,160 00 73,850 00
$83,200 00
Before the change was made, it was decided to reduce the valuation of the
land to $6,000 and increase the valuation of the building to $30,300.
The charter authorized 2,000 shares of $50 par value stock, and the new com-
pany was named the Gandy Corporation. 1,002 shares were issued for the net
assets of the partnership.
Required:
(a) Journal entries on the partnership's books to adjust the assets and
close the books.
(b) Journal entries to open the new books for the corporation.
ASSIGNMENT MATERIAL FOR CHAPTER 19
Questions
1. What items are properly credited to Paid-in Surplus?
2. Explain "stated capital."
3. What is a stock dividend? Will the issuance of a stock dividend affect
the book value per share of the class of stock distributed by the dividend?
4. Are all declared dividends liabilities?
5. When are dividends "in arrears"?
6. Under what conditions might a corporation prefer to declare a stock
dividend rather than a cash dividend?
7. Which would you prefer to acquire from a corporation for $90:
(a) A share of unissued stock of a par value of $100?
(b) A share of treasury stock of the same class?
8. Is there any relationship between dividends and treasury stock? Explain.
9. Tell how the Earned "Surplus account is affected by the following:
(a) Declaration of a scrip dividend.
(b) Payment of a previously declared cash dividend.
(c) Declaration of a stock dividend.
(d) Acquisition of treasury shares.
10. What is appropriated surplus? Give some examples.
Problems — Group A
Problem A-l. General Corporation has 10,000 shares of $10 par value
stock outstanding. Give necessary journal entries for the following, omitting
explanations.
(1) Declared a stock dividend amounting to 1,000 shares. Tn this instance,
the fair value of the stock is equal to par value.
(2) Received a donation of 1,000 shares of treasury stock.
(3) Established a reserve for contingencies in the amount of $5,000.
(4) Sold the donated treasury stock for $12 per share.
(5) Issued the stock dividend previously declared.
(6) A building site worth $15,000 was donated to the corporation.
(7) Declared a cash dividend in the amount of $1 per share.
(8) Established a reserve for plant extension in the amount of $40,000.
(9) Paid the dividend previously declared.
(10) Acquired 1,000 shares of treasury stock for $15,000.
(11) Eliminated the reserve for contingencies.
(12) Sold 200 shares of the treasury stock for $16 per share.
(13) Increased the reserve for plant extension by $10,000.
(14) Sold 300 shares of the treasury stock for $18 per share.
(15) Sold the remaining treasury shares for $7,000.
630
ASSIGNMENT MATERIAL— CHAPTER 19 631
Problem A-2. The following balances were taken from the ledger of the
Sabine Company on August 31, 1954:
Cash . . .... . $14,720.00
Accounts receivable ... . 55,000 00
Subscriptions receivable — Common 15,000 00
Subscriptions receivable — Preferred . 40,000 00
Land 30,000.00
Building 180,000 00
Organization cost ... 3 , 120 . 00
Discount on stock — Common. . ... 7,430.00
Treasury stock — Common 9,48000
Treasury stock — Preferred. . . 6,000.00
Common stock issued . 100 , 000 00
Preferred stock issued 80 , 000 00
Reserve for bad debts. . . . 2,300 00
Earned surplus . . . 21,23000
Paid-in surplus — Treasury stock transactions 14 , 990 . 00
Reserve for depreciation — Building 10,000.00
Subscribed stock — Common. 30,000 00
Subscribed stock — Preferred. . . . 60,000.00
Accounts payable . 19 , 730 . 00
Reserve for plant expansion . 30 , 000 . 00
Inventory 20,000 00
Dividends payable — Common 12,500 00
The treasury stock of both classes is carried at cost. There are 50 shares of
preferred and 70 shares of common in the treasury. Under the laws of the state
of incorporation, earned surplus is restricted to the extent of the cost of the
treasury stock.
The stock subscriptions are due in the near future.
Both classes of stock have a par value of $100 per share. Of the 1,600
authorized shares of preferred, 800 shares are issued. There are 2,000 shares of
common authorized and 1,000 shares are issued. The preferred carries a dividend
rate of 5%, it is cumulative and participating, and there are no dividends in
arrears.
Prepare a classified balance sheet for the Sabine Company as of August
31, 1954.
Problem A-3. Gliders Corporation operated profitably in the early years
of its history. In recent years, sales have declined and operating deficits have
been incurred.
A portion of the corporation's balance sheet is reproduced belo\v :
GLIDERS CORPORATION
Partial Balance Sheet
December 31, 1964
Net worth:
Capital stock:
5% cumulative preferred— $100 par
value; 4,000 shares authorized; 3,000
shares issued ... . $270 , 000 . 00
Common — $10 par value; 50,000 shares
authorized; 42,600 shares issued, of
which 1,000 shares are in the treasury 420,000 00
Earned surplus:
Operating deficit . $111,50000
Deduct premium on common stock 14,000.00 97,500 00*
$592,500.00
* Deduction.
632 ASSIGNMtNl MAltKiAL— uiAvriLK iy
The corporation is seeking a bank loan. The corporation's accountant has
come to you for advice concerning the desirability of giving the bank the bal-
ance sheet in the present form.
During the early years of operation, the corporation issued common stock
at premiums totaling $50,000. Later, additional common stock was issued at
discounts totaling $36,000. Last month the corporation paid $6,000 for 1,000
shares of its own common stock.
The preferred stock was issued on January 1, 1952. No dividends have
been declared to date on this stock.
Prepare the net worth section of the corporation's balance sheet in more accept-
able form.
Problems — Group B
r
Problem B-l. The following were taken from the records of the Hendrix
Corporation, after closing, on December 31, 1954:
Capital stock — $100 par value; authorized, 2,000 shares;
issued, 1,600 shares . .. $160,00000
Reserve for plant extensions 40,000 00
Reserve for contingencies \ 6 , 000 . 00
Capital stock to be issued, January 8, 1955, as a stock divi-
dend, 320 shares. 32,000 00
Paid-in surplus. . 8,00000
Bond sinking fund reserve . 70,000 00
Unappropriated earned surplus 185,000 00
Prepare the net worth section of the balance sheet as of December 31, 1954.
Problem B-2, Following are certain transactions of the Mason Company:
1954
June 1 — The company purchased 88 shares of its stock at $105 per share.
These shares had been issued at their par of $100.
15 — Reissued at $108 per share 55 of the shares purchased on June 1 .
24 — Reissued at $103 per share the remaining 33 shares purchased on
June 1.
Required:
(a) Journalize the above transactions.
(b) Journalize the transaction of June 24, assuming that the company had
no paid-in surplus on that date.
Problem B-3. From the following account balances taken from the ledger
of Mixture Corporation, compute the total earned surplus.
Premium on preferred stock. ... " $11 ,000 00
Earned surplus. ... . 81,00000
Dividends payable . 10,00000
Reserve for plant extension , . 30 , 000 . 00
Reserve for bad debts 7,000 00
Surplus from donations . . , 15,000 00
Cash . . 33,000.00
Discount on common stock . . . 9 , 500 . 00
Reserve for the retirement of preferred stock ... . 22,000 00
Organization costs 5,000 00
Reserve for contingencies 20,000 00
Surplus arising from treasury stock transactions 3,700.00
ASSIGNMENT MATERIAL-CHAPTER 19 633
Problem B-4. The owners' equity section of the balance sheet of the House-
hold Equipment Company on May 31, 1954, appears below:
Owners' equity:
Capital stock — no-par value: Authorized, 4,000 shares;
issued, 3,000 shares at a stated value of $75 per share $225 ,000 00
Paid-in surplus 75 ,000 00
Earned surplus . . 125,00000
Assume that the books are closed monthly. In each case, prepare the jour-
nal entry to record the transaction and any related closing entry on June 30.
Deal with each case independently of all other cases.
(a) The directors declared a dividend of $5 per share on June 15, 1954, to be
paid in cash on July 25 to stockholders of record on July 10.
(b) The directors declared a dividend of $5 per share on June 15, 1954, to be
paid in cash on July 25 to stockholders of record on July 10; one-third of the
dividend was to be charged to paid-in surplus.
(c) On June 15, 1954, the directors declared a stock dividend of yV of a share
for each share held on July 10, to be issued on July 25. The shares are regarded
as having a fair value of $100 each.
(d) The directors declared a dividend on June 15, 1954, to distribute to
stockholders of record on July 10 inventory items costing $12,000. The date
set for distribution was July 25.
Problem B-6. The net worth sections of the Big Gap Corporation as of
December 31, 1953 and December 31, 1954 are presented below. It is the cor-
poration's policy to accept no subscriptions for its shares unless they are col-
lectible immediately in cash.
By comparing the net worth sections, determine the transactions that occurred
to account for the changes in the corporation's net worth. Give journal entries
for these transactions.
BIG GAP CORPORATION
Net Worth Section of Balance Sheet
December 31, 1963
Common stock — $10 par value; 10,000 shares authorized;
5,000 shares issued . $50 , 000 . 00
Premium on stock 5 , 000 . 00
Earned surplus 18,000.00
$73.000.00
BIG GAP CORPORATION
Net Worth Section of Balance Sheet
December 31, 1954
Common stock — $10 par value; 10,000 shares authorized;
6,000 shares issued, of which 100 shares are in the treasury $ 60 ,000 .00
Common stock — To be issued, January 10, 1955, as a stock
dividend, 590 shares . 5,900.00
Premium on stock. .. ... . . 6,000.00
Earned surplus:
Appropriated: Reserve for contingencies $ 5,000.00
Free 28,000.00 33,000.00
Total.. . . " $104,900.00
Deduct cost of treasury stock 1,200.00
$103,700.00
634 ASSIGNMENT MATERIAL— CHAN tK 19
Problem B-6. Linn Corporation presented the net worth section of its June
30, 1954 balance sheet in the following form:
Net worth:
Capital stock, $10 par value; 25,000 shares
authorized; 15,000 shares issued and out-
standing $150,000.00
Surplus 184,413.00 $334,413.00
An analysis of the records of the corporation showed that the surplus resulted
from the transactions summarized below:
Net income $381,99700
Dividends declared and paid 130,000.00
Net losses. . . . 107,384 00
Premium on issuance of capital stock 21 ,000 00
Proceeds from the sale of donated treasury shares. . . . . 30,000.00
Excess of cost of purchased treasury stock over proceeds
from sale thereof . . . 3 ,200 00
Discount on the issuance of capital stock . 8,000 00
During their June meeting, the board of directors approved the establish-
ment of a reserve for plant expansion in the amount of $40,000.
Restate the net worth section of the balance sheet in more acceptable form.
ASSIGNMENT MATERIAL FOR CHAPTER 20
Questions
1. Explain the use of check marks and X's as posting references.
2. What advantages result from the use of expense controlling accounts?
3. If expense controlling accounts are kept and special columns are provided
therefor in the voucher register, how should expenses be recorded and how should
postings be made?
4. If expense controls are used, what is the purpose of the summary of expenses
prepared from the subsidiary expense records at the end of the month?
5. What kinds of entries affecting the expense analysis records are likely to
be made in books of original entry other than the voucher register? How will
such entries be posted?
6. When the note registers are used as books of original entry :
(a) Are special columns for the note controlling accounts required in the
journal? Why?
(b) Are special columns required in the cash books? Why?
7. Give a reason in support of the classification of cash discounts as other
expense and other income.
8. Describe a method of accounting by which discounts lost l\> failure to pay
bills within the discount period may be shown in the accounts.
Problems — Group B
Problem B-l. Street Corporation maintains an account to show purchase
discounts lost; the corporation does not use a voucher system. The corporation's
fiscal year ends on June 30. Prepare entries required during June in general
journal form for the following transactions.
1954
June 2 — Merchandise is purchased from General Supply Company with a billed
price of $800 and with terms of 2/10; n/30.
8 — Merchandise is purchased from James Black with a billed price of $300
and terms of 1/10; n/30.
9 — Paid the June 2 purchase within the discount period.
12 — Office supplies are purchased for $80; the seller, Ace Supply Company,
offers terms of 2/10; n/30.
14 — Merchandise is purchased from Hill Corporation with a billed price of
$710 and terms of 2/10; n/30.
19 — The office supplies are paid for.
20 — Merchandise is purchased from A. B. Company for cash. The mer-
chandise has a list price of $400, but a discount of 2 per cent is
granted for all cash transactions.
28 — Paid $300 to James Black for purchase of June 8.
635
636 ASSIGNMENT MATERIAL— CHAPTER 20
Problem B-2. Young Corporation was organized on June 1, 1954. Its
adjusted trial balance as of June 30, 1954, is as follows:
YOUNG CORPORATION
Adjusted Trial Balance
June 30, 1954
Cash .... 7,00000
Accounts receivable 13 , 500 . 00
Store fixtures.. 12,000.00
Reserve for depreciation ... 120 00
Vouchers payable 6 , 880 00
Capital stock ... . . 1 5 , 000 00
Sales .. . 60,00000
Purchases... 47,040 00
Returned purchases and allowances 2,940 00
Discounts lost. 80 00
Selling expenses .... . 2 , 200 00
General expenses 3,000 00
Depreciation expense . ... . .. 120 00
84,940 00 ^.040 00
Additional facts :
(1) All merchandise is purchased under terms of 2/10; n/30.
(2) All merchandise returned by Young Corporation is returned within five
days.
(3) On June 30, two adjusting entries were made. One \\as for depreciation,
in the amount of $120. The other is given below.
Discounts lost 20 00
Vouchers payable 20 00
To record discount lost on an unpaid invoice for mer-
chandise purchased from Admiral Supply Company.
The invoice was recorded at the net price of $980.
Required:
The June 30, 1954 adjusted trial balance as it would have appeared if the
corporation had not used the net price procedure.
Practice Set
This practice set is based on the transactions of Dale Corporation for the
month of August. The current year should be used in all dates.
CHART OF ACCOUNTS. SUBSIDIARY RECORDS.
Charts of the general ledger accounts and the subsidiary expense accounts
appear on the inside rovers of the general ledger and the books of original entry.
The general ledger contains the following controlling accounts:
1120 — ACCOUNTS RECEIVABLE.
This account controls an accounts receivable subsidiary ledger.
2120 — VOUCHERS PAYABLE.
Vouchers should be recorded net of the available cash discounts, in
the manner described in Chapter 20.
ASSIGNMENT MATERIAL-CHAPTER 20 637
1130 — NOTES RECEIVABLE.
2130 — NOTES PAYABLE.
These accounts control note registers, which are also used as books
of original entry.
5300 — MANUFACTURING EXPENSE — CONTROL.
6000 --SELLING EXPENSE — CONTROL.
7000 — GENERAL EXPENSE — CONTROL.
These accounts control expense analysis records,- or distribution
sheets, containing columns for the subsidiary accounts. You will
make postings to the selling expense analysis record. It is assumed
that your assistant makes the postings to the other analysis records.
BOOKS OF ORIGINAL ENTRY
You will record transactions in the following books of original entry:
Sales hook.
Voucher register.
Cash receipts from customers book.
General cash receipts book.
Cash disbursements book (Check register).
Notes receivable register.
Notes payable register.
General journal.
Payroll summaries will be prepared by an assistant; postings from the sum-
maries will be made by you. At some time before payroll entries are posted, you
should read the material in Chapter 7 and in the appendix dealing with payroll
deductions and taxes.
Postings, except column totals, should be made daily from all books of original
entry.
Expenses and income wholly applicable to August should be recorded directly
in expense and income accounts. Expense and income items not wholly appli-
cable to August should be recorded in prepaid expense and deferred income
accounts. Transfers from these accounts to expense and income accounts will
he made by adjusting entries at the end of the month.
TRANSACTIONS
(The numbers in parentheses are transaction numbers.)
August 1 :
(1) Dale Brothers have been in business for some time, operating as a partner-
ship. They decide to incorporate, and Dale Corporation is organized with
an authorized capital of 4,000 shares of $100 par value. Subscriptions
are received for these shares as follows:
John Dale 2,250
Robert Dale 1_,750
^000
Make an entry to record the subscriptions.
(2) In settlement of the stock subscriptions, the corporation takes over the
assets and assumes the liabilities of the partnership of Dale Brothers,
as stated on the following page.
638 ASSIGNMENT MATERIAL— CHAPTER 20
Assets:
Cash ............... $ 1,151.68
Accounts receivable . $ 16,763 42
Less reserve for bad debts ..... _ 597.90 16, 165 52
Finished goods . . . 74,85435
Goods in process 34,347 83
Raw materials . . 58 , 930 62
Land 52,000 00
Buildings .. 142,00000
Machinery and equipment. . 155,000 00
Tools ' 2,400 00
Delivery equipment .. 6,00000
Furniture and fixtures . 4,800 00
Patents. . 9,000 00
Goodwill , 20,000 00
Total assets $576,650 00
Liabilities:
Notes payable $ 65,000 00
Accrued interest on notes payable 400 00
Mortgage payable — Land and buildings —
6%. 50,000 00
Mortgage payable — Machinery and equip-
ment — 5 % . 60 , 000 . 00
Accrued interest on mortgages payable 1,250 00
Total liabilities . . . 176,650.00
Partners' interests :
John Dale. . $225,000 00
Robert Dale . 175,000 00
Total partners' interests. . . . .".
(a) Make a journal entry recording all of the assets except cash, and all of
the liabilities except notes payable, crediting account 2201 — Dale
Brothers.
(b) Make an entry for the cash in the general cash receipts book, crediting
account 2201.
(c) The $65,000 liability on notes payable is detailed as follows:
Interest
Date Payee Time __ Rate Face
July 8 Citizen7State Bank ........... 9Cfdays ~6% $25,000
June 17 First State Bank ................. 60 " 6% 40.000
$65,000
Record these notes in the notes payable register, debiting account 2201.
(d) Open an account in the subsidiary accounts receivable ledger with each
of the debtors listed below:
C. E. Bruce ........ $ 8,424 30
J.C.Burns ........ 3,21560
C. W. Finley ...... 219.80
C.L. Murphy ..... 113.85
Rowley and Company ..... 1 ,789 87
Stinson Motor Sales . . 3,000.00
$16,763.42
(e) Make a journal entry debiting Dale Brothers and crediting Subscriptions
to Capital Stock for the subscriptions paid by the transfer of the net
assets of the partnership.
ASSIGNMENT MATERIAL FOR CHAPTER 21
Questions
1. Give two advantages of the use of a separate bank account for the pay-
ment of bond interest.
2. Discuss the relative advantages of unregistered and registered bonds,
from the point of view of (a) the issuing corporation, and (b) the bondholder.
3. A $500,000 bond issue has been authorized, but only $300,000 of the bonds
have been sold. How should these farts appear in the balance sheet?
4. Unissued bonds of a face value of $5,000, bearing 6% interest, are sold for
$5,050 one month after the interest payment date. Give the entry or entries
required to record this transaction.
5. From the bondholders' standpoint, what is the object of:
(a) The sinking fund provision?
(b) The sinking fund reserve provision?
6. What is the difference in the nature of a sinking fund reserve and a depre-
ciation reserve?
7. Why are bond discount and bond premium written off to the Interest
Expense account over the life of the bonds?
8. Where do the following appear on the balance sheet?
Unissued Bonds.
Sinking Fund Cash.
Sinking Fund Securities.
Bond Discount.
Bond Premium.
Accrued Bond Interest.
Sinking Fund Reserve.
Bonds Payable.
9. Give an appraisal of the effectiveness of a sinking fund reserve in achieving
the objective for which it is established.
10. What disposition should be made of the following accounts at the maturity
of a bond issue?
Sinking Fund Reserve.
Sinking Fund Securities.
Problems — Group A
Problem A-l. Culver Corporation uses the calendar year as its accounting
year. On May 15, 1955, the corporation was authorized to issue $1,000,000 of
5% first-mortgage bonds. The bonds mature in twenty years from June 30,
1955, and interest is to be paid semiannually on June 30 and December 31. All
of the bonds were issued on July 1, 1955.
639
640 ASSIGNMENT MATERIAL-CHAPTER 21
Prepare journal entries to record the authorization of the bond issue, the
issuance, and the payment of interest and the amortization on December 31,
1955, assuming that the bonds were issued at:
(a) 97.
(b) 103.
Problem A-2, On December 31, 1954, Wiley Company issued $500,000 of
4%, 10-year debenture bonds. The indenture provides for the establishment of
a sinking fund with the Foundation Trust Company as trustee. Beginning in
1955, Wiley Company is to deposit with the trustee, on each December 31 during
the life of the bonds, an amount of cash which, when added to the fund earnings
after trustee fees, will increase the fund by $50,000. The trustee is able to invest
in securities which provide a return of 4% on the fund principal at the beginning
of each year. THe trustee fee charged by Foundation Trust Company is 1 % per
year on the fund balance at the beginning of each year.
Required:
(a) Prepare a table showing, by years, the following:
1. Fund balance, beginning of year.
2. Fund earnings.
3. Trustee fees.
4. Annual contribution.
5. Fund balance, end of year.
(b) Prepare journal entries regarding the sinking fund for Wiley Company
through December 31, 1956, assuming that the trustee immediately
invests all cash in securities.
Problems — Group B
*
Problem B-l. On January 23, 1955, Kilroy Corporation's stockholders and
directors authorized the issuance of $200,000 of 6%, 20-year bonds secured by a
first mortgage. Interest was to be paid semiannually on January 31 and July 31 .
The bonds were dated February 1, 1955.
Interest was to be paid by means of interest coupons, the first of which came
due July 31, 1955. A deposit, against which interest coupons will be charged, is
to be made with Liberty Bank each interest date.
All of the bonds were issued on March 1, 1955, at par plus accrued interest
to that date.
Prepare journal entries to record the authorization of the bonds, their issuance,
the July 31, 1955 interest payment to Liberty Bank, the payment by Liberty
Bank of $3,000 in honoring interest coupons, and the entries necessary to adjust
the books on December 31, 1955, the close of Kilroy Corporation's accounting
period.
Problem B-2. Tibbs Manufacturing Company is authorized to issue $100,000
of 4%, 10-year debentures on March 1, 1956. Interest is to be paid semiannu-
ally on February 28 and August 31. On March 1, 1956, all of the debentures are
issued at 97.
Prepare all entires through December 31, 1956, the close of the company's
accounting period.
Problem B-3. From the after-closing trial balance on page 641, prepare the
balance sheet of Hamilton Corporation.
ASSIGNMENT MATERIAL— CHAPTER 21 641
HAMILTON CORPORATION
After-Closing Trial Balance
December 31, 1965
Cash 20,000 00
Notes receivable. 10,00000
Inventory .. . 40,00000
Investments (non-current) . 30,000 00
Land (for future expansion) 20,000 00
Machinery and equipment . . 240,000 00
Discount on 4% first-mortgage bonds 1 ,000 00
Unissued 6% sinking fund debentures 5,000 00
Unissued 5% collateral trust bonds 2,000 00
Sinking fund securities 5,000 00
Reserve for depreciation 60,000 00
Premium on collateral trust bonds 500 00
Vouchers payable 38,000 00
Accrued taxes 2 , 000 . 00
4% first -mortgage bonds payable, 1970 70,000.00
6% sinking fund debentures payable, 1965 30,000 00
5% collateral trust bonds payable, 1961 20,000 00
Sinking fund reserve 5 , 000 . 00
Preferred stock, $10 par, 8% 40,000 00
Common stock, no-par, 100.000 shares author-
ized, 97,500 shares issued and outstanding 60 , 000 00
Karned surplus 47,500 00
jga.OOOJjO 373,000 00
Problem B-4. Prepare entries in journal form covering the following, through
December 31, 1955. Omit all closing entries. The company is on a calendar-
year basis.
On July 1, 1954, Orson Company was authorized to issue $100,000 of 4%,
10-year bonds, interest payable on June 30 and December 31. The bond inden-
ture required the company to establish a sinking fund and a sinking fund reserve.
On each interest date, a deposit of $5,000 less sinking fund earnings since the
last interest date was required. The indenture provided that the sinking fund
reserve should equal the sinking fund.
On July 1, 1954, $50,000 of the bonds were issued at 101. On September 1,
1954, $48,000 of the bonds were issued at par phis accrued interest. On July 1,
1955, $2,000 of the bonds were issued for $2,036.
The company established a special bank account for the payment of bond
interest. Cash equal to the interest obligation was deposited in the special
account on each June 28 and December 29. Interest checks were issued on the
interest-payment dates.
During the first six months of 1955, the sinking fund trustee, who immediately
invests all cash receipts in securities, reported e?*rnings of $200. During the
second six months of 1955, the trustee reported earnings of $410; the trustee also
submitted a bill for services, in the amount of $150, which the company paid on
December 31, 1955.
Practice Set (Continued)
August 1 — Continued:
(3) The stockholders and directors have authorized an issue of $240,000 of
first-mortgage bonds, to be dated August 1 , to mature in ten years, and to
bear interest at 6%, payable semiannually. The indenture requires the
642 ASSIGNMENT MATERIAL-CHAPTER 21
creation of a sinking fund by monthly additions of $2,000, and the transfer
to a sinking fund reserve of an amount equal to the monthly addition to
the sinking fund. The bonds are to be secured by a mortgage on all of
the company's real estate and machinery and equipment. Details regard-
ing the bonds issued today are shown below:
(a) To retire the 6% mortgage on land and buildings:
Principal of mortgage . $50 , 000
Accrued interest on mortgage 500
Face of bonds issued. $50,500
(b) To retire 5% mortgage on machinery and equipment:
Principal of mortgage. . . $60,000
Accrued interest on mortgage . 750
Total $60,750
Face of bonds issued 60,500
Premium (allowed because the bonds bear 6% interest,
whereas the mortgage bore 5%) ... ^ 250
(c) To Citizens State Bank, to pay note:
Principal of note . $25 , 000
Accrued interest on note . 100
Face of bonds issued $25 , 100
(d) To First State Bank, to pay note:
Principal of note. .-.- . . $40,000
Accrued interest on note ... . 300
Face of bonds issued . $40 , 300
(e) To Lakewood Investment Association, for cash:
Proceeds . $63,950
Face of bonds issued . . 63,600
Premium $ 350
August 2:
(4) Receive a 10-day, non-interest note from C. E. Bruce for $8,424.30, the
amount of the account receivable from him taken over from Dale Broth-
ers. (In order to compress within the limits of one month the transac-
tions which it is desired to include in this practice set, the time periods of
notes are unusually short.)
(5) Issue a check for $1,000 to sales manager T. R. Price as an advance for sales-
men's traveling expenses.
August 3 :
(6) Collect the $1,789.87 receivable from Rowley and Company, less 2% cash
discount.
(7) Purchase from Morley Company (terms, 2/10; n/30):
Gross Net
Materials . $41,380.25 $40,562 64
Factory supplies 2,900 50 2,842 49
$44,280.75 $43,395 13
August 4:
(8) Sale to James Greathead, $35,000; terms, 2/10; n/30.
ASSIGNMENT MATERIAL-CHAPTER 21 643
August 5:
(9) Receive from Stinson Motor Sales a 15-day note for $3,007.50, the amount
of the $3,000 account receivable taken over from Dale Brothers plus
interest at 6%.
(10) Insurance policies expiring one year from August 1 are received today from
Scott and Scott, together with their bill for $4,920. The bill is paid.
August 6:
(11) Sale" to Henry Wright, $20,000; terms, 2/10; n/30.
(12) Issue a check for $22,878.80 to Lippert Reduction Company for materials
purchased today. Terms, cash.
August 8:
(13) Purchase materials from Hubbard and Laurel, $6,354.70. Terms, 2/10;
n/30. Net, $6,227.61.
ASSIGNMENT MATERIAL FOR CHAPTER 22
Questions
1. What are the objectives of a system of internal check in relation to assets?
2. What is the purpose of a petty cash fund? Describe the procedure of
setting up and operating a petty cash fund.
3. List several basic requirements for a good system of internal check with
regard to cash.
4. If a company operates a payroll bank account by drawing a check on the
regular bank account for the exact amount of the payroll and depositing this
check in the payroll bank account, what might be indicated by:
(a) A balance in the payroll bank account in the general ledger?
(b) A balance in the payroll account per the bank statement?
5. Under what circumstances may adjusting entries resulting from a bank
reconciliation be made in the cash journals?
Problems — Group A
Problem A-l. Portions of the September cash receipts book and cash dis-
bursements book of McAuliffe-Moore Corporation are shown below:
Cash Receipts Book
Cash Disbursements Book
Date
Debit
Cash
1954
Sept.
1
372
18
2
176
34
3
192
82
3
44
50
3
310
00
5
422
18
8
322
47
8
50
00
12
428
39
15
730
00
15
217
32
17
109
23
18
15
28
18
317
60
22
57
77
24
182
91
29
50
00
29
177
38
30
62
57
30
378
01
4,616
95
Check
No.
Date
Credit
Cash
426
1954
Sept.
3
678
00
427
5
31
58
428
10
111
72
429
12
73
82
430
15
414
14
431
15
100
73
432
15
7
92
433
18
15
48
434
22
179
97
435
25
33
03
436
29
212
72
437
29
314
76
2,173
87
644
ASSIGNMENT MATERIAL— CHAPTER 22
645
The company maintains one bank account with the Manufacturers' National
Bank. The company deposits all cash receipts. The statement submitted by
the bank covering the transactions for the month of September follows:
Manufacturers9 National Bank
Date
1954
Checks
Deposits
Balance
Aug.
31
Balance brought forward
i
3,913
39
Sept.
2
372
18
4,285
57
3
678 00
176
34
3,783
91
4
Col. 25 Ex. 35
547
32
4,330
63
8
31 58
422
18
4,721
23
9
372
47
5,093
70
11
111.72
4,981
98
15
414.14
428
39
4,996
23
16
100 73
947
32
5,842
82
18
73 82
109
23
5,878
23
19
15 48
332
88
6,195
63
23
Kx. 50
57
77
6,252
90
25
179 97 33 03
182
91
6,222
81
30
314 76
227
38
6,135
43
The bank balance as of August 31, 1954, as shown by the bank statement,
agreed with the balance as shown by the company's ledger account.
Required:
(a) The company's bank reconciliation as of September 30, 1054.
(b) Necessary journal entries as of September 30, assuming that the cash
journals have l^een ruled and posted.
Problem A-2. McAuhffe-Moore Corporation opened an account with the
First State Bank during the following month (see Problem A-l). The trans-
actions recorded during the month of October, 1954, on the books of the company
were as shown on pages 646 and 647.
The statements from the two banks for the month of October, 1954, together
with lists of returned checks and debit memos, are as shown below and on page
648.
Manufacturers' National Bank
1954
Cheeks
Deposits
Balance
Oct.
1
Balance brought for\> iird
6,135
43
1
440
58
6,576
01
2
706
13
7,282
14
4
38 30 132 00
902
03
8,013
87
6
765 07
7,248
80
11
202 00 Toi. 35
2,114
04
9,160
49
14
212 72 Kx. 25
433
81
9,381
33
18
390 07 129 54
1,617
17
10,478
89
21
Col. 1 25 384 04
4,000
00
14,093
60
24
38.20 728.00
171
98
13,499
38
25
1,007
93
14,507
31
31
500 00 550.00
13,457
81
Balance at end of month
13,457
31
646
ASSIGNMENT MATERIAL— CHAPTER 22
8£ 8 SS 8 § 13
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ASSIGNMENT MATERIAL— CHAPTER 22 647
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2
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o |cg« a^ S g-^^-lisf
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648
ASSIGNMENT MATERIAL-CHAPTER 22
Checks and debit memos returned by Manufacturers' National Bank
(rearranged in numerical order) were:
Checks:
No. 436
$212.72
438
38 30
439
132.00
440
129 54
441
202 00
442
765 07
444
390 07
445
384 04
446
728 00
447
38 20
448
500 00
449
550 00
Debit memos:
Exchange charge.
Collection charge.
Collection charge.
I 25
35
1 25
First State Bank
Date
1954
Checks
Deposits
Balance
Oct.
1
Balance brought forward
00
10
2,393
83
2,393
83
11
95 00
2,298
83
15
Col. 45 13 82 757 56
1,010
00
2,537
00
22
28 82
626
16
3,134
34
25
894 78
2,239
5(5
31
Balance at end of month
2,239
5(>
Returned cheeks and debit memos (rearranged in numerical order):
Checks:
No.
$ 95 00
757 56
28 82
13 82
894.78
Debit memos:
Collection charge
45
From the information presented above and in Problem A-l , prepare reconcilia-
tions of the two bank accounts and any necessary journal entries, assuming that
the company's fiscal year ends on October 31.
Problem A-3. The II & M Company, which uses a voucher system, decides
to pay for miscellaneous small expenses out of a special fund, which is to be
maintained on an imprest basis. The following transactions relative to the fund
have taken place during the month of September. The numbers in parentheses
indicate the number of the petty cash voucher used.
1954
Sept. 10 — A petty cash fund of $25 is established.
(1) Sept. 11 — Paid Acme Truckers for freight on merchandise purchased, $7.20,
and for freight on merchandise sold, $2.22.
(2) Sept. 14 — Paid Office Supplies Company for stationery for office, $5.15.
(3) Sept. 15 — Paid Truex Print Shop for miscellaneous posters advertising
special sale, $3.17.
ASSIGNMENT MATERIAL-CHAPTER 22 649
(4) Sept. 21— Paid freight bill to CW & SR Railroad as follows: on merchandise
purchased, $3.19; on merchandise sold, $2.21.
Sept. 22 — The cash on hand in the petty cash fund is $1.86. The fund is
replenished; because of the rapidity with which the fund has
been exhausted, the amount of the fund is increased to $40.
(5) Sept. 23 — Paid the Acme Truckers for freight on merchandise purchased,
$2.38, and for freight on merchandise sold, $2.72.
(6) Paid the Western Union telegraph boy for a collect telegram,
$.85.
(7) Sept. 2&— Gave Jerry Daugherty, office boy, $5 for 100 3jfc stamps and 100
2$ stamps. (Charge to an expense account.)
(8) Sept. 27 — Paid $6 to Tom Donohue for overtime meal allowances.
(9) Sept. 28— Clave Jerry Daugherty $.52 for the purchase of five desk blotters.
(10) Sept. 30 — Paid Acme Truckers for freight on merchandise purchased, $1 .73,
and for freight on merchandise sold, $4.14.
(1 1) Paid 4 boys $2 each for delivering sales circulars house-to-house.
(12) Gave delivery truck driver, Sam Baker, $2.50, to have advertis-
ing sign on truck repainted.
Sept. 30 — Because the company closes its books and prepares statements
monthly, the petty cash fund is replenished today. The cash
on hand amounts to $6.06.
On the basis of the above information, prepare (1) a petty cash book (similar
to the one illustrated in the chapter), and (2) entries in general journal form which
would l>e made relative to the above entries, indicating in which book of original
entry the transactions would be recorded.
Problems— Group B
Problem B-l. Using the following information, prepare a bank reconciliation
for J. B. Field and Son, as of March 31, 1954. J. B. Field and Son maintains a
bank account with the Chita qua Bank.
(1) The balance of the Cash account in the ledger as of March 1, 1954, was
$4,130.56.
(2) The cash receipts book for March shows a total debit to cash of $13,-
512.23; the cash disbursements book for the month shows a total credit to cash of
$14,382.12.
(3) The statement received from the bank shews a balance of $3,277.98 as of
March 31.
(4) The cash on hand, representing receipts for the day, amounts to $289.29.
(5) An examination of the cancelled cheeks shows that the following checks
have not yet been paid by the bank: #1874 for $59.70; #1907 for $209.40; and
#1908 (a certified check) for $200.
(6) The cancelled checks returned by the bank include a check of J. C. Folder
and Sons for $50.
(7) The bank returned a check for $12.50, which was received from George
Pire; the check is marked "N.S.F." and a bank debit slip for this amount is
enclosed with the bank statement.
(8) On March 30, the bank credited the account of J. B. Field and Son with
$100, which represents the proceeds of a $101.50 non-interest-bearing note of
George Roberts. The bank deducted $1 .50 for collection charges. No entry had
been made by J. B. Field and Son for this collection.
650 ASSIGNMENT MATERIAL— CHAPTER 22
Problem B-2* Prepare a bank reconciliation for Kaye and Company on
March 31, 1954, based on the following information.
(1) The balance per books of Kaye and Company is $3,895.82.
(2) The bank statement shows a balance of $5,738.73 as of March 31.
(3) Accompanying the bank statement was a check of W. W. Ward for $77.32,
which was marked N. S- F. by the bank.
(4) Checks outstanding as of March 31 were as follows: #C57 for $902.68
and #C62 for $1,005.
(5) Also accompanying the bank statement was a cancelled check for $57.62
of King Company; the bank had deducted this check from the account of Kaye
and Company erroneously.
(6) On March 29, 1954, the bank collected a non-interest-bearing note for
Kaye and Company. The note was for $152.50; the bank charged a collection
fee of $2,50.
(7) A deposit of $157.63 was in transit; it had been mailed to the bank on
March 31.
(8) The bookkeeper of Kaye and Company had recorded a check received on
account from Baker Company erroneously ; he recorded a $90 check us $9.
(9) The service charges on the account for March amount to $3.20; a debit
memo in this amount was returned with the bank statement.
Prepare necessary journal entries under the assumption that the company's
fiscal year ends on March 31.
» X
Problem B-3. The Walt Kell Paint Distributors Company has the following
payroll for the week ending January 7:
Salesmen's salaries . $ 738 00
Office salaries 419 75
Officers' salaries . 1,92500
The income tax withheld amounted to $612.32. The F.O.A.B. tax rates are
H%; the state unemployment insurance tax rate is 2.7%; the federal unemploy-
ment insurance tax rate is .3 %. All salaries paid were subject to taxes.
The company maintains a special payroll account with the National Bank
and Trust Company.
Prepare the general journal entries to record: (1) the payroll for the week
ending January 7, and (2) the employer's taxes on the payroll.
Problem B-4. Prepare entries in general journal form to record the following,
including any necessary adjusting entries, in the books of Hex Corporation, which
uses the voucher system and closes its books annually on December 31.
1954
November 20 — The corporation established an imprest cash fund of $50.
November 30 — An examination of the imprest cash fund disclosed the following
composition:
Currency and coin $ 3.50
Vouchers showing disbursements for:
Telephone and telegraph 9 75
Postage... . 27 00
General office expense 9 . 55
Owing to the rapid exhaustion of the fund, a check was drawn
to replenish the fund and to increase its amount to $100.
ASSIGNMENT MATERIAL-CHAPTER 22 651
December 31 — The composition of the imprest fund was as follows:
Currency and coin $19 14
Vouchers showing disbursements for:
Telephone and telegraph . . 13 25
Postage.. . ... 40.00
General office expense . 17.61
Traveling expense ... . 10 00
The fund was not replenished as of December 31.
Practice Set (Continued)
August 9:
(14) Sale to Henry Barton, $25,000; terms, 2/10; n/30.
(15) Purchase raw materials from Weber and Fields, $9,400; terms, 10-day
acceptance for amount of invoice less 2% discount. We accept the draft
today.
(16) Purchase raw materials from F. J. Donovan, Inc., for $20,691.40. Terms,
30 days net.
August \0:
(17) Write off C. W. Finley's $219.80 account as uncollectible.
(18) Sale to Burroughs and West, $16,400; terms, 2/10; n/30. Also bill them
$175.75 for delivery charges.
(19) Draw a $200 check to the order of the petty cashier to establish a ^otty cash
fund.
August 11:
(20) Give a $29,750 note to C. D. Fulton & Co. for a purchase of machinery.
The note bears 6% interest and is due in 30 days.
August 12:
(21) Collect from C. E. Bruce the $8,424.30 non-interest note received from him
on August 2.
(22) Sale to Kenneth Dutton, $7,500; terms, 10-day sight draft less 2% discount.
Receive the acceptance, in the face amount of $7,350.
(23) Pay Morley Company voucher No. 2 for $44,280.75, less 2% cash discount.
(24) Discount our 10-day note for $10,000 at the First State Bank. Proceeds,
$9,983.33.
August 13:
(25) Collect from James Greathead the $35,000 invoice of August 4, less 2%
discount.
(26) Receive a credit memo for $500 from F. J. Donovan, Inc., for goods returned
to that company.
August 15:
(27) On August 5, C. L. Murphy's account, $113.85, was placed in the hands of an
attorney for collection. The attorney collected the account. The pro-
ceeds are received today, less $20 attorney's fee.
652 ASSIGNMENT MATERIAL-CHAPTER 22
(28) Pay East and West Railroad freight bill, which is detailed below:
$125.76 On sale to Henry Barton on August 9. Since the terms of this
sale required that Barton bear the expense of the freight, the
$125.76 should be charged to him. The charge should be
entered in the Sundry Debits column of the voucher register;
the customer's name should be written in the Remarks column
to indicate the account in the subsidiary ledger to which the
item should be posted.
315.67 On sales.
219.60 On materials purchased.
$661.03
August 16:
(29) Sale to Fred Madison, $12,000; terms, 10-day sight draft less 2% cash dis-
count. The acceptance is received.
(30) The payroll clerk has prepared the payroll summary for the first half of
August. Your work in connection with the payroll consists of the
following:
(a) Post to the general ledger accounts and to the selling expense analysis
record. (It is assumed that your assistant posts to the manufactur-
ing and general expense analysis records.) The accounts to be
debited and credited are indicated on the payroll summary.
(b) Record a voucher and a check payable to Payroll for the net payroll
amount shown by the payroll summary in the pamphlet of books
of original entry.
If you have not read Appendix 1 , do so at this time.
(31) Sale to Henry Fowler, $20,000; terms, 30-day, 6% note. The note is
received.
August 17:
(32) Sale to Rowley and Company, $14,700; terms, 2/10; n/30.
(33) Pay Daily News $23.45 for want ads for factory labor. (Charge account
5390.)
August 18:
(34) Sale to Charles Lathrop, $30,250; terms, 2/10; n/30.
(35) The discount period on the Hubbard and Laurel voucher expires today, and
we want to take advantage of the 2% discount. However, we have
reported some unsatisfactory materials and have not yet arrived at an
agreement regarding the amount of credit we should receive. By agree-
ment with Hubbard and Laurel, we now make a partial settlement of
$5,000, being allowed a discount of $100, and sending them a check for
$4,900. We expect to claim the discount on the balance, on the grounds
of their delay in issuing a credit memorandum for the unsatisfactory
goods.
August 19:
(36) A credit memorandum is issued to Rowley and Company to correct a $400
error in overfooting their invoice of August 17. Since this credit memo-
randum was not issued for either a return or an allowance, but to correct
an error in the billed amount, the record of the credit memorandum should
not involve a debit to Returned Sales and Allowances.
ASSIGNMENT MATERIAL— CHAPTER 22 653
(37) Receive a bill from Davison Job Printers, terms 15 days, detailed as follows:
Sales forms (account 6090) $69.80
Bookkeeping supplies and office forms (account 7012) 95 30
Total SI 65 10
(38) Pay Weber and Fields acceptance.
ASSIGNMENT MATERIAL FOR CHAPTER 23
Questions
1. What is a red balance in a subsidiary ledger? How are such balances pre-
sented in financial statements?
2. Explain the nature and operation of a reserve for sales discounts.
3. How would you interpret each of the entries in the following account?
Reserve for Bad Debts
1952
1951
Aug.
1
J12
225
36
Dec.
31
1952
Dec.
31
1953
Feb.
24
.18
J15
J20
2,00000
2,20000
22536
4. The following entry was made for an account considered uncollectible:
200 00
Reserve for bad debts
R. F. Burns . ...
200 00
Assume that $100 is collected. What entries should be made if: (a) It is
thought the account may now be collected in full? (b) No more collections are
expected?
5. Describe the circumstances that would justify the following entry:
xxxx
Notes receivable discounted.
Notes receivable
xxxx
6. Describe the circumstances that would justify the following entry, made at
the end of the accounting period:
Interest income.
Deferred interest income
xxxx
7. What is the purpose of the Notes Receivable Discounted account?
8. What transactions are recorded in the following accounts? How should
the facts shown by these accounts appear in the balance sheet?
Notes Receivable
19—
19—
July
1
A. Jones
1,500
00
Aug.
12
A. Tillman
200
00
9
J. Griffin
750
00
21
J. Griffin
750
00
28
A. Tillman
200
00
Aug.
4
J. P. Clark
100
00
Notes Receivable Discounted
19—
19—
Aug.
21
J. Griffin
750
00
Aug.
12
J. Griffin
750
00
14
J. P. Clark
1 100
00
654
ASSIGNMENT MATERIAL— CHAPTER 23 655
9. Compute the proceeds of the following $6,000 notes:
Rate of
Time Interest Date Rate of Discount
Date of Note of Note on Note Discounted Charged by Bank
(a) June 9, 1954 60 days June 15 6%
(b) June 9, 1954 60 dayh 5% June 15 6%
(c) June 9, 1954 2 months June 15 6%
(d) June 9, 1954 2 months 5% June 15 6%
Problems — Group A
Problem A-l. Make entries in journal form to record the following transac-
tions on the hooks of (i. H. Haines Company. Assume that the company closes
its books annually on December 31 . Prepare the entries in the order presented.
(la) March 1— Discounted our $5,000, 30-day note payable at the bank.
Discount rate, 6%.
(Ib) March 31— Paid the above note.
(2a) March 1 —Discounted our $5,000, 60-day note payable at the bank.
Discount rate, 6r '0.
(2b) Apnl 30— Paid the above note.
(3a) March 1 — Received a 30-day, non-interest note from T. Usher, $3,000,
to apply on account.
(3b) March 11 — Discounted the Usher note at the bank. Discount rate, 6%.
(3c) March 31 — Usher paid his note at the bank.
(4a) March 25- -Discounted at bank a 00-day, non-interest note, signed by Paul
LeBreton, dated March 5. Face of note, $5,400. Discount
rate, of/c.
(4b) May 4- LeBreton dishonored his note and \ve paid the bank.
(4c) May 31 —Received a check from LeBreton for payment of his note of
March 5.
(5a) May 25- -Discounted at the bank a 60-day, 6f {, note for $7,200, received
from Webb Johnson, dated May 19. Discount rate, 5%.
(5b) July 18— Johnson paid his note at the bank.
(6a) July 25— Discounted at bank a 90-day, 5 < '0 note for $8,000, received from
O. C. Schnicker. Note dated July 7. Discount rate, 6%.
(6b) Oct. 5- -Schnicker dishonored his note and we paid the bank the
amount due, together with a protest fee of $2.75.
(7a) Aug. 16 — Received a 30-day, non-intere&t note for $4,800 from T. Hoff-
mann to apply on account.
'7b) Aug. 22 -Transferred the Hoffmann note to F, R. Fan-ell to apply on
account. Discount rate, 6%.
(7c) Sept. 15- -Hoffmann paid Farrell for the note due today.
(8a) Sept. 20— Received a 60-day, 6% note for $8,000 from D. Demors to
apply on account.
(8b) Sept. 30 — Transferred the Demors note to R. Biggs to apply on account.
Discount rate, 5%.
(8c) Nov. 19 — Demors dishonored the note and we made payment to Biggs,
including a protest fee of $3.15.
(9a) Oct. 16 — D. Barath sent us, to apply on account, a 30-day, non-interest
note, signed by B. Birch, dated October 1 1, for $3,600. The
note was taken at discounted value; rate, 6%.
(9b) Nov. 10 — Collected the above note from Birch.
(10a) Sept. 27— Sold merchandise to W. Savage, $5,000; terms, n/30.
656
ASSIGNMENT MATERIAL— CHAPTER 23
(lOb) Oct. 27— Savage transferred to us a 60-day, 6% note for $3,000, dated
October 21, signed by R. Sherman, which we took on a 5%
discount basis. Savage paid us the remainder due (on the
September sale) in cash.
(lOc) Dec. 20 — Sherman dishonored his note. Savage paid it in full.
Problem A-2. Make entries in journal form to record the following trans-
actions on the books of Snow and Harris.
Oct. 13 — Jacob Snow sold merchandise to Frank Harris, $2,400, and received a
30-day, non-interest note from Harris for the amount of the sale.
Oct. 19 — Snow discounted the note at the bank; discount rate, 6%.
Nov. 12 — Harris paid the note at the bank.
Problem A-JK Make entries in journal form to record the following trans-
actions on the books of Dempsey, Rogers, and Walton.
May 16 — James Dempsey sold merchandise to B. E. Rogers, $2,400, and received
a 30-day, 6% note for the amount of the sale.
28 — David Walton sold merchandise to James Dempsey, $5,400, and
received the following:
% (I) The note from Rogers, which he took on a 6% discount basis;
(2) A 60-day, 6% note for $2,000, signed by Dempsey;
(3) Cash for the balance.
June 15 — Rogers dishonored the note and Walton collected it from Dempsey.
Dempsey collected $1 ,000 from Rogers.
July 27 — Walton collected the $2,000 note from Dempsey.
Problem A-4. (a) Prepare an aging schedule for the following accounts of
Mid-States Corporation.
Winter Furnace Company
1954
July
7
Aug.
10
17
Sept.
20
Oct.
15
Nov.
7
Dec.
8
20
S8
a 660
00
660
00
SO
h 1,020
00
1,680
00
CR7
a 660
00
1,020
00
S10
e 840
00
1,860
00
Sll
d 900
00
2,760
00
CR9
d 900
00
1,860
00
S12
e 420
00
2,280
00
J5
e 40
00
2,240
00
Coal and Ice Company
1954
June
July
10
S7
J3
310
00
3000
31000
28000
H. C. Motor Company
1954
Aug.
15
S9
m 370
00
370
00
20
J4
m 50
00
320
00
Nov.
12
Sll
n 272
50
592
50
Dec.
7
S12
o 301
00
893
50
15
Note Receivable
J5
n 272
50
621
00
ASSIGNMENT MATERIAL-CHAPTER 23
Green Corporation
657
1954
Oct.
13
Sll
x 372
10
372
10
Nov.
7
Sll
y 181
00
553
10
21
J4
x 40
00
513
10
25
CR9
x 232
10
281
00
Dec.
7
312
z 222
00
503
00
(b) Mid-States Corporation provides a reserve for bad debts at the end of
each year equal to 50 per cent of all amounts over six months old and 20 per cent
of all amounts 91 days to six months old. There is a credit balance in the reserve
account on December 31 in the amount of $38. Prepare the journal entry to
record the provision for bad debts.
Problems— Group B
Problem B-l. Record the following transactions of T. N. Bands Company in
general journal form. Assume that the company closes its books annually on
December 31. Prepare journal entries in the order presented.
(la) Aug.
(lb) Aug.
(Ic) Aug.
(2a) Aug.
(2b) Nov.
(3a) Sept.
(3b) Nov.
(4a) Mar.
(4b) May
(5a) Mar.
(5b) Apr.
(6a) Apr.
(Ob) Apr.
(7a) May
(7b) July
(8a) June
1 — Received a 30-day, non-interest note for $3,900 from W. Jennings
to apply on account.
16 — Discounted the Jennings note at the bank. Discount rate, 6%.
31 — W. Jennings paid his note at the bank.
15 — Discounted at the bank a 90-day, 5% note for $9,000 signed by
P. Whelan, dated August 5. Discount rate, 4%.
3 — Whelan dishonored his note due today and we paid the bank.
4 — Discounted at the bank a 72-day, non-interest note for $8,500,
signed by W. Tate, dated August 29. Discount rate, 6%.
9 — Tate paid his note at the bank.
11 — Discounted at the bank a 60-day, 4% note from W. Coyer for
$2,400, dated March 5. Discount rate, 6%.
4 — Coyer dishonored his note and we paid the bank the amount due,
including a protest fee of $2.60.
7 — Discounted with W. Woodman, a creditor, a 60-day, 6% note
from L. Townsend for $6,600, dated March 1. Discount
rate, 7%.
30 — Townsend paid Woodman for the note due today.
17 — Discounted with R. Plumley, a creditor, a 30-day, 6% note from
G. Bailey for $5,000, dated March 28. Discount rate, 5%.
27 — Bailey dishonored his note due todny and we made a payment to
Plumley for the amount due, including a protest fee of $5.15.
12 — R. Hall sent us, to apply on his account, a 60-day, 6% note for
$4,200, signed by S. Rodman, dated May 6. The note was
accepted at discounted value; rate, 7%.
5 — Collected the above note from Rodman.
7 — H. Shields sent to us, to apply on his account, a 60-day, 6% note
for $7,000, signed by W. Jensen, dated May 1. The note was
taken at discounted value; rate, 5
Vo«
(8b) June 30 — Jensen dishonored the note and we collected it from the endorser,
H. Shields.
658 ASSIGNMENT MATERIAL—CHAPTER 23
Problem B-2. Make entries in journal form to record the following trans-
actions on the books of Brennan and Ward. Brennan is on a calendar-year
basis; Ward closes his books each June 30.
Dec. 19 — Patrick Brennan sold merchandise to Samuel Ward, $6,000, and
received a 60-day, 6% note from Ward for the amount of the sale.
Dec. 31 — Brennan discounted the note at the bank; discount rate, 4%.
Feb. 17 — Ward dishonored the note. Brennan paid the bank the face of the
note, the interest, and a protest fee of $2.87.
Feb. 23 — Ward gave Brennan a new 30-day, 6% note for $3,500 and paid Brennan
the remainder of his indebtedness in cash.
Problem B-3. Make entries in journal form to record the following trans-
actions on the books of Walsh, Voss, and Hartman.
March 13 — Emil Hartman sold merchandise to Homer Voss, $4,500, and received
a 60-day, non-interest note for the amount of the sale.
24 — Peter Walsh sold merchandise to Emil Hartman, $6,200. Hartman
transferred the Voss note to Walsh; Walsh took it on a 6% dis-
count basis. Hartman paid the balance of the invoice in cash.
May 12 — Walsh collected the note from Voss.
Problem B-4. Make entries in journal form to record the following trans-
actions on the books of Vance, Howard, and Spencer,
Aug. 15 — Oliver Vance sold merchandise to Richard Howard, $3,000, and re-
ceived Howard's 60-day, 6% note for the amount of the invoice.
Aug. 21 — L. H. Spencer sold merchandise to Oliver Vance, $4,800, and received:
(1) The Howard note, which he took on a 5% discount basis;
(2) A 60-day, 5% note for $1,500, signed by Vance;
(3) Cash for the balance.
Aug. 24 — Spencer discounted both of the notes at the bank ; discount rate, 4 %.
Oct. 14— Howard dishonored his note and Spencer paid the bank the face, the
interest, and a protest fee of $1.92.
Oct. 15 — Spencer collected from Vance the amount he paid the bank for the dis-
honored Howard note.
Oct. 17 — Vance received from Howard a new 30-day, 6% note for $2,000 and
cash for the remainder of the amount owed.
Oct. 20 — Vance paid his discounted note at the bank.
Problem B-5. The June 30, 1 954 balance sheet of Semi Corporation shows
the following item under current assets: Accounts receivable, $40,647.49. An
examination of the accounts reveals that the amount is composed of the following :
Regular customers — controlling account bal-
ance. . . . $33,702 33
Less amount owing to customers — recorded
in accounts payable ledger . L'^li-J1 $32,201 22
Subscriptions receivable (collected in July, 1954). . 3,500.00
Advances to employees . . 1 ,875 00
Accrued interest receivable. . 87 61
C. O. D. customers 301 .56
Discount on preferred stock . . .. 2,500.00
Red balances in accounts payable . . ... $ 903 54
Less red balances in accounts receivable. . . 721 44 182. 10
What amount should be reported in the balance sheet as accounts receivable?
ASSIGNMENT MATERIAL— CHAPTER 23 659
Practice Set (Continued)
August 20:
(39) Collect the note receivable from Stinson Motor Sales.
(40) Effective today, part of one of the buildings has been rented to Millen Hard-
ware Company for one year, at $300 per month. The first month's rent
is collected today. Credit account 2191 — Rent Collected in Advance.
Monthly transfers will be made to account 8191 — Rent Income.
(41) Discount at First State Bank the 10-day acceptance for $11,760 received
from Fred Madison on August 16. Proceeds, $11,748.24.
(42) Machinery is purchased for $39,500 from Johnson Machine Company. A
cash payment of $19,500 is made today; the balance is payable September
20.
August 22:
(43) Merchandise in the amount of $7,500 was sold to Kenneth Dutton on August
12, and a 10-day acceptance was received from Dutton for the amount of
the invoice less 2</c discount. Dutton dishonors the acceptance today,
and thereby forfeits the discount.
(44) Pay the First State Bank the $10,000 note given on August 12.
August 23:
(45) Sale of merchandise to Osti andei & Company, $43,325 ; terms, 2/ 10 ; n/30.
August 24 :
(46) Issue credit memorandum for $725 to Charles Lathiop because of defective
goods sold him on August 1 8.
August 25:
(47) Collect from Henry Wright the amount of the invoice of August 6, $20,000.
The discount period has expiied.
(48) Purchase materials from Watson Refineries, $7,941.23. Terms, 1/5;
n/30.
August 26:
(49) On August 17 a sale was made to Rowley and Company in the billed amount
of $14,700; on August 19 a credit memorandum for $400 was issued to
correct an overfooting of the invoice. A check for $14,406 is received
from Rowley and Company today. They apparently overlooked the
credit memorandum, overpaid their account, and incidentally took too
much discount. Rowley and Company is notified.
(50) Collect from Charles Lathrop the amount of the invoice of August 18, less
the credit memorandum issued on August 24, and less 2% cash discount.
(51) The bank informs us that Fred Madison paid his $11,760 acceptance which
we discounted at the bank on August 20.
August 27:
(52) Purchase materials from Wagner and Hobson, $28,985.40; terms, 2/10;
n/30.
660 ASSIGNMENT MATERIAL-CHAPTER 23
(53) On August 8 we purchased raw materials from Hubbard and Laurel at a
gross amount of $6,354.70 and a net amount of $6,227.61 . On August 18
we sent Hubbard and Laurel a check for $4,900, and recorded a new
voucher for the remaining $1 ,327.61 of the net amount of the purchase.
Today we receive a credit memorandum for $1,000 and issue a check for
$347.61.
August 29:
(54) Receive a check for $24,625.76 from Henry Barton for the sale on August 9
and $125.76 freight charge on August 15. He is informed that the dis-
count period has expired.
ASSIGNMENT MATERIAL FOR CHAPTER 24
Questions
1. Should the following assets owned by a manufacturing company be
classified in its balance sheet as fixed assets?
(a) Land on which its factory is situated.
(b) Land used as an experimental farm for the improvement of grain used
as one of its raw materials.
(c) Land and buildings formerly used as the company's factory, but now
leased to another company.
(d) Land which the company purchased two years ago and which it hopes
to sell at a profit; the land is not in use.
(e) Land which is not at present in use but is being held for possible plant
expansion.
2. Describe a situation in which appraisal data are considered acceptable for
purposes of establishing the amount to be charged to a fixed asset account.
3. Is it ever acceptable to charge the cost of a building to the Land account?
4. Should the following be charged to the asset account, to the related depre-
ciation reserve, or to expense?
(a) Broker's commission in connection with the purchase of real estate.
(b) Taxes accrued at the date of purchase.
(c) Taxes after purchase.
(d) Cost of remodeling a section of the building to convert it into an office.
(e) Annual painting and decorating costs.
6. What is your opinion regarding the practice of charging losses and cred-
iting gains resulting from the disposal of fixed assets direct to the Earned Surplus
account?
6. Why is it unnecessary to amortize the cost of a trademark?
7. Contrast depreciation and depletion.
8. Why is depreciation not ordinarily credited to the fixed asset account?
9. Describe two methods of accounting for depreciation program revisions.
10. Describe the types of charges that may be assigned to the following
accounts: (1) Leaseholds; (2) Leasehold Improvements. Explain the accounting
procedures applicable to these accounts.
Problems— Group A
Problem A-l. L. Wayne Company was organized on January 1, 1954. At
the end of the year, its ledger contained a Land and Buildings account, with
debit and credit entries as shown on page 662. The bookkeeper stated that the
entries in this account had been made in accordance with the accounting principle
that all costs during the construction period should be capitalized.
661
662 ASSIGNMENT MATERIAL-CHAPTER 24
Debits:
Incorporation fees and expenses $ 500.00
Other organization expenses 300 . 00
Cost of land and old buildings. (There were three build-
ings: the values assigned to the buildings were: Building
4— $20,000; Building B— $20,000; Building C—
$30,000. The land was valued at $50,000. Buildings
A and B were to be demolished; only Building C was
to be retained.) 100,000.00
Broker's commission on above purchase 1 ,000 00
Attorney's fees for the year:
Incorporating company 300 00
Examination of real estate title 100 00
Patent investigation 500 00
Real estate taxes accrued at date of acquisition . . 1,800.00
Paving assessments:
1953 . . .. 250.00
1954.. .. 250.00
Cost of rehabilitation of Building C, completed on June
30, 1954 . 6,300 00
Contract cost of new building completed June 30, 1954. . 350,000 00
Real estate taxes for 1954. ... ... 3,000.00
Cost of demolishing Buildings A and B 7,500 00
Interest on $350,000 for six months at 6% (The now
building was paid for with the funds obtained from the
sale of preferred stock.) .. . 10,500.00
Semiannual dividend on preferred stock 12,500 00
Material, labor, and overhead costs of partitions, shelving,
etc., installed by company employees 12,400 00
Excess of price quoted by a contractor in bid for partitions,
shelving, etc., over the $12,400 stated above 2,600.00
Salary of John Smith for first six months of the year.
Smith supervised the building construction; after June
30 he served as factory superintendent. . 1 ,500.00
Discount on $475,000 of preferred stock issued for cash to
obtain funds for purchase of land and old buildings and
construction of new building . 9,500 00
Par value of preferred stock given to a contractor (on the
same date on which the preferred stock mentioned
immediately above was sold) for filling in swamp land,
grading, landscaping, paving roads, laying sidewalks,
etc . . ... 25,000 00
Replacement of windows broken in August 35 . 00
Repairs necessitated by cyclone in September 5,000 00
Cost of building fence around property 2,000.00
Total debits $552,835.00
Credits:
Recovery from insurance company for cyclone damages. . $ 4,000.00
Proceeds of sale of salvage from buildings demolished. . . 6,000 00
Proceeds of sale of portion of land 10,000 00
Total credits $ 20,000.00
Balance $532,835.00
Required:
An analysis and reclassification of items charged to the Land and Buildings
account, indicating the account which should be charged for each separate item
included in the above account.
ASSIGNMENT MATERIAL-CHAPTER 24 663
Problem A-2. L. W. Thomas Company started in business on January 1,
1952; on that date it purchased the following machines:
Machine A, $4,200, estimated life, 5 years, with a scrap value of $200.
Machine B, $5,400, estimated life, 6 years, with no scrap value.
Machine C, $4,800, estimated life, 10 years, with no scrap value.
On September 1, 1952, Machine D (estimated life, 8 years; scrap value, $200)
was purchased from the K. Wayne Company for $10,000; terms, 2/10; n/30.
The machine was paid for on September 5, 1952.
On July 1, 1953, Machine E (estimated life, 10 years; no scrap value) was
purchased for $7,200, cash.
On December 30, 1955, it was decided that Machine C would become obsolete
by the end of 1958, and that the undepreciated cost would be written off over the
newly estimated remaining life.
On April 1, 1956, Machine A was traded in for Machine F, which had a list
price of $6,000. An allowance of $1,000 was received on Machine A, the balance
of the list price being paid in cash. The life of Machine F was estimated at 10
years, with a scrap value of $200. (Follow the income tax procedure.)
On September 1, 1956, Machine E was sold for $4,000.
You are asked (1) to prepare journal entries in chronological sequence for all
of the transactions above and also the depreciation entry made at the end of
each year; (2) to post the entries above and to submit the Machinery and Reserve
for Depreciation — Machinery accounts, showing their balances as of December
31, 1956; (3) to prepare a schedule showing (a) the cost of the machines on hand
on December 31, 1956 and (b) the depreciation charged to date on those machines.
Problems— Group B
Problem B-l. On January 2, 1956, you are hired by Kass Company as their
accountant. In your preliminary investigation of the accounts as of December
31, 1955, you notice that the Machinery account has a balance of $4,723.92, and
that there is no related Reserve for Depreciation — Machinery account.
Inquiry uncovers the facts that the former accountant kept a very inadequate
set of records and that he had been computing depreciation by taking 10% of the
balance in the account as of January 1 of each year and crediting the asset
account with the depreciation thus computed instead of using a reserve.
The balance in the Machinery account represents the undepreciated portion
of the cost of a single machine purchased on January 1, 1951. The life of the
machine had been estimated at 10 years, with no salvage value. No entries had
been made in the account except the entry recording the acquisition and the
entries recording the depreciation for each year.
After bringing the error to the attention of the president of the company, you
are asked to submit to him a schedule shoving the amount of underdepreciation
for each year. He also asks you to submit the entry necessary to correct the
accounts and to place them on the basis of the accepted method of computing
and recording depreciation.
Problem B-2. The articles of partnership of the firm of A, B, and C, who
share profits and losses in the ratio of 40%, 35%, and 25%, respectively, con-
tained the following provision: "In the event of the death of a partner, the good-
will of the firm shall be computed by capitalizing at 12}% the excess of the
average earnings for the three full years prior to his death over 10% of the net
worth of the firm per the books at the end of the year prior to his death."
664 ASSIGNMENT MATERIAL— CHAPTER 24
B died on May 3, 1955. The profits for the three preceding years were: 1952,
$11,356.20; 1953, $12,287.95; 1954, 812,355.85. The balances in the capital
accounts on December 31, 1954, were: A, $30,000; 5, $25,000; C, $20,000.
Make the proper entry for the goodwill.
Problem B-3. The K & L Wayne Company purchased a used machine on
July 1, 1952, at a cost of $4;000. The machine was immediately overhauled at a
cost of $550. The company also paid an electrician a fee of $150 to check the
electric wiring in the machine and to help install the machine.
The balance sheet prepared by the company on December 31, 1955, contained
the following balances:
Machinery $1,00000
Less reserve for depreciation 1,400 00 $2,600.00
The annual profits, as shown by the profit and loss statements, were:
1952 $2,470 00
1953 .... 3,508 00
1954 3,392 00
1955 3,23800
Compute the effect of the above errors on the profits as reported and show
what the profits would have been if the above expenditures had been given the
proper accounting treatment.
Problem B-4. Universal Mining Corporation purchased a coal mine at a cost
of $70,000. When the "mine was purchased in 1953, it was estimated to contain
350,000 tons of coal. The quantities of coal mined during 1953 and the two
following years were:
1953 . 40,000 tons
1954 . . . 57, 000 tons
1955 . . 78, 000 tons
In 1956, a new vein of coal was discovered, containing an estimated 75,000
tons of coal.
Make the journal entry recording the depletion charge for the year 1956, if
80,000 tons of coal were mined in that year.
Problem B-5. K-X Tile Company leased a store building from Blake Realty
Company for a period of 20 years. The cost of the lease was $100,000, payable
in 20 equal installments on the first day of each year. The lease agreement
stipulated that K-X Tile Company would pay the cost of any alteiations or
improvements made.
K-X Tile Company built partitions in the store at a cost of $4,000. The
partitions were estimated to last the remaining life of the building, 30 years.
K-X Tile Company also built shelving at a cost of $1,200; the shelving would
have to be replaced at the end of 5 years. All of these improvements were made
just prior to occupancy by K-X Tile Company under the lease.
Prepare journal entries for the following:
(1) To record the cost of the partitions.
(2) To record the cost of the shelving.
(3) To record the first annual payment of rent under the lease.
(4) To record the first annual amortization of the cost of the partitions.
(5) To record the first annual amortization of the cost of the shelving.
ASSIGNMENT MATERIAL— CHAPTER 24 665
Practice Set (Continued)
August 30:
(55) Pay East and West Railroad freight bill, which is detailed below:
$319 50 On machinery purchased from Johnson Machine Company.
427 95 On materials purchased.
139.43 On sales.
S886 88
15 00 Railroad's overcharge, on bill paid August 15, for freight
charged to Henry Barton on goods sold to him.
$871 88
August 31 :
(56) Pay Benson Corporation for the following:
Trailer for truck $875
Tires — to replace tiros worn out 70
$945
(57) Pay City Abstract Company $200 for title search relative to real estate
acquired from the predecessor partnership.
(58) Pay Hanson Construction Co. $415 for installing machinery purchased
August 20.
(59) City Garage bills us for the following items, payable September 10:
Gas and oil $108 50
Repairs . . 93 40
$201 96
(60) Because the discount period on the Watson Refineries invoice was five days
instead of the customary ten days, we inadvertently failed to take advan-
tage of the $79.41 discount. Make an entry to record the loss of the dis-
count. Payment will be deferred.
(61) Issue a check for $451.90 to the petty cashier to increase the fund to $500
after replenishing it for the following expenditures'
Account Amount
6057 ~ Sales circulars $ 73 15
7011 Typewriter supplies 2875
1182 Postage 50 00
$151 90
(62) The August bill received from Central Power Co., payable September 10,
is analyzed as follows:
Factory light and power $825 00
Office light 31 65
$856.65
(63) A check for $2,000, the regular monthly sinking fund deposit, is given to
Midland Trust Company, the sinking fund trustee.
(64) Midland Trust Company informs us that it has purchased securities for the
sinking fund at a cost of $1,500.
666 ASSIGNMENT MATERIAL-CHAPTER 24
(65) Credit the sinking fund reserve $2,000.
(66) The directors declare a 1 % cash dividend, payable September 10 to stock-
holders of record August 31.
(67) Post from the August 16-31 payroll summary to the general ledger and the
selling expense analysis record.
ASSIGNMENT MATERIAL FOR CHAPTER 25
Questions
1. What is a consignment? Should goods on consignment be included in the
inventory of the one in possession of the goods?
2. Devise an illustration to show how inventory misstatements affect net
income.
3. List some of the incidental costs that are proper additions in determining
cost for inventory-pricing purposes.
4. Explain the following :
Fifo.
Lifo.
5. If prices are rising, will the last-in, first-out inventory method have any
effect on net income different from the first-in, first-out method? Explain.
6. If the cost-or-market method is used for inventory pricing, name some of
the sources that an accountant might use in secuiing market-price data.
7. Describe the acceptable ways of applying the cost-or-market method.
8. If the inventory of finished goods is valued at market purchase prices,
because they are lower than cost, does the profit and loss statement correctly
state the gross piofit on goods sold?
9. Describe the gross profit method of estimating inventories. Cite some
circumstances under which the method might prove useful.
Problems — Group A
Problem A-l. On January 1, 1955, the Ellis Corporation had on hand three
units of Part No. 1316 which cost $20 per unit. During 1955 purchases of Part
No. 1316 were made as follows:
Date Quantity Unit Cost
January 31 . . . 4 $19
April 20 6 22
July 30 4 23
At the end of 1955, a periodical inventory was taken, and it was determined
that there were five units on hand.
Compute the closing inventory by the following methods:
(1) First-in, first-out.
(2) Last-in, first-out.
(3) Weighted average.
Problem A-2. Warner Appliance Mart maintains two departments — main
salesroom and bargain basement.
On December 31, 1955, the inventory was composed of the items shown on
the following page.
667
668 ASSIGNMENT MATERIAL-CHAPTER 25
Unit Price
Quantity Cost Market
Main salesroom:
Refrigerators 75 $170 $173
Stoves 120 85 85
Washers 50 60 65
Television sets 30 160 150
Bargain basement:
Refrigerators 15 140 142
Stoves 25 50 50
Washers . . 40 40 42
Television sets 60 100 90
Compute the closing inventory at the lower of cost or market, applying the
method to: /(a) each item in the inventory; (b) the inventory in each department;
(c) the entire inventory.
Problems — Group B
Problem B-l. During the calendar year 1956, Mally Fuel Corporation sold
6,000 tons of coal for $120,000. In its inventory on December 31, 1955, the
company had 750 tons of coal which had cost $13 per ton. Purchases during
1956 were as follows:
Quantity
Date "* _t_T?5?L Unit Price Total
January 25 . 1,000 $12 $12,000
March 30 500 13 6,500
June 25 1,500 13 19,500
July 13 2,000 15 30,000
August 20 500 16 8,000
Septembers 500 17 8,500
Novembers . . . 300 18 5,400
Total purchases 6,300 $89,900
Compute the gross profit on sales, assuming the use of the following methods
of determining cost: (a) first-in, first-out; (b) last-in, first-out; (c) weighted
average.
Problem B-2. Following is the after-closing trial balance of Stacy Manufac-
turing Company as of December 31, 1955, the close of its first year of operations:
Cash 10,000.00
Accounts receivable ... . 20,00000
Raw materials 15,00000
Goods in process 30,00000
Finished goods 12,00000
Machinery and equipment 20,000.00
Reserve for depreciation — Machinery and equip-
ment.. . . 1,000 00
Accounts payable . 4,000 00
Bonds payable. 15,00000
Preferred stock 20,00000
Common stock. 40,000 00
Reserve for plant expansion 10,000 00
Earned surplus— free 17,000 00
107,000.00 107,000 00
ASSIGNMENT MATERIAL-CHAPTER 25 669
An audit of the inventory accounts and procedures of the company reveals
the following data:
(1) $3,000 of raw materials in transit on December 31, 1955, were not included
in the closing inventory amount, although, through an oversight, the invoice from
the vendor had been entered in the purchase journal. The goods were shipped
f. o. b. shipping point.
(2) The inventory of goods in process was properly taken and computed.
(3) Finished goods costing $4,000 were shipped on consignment to Cabot
Wholesale Company. None of these goods had been sold by the consignee as of
December 31, 1955, but, since the goods were not on hand when the inventory
count was made, they were not included in the closing inventory.
(4) Finished goods costing $2,000 had been sold to Jeeper Brothers, and the
sale recorded. Jeeper Brothers had requested that delivery be postponed until
January 12, 1956. The cost of these goods was included in the finished goods
inventory on December 31, 1955, although title had passed to Jeeper Brothers.
Required:
(a) Prepare the December 31,1 955 balance sheet in the light of these addi-
tional data. Ignore any income tax adjustments which might be
necessary.
(b) Prepare a schedule showing your computation of earned surplus on
December 31, 1955.
Problem B-3. Mayfair Company sells ladies' dresses. During its first year
of operations, it purchased one lot of 1,000 Type A dresses at a cost of $10 per
dress, another lot of 1,500 Type B dresses at $20 per dress, and a third lot of 500
Type C dresses at $30 per dress. During that year its sales amounted to $70,000.
At the close of its first year, an inventory count revealed the following quanti-
ties on hand:
Type A 300
B . 200
C . . ..50
The company computes its inventory at the lower of cost or market, applied
to each class of merchandise.
Type A dresses are standard styles and patterns, but the market has become
so saturated that these dresses could be replaced for $7 per dress, and, while
these dresses normally would be sold by Mayfair for $17, those on hand are
marked down to $15. They are selling well at this price.
Type B dresses are higher-priced standard styles, and the market has been
quite steady. Replacement cost per dress would be $21.
Type C dresses are strictly style merchandise, and it is customary in the
trade to dispose of season-end stock at a significant reduction in price. It is
expected that these 50 dresses can be sold for approximately $17.50 per dress,
but that a special full-page newspaper advertisement will be needed. The cost
of such an advertisement is $350.
Required:
Prepare a statement of gross profit on sales for Mayfair Company for its
• first year, supporting your statement with a schedule showing the com-
putation of the closing inventory.
670 ASSIGNMENT MATERIAL— CHAPTER 25
Problem B-4. When Carlton Corporation, dealer in automotive parts, took
an inventory on April 30, 1955, the management was surprised to discover that
it amounted to only $12,000, at cost. An investigation revealed that Donald
Crow, the night watchman, had co-operated with thieves systematically to loot
the warehouse. Since Crow was bonded, no loss would be borne by the corpora-
tion, but the amount of the thefts had to be determined. Since Crow had been
hired in February, there was reasonable certainty that the thefts all occurred
during 1955.
The corporation's books showed the following account balances on April 30,
1955:
Sales ... $60,000
Returned sales and allowances 2,000
Inventory, December 31, 1954 25,000
'Purchases 45,000
Returned purchases and allowances 1 ,000
Freight in . . 2,000
For the past several years, Carlton Corporation has averaged a gross profit
of 35% of net sales.
Required:
Compute the amount of the theft claim to be submitted to the bonding
company.
Practice Set (Continued)
(68) Foot and complete the posting of all of the books of original entry.
(69) Take a trial balance of the general ledger. Enter the account balances in
the Trial Balance columns of the working papers provided in the labora-
tory material.
ASSIGNMENT MATERIAL FOR CHAPTER 26
Questions
1. What is income? When is income earned?
2. A company has received orders for future delivery amounting to $5,000;
it has goods on hand, which cost $3,500, which are sufficient to fill these orders.
The management of the company wishes to include $1,500 as profits in its operat-
ing statement. Would you approve this procedure?
3. A printer received an order for 10,000 textbooks, which he completed and
had ready for delivery before the end of the year. As an accommodation to the
publisher, the printer agreed to hold these books in his warehouse and make ship-
ments to schools as directed to do so by the publisher. The printer desired to
include the profit on this work in his operating statement for the year. Would
you approve?
4. How is cost computed when a noncash asset is acquired for noncash
5. A company has its fixed assets appraised at each year-end and adjusts
its accounts to show the values disclosed by the appraisal; the adjustments of the
asset valuations are shown in the operating statement as income or expense.
What comment do you have to make on this procedure?
6. A manufacturing company has expended a total of $3,000 worth of its
own material, labor, and expense in constructing a machine for its own use.
This machine, if bought in the open market, would have cost $4,000. Is it sound
accounting to capitalize this machine at the market price?
7. In determining the amount of cost expirations and cost residues, account-
ants attack the problem from two directions. Explain the two directions refer-
red to in this connection.
8. Is it regarded as good accounting to take up profits on uncompleted work
under the following conditions:
(a) The product is being made for stock?
(b) The work is being done under a contract at a fixed price?
(c) The work is being done on a cost-plus basis?
9. A company purchases for $75,000 a plant which has been in use for fifteen
years. It is in a run-down condition, and the company spends $15,000 to put it
into condition for use. The expenditures are principally for repairs, painting,
and similar work that would have been considered operating charges had the
plant been maintained properly by the previous owner. Should the $15,000 be
recorded as a capital or a revenue expenditure?
10. At certain times of the year, a company has large amounts of cash which
it invests in bonds; these are sold when the cash is needed. How should these
bonds be valued in the balance sheet if their market value at the balance sheet
date is considerably above cost? How should they be valued if their market
value is considerably below cost?
671
672 ASSIGNMENT MATERIAL-CHAPTER 26
11. A company issued $1,000,000 of 4% bonds at 95, and immediately wrote
off the discount to Earned Surplus. Do you consider this procedure correct?
12. Why is the accountant interested in consistency in relation to the appli-
cation of accounting procedures?
13. Explain the clean surplus concept and give some of the arguments that
have been developed in support of the concept.
Problems— Group A
Problem A-l. In an examination of the books of the Connell Company, it is
found that ordinary repairs to equipment have been charged to the Equipment
account during each of the years 1953 and 1954. Repairs in the amount of
$5,220 in 1953 and in the amount of $4,830 in 1954 were so charged. Net income
as reported was $138,432 for 1953 and $143,672 for 1954. The company applies
a rate of 10% to the balance in the Equipment account at the end of each year
in its determination of depreciation charges.
Prepare a schedule showing the correct net income for these two yeans.
Problem A-2. The bookkeeper of Burnett Company prepared the following
balance sheet:
BURNETT COMPANY
Balance Sheet
December 31, 1954
Assets
Current assets:
Cash . 9 2,850 00
Accounts receivable 28,920 00
Inventory 17,200 00 $48,970 00
Other assets . 2,000.00
Fixed assets:
Land and buildings . . 30,000 00
880,970 00
Liabilities and Net Worth
Current liabilities:
Accounts payable $ 7,800 00
Notes payable 4,000 00 $11 ,800 00
Reserves:
Reserve for bad debts $ 320 00
Reserve for plant expansion . 14,040.00
Reserve for depreciation 4,900 00 19,200 00
Net worth:
Capital stock, $10 par . . $40,000 00
Earned surplus . . . 9,910 00 49,910 00
$80,970 00
The account Other Assets consists entirely of 160 shares of the company's
own stock which was purchased for $2,000. The amount shown for the inven-
tory represents the sales value of the merchandise on hand. Gross profit for the
company has averaged 25% of selling price. The land cost $9,000 in 1948.
The notes payable are not due for three years.
In addition, it was discovered, after the above balance sheet had been pre-
pared, that an invoice in the amount of $3,720, for a portion of the original cost
ASSIGNMENT MATERIAL— CHAPTER 26 673
of the building, had been charged to expense on January 1, 1948. The building
had an expected useful life when new on January 1, 1948, of thirty years.
Reconstruct the balance sheet in a more acceptable form, making any cor-
rections which you believe to be required.
Problem A-3. In an examination of the Westcott Company's books, the
auditors discovered that net income had been incorrectly reported by the book-
keeper for the calendar years 1953 and 1954, as a result of the following:
(1) The Store Supplies Expense account had not been adjusted on December
31, 1953, to reflect supplies on hand amounting to $325. The records properly
showed that no store supplies were on hand at the end of 1954.
(2) Major repairs, amounting to $12,000, completed on July 1, 1953, on
second-hand equipment installed on the same date, were charged to expense.
At the date of installation, the equipment had an expected useful life of four
years.
(3) The physical inventory of merchandise taken on December 31, 1953,
understated the actual inventory by $1,500.
(4) Unrecorded accrued wages on December 31, 1953, amounted to $380.
(5) The company does not have a Reserve for Bad Debts account in its
ledger. A Reserve for Bad Debts should have been set up for $640 of receivables
believed to be worthless on December 31, 1953. These accounts were written
off in 1954. Also, no entry was made at the end of 1954 concerning $480 of
accounts about which the management was doubtful of collection.
The reported net income was :
For 1953 $17,381
For 1954 26,483
Prepare a statement showing the computation of corrected net income for
1953 and 1954.
Problem A-4. Wallace Company, publishers of a monthly magazine, began
operations on July 1, 1954, and established the calendar year as the time period
to be used in accounting for its operations.
The publication, issued at the end of each month, was available by the copy
for thirty-five cents, by a one-year subscription for $4, or by a two-year subscrip-
tion for $7. Magazines were sent to subscribers in the month in which subscrip-
tions were received.
All receipts from single-copy sales and from subscriptions were credited to
income. The statement of profit and loss for the six months ended December
31, 1954, showed Magazine Income Earned to be $64,985. Details for single-
copy sales and subscriptions are given below:
Single Copy One-Year Two-Year
Month Sales Subscriptions Subscriptions
July. . $1,75000 $4,00000 $1,400.00
August. 2,625 00 6,000.00 1,750.00
September .... 3,50000 4,800.00 2,100.00
October. . . 3,150.00 6,40000 1,960.00
November 3,850.00 6,80000 2,100.00
December. 3,570.00 7,200 00 2,030.00
* *18>445.00 $35,200.00 $11,340.00
Compute the correct amount of magazine income earned for the six months
ended December 31,1954.
674 ASSIGNMENT MATERIAL-CHAPTER 26
i
Problems— Group B
Problem B-l. Statements of earned surplus for Dalworth Company are
given below:
DALWORTH COMPANY
Statement of Earned Surplus
For the Year Ended December 31, 1953
Balance, December 31, 1952 . $ 64,500 00
Additions:
Net income for the year ... . . $48,70000
Gain on sale of marketable securities ... . 1,250.00 49 ,950 00
Total ^ $1 14, 450 7)0
Deductions:
Dividends paid . . . $9,00000
Storm loss in October, 1953 ... . 5,100 00 _14,100.00
Balance, December 31, 1953 $100,350 00
DALWORTH COMPANY
Statement of Earned Surplus
For the Year Ended December 31, 1954
Balance, December 31, 1953 $100,350 00
Additions:
Net income for the year^ $51 ,300 00
Correction for overdepreciation of equipment during
1951, 1952, and 1953 . 3,600 00 54,900.00
Total $155,250 00
Deductions :
Dividends paid . $10,000 00
Payment of assessment for additional income taxes for
year 1952. . 6,000 00 16,000 00
Balance, December 31, 1954 . $139,250 00
Dividends paid in 1953 included $3,000 of dividends declared in 1952. Divi-
dends paid in 1954 included $4,000 of dividends declared in 1953. An additional
$4,000 of dividends were declared in 1954 to be paid in 1955. No entries were
made on the dates of declaration.
Prepare corrected statements of earned surplus for the years 1953 and 1954,
as they would have appeared if the company had followed the clean surplus
theory.
Problem B-2. The comparative statement of earned surplus on page 675
was prepared by the bookkeeper of Grand Company.
Additional data:
(1) Payment of $1,080 was made in 1954 for merchandise which was on hand
and included in the inventory on December 31, 1953. The liability and charge
for this merchandise were unrecorded at the end of 1953. When the invoice was
paid in 1954, the Purchases account was debited.
(2) Interest income earned but unrecorded on December 31, 1954, amounted
to $830.
(3) Rent expense accrued but unrecorded on December 31, 1954, amounted
to $1,150.
ASSIGNMENT MATERIAL— CHAPTER 26
675
GRAND COMPANY
Comparative Statement of Earned Surplus
For the Years Ended December 31, 1953 and 1954
Year Ended December 31 ,
1953
Balances, end of previous year
Additions:
Net income. .
1954
$ 87,500.00 $147,570.00
Interest income earned in 1953 but not recorded —
collected in 1954
Gain on sale of treasury stock
Gift of land from the city of Arlington
Total additions
Total ...
Deductions:
Dividends declared
Payment of rent expense accrued but unrecorded at end
of previous year
Provision for reserve for contingencies
Total deductions . ...
Balances, end of year . . ....
$ 54,700.00 $ 63,400 00
700.00
20,000.00
1,100.00
$ 75,400 00 $ 64,500 00
$162,900.00 $212,070.00
$ 12,000.00 $ 14,000.00
830.00 950.00
2,500.00
$ 15,330 00 $ 14,950.00
$147,570.00 $197,120 00
Prepare statements of earned surplus for the years 1953 and 1954 as they
would have appeared if the company had adopted the clean surplus theory and
had made all year-end adjustments under the accrual method of accounting.
Problem B-3. Parker Company engaged a new bookkeeper on September
1, 1954, the start of its fiscal year. At the end of September, the Sales account
appeared as follows:
Sales
1954
1954
Sept.
15
Return of mer-
Sept.
7
Merchandise
chandise by a
shipped on
cash customer
CD8
80
00
consignment
J3
19,500
00
22
Order received
from U.S.
Government
J4
32,000
00
23
Collection from
a customer
whose account
was written off
as uncollectible
in 1953
CR7
350
00
25
Sale of treasury
stock
CR7
1,800
00
30
Cash sales for
September
CR7
38,010
00
30
Cash collections
from credit
customers for
September
sales
CR7
61,360
00
30
Appreciation of
inventory
J4
9,400
00
676 ASSIGNMENT MATERIAL— CHAPTER 26
The company maintains a perpetual inventory. Sales on account for the
month were $65,700. The bookkeeper made no entry for any of the charge sales.
The bookkeeper, in observing that wholesale prices had increased, recognized
the increase in the replacement cost of the goods on hand September 30 by adjust-
ing the inventory upward.
The treasury stock disposed of on September 25 cost the company SI, 500.
Upon receipt of the order from the U. S. Government calling for the shipment
on November 1 of merchandise having a selling price of $32,000, the bookkeeper
debited the account "Due from U. S. Government.1'
When the merchandise on consignment, which cost $16,000, was shipped, the
bookkeeper made the following entries:
Consignments out — Azle Company , 19 , 500 00
Sa)es . 19,500 00
Cost of sales . 16 , 000 . 00
Inventory 16,00000
As of September 30, Azle Company had not disposed of any of the merchandise
received on consignment.
Prepare entries to correct the Sales account.
Problem B-4. James Rockwall, an individual proprietor, keeps only a few
records. Assume that he has asked you to prepare a statement of profit and
loss for him for the calendar year 1954.
You discover the following :
(1) A balance sheet was prepared at the end of the previous year, as follows:
Assets
Cash $ 3,200 00
Accounts receivable $25 , 400 00
Less reserve for bad dobts 1,350 00 24,050 00
Inventory 18,700 00
Fixtures $12,000 00
Less reserve for depreciation 4i?9?:P9 8,000 00
853,950^00
Liabilities and Net Worth — — -
Accounts payable .. $18,400 00
James Rockwall, capital . . . 35,550.00
853,950 00
(2) All cash receipts are deposited and all payments are made by check.
(3) Accounts receivable at the end of the year arising from 1954 sales
amounted to $21,500. It was believed that only $600 of these accounts were
likely to be uncollectible. Of the accounts at the beginning of the year, $24,100
were collected. The remainder should be written off as uncollectible.
(4) Accounts payable at the end of the year amounted to $1 9,370. Creditors
at the beginning of the year were paid in full during 1954.
(5) Cancelled checks and check stubs showed payments, in addition to dis-
bursements to creditors, as follows:
Rent $7,800
Insurance 800
Store supplies ... .... 250
Store salaries 4,800
Payment on principal of note given
during year 6,000
Interest expense 70
ASSIGNMENT MATERIAL— CHAPTER 26 677
(6) Cash receipts from all sources for the year amounted to $78,300.
(7) Rockwall borrowed $6,000 on a note during the year.
(8) From a reconciliation of the bank account, the cash balance as of Decem-
ber 31, 1954, was determined to be $2,805.
(9) Other essential data were as follows:
Merchandise inventory at cost on December 31, 1954 $23,800
Depreciation of fixtures for 1954 1 ,000
Rent prepaid . 2,800
Store supplies on hand. ... 75
(10) There was no income other than that derived from sales of merchandise.
Show the computations you made in determining the sales and purchases for
the year as reflected in the profit and loss statement.
Practice Set (Continued)
(70) Apply the following adjustments in the working papers:
(a) Expired insurance, chargeable as follows:
Account Amount
5384 $300
6084 100
7084 10
$410
(b) Postage used, $32.65.
(c) Salesmen's traveling expenses for the month amounted to $863.50.
(d) Factory supplies used, $623.14.
(e) Provision for bad debts — 1 % of gross sales.
(f) Accrued interest on notes receivable, $50.
(g) Accrued interest on notes payable, $99.17.
(h) Depreciation, computed for a full month on August I balances and
for one-half month on increases during the month, at the following
annual rates:
Asset Rate Amount
Buildings. 3% $ 355 00
Machinery and equipment 12 1 , 899 92
Tools 24 48.00
Delivery equipment. . 18 9656
Furniture and fixtures 12 48 00
(i) The patents had a life of 1 5 years from August 1 .
(j) Accrued property taxes: Factory, $325; general, $40.
(k) Of the rent collected in advance, $100 has been earned.
(1) Accrued bond interest, $1,200.
(m) Amortization of bond premium.
(71) Complete the working papers.
The following schedules of subsidiary records, assumed to have been pre-
pared by your assistant, will be found in the laboratory material:
Accounts receivable.
Notes receivable.
Vouchers payable.
678 ASSIGNMENT MATERIAL— CHAPTER 26
See that they are in agreement with the related controlling accounts.
Observe that the accounts receivable schedule shows that one account has a
credit balance. Instead of entering the balance of the controlling account
in the Balance Sheet debit column of the working papers, enter the total
debit balances of the subsidiary ledger in the debit column and the credit
balance in the credit column.
The inventories on August 31 were:
Finished goods $57,705 96
Goods in process , 39 , 872 50
Raw materials . 40,02695
The working papers should show a net income of $11,904.69 before income
tax. Assume that the income tax provision should be $4,000; enter this
provision in the working papers as follows:
Profit and Loss Balance Sheet
Debit Column Credit Column
Provision for federal income tax 4,000 00 4,000 00
(72) Make and post (to the general ledger and the selling expense analysis record)
adjusting journal entries for the matters mentioned in (70). Also make
and post an adjusting entry for the estimated provision for income tax.
Use the journal form provided for adjusting entries.
ASSIGNMENT MATERIAL FOR CHAPTER 27
Questions
1. What is meant by horizontal analysis? Vertical analysis?
2. How is it customary to compute the ratio showing the number of times
bond interest has been earned?
3. Why may comparisons of analytical per cents be misleading?
4. Assume that two companies have the same amount of working capital and
the same working capital ratio. Why may one company be in a better working
capital position than the other?
5. Would you consider the following as reflecting improvements, or not?
(a) Increase in the ratio of receivables to net sales.
(b) Increase in the finished goods turnover.
(c) Increase in the ratio of net worth to debt.
(d) Increase in the ratio of net worth to net fixed assets.
(e) Increase in the ratio of net sales to net fixed assets.
6. Compute the working capital ratio for the following case.
Cash:
On hand . ... $ 500
State Bank 7,500
National Bank (overdraft) . . 3,000* $ 5,000
Accounts receivable — net 10,000
Inventory. . . 15,000
Vouchers payable . . . 12,000
Accrued expenses . ... ... . 3,000
7. Distinguish between the working capital ratio and the acid-test ratio.
8. What is meant by the term "window-dressing?"
9. What is meant by the term "break-even point?" Develop an example to
illustrate the determination of the break-even point.
Problems — Group A
Problem A-l. A comparative statement of profit and loss and a comparative
balance sheet for Barnes Company are given below:
BARNES COMPANY
Comparative Profit and Loss Statement
For the Years Ended December 31, 1954 and 1953
1954 1953
Sales $318, 500. 00 $310,400 00
Deduct cost of goods sold 231,400 00 228,600 . 00
Gross profit on sales . . $ 87,100 00 < 81,800 66
Deduct:
Selling expenses . $ 35,214 00 $ 32,513.00
General expenses 31,184.00 27,404 00
Total expenses $ 66,398 00 $ 59,917.00
Net income $ 20,702.00 $ 21/883.00
679
680 ASSIGNMENT MATERIAL-CHAPTER 27
BARNES COMPANY
Comparative Balance Sheets
December 31, 1954 and 1953
December 31,
1954 1953
Asiets
Current assets:
Cash $ 12,600 00 $ 10,840 00
Accounts receivable — net 64 , 270 00 58 , 750 00
Inventory 82,57000 84,88500
Prepaid expenses 7,685.00 7,120 00
Total current assets $167,125.00 $16l7595 00
Fixed assets:
Land $ 14,000.00 $ 14,000 00
Buildings— net . . 89 , 790 . 00 92 , 415 00
Equipment — net .... 31,350.00 24,625 00
Total fixed assets . $135,140.00 $131,040 00
S302.265.00 $292,635 00
Liabilities and Net Worth
Current liabilities:
Accounts payable . $ 46,835 00 $ 50,038 00
Notes payable . .. _20,OOOLOO 14,000 00
Total current liabilities . . . $ 66,835.00 $ 64,038 00
Net worth:
Capital stock * .... $200,000 00 $200,000 00
Earned surplus . . 35,430.00 28,597 00
Total net worth . $235,430.00 $228,597 00
$302,265.00 $292,635.00
Apply the horizontal-analysis technique, using the above statements. For
the income statement, express the changes in ratios; use per cents in analyzing
the balance sheet.
Problem A-2. A statement of profit and loss and a balance sheet for Idiom
Company follow:
IDIOM COMPANY
Statement of Profit and Loss
For the Year Ended December 31, 1954
Net sales.. , $188,000 00
Deduct cost of goods sold 132,600 00
Gross profit on sales . . $ 55,400.00
Deduct:
Selling expenses . . . . $ 23,200 00
General expenses 17,400 00
Total expenses $ 40,600.00
Net income $ 14,800.00
ASSIGNMENT MATERIAL— CHAPTER 27 681
IDIOM COMPANY
Balance Sheet
December 31, 1954
Assets
Current assets:
Cash ... S 25,470.00
Accounts receivable — net . 65 , 000 00
Inventory 42,800 00
Total current assets. $133,270 00
Fixed assets:
Land $ 15,000 00
Building— net 48,70000
Store equipment — net 30,800.00
Total fixed assets $ 94,500.00
$227,770 00
Liabilities and Net Worth
Current liabilities:
Accounts payable $ 31 ,970 00
Notes payable . . 10,000 00
Total current liabilities $ 41,970.00
Net worth:
Capital stock $150,00000
Earned surplus . . 35,800 00
Total net worth $185,800 00
$227,770.00
Apply the vertical-analysis technique, using the above statements.
Problem A-3. The following are statements of United Company as prepared
at the end of 1954:
UNITED COMPANY
Profit and Loss Statement
For the Year Ended December 31, 1964
Gross sales . . $600 , 000 . 00
Returned sales and allowances 13,000 00
Net sales $587,000~00
Cost of goods sold. 397,000 00
Gross profit on sales $190,000 00
Expenses:
Selling expenses $80,000 00
General expenses 65,000 00 145,000.00
Net income from operations $ 45,000 00
Income from sinking fund securities _____ 240 00
Net income before interest expense and federal income tax. . $ 45,240 00
Interest on mortgage payable 3,600 00
Net income before federal income tax ... . $41,64000
Federal income tax 16,560 00
Net income $ 25,080.00
682 ASSIGNMENT MATERIAL-CHAPTER 27
UNITED COMPANY
Balance Sheet
December Sly 1964
Current assets:
Cash $ 25,000 00
Accounts receivable . $210,00000
Less reserve for bad debts 8,000.00 202,000 00
Inventory 140,00000
Prepaid expenses . 15,000 00
Total current assets
$382,000 00
Other assets:
Investment in sinking fund securities
8,000.00
Fixed'assets:
Land $
18 000 00
Buildings $100,000.00
Less reserve for depreciation 20,000 00
80,000 00
Equipment $ 15,000 00
Less reserve for depreciation 4,000 00
11,000 00
Total fixed assets
109,000 00
$499,000.00
Liabilities and Net Worth
Current liabilities:
Accounts payable $108,700 00
Accrued salaries payable 12,000 00
Total current liabilities " $120,700 00
Long-term liabilities:
Mortgage payable (secured by land and buildings) 60,000 00
Total liabilities .... $180,700 00
Net worth:
Preferred stock — 5%, par value, $100. $ 50,000 00
Common stock— Par value, $100 200,000 00
Earned surplus 68,300 00
Total net worth . 318,300.00
At the end of 1953, the inventory was $120,000 and the total net worth was
$305,960.
Compute the following: (Carry computation to two decimal places; for
example, 6.78%.)
Working capital ratio.
Acid-test ratio.
Inventory turnover.
Per cent of year's net sales uncollected.
Ratio of net worth to debt.
Ratio of net worth to net fixed assets.
Ratio of net sales to net fixed assets.
Ratio of pledged fixed assets to long-term debt.
Earnings per share of common stock.
Ratio of net income to average net worth.
Number of times preferred dividends earned.
Number of times mortgage interest earned.
ASSIGNMENT MATERIAL-CHAPTER 27 683
Problem A-4. The amounts shown below were taken from the comparative
statement of profit and loss of Differential Corporation for the years ended
December 31, 1954 and 1955.
1955 1954
Sales $21,840 120,090
Rent expense 920 1,200
Advertising 1 , 360 1 , 240
Bonuses — officers ... 1,200 — 0 —
Research and development expense . — 0 — 840
Returned sales and allowances. . . . 310 460
Gain (loss*) on disposal of equipment . . 440 120*
Compute the amount and (when possible) the per cent of change for each of
the items above.
Compute per cents to two decimal places; for example, 4.87%.
Problem A-5. Tempo Corporation has issued preferred stock under an agree-
ment to maintain net assets (assets minus liabilities) at an amount not less than
300% of the preferred stock outstanding, to maintain current assets at not less
than 200% of the current liabilities, and to maintain working capital at not less
than 125% of the preferred stock outstanding.
On December 31, 1954, the corporation's adjusted trial balance was as follows:
TEMPO CORPORATION
Adjusted Trial Balance
December 31, 1964
Cash. . . . 12,000 00
Accounts receivable . .. 41,00000
Reserve for bad debts 1 , 000 . 00
Inventory 46,000.00
Prepaid expenses 2 , 000 . 00
Land . ... 6,000.00
Building ... 52,000.00
Reserve for depreciation — Building 7 , 000 . 00
Equipment 63,000.00
Reserve for depreciation — Equipment . 14,000.00
Accounts payable. . 23,000 00
Notes payable— due 1960. 25,000 00
Accrued expenses 2 , 000 00
Preferred stock 50 , 000 . 00
Common stock. ,. . . 50,000.00
Earned surplus 50,000.00
222,000.00 222,000.00
As an accountant engaged by the preferred stockholders, you discover that
the notes payable were issued on December 29, 1954, and that the proceeds were
used to settle current accounts payable, and that, on December 31, 1954, $25,000
cash was disbursed to settle a tax liability.
Contrast, by means of ratios, the existing conditions with those that would
have existed if the transactions discovered had not occurred, so far as they relate
to the agreement with the preferred stockholders.
Comment briefly on your findings,
684 ASSIGNMENT MATERIAL-CHAPTER 27
Problems — Group B
Problem B-l. The following data are from the accounts of Selector Cor-
poration.
December 31, Year
1954 J953 1954
Cash $20,000
Accounts receivable . .. 12,000
Reserve for bad debts 1,000
Inventory. . 8,000 $7,000
Accounts payable . . ... 12,000
Notes payable — due in six months .. 3,000
Sales . $53,000
Discount on sales . 1 , 000
Returned sales and allowances 800
Purchases 34,000
Returned purchases and allowances 750
On the basis of the information presented above, compute the following :
Working capital ratio.
Acid-test ratio.
Inventory turnover.
Problem B-2. Modern Company's working capital ratio was 3 to 1 on Decem-
ber 31, 1953. Assume %that the following additional transactions had occurred
on that date, and indicate whether each transaction would have increased,
decreased, or not affected the working capital ratio.
1. Borrowed cash on a note.
2. Purchased inventory for cash.
3. Paid a note.
4. Sold merchandise for cash.
5. Paid cash for a delivery truck.
6. Declared a cash dividend.
7. Purchased inventory on account.
8. Returned merchandise, for which no payment had been made to creditor.
9. Sold fully depreciated fixed asset for a gain.
10. Discounted a non-interest-bearing note receivable at the bank.
Problem B-3. Statements for Marathon Company follow:
MARATHON COMPANY
t Profit and Loss Statement
For the Year Ended December 81, 1054
Gross sales $235,800.00
Returned sales and allowances 4,500.00
Net sales $231,300.00
Cost of goods sold 160,000.00
Gross profit on sales . $71,300.00
Expenses 57,300.00
Net income from operations . ... $ 14,000.00
Interest on mortgage payable 2,800.00
Net income before federal income tax $ 11 ,200.00
Federal income tax 8,800.00
Net income $ 7,400.00
ASSIGNMENT MATERIAL— CHAPTER 27 685
MARATHON COMPANY
Balance Sheet
December 31, 1954
Assets
Current assets:
Cash $10,000 00
Accounts receivable $85,000 00
Less reserve for bad debts 6,000.00 79,000 00
Inventory . . 60,000 00
Total current assets . . . $149,00000
Fixed assets:
Land $12,000 00
Buildings $60,000 00
Less reserve for depreciation 12,000 00 48,000 00
Store equipment $15,000 00
Less reserve for depreciation 7,000.00 8,000 00
Total fixed assets . ' 68,000 00
$217,000 OO"
Liabilities and Net Worth
Current liabilities:
Accounts payable $74,600 00
Accrued expenses payable 29,000 00
Total current liabilities $103,600 00
Long-term liabilities:
Mortgage payable (secured by land and buildings) 40,000 00
Total liabilities $143, 600. 00
Net worth:
Preferred stock, 6% — par value, $100 $20,000 00
Common stock — Par value, $100 . 40,000 00
Earned surplus 13,400.00
Total net worth T. ~ 73,400.00
$217,000.00
On December 31, 1953, the inventory was $40,000 and the total net worth
was $69,800.
Compute the following (Carry computations to two decimal places; for
example, 14.71%):
Working capital ratio.
Acid-test ratio.
Inventory turnover.
Per cent of year's net sales uncollected.
Ratio of net worth to debt.
Ratio of net worth to net fixed assets.
Ratio of net sales to net fixed assets.
Ratio of pledged fixed assets to long-term debt.
Earnings per share of common stock.
Ratio of net income to average net worth.
Number of times preferred dividends earned.
Number of times mortgage interest earned.
Problem B-4. Determine the break-even point for the following cases:
(1) _(2) (3)
Fixed expenses $80,000 $74,000 $35,000
Per cent of variable expenses to sales 75% 68% 55%
686 ASSIGNMENT MATERIAL-CHAPTER 27
Problem B-5. The following ratios and other data are based on the financial
statements of Booster Corporation.
Working capital ratio: $18,800 -s- $7,800 — 2.41
Acid-test ratio: $8,800 + $7,800 * 1.13
Inventory turnover: $36,000 -5- $9,000 = 4,0
Number of times bond interest earned: $1,800 -5- $200 = 9.0
Gross profit rate: $11,000 -i- $51,000 = 21.57%
A review of the records of the corporation discloses that the following entries
were made as of December 31, 1954, the last day of the accounting period.
Recompute any of the above ratios that were affected by the entries.
1954
Dec. 31 Cash . J ,000 00
t Sales . . . . 1,000 00
Cash sales for January 2, 1955.
31 Cash 1,400 00
Accounts receivable 1 , 400 00
Collections on account received on
January 2, 1955.
31 Accounts payable 2,20000
Cash 2,200 00
Checks issued January 2, 1955, dated
December 31, 1954.
31 Purchases . . . 900 00
Accounts payable 900 00
To record invoices received January 2,
1955. The merchandise covered by
the invoices was received on December
30, 1954, and was included in the Decem-
ber 31, 1954 inventory.
Problem B-6. You are engaged by the bank holding the $30,000 of notes
payable of Jackson Corporation to determine the following:
(a) The distribution of current assets.
(b) Working capital ratio.
(c) Acid-test ratio.
(d) Inventory turnover.
(e) Per cent of sales uncollected.
(f) Earnings per share.
Carry computations to two decimal places; for example, 7.18%.
Jackson Corporation submitted the following financial statements.
JACKSON CORPORATION
Balance Sheet
December 31, 1954
Assets
Cash $16,000.00
Marketable securities . . .. 10,000.00
Accounts receivable . ... 15,000.00
Inventory ,. 18,00000
Prepaid expenses ... . 1 , 200 . 00
Machinery and equipment .. 50,000.00
Treasury stock, 100 shares at cost 1,400.00
$111,600.00
ASSIGNMENT MATERIAL-CHAPTER 27 687
Liabilities and Net Worth
6% notes pay able. . . ... . $30,000.00
Accounts payable . 15 , 000 . 00
Accrued income taxes . . 4,300.00
Accrued expenses 1,800 00
Allowance for doubtful accounts. . . 900.00
Allowance for depreciation . . . 8,000 00
Reserve for contingencies. . .... 2,000.00
Capital stock, $10 par value . 40,000.00
Earned surplus.. . . 9,600 00
$111,600.00
JACKSON CORPORATION
Profit and Loss Statement
For the Year Ended December 31, 1964
Net sales. . ... $130,000.00
Cost of sales:
Inventory, December 31, 1953. . . . $15,000 00
Purchases . 82,000 00
Freight in . .... _ 800 00
Total $97,800.00
Inventory, December 31, 1954 18,000 00 79,800.00
Gross profit on sales $50,200.00
Selling expense . $19,00000
Administrative expense. 18,500 00 37,500.00
Net operating income. $ 12,700 00
Interest expense 1,950 00
Net income before income taxes $ 10,750.00
Federal income taxes — 40% . 4,300.00
Net income $ 6,450 00
In connection with the above statements, you discover the following. The
corporation kept open the cash receipts book, the check register, and the voucher
register until the middle of January, 1955. As a result, checks for $20,000
received in January in payment of merchandise purchased by customers during
November and December were included in the cash receipts book; checks for
$15,000 issued in January in payment of vendors' December invoices were
entered in the check register; and $8,000 of vendors' invoices received in January
for goods delivered and services rendered in December were recorded in the
voucher register. Of the latter amount, $5,000 represented goods included in
the ending inventory and $3,000 was for selling expense items.
The corporation uses the periodical inventory method. On December 30,
1954, a customer returned merchandise which had been sold to him for $600.
The following entry was made on December 30:
Returned sales and allowances 600.00
Accounts receivable ... 600. 00
The returned merchandise was included in the ending inventory at $600; its cost
was $400. The notes payable become due at the rate of $10,000 each July 1st.
Practice Set (Concluded)
(73) The following schedules of subsidiary records, assumed to have been pre-
pared by your assistant, will be found in the laboratory material: Manu-
facturing expenses; General expenses. See that they are in agreement
with the related controlling accounts.
688 ASSIGNMENT MATERIAL— CHAPTER 27
Prepare a schedule of the selling expenses, and see that it is in agreement
with the controlling account.
(74) Prepare the following statements:
Statement of cost of goods manufactured.
Profit and loss statement.
Statement of earned surplus.
Balance sheet.
(75) Close the hooks. Use the journal pages allotted to closing entries.
(76) Take an after-closing trial balance.
ASSIGNMENT MATERIAL FOR CHAPTER 28
Questions
1. Name the records subsidiary to the following controlling accounts:
Raw Materials.
Goods in Process.
Finished Goods.
2. Discuss the alternative policies for accounting for cash discounts on pur-
chases when a perpetual inventory system is being used.
3. State what entries, under the accounting procedure described in this
chapter, affecting general ledger accounts should be ma'de when:
(a) Raw materials are purchased for cash.
(b) Raw materials are used on a production order.
(c) Direct labor is charged to a production order.
(d) Overhead is charged to a production order.
(e) A production order is completed.
(f) A sale is made.
4. Discuss two methods of disposing of underabsorbed and overabsorbed
burden.
6. Describe the functions of:
(a) Raw material perpetual inventory cards.
(b) Material requisitions.
(c) Production orders.
(d) Finished goods perpetual inventory cards.
6. Are manufacturing expenses assigned to production orders in the same
manner as material and direct labor?
Problems— Group A
Problem A-l. Patman Products keeps perpetual inventory records in terms
of quantities and costs. On December 31, 1955, there were on hand 100 units of
material 3623 which had cost $5 per unit. During January, 1956, the following
purchases and requisitions of material 3623 were made.
Purchases Requisitions
Date Quantity Cost per Unit (Quantity)
January 5 50
12 80 $6
17 70
23 10
25 60 4
30 20
Required: Prepare perpetual inventory cards as they would appear for material
3623, assuming that the company uses: (a) First-in, first-out; (b) Last-in,
first-out.
689
690 ASSIGNMENT MATERIAL-CHAPTER 28
Problem A-2. Harmon Foundry manufactures castings on special order
from customers. When a contract is received, a production order is filled out on
which cost data are accumulated. Since Harmon Foundry produces only on
order and delivers immediately upon the completion of production, no inventory
of finished goods is maintained.
On April 15, 1956, an order is received for 100 pulley housings from the
Western Winch Company. The specified sales price to apply to the order is $7.50
per unit.
On April 18, production is begun. Pig iron costing $100 is sent to the furnace
for melting. Other materials costing $25 for making molds (not reused) are
requisitioned on April 19. Direct labor in melting, pouring, and cleaning for
this order amounts to $400. It is assumed that overhead amounts to 25% of
direct labor.
On April 28, the order is completed and delivered, and an invoice is prepared
for $750 and sent to Western Winch Company.
Required:
(a) Prepare production order 1864 as it would appear after reflecting all of
the information above.
(b) Give journal entries which would be made to reflect the production and
delivery of these castings, assuming that perpetual inventory
accounts are maintained by the company for raw materials and goods
in process.
Problem A-S. The "following is the trial balance of Lyons Manufacturing
Company on December 31, 1956, the close of its fiscal year.
LYONS MANUFACTURING COMPANY
Trial Balance
December 31, 1956
Cash 12,000.00
Accounts receivable 40,000.00
Finished goods. . . 15,000 00
Goods in process 20,000 00
Raw materials . . 13,000.00
Unexpired insurance . .. 1,00000
Machinery and equipment 50,000.00
Reserve for depreciation — Machinery and equip-
ment . 10,000.00
Vouchers payable . . . . 25 , 000 . 00
Capital stock. . . 80,00000
Earned surplus .... . 27 , 000 00
Dividends 5,000 00
Sales . 150,00000
Costofsales 110,000.00
Manufacturing expense ... 20 , 000 . 00
Manufacturing expense applied 24,000 00
Selling expense. . , . 20,000.00
General expense. .. . .. . 10,000.00
316,000.00 316,000.00
Additional information:
(1) Depreciation of $3,200 on machinery and equipment has not yet been
recorded. All depreciation is considered a manufacturing expense. ?
ASSIGNMENT MATERIAL—CHAPTER 28 691
(2) Insurance costing $500 has expired. Insurance is allocated 60% to
manufacturing expense, 30% to general expense, and 10% to selling expense.
(3) Underabsorbed or overabsorbed manufacturing expense is treated as an
adjustment of cost of sales.
Required:
Prepare working papers, journal entries to adjust and close the books, and
financial statements.
Problem A-4. Following is the trial balance of Westcott Machine Company
on January 1, 1956. Prepare journal entries for the January transactions, post
to general ledger accounts, prepare adjusting and closing entries for January
31, post, and prepare financial statements for the month of January.
WESTCOTT MACHINE COMPANY
Trial Balance
January 1, 1956
Cash.... . 10,000 00
Accounts receivable ... 25,00000
Finished goods . . ... 20 1 000 . 00
Goods in process . , 12,000 00
Raw materials . . 15,000.00
Equipment . . 30,000.00
Reserve for depreciation — Equipment . . . 9,000.00
Accounts payable 21 ,000 00
Capital stock ... 60,000 00
Earned surplus 22,000.00
112,000 00 112,000.00
Summarized transactions during January were as follows:
(1) Raw materials were purchased on account, $35,000.
(2) Sales were made on account, $60,000. The goods sold cost $40,000 to manu-
facture.
(3) Payments were made for: direct labor, $15,000; indirect labor, $2,000; other
manufacturing overhead costs, $4,000; selling expense, $3,000; general
expense, $1,000.
(4) Collections on account were $63,000.
(5) Payments for material purchases, $32,000.
(6) Raw materials requisitioned for production, $30,000.
(7) Direct labor applied to production, $15,000.
(8) Estimated overhead assigned to production, $6,500.
(9) Production orders completed, $60,000.
Additional data as of January 31, 1956:
(a) Depreciation of equipment for January, $250. Depreciation is considered
to be chargeable 80% to manufacturing expense and 10% each to general expense
and selling expense.
(b) Underabsorbed or overabsorbed manufacturing expense is treated as an
adjustment of cost of sales.
Problem A-5. Hartford Company's trial balance on January 1, 1956 appears
on the following page.
692 ASSIGNMENT MATERIAL— CHAPTER 28
HARTFORD COMPANY
Trial Balance
January 1, 1956
Cash 10,00000
Accounts receivable .. . 20,00000
Finished goods ... . 22,000.00
Goods in process 12,000 00
15,000.00
21,000.00
10,000.00
15,000.00
50,000 00
25,000.00
Raw materials
Machinery and equipment. .
Reserve for depreciation
Vouchers payable. . .
Capital stock
Earned surplus.. .
Sales
Cost of sales
Direot labor
Manufacturing expense.
Manufacturing expense applied
Selling expense
General expense .
looTooo __ _ __
The company keeps the following records and books of original entry, from
which the information below has been summarized.
1. Journal:
No January entries as > et made.
2. Check register:
Cash column total .... $80,000.00
Vouchers Payable column total . 80,000.00
3. Voucher register:
Raw Materials column total . . . $30,000.00
Manufacturing Expense column total 8,000.00
Direct Labor column total 25,000.00
Selling Expense column total 3,000.00
General Expense column total 5,000.00
Vouchers Payable column total 71,000.00
4. Sales book:
Selling Price column total. . . $80,000.00
Cost column total . , 60,000.00
5. Cash receipts book:
Cash column total . . . . $75,000.00
Accounts Receivable column total . 75,000.00
6. Production order direct labor cost summary:
Column total . $25,000.00
7. Requisition register:
Column total.. $33,000.00
8. Register of completed production orders:
Column total ... . . . $70,000.00
No postings to general ledger accounts have been made since taking the
January 1, 1956 trial balance. The company estimates that manufacturing
expenses are equal to 40% of direct labor costs, and estimated manufacturing
expense is entered on individual production orders at the same time as direct
labor costs are entered.
ASSIGNMENT MATERIAL-CHAPTER 28 693
Required:
(a) Prepare journal entries necessary to record the information reflected
on the production order direct labor cost summary, the requisition
register, and the register of completed production orders, and to
record the manufacturing expense applied.
(b) Set up a working paper with the following eight columns:
Trial balance, January 1, 1956 (2 columns)
Debits
Debit references
Credits
Credit references
Trial balance, January 31, 1956 (2 columns)
Enter the January 1, 1956 trial balance m the appropriate columns
(allowing 4 lines for goods in process), make all January postings in
the debit and credit columns, indicating the source in the reference
columns, and extend the balances representing the trial balance on
January 31, 1956.
Problems— Group B
Problem B-l. On June 30, 1956, the close of its fiscal year, Robinson Cor-
poration prepares the following trial balance. Prepare journal entries to adjust
and close the books; also prepare financial statements for the year ended June 30,
1956.
ROBINSON CORPORATION
Trial Balance
June 30, 1956
Cash 10,000 00
Accounts receivable 20,000.00
Finished goods . 18,000.00
Goods in process . . 20 , 000 . 00
Haw materials . , 15 , 000 . 00
Prepaid rent . . . 300.00
Machinery and equipment .. . . 40,000.00
Reserve for depreciation . . 18,000.00
Accounts payable . 15,00000
Capital stock . . . 50,000.00
Earned surplus, June 30, 1955 21,500 00
Sales . . 120,000 00
Cost of sales 92,00000
Direct labor . .. 2,50000
Manufacturing expense. ... ... 30,000.00
Manufacturing expense applied . . 32,300.00
Selling expense 10,000.00
General expense 4,000 00
259,300.00 259,300.00
Supplementary data:
(I) Accrued wages and salaries are $3,000, Of this amount, $2,500 repre-
sents direct labor, $100 represents manufacturing expense, $200 repre-
sents selling expense, and $200 represents general expense.
694 ASSIGNMENT MATERIAL— CHAPTER 28
(2) There is no prepaid rent on June 30, 1056. Rent cost is allocable 50%
to production, 25% to selling expense, and 25% to general expense.
(3) Depreciation of fixed assets is $4,000 and is allocable on the same basis as
rent.
Problem B-2. Using the data given in Problem B-l, prepare working papers
for Robinson Corporation. (Allow 3 lines each for manufacturing expense,
selling expense, and general expense.)
Problem B-3. Zelden Manufacturing Company uses the following books of
original entry:
1. Journal
2. Voucher register
3. Sales book
4. Cafeh receipts book
5. Check register
In addition, the company keeps the following records upon which journal
entries are based:
1. Materials requisition register
2. Production order direct labor cost summary
3. Register of completed production orders
Below are selected transactions of Zelden Manufacturing Company during
April, 1956. For eaeh -transaction, indicate the book of original entry or other
record in which the transaction would be recorded and indicate the final debit-
credit effect that each transaction would have on the general ledger accounts.
Example:
Accounts receivable of $500 are collected.
Enter in cash receipts book.
Debit— Cash $500
Credit — Accounts Receivable 500
(1) Raw materials are purchased on account, $1,000.
(2) Invoices representing manufacturing expense items are received from cred-
itors, $2,000.
(3) Direct labor payroll is paid, $5,000.
(4) Sales are made on account, $3,000. These goods cost $2,000 to manufacture.
(5) Manufacturing operations are completed on goods costing $750.
(6) Creditors are paid for outstanding invoices, $300.
(7) Raw materials are requisitioned for production, $900.
(8) Direct labor cost is assigned to production orders, $3,200.
(9) Manufacturing expense is estimated to be 50% of direct labor costs and is
assigned to production orders at the same time as is direct labor cost. A
summary entry reflecting the application of manufacturing expense to
production orders is made at the end of each month. Total direct labor
assigned to production orders during April, 1956, is $16,000.
Index
Index
Acceptances:
accounts with notes and, 127
nature of, 351
receivable:
discounted, proceeds, 352-353
• endorsements, 351-352
purposes of discounting, 351
trade, 128
Account-form balance sheet, 52
Accounting:
cycle, 43
principles, 394-412
concepts of net income, J09-412
costs, 398-405
general considerations, 405 -409
income, 396-398
nature of, 394
periodic statements, 395
procedures:
sequence of, 30
year, 22
Account numbers, 6, 288-295
cash disbursements book, 294
cash receipts book, 294-295
chart of, 288-295
illustrated, 290-292
check marks, -Y's, and, 293, 295
offset accounts, 289
showing relationships, 289
sundry accounts, 293-295
voucher register, 293
vouchers, 299
vs. account names, 293-295
Accounts:
bad, writing off, 92
balances of, computing, 13-14
basis of, 406
collectibility of, 346-348
controlling, 134-141 (see also Con-
trolling accounts)
current, 108
debit and credit entries, 6-7
drawing, proprietorship, 102-103
form, 5-6
ledger (see Ledger: accounts)
names vs. numbers, 293-295
nature of ^ 5
Accounts (Cont.)
no-balance, 70
with notes and acceptances, 127
numbers of (see Account numbers)
numerical chart of, 288-295
payable (see Accounts payable)
personal, 108
receivable (see Accounts receivable)
recording transactions, illustrated, 7-9
skeleton, or T-, 7
valuation, 92
Accounts payable, 2
in balance sheet, 15
to former partner, 238
payment on, 5, 9
and receivable, with same party, 343-
344
subsidiary ledger, 140, 152
Accounts receivable, 1
account and statement, at one impres-
sion, 344
aging, 346-348, 429-430
bad debt recoveries, 348
in balance sheet, 15, 343-350
bookkeeping machines, use of, 344
collection on, 4-5, 8-9
ledger:
headings, 344
subsidiary, 140, 151, 345-346
movement of, 429-430
and payable, with same party, 343-344
red balances, in subsidiary ledgers,
345-346
Accruals:
adjustments, 33-34
defined, 33
reversing entries, 216, 218
unrecorded expense and income, 31
Accrued expense, adjustments, 34, 217-
218
alternative procedure, 217-218
and entries in subsequent periods, 54-
55
procedure, 217
Accrued income, adjustments, 33-34,
215-216
alternative procedure, 216
and entries in subsequent periods, 55
procedure, 215
697
698
INDEX
Acid-test ratio, current assets, 428
Adjustments:
accruals, 31, 33-34
in subsequent periods, 54-55
alternative procedures, 215-225
accrued expense, 217-218
accrued income, 215-216
apportionments :
of recorded costs, 218-223
of recorded income, 223-224
when required, and amounts, 224-
225
for apportionments, 34-42
at end of period, 31-42
entries:
on admission of partner, 233
departmental operations, 182
in journal, 40
manufacturing company, 188
perpetual inventory, 63-64
purchase discounts lost, 305-306
after reconciliation of bank account,
341
working papers, 52-53
transactions and, 31
trial balance before and after, 41
Advices, purchase routine, 82
Agency, mutual, partnership, 106
Agent, stock transfer, 263
Aging schedule of accounts, 429-430
Aging the receivables, 346-348
Agreement, partnership, 107-108
Allowances, returns and (see Returns
and allowances)
Alternative adjustment procedures, 215-
225 (see also Adjustments: alter-
native procedures)
American Accounting Association, 394,
412
American Institute of Accountants:
accounting principles, 394
on accounting for fixed assets, 277
on book value of good will, 380
on clean surplus concept, 412
on departure from cost basis, 286
on disposal of fixed assets, 369
on organization costs, 245
on paid-in surplus, 275
on stock dividends, 281
on surplus terminology, 276
Amortization:
assets not subject to, 362
assets subject to, 362
of bond discount, 314-315
intangible fixed assets subject to, 375-
377
reason for, 375
Analysis of financial statements, 413-437
(see also Statement analysis)
Apportionments, cost, 403
adjustments for, 34-42
recorded costs and revenues, 31
Appraisal increments, 277
Appraised value, 362
Appreciation, unrealized, 398
Appropriated surplus, how made, 276-
277
Articles of partnership, 107-108
Assets:
account numbers, 290
accounts, debits and credits in, 7
acquired with securities, 402
costs, determination of, 401-403
current (see Current assets)
defined, 1
disposal of, on liquidation of partner-
ship, 239
expirations and residues, 404-405
fixed (see Fixed assets)
nature of, 1
noncash, assets acquired for, 402
partnership, use of to pay retiring part-
ner, 237
several, acquired at lump price, 403
stock preferred as to, 270
tangible and intangible, costs of, 405
withdrawal of, partnership, 107
write-downs and losses, and paid-in
surplus, 275-276
writing down, 365
Assumptions, departmental operations,
178, 180
Audit reports, fact, opinion, and policy
in, 406-407
B
Bad debts:
accounting for, 90-93
losses, 348
departmental, 178
provision for:
estimating, 92-93
in periodic statement, 407
recoveries, 348
reserve for, 321, 346
nature of, 91-92
uncollectible, 350
writing off, 92
Balance:
computing, 13-14
debit or credit, 7
defined, 7
trial (see Trial balance)
INDEX
699
Balance sheet:
account form, 52
accounts payable in, 15
accounts receivable in, 15, 343
bond discount in, 315-316
bond premium in, 315-316
classified, 99-101
conservatism, 395, 407-408
departmental inventories in, 171
equation, 2
fixed assets in, 381
heading of, 21
horizontal and vertical analysis of, 434
inventory in, 59
manufacturing company, 188, 189
nature of, 1
notes payable in, 15
notes receivable in, 15, 357-358
discounted, 357-358
owners' equity, 22
partnership, 113
premium and discount on stock ac-
counts in, 250-251
report form, 52
statement, from working papers, 52
treasury stock in, 283-284
uncollected subscriptions to stock in,
250
Bank:
account:
dividend, 342
opening, 331
payroll, 341-342
reconciling, 336-340
balance:
as cash, 322
record of, 332-333
bills drawn on, 125
charges, 336
checks (see Checks)
certified, 340
columns, in cash books, 324-325
dealings with, 331-342
deposits, 331-332
ticket, 332
discounting notes receivable at, 353-
354
drafts, 333
loans from, 334
miscellaneous services, 333-334
overdraft, 342
register, 332, 333
signature card, 331
statement, 334-336
form, 335
Bearer, paper payable to, 351
Bills of exchange, 125-128
classified, 125
Bills of exchange (Cont.)
commercial, 125
defined, 125
Bondholders, 308, 309
Bonds, 308
classes of, 309-310
coupon, 310
discount, amortization of, 314-315
government, payroll deductions, 464
interest on, 309
number of times earned, 417
payment of, 312-313
issuance between interest dates, 312
junior, 310
mortgage, 308
premium, 315
in balance sheet, 315-316
prior-lien, 310
recording issuance, 310-312
registered, 310
retirement of, 316
through sinking funds (see Sinking
funds)
secured, 308, 309-310
chattel mortgage, 309
collateral trust, 309
real estate mortgage, 309
underlying, 310
unregistered, 310
unsecured, 310
Books:
closing (see Closing the books)
minute, 264
of original entry, 10
abstracting, 472
cash disbursements book, 142, 146-
148, 293, 294
caah receipts book, 142, 144-146,
293, 294-295
columnar, 132, 198
controlling account columns in, 153
division of labor, 142, 143
journal (see Journal)
notes payable register, 302-304
notes receivable register, 299-302
purchase book, 142, 143-144
references to, 148
sales book, 142-143
saving of labor, 132, 143
specialized, 142-153
voucher register (see Voucher'
register)
partnership, 266, 267-268
stock certificate, 259
Book value:
disposal price and, 368
goodwill, 380-381
stock, 272-273
700
INDEX
Buildings, 1
cost of construction, 363
land and, separate accounts, 362-363
rent, transaction entries, 33
Burden, underabsorbed and overab-
sorbed, 455
Business:
going, 110
newly organized, no beginning inven-
tory, 76
recession, 432
seasonal, 404, 427
By-laws, corporation, 264
By-products, determination of cost,
403 404
Calendar-year basis, accounting, 22, 23
Capital:
accounts :
partnership, 108-109
proprietorship, 102
dividends out of, 279
expenditures, 366
ratios, partnership divisions of profit
and loss, 228
stated, 278
stock (see Capital stock)
surplus, 274, 276
working (see Working capital)
Capital stock:
accounts:
capital stock issued, 256
capital stock subscribed, 256
certificates, 244
classes of, 247
common, 247
earned surplus and, 21-22
issuance of, 2-3, 8
preferred, 247
Cash, 1
books (see Cash books)
disbursements, 324
discount (see Discount: cash)
distribution of, on liquidation of
partnership, 239-240
internal check, 322-323
nature of, 322
overage, 330
petty, or imprest, 325-330
purchases, departmental, 169-171
receipts, 323-324
received over counter, 323
received through mail, 323-324
sales, departmental, 169-171
shortage, 330
Cash books:
bank columns in, 324-325
disbursements, 142, 146-148
account numbers, 293, 294
freight in and freight out, 158, 159
interest expense, 158, 159
purchases, 158, 159
purchases debit column, 171
and general ledger, entry in, 160, 162
receipts, 142, 144-146, 293, 294-295
cash sales in, 170, 173
collection and exchange, 156, 157
columns in:
interest income, 156, 157
prepaid interest expense, 156, 157
sales, 156, 157
transactions recorded on two lines of,
160, 161
Certificate:
C.P.A. audit reports, 406-407
employee's withholding exemption, 463
stock, 2-3
Certified checks, 340
Certified public accountants, audit re-
ports of, 406-407
Charges:
exchange, voucher system, 210, 212
transportation, 85-86
Charter, corporation, 242, 211
amendment to, 243
Chattel mortgage bonds, 309
Check, internal (see Internal check)
Check marks, use of, 293, 295
Check register, 200-20!
bank columns in, 325
entries, 202, 203-205, 208
partial payments, 21 1
posting from, 208
Checks, 76, 82, 125
cashier's, 333
certified, 340
check book stub, 332
wage payment data on, 469
disbursements made by, 323, 324
payment of invoice by, 81-83
payroll, 341, 342 ,
returned, 340
Clean surplus concept, net income, 410,
411-412
Closing entries:
departmental operations, 182, 184
manufacturing company, 188, 192-193
periodical inventory, 75-76
perpetual inventory, 63-64
working papers, 53-54
Closing the books, 23-30
accounts remaining open after, 28
on admission of partner, 233
INDEX
701
Closing the books (Cont.)
annual, preparation of monthly state-
ments, 478-483
at close of natural business year, 427
dividends account, 26
expense accounts, 24
graphic summary, 25
income accounts, 23-24
journal with closing entries, 27
ledger with closing entries, 28-29
manufacturing cost, 456
partnership, 110-111
procedure, graph of, 27
profit and loss account, 25-26
proprietorships, 103
ruling accounts, 24-25
summary of entries, 26-27
trial balance after, 29-30
C.O.D. sales, recording, 344-345
Collateral trust bonds, 309
Collectibility of accounts, 346-348
Collection:
on accounts receivable, 4-5, 8-9
accrued income, entries for, 215, 216
and exchange, m cash receipts book,
156
Columnar journals, 132-133
Columnar sales and purchase records, 169
Commercial bills, 125
Commissions earned, 31-32
account, 23, 24, 25
Common stock, 247, 309
earnings per share, 416-417
Comparative statement, 413
Compensation, unemployment, 460
Compound journal entries, 15-16
Conservatism :
balance sheet, 395, 407-408
cost principle and, 399
Consignee, 382
Consignment, defined, 382
Consignor, 382
Consistency, importance of, 408
Contingent liability, 351, 352
Contra accounts, 92
Contract, partnership, 107-108
Control, internal, 76-77
Controlling accounts, 134-141
columns, in books of original entry,
153
errors in, 163
expense, 296-299
general ledger, 150-151
illustration, 136-141
inventory, 445-450
raw materials, 451
six-column journal and, 148, 149
subsidiary ledgers, 134-136
Copyrights, 1, 362
amortization, 376
Corporations, 242-287
advantages of, 243
application, 244
borrowing power of, 242
by-laws, 264
change from, to partnership, 264,
267-268
change from partnership to, 264-267
additional investments, 265
adjustment of asset values, 265
balance sheet, 264
new books opened, 265, 266-267
partnership books closed, 265, 266
partnership books retained, 265, 266
charter, 242, 244
continuity of life, 242
defined, 242
differentiated from partnership, 106
disadvantages of, 243-244
dissolution of, 242
dividends (see Dividends)
double taxation, 243
foreign, 243
management, 245
nature of, 242-244
net worth, elements of, 245, 247
officers, 245, 246
organization of, 244
costs, 244-245
personnel, 245
chart, 245
records, 258-264
minute book, 264
stock certificate and stub, 259
stockholders' ledger, 259
subscribers' ledger, 258
registrar, 263
sources of funds, 308
stated capital, 278
state restrictions on, 244
stockholders (see Stockholders)
surplus (see Surplus)
transfer agent, 263
Cost; costs:
acquisition, 367
apportionments, 36-38, 403
adjustments required, 36-38
asset, determination of, 401-403
basis of valuation, 362
criticism of, 399-400
departures from, 400
inventory pricing, 387-389
reissuance of treasury stock, 285-286
by-products, 403-404
defined, 398
direct labor, 442-443
02
INDEX
/oat; costs (Cont.)
expiration (depreciation), 38, 403-405
expired, 403
denned, 399
favors and exemptions, 403-404
of goods finished, 186, 448-449
of goods sold, 449-450
perpetual inventory method, 58
statement, manufacturing company,
187
installation, 367
less depreciation, depletion, or amor-
tization, 362
lost, 403
denned, ''399
manufacturing, controls, 438-458
manufacturing accounts, 185-186
or market method, inventory pricing,
389-393
application of, 391-392
effect on gross profits, 392-393
principles governing, 390-391
sources of information, 389
organization, corporations, 244-245
outlays:
classified, 400-401 -.-
defined, 398
principle, 399-400
residue, defined, 399
seasonal operations, 404
terminology, 398-399
transfer of, into goods in process, ledger
accounts, 448
transformations, 403-404
defined, 399
utilized, defined, 399
Coupon bonds, 310
Credit:
balance, 7
entries, 6-7
memorandum, 87
ratings, 344
uses of word, 6, 9-10
Creditors:
contracts with, appropriated surplus
and, 276
discounting notes receivable with, 354
protection of, 278
Credits and allowances, 86-87
Cross-footing columnar journals, 132,
133
Cumulative stock, 269
dividends on, 281
Current account, 108
Current assets, 100, 405
account numbers, 290
distribution of, 427-429
percentage, 429
Current assets (Cont.)
movement of, 428
accounts receivable, 429-430
finished goods, 430
raw materials, 430-431
Current liabilities, 100
account numbers, 290-291
Current operating concept, net iiu-omo,
409-411
Customers' partial payments, sales dis-
count on, 350
Cycle, accounting, 43
Damaged merchandise, 393
Dartmouth College rase, 242
Dashes, use of, 30
Death of partner, 107, 233
dissolution of partnership on, 238
Debentures, 310
Debit:
balance, 7
entries, 6-7
uses of word, 6, 9-10
Debts, 2
bad (see Bad debts)
long-term, security for, 432
ratio of worth to, 431
Deferred credits, long-term, account
numbers, 291
Deficit, 67
Delivery charges, 85-S6
Departmental operations, 165-184
adjusting entries, 182
approximations, dangers of, 174
cash discounts, 171
cash sales and purchases, 169-171
closing entries, 182, 184
columnar sales and purchase records,
169
discontinuance of a department, 180-
181
Freight In account, 165
gross profits, 165-168
less selling expenses, 174-176
inventories, in balance sheet, 171
net income by, 178-180
overhead, contribution to, 182
profit and loss statements, 168, 177,
179, 183
significance of, 180-181
profits, 165-168
working papers, 166-167, 176-176
Depletion, natural resources, 374-375
Depreciation:
assets not subject to, 362
assets subject to, 361
INDEX
703
Depreciation (Cont.)
computing, 365
disposal of fixed assets, 367-370
equipment, 37-38
for fractional periods, 101, 369
over-, 371-372
plant, 363-364
property subject to, 361
program, revisions, 371-373
vs. provision for replacement, 366
recording, 365-366
reserve for, 321, 365
under-, 372-373
Development expenditures, 374
Direct labor, 441-443
account numbers, 291
spent on goods in process, 447
Directors:
meetings, 244
rights and duties of, 245, 264
Disbursements:
cash, 324
cash book, 293, 294
immediate, vouchers for, 203
Disclosure, full, 408
Discount:
available, 451
bond, 314
cash, 89-90, 171,401-402
alternative treatments, 304r-307
departments, 171
and interest, 401-402
purchase discounts lost, 305-307
on purchases, 89-90
reserves for, 348-349
on sales, 89
treated as other income and expense,
304-305
lost, 305-307
accounting method described, 307
adjusting entries, 305-306
purchase, 450-451
on returned sales, 349-350
sales, on customers' partial payments,
350
stock, 250-251
taken, 451
by customer, 350
trade, 88-89
unissued stock, acquired at, 282-283
Discounting:
notes payable, 124
notes receivable (see Notes receivable:
discounting)
Dishonor:
discounted note, 355-356
notice of, 356
Dissolution:
of corporation, 242
of partnership, 234
Dividends:
accounts:
closing, 26
periodic nature of, 22-23
in arrears, on preferred stock, 281
bank account, 342
dates applicable to, 280
defined, 18
entry for, 19
financial policy regarding, 279-280
legality of, 279
not an expense, 18
out of capital, 279
out of surplus, 279
paid-in surplus available for, 275, 277
preferred, number of times earned, 416
restrictions on, 278
scrip, 281
sinking fund reserves, 319, 320, 321
stock, 279, 281-282
stock preferred as to, 268-270
unpaid declared, 280
Documents, periodical inventory, 76-84
Dollar signs, use of, 30
Donation of treasury stock, 284, 285
Double-entry bookkeeping, 14
Drafts (see also Bills of exchange) :
acceptance of, 126-127
sight, 125
three-party, 125
time, 125
when payable, 126
two-party, 125
two-party time:
for collection purposes, 127
entries, sequence of, 128
form, 126
per terms of sale, 127-128
Drawing accounts:
partnership, 108-109
proprietorship, 102-103
E
Earned income, 396
Earned surplus:
appropriated surplus from, 277
capital stock and, 21-22
defined, 21, 274
frozen, 321
statement, from balance sheet, 52
Earnings, retained, 276
Employees:
Fair Labor Standards Act and, 464-467
social security number, 459
704
INDEX
Employees (Cant.)
wage payment reports to, 469-470
Employers:
defined, 460
federal income tax withholding, 463-
464
not subject to unemployment insur-
ance tax, 461
Endorsee, 351
Endorsements :
nature of, 351
qualified, 352
unqualified, 351-352
without recourse, 352
Endorser, 351
Equipment, 1
depreciation of, 37-38
Equity:
analysis of equities, 432
owners' (see Owners' equity)
Erasures, 42
Errors:
controlling accounts, 134, 163-164
correcting, 476-477
debit treated as credit, 41 42, 475-576
locating, 41-42, 471-477^
checking general ledger, 471
checking subsidiary ledgers, 473-474
note registers, 474-475
posting to work sheets, 472
special tests, 475-476
voucher register, 474
subsidiary ledgers, 163-164
transpositions of figures, 476
Estimates, 406-407
of losses, 92
provisions for bad debts, 92-93
of useful life, 365-366
Exchange-
bills of (see Bills of exchange; Drafts')
charges*, voucher system, 210, 212
Expenditures:
capital, 366, 367
and revenue, differentiated, 400-401
defined, 36, 398
development, 374
during ownership, 366-367
labor, 446
material, 446
overhead, 446
revenue, 366, 367
Expenses, 17
accounts:
illustrative statements, 96-99
periodic nature of, 22-23
accrued (see Accrued expense)
classified, 85
closing, 24
Expenses (Cont.)
controls, 296-299
account numbers on vouchers, 299
controlling accounts, 296-299
posting from vouchers, 299
entries for, 18-19
general, 85, 292
income and, statement, 51, 56
income tax, 96
interest, departmental, 178
manufacturing (see Manufacturing ex-
penses)
miscellaneous, 292
"other," 96
reflected by transaction entries only,
31,33
reinstallation, 367
selling:
account numbers, 292
classified, 85
sinking fund, 319
statement of, 21
unrecorded, accruals of, 31
Expired costs, 399, 403
Express:
charges, 85, 86
money orders, 322
Extraordinary charges, 411, 412
Federal Fair Labor Standards Act, re-
quirements of, 464-467
Federal taxes (see Taxes: federal)
Federal Unemployment Tax Act, 94
Fees:
collection, for bank services, 333
legal, 401
sinking fund trustee, 319
File:
accounts, 6
tickler, 81, 198
Financial position:
balance sheet analysis, 434
equities, 432
long-term debt, security for, 432
overinvestment in fixed assets, pos-
sible, 432-434
ratio:
of sales to fixed assets, 433-434
of worth to debt, 431
of worth to fixed assets, 433
statement analysis, 415, 431-434
Financial statements:
amount of retained earnings, 22
analysis of (see Statement analysis)
balance sheet, 52
basis of, 406
INDEX
705
Financial statements (ConL)
classified, 85-101
earned surplus, 21-22, 52
general financial position (see Finan-
cial position)
income, 394-395
income and expense, 21, 51
merchandise operations, 56
manufacturing cost, 458
operations, results of, 415, 416-424
partners' capitals, 1 13
periodic, 395
periodical inventory method, 75
prepared annually, 22
prepared each month, 23
prepared from working papers, 51-52
merchandise operations, 63
profit and loss, 56
proprietorships, 104, 106
working capital, 415, 425-431
Finished goods:
cost of, 186, 448-449, 450
inventories, 382
inventory cards, 444, 445, 446
movement of, 430
production orders, completed, 444
sold, 445
First-m, first-out method, 388-389
Fiscal-year basis, accounting, 22, 23
Fixed assets:
account numbers, 290
in balance sheet, 381
charging costs to operations, 361
classification of, 361-362
definitions, 100, 361
depreciation, 363-364 (see also Depre-
ciation)
disposal of, 367-370
disposal price:
equal to book value, 368
less than book value, 368
more than book value, 368
expenditures during ownership, 366-
367
intangible:
not subject to amortization, 362,
377-381
subject to amortization, 362, 375-377
losses and gains on disposal of, 369
natural resources, 362, 374-375
overinvestment in, 432-434
pledged, ratio to long-term debt, 432
ratio of sales to, 433-434
ratio of worth to, 433
subsidiary records, 373-374
tangible, 361-362
trade-ins, 370-371
valuation of, 362-363
F, o. b. destination, 86
F. o. b. shipping point, 86
Foreclosure, by bondholders, 309
Foreign corporations, 243
Fractional periods, depreciation for, 101 ,
369
Franchises, 1, 362
amortization, 376
Franchise tax, corporation, 243
Freight:
charges, 85, 86
paid, and discount taken by cus-
tomer, 350
reserves for, 348-349
terms, 86
Freight in:
accounting for, 450
departmental, 165
and freight out in cash disbursements
book, 158, 159
Fund:
corporate, sources of, 308
petty cash, or imprest, 325
General expenses:
account numbers, 292
classified, 85
General journal, 142
General ledger:
accounts in, 134, 150-151
checking, for errors, 471-472
column :
posting to subsidiary ledgers from,
153
two entries in, 160
controlling accounts, 150-151
proving, 134, 140
Goods (see also Merchandise):
finished (see Finished goods)
in process, 186
direct labor spent on, 441-443, 447
inventories, 382
perpetual, 440-444
ledger accounts after transfer of
costs into, 448
production orders, 440
raw materials, 440-441
sold, cost of, 449-450
unfinished, 186
Goodwill, 362
admission of partner by investment,
235
book value of, 380-381
computation of, 379-380
defined, 378
how created, 378
706
INDEX
Goodwill (Cont.)
nature of, 378
partnership, 110
unrecorded, on retirement of partner,
236
Graphic summary, closing entries, 25
Gross profits:
cost-or-market rule and, 392-393
denned, 56
departmental, 165-168
less selling expenses, by departments,
174-176
method of estimating inventories, 393
Headings:
ledger, accounts receivable, 344
working papers, 44
Horizontal analysis:
balance sheet, 434
profit and loss statement, 418, 420-424
I
Imprest cash (see Petty cash)
Improvements, leasehold, 376-377
Income:
accounts:
closing, 23-24
numbers of, 292
periodic nature of, 22-23
accrued (see Accrued income)
apportionments, 34-36
adjustments required, 34-36
earned, 396
after point of sale, 396-397
at point of sale, 396
before point of sale, 397
entry for, 18
expense and, statement, 51 , 56
incidental, 96
interest:
accrued, 33-34
nature of, 396
net (see Net income)
from production and sales activities,
396-397
reflected by transaction entries only,
31-33
related costs and, matching of, 395,
405-406
retained, 276
savings and, 398
from services, 397-398
sources of, 17
statement of, 21
tax (see Income tax)
Income (Cwit.)
unrealized appreciation, 398
unrecorded, accruals of, 31
Income tax:
bond interest deductible, 309
employees', withheld, 93-95, 463-464
expense, 96
paid by corporations and stockholders,
243
in profit and loss statement, 178, 180
withheld, 93-95, 463-464
Individual proprietorships, 102-106 (see
oho Proprietorships, individual)
Installation :
cost, 367
Installment purchases:
separate vouchers for, 210
Installment sales:
earned income, 397
Insurance:
automobile, 178
cost :
apportionments, 36-37
determination of, 401
unemployment, 460 462
Interest:
bonds, 309
number of times earned, 417
payment of, 312-313
registered as to interest, 310
on capitals, partnership divisions, 228,
229
expense:
in cash disbursements book, 158, 159
in cash receipts book, 156
departmental, 178
income:
accrued, 33-34
in cash receipts book, 156
departmental, 178
notes, 115-117
receivable, accrued, 216
Internal check, 77, 322-330
methods described, 323-330
objectives of, 322
system of, 322-323
Internal control, 76-77
Inventories, 382-393
accuracy in taking and pricing, 382-
384
in balance sheet, 59
at beginning of period, 57
controlling accounts, 445-450
finished goods, 446, 448-450
goods in process, 446, 447-448
raw materials, 446, 447
cost of goods sold, 58
damaged merchandise, 393
INDEX
707
Inventories (Cont.)
defined, 57
departmental, in balance sheet, 171
end-of-period, 59, 69
estimating, gross profit method, 393
inclusions and exclusions, 382
inventory card, 59
obsolete merchandise, 393
overstatement of, 383-384
periodical, 56, 68-84
perpetual, 56-67, 438-445 (see Per-
petual inventories)
physical, 69
pricing methods, 386-393
cost basis, 387-389
cost or market, whichever lower,
389-393 (see Cost or market
method)
cost selection for, 387
disclosure of, 393
first-in, first-out, 388-389
last-in, first-out, 389
weighted-average, 388
purchases debited to, 57
records, detailed, 59
sales, 57, 58
sheets, 386
tags, 384-386
taking, procedure, 384-386
understatement of, 384
Investment, admission of partner by, 235
Invoice, 79-81, 194, 195, 445
check sheet, 80, 194
forms, 79, 195
payment of, 81
purchaser's verification of, 80-81
sales, 76
I.O.U.'s, 322
Issuance of stock, 2-3, 8
on collection of subscriptions, 256-258
no par value, 251-254
par value, 247-251
for property, 255
Journal:
adjusting entries, 40
advantages of, 11-13
columnar, 132-133
complete, illustration, 19
defined, 10
dollar signs in, 30
entries:
adjusting, periodical inventory, 75-
76
closing, 27
compound, 15-16
transactions, 38-40
Journal (Cant.)
general, 142
punctuating numbers in, 30
purchase, 142
sales, 142
stock transfer, 262
use of zeros and dashes, 30
Journalizing, 30
defined, 10
procedure, 10-11
Junior bonds, 310
Key letters, in working papers, 44
L
Labor:
direct, 186, 291, 441-443
indirect, 186
Land, 1
and buildings, separate accounts, 362-
363
improvements, expenditures for, 363
purchase of, 3, 8
sale of, 4, 8
Last-in, first-out method, 389
Leasehold improvements, 362
amortization, 376-377
Leases, long-term, amortization, 376-377
Ledger:
accounts:
after adjusting and closing, 64-66
after transfer of costs into goods in
process, 448
arrangement of, 6
numbers of, 288-295
organization of, 293
punctuating numbers in, 30
use of zeros, dashes, dollar signs, 30
accounts receivable, 151
headings, 344
with closing entries, 28-29
defined, 6
division of, 134
general (see General ledger)
illustrative entries, 19-20
posting, defined, 10,12
stockholders', 259
subscribers', 258
subsidiary, 134-136
"L. F.," meaning of, 12
Liability; liabilities:
account numbers, 290-291
accounts, debits and credits in, 7
contingent, 351, 352
current, 100
708
INDEX
Liability; liabilities (Cont.)
defined, 2
limited, 278
long-term, 101
of partner, 243
of stockholders, 242
unlimited, partnership, 107
unpaid dividend as, 280
Limited partnership, 107
Liquidation:
of partnership, 238-241
value of stock, 273
Loan accounts, partnership, 109
Loans from Vjanks, 334
Long-term deferred credits, 291
Long-term liabilities, 101, 291
Loose-leaf binder, 6
Losses:
ascertained, 92
bad debt, 90-93, 348
estimated, 92
net (see Net loss)
profit and (see Profit and loss)
Lost costs, 399
Lost discounts, 305-307
Lump price, assets acquired at, 403
M
Machinery:
constructed by company, 363
costs, 362, 401
obsolescence of, 364
in subsidiary records, 373-374
Machines, bookkeeping, 344
Manufacturing accounts, 185-193
adjusting entries, 188
balance sheet, 188, 189
closing entries, 188, 192-193
cost of goods sold statement, 187
costs, 185-186
operating statements, 186-187
profit and loss statement, 186-187
surplus statement, 188
working papers, 188, 190-191
apportioned items in, 193
Manufacturing cost controls, 438-458
freight in, 450
inventory controlling accounts, 445-
450
perpetual inventories, 438-445
purchase discounts, 450-451
returned purchases and allowances, 451
summary, chart, 452
Manufacturing expense, 186, 443-444
account numbers, 291-292
charged to goods in process, 447
Market, cost or, whichever lower,
393
Market value:
decreases in, 364
of stock, 273
Marshall, Chief Justice John, 242
Materials:
inclusions, 186
raw (see Raw materials)
requisition, 439
Maturity of notes, 114-115
Meetings, directors' and stockholders',
244
Memorandum, credit, 87
Merchandise, 1 (see also Goods) :
bookkeeping procedures, comparative
summary, 69
consignment, 382
obsolete and damaged, in inventory,
operations:
periodical inventory method. 56, 68
84
perpetual inventory method, 56-67
stolen, 403
title to, 382
Mines, 362, 374
Minute book, 264
Money orders, 322
Monthly statements, 84
books closed annually, 478-483
Mortgage:
bonds, 308
chattel, 309
real estate, 309
first, 310
nature of, 308
notes, 308
payable, 2
second, 310
third, 310
Natural business year, 427
Natural resources, 362
depletion of, 374-375
valuation of, 374
Negotiable Instruments Act, 114
Net income:
clean surplus concept, 410, 4! 1-412
current operating concept, 409-411
by departments, 178-180
ratio to average net worth, 416
"sharp" determination of, 395
and success of business, 21
Net loss, 21, 66-67
Net price procedure, 307
INDEX
709
Net worth, 99, 101
account numbers, 291
average, ratio of net income to, 416
elements of, corporate accounts, 245,
247
ratio to debt, 431
Non-cumulative stock, 269
Non-participating stock, 269, 270, 309
No par value stock, 247
accounting procedures, 252
advantages of, 251-252, 255
disadvantages of, 252
dividends on, 279
recording issuance of, 251 -254
subscriptions:
immediate collection of, 253
stock issued before collection of, 254
when issued, 257-258
Note registers:
as books of original entry, 299-304
checking, 474-475
notes payable, 130, 131, 302-303
notes receivable, 128-130, 131, 299-302
Notes, 76, 114-124
defined, 114
discounted, dishonored by maker, 355-
356
endorsements, 351 352
interest, computing, 115-117
general formula, 115-116
short methods, 116
maturity of, 1 14-115
mortgage, long-term, 308
nature of, 351
parties to, 114
payable (see Notes payable)
receivable (see Notes receivable)
Notes payable, 2, 114, 121-124
account, 121
in balance sheet, 15
discounting, 124
entries for transactions, 121-124
dishonor of note, 123
issuance of note, 121-122
note partially paid, 123
payment of note, 122
renewal of note, 124
maturity:
after end of accounting period, 124
before end of accounting period, 124
register, 130, 131, 302-304
voucher system, 214
Notes receivable, 1, 114, 117-121
account, 117-118
in balance sheet, 15, 357-358
discounted:
in balance sheet, 357-358
endorsements, 351-352
Notes receivable (Cont.)
taken from debtor on account, 358-
360
discounted, account:
disposition of, 356
purpose of, 356-357
discounting:
at bank, 353-354
with creditor, 354
note dishonored by maker, 355-356
note paid by maker, at maturity, 355
protest, 356
purposes of, 351
entries for transactions, 1 18
collection of note, 119
note dishonored, 119-120
note partially collected, 120
receipt of note, 118-119
renewal note, 120-121
register, 128-130, 131,299-302
uncollectible, 350
Numbers:
account (sec Account numbers)
punctuating, 30
Obsolescence, 363 -364
Obsolete merchandise, in inventory, 393
Office:
expense, 17
routines, 76-77
Officers, rights and duties of, 264
Offset accounts, 92
numbering of, 289
Oil wells, 362, 374
Old age benefits taxes, 94, 459-460
Opening the books, partnership, 110
Operating statements, manufacturing
accounts, 186-187
Operations, results of, 416-424
Opinion, in audit reports, 406 -407
Overabsorbed burden, 455
Overdepreciation, 371-372
Overdraft, bank, 342
Overhead account, 446
Overhead expenses, 443-444
Overinvestment in fixed assets, 432-434
Owners' equity, 99
accounts, debits and credits in, 7
changes in, 17-23
defined, 2
sources of, 2
Paid-in surplus:
accounts, 275
appropriated surplus from, 277
710
INDEX
Paid-in surplus (Cant.)
asset write-downs and losses and, 275-
276
available for dividends, 275, 277
nature of, 274-276
Partial payments, voucher system, 210
Participating stock, 269, 309
Partner (see also Partnerships) :
death of, 233
with debit balance, on partnership dis-
solution, 240-241
differentiated from stockholder, 242-
243
liability of, 243
new, admission of, 233
by investment, 235
goodwill to new partner, 235
goodwill to old partners, 235
no goodwill, 235
by purchase, 234
from more than one partner, 234
from one partner, 234
reimbursement of, 107
retirement of, 233
payment from partnership assets,
237-238
sale to other partners, 237
sale to outsider, 236
Partnerships (see also Partner):
agreement, 107-108
articles of, 107-108
on change in personnel, 234
assets, payment from, 237
balance sheet, 113
capital account, 108-109
change from, to corporation, 264-267
(see also Corporation: change
from partnership to)
change from corporation to, 264
corporation books retained, 267
new books, 267-268
changes in personnel, 233-238
causes of, 233
dissolution, 234
general procedures, 233-234
closing the books, 110-111
capitals maintained at fixed amounts,
110-111
no agreements for fixed capitals, 1 1 1
contract, 107-108
defined, 106
differentiated from corporation, 242-243
dissolution of, on death of partner, 238
dividing profits and losses, 226-232,
233
in capital ratio, 228
determinants of equitable division.
226
Partnerships (Cont.)
dividing profits and losses (Cont.)
in fractional ratio, 227
interest on capitals, 228
on liquidation, 239
in ratio of capitals at beginning of
period, 228
in ratio of capitals at end of period,
228
remainder in fractional ratio, 228-
231
salaries and interest, 229, 231
salaries to partners, 229
working papers, 230
drawing account, 108-109
goodwill, 110
limited, 107
liquidation of, 238-241
disposal of assets, 239
distribution of cash, 239-240
division of profit and loss, 239
partner with debit balance, 240-
241
loan account, 109
nature of, 106-107
division of profits, 107
limited right to dispose of interest,
107
mutual agency, 106
no separate legal entity, 106
partner's death, effect of, 107
unlimited liability, 107
withdrawal of assets, 107
profit and loss ratio, 110
profit and loss statement, 111, 113
statement of partners' capitals, 113
termination of, 238
working papers, 111, 112
Par value stock, 247, 272
all stock issued at par, 247
all stock issued at premium, 248-249
all stock subscribed for at par, 249
immediate collection of subscriptions,
247-249
issued before collection of subscrip-
tions, 249-250
nature of, 247
part of stock issued at par, 248
premium and discount:
accounts, disposition of, 251
in balance sheet, 250-251
recording issuance of, 247-251
subscriptions at premium, 249-250
uncollected subscriptions in balance
sheet, 250
when issued, 256-257
Patents, 1, 362
amortization, 375-376
INDEX
711
Payment:
on account payable, 5, 9
of invoice, 81
partial:
sales discount on, 350
voucher system, 210
Payrolls, 459-463
bank account, 341-342
Federal Fair Labor Standards Act re-
quirements, 464-467
miscellaneous deductions, 464
procedures, 467-469
records, 298, 463, 470
summary, 468
taxes, 93
deductions, 459-464
Percentage distribution, current assets,
429
Per cents, computation of:
horizontal analysis, 420-424
vertical analysis, 418-420
Periodical inventory method:
adjusting journal entries, 75
bookkeeping procedure, 69
closing entries, 75-76
comparative trial balances, 69-70
financial statements, 75
statement procedure, 69
working papers, 70-74
Periodic statements, 395
Perpetual inventories, 438-445
cards, 439-440
finished goods, 444-445
goods in process, 440-444
method, 56-67
additional transactions, 59-60
adjusting and closing entries, 63-64
at beginning of period, 57
bookkeeping procedure, 68
comparative trial balances, 69-70
cost of goods sold, 58
at end of period, 59
journal entries, 59-60
ledger accounts, after adjusting and
closing, 64-66
purchases, 57
records, 59
sales, 58
statement procedure, 68
trial balance, 60
working papers:
completed, 60-62
statements prepared from, 63
raw materials, 438-440
Personal account, 108
Personnel:
chart, corporation, 245, 246
partnership, changes in, 233-238
Petty cash, 325-330
book, 328
fund:
disbursements from, 325, 328
establishment of, 325
replenishment of, 329
voucher, 328
Physical inventory, 69
Plant property:
depreciation, 361
rehabilitation, 401
Postage stamps, 322
Postal money orders, 322
Posting, 30
from check register, 208
defined, 10, 12
from voucher register, 208
from vouchers, 299
process, 12-13
to work sheets, 472
Pre-emptive rights of stockholders, 268
Preferred dividend, number of times
earned, 416
Preferred stock, 247, 268-272, 309
as to assets, 270
as to dividends, 268-270
cumulative and non-cumulative, 269
participating and non-participating,
269-270
rights under various conditions of
preference, 270
dividends in arrears on, 281
Preferred stockholders, contracts with,
276
Premium:
bond, 315
in balance sheet, 315-316
on stock, in balance sheet, 250-251
Pricing methods, inventories (see Inven-
tories: pricing methods)
Principal, bonds registered as to, 310
Prior-lien bonds, 310
Production:
income from, 396-397
orders, 440
completed, 444
direct labor cost summary, 442
Profit and loss:
account, 23, 24
closing, 25-26
dividing (see Partnerships: dividing
profits and losses)
ratio, partnership, 110
statement, 56
bad debts, 91
comparative statements, 419-424
departmental operations, 168, 177,
179, 180-181, 183 /
712
INDEX
Profit and loss (Cant.)
statement (Cont.)
gross profit:
by departments, 166
less selling expenses, departments,
177
income tax in, 178, 180
manufacturing company, 186-187
partial, 85
partnership, 111, 113
periodical inventory, 75
vertical analysis of, 418-420
Profits:
departmental, 165
division of, partnership, 107
gross (see Gross profits)
Promissory notes, 114 (see a/so Notes)
Property, stock issued for, 255
Proprietorships, individual :
capital account, 102
closing the books, 103
accounts after, 103-104
drawing account, 102-103
statements, 104, 106
working papers, 104, 105
Protest, defined, 356
Punctuating numbers, 30
Purchase:
admission of partner by, 234-235
book, 142, 143-144
cash credit column, 171
discounts, 450-451
journal, 142
order, 78-79
requisitions, 77-78
routine, 77-83
checks, advices, 82
invoice, 79-83 (see also Invoice)
orders, 78-79
receipts, 82
requisitions, 77-78
Purchaser, verification of invoice, 80
Purchases:
cash, departmental, 169-171
in cash disbursements book, 158, 159
cash discounts on, $9-90
debited to Inventory account, 57
returned (see Returns and allowances)
R
Ratio:
acid-test, current assets, 428
capital, 228
expressed decimally, 423-424
meaningless, 434
misinterpretation of, 434
net income to average net worth, 416
Ratio (Cont.)
partnership division of profits and
losses, 227-231
pledged fixed assets to long-term debt,
432
profit and loss, partnership, 110
related ratios, appraisal of, 434
sales to fixed assets, 433-434 •
working capital, 425-427
worth to debt, 431
worth to fixed assets, 433
Raw materials:
inventories, 382
movement of, 430-431
purchased, 438-439
requisition, 439, 440-441
register, 447
used, 439-440, 447
Real estate:
acquisition of, costs, 401
mortgage bonds, 309
Receivables, age distribution of, 346-348
Receiving record, 80
Reconciliation of bank account, 336-340
adjustments after, 341
statement, 340
steps in, 339-340
Records:
bank balance, 332-333
compensation, for employees, 463
corporation, 258-264 (see also Corpora-
tion: records)
individual employment and compensa-
tion, form, 470
inventory, 59
payroll, 298
receiving, 80
subsidiary (see Subsidiary records)
wage payment, to employees, 469-470
Redemption value of stock, 273
Registered bonds, 310
Registers, 128-131
bank, 332, 333
check (see Check register)
completed production orders, 448-449
note (see Note register)
notes payable, 130, 131
notes receivable, 128-130, 131
requisition, 447
voucher (see Voupher: register)
Registrar, 263
Reinstallation expense, 367
Repairs:
cost of, 363
apportionments, 37
extraordinary, 367, 369
income, 32
ordinary, 367
INDEX
713
Replacement, depreciation vs. provision
for, 366
Report form balance sheet, 52
Reports, audit, 406 407
Requisition:
material, 439
raw material, 440-441
register, 447
Reserves:
for bad debts, 91-92, 321, 346
for cash discounts, 34&-349
for depreciation, 321, 365
revision of, 371-372
for freight, 348-349
meaning of, 92
requirement, estimating, 346-348
for returns and allowances, 348-349
sinking fund, 319-321
special-purpose, 276-277
valuation, 92
Resources, natural, 362, 374-375
Retained earnings (see Earned surplus)
Retained income, 276
Retirement:
of bonds, 316
of partner, 233, 236-238
Returns and allowances, 86-87, 88, 451
discounts on returns, 349-350
reserves for, 348-349
voucher system, 212
Revenues:
expenditures, 366
unrecorded, apportionments of, 31
Reversing entries:
adjustments:
accrued expense, 217
accrued income, 216
apportionments :
recorded costs, 219
recorded income, 223, 224
desirability of, 216
Rulings:
on columnar paper, 30
single and double, closed accounts, 2-4
25
subsidiary ledgers, 135 136
Salaries:
accrued, 60
departmental, 178
expense, 17
to partners, divisions of profit and
loss, 229
transaction entries, 33
Sales:
accounts, numbers of, 291
Sales (Cent.)
activities, income from, 396-397
book, 142-143, 449
cash sales in, 170, 172
departmental operations, 169
cash, departmental, 169-171
cash discounts on, 89
in cash receipts book, 156
C.O.D., recording, 344-345
expenses, account numbers, 292
gross profit on, 56
invoices, 76
journal, 142
loss on, 67
perpetual inventory method, 58
ratio to fixed assets, 433-434
returns (see Returns and allowances)
routine, 83-84
monthly statements, 84
taxes, 96
Savings, income and, 398
Scrip dividends, 281
Seasonal business:
cost, 404
effect of, 427
Secured bonds. 308, 309-310
Securities, assets acquired with, 402
Securities and Exchange Commission,
Security for long-term debt, 432
Self-employed persons, taxes, 460
Selling expenses, account numbers, 292
Services, income from, 397-398
Shares, transfer of, 259, 261-262
Sight drafts, 125
Sinking funds, 316-321
expense, 319
reserves:
annual entries, 320
dividends, 319, 320, 321
terminology, 321
Skeleton accounts, 7
Social security, 94, 459
Social Security Act, 94, 459
Special-purpose reserves, 276-277
Stated capital, 278
Stated value of stock, 273
Statement analysis, 413-437
cautions regarding, 434-437
illustrations, 413-415
operations, result of, 415, 416-424
working capital, 415, 425-431
Statements:
bank, 334-336
financial (see Financial statements)
form, 84
general financial position (see Financial
position)
714
INDEX
State taxes (see Taxes: state)
Stock:
and bonds, advantages and disadvan-
tages, 309
book value of, 272-273
cancellation, 282
capital (see Capital stock)
certificate, 2-3, 259
forms, 3, 260, 261
classes of, 268-272
reasons for, 270-271
various, accounts with, 271-272
common (see Common stock)
cumulative, 269
discount/
accounts, disposition of, 251
in balance sheet, 250-251
dividends, 279, 281-282
issuance of (see Issuance of stock)
liquidation value of, 273
market value of, 273
non-cumulative, 269
non-participating, 269, 270
participating, 269, 309
preferred, 268-272 (see also Preferred
stock)
redemption value of, 273
registrar, 263
stated value of, 273
subscriptions to (see Subscriptions to
stock)
transfer agent, 263
transfer journal, 262
transfer of shares, 259, 261-262
treasury (see Treasury stock)
unissued, 282-283
values, 272-273
Stockholders, 245
basic rights, 268
differentiated from partners, 242-243
dividends to, 18
ledger, 259, 263
liability, 242
meetings, 244
pre-emptive rights, 268
preferred, 276
protection of, 278
rights and duties, 264
status, when acquired, 256
transfer-ability of interest, 242-243
and unissued stock, 282-283
Straight-line method, depreciation, 365
Subscribers' ledger, stock, 258
Subscriptions to stock:
no-par stock:
immediate collection of, 253
stock issued before collection of,
254
Subscriptions to stock (Cont.)
par value:
immediate collection of, 247-249
uncollected, in balance sheet, 250
stock issued before collection of, 249-
250
stock issued on collection of, 256-258
subscribers' ledger, 258
uncollected, in balance sheet, 250
Subsidiary ledgers, 345-346
accounts payable, 140, 152
accounts receivable, 140, 151
checking, 473
defined, 134
errors in, 163-164
posting to, from general ledger column,
153
proving, 134, 140-141, 152
rulings in, 135-136
Subsidiary records:
checking, 474-475
expense controls, 296-299
fixed assets, 373-374
Sundry accounts, account numbers, 293-
295
Supplies and materials, 186
Surplus:
appropriated, 276-277
capital, 274
defined, 274
dividends out of, 279
earned (see Earned surplus)
nature of, 274
paid-m, 274
restrictions, from treasury stock acqui-
sitions, 286-287
statement, 188
terminology, 276
T-accounts, 7
Taxes, 93-96
double, paid by stockholders, 243
entries, 95
federal, 94-95
income tax withholding, 463-464
old age benefit, 94, 45<)-460
unemployment insurance, 94, 460
462
payable, 2
payroll, 93-95
sales, 96
state, 94, 95
unemployment compensation, 94,
462-463
statement presentation, 95
withholding, 93-95, 459
Termination of partnership, 238
INDEX
715
Terminology:
costs, 398-399
sinking fund reserves, 321
Tickler file, 81
defined, 198
Timber tracts, 362, 374
Time cards, 441-442
Time drafts, 125-127
two-party (see Drafts: two-party time)
Trade acceptance, 128
Trade discounts, 88-89
Trade-ins, 370-371
Trademarks, 362, 377
Trading companies, operating state-
ments, 186
Transactions:
and adjustments, 31
entries:
expense reflected by, 31, 33
income reflected by, 31-33
in journal, 38-40
trial balance after posting, 40
recording, 7-9
Transfer agent, 263
Transportation charges, 85
Treasury stock:
acquired by donation, 284, 285, 286
in balance sheet, 283-284
cost basis of recording, 284-285
nature of, 282
not an asset, 283
reissuance of, banes for, 285-286
surplus restrictions, from acquisitions
of, 286-287
unissued and, liability for discount,
282-283
Trial balance, 30
after closing of books, 29-30
after posting transaction entries, 40
before and after adjustments, 41
defined, 14
errors in, 41-42
illustrative entries, 20
punctuating numbers in, 30
use of zeros, dashes, dollar signs in, 30
uses of, 14-15
in working papers, 60
Trust bonds, collateral, 309
Trust deed, 311
Trustee:
authentication by, 311
sinking fund, 316-319
under the mortgage, 308
Underabsorbed burden, 455
Underdepreciation, 372-373
Underlying bonds, 310
Unemployment insurance taxes, 94
federal, 460-462
state, 462-463
Unfinished goods, 186
Uniform Negotiable Instruments Act,
125
Uniform Partnership Act, 106
Unissued stock, acquired at discount,
282-283
Unrealized appreciation, 398
Unsecured bonds, 310
Utilized costs, 399, 403
Valuation:
account, 92
of fixed assets, 362-363
of goodwill, 379-380
of natural resources, 374
Vertical analysis:
balance sheet, 434
profit and loss statement, 418-420
Voucher:
account numbers, 299
clerk, 195
filing, until payment, 198
forms, 196, 197, 2oO, 201
for immediate disbursement, 203
paying, 200
petty cash, 328
posting from, 299
preparing, 194-197
recording, 197-198
recording payment, 200-203
register, 198, 199
account numbers, 293
checking, 474
controlling accounts, 296-297, 299
discounts lost in, 305, 306
entries, 201, 202, 203-207
partial payments, 211
posting from, 208
returns and allowances, 213
system, 194-214
accounts payable ledger eliminated,
208-209
accounts receivable and payable
with same party, 344
balance sheet title for liability, 210
exchange charges, 210, 212
notes payable, 214
partial payments, 210
returned purchases and allowances,
21
Vouchers payable account, 197, 198
716
INDEX
Wages:
Fair Labor Standards Act and, 464-467
payable, 2
payment reports to employees, 469-
470
tax withholding from, 459-461, 463,
467
Weighted-average method, 388
Window dressing, 426-427
Withholding taxes, 459
federal income, 463-464
Working capital:
amount 6f , 425
current assets, distribution and move-
ment of, 427-428
ratio, 425-427
boom and depression, effect on, 427
seasonal business, effect on, 427
2 to 1 rule, 427
window dressing, 426-427
Working papers, 480-483
adjusting entries, 52-53
closing entries, 53-54
completed, merchandise operations,
60-62
defined, 43
Working papers (Cant.)
departmental operations, 166-167
gross profit, by departments, 166
gross profit less selling expenses, 175-
176
headings, 44
illustrative, 43-51
key letters in, 44
manufacturing company, 188, 190-191
apportioned items in, 193
manufacturing cost, 456, 458
partnerships, 111, 112
periodical inventory method, 70-74
proprietorships, 104, 105
statements prepared from, 51-52, 63
steps in preparing, 44, 51
when not necessary, 43
Work sheets, posting to, 472
Worth, ratio to fixed assets, 433
Writing off bad debts, 92
Year, accounting, 22, 23
Z
Zeros, use of, 30
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