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OSMANIA UNIVERSITY LIBRARY 

Call No. &$>tlH&*'t Accession No. 2- <T 

Author '^^ V -ft. 
Title 
This book should be returned on or before the date last marked below. 



PROBLEMS IN ACCOUNTING 



*A JQst of the 

HARVARD PROBLEM BOOKS 

* * * 

Borden PROBLEMS IN ADVERTISING 

Ebersole BANK MANAGEMENT A Case Book 

Hanson PROBLEMS IN AUDITING 

Hosmer PROBLEMS IN ACCOUNTING 

Learned - PROBLEMS IN MARKETING 

Lewis ' PROBLEMS IN INDUSTRIAL PURCHASING 

McNair, Gragg, and Teele - PROBLEMS IN RETAILING 

Malott PROBLEMS IN AGRICULTURAL MARKETING 

Masson and Slratton - FINANCIAL INSTRUMENTS AND INSTITUTIONS 

Masson and Stratton PROBLEMS IN CORPORATION FINANCE 

Robbins and Foils INDUSTRIAL MANAGEMENT A Case Book 

Roorback PROBLEMS IN FOREIGN TRADE 

Ruggles - PROBLEMS IN PUBLIC UTILITY ECONOMICS AND 
MANAGEMENT 

Sanders PROBLEMS IN INDUSTRIAL ACCOUNTING 
Tosdal PROBLEMS IN SALES MANAGEMENT 



PROBLEMS 
IN ACCOUNTING 



BY 

WINDSOR ARNOLD HOSMER 

DICKINSON FELLOW 
PROFESSOR OF ACCOUNTING 



GRADUATE SCHOOL OF BUSINESS ADMINISTRATION 

GEORGE F. BAKER FOUNDATION 

HARVARD UNIVERSITY 



SECOND EDITION 
SECOND IMPRESSION 



McGRAW-HILL BOOK COMPANY, INC. 

NEW YORK AND LONDON 
1938 



COPYRIGHT, 1934, 1938, BY THE 
MCGRAW-HILL BOOK COMPANY, INC. 



PRINTED IN THE UNITED STATES OF AMERICA 

All rights reserved. This book, or 

parts thereof j may not be reproduced 

in any form without permission of 

the publishers. 



THE MAPLE PRESS COMPANY, YORK, PA. 



To 
WILLIAM MORSE COLE 

For Thirty Years 

An Inspiring Teacher of Accounting 
In Harvard University 



PREFACE 

Changes in industry in the last generation have thrown added 
responsibilities on accountants. The necessity of relying in 
increasing measure on accounting information, rather than on 
direct contact with the facts of smaller business units, has led 
executives, creditors, stockholders, and others to be increasingly 
interested in the completeness and accuracy of accounting 
information. 

The ability to lay bare the essential facts of a business situation 
requires a rigor of analysis and a breadth of view commensurate 
with the complexity of the issues involved. A narrow formalism 
in accounting will not suffice. It must deal with business facts 
as they arise and must keep its technique and methods of analysis 
flexible, in order to meet new demands in whatever form they occur. 

In selecting the cases for this volume we have tried to maintain 
a proper balance between the broader aspects of accounting and 
the constant emphasis on analysis on the one hand, and the neces- 
sity on the other that students become familiar with bookkeeping 
and other matters of technique. We have also sought to preserve 
in the cases the vividness of the experience in which they arose 
and the significance of the situations to the enterprises concerned. 

This book is planned for the use of students with or without 
previous acquaintance with accounting. Cases are presented in 
Part I which give a general picture of the structure and functions 
of the principal accounting statements and provide instances in 
which the meaning of the terms used therein may be examined. 
Bookkeeping is considered in Part II in the light of the analysis 
thus developed. Both together constitute an introduction to the 
problems in substantive accounting beginning in Part III. 

This book is the sixth of those made possible by the Arthur 
Lowes Dickinson Fund, given by Price, Waterhouse & Co., for 
Accounting Research at the Harvard Graduate School of Business 
Administration. 

A case book necessarily involves the cooperation of many 
persons. We wish to express our appreciation of the assistance 



viii PREFACE 

of business men and of the courtesy with which that assistance 
has been given. This collection of cases is a part of and is depend- 
ent upon the larger body of case material used in the other courses 
in accounting and in related courses in the School. Professor 
Sanders and Professor Hanson have made available several cases 
previously used in Industrial Accounting and Financial Manage- 
ment. Professor Walker developed cases on the budgetary con- 
trol of funds and on the analysis of income, and Professor Nickerson 
developed many of the cases on inventories. My colleagues have 
given liberally of their judgment and criticism throughout the 
preparation of this volume. 

Keith Funston, formerly of the Research Staff of the School 
and now with the American Radiator Company, Thomas H. 
Carroll, Instructor in Accounting, and Cedric W. Lutz, Assistant 
in Research, cooperated in the preparation of many of the cases. 
Miss Virginia Jenness has served as research assistant throughout 
the preparation of this edition and has taken charge of many 
aspects of the preparation of the manuscript. 

W. A. HOSMER. 

SOLDIERS FIELD, 
BOSTON, MASS., 
September, 1938. 



CONTENTS 

PAGE 

PREFACE vii 

ALPHABETICAL LIST OF CASES xv 

PART I 

AN INTRODUCTION TO ACCOUNTS, BALANCE SHEETS, 
AND INCOME STATEMENTS 

I. THE GENERAL STRUCTURE AND FUNCTION OF FINANCIAL 
STATEMENTS 

American Telephone and Telegraph Company No. i 3 

The Cudahy Packing Company 9 

Wellington Shoe Company . . 17 

II. PREPAYMENTS AND ACCRUALS 

Bristol Valley Stove Company 25 

Riverbank Gas and Electric Company 28 

III. THE EFFECT OF INVENTORIES ON THE CURRENT POSITION 

AND ON INCOME REPORTED 

Herendeen and Haply Woolen Mills No. i . . . . 31 

IV. PLANT AND DEPRECIATION 

Chelmsford Knitting Company No. i 39 

Boston Elevated Railway Company 40 

V. THE ANALYSIS OF FINANCIAL STATEMENTS 

Aluminum Company of America 51 

PART II 
BOOKKEEPING 

VI. THE RELATION BETWEEN THE STATEMENTS AND THE 
BOOKS OF ACCOUNT 

Herendeen and Haply Woolen Mills No. 2 .... 65 

VII. THE ANALYSIS OF TRANSACTIONS 

The Analysis of Transactions No. i 68 

John L. Steele, Realtor No. i . . 79 

John L. Steele, Realtor No. 2 90 

ix 



x CONTENTS 

PAGE 

John L. Steele, Realtor No. 3 94 

The Analysis of Transactions No. 2 94 

General Trust Company 99 

Wilcox Lumber Company No. i 106 

Wilcox Lumber Company No. 2 in 

Brewster Paper Company No. i 114 

Brews ter Paper Company No. 2 123 

Detroit Edison Company No. i 125 

Pendar Paper Company No. i 126 

VIII. ADJUSTING AND CLOSING THE BOOKS. THE USE OF THE 
WORK SHEET 

Robinson Shoe Company No. i 128 

Robinson Shoe Company No. 2 129 

Drake Chemical Company No. i 131 

Drake Chemical Company No. 2 133 

PART III 

ACCOUNTING FOR CURRENT ASSETS AND CURRENT 

LIABILITIES. AN INTRODUCTION TO SPECIAL 

JOURNALS 

IX. CASH 

Henderson Mills 137 

X. ACCOUNTS AND NOTES RECEIVABLE 

Nor they National Bank 139 

C. F. Hartshorn and Sons, Inc 141 

Bowers Rubber Manufacturing Corporation .... 145 

Pendar Paper Company No. 2 147 

McKesson & Robbins, Inc. No. i 154 

XL INVENTORIES 

A. Cost, Market, and Cost or Market, Whichever Is Lower 

The American Tobacco Company 157 

Warner Bros. Pictures, Inc 162 

Delta Packing Company 171 

Southern Peanut Products Company 176 

B. The Control of Inventories 

Churchill Publishing Company No. i 177 

Whitman Tin Plate Company 182 

Texas Gulf Sulphur Company, Inc 183 

Clark Wholesale Paper Company 188 

McKesson & Robbins, Inc. No. 2 191 



CONTENTS xi 

PAGE 

C. The Determination of Cost 

Hastings and Eau Claire Print 197 

Harmon Coal Company 207 

Churchill Publishing Company No. 2 212 

Grant Rubber Company 215 

D. The Base Stock Method and Inventory Reserves 

National Lead Company 229 

Swift & Company 238 

International Harvester Company No. i 243 

XII. BUDGETARY CONTROL OF FUNDS 

Glenway Company 247 

XIII. AN INTRODUCTION TO SPECIAL JOURNALS 

Kirkwell Manufacturing Company No. i 253 

Kirkwell Manufacturing Company No. 2 258 

Kirkwell Manufacturing Company No. 3 262 

Davis and Wall, Inc 268 

Mayberry Bag Company 277 

R. G. Clarkson and Sons 283 

PART IV 

VCCOUNTING FOR PERMANENT ASSETS, FUNDED DEBT, 
AND PROPRIETORSHIP 

XIV. PLANT AND DEPRECIATION 

A. The Meaning of Cost 

Northern Electric Manufacturing Company No. i. 289 

Lincoln Company 292 

Halstead Company 293 

Harvard Cooperative Society 295 

Northern Electric Manufacturing Company No. 2. 299 

Edinburgh Gas and Electric Company 304 

Trundell Power Company 308 

Blaw-Knox Company 311 

B. The Meaning of Cost of Reproduction 

Chelmsford Knitting Company No. 2 316 

C. Methods of Determining Depreciation 

Boren Steamship Company No. i 323 

Boren Steamship Company No. 2 329 

Northern Electric Manufacturing Company No. 3. 331 

Northern Electric Manufacturing Company No. 4. 334 

New England Telephone and Telegraph Company . 338 

Henley Radio Company 351 



xii CONTENTS 

PAGE 

United States Steel Corporation No. i 356 

American Telephone and Telegraph Company No. 2 378 

Pullman, Inc 379 

D. Retirement Accounting 

Boston Edison Company 396 

Long Point Gas Company 404 

Detroit Edison Company No. 2 412 

XV. INTANGIBLES 

Winbigler Textile Mills Company 425 

XVI. INVESTMENTS 

Manger Manufacturing Company 432 

General Manufacturing Corporation 434 

XVII. FUNDED DEBT 

Detroit Edison Company No. 3 438 

Northern States Power Company 442 

XVIII, PROPRIETORSHIP 

A. Development of a Corporation from a Single Proprie- 

torship 

Aberdeen and Company 445 

B. Types of Dividends 

Eastman Kodak Company 454 

A. M. Byers Company 459 

The Westinghouse Air Brake Company 462 

Hamilton Woolen Company 467 

Deere & Company 470 

California Packing Corporation 474 

Plymouth Oil Company 479 

General Electric Company 480 

General Motors Corporation 481 

American Telephone and Telegraph Company 

No. 3 484 

C. Reduction of Capital, Capital Surplus, Earned Surplus 

Radio Corporation of America No. i 487 

American Smelting and Refining Company 492 

Packard Motor Car Company 499 

American Locomotive Company 502 

Allis-Chalmers Manufacturing Company 505 

Coca-Cola Company 508 

Allied Chemical & Dye Corporation 512 



CONTENTS xiii 

PAGE 

D. Issuance of Stock 

United States Steel Corporation No. 2 521 

Hershey Chocolate Corporation 526 

Air Reduction Company, Incorporated 534 

XIX. CONSOLIDATED STATEMENTS 

Yorktown Manufacturing Company 542 

American Telephone and Telegraph Company 

No. 4 547 

United States Steel Corporation No. 3 568 

XX. STATEMENT or SOURCE AND APPLICATION OF FUNDS 

General Refractories Company 569 

Radio Corporation of America No. 2 575 

PART V 
ACCOUNTING FOR INCOME AND EXPENSE 

XXI. THE MEASUREMENT or INCOME 

Cases on Income Measurement 579 

XXII. DETERMINATION OF GROSS INCOME 

Richards Realty Company 581 

Bancroft Company 582 

Wellman Construction Company 589 

Self arm Building Supply Company, Vincent Com- 
pany, Gillette Safety Razor Company 593 

Greenleaf Textile Mills 595 

Arnett Textile Mills 597 

Coleworthy Print Mills 598 

Fells Manufacturing Company 599 

West Virginia Investment Corporation 601 

XXIII. THE DISTINCTION BETWEEN OPERATING AND NON-OPER- 

ATING INCOME AND EXPENSE. DIRECT CHARGES TO 

SURPLUS 

Tri-Continental Corporation 603 

Curwood Manufacturing Company 606 

Rogers Copper Company 607 

Austin Mining Company 609 

Brolind Mining Company 612 

Union Carbide and Carbon Corporation 613 

American Commercial Alcohol Corporation .... 621 

XXIV. RESERVES 

Uvalde Company 627 

Market Basket Corporation 629 



xiv CONTENTS 

PAGE 

Atlas Powder Company 631 

Chrysler Corporation 635 

The Limmer and Trinidad Lake Asphalt Company, 
Ltd., Daily Mirror Newspapers, Ltd 637 

XXV. POLICIES IN THE DETERMINATION OF INCOME 

International Harvester Company No. 2 645 

INDEX 687 



ALPHABETICAL LIST OF CASES 



Aberdeen and Company 445 

Air Reduction Company, In- 
corporated 534 

Allied Chemical & Dye 
Corporation 512 

Allis- Chalmers Manufactur- 
ing Company 505 

Aluminum Company of 
America 51 

American Commercial Alco- 
hol Corporation 621 

American Locomotive Com- 
pany 502 

American Smelting and Re- 
fining Company 492 

American Telephone and Tel- 
egraph Company No. i 3 

American Telephone and Tel- 
egraph Company No. 2 378 

American Telephone and Tel- 
egraph Company No. 3 484 

American Telephone and Tel- 
egraph Company No. 4 547 

American Tobacco Company, 
The 157 

Analysis of Transactions, The 
No. i , 68 

Analysis of Transactions, The 
No. 2 94 

Arnett Textile Mills 597 

Atlas Powder Company 

Austin Mining Company 

Bancroft Company 582 

Blaw-Knox Company 311 

Boren Steamship Company 
No. i 323 



Boren Steamship Company 
No. 2 329 

Boston Edison Company 396 

Boston Elevated Railway 
Company 40 

Bowers Rubber Manufactur- 
ing Corporation 145 

Brewster Paper Company 
No. i 114 

Brewster Paper Company 
No. 2 123 

Bristol Valley Stove Com- 
pany 25 

Brolind Mining Company 612 

Byers, A. M., Company 459 

California Packing Corpora- 
tion 474 
Chelmsford Knitting Com- 
pany No. i 39 
Chelmsford Knitting Com- 
panyNo. 2 316 
Chrysler Corporation 635 
Churchill Publishing Com- 
pany No. i 177 
Churchill Publishing Com- 
pany No. 2 212 
Clark Wholesale Paper Com- 
pany 1 88 
Clarkson, R. G., and Sons 283 
Coca-Cola Company 508 
Coleworthy Print Mills 598 
Cudahy Packing Company, 

The 9 

C u r w o o d Manufacturing 
Company 606 



xv 



XVI 



ALPHABETICAL LIST OF CASES 



Davis and Wall, Inc. 268 

Deere & Company 470 

Delta Packing Company 171 
Detroit Edison Company 

No. i 125 

Detroit Edison Company 

No. 2 412 

Detroit Edison Company 

No. 3 438 

Drake Chemical Company 

No. i 131 

Drake Chemical Company 

No. 2 133 

Eastman Kodak Company 454 
Edinburgh Gas and Electric 
Company 304 

Fells Manufacturing Com- 
pany 599 

General Electric Company 480 
General Manufacturing Cor- 
poration 434 
General Motors Corporation 481 
General Refractories Com- 
pany 569 
General Trust Company 99 
Glenway Company 247 
Grant Rubber Company 215 
Greenleaf Textile Mills 595 

Halstead Company 293 

Hamilton Woolen Company 467 

Harmon Coal Company 207 
Hartshorn, C. F., and Sons, 

Inc. 141 

Harvard Cooperative Society 295 
Hastings and Eau Claire 

Print 197 

Henley Radio Company 351 

Henderson Mills 137 
Herendeen and Haply Woolen 

Mills No. i 31 



Herendeen and Haply Woolen 
Mills No. 2 65 

Hershey Chocolate Corpora- 
tion 526 

International Harvester Com- 
pany No. i 243 

International Harvester Com- 
pany No. 2 645 

Kirk well Manufacturing 
Company No. i 253 

Kirk well Manufacturing 
Company No. 2 258 

Kirkwell Manufacturing 
Company No. 3 262 

Limmer and Trinidad Lake 
Asphalt Company, Ltd., 
The, and Daily Mirror 
Newspapers, Ltd. 637 

Lincoln Company 292 

Long Point Gas Company 404 

McKesson & Robbins, Inc. 
No. i 154 

McKesson & Robbins, Inc. 
No. 2 191 

Manger Manufacturing Com- 
pany 43 2 

Market Basket Corporation 629 

Mayberry Bag Company 277 

National Lead Company 229 

New England Telephone and 
Telegraph Company 338 

Northern Electric Manufac- 
turing Company No. i 289 

Northern Electric Manufac- 
turing Company No. 2 299 

Northern Electric Manufac- 
turing Company No. 3 331 

Northern Electric Manufac- 
turing Company No. 4 334 



ALPHABETICAL LIST OF CASES 



xvn 



Northern States Power Com- 
pany 442 
Northey National Bank 139 

Packard Motor Car Com- 
pany 499 

Pendar Paper Company 
No. i 126 

Pendar Paper Company 
No. 2 147 

Plymouth Oil Company 479 

Pullman, Inc. 379 

Radio Corporation of Amer- 
ica No. i 487 

Radio Corporation of Amer- 
ica No. 2 575 

Richards Realty Company 581 

Riverbank Gas and Electric 
Company 28 

Robinson Shoe Company 
No. i 128 

Robinson Shoe Company 
No. 2 129 

Rogers Copper Company 607 

Selfarm Building Supply 
Company, Vincent Com- 
pany, Gillette Safety Razor 
Company 593 

Southern Peanut Products 
Company 176 

Steele, John L., Realtor 
No. i 79 

Steele, John L., Realtor 
No. 2 90 



Steele, John L., Realtor 

No. 3 94 

Swift & Company 238 

Texas Gulf Sulphur Com- 
pany, Inc. 183 
Tri-Continental Corporation 603 
Trundell Power Company 308 

Union Carbide And Carbon 
Corporation 613 

United States Steel Corpora- 
tion No. i 356 

United States Steel Corpora- 
tion No. 2 521 

United States Steel Corpora- 
tion No. 3 568 

Uvalde Company 627 

Warner Bros. Pictures, Inc. 162 
Wellington Shoe Company 17 
Wellman Construction Com- 
pany 589 
Westinghouse Air Brake 

Company, The 462 

West Virginia Investment 

Corporation 60 1 

Whitman Tin Plate Company 182 
Wilcox Lumber Company 

No. i 106 

Wilcox Lumber Company 

No. 2 in 

Winbigler Textile Mills Com- 
pany 425 

Yorktown Manufacturing 
Company 542 



PART I 

AN INTRODUCTION TO ACCOUNTS, BALANCE 
SHEETS, AND INCOME STATEMENTS 



I. THE GENERAL STRUCTURE AND FUNCTION 
OF FINANCIAL STATEMENTS 

AMERICAN TELEPHONE AND TELEGRAPH COMPANY No. i 

THE STRUCTURE AND FUNCTION OF BALANCE SHEETS 
AND INCOME STATEMENTS 

The American Telephone and Telegraph Company has long 
been noted as a corporation which has attempted through its 
annual reports and by other means to present relatively complete 
information to its stockholders and creditors and to other persons 
interested in the enterprise. At December 31, 1936, there were 
641,000 stockholders of record of the American Telephone and 
Telegraph Company, no one of whom held as much as i per cent of 
the total stock. 

The annual report for 1936, which was a document of 30 pages, 
included balance sheets of the American Telephone and Telegraph 
Company for December 31, 1936, and for December 31, 1935, and 
an income statement for the intervening period, the year ending 
December 31, 1936. These statements are reproduced below, 
together with a supporting schedule showing the investment in 
subsidiary or other companies as of December 31, 1936, and a 
second schedule showing the separate issues of bonds included in 
funded debt in 1936 and in 1935. 



ACCOUNTING STATEMENTS 



AMERICAN TELEPHONE AND TELEGRAPH COMPANY 
BALANCE SHEET 



Assets 


December 31, 
1936 


December 31, 
1935 


Plant and Other Investments: 
Telephone Plant . 


$4.32 114. 2<\8 


$4.36 331 74.2 


Plant and equipment mainly for pro- 
viding interconnection between and 
through territories of operating tele- 
phone subsidiaries and other telephone 
companies 
Investments in Subsidiaries (at cost) (a) . 
Stocks(b) . . $2,182,225,246 
Notes and advances .. 114,517,131 
Other Investments (at cost) (a) 


2,296,742,377 

4.2 .4.18. 124. 


2,274,761,609 
4.7 806 . 04.6 


Stocks $ 41,725,605 
Notes 453,591 
Miscellaneous Physical 
Property . 238,928 
Sinking Funds 


500 , ooo 


1,202,573 


Total Plant and Other Investments 


$2,771,774,759 


$2,760,102,870 


Current Assets: 
Cash required to retire funded debt called 
for redemption including premiums 
Other Cash and Deposits 
Temporary Cash Investments 
United States Government obligations. 
Market value December 31, 1936, 
$i7o,559,9oo. 
Current Receivables . 
Amounts due for service (less reserve for 
uncollectible accounts), interest and 
dividends receivable, working ad- 
vances, etc. 
Material and Supplies 


$ 138,960,090 
9,622,308 
170,633,835 

13,942,404 
8,661,481 


$ 
18,236,185 

194,339,659 
13,010,978 

8,38l , 300 








Total Current Assets ... . 


$ 341,820,118 


$233 068 131 








Deferred Debits: 
Unamortized Discount on Funded Debt 


j> 2,577,679 


$ 


Other Deferred Debits ... 
Prepayments of rents, taxes, insurance, 
etc.; deposits with workmen's compen- 
sation commissions; and miscellaneous 
items the final disposition of which had 
not been determined at close of year. 


1,517,021 


1,680,878 


Total Deferred Debits 


$4. , OQ4, . 7OO 


$ 1,680,878 








Total Assets 


$3,117,689,577 


$2,995,751,879 









(a) See detailed list of investments in securities. 

(b) At December 31, 1936, stocks of subsidiaries earned at $112,460,166 were pledged under 
a trust indenture securing the Company's Thirty Year, Collateral Trust $s, called for redemp- 
tion on December i, 1936. It is expected that the collateral pledged will be released dunng 
1937. (Continued on page 8) 



AMERICAN TELEPHONE & TELEGRAPH CO. NO. 



AMERICAN TELEPHONE AND TELEGRAPH COMPANY 
BALANCE SHEET. (Continued) 



Liabilities 



December 31, 
1936 



December 31, 
1935 



Capital Stock: 

Stock issued and outstanding (Authorized 

$2,500,000,000.) 

Par value, $100 per share, of common 
stock outstanding. 

Premiums on Capital Stock 

Amount received in excess of par value. 

Capital Stock Installments 

Amount received under Employees' 
Stock Plan on stock subscriptions not 
yet completed or cancelled. (This 
Plan was discontinued as to new sub- 
scriptions in 1933.) 

Total Capital Stock 
Funded Debt(c) < ...... . 

Notes sold to Trustee of Pension Fund 

Demand notes held by Trustee as an in- 
vestment of pension funds not pres- 
ently required to meet pension pay- 
ments. 
Current and Accrued Liabilities: 

Funded Debt called for redemption but not 
presented for payment, including pre- 
miums 

Dividend Payable January 
Accounts Payable 
Interest and Taxes Accrued 

Total Current and Accrued Liabili- 
ties 
Deferred Credits 

Items, the final disposition of which had 

not been determined at close of year. 
Depreciation Reserve 

Provision to meet loss of investment in 
depreciable plant upon its ultimate re- 
tirement from service. 
Surplus. 

Surplus Reserved 

Amount reserved against general con- 
tingencies. 

Unappropriated Surplus 

Additions during 1936: 
Net income after divi- 
dends 
Miscellaneous additions. 

Total additions 
Deductions during 1936: 
Premiums on funded debt 

called . . .. $30,041,730 

Miscellaneous deductions 887,647 

Total deductions . . . $30 ,929,377 

Net decrease . 

Total Liabilities 



$1,868,509,300 

269,889,978 
250,602 



$1,866,227,500 

268,749,078 
4,330,337 



$2,138,649,880 



$2,139,306,915 



$ 443,093,700 
11,022,113 



$ 443,532,600 
11,022,113 



$ 138,960,090 
42,041,459 
6,802,723 
7,782,816 



41,990,119 

3,416,837 

11,263,579 



$ 195,587,088 



S 56,670,535 



1,455*165 



IO2 ,649,072 



64,664,444 



160,568,115 



$ 



1,775,453 



95,040,547 



64,664,444 



183,739,272 



6,745,235 
1,012,985 



$ 7,758,220 



$23,171,157 



$3,117,689 ,577 



$2,995,751,879 



5 ACCOUNTING STATEMENTS 

AMERICAN TELEPHONE AND TELEGRAPH COMPANY 
INCOME STATEMENT 

Operating Revenues Year 1936 

Toll Service Revenues . . $ 89,636,121 

Message tolls and private line service revenues. 

License Contract Revenues 13,450,531 

Payments received for services furnished telephone com- 
panies under license contracts. 

Miscellaneous Revenues 4,199,119 

Less: Uncollectible Operating Revenues. . . . 364,987 

Total Operating Revenues $106,920,784 

Operating Expenses (a) 

Current Maintenance $ 16,143,285 

Depreciation Expense 17,376,311 

Traffic Expenses 6 , 1 29 , 897 

Commercial Expenses 2,590,614 

Operating Rents i I > 2 55>777 

General Administration (b). . . . 15,638,501 

Accounting and Treasury Department Expenses 3,284,487 

Provision for Employees' Service Pensions 914,521 

Employees' Sickness, Accident, Death and Other Benefits . . 450,960 

Other General Expenses i , 163 , 791 

Less: Expenses Charged Construction 100, 210 

Total Operating Expenses $ 74, 847 ,934 

Net Operating Revenues $ 32,072,850 

Operating Taxes 

Federal Income $ 85 2 , 434 

Social Security (Excludes $17,170 charged Construction) . 302 , 725 

Other Principally state and local . . 5 , 607 , 834 

Total Operating Taxes . . $ 6, 762,993 

Net Operating Income . $ 25,309,857 

Dividend Income . . 166,071,313 

Interest Income . 7,048,640 

Other Income Net ... ... .. . 839,682 

Total Income $199,269,492 

Interest Deductions . . 24,443,078 

Net Income(c) . . $174,826,414 

Dividends Declared . ... 168,081,179 

At $9 oo per share of capital stock. 

Balance transferred to Surplus. . . $ 6,745,235 



(a) The greater part of Operating Expenses are incurred in connection with the Company's 
long distance communication service, but such expenses also include substantial amounts 
incurred by the Company in the performance of its License Contract services furnished tele- 
phone companies. 

(b) Includes $9,596,878 for 1936 for cost of development and research work earned on in 
behalf of the Company by Bell Telephone Laboratories. 

(c) Net Income of the Company by itself for 1936 is less by $9,918,050 than the Company's 
proportion of the consolidated Net Income of the Bel 1 System for these years. 

Note . The Company does not consider that any liability exists in respect of Federal surtax 
on undistnbuted earnings in 1936. 

C. A. HEISS, Comptroller. 
Source: Company report. 



AMERICAN TELEPHONE & TELEGRAPH CO NO. i 7 



SCHEDULE i 

AMERICAN TELEPHONE AND TELEGRAPH COMPANY 

INVESTMENTS IN SUBSIDIARY AND OTHER COMPANIES AT 

DECEMBER 31, 1936 





Capital Stocks (a) 


Notes and 
Advances 


Par Value of 
Holdings 


% of 
Total 
Out- 
standing 


Book Value 
(Cost) 


Face Value 


Subsidiary Companies 
New England Tel. & Tel. Co 
New York Tel. Co 
New Jersey Bell Tel. Co 
Bell Tel. Co. of Pennsylvania 
Diamond State Tel. Co 
Chesapeake & Potomac Tel Co 
Chesapeake & Potomac Tel. 
Co. of Bait. City 
Chesapeake & Potomac Tel. Co. 
of Va 
Chesapeake & Potomac Tel. Co. 
of West Va . . . 
Southern Bell Tel. & Tel. Co . 
Ohio Bell Tel. Co 
Michigan Bell Tel. Co 
Indiana Bell Tel Co 


$ 87,094,200 
421 ,300,000 
140,000,000 

110,000,000 

5,000,000 
20 ,000 , ooo 

30,000,000 
18,000,000 

16,200,000 
124,998,700 
120,999,600 
124,989,607 
32,999,100 
40,000,000 
148,959,600 
100,000,000 
172,999,000 
34,987,500 

154,870,900 
64.095,700 
50,000 

(ch,o/>5,Q75 
S , 500 ,000 

75 ,000 

$ 13,337,400 

8, 169 , 150 
i8.749.8oo 

432,500 

325,000 
1,230 


65 3i 

IOO OO 
100 OO 
IOO 00 
IOO OO 
IOO 00 

IOO 00 
IOO 00 

IOO OO 
99 99 
99 99 
99 99 
99 99 

IOO OO 

99 3i 

IOO OO 

99 99 
72.82 

85 80 
78 17 
(b)so oo 
09 43 

IOO OO 
IOO OO 

33 34 

20 72 
23 86 

50 oo 
50 oo 


$ 92,045,721 
444,280,335 
153.667,184 
116,316,050 
5,700,000 

21 .OOO.OOO 
31,467,862 
l8,OOO,OOO 

16, 200,000 
126,815,773 
130,041 ,808 

125,402, 210 
33,585,586 
43,223,835 
154,440,399 

ioi ,030,490 
176, 2S2.O78 

36,362,463 
150,529,084 

55,999, i 80 
50,000 

144,216,098 
5,515,000 

75,000 


$ 17,100,000 

6,500,000 
5,607,769 
730,000 
2,895 ,000 

4,225,000 
4,675,000 

1,900,000 
8,000,000 

6, 150,000 
5,414,362 

ii ,240,000 
16,200,000 
4,400,000 

2,475,000 

(d)i5,520,ooo 
i ,485,000 


Wisconsin Tel. Co 


Illinois Bell Tel. Co 
Northwestern Bell Tel. Co . 
Southwestern Bell Tel. Co 
Mountain States Tel. & Tel. Co. 
Pacific Tel. & Tel. Co. Com- 
mon 


Pacific Tel. & Tel. Co. Pre- 
ferred 


Bell Telephone Laboratories, 
Inc . 
Western Electric Co., Inc. (no 
par value) . 
195 Broadway Corporation 
Eastern Tel. & Tel. Co. (Can- 
ada) 


Total Book Value (Cost) 
Other Companies 
Southern New England Tel. Co 
Cincinnati & Suburban Bell 
Tel. Co . 
Bell Telephone Co. of Canada 
Cuban American Tel. & Tel. 
Co. Common 
Cuban American Tel. & Tel. Co. 
Preferred 
Sundry 


$2,182,225,246 $114,517,131 


$ 13,649,213 

8,732,568 
18,854,783 

162,500 

325,000 
1,541 


$ 450,000 






3,591 


Total Book Value (Cost) 


$ 41,725,605 $ 453,591 


1 



(a) Common shares except as otherwise indicated, (b) Remaining 50% owned by Western 
Electric Company, Inc. (c) Number of shares, (d) Includes real estate mortgages of 
$13,100,000. 

Source: Company report. 



ACCOUNTING STATEMENTS 



SCHEDULE 2 

AMERICAN TELEPHONE AND TELEGRAPH COMPANY 
FUNDED DEBT 





1936 


1935 


Thirty-Year Collateral Trust 55, 1946 


(a) 


$ 64,865,200 


Thirty-five Year Sinking Fund Debenture 55, 1960 


(a) 


117,984,700 


Thirty-five Year Debenture 55, 1965 


(a) 


150,000,000 


Twenty-Year Sinking Fund Debenture 5^s, 1943 


$ 95,170,700 


95,170,700 


Twenty-five Year Debenture 3^8, 1961 


175 ,000,000 




Thirty-Year Debenture 3M S > J 9 66 - 


I 60 , OOO , 000 




Thirty-Year 45, 1936 




2,589,000 


Ten- Year Convertible 4J^s, 1939 . 


12,923,000 


12,923,000 


Total Funded Debt . 


$443,093,700 


$443,532,600 



(a) Amount of this issue outstanding on December 31, 1936, treated as a current liability. 
Source: Company report. 



1. What groups of persons are interested in the facts recorded 
in the annual report of this corporation? In what decisions do 
they rely on the facts recorded? 

2. To what extent are these persons familiar with financial 
statements and with the business facts reflected therein? Is the 
situation different in the case of this corporation from the situation 
in the case of smaller and somewhat less complex business enter- 
prises of 50 and a 100 years ago? 

3. What are the principal facts which an investor might wish 
to find recorded in a balance sheet and income statement? Is it 
possible for a typical investor to find these facts clearly set forth 
in the statements? 

4. What is the function of the annual report of this corpora- 
tion? As elements in this annual report, could the balance sheet 
and income statement be changed so that they would fulfill the 
function of the report more fully? 

(Continued from page 4) 

(c) At December 31, 1936, $126,560,600 face amount of funded debt called for redemption 
had not been presented for payment. This liability, together with the premiums of $12 ,399,490, 
is shown under Current and Accrued Liabilities. 

No specific provision has been made in the accounts in respect of a contingent liability 
to the City of New York for taxes imposed under Local Law No. 19 of 1933, and subsequent 
similar laws, since the Company denies liability for such taxes; nor has specific provision been 
made for contingent liabilities in connection with certain suits involving patent licensing agree- 
ments and alleged patent infringements since it is the opinion of counsel for the Company that 
it is improbable that the claims thereunder can be sustained. 

On December 31, 1936, the Company was surety on bonds for $17,112,669, executed by The 
Ohio Bell Telephone Company (a subsidiary) as principal, to secure possible refunds to telephone 
users. In this connection, the Company was also surety on a bond for $20,000,000 filed in 
connection with the appeal from a judgment of the Supreme Court of Ohio to the Supreme 
Court of the United States contesting the obligation of The Ohio Bell Telephone Company to 
make these refunds. 

Federal income tax returns of the Company have not been closed for the years subsequent 
to IQ3O. 

C. A. HEISS, Comptroller. 



THE CUDAHY PACKING COMPANY 9 

THE CUDAHY PACKING COMPANY 

THE STRUCTURE OF BALANCE SHEETS, INCOME STATEMENTS, 
AND SURPLUS STATEMENTS 

It is the purpose of this case to examine certain structural 
features in the relation of the balance sheet of an enterprise at the 
beginning of the period, the income statement and surplus state- 
ment for the period, and the balance sheet at the end of the period. 
These statements for The Cudahy Packing Company for the year 
ending October 31, 1936, are reproduced below. 



1. a. Determine the current ratios for November 2, 1935, and 
for October 31, 1936. For this purpose, divide total current assets 
by current liabilities. 1 

b. In using ratios it is necessary to examine critically the 
facts on which they are based. In this case is there any reason to 
question the items classified as current? 

c. Why did the current ratio change between the two 
balance sheets? 

d. Is it possible to determine from the statements why the 
corporation borrowed additional funds during the year? 

e. Were there alternative methods of meeting the financial 
needs of the business which would have resulted in showing a 
higher current ratio in 1936? 

/. Determine net working capital (current assets minus 
current liabilities) in 1935 and 1936. 

2. #. Determine the days' sales on the books in 1936. For this 
purpose divide net sales and operating revenue for 1936 by 360 to 
obtain an approximation of the average daily sales. Add notes 
receivable to accounts receivable trade, and divide the total by 
the figure for average daily sales. 

b. Net sales and operating revenue for the year ending 
November 2, 1935, were $180,218,129. Make a similar computa- 
tion of the days' sales on the books for 1935. 

c. Is it reasonable to assume that mpst of the customers took 
about the number of days indicated to pay their bills? 



1 Ratios determined in a comparable manner for The Cudahy Packing Company 
in earlier years, and for other packing companies in 1935 and 1936, and also in 
earlier years are given in Exhibit i. 



io ACCOUNTING STATEMENTS 

3. a. Determine the turnover of inventories for 1936. One 
method would be to divide the figure given for cost of goods sold 
by the inventories at the end of the period. 1 Determine also the 
ratio of sales to inventory in 1935 and 1936 by dividing sales for 
each year by inventory at the end of the year. 

b. If it were possible to operate this business with a higher 
turnover of inventories, what would be the effect on the working 
capital position of the company ? 

4. a. In every business there is a flow of funds in to the business 
and a similar flow outward. What were the principal sources of 
the funds received by this business during 1936? 

b. In what ways were the funds applied which were paid out 
during the year? 

5. Determine the percentage of secured, long-term debt to 
fixed assets in 1935 and 1936. For this purpose include the sinking 
fund payments due within one year and use the net figure for 
fixed assets after deducting the reserve for depreciation. The 
security lying behind the first mortgage bonds and the debentures 
was summarized as follows by the Standard Statistics Company : 

First Sinking Fund, 3% s > Series A, due 1955: 

Nature of Lien A direct obligation of company and secured by first mortgage 
lien upon: 

(1) All of more important properties owned by company on Sept. i, 1935. 
After acquired properties are also to be conveyed as security. Company covenants 
that subsidiaries will keep their properties free and clear of lien, other than those 
existing thereon Sept. i, 1935, and lien of current taxes or purchase money mortgages. 

(2) By pledge of all capital stock of following subsidiaries: 
Cudahy Packing Co. of Alabama 

Cudahy Packing Co. of Louisiana, Ltd. 

Barry Machinery Co. 

Dow Cheese Co. 

Olneyville Wool Combing Co. 

Bissel Leather Co. 

Willows Cattle Co. 

Cudahy Packing Co., Ltd. (Foreign) 

Cudahy Co., Ltd. (Foreign) 

Also by pledge of 23,487 shares Class A and 83,487 shares Class B stocks of 
American Salt Company. 

Stocks of subsidiaries acquired after Sept. i, 1935 are also to be pledged as 
security. 

The indenture contains provisions for release of security and substitution there- 
for. Company also covenants that so long as any of these bonds remain outstanding, 
consolidated current assets at all times will be maintained at an amount equal to 
at least one and one-half (iK) times consolidated current liabilities. 



1 Figures for cost of goods sold, necessary to the computation of turnover, are not 
available for other packing companies, and for the Cudahy company are available in 
1936 only. 



THE CUDAHY PACKING COMPANY n 

Company covenants that it will not permit any subsidiary to create any indebted- 
ness, other than to the company, maturing in more than 12 months and that it will 
not permit any subsidiary to sell any stocks which rank prior to or on a parity with 
common stock of such subsidiary pledged unless such stock is deposited with the 
trustee for pledging hereunder. 

Dividend Restrictions Company covenants not to declare or pay any dividends 
and make any distribution on its common stock (other than stock dividends) except 
out of earned surplus, and, shall not (i) during any period that earned surplus is 
less than, or which by such declaration would be reduced below $6,000,000, make 
any such payment at a rate greater than i % quarterly on its then outstanding com- 
mon stock of $50 par value, and (2) during any period that earned surplus is less 
than $5,000,000, make any declaration or distribution. 

Equity Prior in lien to $4,937,500 of 4% Convertible Debentures of 1950. 

Prior Liens Subject to $40,000 purchase money mortgages. 

Offered ($20,000,000) on Aug. 4, 1935, at 100 and interest. 
Convertible Sinking Fund Debenture 45, due 1950: 

Security A direct obligation of company but not secured by mortgage. The 
agreement under which the debentures were issued contains a covenant that the com- 
pany, while any of the debentures remain outstanding, shall at all times maintain 
current assets of company and its subsidiaries at least equal to \}/ times all current 
liabilities, plus the principal amount of debentures then outstanding. 

Dividend Restrictions have been published under ist Mtge S. F. A 3%s, 1955. 

Prior Liens Subject to $40,000 purchase money mortgages and $19,825,000 
first mortgage, A 3%s, due Sept. i, 1955. 

Offered ($5,000,000) on Aug. 4, 1935, at 100 and interest. 1 

6. a. Determine the percentages of total liabilities represented 
by current liabilities, long-term debt, and net worth in 1936. For 
this purpose include the sinking fund payments with current 
liabilities and leave the minority interest out of the three major 
classes. The total of the three percentages will thus be slightly 
below 100 per cent. 

b. Determine similar percentages for 1935. 

c. What are the reasons for the changes? 

7. a. Determine the number of times interest was earned in 
1936. For this purpose use the net income figure before interest 
charges less the provision for Federal income tax. Divide this by 
the total of all interest charges. 

b. Determine the percentage which net income for 1936 was 
of net sales and operating revenue for that year, total assets at the 
end of the year, and net worth at the end of the year. 

8. In this case is the amount of long-term debt so great that it 
jeopardizes the position of the common stock in the event of the 
corporation meeting several years of depression and reduced 
earnings? 



1 Standard Bond Descriptions, Individual Descriptions Section, Vol. n, No. 1023, 
January 20, 1937. 



12 



ACCOUNTING STATEMENTS 



THE CUDAHY PACKING COMPANY 

(A MAINE CORPORATION) 
CONSOLIDATED BALANCE SHEETS 



Assets 


November 2, 
1935 


October 31, 
1936 


Current Assets: 
Cash 


$ 5,933,343 55 
19,257 12 

8,328,901 08 
260,273 43 

r9, 828, 842 oo 
1,532,240 92 
73,023 96 


$ 5,342,974 05 
42,433 55 

8,879,935 78 
412,212 38 

24,459,762 oo 
1,640,972 75 
47,006 99 


Notes receivable ... 


Accounts receivable 
Trade 
Other . 


Inventories Products where costs were not ascertain- 
able were valued at approximate market prices, 
allowing for estimated selling expenses; other prod- 
ucts, and ingredients and supplies at the lower of 
cost or market 
Product 
Ingredients and supplies . . 


Due from employees , 

Investments and Other Assets: 
Stock of subsidiaries not consolidated 
Other investments earned at cost 
Long-term receivables, etc. ... 

Special Deposits under State Compensation Acts 

Fixed Assets- 
Real estate, buildings, machinery, etc Appraised 
value at Oct. 30, 1915 (date of reorganization) plus 
subsequent additions at cost 
Packing and other manufacturing plants 
Sales branches 
Car and refrigerator line 
Farm and mineral lands . ... 

Less: Reserve for depreciation 

Intangible Assets: 
Old Dutch Cleanser advertising investment . . 
Royalty interest, goodwill, etc , being amortized 

Prepaid Expenses and Deferred Charges: 
Prepaid insurance and interest 
Stationery and advertising inventories 
Miscellaneous deferred charges . . . 
Bond and debenture discount and expense, being amor- 
tized over the life of the present issues, including 
$782,304.38 in 1935, and $732,768 oo in 1936, or 
premiums and discount and expense, applicable to 
refunded issues ..... 


$35,975,942 06 


$40,825,297 50 


$ 28,750 oo 
252,564 12 
302,903 88 


$ 28,750 00 
225,506 45 
300,497 30 


$ 584,218 oo 


$ 554,753 75 


$ 30,000 oo 


$ 29,540 63 


$32,564,945 04 
6,693,281 .07 
3,340,993.00 
1,709,187 31 


$33,970,686 94 
6,698,459 78 
3,267,611 oo 
1,682,884 50 


$44,308,406 42 
7,226,961 70 


$45,619,642 22 

7,520,625.62 


$37,081,444 72 


$38,099,016 60 


5 750,000 oo 
no, 168 oo 


$ 750,000 oo 
94,656 oo 


t 860, 168 oo 


$ 844,656 oo 


186,057 96 
171,091 07 
106,766 99 

1,441 , 103 60 


$ 255,458 40 

173,854 13 

157,057 89 
i , 383 , 498 oo 




I ,905,019 62 


1,969,868 42 


^76,436,792 40 


82,323,132 90 







* The first sinking fund payment on the First Mortgage sinking fund bonds, due Sept. i, 
, was due on Sept. i, 1936, and semiannually thereafter. The first sinking fund payment 
on the Convertible sinking fund 4% debentures was likewise due Sept. I, 1936, and semiannu- 
ally thereafter. 



THE CUDAHY PACKING COMPANY 



THE CUDAHY PACKING COMPANY 

(A MAINE CORPORATION) 
CONSOLIDATED BALANCE SHEETS. (Continued) 



Liabilities 


November 2, 
1935 


October 31, 
1936 


Current Liabilities: 
Notes Payable 
Banks and brokers . 


$ 4,505,000 oo 

453.OOO .00 

797,899.47 
3,224,618.17 
1,037,840.87 
85,960.00 

167,154.66 


$ 9,780,500 oo 
483,000 oo 
1,074,775 90 

1,102,147 50 
158,555 oo 

1,289,201 95 
I , OOO , OOO OO 

289,267 .50 
292, 187.78 

350,000 oo 
125,000 oo 


Others 


Accounts payable 


U. S. processing tax 
Due to officers and employees . .... . . 
Bond and debenture interest accrued 
Reserve for Federal and state taxes, embracing income, 
unjust enrichment and social security (subject to 
final determination) 


Employees' pension trust ... ... ... 


Preferred dividends payable Nov. i, 1936 




Common dividends payable Nov. 5, 1936 




Sinking fund payments due within one year 
First mortgage sinking fund bonds, due Sept. i, 1936, 
and Mar. i.and Sept. i, 193? 
Convertible sinking mnd debentures, due Sept. i, 
1936, and Mar. i and Sept. i 1937 


175,000.00 

62,500 oo 
32,000 oo 


Purchase money mortgages, oue Nov. i, 1936 . . 

Long-term Debt:* 
First mortgage sinking fund bonds, due Sept. i, 1955 
Authorized $30,000,000, Issued series "A" 3^4% 


$10,540,973 17 


$15,944,635.63 


$20,000,000 oo 


$20,000,000 oo 
175,000 oo 


Less: Bonds calfed (cash deposited with trustee) 

Deduct: Sinking fund payments due Sept. i, 1936, 
and Mar. i and Sept. i, 1937, provided above 

Convertible sinking fund 4% debentures, due Sept. r, 
1950 
Authorized and issued 
Less: Debentures called (cash deposited with trustee) 

Deduct: Sinking fund payments, due Sept. i, 1936, 
and Mar. i and Sept. i, 1937, provided above 

Purchase money mortgages 


$20,000,000 oo 
175,000 oo 


$19,825,000 oo 
350,000 oo 


$19,825,000 oo 


$19,475,000 00 


$ 5,000,000 oo 


$ 5,000,000 oo 
62,500 oo 


$ 5,000,000.00 
62,500 oo 


$ 4,937,500 oo 
125,000 oo 


$ 4,937.500 00 


$ 4,812,500 oo 


$ 107,500 oo 


$ 40,000 oo 


Minority Interest in Subsidiary Company: 
Capital Stock 
Surplus . 


$24,870,000 oo 


$24,327,500 oo 


$ 126,096 oo 

47,700 40 


$ 121,248 oo 
52,791 74 


Capital Stock and Surplus: 
Capital stock 
Preferred stock 6% cumulative, $100 par value: 
Authorized and outstanding 


$ 173,796 40 


$ 174,039 74 


$ 2,000,000 00 

6,550,500 oo 

23,374,450 00 


$ 2,000,000.00 

6,550,500 oo 

23,374,450 00 


Preferred stock 7% cumulative, $100 par value: 
Authorized and outstanding 


Common stock $50 par value: 
Authorized $36,449,500 


Outstanding . 


Surplus 
Caoital surplus 


$31. 924,950 oo 


$31,924,950 oo 


$ 1,720,414 03 
7,206,058 80 


$ 1,722,801 49 
8,229,206 04 


Earned surplus 


Contingent Liabilities: 
Foreign drafts discounted, $247,180.32 in 1935, and 
$158,100 46 in 1936. 
Possible liability arising out of sundry lawsuits which, 
in the opinion of officers of the company, will not 
exceed $5,ooo in 1935, and $10,000 in 1936. 


$ 8,9*7,072.83 


$ 9,952,007 53 


$40,852,022 83 


$41,876,957.53 






$76,436,792 40 $82, 323, 132. 90 



i 4 ACCOUNTING STATEMENTS 

THE CUDAHY PACKING COMPANY 

(A MAINE CORPORATION) 

CONSOLIDATED INCOME STATEMENT 

FOR THE PERIOD FROM NOVEMBER 2, 1935 TO OCTOBER 31, 1936 

Net sales and operating revenue $201 ,605, 825 .00 

Cost of goods sold, including operating costs, 
and excluding the charges deducted below 185,475, 400 . oo 

$ 16,130,425.00 

Selling, advertising, general and adminis- 
trative expense $10,283,543.00 

Depreciation 1,552,609 oo 

Taxes (other than income taxes) 853,907.00 

Bad debts, charged off, less recoveries .... 136,88900 12,826,948.00 

Operating income $ 3,303,477.00 

Other income and deductions: 
Dividends other invest- 
ments $ 2,418.00 

Interest received misc 9 , 548 . oo 

Rents received 36,075.00 

Proceeds from life insurance 
policy 25,563.00 $ 73,604.00 



Loss on sale of capital assets 16,672.00 56,932.00 

$ 3,360,409.00 
Interest charges: 

Interest on funded debt $ 949,841 .00 

Amortization of debt discount and 

expense 101,492.00 

Other interest 136,05400 1,187,387.00 

$ 2,173,022.00 
Provision for Federal income tax 345 , 065 . oo 

$ 1,827,957.00 
Less: Earnings applicable to minority 

interest 12, 344 . oo 

Net income for the period $ 1,815,613 oo 



THE CUDAHY PACKING COMPANY 15 

THE CUDAHY PACKING COMPANY 

(A MAINE CORPORATION) 
CONSOLIDATED SURPLUS ACCOUNT 

FOR THE PERIOD FROM NOVEMBER 2, 1935 TO OCTOBER 31, 1936 
Capital surplus: 

As at November 2, 1935 $1,720,414.03 

Add: 

Capital surplus arising from acquisi- \ 
tion of additional interest in a sub- 
sidiary company 2,387.46 

$1,722,801.49 
Earned surplus: 

As at November 2, 1935 $ 7,206,658.80 

Add: 

Transferring to surplus the hog process- 
ing tax accrued to November 2, 1935 
and unpaid at the date the tax was 
invalidated, January 6, 1936 3,166,867.89 



$10,373,526.69 
Deduct: 

Provision for liabilities 
arising from invalid- 
ation of the hog proc- 
essing tax, viz.: tax 
on unjust enrich- 
m e n t , additional 
Federal income tax 
and legal and other 
expenses $1,212,648.13 

Appropriated for con- 
tribution to Pension 
Trust 1,000,00000 2,212,648.13 



$ 8,160,878.56 
Net income for the period from November 

2, 1935 to October 31, 1936 ......... 1,815,613.00 



Dividends paid or accrued 
Preferred stock ....... $ 578,535 oo 

Common stock ........ 1,168,750.52 1,747,285.52 8,229,206.04 

Surplus, October 31, 1936 .................. $9,952,007.53 



Source: Company reports. 



i6 



ACCOUNTING STATEMENTS 



EXHIBIT i 

THE CUDAHY PACKING COMPANY 
TEN- YEAR RATIO ANALYSIS OF FOUR PACKING COMPANIES 





1927 


1928 


1929 


1930 


1931 


1932 


1933 


1934 


1935 


1936 


Current Ratio: 
Cudahy Packing Company . . . 
Armour & Company 


2 9 

3 8 


2.2 

6 o 


2 .5 
5 -2 


3 3 

7 2 


5.8 

IO I 


6 3 
IO 3 


3 8 
5 6 


2 3 
4 -9 


A A 


3 7 


Swift & Company 


7 o 


4 5 


3 8 


6 2 


6 5 


7 i 


8 3 


7 7 


6 3 


6 I 


Wilson & Company, Inc . . . 


7 7 


8 7 


6 4 


9.2 


9 4 


ii 6 


8 o 


4 2 


3 9 


3 2 


Days' Sales: 
Cudahy 


17 


17 


16 


15 


15 


16 


19 


20 






Armour 


26 


25 


26 


21 


20 


22 


27 


21 


20 


17 


Swift 


26 


28 


27 


23 


2 4 


19 


2 3 


23 


19 


18 


Wilson 


16 


18 


17 


17 


14 


15 


19 


17 


17 


15 


Sales to Inventory: 
Cudahy 


10 .4 


10.2 


12.3 


12 4 


13 3 


II .2 


7 7 


7 .2 






Armour 


7 6 


7 I 


7 o 


8 o 


9 6 


8 9 


6 I 


6 3 


7 4 


7 2 


Swift 


8 o 


7 8 


7 8 


8 8 


9 4 


9 5 


7 o 


6 2 


7 8 


7 9 


Wilson 


II 2 


II 6 


ii 3 


ii 8 


14 3 


12 I 


8 6 


8 4 


9 6 


8 8 


Percentage of Secured Debt to 
Fixed Assets: 
Cudahy 


27 o 


24 o 


23 o 


22 


21 O 


20 o 


19 o 


18 o 






Armour 


56 o 


57 .0 


57 o 


57 O 


56 o 


47 o 


45 o 


61 o 


63 o 


56 o 


Swift 


24 o 


22 


22 O 


21 


23 o 


23 o 


22 O 


22 O 


44 o 


43 


Wilson 


43 o 


42 o 


41 o 


39 o 


36 o 


34 o 


46 o 


44 o 


52 o 


50 o 


Percentage of Current Liabilities 
to Total Liabilities: 
Cudahy 


19 o 


26 o 


21 .0 


14 


7 o 


6 


II .O 


21 O 






Armour 


110 


7 o 


9 


6 o 


4.0 


3 .O 


7 O 


9 


IO O 


13 o 


Swift . . 
Wilson 


9 
5 o 


14 o 
5 o 


16 o 

7 o 


9 
5 


8 o 
4 o 


7 o 
3 


6 o 
5 


7 o 

II O 


9 
12 O 


9 o 
15 o 


Percentage of Long-term Debt to 
Total Liabilities: 
Cudahy 


29 o 


26 o 


26 o 


27 o 


29 o 


29 o 


26 o 


23 o 






Armour 


29 o 


30 o 


7Q O 


29 o 


32 o 


28 o 


25 o 


29 o 


30 o 


26 o 


Swift 


21 O 


18 o 


16 o 


16 o 


17 .0 


18 o 


16 o 


15 o 


13 o 


13 o 


Wilson ... 


28 o 


27 


26 o 


24 o 


24 o 


23 o 


25 o 


23 o 


25 o 


22 O 


Percentage 9f Net Worth to Total 
Liabilities: 
Cudahy 


52.0 


49 


53.0 


59-0 


64 o 


65 .0 


62 .0 


56.0 






Armour ... . . 


59 o 


02 o 


61 o 


64 o 


64 o 


68. 


68 o 


61 o 


59 O 


61 o 


Swift 


70 o 


69 o 


68 o 


75 O 


74 O 


75 O 


76 o 


75 O 


72 o 


73 O 


Wilson 


65 o 


66 o 


66 o 


71 


72 


74 


69 


66 O 


63 o 


63 o 


Times Interest Earned: 
Cudahy 


2 3 


2 2 


2 .0 


2 5 


2 4 


1.7* 


2 6* 


3 o 


2 O 




Armour 


I I 


2 I 


I 9 


I 5 


T Id 


o 4 


2 5 


3 i 


2 8 


3 3 


Swift 


t 


f 


t 


3 4 


I 2 


o .id 


4 6 


5 4 


8 2 


5 9 


Wilson 


I .2 


2 3 


2 3 


2 6 


o 4<f 


o 8 


3 7 


4 6 


4 9 


5 6 


Percentage of Net Income to Net 
Sales: 
Cudahy 


I O 


I O 


O.9 


I 3 


i i 


o 7 


I 5 


i 3 


o 7 




Armour 


O . I 


1 .3 


I .1 


O 5 


2 6d 


o Sd 


I 7 


I 9 


i 4 


i 4 


Swift . 


I 3 


I 5 


I 3 


i 4 


I 2 


o .$d 


2 O 


i 9 


2 3 


i i 


Wilson 


O I 


o 8 


7 


o 9 


i od 


O 


2 2 


2 I 


i 8 


i 6 


Percentage of Net Income to Total 
Assets: 
Cudahy 


3 ! 


3 I 


3 2 


4 o 


3 -I 


1 .4 


2 7 


2 .7 


I 6 




Armour 


O I 


2 5 


2 2 


i i 


4 6d 


T Trf 


2 3 


3 4 


2 9 


3 O 


Swift 


3 6 


4 3 


3 7 


3 9 


2 7 


I Bd 


3 4 


3 7 


5 5 


2 9 


Wilson 


2 


2 3 


2 4 


2 7 


2 3d 


I 


4.4 


5 


5 2 


4-7 


Percentage of Net Income to Net 
Worth: 
Cudahy 


5 9 


6 4 


5 -9 


6.9 


4.8 


2 2 


4 4 


4 8 


3 O 




Armour 


O 2 


A I 


3 5 


1 .7 


7 2a 


i 6d 


3 4 


5 6 


5 o 


5 i 


Swift 


5 2 


6 7 


"> 4 


5 2 


3-6 


2 .Afd 


4 5 


5 o 


7 6 


3 -9 


Wilson 


O .2 


3 4 


3.6 


3 9 


3 2d 


O. I 


6 3 


7.6 


8 2 


7 '5 

























* Does not include Miscellaneous Income, Discount on Bonds and Debentures Retired and 
held for retirement, t Figures not reported. 
d " deficit. 
Sources: Companies' reports; Moody 's Industrials, 1937, for the Sales- to-Inventory ratio. 



WELLINGTON SHOE COMPANY 17 

WELLINGTON SHOE COMPANY 

WORKING CAPITAL AND CURRENT POSITION 

In December, 1934, the treasurer wished to determine whether 
it would be necessary to borrow funds to meet the financial needs 
of the business at the date of the next balance sheet, November 30, 

1935- 

The company had a line of credit of $250,000 at each of two 
banks. This meant that if the credit condition of the company 
remained as sound as it was in 1934, each bank was willing to lend 
up to $250,000 on the unsecured notes of the Wellington company. 
The treasurer believed that if additional funds were needed to 
finance the current operations of the business, the larger of the 
two banks would be willing to increase its line of credit. Negotia- 
tions would be facilitated if requirements were known in advance. 

In order to determine the financial requirements at Novem- 
ber 30, 1935, the treasurer wished to set up a forecast or budgeted 
balance sheet for that date. 

The lines of shoes to be offered during 1935 had been deter- 
mined, and the cost department had estimated the cost of produc- 
tion on the basis of known past costs for labor, materials, and 
overhead, and on estimates of material prices and wages during 
the coming year. The sales department had prepared estimates of 
sales by lines and by territories based on the records of past sales 
and on estimates of the trends during the year. The chief execu- 
tives of the company in reviewing the figures on cost and sales 
set $8,499,272 as the budgeted gross sales for the year ending 
November 30, 1935. 

This budget estimate of sales had been translated into physical 
units of pairs of shoes and from these figures the amounts of final 
inventories, raw material requirements, and expenses had been 
estimated. 

Inventories had been low in 1934 as a result of the active sales 
in the last few months of that year, and it was apparent that 
heavier inventories would be required in 1935 if sales occurred at 
the budgeted rate and especially if prices increased. The esti- 
mates of inventories required at November 30, 1935, to meet the 
needs of the business are given in the budgeted income statement 
on page 24. Supplies had been high in 1934, and a reduction in 
that inventory was anticipated. 



i8 ACCOUNTING STATEMENTS 

From the estimated sales in physical units and the require- 
ments for building up the inventories, the purchases were estimated 
at the figure given on the budgeted income statement. From an 
analysis of past costs and estimates of wage rates and similar data, 
the other figures on the budgeted income statement were 
derived. 

Having completed the budgeted income statement for the year 
ending November 30, 1935, the treasurer had some additional 
figures developed which were needed in preparing the budgeted 
balance sheet for the end of the fiscal year. 

One estimate required was that for the amount of trade receiv- 
ables. The number of days' sales on the books in the form of 
receivables for 1934 was determined by dividing net sales by 360 
and dividing the total of receivables by this figure. 



= $ ^ 

* '* 4/ y 



360 ' $22,321 

On the basis of experience of past years the treasurer estimated 
that the number of days' sales would increase to approximately 
53 in 1935. From this the amount of trade notes and accounts 
receivable at November 30, 1935, could be derived. He believed 
that the reserve for doubtful accounts and notes should be the 
same percentage of receivables as in 1934. 

Cash could be allowed to go down somewhat, but approxi- 
mately $375,000 would be needed to meet the current requirements 
of the business. The treasurer therefore used $375,000 as the 
figure for cash on the budgeted balance sheet. 

Some additional investment in fixed assets would be required 
to meet the scheduled rate of operations and some units would be 
retired. A separate plant budget indicated that fixed assets at 
November 30, 1935, would be $3,423,000, less a reserve of 
$2,087,000. 

Using a method similar to that applied to receivables, it was 
determined that the days' purchases on the books as trade accounts 
payable in 1934 was 15. 



= $10,874 - = 15 days 
360 '* $10,874 5 y 



WELLINGTON SHOE COMPANY 19 

It had been the company's policy in the past to pay for 
purchases as soon as the goods were received and inspected, and 
the invoices were checked, because with such a policy it could take 
advantage of discounts and could buy at better prices. About 15 
days were required, on the average, for inspecting and checking. 
This figure of 15 days was applied to the purchases on the budgeted 
income statement for 1935 in order to determine the trade accounts 
payable for the budgeted balance sheet. 

November 30, 1935, came four days after the regular pay day 
and accrued wages (wages earned but unpaid at the balance sheet 
date) were estimated as $107,000. It was estimated that the 
liability for Federal and state taxes at November 30, 1935, would 
be the same as the related expense on the budgeted income 
statement. 

It was expected that if operations showed the profit indicated 
by the budgeted income statement, dividends would be paid at the 
rate of $7 per share. If the company used its customary dividend 
dates, the dividends would all be paid during the year, and there 
would be no item of dividends payable on the balance sheet. No 
change in capital stock was anticipated during the year. There 
were a number of small items on the balance sheet for which 
separate estimates were not made. It was assumed that they 
would be the same in 1935 as in 1934. 



1. Using the paper in the Working Forms, prepare a blank 
form for the budgeted balance sheet as of November 30, 1935, 
providing the same headings and titles as in the balance sheets for 
1933 and 1934. From the facts given in the case determine the 
amounts of all items other than Notes Payable to Banks. Com- 
plete the budgeted balance sheet by determining the amount 
necessary to borrow from the banks and inserting this amount as 
Notes Payable to Banks. In making the several computations 
the use of three decimal places is sufficient for the purposes of this 
case. 

2. When completed, the budgeted statements were submitted 
to an executive committee, consisting of the president and the 
heads of the major departments. The president was convinced 
that the business anticipated could be financed without borrowing 



20 ACCOUNTING STATEMENTS 

if each executive revised his plans to provide for a more efficient 
use of working capital. The borrowing of nearly half a million 
dollars was not justified unless it was necessary to an efficient 
operation of the business. The president, therefore, asked the 
members of the committee to reexamine the situation disclosed by 
the budget and to discover, if possible, practicable methods of 
reducing the working capital required. 



WELLINGTON SHOE COMPANY 



21 







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OE COMPANY 
OF NOVEMBER 




urrent Liabilities: 
Notes Payable to Ba 
Trade Accounts Pay 
Accrued Liabilities: 
Wages 
Federal and State 
Miscellaneous Ace 
Sundry Creditors . 


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22 ACCOUNTING STATEMENTS 

WELLINGTON SHOE COMPANY 

INCOME STATEMENT FOR THE YEAR ENDING 

NOVEMBER 30, 1934 

Gross Sales $8, 196, 182 

Less: Sales Returns and Allowances 1 60, 709 

Net Sales $8,035,473 

Less: Cost of Goods Sold 
Inventories: 

Finished Goods, December i, 1933 $ 993,812 

Goods in Process, December i, 1933. . $ 175,596 
Raw Materials on Hand, 

December i, 1933 . $ 437,861 
Miscellaneous Supplies, 

December i, 1933 .... 136,442 
Purchases of Materials and 

Supplies 3,914,717 



$4,489,020 

Inventories: 

Raw Materials 
on Hand, 
November 30, 
1934 $469,756 

Miscellaneous 
Supplies, No- 
vember 30, 
1934 213,288 683,044 



Raw Materials and Supplies Used . 3,805,976 
Factory Expenses: 

Wages 2,587,680 

Maintenance and Repairs in Factory 96 , 600 

Depreciation on Factory 99, 582 

Taxes on Factory 34, 142 

Royalties (including Rents on Ma- 
chinery) 213,145 

Other Manufacturing Expenses 132,717 

$7,145,438 
Goods in Process, November 30, 1934. 171,842 

Cost of Goods Manufactured 6,973,596 

$7,967,408 
Finished Goods, November 30, 1934 i , 142,689 

Cost of Goods Sold 6,824,719 

Gross Profit $i , 210, 754 



WELLINGTON SHOE COMPANY 23 

WELLINGTON SHOE COMPANY 
INCOME STATEMENT FOR THE YEAR ENDING 

NOVEMBER 30, 1934. (Continued] 
Selling, General and Administrative Expenses: 

Office Salaries and Wages $ 284, 263 

Advertising 205 , 186 

Traveling Expenses 50,484 

Maintenance and Repairs of Offices 28, 246 

Depreciation on Offices 20,572 

Taxes on Offices 22 , 189 

Rents on Other Real Instate 117, 297 

Provision for Doubtful Accounts 9>4 2 9 

Other Costs and Expenses 101 ,897 $ 839,563 

Net Operating Income $ 371 , 191 

Other Income 19 , 090 

Total Income $ 390, 281 

Other Expense 7,6i6 

Net Profit before Income Taxes $ 382,665 

Provision for Federal and State Taxes 63,827 

Net Profit for Period $ 318,838 

Surplus Balance, December i, 1933 i , 591 , 798 

Total $1,910,636 

Less: Goodwill Written Off $ 999,999 

Dividends Paid . . 261 , 100 i , 261 ,099 

Surplus Balance, November 30, 1934 $ 649,537 

WELLINGTON SHOE COMPANY 

BUDGETED INCOME STATEMENT FOR THE YEAR ENDING 
NOVEMBER 30, 1935 

Gross Sales $8,499,272 

Less: Sales Returns and Allowances 166,652 

Net Sales $8,332,620 

Less: Cost of Goods Sold 
Inventories: 

Finished Goods, December i, 1934 $1,142,689 

Goods in Process, December i, 1934. $ 171,842 
Raw Materials on Hand, 

December i, 1934 $ 469, 756 

Miscellaneous Supplies, 

December i, 1934. . . . 213,288 
Purchases of Materials and 
Supplies 4,129,152 

$4,812,196 



24 ACCOUNTING STATEMENTS 

WELLINGTON SHOE COMPANY 

BUDGETED INCOME STATEMENT FOR THE YEAR ENDING 
NOVEMBER 30, 1935. (Continued} 

Inventories : 
Raw Materials 

on Hand, 

November 30, 

1935 - - $713,665 
Miscellaneous 

Supplies, 

November 30, 

iQ3S 118,095$ 831,760 



Raw Materials and Supplies Used . . $3,980,436 

Factory Expenses: 

Wages 2,729,439 

Maintenance and Repairs in Factory 73 , 858 
Depreciation on Factory . . . . 79,109 
Taxes on Factory . . . 36,087 
Royalties (including Rents on Ma- 
chinery) 223,514 
Other Manufacturing Expenses 139,971 

$7,434,256 
Goods in Process, November 30, 1935 222,465 



Cost of Goods Manufactured . . $7,211,791 

$8,354,480 
Finished Goods, November 30, 1935 . . . 1,366,212 

Cost of Goods Sold. . . . ... $6,988,268 

Gross Front . . ... $i ,344, 352 

Selling, General and Administrative Expenses: 

Office Salaries and Wages ... .. . . $ 290,112 

Advertising 216,653 

Traveling Expenses ... ... , 54,371 

Maintenance and Repairs of Offices . . . 47,850 

Depreciation on Offices . . ... 15,895 

Taxes on Offices . . 26 , 1 22 

Rents on Other Real Estate . ... 128,097 

Provision for Doubtful Accounts. . . . 12,020 

Other Costs and Expenses. . . . . . . 148,845 939,965 

Net Operating Income . $ 404,387 

Other Income . . . 24,036 

Total Income $ 428,423 

Other Expense . 7 ,027 

Net Profit before Income Taxes $ 421 ,396 

Provision for Federal and State Taxes 92,082 

Net Profit for Period $ 329,314 

Surplus Balance, December i, 1934 649,537 

Total $ 978,851 

Less: Dividends Paid 261 , 100 

Surplus Balance, December i, 1935 $ 717,751 



II. PREPAYMENTS AND ACCRUALS 
BRISTOL VALLEY STOVE COMPANY 

PREPAYMENTS AND ACCRUALS 

The Bristol Valley Stove Company started business on 
January i, 1932. In preparing the balance sheet for December 31, 
1932, and the income statement for the year ending on that date, 
an analysis of the following items was necessary in order to deter- 
mine in each case how much should appear on the balance sheet as 
an asset or a liability and how much on the income statement as 
expense or income. 

The balance sheet and income statement are given in a form 
which is complete except for the items affected by prepayments 
or accruals. 



i. Determine from the data given below in paragraphs a to h 
the amounts necessary to complete the statements. 

BRISTOL VALLEY STOVE COMPANY 
BALANCE SHEET AS OF DECEMBER 31, 1932 



Current Assets: 
Cash $ 20,914 ?6 
Accounts Re- 
ceivable . . 69,995 87 
Note Receiv- 
able 


Current Liabilities: 
Accounts Pay- 
able $74,430 94 
Salaries Ac- 
crued .... 


Wages Acnnied 


Interest In- 
come A c- 
crupd 


Interest Ex- 
pense Ac- 
crued 


Inventory . . 88,360 93 




Tntal $ 


Total , $ 


Deferred Income: 
Rent Prepaid 


Buildings and 
Equipment $149,519 72 
Less: Reserve 
for Deprecia- 
tion .. 9,465 87 140,053 85 


Mortgage on Real 
Estate 


Capital Stock 200,000 oo 
Surplus 






Deferred Charges: 
Insurance Pre- 
paid ........ 


Mortgage Dis- 


Organization 
Expense 




$ 


$ 







26 ACCOUNTING STATEMENTS 

2. Complete the balance sheet and income statement by 
inserting the proper amounts. 

BRISTOL VALLEY STOVE COMPANY 
INCOME STATEMENT FOR THE YEAR ENDING DECEMBER 31, 1932 

Net Sales $310, 231 . 94 

Less: Cost of Goods Sold 

Purchases $228,385 14 

Ending Inventory, December 31, 1932 88,360.93 

Cost of Goods Sold 140,024 21 

Gross Profit $170,207.73 

Less: Operating Expenses 

Wages $ 

Heat, Light, and Power 6 , 298 . 01 

Maintenance 3, 187 .90 

Insurance 

Depreciation 9 , 465 . 87 

Advertising 14 , 405 . 30 

Other Selling Expenses 2 ,963 . 54 

Salaries . . 

General Administrative Expense 20,427 . 84 

Interest 

Mortgage Discount 

Organization Expense 



Net Operating Loss $ 

Add: Other Income 

Interest . $ 

Rent 



Net Profit for the Year. 



a. Salaries of $14,025 had been paid for the year 1932 prior to 
December 31. It was customary to pay salaries on the first 
business day of each month for the preceding month. On 
December 31, salaries had been earned to the extent of $1,275 and 
were to be paid on Tuesday, January 3, 1933. 

b. Wages were paid on Friday of each week and included 
amounts earned by the employees up to the close of business on 
the preceding Wednesday. Prior to the last week of December, 
the company had paid $92,873 in wages for 1932. On Friday, 
December 30, $1,857 was paid. From a computation based on 
the pay roll records, it was determined that wages earned by the 
employees on Thursday, Friday, and Saturday, and which would 
be included in the next wage payment, were $846. 

c. On December 31, 1931, the company had paid $1,125 as a 
premium on fire insurance policies, which were in force from noon 



BRISTOL VALLEY STOVE COMPANY 27 

of that day and were to expire at noon on December 31, 1934. 
The premium covered the entire three years. 

d. On April i, 1932, the company borrowed on a $50,000 first 
mortgage on its real estate. The mortgage was to run for 10 years 
with interest of 6 per cent per annum, payable semiannually on 
April i and October i. Only $47,000 was received, however, and 
the difference was set up on the books as mortgage discount and 
included under deferred charges on the balance sheet. The com- 
pany expected to write this discount off over the life of the 
mortgage at a rate which would be uniform, as computed by 
months. 

e. Six months' interest on the mortgage was paid on October i, 
1932. In determining the amount of accrual, if any, on mortgage 
interest, make computations by months. 

/. A building belonging to the company was rented to another 
manufacturer for $6,000 per year, payable quarterly in advance. 
The arrangement was made as of July i, 1932. The rent for the 
first three months of 1933 was received on December 30, 1932. 

g. The company held a note from one of its dealers for $3,000, 
dated November i, 1932, payable in equal installments on 
February i, May i, August i, and November i, 1933, with interest 
at 6 per cent. Interest for the preceding three months was to be 
paid with each installment of principal. Compute by months. 

//. Organization expense of $5,684.80 was incurred when the 
business was started. This deferred charge was to be written off 
over a five-year period. 



28 ACCOUNTING STATEMENTS 

RlVERBANK GAS AND ELECTRIC COMPANY 
DISCOUNT ON FUNDED DEBT 

On December 15, 1927, the directors of the Riverbank Gas and 
Electric Company voted to issue $65,000,000 of 5 per cent Deben- 
ture Gold Bonds, Series A, dated January i, 1928, and due 
January i, 1938. Interest was payable January i and July i of 
each year. The bonds were a direct obligation of the company, 
but were not secured by a mortgage on the property as were the 
First Gold 6 per cent bonds already outstanding. 

The entire principal amount was sold by the company as of 
January i, 1928, to underwriters for cash at $935 for each $1,000 
bond. In addition, the company paid expenses of $1,261,980, 
which included such items as listing, legal and accounting fees, and 
costs of printing and engraving. Therefore the company received 
the net amount of $59,513,020 for the new bond issue. 

In the process of preparing the statements for December 31, 
1928, a question arose concerning the treatment of the discount 
and expense on the new issue. One suggestion was that the entire 
amount of discount and expense be written off by a charge to 
surplus in 1928, the year the bonds were issued. A second 
suggestion was that the discount and expense be amortized or 
written off over the lo-year life of the bonds by charging one-tenth 
of the total each year as an expense. There were precedents for 
each of these methods in the practice of similar companies. 

The management realized that an amortization table might be 
set up on a mathematical basis, which would give results slightly 
different from those under the second method above. Amortiza- 
tion tables of this nature were seldom used in practice, and the 
management felt that the slight differences did not justify the 
added complexity. If amortization was to be undertaken at all, 
it was decided to use the so-called straight-line method, under 
which the total amount was divided by the years of life of the 
bonds to obtain the expense of each year. 

The condensed statements given below were prepared in final 
form except for the items connected with the bond discount and 
expense. 



RIVERBANK GAS AND ELECTRIC COMPANY 29 

1. Complete the statements for December 31, 1928, as they 
would appear under each of the two methods suggested, using 
therefor the paper in the Working Forms. 

2. During the negotiations preceding the issue of the bonds, 
the underwriters suggested that they would absorb all of the 
expense and pay par for the bonds if the interest rate were made 
high enough. On this basis the company would have issued only 
$59,500,000 in face value of bonds and would have had no expense 
in connection with the issue except for the payment of interest. 
The underwriters indicated that the rate paid for funds by the 
Riverbank company would be approximately the same with these 
high coupon bonds, but they believed that the 5 per cent bonds at 
a discount could be distributed better in the investment market. 
From the facts given, determine the approximate rate of interest 
the underwriters would probably have asked if they had absorbed 
all expenses and paid par for the bonds. 

3. Which of the two methods of writing off bond discount and 
expense would have shown net income for 1928 more accurately? 

4. Which method should the company have used? 

RIVERBANK GAS AND ELECTRIC COMPANY 
CONDENSED BALANCE SHEET AS OP DECEMBER 31, 1928 

Property, Franchises, etc $i 68, 170,628 

Investments in Subsidiaries i ,564,095 

Current Assets . . 8,986,857 

Prepayments . ... 459,054 

Unamortized Debt Discount and Expense 



Preferred Stock $ 26,086,000 

Common Stock 12,500,000 

Funded Debt: 

First Gold 6s, Series A . $60,000,000 

Debenture Gold 55, Series A 65,000,000 125,000,000 



Current Liabilities 7,727, 878 

Surplus 

$ 



30 ACCOUNTING STATEMENTS 

RlVERBANK GAS AND ELECTRIC COMPANY 

CONDENSED INCOME AND SURPLUS STATEMENTS FOR THE YEAR ENDING 

DECEMBER 31, 1928 

Gross Earnings $32 ,666, 283 

Operating Expenses 21 ,303,303 

Net Earnings $11, 362 , 980 

Fixed Charges: 

Interest Expense $6 , 850 , ooo 

Amortization of Debt Discount and Expense 



Net Income $ 

Surplus, December 31, 1927 12,905,916 

Total $ 

Preferred Dividends $i , 565 , 160 

Common Dividends 2,500,000 4,065,160 



Unamortized Debt Discount and Expense Written 
Off 

Surplus, December 31, 1928 



III. THE EFFECT OF INVENTORIES 
ON THE CURRENT POSITION AND ON INCOME REPORTED 

HERENDEEN AND HAPLY WOOLEN MILLS No. i 

THE EFFECT OF INVENTORY VALUATION ON THE CURRENT 
POSITION AND ON INCOME REPORTED 

It was the policy of the company to state its inventories at cost 
or at market, whichever was lower as of the balance sheet date, and 
to prepare its statements on that basis. The determination of 
inventory amounts was always a complex matter, but when the 
books were closed for the year at June 30, 1934, it proved to be 
peculiarly difficult because of the conditions existing in the wool 
market at that time. 

The methods of determining cost differed for the three types of 
inventories carried: raw material, goods in process, and finished 
goods. The cost of raw material inventory was determined largely 
from the books of account and included the price paid the vendor, 
brokerage and similar fees if any, transportation to the mill, 
and any other expenses involved in laying the incoming raw 
material on the warehouse floor ready to use. The company used 
a first-in first-out basis, under which it assumed that the wool going 
into the manufacturing process was the oldest wool of that grade 
on hand, regardless of whether this assumption was true of any 
particular physical lot of wool. It thus followed that the wool of 
any grade on hand at the inventory date was assumed to consist 
of the most recent purchases necessary to make up that amount. 
For example, if the inventory at June 30 showed 30,000 Ib. of 625 
and wool of that grade had been bought as follows: May 4, 6,000 
Ib.; May 20, 15,000 Ib.; June 5, 10,000 Ib.; and June 17, 10,000 Ib.; 
cost was determined as the total of the purchases of June 17 and 
June 5, and enough pounds at the price paid on May 20 to make up 
the 30,000 Ib. 

31 



32 ACCOUNTING STATEMENTS 

In determining the physical amount of wool on hand, figures 
were derived giving the total pounds of each grade of wool tops 1 in 
the inventory. This was not a simple task, but required well- 
devised records and great care in taking the inventory. The 
weight of wool in a bale could not be calculated directly by weigh- 
ing it because the moisture content varied with the weather, and 
wool was bought on a basis of air-dry content plus 15 per cent for 
moisture regain. 

The cost of goods in process inventory included the cost of the 
raw material involved, labor already applied, and a proper alloca- 
tion of the overhead expenses involved in bringing the goods to the 
stage of completion at which they were on the balance sheet date. 
The determination of these costs was dependent on the cost system 
in use in the plant. Reliable figures could be obtained only if the 
cost system was well devised and was operated with skill and 
judgment in adapting it to the complexities and changing condi- 
tions of production. In the opinion of the management and the 
auditors, the costs shown for goods in process were reliable and 
conservative. 

For certain portions of the goods in process, such as finished 
yarn ready for weaving, physical amounts could be determined 
readily, although adjustment had to be made as before for moisture 
content, and an allowance for waste in process was necessary in 
order to arrive at the pounds of raw material of particular grades 
represented. For yarn on the spinning frames and for warp and 
partly completed cloth on the looms, which could not be weighed, a 
process of estimating was necessary, but methods had been 
devised which yielded results accurate within a narrow margin of 
error. 

The cost of finished goods inventory included the same ele- 
ments found in the cost of goods in process inventory : the actual 
cost of raw material content, labor, and an allocation of overhead 
expenses. These three items were also determined from the 
company's cost system as were the costs of goods in process 
inventory. Since it was possible to identify finished goods, the 



1 Wool tops are the product of the scouring, carding, and combing of grease, or 
raw wool, and come out of the combing in a continuous strand of fibers lying more 
or less parallel with each other. This product is then ready for what is known as the 
drawing and spinning process, which consists essentially of attenuating this strand 
and at the same time twisting it. 



HERENDEEN & HAPLY WOOLEN MILLS NO. i 33 

physical amount in the inventory was determined on an individual 
lot basis. 

Turning now to methods of determining market, the figure for 
raw material inventory was determined by applying, to the total 
pounds of each grade of wool tops in the inventory, the current 
costs per pound of replacing that wool at balance sheet date, plus 
adjustments for inward transportation and similar items. 

In the determination of market for the goods in process inven- 
tory, the raw material content of goods in process by grades of wool 
was secured from the company's cost system, and then market 
figures at balance sheet date were applied to these amounts. 
Labor and overhead did not change so much as the price of the 
raw material content, but if significant changes in these elements 
occurred, suitable adjustments were made. The term market, 
therefore, as applied to goods in process was assumed to mean the 
cost of replacing those goods under conditions existing at balance 
sheet date; except that if yarn, for which there was a market, could 
be purchased outside for less than the figure shown, that lower 
figure was used. 

In the determination of market for finished goods inventory, 
cost of replacement under conditions existing at balance sheet date 
was computed under a method similar to that used for goods in 
process. There were, however, two additional factors. Finished 
goods were designed for sale and had a market of their own, 
independent from, but related to, the market for wool. The 
sales department estimated the amount that could be obtained for 
each item of finished goods, net of cost of selling and delivery under 
conditions existing at balance sheet date. In this case, market 
meant net realization in the market of sale. 

A further factor was that the company was producing style 
merchandise and could not avoid holding some goods which were 
subject to style obsolescence. Such goods were not worth the cost 
of replacing them. The sales department estimated the liquida- 
tion price of obsolete items and special care was taken to see that 
these prices reflected fully any losses implicit in obsolete stock. 
The sales department was expected to keep such stock at a mini- 
mum by selling it for what it would bring as soon as the fact of 
obsolescence was known. 

Cost or market, whichever was lower as applied to finished goods 
therefore meant the lowest of three bases: actual cost, cost of 



34 ACCOUNTING STATEMENTS 

replacement, or net realization with prospective loss on any 
obsolete items fully reflected in the net realization figure. 

At June 30, 1934, the cost of inventories had been determined 
by the methods described. No significant changes were at issue 
in the amounts of labor and overhead to be included in inventories. 
The market for wool, however, was such that it was extremely 
difficult to determine what figures should be used for raw material, 
and raw material content of goods in process and finished goods in 
determining the cost of replacement. The net realization esti- 
mates of the sales department had already been made, and the wool 
price to be used was the only issue yet to be decided. 

In order to describe the situation in the wool market at June 30, 
1934, it is first necessary to go back to 1933 and trace the price 
changes in the wool top market. The price of standard 625 will 
be used, because about 70 per cent of the total wool tops in the 
inventory of this company were of this grade. In 1933 the price 
of standard 625 rose from 55 cts. to about $1.10 per pound. This 
rise was caused by two factors: In the first place, there was a 
demand for cloth from the cutters and makers of clothes, who 
expected their costs to rise because of labor conditions and who 
wanted to secure their raw material at low prices. In the second 
place, the woolen mill operators expected inflation, if not monetary, 
at least credit inflation, and they were bidding for tops to protect 
themselves against a high raw material cost. In other words, 
speculation in raw materials took place in order to avoid antic- 
ipated higher prices. 

A rather rigid price structure existed in the retail trade division 
of the woolen industry. Raw material prices could reach a certain 
point only, for beyond that point the normal price channels for 
finished goods in the retail trade were thrown out of balance. For 
example, department-store dresses retailed for fixed prices, $3.75, 
$5.95, $10.95, etc. In order to keep within the limits when wool 
top prices were too high, manufacturers would begin to adulterate 
their fabrics with cotton and rayon, sometimes notifying buyers of 
this adulteration and sometimes not. Congestion would therefore 
result in the woolen retail trade, because of adulteration and hesi- 
tant consumer demand, and a downward movement in wool top 
prices would begin. 

Combined with these natural limiting phenomena in the wool 
trade, there was some question in 1934 about the extent of 



HERENDEEN & HAPLY WOOLEN MILLS NO. i 35 

inflationary forces and where they would carry wool prices. The 
first wave of a bear movement brought the price of tops down from 
$1.10 to about 95 cts. The large inventory gains of 1933 were 
reduced considerably in 1934. 

Top makers had been enthusiastic during the upward price 
movement, and therefore were caught with large stocks when 
demand fell off. From the first of June well on through the 
summer, there was scarcely a real demand for tops; that is, buyers 
would not offer definite prices for definite quantities. 

Consequently at June 30, when this company faced the neces- 
sity of determining cost of replacement for the tops in the inven- 
tories, there were no exchanges going on in the market. The 
auditors, who were preparing the statements, looked up wool top 
quotations in the trade journals, but found that they were pro 
forma only and did not reflect any actual sales of wool. Then 
they approached the chief top makers, who also were unable to 
put a price on 625 because no wool was moving. The problem 
therefore became one of estimating, on the basis of conditions 
existing in the market, what prices would be when actual sales 
began again. The consensus of opinion seemed to be that this 
price would be between 98 and 95 cts., and most of those familiar 
with the trade felt that 95 cts. was a conservative figure. 

However, there were a few distress lots of wool available, and 
one woolen mill had offered somewhat confidentially to sell 200,000 
Ib. of 625 at 92.3 cts. This mill did not ordinarily sell wool tops, 
but it was hard pressed for working capital and needed funds to 
meet its current commitments. 

Exhibit i indicates what the inventories would have been, 
using cost of $1.046, market of 95 cts., and market of 92.3 cts. for 
wool tops. The balance sheet and income statement are given as 
they would have been if inventories had been included at cost for 
wool tops. 



1. Draw up the balance sheet and income statement as they 
would have been if the price of 95 cts. had been used. 

2. Draw up the same statements using figures resulting from a 
price of 92.3 cts. Use the paper in the Working Forms. In both 
cases you may summarize those portions not affected by inventory 
amounts. 



3 6 ACCOUNTING STATEMENTS 

3. By what person or group in the corporation should the 
decision as to inventory valuation have been made? 

4. In deciding what basis of inventory valuation to use, should 
the management have been guided solely by conditions in the 
wool market or should it also have considered the effects on income, 
on the market appraisal of the common stock, and on the interests 
of stockholders and others? 

5. It is not intended to raise the whole issue of inventory 
policy at this time, but in view of the facts given, what figures 
should have been used? 

HERENDEEN AND HAPLY WOOLEN MILLS 
BALANCE SHEET AS OF JUNE 30, 1934 

Current Assets: 

Cash $ 762,151 39 

Trade Accounts Receivable . $i , 497 , 81 7 . 26 
Less: Reserve for Doubt- 
ful Accounts 307,629.28 1,190,187.98 

Inventories, at Cost: 

Raw Material $1,050,693.18 

Goods in Process 1,176,614.68 

Finished Goods 237,563 oo 2,464,870.86 

Total Current Assets . . $4,417,210 23 

Cash Value of Life Insurance Policies . 88, 102 . 50 

Deferred Local Taxes, Insurance Premiums, etc. 87 , 5 1 9 . 03 

Fixed Assets: 
Land, Buildings, Machinery, and Equipment $2,049,338 76 

Less: Reserve for Depreciation . . . . 961,212 27 1,088,126 49 



$5,680,958 25 

Current Liabilities: 

Notes Payable Banks $ 850,000 oo 

Trade Accounts Payable .... 129,086 32 

Accrued Taxes, Wages, and Commissions 163,066.38 



Total Current Liabilities $i , 142 , 152 . 70 

Capital Stock (No Par Value) : 

Authorized, 63,036; Issued, 52,454 shares . . 2,622,675 oo 

Surplus, Balance June 30, 1933 . . $1,738,952.18 

Net Profit for the Year 177,178.37 

Surplus, Balance June 30, 1934 i , 916 , 130 . 55 

$5,680,958 25 



HERENDEEN & HAPLY WOOLEN MILLS NO. i 37 

HERENDEEN AND HAPLY WOOLEN MILLS 
INCOME STATEMENT FOR THE YEAR ENDING JUNE 30, 1934 

Net Sales.. $3,554,559-24 

Less: Cost of Goods Sold 

Finished Goods Inventory, June 30, 1933 . . $ 371,975.30 
Goods in Process Inventory, 

June 30, 1933 $1,218,797.61 

Raw Mate- 
rial Inven- 
tory, June 

30, 1933 . $1,285,188.59 
Purchases... 1,825,547.19 

Freight In. . 1,565.34 

$3,112,301.12 
Discounts 

Received . 101 , 265 . 04 

$3,011,036.08 
Raw Mate- 
rial In- 
ventory, 
June 30, 
1934... 1,050,693.18 

Raw Material Used 1,960,342.90 

Factory Expenses: 

Labor 787,691.48 

Taxes 33,796.39 

Depreciation 54,811.01 

Repairs 53, 708.75 

Insurance 1 1 , 236 . 56 

Miscellaneous 4^65 . 14 

$4,124,549.84 
Goods in Process Inventory, 

June 30, 1934 1,176,614.68 

Cost of Goods Manufactured 2 , 947 , 935 . 16 

$3,319,910.46 
Finished Goods Inventory, June 30, 1934 . 237,563.00 

Cost of Goods Sold 3,082,347.46 

Gross Profit $ 472,211.78 

Less: Selling and General Expenses 

Commissions to Salesmen $ 49,812.58 

Selling Expenses 49 , 886 . 30 

Advertising 8,772.80 

Freight and Express Outward 13, 136.89 

Salaries 90, 100.00 

General Expenses 40,000.17 

Telephone and Telegraph 4,357-9& 

State Excise and Capital Stock Taxes 14,450.00 

Interest Paid 8,819.31 279,336.03 

Net Operating Profit $ 192,875. 75 

Add: Interest Received 7,*53-7Q 

Total Income $ 200,029 . 45 

Less: Other Charges 22,851.08 

Net Profit $ 177,178.37 



ACCOUNTING STATEMENTS 



EXHIBIT i 
HERENDEEN AND HAPLY WOOLEN MILLS 





Cost of inven- 
tories at $1.046 
per pound for 
wool tops 


Market of inven- 
tories at 95 cts. 
per pound for 
wool tops 


Market of inven- 
tories at 92.3 
cts. per pound 
for wool tops 


Raw Material . . 
Goods in Process 
Finished Goods 


$1,050,693.18 
1,176,614.68 
237,563.00 


$ 959,082.52 
i, 116,690. 15 
224,921 39 


$ 933,3 I 7-03 
1,099.836 37 
221,365.94 



IV. PLANT AND DEPRECIATION 
CHELMSFORD KNITTING COMPANY No. i 

THE NATURE OF DEPRECIATION 

The Chelmsford Knitting Company, which was organized in 
Massachusetts prior to the Civil War, was still using in 1926 a 
water wheel which was described as follows on the detailed plant 
records. 



Classification 
Building No 



Water Power Development 



Floor No. 



Basement 



Dept. Power 



Original 
date of 
acquisi- 


Quan- 
tity 


Description 


Original 
cost 


Depreciation 


Depre- 
ciated 
value 






tion 








Date 


Amount 








Water Wheels- #i 










1878 


i 


Swain vertical 72" 














wheel, steel casing 














300 hp under 20' 














o" head, 7" center 














shaft, & beveled 














gears 














(Installed) 


$3 , 7oo 


12/31/26 


$2,180 


$1,520 



An engineer reported that the wheel probably had an efficiency 
when new of 79 per cent, but that the efficiency in 1926 was about 
77 per cent, largely as a result of abrasion of the leading edges of 
the blades. A wheel of modern design, adapted to the available 
head and to other operating conditions, would have an efficiency 
of about 86 per cent. There was not much rust, but the beveled 
gears were badly worn, although still serviceable. 



1. Did depreciation exist in this water wheel in 1926? 

2. If by maintenance it had been possible to make it work as 
well as it did when new, would there still have been depreciation? 

3. What causes of the exhaustion of the value of this asset may 
be distinguished? 

39 



40 ACCOUNTING STATEMENTS 

4. " Since this water wheel still had an efficiency of 77 per cent, 
it was absurd to depreciate it to less than 77 per cent of its cost 
when new." Comment on this statement. 

5. On what factors would a determination of the relative 
accuracy of the depreciation taken depend? Do these factors lie 
in the area of engineering or accounting, or both? 

BOSTON ELEVATED RAILWAY COMPANY 

ACCOUNTING PROBLEMS IN CONNECTION WITH BUSES 

The Boston Elevated Railway Company operated elevated, 
subway, and surface lines as a coordinated system of transporta- 
tion in Boston and the surrounding metropolitan area. The 
company first introduced buses in 1921, but it was not until 1925 
that they assumed an important place in the system. Since that 
time they have become increasingly more important as a means of 
transportation. The increasing use of buses is shown by the 
figures presented in Exhibit i. 

The buses represented a new type of property and involved 
operating problems somewhat different from those arising with 
rail equipment. The executives therefore decided to develop 
property and operating records especially adapted to buses. The 
period prior to 1930 was largely experimental both in operation and 
in the development of accounting methods. The accounting 
records were revised in 1930, and there have been relatively few 
changes since that time. 

When a bus was bought, the total cost, delivered and ready to 
use, was added to the asset, Buses Owned. When a bus was 
retired, its cost was deducted from the asset, Buses Owned. The 
balance shown in the asset account at the end of each year there- 
fore gave the cost of all buses owned at that time. This amount 
appeared in the balance sheet of that date as one of the fixed 
assets. 

In order to provide additional records concerning the invest- 
ment in buses, a card ledger was maintained with one card for each 
bus. The front of this card provided space for recording general 
information about the bus, such as company number, make, model, 
cost, date of purchase, identification numbers, and specifications. 
This side of the card also presented information on the location of 
the bus, registration numbers, and taxes paid on the vehicle during 



BOSTON ELEVATED RAILWAY COMPANY 41 

its life. The reverse side of the ledger card presented a running 
record of depreciation charges and mileage covered for each unit. 
These cards were arranged in a file so that the property number, 
make, and model were visible. Exhibit 2 reproduces the ledger 
card for No. 920. This vehicle made no mileage during the four 
months beginning June, 1937. The adjustment items appearing 
in the years 1931 and 1932 were made necessary by the revisions of 
the estimated service life on No. 920. In the last year of estimated 
life a tab was placed on the series of months appearing along the 
lower edge of the card to indicate to the bookkeeper the last month 
in which depreciation would be entered. When a bus was retired, 
its ledger card was removed from the active file and placed 
in a separate file which provided a complete record of retired 
equipment. 

Other plant assets were separated into two divisions. The 
first and larger division was depreciated on a group basis. In this 
case, the reserve for depreciation was set up to cover the exhaus- 
tion of service capacity in the entire group rather than for specific 
units, as was the case with buses. For the second and smaller 
division which consisted mainly of track, the company used a 
method whereby the cost of retirements, less salvage, was charged 
as an expense of the period when they occurred. This method is 
called retirement accounting and its characteristics will be 
examined in later cases. 

When the new type of equipment was acquired and it became 
apparent in 1924 that buses would become an important element 
in the transportation system the company decided to apply to 
this equipment a method of depreciation accounting which was 
similar to that used in industrial practice. The essential difference 
between this and the older retirement method was that deprecia- 
tion accounting sought to record the exhaustion of the service 
capacity of an asset during the periods of its use, as that exhaustion 
occurred. The estimated amount of exhaustion of service capacity 
occurring in any accounting period was recorded as an expense of 
that period. 

In 1924 it was recognized that buses had a short service life, 
and at that time life was estimated at five years. In the next few 
years there was marked development in design and construction. 
The newer models had greater capacity, were more comfortable 
and attractive to passengers, and were better built from an 



42 ACCOUNTING STATEMENTS 

engineering standpoint so that they could deliver more mileage 
before the expense for repairs became excessive. In addition, the 
company was constantly acquiring new data on the life charac- 
teristics of the equipment. Therefore, in 1927, the life estimate 
was extended to six years on all buses to be acquired after the end 
of that year. On two occasions following the 1927 revision, life 
estimates were extended to seven and eight years, respectively. 
Finally, in 1932, the estimated service life was set at 10 years and 
that figure was in use from then on. 

In applying these life estimates, the company used the straight- 
line basis, which is used in industrial practice in one of its several 
forms for about 90 per cent of all industrial plant. Under this 
method it is assumed that the exhaustion of the original service 
capacity of the unit of property occurs uniformly over its service 
life. The company had estimated service lives as described above. 
In determining the amount of depreciation which should be 
accrued each month, the company assumed that there would be 
no scrap value or salvage when the buses were retired. Therefore, 
for a bus acquired after 1932, the original cost, delivered and 
ready to use, was divided by 120. Had scrap value entered into 
the calculation, it would have been deducted from the original cost 
and the result divided by 120 to get the monthly depreciation. 

The amount so determined was entered each month on the 
reverse of the card recording cost and other data for the coach, as 
illustrated in Exhibit 2. At the first of each year the depreciation 
already taken was totaled. By subtracting this from the total 
cost shown on the front of the card, it was possible to determine 
the net plant or service value not yet exhausted according to the 
estimates of the company. A total was taken each month of 
depreciation for that month on all buses owned, and this was made 
the basis for a summary entry in the books. Like all other 
transactions, it was dual in nature. The amount recorded the 
estimated depreciation taking place during the month on buses. 
It was therefore recorded as an operating expense of the month 
Depreciation on Buses. The same amount measured the decline 
in the service capacity of the asset and was entered as an increase in 
Reserve for Depreciation on Buses and thus reflected the decrease 
in proprietorship connected with this expense. The depreciation 
which had accumulated on the various buses since the time of their 
purchase, representing the estimated portion of the original value 



BOSTON ELEVATED RAILWAY COMPANY 43 

used up, was thus recorded in the reserve for depreciation which 
was shown on the balance sheet as a deduction from the asset 
account. 

At December 31, 1936, buses were reported as follows on the 
balance sheet of the Boston Elevated Railway Company : 

Buses Owned $4,570,88388 

Less: Reserve for Depreciation on Buses. .. . 1,888,206 64 $2,682,677.24* 



* In the condensed balance sheet published in the report of the company, buses were included 
in the item Equipment. 

In the records of the company the plant ledger, consisting of the 
cards for all buses, supported these figures. The total of the costs 
shown on each card equaled the amount shown for buses owned. 
The total of the depreciation on the several buses equaled the 
reserve appearing on the balance sheet. Similarly, if the net book 
value for each bus had been determined, the total of these figures 
would have equaled the net book value for buses shown above. 
The depreciation of $440,816.36 taken on buses during 1936, which 
was one element in the operating expenses for that year, was equal 
to the total of the depreciation entered during the year on each of 
the ledger cards. 

When the life estimates with respect to buses still in service 
were changed, the amount of the reserve required adjustment to 
bring it down to the amount necessary under the new estimate. 
This was accomplished by inserting a red ink figure in the proper 
amount on the reverse of the ledger card for each unit concerned, 
and by a summary entry in the books reducing the reserve and 
showing its other aspect as income for the period when the revision 
took place. In similar circumstances some other companies have 
shown the amount as an increase in surplus, on the theory that 
depreciation in past periods was charged in excessive amounts and 
that any necessary correction should be shown as an increase in 
the accumulated results of past earnings recorded in surplus. 

The mileage run each month and totals at the first of each year 
were also recorded on the reverse of the ledger card. These were 
statistical figures and did not involve an entry in the books of 
account. 

The company maintained records of maintenance and service 
costs by groups of buses; each group represented units of the 
same make and design. The sources from which maintenance 
data were collected consisted of the time cards, material requisi- 



44 ACCOUNTING STATEMENTS 

tions, and job cards of the repair shops. On the time cards and 
job and material requisition cards, costs were apportioned to the 
various buses worked upon through the use of a number code. 
These cards were collected each week and sent to the accounting 
office where they were classified and summarized. At the end of 
each month the information in the weekly summaries was com- 
bined and placed in the ledger so that the ledger contained a 
monthly record for maintenance by types of buses, broken down 
into the classifications, Chassis, Body, Tires, and Electrical Equip- 
ment, depending on the part of the bus on which the maintenance 
work had been done. 

Maintenance costs on tires were collected as explained above. 
The major portion of tire costs, however, was due to wear. The 
company did not buy tires outright but entered into contracts 
with tire manufacturers whereby tires were furnished at a fixed 
charge per mile. These costs were obtained by multiplying the 
contract rate by the number of miles covered by a bus during the 
period. Fuel costs were charged by types of buses from records 
kept at the several company-owned garages where gas pumps were 
located. Both tire and fuel costs were collected, summarized by 
types of buses, and placed in the ledger. At the end of the year 
the ledger contained monthly records of all these charges and from 
these data a table such as that shown in Exhibit 3 was prepared. 

Maintenance costs were not recorded on the property cards, 
because to do so would have required extensive records with all 
expenses broken down by individual buses. The accounting force 
was already responsible for a large amount of detail, and it was not 
thought desirable to add to this load unless the results so produced 
warranted the extra clerical effort. Although the head of the 
accounting department thought that individual maintenance 
records might be useful in uncovering individual " lemons" among 
the buses, the superintendent of rolling stock believed that his 
maintenance force learned to know the buses quite well and that 
if there were any " lemons " among them they were soon found out. 
Furthermore, maintenance by classes gave him all the data he 
needed in making comparisons among the different makes. 

Retirements of buses were made by the general manager upon 
the recommendation of the superintendent of transportation 
and /or the superintendent of rolling stock and shops. The head 
of the accounting department believed that retirements were based 



BOSTON ELEVATED RAILWAY COMPANY 45 

largely upon the estimated service lives. Accordingly, when a bus 
approached the end of its estimated service life, it was considered 
subject to retirement and in all probability would be eliminated as 
soon as the original cost was fully depreciated. He believed that 
it would be preferable to base retirements upon comparative 
cost studies rather than upon the amount of accrued depreciation. 
As has been explained above, retirements were recorded on the 
books by deducting the cost from both the asset and the reserve 
for depreciation accounts. In case the accrued depreciation shown 
on the ledger card was not equal to the cost of the bus, additional 
depreciation expense, sufficient to increase the reserve account to 
the required figure, was charged to the accounting period during 
which the retirement was made. For example, assume that bus 
No. 920 was to be retired on November 30, 1939, with a return from 
salvage of $100. Accrued depreciation at the time would be 
$10,393.51. Then the effect on the books would be to increase 
the cash account by $100, increase the depreciation expense 
account by $166.49, decrease the asset account by $10,660, and 
decrease the reserve for depreciation account by $10,560. 



1 . Was the service capacity of the buses owned at December 3 1 , 
1936, partly exhausted? 

2. Did the method used by the company bring about a proper 
charge to operating expenses to cover depreciation on buses 
during 1936? 

3. Is there evidence in the facts given that the life estimates 
should be revised again? On what person or group in the corpora- 
tion does the responsibility for such a decision presumably rest? 
What additional facts would be required for a decision as to 
revision of the estimates? 

4. What was the meaning of the figures shown in the report 
for 1936 for Buses Owned, Reserve for Depreciation on Buses, 
the difference between these figures or net book value, and 
Depreciation on Buses? 

5. In a problem involving the retirement of buses, on whom 
should the responsibility for the decision rest? What facts drawn 
from the accounting records or from other sources are essential to a 
decision? 

6. In deciding whether to buy new buses and, if so, the types 
and specifications of buses to be obtained, what facts drawn from 



4 6 



ACCOUNTING STATEMENTS 



the accounting records or from other sources are essential to a 
decision ? 

EXHIBIT i 

BOSTON ELEVATED RAILWAY COMPANY 

INCREASED USE OF BUSES 

1921-1936 



Date 
(December 
30 


Buses 
on hand 


Bought 


Retired 


Investment 
in buses 


Total 
miles 
operated 


Round 
trip, 
miles of 
routes 


1921 


i 


i 




* 


* 


* 


1922 


7 


6 




* 


63,959 


21. 2O 


1923 


33 


27 


i 


* 


465,39! 


35-81 


1924 


65 


33 


i 


224,425.77 


961,178 


62.57 


i9 2 5 


149 


84 




474,434.27 


2,713,729 


125.15 


1926 


230 


81 




1,028,597.58 


5,146,443 


173-43 


1927 


242 


13 


i 


1,491,543-59 


6,071,466 


195.37 


1928 


293 


Si 




2,231,810.92 


6,533,6i5 


216.31 


1929 


3M 


27 


*6 


2,600,456.13 


7,670,805 


289.27 


1930 


3 6 4 


66 


16 


3,163,817.92 


8,320,323 


359.43 


1931 


386 


45 


23 


3,458,135.50 


9,207,840 


426.57 


1932 


393 


28 


21 


3,625,608.51 


9,298,897 


491.92 


1933 


38i 


37 


49 


3,644,212.47 


9,539,738 


589.79 


1934 


388 


64 


57 


3,922,471.43 


10,378,326 


617.95 


1935 


407 


72 


53 


4,211,777.10 


10,711,732 


664 76 


1936 


434 


59 


32 


4,570,883 88 


10,941,862 


696.37 



k Figures not available. 



BOSTON ELEVATED RAILWAY COMPANY 



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V. THE ANALYSIS OF FINANCIAL STATEMENTS 

ALUMINUM COMPANY or AMERICA 

THE EFFECT OF MANAGEMENT POLICIES ON THE INTERESTS 

OF INVESTORS 

An investor in the common stock of the Aluminum company, 
who was himself an executive of a large industrial corporation, 
asked an investment counselor for his opinion concerning the 
policies of the Aluminum company in the retirement of bonds and 
preferred stock, and in the accumulation of dividends on the 
preferred, and the effects of these policies on his interest as a 
holder of the common stock. The investor realized that these 
policies were intimately related to the earnings of the business and 
to amounts necessary to finance inventories, receivables, and 
plant extensions. 

No cash dividends had been paid on the common stock since 
1925. In 1928 the company gave one share of Aluminum Com- 
pany, Ltd., common stock as a dividend on each three shares of 
Aluminum Company of America common. It was possible that 
the changes in securities in recent years, together with the effects 
of the surtax on undistributed profits, 1 might indicate an intention 
on the part of the management to initiate dividends on the common 
stock in the near future. 



1 Under the Federal Revenue Act of 1937, corporations were required to pay a 
tax of 8% to 15% on normal tax net income as shown in the table below: 

GRADUATED CORPORATION NORMAL TAX ON "NORMAL TAX NET INCOME" AS 

DEFINED (FOR YEARS BEGINNING JAN. i, 1936 AND AFTER) 
Income Bracket Rate 

$ o to $2,000 8% 

Over $ 2 , ooo to $15, ooo 1 1 

Over $15,000 to $40,000 13 

Over $40,000 15 

(Banks and trust companies, nonresident foreign corporations taxed at flat 
15% rate. Resident foreign corporations at 22%.) 

Corporations were also subject to a surtax on undistributed profits at rates indi- 
cated in the table at foot of page 52. 



52 ACCOUNTING STATEMENTS 

The investment counselor, who was a man of wide experience 
and whose firm supervised professionally the investment of many 
millions of funds, submitted the following analysis and opinion. 
After reading this opinion, the investor turned again to the state- 
ments for the last four years in an effort to evaluate, as well as he 
could from the data available, the policies of the management and 
their effects upon the interests of investors. . 



ALUMINUM COMPANY OF AMERICA 
OPINION OF THE INVESTMENT COUNSELOR 

In studying the present position of the Aluminum company's 
common stock it is helpful to start back in 1925 when six shares of 
new common stock, in addition to seven shares of preferred, were 
given in exchange for each share of old common stock. As a 
consequence of the 1925 split, and the issuance of preferred shares, 
the company's capital structure was highly pyramided. Bonds 
and preferred stocks, as of December 31, 1929, amounted to 85 per 
cent of invested capital. Such a pyramid obviously constituted 
an element of risk in a company whose business is highly cyclical, 
although the financial hazard was minimized to some extent by the 
fact that preferred stock, which lacks a creditor position, con- 
stituted the bulk of the senior ranking securities, amounting to 
over 66 per cent of invested capital at the end of 1929. 

In 1930 and 1931 the company borrowed heavily from banks 
and built up inventories, probably for several reasons : production 



SURTAX ON UNDISTRIBUTED PROFITS 
BASIS OF TAX, " UNDISTRIBUTED NET INCOME" AS DEFINED 



Percentage of ''Adjusted Net Income " 
Retained as " Undistributed Net Income" 


Rate of Tax 


Effective Rates 
Total Income 


First 10% 


7% 


o 7% 


Over 10% to 20% 


12% 


o 7% to i .9% 


Over 20% to 40% 


17% 


i .9% to 5.3% 


Over 40% to 60% 


22% 


5 3% to 9.7% 


Over 60% to 100% . 


27% 


9. 7% to 20.5% 









For corporations whose adjusted net income is less than $50,000 a specific 
credit is allowed in computing the tax, which increases 7% bracket to $5,000. 

See: The Revenue Act of 1936 as Amended by the Revenue Act of 1937; Section 
13, paragraph n; Section 14, paragraphs 17 and 18; Section 104, paragraph 198; 
Section 231, paragraphs 424 and 425. 



ALUMINUM COMPANY OF AMERICA 53 

costs were low, the company's water power would otherwise have 
been wasted, and the management wished to avoid aggravating 
the employment situation as much as possible. Net working 
capital remained at a fairly stable level, and funded debt was 
reduced by approximately two and one-half million dollars. 

During 1932 the company operated at a loss. As a result, the 
banks probably became more conservative in their attitude 
toward the loans, and dividends were allowed to accumulate on 
the preferred stock. In the three years 1932 to 1934, inventories 
declined moderately and bank loans were reduced by about nine 
and one-half million dollars from over twenty-five million dollars. 
Net working capital remained at approximately the 1929 level, 
and the company continued to purchase and retire its bonds with 
cash released by depreciation and other non-cash charges. In 
1935 and 1936 substantial reductions were made in both funded 
debt and preferred stock outstanding. In 1935 bonds aggregating 
twelve million dollars and preferred stock aggregating six hundred 
thousand dollars were purchased and retired. Net working capi- 
tal was reduced moderately, and dividends on the preferred stock 
continued to accumulate. In 1936 the company's operations were 
profitable, and a total of $12 per share was paid on the preferred 
stock, reducing arrearages thereon from $15 to $9. Bonds were 
reduced further by about one million dollars, and working capi- 
tal was drawn on to finance expenditures for plant as well as the 
purchase and retirement of preferred stock to the extent of ten 
million, six hundred thousand dollars. 

No cash dividends have ever been paid on the present common 
stock. The book value of this issue has never exceeded $25 a 
share and dropped to below $10 a share at the depths of the depres- 
sion, when the depreciation in the value of investments is taken 
into account. 

With the above background, the pros and cons of Aluminum 
company's policies can now be discussed. With respect to the 
management's policy of retiring bonds and preferred stock in 1935 
and 1936, at a time when the company was faced with the prob- 
ability of having to expand plant, and was borrowing from the 
banks, two pertinent questions were involved from the common 
stockholder's point of view. First, would the use of approxi- 
mately $25,000,000 of cash to retire senior securities, $13,000,000 
of it taken from working capital, unduly impair the soundness of 



54 ACCOUNTING STATEMENTS 

the enterprise? Second, could the funds have been put to a more 
profitable use? 

In answer to the first question it is probably fair to say that the 
management felt assured that it could borrow additional funds 
from the banks should another emergency arise. There was 
reason for this assurance in the good past record of loan reduction 
and in the excellent relationship with the banks. Furthermore, 
the business appeared to be facing a period of cyclical recovery and 
(this will be discussed later) it seems clear that the management's 
action was preliminary to a broad-scale financing program which 
there was good reason to believe could be put through on favorable 
terms during more prosperous times. Thus the answer to the 
first question is that the use of cash to retire senior securities did 
not seriously endanger the finances or operations of the company 
and the risk involved was not great. 

In connection with the second question, as to whether or not 
the funds could have been better employed, the thought inevitably 
occurs that a management in the early phases of an upward busi- 
ness trend should be able to use its funds to better advantage for 
plant or inventory purposes than for the reduction of senior 
capital. The management can hardly be criticized, however, for 
the way it did use its funds in 1935 and 1936. Fair cyclical 
recovery had already been experienced, and inventories were being 
reduced rather than increased. As explained before, inventories 
were built up early in the depression and the company through 
1936 had adequate plant facilities. Since money could undoubt- 
edly be borrowed from banks at a lower cost than the 5 per cent 
being paid on the bonds and the 6 per cent requirement on the 
preferred, the company's action resulted in a definite saving in 
senior capital costs. Indefinite, or too heavy, reliance upon bank 
loans would, of course, have been dangerous and, since the com- 
pany was growing, it was evident that there would be need in the 
near future to bolster working capital and to secure more funds for 
plant expansion than could be supplied from depreciation. In 
buying in its own securities, the management must have had some 
more permanent financing plan in mind, particularly since passage 
of the undistributed profits tax law in 1936 meant that additional 
capital could be accumulated from earnings only at a high cost. 
It is quite obvious that the retirements in 1935 and 1936 were in 
fact preliminary to a general financing program. This actually 



ALUMINUM COMPANY OF AMERICA 55 

took place, in July, 1937, through the sale to a group of insurance 
companies of a $24,000,000 issue of 3% per cent Debentures and 
through the making of serial bank loans of $6,000,000. The 
remaining 5 per cent bonds were recently called at 103. The 
answer to the second question is, then, that, bearing in mind 
the expectation of raising new capital, the cash was well employed 
in retiring bonds and preferred stock in 1935 and 1936. 

In discussing the management's policy of accumulating divi- 
dends on the preferred, it is worth pointing out that this policy 
might be subject to criticism by the preferred stockholder were the 
company using the money thus retained to buy in the preferred 
stock plus accruals at a discount. Preferred dividends were 
reduced, however, in 1932, when the company was operating at a 
loss and the banks could hardly be expected to loan money for the 
full payment of these dividends. Thus the arrears were built up 
prior to 1936, the only year in which a large amount of preferred was 
purchased. During the same year, which was the first since 1930 
when there had been more than nominal earnings for the common, 
dividend accumulations on the preferred were reduced by the 
payment of $12 a share. This should have made it reasonably 
clear to the preferred stockholder that the management's intention 
was to pay the arrears in full in cash. 

The effect of the two policies on the common stockholders was 
beneficial on balance. The broad refinancing program to which 
the purchase of bonds and preferred stock was preliminary was 
beneficial because it reduced the cost of capital ahead of the 
common. Any net reduction in prior-ranking securities also 
strengthened the asset position of the common. Moreover, the 
cash borrowed at the banks was undoubtedly secured at lower 
interest rates than the charges on the bonds and preferred, and the 
purchase of preferred at prices below call plus arrears in effect 
paid for the arrears at a discount. The retention of preferred 
dividend money at no interest cost was also obviously beneficial to 
the equity. Assuredly there was some risk involved in retiring 
prior obligations at a time when the funds could be used for 
reducing bank debt or for bolstering working capital and when it 
was becoming apparent that further additions to plant would be 
necessary. However, in the particular case of Aluminum com- 
pany, with its established position, capable management, and 
readily available bank credit, the risk was not great. It may be 



56 ACCOUNTING STATEMENTS 

concluded that in effect Aluminum company could adopt policies 
with reasonable safety which might be considered as involving 
unwarranted risk in the case of a less favorably situated company. 
Looked at from considerations of sound capital structure, how- 
ever, while the lowered cost of senior capital (including bank loans) 
facilitates trading on the equity during periods of prosperity and 
capacity operations, the financial policies initiated and carried 
through by the management have not made the company's 
finances appreciably less unwieldy in terms of an enterprise 
subject to violent cyclical fluctuations in business. On Decem- 
ber 31, 1936, bonds and preferred stock amounted to 84 per cent of 
invested capital. This does not spell financial disaster for the 
company during a depression any more than it did in 1932, since 
preferred stock comprises 66 per cent of total invested capital, but 
it means that common shareholders may continue to expect wide 
fluctuations in their earnings per share (and a necessarily uncertain 
dividend policy if dividends are initiated on the common stock) 
with fluctuations in the company's total net earnings, owing to the 
continued presence of excessive leverage in the amount of senior 
capital. 



Balance sheets and income statements in comparative form 
are given for the period from 1933 to 1936. The texts of the 
reports for 1934, 1935, and 1936 are also included. In Exhibit i, 
ratios similar to those developed in the Cudahy case are presented. 
In Exhibit 2, the prices of aluminum metal are shown, and in 
Exhibit 3, the prices of the securities of the company are given. 



1. In the Working Forms, a form of statement sometimes 
called a where-gone where-got statement is worked out to show the 
changes in individual balance sheet items between 1934 and 1935. 
Prepare a similar statement for 1935-1936. 

2. Determine for each of the years 1933-1936 the amount of 
income before interest necessary to cover the interest on bonds 
outstanding at the end of the year and the dividends on preferred. 
For this purpose, consider only the currently accruing dividends 
on the preferred and ignore the past accumulations. 

3. Analyze the most significant changes shown by the where- 
gone where-got statements and the computation of interest and 



ALUMINUM COMPANY OF AMERICA 



57 



ALUMINUM COMPANY OF AMERICA 
COMPARATIVE CONSOLIDATED INCOME AND SURPLUS ACCOUNTS 





1933 


1934 


1935 


1936 


Beginning Surplus 

Earnings, after deduct- 
ing all Expenses inci- 
dent to Operations. . 
Less Reserves for Depre- 
ciation & Depletion. 

Earnings 
Gain from Purchase & 
Retirement of Pre- 
ferred Stock 


$15,712,399 


$15,173,617 


$15,571,889 


$18,626,077 


$ 7,447,469 
5,825,056 


$12,058,955 
5,684,242 


$14,939,782 
5,520,661 


$27,617,665 
5,522,416 


$ 1,622,413 
42,i34 


$ 6,374,713 
9i,435 


$ 9,419,121 
152,086 


$22,095,249 
1,228,313* 


Net Income . 
Dividends on Preferred 
Stock 
$ 1.75 per share f . 
2.75 per share! . . 
12.00 per share j . . 

Reserve for Decrease in 
Value of Securities & 
Investments 

Ending Surplus. . . . 


$ 1,664,547 
2,203,329 


$ 6,466,148 


$ 9,571,207 


$20,866,936 


2,567,876 






. . 


4,017,019 




17,463,175 






$ 538,782* 


$ 3,898,272 
3,500,000 


$ 5,554,i88 
2,500,000 


$ 3,403,761 




$15,173,617 


$15,571,889 


$18,626,077 


$22,029,838 











* Loss. 

t Includes $ 25 on accumulated dividends in arrears, payable January 2, 1935. 
t Includes $ 8?K paid January I, 1936; and $1.50 paid Janaury i, 1937. 
Source: Company reports. 

dividend requirements from the point of view of the investor in 
the common stock. 

4. In examining the prospects for dividends on the common 
stock, the investor, who was himself an executive of an industrial 
corporation, decided that if he analyzed the problem as he would 
do if he were a member of the management of the Aluminum com- 
pany, he would have good grounds for determining what the 
actual management probably would do, or at least for determining 
the limits within which its decisions would lie. In doing this he 
wished to separate clearly those factors having to do with the 
operation of the business from other factors which were concerned 
solely with the refinancing. In view of the facts given, what 
dividend policy should the Aluminum company have followed? 



ACCOUNTING STATEMENTS 



ALUMINUM COMPANY OF AMERICA 
COMPARATIVE CONSOLIDATED BALANCE SHEETS 





1933 


1934 


1935 


1936 


ASSETS 
Current Assets 
Cash 
Accts. & Notes Rec., Less Res. 
Marketable Securities, at Cost 
Inventories of Aluminum, Ma- 
terials & Supplies . 


$ 2,862,878 
10,318,237 
23,464,318 

38,563,936 


$ 3,588,870 
10,844, 117 
4,053.486 

36,271,135 


$ 4,114,747 
14,070,927 
2,761,842 

31,417,342 


$ 2,515,567 

15,779,020 
2,339,976 

29,653,256 


Total Current Assets <t 
Sinking Fund Balance in 
Hands of Trustee . . . . 
Prepaid Expenses and De- 
ferred Charges to Opera- 
tions 
Invest, in Subsid. & Other 
Cos. not Consolidated 
Herein 

Land, Water Rights, Plants & 
Facilities 
Less Amortization, Depletion 
& Depreciation . . . 


$ 75,209,369 
700 

3,558,006 
15,455,844 


$ 54,757,608 
956 

3,094,272 
36,162,718 


$ 52,364,858 
I5i 

2,841,158 
36,006, 283 


$ 50,287,819 
551 

3,225,754 
35,96i,7i8 


$216,610,135 
76,830,951 


$216, 149,672 
80,931,767 


$216,887,574 
85,119,179 


$221 , 254,268 
87,686,589 


Net Plant . . ... 


$139,779,184 


$135, 217, 905 


$131,768,395 


$133,567,679 


LIABILITIES 
Current Liabilities 
Accounts Payable ... 


$234,003,103 


$229,233,459 


$222,980,845 


$223,043,521 


$ 1,678,214 
22,550,000 

2, 140,414 

564,568 
550,601 


$ 1,234,180 
15,920,000 
1,784,510 

1,526,015 
916,072 


$ 1,736,476 
8, 270,000 
1,858,064 

2,616,386 
i ,277,832 

6,385,050 


$ 2,511 , 270 
16,625 ,000 
2,487,807 

6,335,970 
2,i8i,335 


Bills Payable . 
Accrued Items not yet Due 
Res. for Income and other 
Taxes 


Pfd Stk. Div. Payable Jan. i 
25- Yr. 5% S.F. Debenture 
Gold Bonds, incl. Premium, 
called for Redemption, 
March I, 1936 .... 


Total Current Liabilities 






$ 27,483,797 


$ 21,380,777 


$ 22, 143,808 


$ 30,141,382 


25-Yr. 5% S.F. Debenture 
Gold Bonds, due 1952 
Less in Treas. for Redemption. 
Less Bonds Called for Re- 
demption March i, 1936. 


$ 35,050,000 


$ 33,968,000 
924,000 


$ 27,033,000 

6, 08 i ,000 


$ 20,000,000 




10- Yr. 6% S.F. Gold Notes, due 
December i, 1934 
Misc. Oper. & Other Reserves. 
Res. for Decline m Value of 




$ 35,050,000 


$ 33,044,000 


$ 20,952,000 


$ 20,000,000 


$ 335,ooo 
1,772,064 


$ 

1,803,168 

3,500,000 
146,570,500 

7,363,125 
15,571,889 


$ 

1,858,535 

6.0OO.OOO 
I46,O37,30O 

7,363,125 
l8,620,O77 


$ . 
2,086,876 

6,OOO,OOO 
135,422,300 

7,363,125 
22,029,838 


Capital Stock 
Preferred Stock Par Value 
per Share $100; authorized 
1,500,000 shares; out- 
standing* 
Common Stock No Par 
(Stated Value $5 per Share); 
authorize d 1,500,000 
shares; outstanding 1,472,- 
625 shares 
Earned Surplus f 


146,825,500 

7,363,125 
15,173,617 


$234,003,103 


$229,233,459 


$222,080,845 


$223,043,521 



* 1,468,255 shares in 1933; 1,465,705 in 1934; 1,460,373 in 1935; and 1,354,223 in 1936. 

t Dividends of $7 50 per share in 1933, $n.75 in 1934, $I5.0O in 1935, and $9.00 in 1936 have 
accumulated on the preferred stock. 
Source: Company reports. 



ALUMINUM COMPANY OF AMERICA 59 



TEXT OF THE 1934 ANNUAL REPORT 

There is submitted herewith Consolidated Balance Sheet of Alu- 
minum Company of America and its wholly owned subsidiary com- 
panies as of December 31, 1934, together with Consolidated Income 
and Surplus Account for the year 1934. 

Current Assets, excluding Marketable Securities, remain substan- 
tially the same as in 1933. Securities of the Niagara-Hudson Power 
Corporation, heretofore carried in Current Assets as Marketable 
Securities at their cost to Aluminum Company of America of 
$20,699,178.37, are now more appropriately classified under Invest- 
ments in Subsidiary and Other Companies. The balance sheet of the 
Niagara-Hudson Power Corporation indicates the book value of these 
securities as nearly equal to their cost to Aluminum Company of 
America. The December 31, 1934 market value of these Niagara- 
Hudson securities was $3,229,307.87. 

During the year, Bills Payable decreased $6,630,000.00. Other 
current liabilities remain substantially the same. Funded debt 
decreased $1,417,000.00 by the retirement at maturity of the bonds of 
the Franklin Fluorspar Company and by retirement through the usual 
sinking fund of the required amount of Aluminum Company of America 
25-year 5% Debenture Bonds. There were also acquired during the 
year, bonds having par value of $924,000.00, which were held in the 
treasury at the end of the year. These bonds were retired through 
the sinking fund January 24, 1935. 

Deliveries made upon orders and sales contracts were 37% greater 
than in the preceding year. There was an increased use of aluminum 
in nearly all of the older fields of application, and development of new 
uses for the Company's products continues to advance favorably. The 
utilization of aluminum in the fields of transportation and architecture 
is expanding. In 1934, aluminum experienced its most successful year 
in the truck and bus industries. The prospects are favorable for a 
further increase in sales during 1935. 

TEXT OF THE 1935 ANNUAL REPORT 

The consolidated financial statements of the Aluminum Company of 
America and its entirely owned subsidiary companies for the year ended 
December 31, 1935 appear on the following pages. 

Excluding marketable securities, current assets decreased 2*^% 
and inventories 13}^% as compared with the end of 1934. The hold- 
ings in securities of the Niagara-Hudson Power Corporation were 
slightly reduced during the year so that the Company's present interest 
in that corporation is now less than 10%. The market value of the 
Niagara-Hudson securities at December 31, 1935 was $8,117,399, an 
increase of 160% over their market value at the end of 1934. The 
large stock of aluminum accumulated during the years 1929 to 1932 
inclusive was considerably reduced during the year and at the close of 
1935 was 22% less than on December 31, 1934. 



60 ACCOUNTING STATEMENTS 

Due to additions and betterments in excess of retirements, the fixed 
capital of the Company was increased $737,901.99 during the year. 
As a result, however, of the application of normal depreciation and 
depletion rates, the net investment in fixed capital was decreased by 
2 M% as compared with the previous year. After provision for bad 
debts, accounts and bills receivable show an increase of 29%%, and cash 
an increase of 14}^%, as compared with the previous year. 

In addition to the regular sinking fund retirement effective March i, 

1935, $6,000,000 par value of the Company's bonds were called and 
retired as of September i, 1935 and an additional $6,081,000 were 
called December 30, 1935 for redemption on March i, 1936. Since the 
date of the attached statement, $952,000 par value of bonds were 
retired by sinking fund requirements, so that as of the present date the 
Company's funded debt is $20,000,000. Bills payable were reduced 
48% during the year. Interest payments decreased 27^2%; on the 
other hand, taxes paid to the United States and the various State 
Governments increased 63)^%. 

In 1934 a reserve of $3,500,000 was appropriated from net income for 
decrease in value of securities and investments. A further amount of 
$2,500,000 was appropriated for this same purpose during 1935 so that 
the present reserve against decrease in market value of securities and 
investments amounts to $6,000,000. 

Gross sales were 29*4% greater in 1935 than during the previous 
year and practically all manufacturing operations increased. New or 
crude aluminum was produced in an amount 60% % greater than during 
the previous year and this production has been still further increased in 

1936. The Niagara plant for the production of aluminum, closed in 
1931, resumed production in January, 1936. The average number of 
employees during 1935 was 18,152 as compared with 16,351 in 1934, 
an increase of 11%. During December of 1935 there were 20,523 
employees. 

The research and development work accounts for a considerable 
portion of the increase in sales, and furthermore has resulted in numer- 
ous economies in manufacturing operations. The outlook for further 
expansion and economies of a similar nature is excellent. 

TEXT OF THE 1936 ANNUAL REPORT 

Consolidated financial statements of Aluminum Company of 
America and its wholly-owned subsidiary companies for the year ended 
December 31, 1936, are submitted on succeeding pages. 

After deducting taxes, operating expenses, depreciation and deple- 
tion, the net income for the year is $20,866,936.33, as compared with 
$9,571,206.29 in 1935. After setting aside $6.00 per share for the 
annual dividend on the preferred stock, there would remain an amount 
equivalent to $8.65 per share of outstanding common stock, as com- 
pared with 55 cents per share in 1935. 

Accounts and notes receivable show an increase of 12^%. Bills 
payable increased from $8,270,000.00 at the end of 1935 to $16,625,000.00 
at the end of 1936. This increase was due in part to the payment of 



ALUMINUM COMPANY OF AMERICA 



61 



$7.25 per share on December 2ist against the accumulated back 
dividends on the preferred stock, on which there still remains unpaid 
back dividends amounting to $9.00 per share. 

The average wage paid to employees and the number of employees, 
of whom there were 26,168 in December of 1936, have increased during 
the year. Taxes paid to the United States and the State Govern- 
ments were 137% greater in 1936 than in the previous year. 

The demand for aluminum has grown until at the end of 1936 
practically all plants were in operation. Gross sales were 35% greater 
than in 1935. Several of the fabricated products, such as cooking 
utensils, forgings, tubing, extruded shapes and aluminum powder, have 
shown notable increases during the year. 



EXHIBIT i 

ALUMINUM COMPANY OF AMERICA 
RATIO ANALYSIS 





*933 


J 934 


iQ35 


193^ 


Current Ratio .... ... 


2.7 


2.6 


2.4 


i-7 


Current Liabilities to Total Liabilities, per cent 


11.7 


9.3 


Q Q 


J3-5 


Long-term Debt to Total Liabilities, per cent 


I5-I 


14.4 


0-4 


9.0 


Net Worth to Total Liabilities, per cent. . . 


73-1 


76.3 


80 7 


77-5 


Net Income to Total Assets, per cent 


0.7 


2.8 


4-3 


9 4 


Net Income to Net Worth, per cent 


I 


3 7 


5 3 


12 I 



Days' sakvS, turnover, times interest earned, and percentage of net income to sales 
cannot be computed, because of lack of information in the reports. 
Source: Company reports. 



EXHIBIT 2 
ALUMINUM COMPANY OF AMERICA 

ALUMINUM PRICES 

AVERAGE PRICES IN CENTS PER POUND, BASED ON OPEN MARKET 

QUOTATIONS OF PURE ALUMINUM (No. i VIRGIN 98%~99%, 

1912-1929; 99+%, 1930-1937) IN NEW YORK 



1912 


22.52 


1921 


21 21 


1930 


23 79 


1913 


23.63 


1922 


18.68 


1931 


23 3 


1914 


18.59 


1923 


25-41 


1932 


23-30 


1915 


34.13 


1924 


27.03 


1933 


23 30 


1916 


60.73 


1925 


27.19 


1934 


21 58 


1917 


51.25 


1926 


26 99 


1935 


20 50 


1918 


33-60 


1927 


25-41 


1936 


20 50 


1919 


32.14 


1928 


23.90 


Jan.-Oct. 1937 


20 10 


1920 


30.61 


1929 


23.90 







Sources: Metal Statistics, 1925, p. 433; 1936, p. 465; American Metal Market, November 2, 
1937, p. 7. 



62 



ACCOUNTING STATEMENTS 



EXHIBIT 3 

ALUMINUM COMPANY OF AMERICA 
BOND AND STOCK QUOTATIONS 







Stock 




5% Debenture 






Gold Bonds 










Preferred 


Common 


1925* 


106^ 


99 -loo 


63 - 65 


1926* 


iosH-105/i 


102 -103 


7iM- 72H 


1927* 


IOlJ^-101% 


105)^-106 


120 -125 


1928 


loo -io^i 


104 -HOJ4 


120 -197% 


1929 


99%- 1 03}^ 


103 -108% 


146 -524/^ 


1930 


100^-104% 


104 -inM 


HoM-356 


1931 


93^-105% 


56^-109^ 


48 -224 


1932 


81 - 99H 


33H- 67% 


22 - 90 


1933 


80-99 


37 - 77^ 


37H- 96 


1934 


95H-I07M 


60 - 78 


43 - 85% 


1935 


105^-108 


69^-114 


32 - 95 


J 936 


105^-108^ 


109 -125*4 


87 -161 


Jan.-Oct.i937 


1021^5-107 


109 -119% 


76 -I77M 



* Quotations in 1925-1927 were not the yearly high and low quotations as in 1928-1937, 
but were bid and asked quotations at the end of each year. 

Source: Bank 6* Quotation Record, January issues, 1926-1937; October, November, 1937. 



PART II 

BOOKKEEPING 

There is no clear line of demarcation between bookkeeping and 
accounting. Bookkeeping is a part of accounting work; it is that 
part which relates to the actual recording of business transactions 
in systematic fashion; therefore it tends to be of a routine nature. 
Accounting is concerned with problems of valuation, the com- 
parison of different methods of determining depreciation, and 
similar questions involving considerations somewhat broader than 
the routine recording of transactions. Accounting includes, 
moreover, the planning of a set of records which will at the same 
time furnish all the information which may be required and do it 
economically. The distinction is somewhat the same as that 
between the work of an artisan and an engineer. 

Historically there is an important distinction. While records 
of some sort have been kept since the earliest times, the systematic 
consideration of accounting problems was rather unusual before 
1890, and most of the literature on the subject appeared after 1900. 

Modern bookkeeping, which is almost synonymous with 
double entry, is a tradition which has developed gradually over a 
period of some seven centuries. It is a logically cohesive system 
which is based on two principles: first, that in any business the 
assets are equal to the claims against the assets, and second, that 
every transaction is dual in nature. The first of these principles 
is the basis of the balance sheet; the second is the basis for the 
record of every transaction by modern methods. 

Double entry was first used in connection with the commercial 
revival accompanying the Italian Renaissance. A few pages 
from the account book of a Florentine banking and money-lending 
partnership of 1211, which is the earliest accounting record of this 
period, show a recognition of the dual nature of some transactions, 
but the system was fundamentally that of the older diary or 
paragraph accounting, in which each transaction was described 
in a separate paragraph without any attempt at classification or 
formal arrangement. The accounts of the communal stewards of 

63 



64 BOOKKEEPING 

Genoa of 1340 are probably the earliest instance of the use of 
double entry. In these records, the separation of the two aspects 
of each transaction was complete, and each aspect was classified 
into accounts which are remarkably similar in form to those now 
in use. In 1494 Lucas Pacioli wrote a treatise on double entry 
bookkeeping in which he described the commercial practice in 
Venice at that time. This treatise and those account books of 
the period which have been preserved show that the underlying 
principles of double entry were firmly established by the end of the 
fifteenth century. Pacioli's treatise was the standard text on 
bookkeeping for two centuries and was translated into English, 
French, German, and Dutch, so that it exercised a considerable 
influence on the development of bookkeeping throughout Europe. 

The books of the Massachusetts Bank, which was opened in 
Boston in 1784, are an excellent example of bookkeeping technique 
at the time and show some interesting evidences of Pacioli's 
influence. 

The cases in Part II are designed to familiarize the students 
with what might be termed the classical tradition of bookkeeping. 
Most businesses at present use special journals and ledgers, each 
of which is adapted to record a particular type of transactions. 
These special books are considered in a later chapter, but they 
are all based upon the principles of the simple journal and ledger 
considered here. 

Familiarity with bookkeeping is essential to an understanding 
of accounting. It is also useful as a tool of analysis even when 
the results are not embodied in formal books of account. The 
principles of bookkeeping are relatively simple but it is as impos- 
sible to learn the art without practice as it would be to play tennis 
after reading a book on the subject. Bookkeeping partakes 
somewhat of the nature of a manual skill; it cannot be considered 
to be fully learned until most of the operations become automatic. 

The cases in Part II contain typical transactions from a 
number of different businesses. They are designed to give suf- 
ficient practice in the analysis of transactions, posting, adjusting, 
and closing to illustrate the principles involved and to show the 
relations between the fundamental books of account and the 
statements. An opportunity for further practice is available in 
the laboratory. 



VI. THE RELATION BETWEEN THE STATEMENTS AND 
THE BOOKS OF ACCOUNT 



HERENDEEN AND HAPLY WOOLEN MILLS No. 2 

THE RELATION BETWEEN THE STATEMENTS AND THE LEDGER 

The balance sheet and income statement of this company for 
June 30, 1934, were summaries of information preserved in greater 
detail in the several accounts in the ledger. In some instances an 
item appearing on the statements was the balance of a single 
account in the ledger, while other items represented the total of 
the balances of a series of accounts. The extent of subdivision in 
the ledger depended on the amount of detail needed in the adminis- 
tration of the business. It is possible to obtain by examining the 
statements a condensed list of accounts with their balances as 
carried in the ledger, that is, a condensed trial balance. By 
analyzing the needs of the business for additional information, it is 
possible to determine the points at which there presumably was 
additional subdivision of the accounts in the ledger. 

Using the balance sheet as of June 30, 1934, and the income 
statement for the year ending on that date, shown on pages 36 and 
37, determine as far as possible the accounts carried in the ledger 
of the company and the balances of those accounts. For that 
purpose use the paper in the Working Forms, and enter the data 
in the following manner: 



Title of account 


Kind of account 


Balance 


Debit 


Credit 


Cash 


Asset 


762,151.39 







In the process of closing the books and preparing the state- 
ments, the primary expense and income accounts were closed out 
through various clearing accounts, the net effect of all their 
balances being reflected in the change in surplus during the period. 

65 



66 



BOOKKEEPING 



For the purposes of this case, therefore, show the accounts as they 
were before closing. 

For instance, show net sales and purchases at the figures at 
which they appear in the income statement and do the same for the 
expenses, such as repairs and advertising. If this is done, it is 
necessary to use the beginning figure for surplus, the balance at 
June 30, 1933. It was only after all the income and expense 
accounts were closed thereto that the final balance of surplus at 
June 30, 1934, appeared. 

Include the inventories in the trial balance as assets at the 
figures shown on the balance sheet. It may be noted that begin- 
ning and final inventories for raw material, goods in process, and 
finished goods appeared in the income statement as part of the 
computation of the cost of raw material used, the cost of goods 
manufactured, and the cost of goods sold. In order to provide for 
these facts, include the three clearing accounts in the trial balance 
with the amounts shown. No other amounts in connection with 
the inventory facts on the income statement need be included. 
The reasons for this treatment will be examined in connection with 
later cases. 



Title of account 


Kind of account 


Balance 


Debit 


Credit 


Raw Material Used. 
Cost of Goods Manufactured 
Cost of Goods Sold 


Clearing 
Clearing 
Clearing 


1,285,188 59 
1,218,797.61 
37i,975 30 


1,050,693.18 
1,176,614 68 
237,563 oo 



Take totals of the amounts appearing in the debit and credit 
columns of the trial balance. 

The process of adjusting and closing the books and the prepara- 
tion of statements will be examined in later cases. The purpose 
at this point is to examine the relations between amounts appear- 
ing in the statements and in the ledger. 



HERENDEEN AND HAPLY WOOLEN MILLS NO. 2 67 

1. What type of balance is shown by each of the main classes 
of accounts appearing in the ledger? 

2. What is the relation of each of these classes of accounts to 
the balance sheet and to the income statement? 

3. For which items in the trial balance were a series of accounts 
probably carried in the ledger? That is, at which points did the 
needs of the business presumably require the carrying of additional 
accounts to give the management information needed in the 
conduct of the business? 



VII. THE ANALYSIS OF TRANSACTIONS 

THE ANALYSIS OF TRANSACTIONS No. i 

Each of the cases below includes a description of a transaction 
or transactions and a list of the balances of certain ledger accounts 
as they were before the transactions occurred. The balances are 
given in a single column in order to provide experience in deter- 
mining from the nature of the accounts concerned whether they 
have debit or credit balances. Each list of accounts includes all 
of those necessary in an analysis of the transactions. Do not 
use any accounts that are not listed. 



1. In each case set up the ledger accounts with the balances 
indicated. 

2. Analyze the transactions described, determine exactly what 
occurred, and make any computations which are necessary. 

3. Prepare the requisite journal entry or entries. 

4. Post the journal entries to the ledger. 

Use the journal and ledger paper in the Working Forms. Com- 
plete all operations with respect to a before proceeding to b. It is 
intended that the journal and ledger for each of the sections 
below shall constitute a unit. There is no necessary connection 
between successive sections, and in most cases they do not refer 
to the books of the same company. In the journal allow two 
blank lines between the entries arising from successive sections. 
In the ledger use one page for the accounts involved in each 
section. 

In a number of instances the balances of certain accounts 
would be likely to be affected between the dates indicated by 
entries arising from other transactions. In these cases assume 
that no entries were made except those arising from the trans- 
actions described, and ignore the effects of other transactions. 

a. The company issued 1,000 additional shares of its $100 par 
common stock on June i, 1937, arid received therefor $115,000.00 
in cash. Expenses involved, including legal and accounting fees, 

68 



THE ANALYSIS OF TRANSACTIONS NO. i 69 

taxes, registration fees, and printing and engraving, were 
$5,218. 71. Assume that the expenses were incurred and paid on 
June i. 

Balances May 29, 1937: 

Cash $ 97,384.43 

Common Stock i ,000,000 oo 

Premium on Stock 112, 300 oo 

Expenses of Issue, Common Stock . . 8,642. 15 

b. On May i, 1937, in order to secure additional working 
capital, the company issued $500,000 of 4 per cent Sinking Fund 
Debentures. These were sold to underwriters at 96. The 
underwriters absorbed the expenses of the issue. 

Balances April 30, 1937: 

Cash ; $126,839.37 

4 Per Cent Sinking Fund Debentures 

Bond Discount 

c. On November 13, 1937, the company paid to its employes 
wages of $595.25 for the week beginning November 8. 

Balances November 12, 1937: 

Cash $49 , oio . 68 

Wages Expense 16,908 73 

d. On September 13, 1937, the Chase Belting Company 
ordered leather from the Barkley Company of Philadelphia. 
The invoice, received on September 18, gave the following 
information : 

500 rough cow butt bends, 6,165 Ib. at 55 cts $3 , 390 .75 

Terms: 2 per cent 30 days; net 60 days. 

The shipment was delivered on September 20, and the Chase 
Belting Company paid $55.62 freight charges to the Seaboard 
Freight Line on September 21. The Barkley Company had 
agreed to allow freight charges to be deducted from the amount of 
the bill. These freight charges were treated as cash payments in 
figuring cash discount. 

The Chase Belting Company sent a check to the Barkley 
Company on October 4, 1937, for the balance due. 

Balances September 18, 1937: 

Cash $ 74 , 287 . 96 

Purchases. 151,460.27 

Discount on Purchases 4,623.38 

Accounts Payable Barkley Company 



70 BOOKKEEPING 

e. On October 6, 1937, the Jason Paint Company received a 
shipment of raw materials from the Barnard Whiting Company: 

10 bbl. whiting, 2,000 Ib. at 2 cts, $40.00 

The shipment arrived by truck with freight prepaid by the 
vendor. Terms were i per cent 10 days; net 30 days. 

On October 15 the Jason Paint Company mailed a check to 
the Barnard Whiting Company to cover the balance due. 

Balances October 5, 1937: 

Cash $75,654. 10 

Accounts Payable Barnard Whiting Company 

Purchases 96 , 47 1 . 28 

Discount on Purchases 728 . 91 

/. On September 7, 1937, the Hulst Shoe Company received a 
shipment of leather from the Linquist Leather Company. The 
invoice, dated September 3, gave the following information: 1 



1 Explanation of leather invoice by lines: 

i doz., Grade I), weight H, color No. 14, Eskimo veals waterproofed. 
8^2 doz., Grade K, weight H, color No. 14, Eskimo veals waterproofed. 
i% doz., Grade Q, weight H, color No. 14, Eskimo veals waterproofed. 

1 doz., Grade D, weight M, color No. 24^, Cretin calf butts (The part of a hide 
or skin of an animal corresponding to the upper part of the rear haunches and back.) 

$% doz., Grade K, weight M, color No. 24}^, Cretin calf butts. 

2 doz., Grade K, weight L.M , color No. 6, Norwegian calf. 
19 doz., Grade 2, weight M, Russian lining calf waterproofed. 

i doz., Grade 3, weight M, Russian lining calf waterproofed. 

LIST OF WEIGHTS 

HH Very heavy 

H . . . Heavy 

H.M.. . . . . . Heavy medium 

P.M.... . . Plump 

M . . . . . . Medium 

M Dash .... . . Medium 

M.L . . Light medium 

L.M Light medium (minus) 

L Thin 

L.L Very thin 

LIST OF GRADES 

B 

C 

D 

Dx 

These are the first four standard grades. Grade A is not listed because it is so 
rare now that for practical purposes it does not exist. 

Grades below these are unimportant and are marked according to individual 
desires of tanners. 



THE ANALYSIS OF TRANSACTIONS NO. i 







Sq. Ft. 


List 


Extension 


i DZ 


HD #14 ESK VLS WP 


208^ 


at 47^ 


$ 98.00 


8K2 E>Z 


HK #14 ESK VLS WP 


I >7 1 7/^ 


at 42^ 


721.35 


i% DZ 
i DZ 


HQ #14 ESK VLS WP 
MD #24^ Cret. CF Butts 


388 3 


at 39^ 
at 48 f* 


151-32 
57.00 


sH DZ 

2 DZ 


MK #24^ Cret. CF Butts 
LMK #6 NOR CF 


662*4 
282^ 


at 43^ 
at 33^ 


284 77 
93 T 4 


19 DZ 


M #2 Russ Lin CF WP 


2,833% 


at 22ff 


623.43 


i DZ 


M #3 Russ Lin CF WP 




at 20^ 


35.05 










$ 2 , 064 . 06 



Terms: 2 per cent on bills settled the i5th of following month; interest at the 
rate of 6 per cent per annum to be charged thereafter. 

Freight to the amount of $16.24 was paid to the Jackson Truck 
Company upon receipt of the shipment and was deducted from 
the amount of the bill. In this case, freight charges could not be 
considered as cash payments in figuring cash discount. 

The Hulst Shoe Company was pressed for working capital at 
the time and allowed the account to run until December 7, when 
a check was issued for the balance due, including interest of 
$18.09. 

Balances September 7, 1937: 

Purchases $215,337 12 

Discount on Purchases . . 5 , 772 68 

Accounts Payable Linquist Leather Company 

Cash . . 97,628.14 

Interest Expense 302 76 

g. On September 16, 1937, the Jason Paint Company received 
the following order from the Jackson Company, of 245 High 
Street, Clinton, Mass. 







List 




8 

4 

i 


i Gal. Cans No. 1528 
i Gal. Cans No. 535 
Yv Gal. Can No. 303 


$2.95 gal. 
2-95 gal. 
i 69 Yi gal. 


$523.60 
1 1. 80 
i .69 


$37 09 



Terms: 12 and 4 per cent trade discount; i per cent cash discount for payment 
by the end of the month; net at the end of the second month; f.o.b. seller's plant, 
Worcester. 1 



1 Enter the sale net of trade discounts. The discount of 4 per cent should be 
applied to the balance after deducting the discount of 12 per cent. 



BOOKKEEPING 



The order was shipped on September 17 by the Clinton 
Auto Express. 

On September 30, the Jackson Company paid the balance of 
its account. The cash discount period on the balance of $62.82 
had already elapsed. 

Balances September 16, 1937: 

Cash ; $34,376.48 

Accounts Receivable Jackson Company 62 . 82 

Sales 328,417.83 

Discount on Sales 2 , 846. 24 

h. On July 6, 1937, the Chase Belting Company of Buffalo, 
New York, received an order from the Castro Machinery Corpora- 
tion of Akron, Ohio. The order, as described below, was shipped 
and billed on July 7. 



Item 


List 


Amount 


Soft 
Soft. 


X iH in. single 0; 
X 3 in. single Oak 


ik Belting 


$o 36 
o 72 


$18.00 
36.00 


Belting 




$54 oo 



Terms: 40 and 5 per cent trade discount; 2 per cent 10 days; net 30 days; f.o.b. 
Buffalo. 

On July 1 6 the Chase Belting Company received a check 
from the Castro Machinery Corporation for the entire balance of 
its account. The cash discount period on the balance of $132 . 10 
had already elapsed. 

Balances July 6, 1937: 

Cash $ 67, 482 . 14 

Sales 416,908.28 

Discount on Sales 7,326.56 

Accounts Receivable Castro Machinery Corporation 132. 10 

i. On October 4, 1937, the Alton Leather Company, of Balti- 
more, sold the goods listed below to the Bolton Shoe Company, 
of St. Louis. The goods were shipped the same day. 



THE ANALYSIS OF TRANSACTIONS NO. 



73 



Amount 


Specifications 


Feet 


Price 


Extension 


52 doz. 


76 Spec. 50 


4,700-2 


20 




52 doz. 


yB Spec. 50 


4,740 


2O 




44 doz. 


yB Spec. 50 


3,943-1 


20{ 


$2,676 75 


10 doz. 


FXB Color 50 


938-2 


19* 




55 doz. 


FXB Color 50 


4,780-3 


l<)l 




50 doz. 


FXB Color 50 


4,685 


i9ff 


1,976.81 


22 doz. 


FXB Color 50 


2,015 


i6ff 


322.40 






25,801-8 




$4,975 96 



Terms: 2 per cent 30 days; i per cent 60 days; net plus 6 per cent per annum 
thereafter; f.o.b. Baltimore. 

On December 15, 1937, a check for the balance due was received 
from the Bolton Shoe Company, including interest of $9.95. 
Balances October 4, 1937: 



Cash 

Accounts Receivable Bolton Shoe Company 

Sales 

Discount on Sales 

Interest Income 



$ 36,432 18 



916,485.96 

15,465.42 

757.29 



j. On October i the company, a wholesale druggist, received a 
check from the receiver for the Watkins Drugstore, which had 
failed a few months previously. The assets had been liquidated, 
and the receiver was paying the general creditors at 60 cts. on the 
dollar. No further payments could be expected. The company 
charged off the balance of the account as a bad debt loss to the 
reserve set up for that purpose. 

Balances September 30, 1937: 

Accounts Receivable Watkins Drugstore $ i, 516 42 

Reserve for Bad Debts 110,540.87 

Cash 221,652.39 

k. It was the practice of the company, when it was recognized 
that an account receivable would not be collected, to debit Bad 
Debts Written Off and credit Accounts Receivable. This was 
done during the year whenever it became apparent that an account 
could not be collected. The credit was, of course, to the account 
receivable from an individual customer, but for purposes of this 
case, only the total of accounts receivable is given above. 

Bad Debts Written Off was closed out at the end of the year 
to the Reserve for Bad Debts, and after this was done, the com- 



74 BOOKKEEPING 

pany adjusted its reserve so that it represented 4 per cent of the 
balance in the Accounts Receivable account at that time. The 
amount by which it was necessary to increase the reserve estab- 
lished the amount of the bad debt expense for the year. 

Make all entries necessary to close Bad Debts Written Off 
and to adjust the Reserve for Bad Debts. 

Balances December 31, 1937: 

Accounts Receivable $821 ,097 . 56 

Reserve for Bad Debts 39,430. 71 

Bad Debts Written Off 18,140.63 

Bad Debts Expense 

/. The Reserve for Bad Debts had been built up through a 
charge of ^ per cent of sales per month to Bad Debts Expense. 
On December 31, officers of the concern went through the accounts 
receivable and wrote off accounts aggregating $19,897.45. This 
required a credit to the individual accounts receivable, but for the 
purposes of this case, enter the total as a credit to Accounts 
Receivable. The bad accounts were charged to Bad Debts 
Charged Off. The balance of Bad Debts Charged Off was then 
charged against the Reserve for Bad Debts. 

During the year bad debts previously charged off had been 
collected to the extent of $5,280.06. This amount appeared on 
the books as a credit to Bad Debts Collected. On December 31, 
Bad Debts Collected was closed out to Reserve for Bad Debts. 
Any balance then remaining in the reserve was carried over to the 
next year. 

Balances December 31, 1937: 

Accounts Receivable . ... . $212,502.69 

Reserve for Bad Debts .... 28,114.37 

Bad Debts Expense 21,023.54 

Bad Debts Collected 5,280.06 

Bad Debts Charged Off 

m. On October 19 the company declared a quarterly dividend of 
1 1/2 per cent, payable December 15 to stock of record November 20. 

Show journal entries to record both the declaration and the 
payment of the dividend. Close Dividends into Surplus as of 
December 31. 

Balances October i, 1937: 

Common Stock $1,000,000.00 

Surplus 440,947.21 

Cash 105,836.47 

Dividends Payable 

Dividends 45,000.00 



THE ANALYSIS OF TRANSACTIONS NO. i 75 

n. Interest was payable August i and February i and had been 
paid in full on August i, 1936. Interest on the bonds had been 
accrued to December 31, 1936. On February i, 1937, another six 
months' interest was paid on the bonds. 

Show entries to record interest expense for the month of 
January and the payment of interest February i, 1937. 

Balances January 30, 1937: 

5 Per Cent First Mortgage Bonds $15 ,000,000 oo 

Interest Expense Accrued 312,500.00 

Interest Expense 

Cash 993,617.48 

o. On December 8 the company ordered from the La Salle 
Equipment Company a new stamping machine that cost $10,- 
500.00. The machine arrived on December 13, and was installed 
the same day. Freight charges were $198.32, labor cost on instal- 
lation, $145.96, and materials and supplies used in installation, 
$23.16. 

Show journal entries to record the payment of freight, and the 
payment of wages involved in the labor cost of installation as of 
December 13. The materials and supplies were already on hand 
and were recorded in that account. 

The expenses incurred up to the time a machine started pro- 
ducing goods were considered a part of its cost and were debited 
to the asset account. Show additional entries necessary to bring 
this about. The machine was paid for on December 20. 

On December 23 the company dismantled and retired an old 
stamping machine. This machine had cost $9,428.00, and 
depreciation of $8,980.50 had been accrued by yearly charges to 
operations. The cost of dismantlement was $95.12, and salvage of 
$250.93 was received. 

Assume that the cost of dismantlement was paid in cash, and 
that cash was received for salvage. This company charged the 
balance of undepreciated cost as an addition to the depreciation 
expense for the year. 

Use the account Machinery Retired to bring together the 
several facts involved in the retirement of this machine. Show 
entries to transfer to Machinery Retired the amounts previously 
standing in Machinery and Equipment and Reserve for Deprecia- 
tion, with respect to this machine. Similarly, transfer the 
amounts standing in Cost of Dismantlement and Salvage to 



76 BOOKKEEPING 

Machinery Retired, and transfer the final balance of Machinery 
Retired to Depreciation Expense, in accordance with the policy of 
the company. 

Balances December i, 1937: 

Cash $34,364.29 

Machinery and Equipment 93,616. 75 

Reserve for Depreciation 29,475 36 

Accounts Payable La Salle Equipment Company 

Depreciation Expense 9 , 450 . 67 

Freight 752 81 

Wages 25 , 618 . 05 

Materials and Supplies 10,417.22 

Cost of Dismantlement 

Salvage 

Machinery Retired 

p. In 1937 the Montin Manufacturing Company purchased a 
new-type punch press and auxiliary equipment from the Palman 
Machine Company of Newark, N. J. On May 13 in a conference 
with the engineers of the Palman company, executives of the 
Montin Manufacturing Company had submitted the problem of 
developing a new type of press which could perform numerous 
operations on a new product. In July the Palman company 
presented drawings of the new equipment. These were examined 
by the Montin company and found to be satisfactory. On 
July 21 a contract for the new machine was signed. 

On November 2 the Palman company shipped punch press 
No. 33 with auxiliary equipment, a detailed set of drawings, and a 
complete set of manufacturing tools to the Montin company and 
billed the latter for the price agreed upon. The shipment arrived 
at its destination on November 6, and by November 12, the equip- 
ment was installed and ready to function. After several days' 
operations it was apparent that the new machinery was satis- 
factory so that final acceptance was made by the Montin company 
on November 16. On this latter date the purchase was booked by 
the Montin company. The amounts involved were : 

1 No. 33 punch press with standard die head and arranged for 

motor drive $ 4,000 oo 

2 Extra die heads at $550 i , 100. oo 

i Lever press at $650 650 oo 

i Set of detailed drawings 350 oo 

i Complete set of tools 4 , ooo . oo 

Freight 179-38 

Installation charges 532 . 91 

$10,812 29 



THE ANALYSIS OF TRANSACTIONS NO. i 77 

A check for $10,100.00 was sent to the Palman company on 
November 16, and on the same day, a check was issued to the 
Central Railroad Company for the freight on the press. In 
accordance with the practice of the company, drawings and tools 
should be recorded in separate accounts, but the punch press, die 
heads, and lever press should be recorded as machinery and equip- 
ment. The installation charges of $532.91 had already been paid 
and were included in Press Department Maintenance, but should 
be transferred to the account Installation Charges to facilitate 
allocation as indicated below. 

The expenses incurred in installing the press were allocated as 
follows: of the freight, $24.03, and of the installation charges, 
$72.07, were charged to the tools, and the balance of the two 
amounts was added to the cost of the press. 

It was the practice of this company to write off tools and draw- 
ings to Press Department Maintenance. This was done on 
November 30. 

The new machine displaced seven old-type presses which were 
retired on November 30. These presses had originally cost 
$2,877.00, but during the life of these machines additions amount- 
ing to $284.00 had been made, so that $3,161.00 was the capitalized 
value of the machines. Depreciation of $3,075.80 had been 
accrued to the date of retirement. The cost of dismantlement 
was $156.69 and salvage of $210.31 was received. 

Assume that the cost of dismantlement had already been paid 
and charged to Press Department Maintenance, and that the 
salvage was received in cash. Show entries to transfer the cost of 
dismantlement to the account of that title, and to record the 
receipt of the salvage in cash. The Montin company charged 
undepreciated cost to an earmarked surplus account, Reserve for 
Obsolescence. As in the preceding case, transfer all of these 
amounts to Machinery Retired and close the balance of this 
account in accordance with the practice of the company. 



78 BOOKKEEPING 

Balances November 15, 1937: 

Machinery and Equipment Press Department $116, 741 .58 

Drawings 

Small Tools 

Freight 480.49 

Installation Charges . . 

Cash . . . . 147,923.47 

Press Department Maintenance 5 , 260. 61 

Cost of Dismantlement 

Salvage 

Reserve for Depreciation 25,348.32 

Reserve for Obsolescence 52,629 84 

Machinery Retired 

q. A Standard Bond Card dated May 6, 1931, issued by the 
Standard Statistics Company gave the following information 
concerning the 4^ convertible bonds of the American Telephone 
and Telegraph Company. 

IO-YEAR 4^/2 PER CENT CONVERTIBLE BONDS, 1939 

Convertible into company's stock at Treasurer's office, on and after 
January i, 1930, and until December 31, 1937, at the following prices: 
During 1930 at $166.88 a share; during 1931 and 1932 at $175.46 a 
share; and during the years 1933 to 1937, inclusive, at approximately 
$183.60 a share with adjustment of interest and dividends. If bonds 
are called for redemption they may be converted not later than the 
redemption date. (Interest payable January i and July i.) 
Conversion Options. 

a. The bondholder may take one share of stock for each $100 
principal amount of bonds surrendered, on payment in cash for each 
such share of the difference between the conversion price then in effect 
and $100 or 

b. The bondholder may take as many shares as the principal amount 
of bonds surrendered is a multiple of the conversion price then in 
effect, and if there be a remainder, the bondholder may take one addi- 
tional share on payment in cash of the difference between such conver- 
sion price of such share and such remainder. 

Assume that a bondholder on April 15, 1931, offered $10,000 
principal amount of bonds of this issue for conversion under option 
a and included a check for the requisite amount of cash. The 
interest owed to the bondholder was paid in a separate check. 
Consider the interest period to be 3% months. Because of the 
date, no adjustment was necessary for dividends. 

Assume that a second bondholder offered the company the 
same amount of bonds the same day for conversion under option b 
and that he took the additional share to which he had a right under 
the second part of option b above. 



JOHN L. STEELE, REALTOR NO. i 79 

Show journal entries to record the bond conversion under each 
of the assumptions made above. 

Assume that the balances of the accounts involved before these 
transactions were entered were as follows: 

Capital Stock ($100 par) $1,801,968,100.00 

Convertible Bonds . . . 12,923,00000 

Cash . 38,165,131.22 

Interest Expense . . . . 8,147,58439 

Premiums on Stock . . 261,026,672.75 

JOHN L. STEELE, REALTOR 1 No. i 

THE RELATION BETWEEN THE STATEMENTS AND THE BOOKS 

OF ACCOUNT 

The facts of this case have been simplified in order to show 
more clearly the relation between the statements and the ledger, 
between the ledger and the journal, and the manner in which the 
transactions are entered in the journal. No details of the trans- 
actions are given. Details with respect to a similar group of 
transactions are given in the next case. 

The changes between the balance sheets of December 31, 1931, 
and January 31, 1932, resulted from the outside transactions 
during the month and certain adjustments based on the following 
facts. 

John L. Steele owned the building in which his office was 
located, subject to a mortgage of $9,000, and rented part of the 
building as a store for $110 per month. He had estimated that 
the land was worth $8,000 and that the building represented the 
balance of the cost. Depreciation was charged on the value of 
the building at 5 per cent per year, distributed by months. 
Interest on the mortgage was payable February i and August i 
at 5 per cent. His automobile was included as an asset of the 
business at cost, less depreciation at 3 per cent per month. The 
personnel consisted only of himself and a secretary-bookkeeper 
who received a salary of $100 per month. 



1 " Real tors are real estate brokers or agents who are active members of a local 
Real Estate Board which is connected with the National Association of Real Estate 
Boards. They are licensed to use this designation by the National Association, 
whose exclusive right to the use of the term has been upheld by the Courts." From 
a pamphlet published by the local real estate exchange. 



80 BOOKKEEPING 

The ledger is shown as it appeared after all bookkeeping 
operations for the month had been finished. For the purposes of 
this case all balances standing in the ledger at the beginning of 
the period are marked (a), the entries which resulted from the 
outside transactions during the month are marked (6), the adjust- 
ing and closing entries are marked (c) and (d), respectively, and 
the balances at the end of the month are marked (e). 

The bookkeeper drew up the statements on February i, 
including transactions up to the close of business on Saturday, 
January 30, although the statements were dated as of the last 
day of the month, even when that fell on Sunday. 

The journal shows the accounting analysis of the transactions. 
The details were preserved in documents filed in numbered folders, 
the number being included in the journal entry, so that the 
supporting documents for any entry could be readily found. 

The entries necessary for adjusting and closing are also 
included in the journal. The process of simplification for the 
purposes of this case has distorted the picture somewhat, since in 
actual practice, the number of outside transactions was much 
greater. 



1. Trace each item on the balance sheets and income state- 
ment to the ledger and determine the relation between the state- 
ments and the ledger. 

2. Trace each item on the journal to the ledger and determine 
the relation between the two books. 

3. Check the source of each journal entry. 

4. Take a trial balance of the ledger as it is after closing. 
Use the paper in the Working Forms. 

BALANCE SHEET, DECEMBER 31, 1931 

Cash $ 6,389 oo Mortgage $ 9,000.00 

Supplies . 290 oo Interest Accrued ... 187 50 

Land . 8,000.00 Rent Prepaid .. no oo 

Building $13,680.00 John Steele, Capital. . . 15,000 oo 

Less: Res. John Steele, Drawings.. . 3,112.50 

Depn. . 2,280.00 11,400.00 



Furniture & 






Fixtures . . 




782 .00 


Automobile. . $ 


900.00 




Less : Res. 






Depn.... 


351-00 


549.00 



$27,410.00 $27,410.00 



JOHN L. STEELE, REALTOR NO. i 



81 



BALANCE SHEET, JANUARY 31, 1932 

Cash $ 6,637. 70 Mortgage $ 9,000.00 

Supplies 242.00 Interest Accrued 225.00 

Land 8,000.00 Rent Prepaid no.oo 

Building. . . . $13,680.00 John Steele, Capital 15,000.00 

Less: Res. John Steele, Drawings.. . 3 , 191 . 70 

Depn. .. 2,337.00 11,343.00 



Furniture & 






Fixtures . 




782.00 


Automobile $ 


900.00 




Less: Res. 






Depn. . 


378 oo 


522.00 


$27,526.70 



$27,526 70 



INCOME STATEMENT FOR THE MONTH ENDED 
JANUARY 31, 1932 

Commission on Sales ... $447 50 

Commission on Leases . . . . ... . 54 .00 

Rental Income . . . .... . 110.00 



Total Income 
Less: Expenses 

Salaries 

Advertising .... 
Depreciation 
Supplies Expense . . . 
Interest Expense . 

Net Income 

Less: Withdrawn by Proprietor 

Surplus for the Month . . . 



$611 50 



$100.00 
12.80 
84.00 
48 oo 
37-50 



282.30 



$329. 20 
250.00 

$ 79-20 



82 



BOOKKEEPING 



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JOHN L. STEELE, REALTOR NO. i 



89 



The following transactions took place during January, 1932: 

January 4 A building lot was sold for $1,750.00. The commission 
of 5 per cent was collected in cash, the rest of the 
payment being made directly to the vendor by the 
vendee. 

January 8 Three houses were advertised in the newspaper; charges 
of 40 cts. per line for a total of 32 lines were paid in 
cash, the expense being borne by the broker. 

January n A single house of eight rooms was leased for one year 
beginning February i at $90 per month. The tenant 
deposited $60 to apply on the first month's rent. The 
broker deducted his commission of 5 per cent of a year's 
rent and remitted the balance to the owner. 

January 12 One of the houses advertised on the eighth was sold for 
$9,000. The transfer did not take place till March i, 
but the commission was considered earned when the 
sales contract was signed on January 12. On that 
day the purchaser deposited $500 with the broker, who 
retained his commission of 4 per cent and remitted the 
balance to the owner. 

January 30 On Saturday, January 30, rent of $110 was received for 

February on the store next to the office. 
The secretary-bookkeeper's salary for January was paid, 

$100. 

Steele withdrew $250, leaving the rest of the profit for 
the month in the business. 

An inventory, taken on January 30, disclosed that $242 of 
supplies were still on hand. 



90 BOOKKEEPING 

JOHN L. STEELE, REALTOR No. 2 

RECORDING TRANSACTIONS IN THE JOURNAL 

The outside transactions for February are indicated below. 
Enter these transactions in the journal, using therefor the paper 
in the Working Forms. 

In charging for his services, Mr. Steele adhered to the rates 
established by the Boston Real Estate Exchange for suburbs 
of Boston. 

FOR BOSTON SUBURBS 
AND CITIES OTHER THAN BOSTON OVER 100,000 POPULATION 

Minimum 
Sales 

4% up to $25,000 and 3% on next $175,000 and ij^% on balance 

of price (except as follows) $100 

Cooperative Apartment; 5% on price 

Land (vacant or with building incapable of yielding net rent), 

Garage or Stable; 5% up to $100,000 and 3% on balance .... 50 

Farm, Industrial Plant or Wharf; 6% .... 200 

Subdivision Contract; 15% to 25% by agreement 

Subdivision House Lot; 5% to 10% by agreement 25 

Mortgages 

First Mortgages and Construction Loans; 2% $ 50 

Second Mortgages; 3% . ... 50 

Exchanges Commissions as above paid by both parties. 

Leases 

Business Premises; 4% on rent for first two years, 2% on rent for 

next two years and i% on rent for balance of term . ... $ 25 
Less Than One Year or Tenant-at- Will; 45% of a month's rent . 15 
Garage, Industrial Plant, Stable, Wharf or Land; 6% on rent for a 

year and 3% on rent for balance of term . . . 25 

Residence or Apartment; 5% on rent for a year (or season) and 

2 1 4>% on rent for balance of term 25 

Tenant-at-Will; 50% of a month's rent 15 

Management 

On Amounts Collected by Agent 6% 

Monthly rents under $15 and Weekly Rents . . .... 10% 

On Cost of Improvements (not repairs) supervised by Agent. ... 5% 

On Cost of Repairs, only when specifically agreed to 5% 

The following transactions took place during February: 

February i The interest on the mortgage was paid. 

February 3 The previous month a two-family stucco house, at 46 

Ipswich Street, had been listed under an exclusive sale 

contract. 



JOHN L. STEELE, REALTOR NO. 2 91 



JOHN L. STEELE 

Realtor 

464 Main Street Hartford 
EXCLUSIVE SALE CONTRACT 

Hartford Mass. 

January 18 1932 
In consideration of special service on the part of J. L. Steele, I hereby give the 

said J. L. Steele exclusive sale of the property listed below for a period of 

three months from this date, and thereafter until this agreement is re- 
voked by me by written notice delivered to J. L. Steele. I hereby agree to pay 
J. L. Steele the usual broker's commission in case the property is sold during the 
fife of this contract. 

The two family stucco house with double garage at 46 Ipswich Street, being 
lot number 182, in the Ipswich subdivision, in which I have a good and clear 
title except for a mortgage of $4,500 held by the Stebbins Cooperative Bank. 
Sale price $12,500 cash. 

Accepted by Signed in duplicate 

SARAH BENTON Owner 
John L. Steele 



On January 28 a customer, Henry Lancaster, submitted an 
offer of $9,500 which was not accepted. On February i he 
increased his offer to $10,000 in cash, which was accepted on 
February 3. A contract of sale was drawn up providing for the 
transfer of the property March i. 1 On February 3 the purchaser 
deposited $800 with the broker, who deducted his commission 
and remitted the balance to the owner. Commissions were con- 
sidered as earned upon the signing of the contract of sale. 

AGREEMENT made this 3rd day of February A. D. 

1932 between Sarah Benton of Hartford, County of Clinton, Commonwealth of 
Massachusetts, 

of the first part, and Henry Lancaster of Oakland, County of Houston, Common- 
wealth aforesaid, 
of the second part. 



1 On March i the owner, the broker, a representative of the bank holding the 
mortgage, and the attorney representing the purchaser met at the registry of deeds 
for the county in which the property was located. The attorney, who had already 
examined the title, satisfied himself that no changes had occurred since his examina- 
tion. The quitclaim deed, which had been prepared by the broker, was signed by 
the owner, and revenue stamps at the rate of $i per $1,000 of the agreed price were 
affixed at the expense of the owner. The representative of the Stebbins Cooperative 
Bank gave the attorney the canceled note for $4,500 and a discharge of the mortgage 
and surrendered the insurance policies properly assigned to the new owner. 

The water rates, taxes, mortgage interest, and insurance premiums were adjusted 
as of the date of the transfer, and $9,200 plus the amount of the adjustments was 
paid to the vendor in treasurer's checks. The bank then collected $4,500 plus 
accrued interest from the mortgagor. 

The computations were made by the broker as representative of the owner and 
were checked by the representatives of the other parties at interest. 

The deed and the discharge of the mortgage were left at the registry of deeds 
to be recorded and were sent to the new owner six or seven weeks later. 



92 

The party of the first part hereby agrees to sell, and the party of the second 
part to purchase, 

the land in said Hartford with the buildings thereon at No. 46 Ipswich Street, 
being Lot No. 182 in the Ipswich Subdivision as shown on a "Plan of land 
belonging to Ipswich Associates, Hartford, Mass./' by Harvey S. Johnson, 
C. E., dated February 10, 1922 and recorded with Clinton County Registry 
of Deeds in Book of Plans 243, Plan 21, and bounded and described as follows: 

Northeasterly By Ipswich Street, Seventy-five (75) feet; 

Southeasterly by Lot No. 183 on said plan, One Hundred (100) feet; 

Southwesterly by land now or formerly of the Ipswich Associates, Seventy- 
five (75) feet; 

Northwesterly by Lot No. 181 on said plan, one Hundred (100) feet; con- 
taining according to said plan Seventy-five Hundred (7500) 
square feet of land. 

Being the same premises conveyed to the Seller by Joseph L. Dawes by deed 
dated June 19, 1924, recorded with said Deeds in Book 4625, Page 429. 

Said premises are to be conveyed on or before March i, 1932 by a good 
and sufficient Quitclaim deed of the party of the first part, conveying a good 
and clear title to the same free from all encumbrances except taxes assessed as 
of April i, 1932, restrictions of record so far as the same may now be in force 
and applicable. 

and for such deed and conveyance the party of the second part is to pay the 
sum of 

Ten Thousand ($10,000) dollars 

of which Eight Hundred ($800) dollars 

has been paid this day, Ninety-two Hundred ($9200) dollars 

is to be paid in cash upon the delivery of said deed. 

Full possession of the said premises, free of all tenants except tenant at will 
in lower apartment is to be delivered to the party of the second part 

at the time of the deed, the said premises to be then in the same condition in 
which they now are, reasonable use and wear of the buildings thereon, and 
damage by fire or other unavoidable casualty excepted. 

The buildings on said premises shall, until the full performance of this 
agreement, be kept insured in the sum of Seven Thousand ($7000) dollars by 
the party of the first part, in offices satisfactory to the party of the second part, 
and, in case of any loss, all sums recovered or recoverable on account of said 
insurance shall be paid over or assigned on delivery of the deed, to the party of 
the second part, unless the premises shall previously have been restored to their 
former condition by the party of the first part. 

Rents, Taxes, Insurance and Water Rates shall be apportioned as of the 
day of the delivery of the deed. 

The deed is to be delivered, and the consideration paid, at the Registry of 
Deeds in which the deed should by law be recorded, at twelve o'clock, noon, of 
the First day of March 1932 unless the parties 

hereto agree in writing to some other time and place. 

If the party of the first part shall be unable to give title or make conveyance 
as above stipulated, any payments made under this agreement shall be refunded, 
and all other obligations of either party hereunto shall cease, but the acceptance 
of a deed and possession by the party of the second part shall be deemed to be 
a full performance and discharge hereof. 

In consideration of the above, Harold Benton, Husband of the said 
Sarah Benton , hereby agrees to join in the deed to be made as aforesaid, and 
to release to the party of the second part all right of curtsy and homestead in 
the said premises. 

It is understood that a broker's commission of Four (4) per cent on the said 
sale is to be paid to John L. Steele, Agent by the said party of the first part. 

IN WITNESS WHEREOF the said parties hereto and to another instrument of 
like tenor, set their hands and seals on the day and year first above written. 

In presence of SARAH BENTON (Seal) 

JOHN L. STEELE HAROLD BENTON (Seal) 

EMILY NEWELL HENRY LANCASTER 



JOHN L. STEELE, REALTOR NO. 2 



93 



February 6 An apartment was rented for a year for $70 per month, 
beginning March i. The tenant deposited $35 with 
the broker when the lease was signed on February 
6, with the understanding that this would apply on 
the first month's rent. The rest of the commission 
was to be paid by the owner on March i. 

February 9 The house at 1 1 Ipswich Street was listed by the owner, 
A. V. McKenzie, and a listing contract similar to 
that in a previous transaction was signed. 

February 10 Four houses, including the one above, were advertised 
at the expense of the broker, 38 lines at 40 cts. per 
line, paid in cash. 

February 16 Some time previously, a client had been referred to 
Mr. Steele by a broker in Boston. After being shown 
a large number of properties, he decided to make an 
offer of $9,800 on a house listed for $11,000. The 
offer was accepted by the owner and a contract of 
sale was signed on the sixteenth, possession to be 
given March i. In order to close the transaction 
Mr. Steele had to negotiate a first mortgage of $6,000. 
Since the sale went through his office, however, he 
made no charge for this service. 

The purchaser deposited $500 when he signed the con- 
tract of sale. The commission was subtracted and 
the balance was remitted to the owner. One-half 
the commission was then paid to Holbrook and 
Mahoney, the brokers who referred the client to 
Mr. Steele. 

February 23 Mr. Steele negotiated a sale of a lot belonging to a 
builder and a contract for the erection of a house 
thereon by the builder. The contract, which included 
specifications for the house, which was to be erected 
before June i, was signed February 23. The total 
price was $16,400. The commission, at the rate of 
4 per cent on the total price, was deposited with the 
broker. 

February 27 A store was leased for three years to a baker for $85 per 
month. The lease was signed February 27, with 
occupation April i. Fifty dollars was deposited with 
the broker when the lease was signed and the owner 
agreed to pay the rest of the commission from the 
first sums received from the tenant. 

February 29 The secretary-bookkeeper's salary of $100 was paid for 
February. Rent of $110 was received for March on 
the store next to the office. Mr. Steele withdrew $250 
in cash. 

An inventory showed $186 in supplies still on hand. 



94 BOOKKEEPING 

JOHN L. STEELE, REALTOR No. 3 

POSTING AND CLOSING 

Set up the ledger accounts given in the first case of this series 
with the balances as of February i, 1932. Post the journal 
entries resulting from the transactions during February, adjust 
and close the books as of February 29, and draw up the state- 
ments. Use the paper in the Working Forms. 

THE ANALYSIS OF TRANSACTIONS No. 2 

The facts given in the several sections below relate to adjust- 
ment and closing. As in The Analysis of Transactions No. i, set 
up the ledger accounts involved in each section. Prepare journal 
entries necessary to bring the adjustments on the books and post 
these entries. Then prepare and post journal entries necessary 
to close the accounts in accordance with the suggestions made in 
each section. 

Journal and ledger paper for use in this case will be found in 
the Working Forms. 

a. On December 31 the inventory of supplies still on hand was 
$15,613.74. 

It was the practice of the company to charge Supplies Inven- 
tory when supplies were purchased. The balance of $76,724.83 
therefore included the inventory of supplies at the beginning of the 
year and supplies purchased during the year. After adjustment, 
Supplies Inventory recorded as an asset the amount of inventory 
on hand and Supplies Expense recorded the expense for the 
period. 

Show a journal entry to record the adjustment, and close 
Supplies Expense into Loss and Gain. 

Balances December 31, 1937: 

Supplies Inventory $76,724.83 

Supplies Expense 

Loss and Gain 

6. Wages and salaries accrued for the last four days in Decem- 
ber amounted to $1,989.35. 

Make entries necessary to set up the accrual and to close 
Wages Expense into Loss and Gain. 



THE ANALYSIS OF TRANSACTIONS NO. 2 95 

Balances December 31, 1937: 

Wages Expense $187,835.92 

Wages Accrued 

Loss and Gain 

c. On December 6 the company took out a two-year fire insur- 
ance policy on its furniture and fixtures, paying therefor $1,283.50. 
The old policy expired at noon the same day, and the amount still 
prepaid on it as of December i, was $17.12. 

The balances in the accounts showed the amount of insurance 
prepaid and insurance expense for all policies in force. It was the 
custom of the company to charge insurance expense on the last 
day of each month for the amount applicable to that month. 
The balance of $3,732.96 in Insurance Expense represented the 
amount of that expense for 1937 through the month of November. 
The expense for December was $253.76, exclusive of the expense on 
the new and on the expiring policy. 

Make entries to record the purchase of the new policy, and to 
record the proper insurance expense for December. Since all 
of the policies expired at noon, compute the expense up to noon 
December 31, and ignore the fact that this was not the close of 
business on that day. Close Insurance Expense to Loss and Gain. 

Balances December i, 1937: 

Insurance Prepaid $ 4,045. 21 

Insurance Expense . 3 , 732 . 96 

Cash . i5>7 2 893 

Loss and Gain 

d. In October, 1932, the Catron Company mortgaged its plant 
for $2 10,000.00. The terms of the mortgage provided that interest 
at 6 per cent was due and payable on December 31 of each year. 
The principal was to be amortized by the following payments: 

December 31, 1935 $ 50,000 oo 

December 31, 1936 60,000.00 

December 31, 1937 100,000.00 

On December 31, 1937, the Catron Company made the last pay- 
ment plus interest due at that time. 

Record the December 31 payments and close to Loss and Gain 
any accounts which need to be closed at the end of the period. 



96 BOOKKEEPING 

Balances December 31, 1937: 

Cash $191,627.13 

Interest Expense. . . 7 , 293 . 26 

Mortgage Payment due December 31, 1937 100,000.00 

Accrued Interest Payable on Mortgage (to November 30) 5 , 500 . oo 

Loss and Gain 

e. The leaseholds recorded below had cost $25,520.00 on 
July i, 1934. The life of the leases was 20 years, and the cost 
was to be amortized over that life. At December 31, 1934, one- 
half year's amortization was taken, and a full year's amortization 
was charged at December 31 of subsequent years. 

Make entries necessary to set up the amortization and to close 
that expense to Loss and Gain. 

Balances December 31, 1937: 

Leaseholds $22 ,330 oo 

Amortization of Leaseholds 

Loss and Gain . . .... 

/. The Hulst Shoe Company obtained a large portion of its 
machinery on a rental or royalty basis from the Black Shoe 
Machinery Corporation, which retained title to the machines. 
The rental contract provided for payments on a time basis; the 
royalty payments were based upon the number of pairs of shoes 
on which machines were used. 

The balances in the expense accounts below recorded the 
amount of the expenses for the first n months of the year. An 
assistant in the office of the factory manager of the Hulst Shoe 
Company prepared at the end of each month a schedule showing 
the amount of rent and of royalties applicable to that month on 
the machines obtained from the Black Shoe Machinery Corpora- 
tion. This schedule was sent monthly to the accounting depart- 
ment and was the basis of an entry to the expense accounts below 
and to the accrual account. The amounts on December 31 were: 

Rent: 

Stitching and cutting operations $ 82 . oo 

Sole leather and lasting rooms 137 . 75 

Finishing operations 39 . 50 

$ 259.25 
Royalties 1,570.58 

The Hulst Shoe Company paid these charges on machinery 
monthly, but the accrual account ordinarily carried a small balance 



THE ANALYSIS OF TRANSACTIONS NO. 2 97 

because the billing by the Black Shoe Machinery Corporation did 
not coincide exactly with the accruals entered by the shoe company. 

The Hulst Shoe Company paid $1,731.62 on December n, on 
rents and royalties. Show entries to record this payment and 
entries as of December 31 to record the expense. Close Rent 
Expense and Royalty Expense into a clearing account, Cost of 
Goods Manufactured. 

Balances December i, 1937: 

Cash . .... $24,631.96 

Rent Expense 2 , 592 . 50 

Royalty Expense . . . . 15,705 80 

Accrued Rents and Royalties . . .... .... 2,085 84 

Cost of Goods Manufactured . . . 

g. In the process of closing the books of a trading company 
as of December 31, 1937, a physical inventory of merchandise still 
on hand was taken and found to be $490,352.81. 

Enter the new inventory by debiting it and crediting Cost of 
Goods Sold. Close Purchase Returns and Allowances to Pur- 
chases, and transfer the balance of that account, or net purchases, 
to Cost of Goods Sold. Close the old inventory into Cost of 
Goods Sold. The balance of this account now represents the 
cost of the goods sold during the period. 

Balances December 31, 1937: 

Inventory of Merchandise, January i, 1937. . ... $601,463.52 

Inventory of Merchandise, December 31, 1937 . ... 

Purchases . . .... 994,572.86 

Purchase Returns and Allowances . ... 8,831.79 

Cost of Goods Sold ... . 

h. Close Sales Returns and Allowances into Sales and the 
balance of that account, or net sales, into Trading. Close the 
balance of Cost of Goods Sold into Trading. The balance of this 
account now represents the gross profit on the goods sold during 
the period. 

Balances December 31, 1937: 

Cost of Goods Sold . $1,096,851.78 

Sales . 1,768,006.23 

Sales Returns and Allowances 16,457 . 19 

Trading 

i. Transfer the gross profit to Loss and Gain, and close the 
operating expenses into that account. Transfer the balance of 



98 BOOKKEEPING 

Loss and Gain, or net profit for the period, to Surplus. Close 
Dividends to Surplus. 

Balances December 31, 1937: 

Trading $654,697.26 

Wages and Salaries 178, 906 . 73 

Heat and Light 60 , 238 . 91 

Advertising 139,117.42 

Other Operating Expenses. 220,724.38 

Loss and Gain . ... 

Surplus 331,835.67 

Dividends . . 52,641.25 

j. On December 31, the physical inventory of merchandise still 
on hand was $1,471,058.43. 

Prepare and post all entries necessary to adjust and close the 
accounts shown below. 

Balances December 31, 1937: 

Merchandise Inventory, January i, 1937 $i ,804,390 56 

Merchandise Inventory, December 31, 1937 

Surplus 995 , 507 01 

Sales 5,304,01869 

Sales Returns and Allowances 49, 371. 57 

Purchases ... ... 2,983,718 58 

Discounts on Purchases. . . . . 26,495.37 

Salaries and Wages .. . 536,720 19 

Office Expenses . ... 180,716 73 

Selling Expenses .. . 417,352.26 

Administrative Expenses . 466,088.40 

Interest Expense . . . . 196,084 74 

Dividends i57,9 2 3-75 

Cost of Goods Sold 

Trading 

Loss and Gain 



GENERAL TRUST COMPANY 99 

GENERAL TRUST COMPANY 
THE COMPUTATION OF DISCOUNT ON NOTES 

This subject presents a number of complications because of the 
different forms of notes handled and because notes of the same 
form may appear in transactions in different ways. Also, current 
practices differ slightly between banks in different parts of the 
country, and even between banks in the same state. Business 
houses other than banks customarily use methods slightly different 
from those used by banks. This case records the computations 
and the journalization with respect to a group of typical note 
transactions by a bank of medium size, operating in Massachusetts. 

Some notes are written with interest and some without. If a 
note is written with interest, the borrower receives the principal 
amount when the loan is made and pays the principal and the 
stipulated interest at maturity. If it is written without interest, 
it is discounted; that is, the stipulated amount is subtracted from 
the principal at the time the loan is made and the principal alone 
is paid at maturity. The bank makes its loans primarily on notes 
without interest, although it frequently loans on notes with inter- 
est when borrowers present notes received from their customers, 
and occasionally loans on the note of the borrower written with 
interest when the borrower for some reason wishes it written in 
that way. 

The first step in computing interest or discount is to determine 
the time involved. The bank uses the 36o-day basis, that is, one 
day's discount is considered to be J^o of the agreed rate, and if 
the effective time on a note is 34 days the discount is 3 ^eo of the 
rate per year. In computing the time on a note, the bank uses 
the total elapsed days, not counting the day of making or dis- 
count, but counting the date of maturity. If a note matures on 
Saturday, Sunday, or a bank holiday, it is payable on the next 
full business day and interest is computed to and including that 
day. It is the custom to permit borrowers to pay notes in 
advance if they wish, and discount is rebated if the amount 
involved is over $i. 

Computations and booking are given for the following notes 
which are typical of those handled by the bank. 



100 



BOOKKEEPING 



i. On November 27, 1931, the bank loaned C. E. Allen on a 
note of the same date for $1,000, due in three months, the note 
being written without interest, but a discount rate of 6 per cent 
being agreed upon. 

A three months' note matures on the corresponding day of 
the calendar month three months hence. February 27, 1932, fell 
on Saturday, so the note was payable on Monday, February 29. 
The bank uses a special calendar which gives each day in the 
year a consecutive number and includes a calendar for the next 
year with the consecutive numbers continued so that the elapsed 
days can be determined by subtracting 331, the number for 
November 27, from 425, the number for February 29, giving 94 
elapsed days. Without such a calendar the elapsed days can be 
computed in the following manner: 



Month 


Days in 
the month 


Note dates 


Elapsed 
days 


November 


^o 


November 27 


2 


December 


2T 




2T 


January 


^1 




O A 

11 


February 


20 


February 29 


2O 








94 



If the note had been written for 90 days, it would have matured 
on February 25 and the elapsed time would have been, of course, 
90 days. 

The note teller has a table giving simple interest at various 
rates for any number of days up to one year; but since the cus- 
tomary rate is 6 per cent, she performs most of the computations 
by the 6 per cent method and many of them in her head. For 
instance, since interest on $600 at 6 per cent is 10 cents per day, 
the interest on $600 for 94 days would be $9.40 and by dividing 
by six and multiplying by 10 the interest on $1,000 at 6 per cent 
for 94 days is found to be $15.67. 

A somewhat more laborious method is often used by those who 
do not handle notes constantly. This involves the use of a table 
which need not be remembered since it can be computed in a few 
minutes at any time. It is based on the assumption that a year 



GENERAL TRUST COMPANY 101 

consists of 360 days and gives rates for different numbers of days 
so that the rate corresponding to the effective days on a note can 
be found by addition. 

Period, days Rate 

360 o 06 

60 o 01 

30 o 005 

20 o 0033333 

15 o 0025 

10 o 0016666 

6 o ooi 

5 o 0008333 

4 0.0006666 

3 000 S 

2 O 0003333 

I 0.0001666 

The repeating fractions should be carried to one more decimal 
place than there are places in the principal sum, including cents. 
For example, $9,000.00, six places, plus one, or seven places for 
the repeating fractions. 

The interest on $1,000 for 94 days can be computed in the 
following manner by building up from the table the requisite 
number of days. 

Period Rate Principal Interest 

94 days o . 06 $i , ooo 



60 days o.oi 

30 days 0.005 

4 days 0.0006666 



94 days 0.0156666 X $1,000 = $15.67 

If the discount rate were 5 per cent, the interest could be 
computed on the 6 per cent basis and the result obtained by 
dividing by six and multiplying by five. 

When this note was discounted, entries were made on the 
books as follows, and a notice of the amount of the discount and 
the amount of the credit to his account was sent to Mr. Allen. 

November 27, 1931 Notes Discounted $i ,000 

Deposits, C. E. Allen... $984.33 

Discount 15-67 



102 BOOKKEEPING 

When the note was paid by Mr. Allen's check on the General 
Trust Company, the entry was: 

February 29, 1932 Deposits, C. E. Allen $i ,000 

Notes Discounted $i ,000 

The bank uses only two interest accounts. All discount on 
notes is credited to Discount which is closed at the end of the 
period into Loss and Gain. The interest on mortgages, demand 
loans, and the balances of this bank carried in other banks is 
credited to an account called Interest, which is likewise closed 
into Loss and Gain at the end of the period. Interest and dis- 
count are carried on a cash basis and no accruals are figured even 
when the books are closed. 

2. On December 2, 1931, the bank loaned A. R. James $300 
on a note which appeared as follows: 

Boston, Massachusetts 
December 2, 1931 

Thirty days after date I promise to pay three hundred dollars ($300) 
to the order of the General Trust Company, for value received, with 
interest at 6 per cent. 

A. R. James 

This type of note is unusual, since the bank ordinarily loans 
on notes without interest when the notes are made by the borrower, 
but it is done occasionally. The bank frequently discounts notes 
receivable of its customers which are written with interest. 

Since this note was dated December 2 and was due in 30 days, 
it matured on January i, 1932, which was a holiday, and the next 
day being Saturday the note was payable on Monday, January 4, 
and the period for interest computation was, therefore, 33 days. 

If a note of this sort were large, the bank would add the interest 
to the principal and discount the total, but usually the bank 
simply takes the interest for the period. 

The interest of $1.65 was added to the principal, in pencil, on 
the face of the note. 

$ 1.65 
300. oo 

$301.65 



GENERAL TRUST COMPANY 103 

The journal entries were : 

December 2, 1931 Notes Discounted $301 .65 

Deposits, A. R. James. . . $300.00 

Discount 1.65 

January 4, 1932 Deposits, A. R. James $301 .65 

Notes Discounted $301 . 65 

3. On December 2, 1931, the bank also discounted for A. R. 
James one of his notes receivable, given him by a customer, dated 
November 9, $500, 60 days, with interest at 6 per cent. Discount 
rate 6 per cent. 

The note was due January 8, 1932, and the interest, payable 
at maturity date, was $5. The discount period was 37 days. 
The bank added the interest to the face of the note and discounted 
the total for 37 days, the discount being $3.11. The entries were 
as follows: 

December 2, 1931 Notes Discounted $505.00 

Deposits, A. R. James. . . $501 . 89 

Discount 3- 11 

January 8, 1932 Cash (check from maker) . $505.00 

Notes Discounted $505 . oo 

4. The bank discounted another note on December 2, 1931, 
which A. R. James had received from a customer, dated October 9, 
$600, three months, without interest. Discount rate 6 per cent. 

The note was due January 9, 1932 ; but since this was Saturday, 
the note was payable on Monday, January n. Discount was, 
therefore, computed for 40 days. 

December 2, 1931 Notes Discounted $600.00 

Deposits, A. R. James. . . $596.00 

Discount 4 . oo 

January n, 1932 Cash (check from maker). . $600.00 

Notes Discounted $600.00 

5. On September n, 1931, E. J. Eaton discounted a note 
receivable, dated September n, three months, $2,100 with interest 
at 5 per cent, discount rate 6 per cent. 

This note matured on December n, 1931, and the period, for 
both interest and discount, was 91 days. The interest for 91 days 
at 5 per cent was computed as $26.54. This was added to the 
face of the note and the total $2,126.54 discounted at 6 per cent 
for 91 days, the discount being $32.25. This was subtracted 
from $2,126.54 to give the credit to deposits. 



104 



BOOKKEEPING 



September n, 1931 Notes Discounted. . . $2,126.54 

Deposits, E. J. 

Eaton 

Discount 



$2,094.29 
32.25 



The note was not paid by the maker on December n, so 
notice of protest was sent to E. J. Eaton on that day. 

On Monday, December 14, Mr. Eaton paid $2,127.60 in a 
check on the General Trust Company, this total representing the 
face of the note, $2,100, interest $26.54 and added interest for 
three days $1.06. 

December 14, 1931 Deposits, E. J. Eaton $2,127.60 

Notes Discounted . . $2 , 1 26 . 54 

Interest 1.06 

6. On April 16, 1931, the bank loaned H. N. Durfee $2,000 
on a demand note with interest at 6 per cent secured by $3,000 
face value of bonds as collateral. Interest on this note was 
payable July i, October i, January i, and April i, until the note 
was paid. Interest was computed on the 36o-day basis for the 
elapsed days in each quarter, and for the elapsed days till and 
including the date of payment, no adjustments being made for 
Saturdays, Sundays, or holidays. This note was paid on January 
6, 1932. 



Period ending 


Elapsed days 


Interest 


Tune 30 


7^ 


$25 .00 


September 30 


02 


^0.67 


December 31 


02 


30.67 


January 6 


6 


2.OO 









April 1 6, 1931 
July i, 1931 



Demand Loans $2,000.00 

Deposits, H. N. Durfee $2 , ooo . oo 

Deposits, H. N. Durfee. 25.00 

Interest 25.00 

October i, 1931 Deposits, H. N. Durfee. 30.67 

Interest 30. 67 

January i, 1932 Deposits, H. N. Durfee. 30.67 

Interest 30.67 

January 6, 1932 Deposits, H. N. Durfee. 2,002.00 

Demand Loans 2 ,000. oo 

Interest 2 . oo 



GENERAL TRUST COMPANY 



In this instance, each payment was made in a check on the 
General Trust Company. As explained above, interest on mort- 
gages, demand loans, and balances in other banks is credited to 
Interest and not to Discount. 

Mortgages are written for three years and interest is com- 
puted and entered quarterly as indicated in the instance of the 
demand loan. Construction mortgages are written for one year, 
and payments are made to the mortgagor as construction pro- 
gresses, but interest is charged quarterly for the entire amount 
of the mortgage. 

During the period covered by this case Sundays fell on the 
following days: 



1931 


1932 


September 


October 


November 


December 


January 


February 


March 


6 


4 


i 


6 


3 


7 


6 


13 


ii 


8 


J 3 


10 


14 


13 


20 


18 


IS 


20 


17 


21 


20 


27 


25 


22 


27 


24 


28 


27 






2Q 




3i 







1. Verify the computations of interest and discount on the 
notes above. 

2. Make computations for the following notes and show 
journal entries to record in each case the making of the loans and 
payment at maturity. Use the paper in the Working Forms. 

a. L. S. Douglas borrowed $800 from the bank on December 
4, 1931, giving a note for two months, without interest. Discount 
rate 6 per cent. 

b. On December 8, 1931, Howard Adams borrowed $2,300 on 
a note for 60 days, without interest, the rate being 5^ per cent. 

c. Arthur Vaughn received a note for $1,700, with interest at 
5 per cent, from a customer in settlement of an account. The 
note was dated December i, 1931, and was payable at 90 days. On 
December n, 1931, he discounted the note at the bank, the rate 
being 6 per cent. The customer paid the note at maturity. 

d. E. R. Huff borrowed $4,000 on December 14, 1931, on a 
one-month note, without interest. Discount rate 6 per cent. 



io6 BOOKKEEPING 

e. On December 15, 1931, John Wilshire discounted a note 
receivable dated December 10, and due in three months, for $2,400, 
without interest. Discount rate 6 per cent. 

/. Mitchell Roy borrowed $800 on September i on a demand 
note, with interest at 6 per cent, and agreed to pay $200 on the 
first of each month until the note was paid in full. He also agreed 
to pay on the first of each month all interest which had run on 
those dates. Show all the journal entries involved. 

WILCOX LUMBER COMPANY No. i 

RECORDING PURCHASES 

The following purchases are typical of those recorded on the 
books of the company. In each instance, the original invoice 
received by the Wilcox Lumber Company from the vendor is 
given, together with a description of other phases of each purchase 
and of the payment therefor. 



Using the paper in the Working Forms, enter in a journal all 
transactions involved in each purchase. Use the account Pur- 
chases and instead of a general Accounts Payable account, use 
Accounts Payable, Keefe Lumber Company. It is not customary 
to separate notes payable in the books by name; therefore all notes 
may be recorded in a single account, Notes Payable. Enter each 
purchase on the earliest date when both the goods and the invoice 
have been received. 

A. On April 9, 1929, the company purchased three lots of 
No. i fir lumber to be delivered from the cargo of a vessel to 
arrive approximately one month later. The invoice on page 107, 
which carried the date of the original order, was received May 8, 
and the lumber arrived by rail May 9 and 10. 

048, Y f scant meant that the lumber was dressed or planed 
on four sides and that both width and thickness were } in. less 
than the measurements indicated. The No. 2 lumber developed 
in manufacturing was usually 5 to 10 per cent. Adjustment was 
asked for if it ran much above that on any order. 15/16 meant 
15 pieces 16 ft. long. 

The price quoted was f.o.b. the vendee's yard, but the ocean 
and railroad freight had to be paid within 48 hours of arrival, the 



WILCOX LUMBER COMPANY NO. i 107 

amounts so paid being deducted from the invoice price. The 
railroad collected the ocean freight as agent for the steamship line. 
The bill on page 108 was received from the railroad giving the ocean 
freight on each lot and the railroad freight for each car. This was 
paid May n, 1929, by check to the Boston and Maine. 

When the lumber was unloaded, it was checked on tally sheets 
and the board feet were computed. Lot 1612 was found to be 



INVOICE 

Boston, Mass. A P ril 9 1929 
Wilcox Lumber Co. 

Portsmouth, Mass. 



Bought of KEEFE WHOLESALE LUMBER CO. 
Lumber and Timber 

Sold by Mr. Pierce 

Terms: 60 days Net or 4 mos. Note with Interest after 60 Days. 

S. S. Cotuit Order #309 Shipped to Wilcox Lumber Co. 



# i COMMON FIR D 4 S Y" SCANT, WITH #2 DEVELOPED IN 



MANUFACTURING INCLUDED 



Lot#i6n 4 X 6"* ^6, 15 %8, 5 %4, 10 %6, J %8> %4 14492 FT. 

4 X 8" ^Ks 4464 FT. 

18956 FT. at $36.00 $ 682 . 42 

Lot #1612 2 X 8" 98% r 5U. 100^. 100^ 



25149 FT. at $36.00 905.36 

," 490/ 40CUV IOC/*. 500 X < _ 50^ n _ 



Lot #1614 2X6 

28432 FT ."at $36.00 



72537 FT. $2,611.33 

Ocean freight to be No claims, shortage or otherwise, 

paid in cash. Not will be allowed unless a complete 

subject to cash dis- tally, showing both pieces, size 

count. and lengths and verified by affi- 

davit is returned to us within ten 
days of delivery. 



* "Board foot. A volume equal to that of a board i ft. X I ft. X I in., or 144 cubic inchest 
used in measuring lumber. Thus a board 2" X 4" X 12' contains eight boara feet." From 
Webster's Collegiate Dictionary, 3d Ed., 1930. 



io8 



BOOKKEEPING 



Lot number 


Ocean freight 


Car number 


Railroad freight 


1611 


$239.06 


90273 


$60.58 


1612 


289.38 


( 80432 
I 91118 


73-03 

6. 22 


1614 


321.96 


/ 90365 
I 9754 


76.30 
I3-4I 



1504 board feet short. The tally sheets and an affidavit were 
sent to the vendor, and a credit memorandum was received under 
date of May 23. 

An error was discovered in the computation of the board feet 
in lot 1614. A credit memorandum covering this was received 
May 28. 

The purchase was entered in the books on May 10, when the 
last car was received and the shortage and error were carried to 
Purchase Returns and Allowances when the credit memoranda 
were received. 

On June i the Wilcox Lumber Company sent the vendor three 
notes, two being for $500 each and maturing on September 10 
and 20. The third was for the balance of the account as shown 
by their books and matured on September 30. 

When the notes came due, they were paid with interest at 
6 per cent beginning 60 days after May 10 (July 9). Interest 
was computed as $5.25, $6.08, and $6.36, respectively, on the 
three notes. 

B. The invoice on page 109 was received June 9, 1929, and 
the shipment on June 22. Freight of $491.09 was paid June 23 
by a check payable to the Boston and Maine Railroad. According 
to the terms of the purchase agreement, freight was to be deducted 
from the invoice price. Two notes were given to the vendor, one 
of $584.86 due November 10, and one of $584.87 due November 17. 
The notes were paid at maturity, together with interest at 6 per 
cent beginning 60 days after June 22 (August 21), the interest 
being $7.90 and $8.58, respectively. 



WILCOX LUMBER COMPANY NO. i 109 



Boston, Mass., June 8 1929 
Wilcox Lumber Co. 
Portsmouth, Mass. 



Bought of KEEFE WHOLESALE LUMBER Co. 
Lumber and Timber 

Sold by Mr. Pierce 

Terms: 60 days net or 4 Mos. Note with Interest after 60 days 

SOO Line 75726 Order #4444 Shipped to Wilcox Lumber Co. 



CEDAR SHINGLES 

124,800 18" Perfections $7.26 $ 906.05 

128,800 16" xxxxxx $5-86 754-77 

$1,660.82 
Less Freight 



C. On August 5, 1929, the wholesaler offered the lumber 
included on the invoice on page no at $29.50 and the salesman 
agreed orally that it need not be paid for until sold. Railroad 
freight of $41.62 was paid to the Boston and Maine on August 10, 
the day after the shipment was received. This amount was 
deducted from the bill. Ocean freight was paid by the vendor 
and this amount was not deducted, since the $252.95 had not been 
added to the invoice price. 



no BOOKKEEPING 



Boston, Mass. August 5 1929 

Wilcox Lumber Co. 

Portsmouth, Mass. 



Bought of KEEFE WHOLESALE LUMBER Co. 
Lumber and Timber 

Sold by Mr. Pierce 

Terms: 60 Days or 4 Mos. Note with Int. after 60 days 

S. S. "John Smith " Order #3437 Shipped to Wiicox Lumber Co., 



SDG., #1286 #501 Lot #18 



#i COMMON FIR &/OR HEMLOCK 048 %" X K" SCT." 



WITH #2 DEVELOPED IN MFG. INC. 



I X 12" 1, , 

10 KO, %2, %4 

25,136 at $29.50 
WE PAY OCEAN FREIGHT $252.95 



* W X iix-i" actual measurement. 



In checking the shipment, several overages and shortages were 
discovered. A credit memorandum covering a net shortage of 
486 ft. 1 was received August 27. 



Overage 


Shortage 


% 24 


l % H4 


i y\4 244 

%2 66 


1 %o 190 

y\2 36 


334 


2is 1Q 2 

724 4& 




820 




334 



486 



The balance was paid March 13, 1930, when most of the 
lumber had been sold. 



1 Note the error in the computation. 



WILCOX LUMBER COMPANY NO. 2 



in 



WILCOX LUMBER COMPANY No. 2 

RECORDING SALES 

Sales were of two general types. Most of them were made 
"over the counter " without a contract or agreement in advance. 
Some of these were for cash, but 90 per cent in dollar volume were 
on account. The terms were 30 days net, but they were allowed 
in many instances to run longer, depending on the credit of the 
customer. 

When a builder built a house, either for sale after completion or 
on contract, he usually asked two or three lumber companies to 
figure on the bill of materials. If the Wilcox Lumber Company 
got the order, a contract was prepared which usually provided for 
a monthly billing for the material delivered during the month. 
These bills were supposed to be paid currently from the first and 
second mortgage financing. In many cases this was done, but in 
the lumber and building industries in 1929 there was no rigid 
administration of credit terms. Builders had most of their funds 





WILCOX LUMBER COMPANY 
Portsmouth, Mass., October i, 1929 




Sold To: John Anderson 






Checked By 
J 


Sold By 

N 


Delivered 16 Main Street 


Ledger 


Teamed By 
D 








Quantity 


Material 


Feet 


Price 


Amount 


I 

200 
200 
16 
8 
4 
5 


Doors for Cupboard 16" X 48" 
PCS. 4X8 Rockwall 
Pine % a 
Lineal ft 6" N. C. Finish 
Lineal ft. Base Mldg. 
Side Stop 5' 
Head Stop 3' 
Door Frames 2-6-6-6-5% wide 
Door Frames 2-6-6-6-3}^ wide 


160 
24 

IOO 

80 
24 


$ i 

45 
90 

IOC 


70 

03 
4M 


$3 
7 

2 
IO 

6 

3 
i 

12 
II 


40 

20 

16 
oo 

oo 

60 
80 

00 
00 


57 


16 



112 



BOOKKEEPING 



invested in lots or completed houses, and if one lumber company 
imposed strict credit terms the business went elsewhere. 



Enter all transactions involved in each sale in a journal, using 
therefor the paper in the Working Forms. Instead of a general 
Accounts Receivable account, use a separate account for each 
customer, as Accounts Receivable, John Anderson, and use a 
Sales account. 

A. On October i lumber was sold to John Anderson as shown 
by the invoice on page in. Payment was received November 17. 

B. 





WILCOX LUMBER COMPANY 
Portsmouth, Mass., October i, 1929 




Sold To: H. Ransome 






Checked By 
J 


Sold By 

N 


Delivered #2 Cliff Road 


Ledger 


Teamed By 
D 








Quantity 


Material 


Feet 


Price 


Amount 


2 X 8 
2 X 10 
2 X 6 
2 X 6 
88 
4X 6 

IOO 
100 


53 A 6 *H* 
Ha 

^0 
15 Afi % l Xl 
Lineal 3" crown 

H4 

Lineal 2X4 
Lineal 2X3 
300 sq. ft. S. E. Fir Bds. 


1,691 

74 
1 80 
738 

48 
67 
50 


$42 
48 
42 
42 

44 
40 
40 
37 


00 

04 


$ 71 
3 
7 
3 1 
3 

2 
2 
2 
II 


O2 

55 
56 

00 

52 
ii 
68 
oo 

10 


134 


54 



A partial payment of $75 was received November 6 and $30 
on December 5. The balance of the account was carried until 
December 31, 1930, when it was written off to Reserve for Bad 
Debts. 

C. A sale was made to Henry Wallis October 4 as shown by 
the invoice on page 113 and payment was received in cash on that 
date. Wallis had had an account but had paid in full some time 
previously. Carry the sale through his account, so that the 
account will record the amount of sales to him. 



WILCOX LUMBER COMPANY NO. 2 



D. On October 5 H. A. Jensen submitted a list of materials for 
a house he planned to build at 28 School Street and asked for a 
price. The materials were figured at cost and a margin was added 
to give a total of $978. He had obtained figures at two other 





WILCOX LUMBER COMPANY 
Portsmouth, Mass., October 4, 1929 




Sold To: Henry Wallis 


Checked By 
J 


Sold By 
N Delivered 186 South Avenue 


Ledger 


Teamed By 
D 








Quantity 


Material 


Feet 


Price 


Amount 


84 
2X 7 


Lineal 4X5 Gutter 
%6 
%4 


61 
56 


$ 
Si 
50 


15 


$12 60 

3 JI 
2 80 


18 51 



yards but accepted the quotation from the Wilcox Lumber 
Company and signed a contract October 7. 

The contract contained a provision which made it a conditional 
sale and enabled the lumber company to file a lien on the house. 
The company did not ordinarily do this but took a second mortgage 
on the house for $1,500. No lumber was delivered until the 
attorney of the company reported that the second mortgage was 
recorded. 

The lumber was delivered as requested by the builder and a 
detailed record was kept and compared with the contract. On 
the last day of each month, a bill was sent for an amount in round 
numbers which corresponded to the portion of the contract 
delivered. Extras were billed as an addition in detail. 

Billings and payments on this contract were as follows: 



October 31 

November 30 

December 31 

December 31 Extras. 



Billings Payments 

325.00 November 14 $ 300. oo 

450.00 December 8 400.00 

203.00 December 27 150.00 

78.31 Januarys 206.31 



$1,056.31 



$1,056.31 



BOOKKEEPING 

At the time of the payment on December 27, all of the lumber 
had been delivered and Jensen asked that the second mortgage be 
discharged, as he had a chance to sell the house. Since his credit 
was good, the mortgage was released and the house was sold on 
January 3, 1930. 

Consider the second mortgage as security for the debt and do 
not enter it in the books. Book the sale as of the date of the 
billings. 

BREWSTER PAPER COMPANY No. i 

THE PURCHASE OF MATERIALS, SUPPLIES, AND MACHINERY 

Using the paper in the Working Forms, enter the following 
transactions in a journal : 



TAREYTON FUEL COMPANY 

Boston, Massachusetts 

Sold To: Date June 5, 1933 

Brewster Paper Company Invoice No. P-; 



Oswego, Maine Shipping No. Sn-27 

Shipped From Portland 
F. O. B. Cars 
Shipped To Oswego, Maine 



Terms: Cash on isth. of Month Following Shipment 



Date Car Initial Car Number Grade Weight Lbs. Price Amount 

per 
2,240 Lbs. 

1933 

6/i Me C 2970 Nut & 97,500 

3004 Slack 99 , 200 

2991 94,9oo 

291,600 $4-50 $585.80 



Rubber Stamp 
Bill Rec'd. June 7, 1933 



Goods RecU 6/1 



Fit. Pro. 50-51-52 



Mill 



Approved 

B Office N 



F. O. B. Cars Portland 



Account Fuel Expense 



BREWSTER PAPER COMPANY NO. i 115 

A. The invoice on page 114, covering the purchase of three 
carloads of coal, was received by the Brewster Paper Company. 

The invoice, in duplicate form, was received at the general 
office of the company. It was rubber stamped by a clerk in 
the purchasing department, who indicated the date of receipt of the 
bill, f.o.b. point, and account to be charged, and then had the 
invoice approved by the purchasing agent. The original copy 
was then forwarded to the mill for approval there by the mill 
representative. The duplicate copy was retained in the general 
office until the original was returned approved. The initial B 
on the lower left of the invoice was the initial of the receiving 
clerk at the mill, who also indicated the date the goods were 
received and the numbers of the freight bills covering the ship- 
ment. (" Freight Pro." meant freight progressive, that is, the 
progressive number of the freight bills received from the railroad 
covering this shipment.) When the invoice was approved, it 
was returned to the accounting department at the general office 
where the payment date was indicated after the price and exten- 
sions had been checked. The transaction was then ready for 
entry in the journal. 

At the time of entry, the invoice was rubber stamped as follows: 

Journal Entry 

Page By 

Checked 

The journal page was indicated, together with the initial of 
the person making the entry. The entry was checked by a second 
clerk who also added his initial. The invoice was then filed 
awaiting date of payment. 

Upon payment, the cashier made a journal entry and a second 
clerk checked the entry and placed on the invoice the journal 
page, the check number, and his initial. The invoice was then 
stamped "Paid" and filed in a " Bills Paid" file under the name 
of the vendor. 

A statement was received from the railroad company each 
day, which was a summary of bills covering shipments received 
on the previous day. Freight bills were not carried through 
Accounts Payable, because they were paid shortly after they were 
received. Freight bills covering this invoice were as follows: 



n6 BOOKKEEPING 



No. 50 $ 65 . 72 




$196.56 



These freight bills were paid in total on June 3, 1933. All 
freight was charged to Freight Expense, which was used to 



HUDSON PULP COMPANY 

Jamaica, New York 

To Brewster Paper Company Date June, 1933 

Oswego, Maine Inv. No. 513 

Shipped ToOswego, Maine 



Terms: Net Cash 30 Days 

Interest at 6% Per Annum Chargeable on Overdue Payments 



91 Bales (13.86 Tons) of Hudson Prime Bleached 

Sulphite, Strong Quality 
33,905 Ibs. at 91.59% equal to 31,054 Ibs. air dry 

weight at $2.00 per 100 Ibs. Dock Portland, 

Maine $621.08 

Test Weight 3 1 . 190 Ibs. 

Billed Weight 31.054 

136 over 

43% 



Rubber Stamp 
Bill Rec'd. June 22, 1933 



Goods Rec'd. 6/24 
Frt. Pro. #562 

Mill _S 

Approved 

B Office N 



F. O. B. Ex. Dock Portland 



Account Pulp Stock 



centralize all freight expenditures. Freight bills were sorted at 
the close of each month by classification such as Pulp Stock, 
Fuel Expense, Supplies, Machinery and Equipment, etc. The 
proper accounts were then debited for their share of the freight 
expense, a credit for the total being made to Freight Expense 
to clear this account. 

The Tareyton Fuel Company was paid in full on June 15, 1933. 

Note. It was the policy of this company to charge coal to Fuel 
Expense as purchased. At the close of the year an estimate was made 



BREWSTER PAPER COMPANY NO. i 117 

of the quantity of coal on hand. This quantity was priced by working 
back from the most recent invoice until sufficient invoices had been 
drawn from the files to cover the amount of coal on hand. Freight 
bills covering coal shipments were also drawn from the files. The total 
value so obtained formed the basis of a journal entry debiting Fuel 
Inventory and crediting Fuel Expense. The Fuel Expense account 
then represented fuel consumed. 

B. The invoice shown on page 116 was received covering a 
purchase of pulp. 



VALLEY PULP COMPANY 

130 East 42nd. St. 

New York, N. Y. 
Invoice No. N P 568 

Your Order No. B O 424 Terms Net 30 days 

Our Order No. N P 368 G 

Shipped From Portland, Me. Date June 26th, 1933 

Car. No. Me C 36172 

Routing Me Cent. R. R. Sold To Brewster Paper Company 

Oswego, Maine 
Shipped To Oswego, Maine 



A. D. Tons On Dock 
144 Bales Valley New Standard 
Bleached Sulphite Pulp 

Lot #844 27.204 $41.00 $1,115.36 



Rubber Stamp 
Bill Rec'd. July i, 1933 



Goods Rec'd. 6/28 
Frt. Pro. #636 



__ 

Approved 

B Office N 



F. O. B. Ex. Dock Portland 



Account Pulp Stock 



All pulp received was tested by the chemists of the Brewster 
Paper Company to check the air dry weight. Any marked 
difference between the test weight and the billed weight was 
called to the attention of the Hudson Pulp Company for adjust- 
ment. If the Hudson Pulp Company objected to the results 
of the test, an independent chemist was called in to make a test 
and his word was accepted as final. No adjustment was made 



n8 BOOKKEEPING 

if the difference between billed weight and test weight was less 
than i per cent. 

Pulp was charged to an inventory account called Pulp Stock. 

The freight on this shipment from Portland to Oswego 
amounted to $38.71 and was paid on June 26. 

The pulp bill was paid in full on July 15, 1933. 

C. The invoice shown on page 117 was received covering 
another purchase of pulp. 

This bill was paid on July 12. 

Freight on this shipment amounted to $65.60 and was paid 
on June 30. 

D. The following invoice was received covering a purchase 
of rosin : 



PAPER MANUFACTURER'S SUPPLY CO. 
Boston, Massachusetts 

Date July 5, 1933 
To Brewster Paper Company 
Oswego, Maine 

Sale No. 62638-6827 
Buyer's No. B O 364 
Via B. & M. R. R. Freight Collect and Allowed 



300 Bbls. Gum Rosin 87.600 # at 4.50 per 

280 # C I F Oswego Maine $i ,407 87 

Less Freight at 39^ cwt. & 3^ per pkg. 350. 64 



$1,057.23 

Terms Net cash payable on receipt 
of bills of lading 



Rubber Stamp 
Bill Rec'd. July 7, 1933 



Goods Rec'd. July 7, 1933 
Frt. Pro. F 112 



Mill S 

Approved 

B Office N 

F. O. B. Oswego 



Account Manufacturing 



Supplies Expense 



Rosin was purchased on a C. I. F. basis; that is, the purchase 
price included the cost of the article, insurance during shipment, 
and freight. This particular shipment, however, was sent freight 



BREWSTER PAPER COMPANY NO. i 



119 



collect, which meant that the Brewster Paper Company had to 
pay the freight on arrival. In recognition of this, the vendor's 
traffic manager estimated what the freight would be and this 
amount was deducted from the invoice at the time that it was 
prepared. In journalizing the transaction, the Brewster Paper 
Company entered only the net amount of $1,057.23 from this 
bill. The freight on this shipment actually amounted to $350.64 
and was paid on July 8. At the close of the month, as part of the 
allocation of Freight Expense this amount was charged to Manu- 
facturing Supplies Expense to bring the cost of the rosin up to 
$1,407.87. The rosin was paid for on July n. 

E. The following invoice was received, covering printing of 
office forms, paper for which was supplied by the Brewster Paper 
Company : 



Brewster Paper Company 
Oswego, Maine 

Terms 3% Cash 10 days 



July 1 8, 1933 



To Oswego Press, Dr. 
Oswego, Maine 



Number 
30326 



Quantity Description 

1,300 4 % X 10 %{$ Blue Printed and Ruled in Black 

3,250 " " Buff " " " "Red 

8,500 " " " " " " "Black 

1,850 " " " " " " "Green 



Price 



14,900 



All forms punched 
12 round holes 



$40.00 



Rubber Stamp 
Bill Rec'd. July 19, 1933 



Goods Rec'd. 7/19 
Frt. Pro. 



Mill S 



Office N 



Approved 

F. O. B. 

Account Office Expense 



This bill was paid on July 26. The 3 per cent cash discount 
was taken. Inasmuch as all cash discounts were taken, invoices 
were journalized at the billed price less discount. 



120 BOOKKEEPING 

F. The invoice shown on page 121 was received covering a 
purchase of nails. 

Items such as nails, rope, small tools, etc., were charged to a 
Storehouse account, from which they were issued to the mill on 
requisition. 

This bill was paid July 3. The discount was taken at the time 
the invoice was first journalized. 

G. The invoice shown on page 122 was received covering the 
purchase of a new machine. 



BREWSTER PAPER COMPANY NO. 



121 



HARDWARE S 
Boston, I 

Car No. 
Freigh t Prepaid 
F. O. B. Oswego, Maine 

Sold To Brewster Paper Cor 
Oswego, Maine 

Shipped To same 
Destination Oswego, Maine 
Via B. & M. c/o M. C. Pick Up 

Terms: Due net 60 days from date o 
allowed on the discountable a 
count notice," if payment is n 


UPPLY COMPANY 

Massachusetts 

Inv. Date June 26, 1933 
Refer to 
Invoice No. WSW 9091 


Important 


npany Cash Discount Notice 
If paid within the discount 
period, the discount will be 
allowed on 
$221.31 
No discount is allowed on freight 
included in delivered cost 


[ invoice, 2 per cent cash discount will be 
Lmount shown under "important cash dis- 
lade within 10 days from date of invoice. 


Price 
Quantity Description of Material Weight Extras Amount Total 
5 Kegs 6 smooth box 65 $ 3. 25 

i 8 55 -55 
5 4 common 80 4 . oo 
5 6 60 3.00 
5 8 50 2.50 
10 10 40 4 oo 

10 20 25 2 50 

5 30 25 1.25 
10 50 25 2.50 

56 Kegs 5,600 
Base 2.803 156.97 $180.52 


Coated Nails 
10 Kegs 10 Sinkers 
10 9 

20 

76 Kegs Total 


Extras 
65 $ 6.50 
75 7-50 

2,000 
Base 2.803 56.06 70 06 


7,6oo $250.58 


Rubber Stamp 
Bill Rec'd. J une 2 9, *933 


Goods Rec'd. 6/29 


Frt. Pro. F 2649 


Mill S 


Approved 
B Office N 


F. O. B. Oswego 


Account Storehouse 





122 



BOOKKEEPING 



MANSFIELD EQUIPMENT COMPANY 

Mansfield, N. Y. 



Sold To Brewster Paper Company 
Oswego, Maine 



Shipped To Oswego, Maine 
Via Freight Me. Central R. R. 
Delivery 



Date June 16, 1933 



Inv. No. 16450 



Your Order No. 
Dated 6/1/33 " 



Our Order No. 418 

F. O. B. Factory 

Terms: i% 10 days 30 days net 



i Model X Mansfield Portable Mixer 

i H. P., no Volt, Single Phase, 60 Cycle 
iH " X 72" Monel Shaft, 6" Dual Propellers 



$205.00 



Rubber Stamp 
Bill Rec'd. June 19, 1933 



Goods Rec'd. 6/25 
Frt. Pro. F 1820 A 



MiU S 



N 



Approved 

B Office 

F. O. B. Mansfield 
Account Machinery and 



Equipment 



This bill, less i per cent for cash discount, was paid June 27. 
The freight on this shipment amounted to $3.21 and was paid 
on June 26. 



BREWSTER PAPER COMPANY NO. 2 123 

BREWSTER PAPER COMPANY No. 2 

JOURNALIZING SALES TRANSACTIONS 

Orders received by this company were handled by an order 
department, which was the contact point between sales and 
production. This department carried on the bulk of correspond- 
ence with sales offices regarding customers' orders. It was 
responsible for keeping posted on prices of all items manufactured, 
and for pricing all invoices sent to customers. When an order 
had been checked, to make sure that it was understood and 
could be filled, detailed instructions regarding it were sent to the 
mill, and it was placed in an " ordered" file. The work of the 
order department required it to be in constant touch with 
the manufacturing and sales departments. 

When an order was shipped, the mill office made out an invoice 
in triplicate (additional copies prepared if requested by customers), 
showing the items shipped and their quantities. It did not enter 
the prices charged, that function being handled by the order 
department. The original and duplicate were sent to the general 
office and the triplicate was retained in the files at the mill office. 
At the general office the order department checked the invoice 
with the customer's original order and wrote in unit prices on the 
duplicate. The customer's order was filed under his name for 
future reference. The original and duplicate were then sent to 
the billing clerks, where the unit prices were inserted on the 
original. Working independently, one clerk extended the prices 
on the original and another extended them on the duplicate, the 
weights being carefully analyzed and checked as well. The two 
were then compared, and, if alike, it was assumed that the exten- 
sions were correct. The original was then sent to the customer 
and the duplicate was placed in a loose-leaf folder to serve as the 
basis for journal entries. 

The following duplicates, among others, appeared in the 
folder for sales made on August 21, 1933. (Terms on all sales 
were i per cent 10 days, net 30 days, f.o.b. mill.) 1 



1 Reading an invoice from left to right, Bundles, Rolls, and Reams indicated the 
units in which the items were prepared. The Order Number was the number given 
to this order by the customer and was used when referring to this particular order 
with the customer. (The paper company's order number appeared on the duplicate 

(Continued on page 124) 



124 



BOOKKEEPING 



Enter these transactions in a journal, using the paper in the 
Working Forms. 



Bdls. Rolls Reams Order No. 
30 1234 

1234 



Sold To Paper Supply Company 
14 Kay Street 
Boston, Mass. 

Price 

1 8 50 Modern Waxed 1225 4% 
48 50 Blackstone 253 2% 



F.O.B. Mill 
Nugent Motor Trans. Co. 



$56.66 
6.96 

$63.62 



Bdls. Rolls Reams Order No. 



Sold To Paper Wholesalers, Inc. 
1 80 First Street 
Boston, Mass. 
Price 



9o;A 18 Brewster Striped 1370 4^ 
Brewster Striped Labels 
No weight marks 

F.O.B. Mill 
B. & M.R.R. Delivery Service 



$61.65 



Bdls. Rolls Reams Order No. 



Sold To Hastings & Kay 

230 Fulton Street 
New York, N. Y. 

Price 



10 
10 
25 



10 

IO 

25 



1891 40 X 48 200 General Fibre 1981 
1891 40 X 48 200 General Fibre 1993 
1891 40 X 48 250 General Fibre 6294 



No grade marks 



10268 2 $205.36 



F.O.B. Mill 
Charge Freight 1 
In New York Car Frt. Prepaid 



$ 3i 83 



Bdls. Rolls Reams Order No. 

20 AX 201 

15 AX 201 

10 AX 201 



Sold To Pennsylvania Stationery Co. 
221 Market Street 
Philadelphia, Pa. 

Price 



9 35 Brewster Drug 360 
12 35 Brewster Drug 340 
30 35 Brewster Drug 115 

815 



$34-64 



1 In this instance, the freight was prepaid and the amount was charged to the customer as 
an addition to his bill. 

(Continued from page 123) 

retained in the general office, in a column provided solely for the paper company's 
use.) This was followed by a description of the items ordered giving the size, the 
name, and the number of pounds. The price was the unit price per pound. 



DETROIT EDISON COMPANY NO. i 125 

Sold To Smith & Bird 

20 Knowlton Street 
New York, N. Y. 

Bdls. Rolls Reams Order No. Price 

5 3020 38)^ 35 Manila Sh. #in 268 

40 35 Manila Sh. 1433 

3&M 35 Manila Sh. 1109 

42 35 Manila Sh. 930 

3740 4)4 $158.95 
F.O.B. Mill 
Charge Freight 1 $ 11.59 

1 In this instance the freight was prepaid and the amount was charged to the customer as 
an addition to his bill . 

Payment for these invoices was received as follows: 1 

Paper Supply Company August 29 

Paper Wholesalers, Inc August 29 

Hastings & Kay September 2 

Pennsylvania Stationery Company August 30 

Smith & Bird August 30 

DETROIT EDISON COMPANY No. i 

TRANSACTIONS INVOLVING FUNDED DEBT 

The following excerpt was taken from the text of the report of 
the Detroit Edison Company for December 31, 1931: 

BALANCE SHEET LIABILITIES 

Important changes have been made [during 1931] in the Long Term 
Debt. The entire First and Refunding issue which was due in 1940, 
amounting to $34,984,000, was called for redemption on March ist, 
at a premium of 5%. More than half of this issue ($18,319,000) bore 
interest at 6%, and the remainder bore 5%. The 6% bonds were sold 
in the troubled years 1920 and 1921, when they brought very low 
prices notwithstanding their high rate of interest. On February i, we 
sold 4^% bonds to the same principal amount as the bonds called 
this 4^% series being Series D, General and Refunding Bonds due in 
1961, but payable at par if called during five preceding years. This 
substitution of a 4^% issue makes a decrease by $358,110 of annual 
interest charge on the same par value. The unamortized remainder 
of the selling discount and expense of the First and Refunding Bonds 
was $2,221,573.06, which has been written off against Surplus. This is 
its proper disposition and it occasions the reduction of Surplus which is 
shown. On the issue of the like amount of General and Refunding 
Bonds, the State fees and recording tax were paid to the amount of 
$227,396, which amount likewise has been written off out of Surplus, 
according to our custom. The discount on the sale of this lot of 



[ Discounts were not allowed on freight charged. 



126 BOOKKEEPING 

bonds [assume that the discount was 3,^ per cent], and the premium 
paid on the call, are charged to Debt Discount and Expense, to be 
amortized in equal monthly charges over the long life of the new bonds. 



Show journal entries for the above transactions in as much 
detail as possible. Use the paper in the Working Forms. 

PENDAR PAPER COMPANY No. i 

RESERVE FOR BAD DEBTS AND RELATED ACCOUNTS 

The trial balance of the Pendar Paper Company at Decem- 
ber 31, 1935, before adjustment and closing showed the following 
balances in certain accounts related to receivables: 

Sales .. .. $1,118,200 

Bad Debt Expense . . 5 , 600 

Bad Debts Collected 4,000 

Accounts Receivable .... r ?? ' 700 

Bad Debts Charged Off .. 

Reserve for Bad Bebts 8, 200 

Loss and Gain 

In order to facilitate the preparation of monthly statements, it 
was the practice of the company to charge }^ per cent of sales as 
bad debt expense each month. This produced the balance of 
$5,600 appearing above. The company did not charge off bad 
debts until the end of the year; therefore that account above 
showed no balance, but the credit manager had determined that 
$12,300 should be charged off as of December 31. The credit 
department continued its efforts to collect accounts after they had 
been written off, and had collected $4,000 during 1935. 

While entries were made to bad debt expense monthly on the 
basis of a percentage of sales, the company adjusted the amount of 
bad debt expense and of the reserve for bad debts as of the end of 
the year through the use of additional facts. Bad debts collected 
and bad debts charged off were both closed into the reserve for 
bad debts. The amount needed in the reserve was then deter- 
mined by the method described below. If the actual balance was 
less than the reserve requirement as computed, bad debt expense 
was increased to bring the reserve up to the required amount. If 
the actual balance was too high, bad debt expense was reduced in 
order to bring the reserve down. 

Total accounts receivable at December 31, 1935, were $121,400. 
Of this amount, $35,200 consisted of the balances of the accounts 



PENDAR PAPER COMPANY NO. 



127 



which were in part overdue in that some portion of the balance of 
each account was over two months old. That part of the total 
balance of overdue accounts arising in the current month, Decem- 
ber, was $11,000. The amount arising in the second month, 
November, was $10,000, and that arising from sales during the 
third month, October, was $11,000. 

In accordance with an established practice, it was desired to 
have the reserve for bad debts after closing show the following 
percentages of the balances standing in overdue accounts : current 
month, Y per cent; second month, i per cent; third month, 3 per 
cent; fourth, fifth, and sixth months, 25 per cent; seventh, eighth, 
and ninth months, 50 per cent; tenth month and over, 100 per cent. 
No reserve was provided for the balance of current accounts or for 
notes receivable. The accounts receivable control sheet showed 
the following data for December 31, 1935, after the $12,300 credit 
referred to above. 





Months old 


December 31 




10 and over 

9 

8 

6 
5 
4 
3 


$ I, 100 

400 
200 
300 

200 
400 
600 
11,000 


Total of Overdue Balances of Overdue Accounts 
Current Balances in Overdue Accounts . . 


""{!"" 


$ 14,200 
10,000 
II ,000 


Total Balance of Overdue Accounts 




$3S . 2OO 


Balance of Current Accounts 




86, 200 








Total Accounts Receivable 




$121 ,4OO 


Notes Receivable 




0, 2OO 








Total Outstanding Receivables. 




$130, 600 









Set up the ledger accounts concerned. Make and post journal 
entries to record bad debts charged off and to adjust the reserve 
and close the accounts concerned in accordance with the practice 
of the company. Use the paper in the Working Forms. 



VIII. ADJUSTING AND CLOSING THE BOOKS. THE USE 
OF THE WORK SHEET 

ROBINSON SHOE COMPANY No. i 

ADJUSTING AND CLOSING THE BOOKS 

In the Working Forms will be found the ledger of the Robinson 
Shoe Company at December 31, 1936, before adjusting and closing. 
This ledger included the results of all transactions during 1936, 
except those presently to be entered in the process of adjusting and 
closing the books. In the original ledger of the company, most of 
the accounts included a number of entries made since the books 
were last closed at December 31, 1935, and a few accounts, such as 
Cash and Sales, included a very large number of entries. In order 
to save space, however, full detail is given with respect to only two 
accounts: Notes Payable and Interest Expense. For the other 
accounts only the balance is given as it stood in the ledger at 
December 31, 1936. 

Certain preparatory work was done during December in 
computing the amount of adjustments, but the actual closing 
took place early in January as of the close of business on Decem- 
ber 31. The adjustment data, determined as of December 31, 
were as follows: 

Inventory of Merchandise, December 31, 1936 $1,756,142 

Inventory of Supplies, December 31, 1936 16,757 

Unexpired Insurance . . . . 63 ,627 

Rent Prepaid .... 52 ,949 

Interest Expense Accrued 3> n8 

Wages and Salaries Accrued 14,805 

Depreciation Expense . . . . 223,569 

Estimated Loss from Bad Debts 2 ,407 

Federal Income Tax 64 , 093 



1. Take a trial balance of the ledger as it stands before adjust- 
ment, using therefor the paper in the Working Forms. 

2. Record in the general journal in the Working Forms, entries 
necessary to bring the adjustment data into the books. 

3. Post these adjustment entries to the ledger. 

128 



ROBINSON SHOE COMPANY NO. 2 129 

4. Record in the general journal entries necessary to close the 
books. In closing use the following clearing accounts: Cost of 
Goods Sold, Trading, and Loss and Gain. 

5. Post the closing entries to the ledger. 

6. Close and rule all accounts. 

7. Draw up the balance sheet as of December 31, 1936. 

8. Draw up the income statement and the surplus reconcilia- 
tion statement for the year ending on that date. 

ROBINSON SHOE COMPANY No. 2 

THE WORK SHEET 

The trial balance, taken from the books as at December 31, 
1937, before adjustment and closing, is given in the Working 
Forms. In Robinson Shoe Company No. i the process of adjust- 
ment and closing involved direct use of the journal and ledger. 
When the number of accounts is large, this is awkward, and the 
process has the further difficulty that if an error is made in any of 
the entries, it is not likely to be discovered until after the entry has 
been posted to the ledger. Correction is then difficult. In prac- 
tice accountants use a work sheet on which all entries involved in 
adjusting and closing may be made or indicated, and the entire 
process checked before any entries whatever are made in the 
journal or posted to the ledger. In any complicated closing 
process a work sheet saves time and avoids in large part the defac- 
ing of the books of account with erroneous entries which later need 
to be corrected. 

In the Working Forms a work sheet of this form, developed 
for another company, is given as an indication of one method 
commonly used. 

It may be observed that the adjustment entries are made in the 
Adjustment columns in a form similar to that in which they were 
made in the journal in the preceding case. Those amounts which 
will appear in the Cost of Goods Sold account in the ledger are then 
transferred to the Cost of Goods Sold columns. The balance of 
these columns is transferred to the Trading columns, and any 
amounts which in the ledger are closed into that account appear 
likewise in these columns. The balance of the Trading columns, 
which is the gross profit for the period, is transferred to the Loss 
and Gain columns, and any amounts appearing on the trial balance 



130 BOOKKEEPING 

which in practice are closed directly to Loss and Gain are extended 
to these columns. The balance of the Loss and Gain columns is 
transferred to the Surplus columns. Dividends and any other 
amounts carried direct to Surplus are also shown in the Surplus 
columns. The balance of Surplus is transferred to the Balance 
Sheet columns as the amount of surplus at the end of the year. 

With a work sheet arranged in this form, the process of adjust- 
ment and closing as represented on the work sheet is an exact 
parallel of the method illustrated in Robinson Shoe Company 
No. i, in which adjusting and closing entries were made directly in 
the journal and posted therefrom to the ledger. On the work 
sheet the Adjustment columns give in full detail the adjustment 
entries which will later be made in the journal. The Cost of 
Goods Sold, Trading, Loss and Gain, and Surplus columns include 
the same amounts which will be found in ledger accounts of the 
same titles after the closing process is completed. 

When the work sheet is finished and checked, both the adjust- 
ing and closing entries may be drawn directly therefrom. The 
balance sheet and income statement may also be drawn up directly 
from the work sheet. In practice the work sheets prepared for 
successive closings are customarily included as a part of the general 
ledger or filed in other permanent form so as to be available for 
later reference in any problem involving the source of the state- 
ments or the procedure used in closing in prior periods. 



1 . Prepare the work sheet for the Robinson Shoe Company for 
December 31, 1937, in the form shown for Harrington and 
Marshall, Inc. The adjustment data, determined as of Decem- 
ber 31, were as follows: 

Inventory of Merchandise, December 31, 1937 $t ,317,378 

Inventory of Supplies, December 31, 1937 15 ,463 

Unexpired Insurance 13 ,081 

Rent Prepaid 47 , 577 

Wages and Salaries Accrued 17 ,473 

Depreciation Expense 226,445 

Estimated Loss from Bad Debts 2 , 208 

Federal Income Tax 55 , 536 

2. After the work sheet has been checked and found correct, 
prepare therefrom the adjusting entries and the closing entries. 

3. Draw up from the work sheet the balance sheet, the income 
statement, and the surplus reconciliation statement. 



DRAKE CHEMICAL COMPANY NO. i 131 

DRAKE CHEMICAL COMPANY No. i 

ADJUSTING AND CLOSING THE BOOKS OF A MANUFACTURING 

ENTERPRISE 

The process of adjustment and closing in a manufacturing 
business differs from that in a merchandising concern in two 
particulars. There are, typically, three inventories, Raw Mate- 
rials, Goods in Process, and Finished Goods, and it is necessary in 
closing to differentiate clearly between manufacturing expenses 
and other expenses. 

The process of adjustment is the same as that in a merchandis- 
ing business except that there are three inventory adjustments to 
make. The appropriate inventory account is debited to record 
each of the new inventories, the credit for raw materials being to 
Raw Materials Used, the credit for goods in process to Cost of 
Goods Manufactured, and for finished goods to Cost of Goods 
Sold. 

Several methods of closing are in general .use, but only one will 
be illustrated at this point. Under this method five main clearing 
accounts are used: Raw Materials Used, Cost of Goods Manu- 
factured, Cost of Goods Sold, Trading, and Loss and Gain. The 
original inventory of raw materials is closed into Raw Materials 
Used, to which the credit related to the final inventory has already 
been carried as an adjustment. After purchase returns and 
purchase discounts and allowances have been closed into pur- 
chases, the balance of the Purchases account is closed into Raw 
Materials Used. The balance of this account, as its title indicates, 
then gives the raw materials used in the business. This balance is 
closed into Cost of Goods Manufactured. 

The initial inventory of goods in process is closed into Cost of 
Goods Manufactured, to which the credit related to the final 
inventory has already been carried as an adjustment. All the 
manufacturing expenses are then closed into Cost of Goods Manu- 
factured. Manufacturing expenses are those which are incurred 
with respect to the goods manufactured up to the time the finished 
goods are delivered to the finished goods storeroom. They 
include direct material, which has already been transferred as the 
balance of Raw Materials Used, direct labor, and the several types 
of overhead applicable to a factory. After expenses of this type 



i 3 2 BOOKKEEPING 

have been closed to Cost of Goods Manufactured, the balance of 
the account, as its title indicates, shows the cost of goods manufac- 
tured during the period. This balance is closed to Cost of Goods 
Sold. 

From this point on the closing procedure is identical with that 
used in the Robinson Shoe Company. 

The ledger of the Drake Chemical Company at December 31, 
1936, before adjusting and closing, will be found in the Working 
Forms. The adjustment data, determined as of December 31, 
were as follows: 

Inventories, December 31, 1936: 

Raw Materials $5 ,013 ,408 

Goods in Process 3,654,836 

Finished Goods 7 , 863 ,948 

Real Estate Taxes Accrued 1 81 , 247 

Interest Expense Accrued 96,300 

Depreciation on Plant and Equipment 1 905,562 

Insurance Expense 1 . . 110,647 

(Insurance Unexpircd included under Deferred Charges) 

Estimated Loss on Bad Debts in ,915 

Estimated Income Tax . 1,017,944 



1 The portion of these items properly chargeable to selling and administration has already 
been transferred to Selling and Administrative Expense. 



1. Take a trial balance of the ledger as it stands before adjust- 
ment, using therefor the paper in the Working Forms. 

2. Record the adjusting entries in the general journal in the 
Working Forms. 

3. Post these adjusting entries to the ledger. 

4. Record in the general journal entries necessary to close the 
books. 

5. Post the closing entries. 

6. Draw up the balance sheet as of December 31, 1936. 

7. Draw up the income statement and the surplus reconcilia- 
tion statement for the year ending on that date. 



DRAKE CHEMICAL COMPANY NO. 2 133 

DRAKE CHEMICAL COMPANY No. 2 

THE WORK SHEET 

It is even more important in a manufacturing than in a mer- 
chandising business to use a work sheet in the process of adjusting 
and closing the books, because the complexity of the accounts 
involved is somewhat greater. A work sheet adapted to the 
requirements of manufacturing closing is illustrated in the Working 
Forms. The trial balance of the Drake Chemical Company at 
December 31, 1937, is given in the Working Forms. The adjust- 
ment data, determined as of December 31, 1937, are given below: 

Inventories, December 31, 1937: 

Raw Materials . ... . . ... $6,114,775 

Goods in Process . .. 3,875,335 

Finished Goods . . 9,201,865 

Real Estate Taxes Accrued 1 113,300 

Interest Expense Accrued 114,480 

Depreciation on Plant and Equipment 1 i , 104,905 

Insurance Expense 1 . .. .115,220 

(Insurance Unexpired included under Deferred Charges) 

Estimated Loss on Bad Debts 114,150 

Estimated Income Tax 809 , 281 



1 The portion of these items properly chargeable to selling and administration has already 
been transferred to Selling and Administrative Expense. 

The adjustments are entered in a manner similar to that used 
in the work sheet of the Robinson Shoe Company, except that 
there are three inventories to be recorded. The work sheet is 
expanded to provide columns representing each of the main clear- 
ing accounts used in closing the books of a manufacturing enter- 
prise. The several amounts arising out of the trial balance and 
the adjustments are extended to these columns in accordance with 
the closing procedure described in Drake Chemical Company 
No. i. The balances which appear in these columns on the work 
sheet will therefore be identical with those shown by the accounts 
with the same titles in the ledger after the closing entries have been 
posted. 



i. Prepare the work sheet of the Drake Chemical Company for 
December 31, 1937, in the form shown for the Wabash Manufac- 
turing Company. 



i 3 4 BOOKKEEPING 

2. After the work sheet has been checked and found correct, 
prepare therefrom adjusting and closing entries. 

3. Draw up from the work sheet the balance sheet, income 
statement, and surplus reconciliation statement. 



PART III 

ACCOUNTING FOR CURRENT ASSETS AND CURRENT 

LIABILITIES. AN INTRODUCTION 

TO SPECIAL JOURNALS 



IX. CASH 

HENDERSON MILLS 

ITEMS TO BE INCLUDED IN CASH 

The quarterly report of the auditors of the Henderson Mills 
to the directors, as of March 31, 1928, included a condensed 
balance sheet and a detailed balance sheet. In the first, cash was 
given as $470,312.89. In the second, cash and certain other items 
were reported as follows: 

Cash on Hand and in Banks $468,164.61 

Interest on Deposits Accrued i ,433 28 

Cash Advances 715.00 



$470,312 89 

The text of the report included additional information on these 
items : 

Cash on Hand and in Banks . . $467,904. 12 

The Cash on Hand and on Deposit, amounting to $467,904.12, consists of the 

following : 

On Hand: 

Boston Office Fund $ i , 300 . oo 

Lowell Fund 4,011.32 

Manchester Cash Fund 7,176 85 $ 12,488.17 

On Deposit: 

Bank A $90,981.70 

Bank B 96,83462 

Bank C 18,371.57 

Bank D . . . 15,696 29 

Bank E 121,178 80 

Bank F 6,500.00 

Bank G 8,49697 358,059.95 



Certificate of Deposit pledged as collateral security on bond, 

Bank C . . . ... 97,50000 

Preferred Stock Sinking Fund, Bank C 116 49 



$468, 164.61 
Less Petty Cash Items Accrued 260.49 

Total Cash on Hand and in Banks $467,904 12 

Interest on Deposits Accrued . . $r ,433 28 

Interest accrued on deposits, but not actually credited to the several bank 
accounts as of March 31, 1928, as determined from letters received from deposi- 
tories, amounts to $1,433.28, as follows: 

137 



138 CURRENT ASSETS AND CURRENT LIABILITIES 

Bank C 

Certificate of Deposit $ 787 . 87 

Bank C regular account 35 1 . 30 

Bank B regular account 143 2 * 

Bank A 150 90 

Total $1,433-28 

Cash Advances. $715- 

The cash advances, as evidenced by the book records as well as by certificates 
received from the holders, are as follows: 
A. B $260.00 



C. D 3 2 5-oo 



Total $715-00 




Note. A certificate of deposit is an obligation issued by a bank. 
If a customer of the bank has funds which he will not need for some 
time, he may deposit them in the bank and take a certificate of deposit 
payable on demand, after 30 days' notice, or at a definite future date. 
The bank is required to keep a separate record of demand and other 
certificates outstanding, since the reserve required against demand cer- 
tificates is the same as that against demand deposits, while other 
certificates are treated for reserve purposes like time deposits. The 
bank customarily pays interest on certificates outstanding, the rate 
being lower on those payable on demand. 

The document appeared as follows before being pledged. Although 
it was stated that it was pledged as security on a bond, the nature of the 
bond was not indicated in the report. From other sources it appeared 
that the bond was given in connection with litigation pending against 
the company. 



s BANK C $97,500.00 

^ Boston, Massachusetts, February i, 1928 

^ Henderson Mills 

g* have deposited in 

"g Bank C 

gj J Ninety Seven Thousand Five Hundred Dollars 

g ^ Payable to the Order of 

*> g Themselves Thirty Days after Notice 

s *} on return of this certificate properly endorsed 

(3 No. 811 John Tyler, Treasurer 



Questions arose concerning the inclusion of several of the items 
above as cash. Which of the items should, in your judgment, 
have been included in the figure given for cash on the published 
statements? 



X. ACCOUNTS AND NOTES RECEIVABLE 
NORTHEY NATIONAL BANK 

THE EFFECT OF LOANS TO OFFICERS ON THE CREDIT OF A 

COMPANY 

In March, 1935, the vice-president in charge of new business 
for the Northey National Bank of Chicago, was interested in 
enlarging the bank's borrowing clientele in order to loan profitably 
excess funds then on hand. 

The Thornton Radiator Company, a Cleveland manufacturer 
of radiators and plumbers' supplies, was one of the prospective 
customers. In order to investigate its financial condition and 
credit standing, the vice-president secured data, shown in Exhibit i 
in a somewhat condensed form. 

EXHIBIT i 

CONDENSED FINANCIAL STATEMENTS OF THE THORNTON RADIATOR 
COMPANY AS OF DECEMBER 31 





1932 


1933 


1934 


Current Assets 


$2,082,620 


$1,893,328 


$1 ,7^O.4.<;* 


Investments . . . 
Fixed Assets . . 


43,400 
i . 740.080 


3,163 
1,768,381 


7,052 
I .678, 160 


Other Notes and Accounts 


2^7 . ^67 


^^ .4.20* 


7C4.. 5:6^* 


Miscellaneous Items 


2 c6 . <\OO 


374.. si6 


4.14. 777 












$4,360,167 


$4,594,817 


$4,605,216 


Current Liabilities 


$ 36,558 


$ 82,071 


$ 0^,O08 


Reserves . 


660 . <; < 2 


781 . no 


784.. 4.^2 


Capital Stock 


l.OIO.OOO 


^.OIO.OOO 


3 .OIO.OOO 


Surplus 


6$i,os7 


721 ,416 


714.. 766 












$4,360,167 


$4,594,817 


$4,605,216 


Contingent Liabilities 


$ 104,621 


$ 190,651 


$ i52,856f 


Net Salest 


2,367,722 


2,175,974 


2,288,637 


Net Income 


27,453 


60,410 


77, 76* 


Current Ratio 


56.07 


23 .07 


l8 2\ 


Net Worth to Debt 


118.27 


<54 08 


4-6 Q7 


Sales to Net Worth 


0.55 


o 48 


O SI 


Profit on Sales, per cent 


1.16 


1 . IQ 


\ . 4O 











* Details of the larger items making up these totals were given and included amounts due 
from R B. Webber and Son, IQ33. $274,680; 1934. $481,627. 

t Drafts and trade acceptances discounted, $84,410; accounts receivable discounted, 
$68,446. 

% Net Sales in 1930 were $3,322,862; in 1931, $3, 731,305. 

139 



140 CURRENT ASSETS AND CURRENT LIABILITIES 

A report from a credit agency stated that: 

On the whole the situation is attractive from a credit viewpoint. 
With a good operating record over a period of years, this company has 
built up a more than adequate working capital position and has con- 
sistently accorded creditors a wide margin of safety. 

On the basis of these facts, the vice-president decided that the 
Thornton Radiator Company would be a profitable customer if a 
share of its business could be obtained. Therefore he referred the 
statements to the head of the bank's credit department for advice 
as to whether or not that department would consider unsecured 
loans to the company desirable enough to make advisable the 
solicitation of its business. 

In examining the data, the credit manager noticed the following 
item under " Other Notes and Accounts" on the 1933 and 1934 
balance sheets: 





1933 


1934 


R. B. Webber and Son (Secured by Thornton Radiator 
stock) 


$274.680 


$481 627 









Although the credit manager knew that R. B. Webber was 
president of the company, he assumed from the form in which this 
item was reported that it represented a loan to an affiliated com- 
pany. However, because of the size of the account and its rapid 
growth, he asked a credit agency for more information. The 
agency reported that this item resulted from advances to R. B. 
Webber, and to his son, L. A. Webber, secretary of the Thornton 
Radiator Company. Several years previously the two had been 
associated in another business venture incorporated under the 
name of R. B. Webber and Son Corporation, but these advances 
were to the two men individually. 

The credit manager looked over the audit certificates and found 
that in each year the auditor had certified that in his opinion, the 
balance sheets fairly presented the financial position of the com- 
pany, although he had made no detailed audit of transactions. 

After studying the facts thoroughly, the credit manager 
advised the vice-president in charge of new business that he did not 
think the Thornton account merited solicitation, mainly because 
of the uncertainty surrounding the sizable advances to R. B. 



C. F. HARTSHORN AND SONS, INC. 141 

Webber and his son, and partly because of the company's declining 
sales volume, and the fact that sales were so low in comparison with 
net worth. 

C. F. HARTSHORN AND SONS, INC. 

RECEIVABLES AS COLLATERAL SECURITY FOR BANK LOANS 

The corporation was organized in 1934 to manufacture rum. 
It obtained a plant in Peoria, 111., and purchased the right to use 
the Hartshorn name, which, prior to prohibition, had been used by 
a distiller of a high grade of rum, well known in the area. 

From its inception the company maintained a deposit with the 
Loop Bank and Trust Company of Chicago. In November, 1934, 
the bank agreed to loan the corporation up to $15,000 on the 
security of tax-paid rum and assigned accounts receivable. On 
November 30, 1934, the full amount of the loan was outstanding. 

The portion of the bank's staff that supervised commodity- 
secured loans had developed a procedure for handling loans 
secured by assignment of accounts receivable. The borrower sub- 
mitted a list of his receivables, stating the name of the debtor, also 
the terms, the amount, and the age of each account. The bank 
selected from this list the accounts which it would accept as 
security. In making the selection the bank obtained a rating of 
the debtors from a commercial agency and chose those accounts 
which seemed the least likely to give trouble. The size of account 
also entered into the selection, as the expenses of administering the 
loan varied with the number of accounts that had to be supervised. 
When doubt existed, the bank decided in favor of its customer. 1 

The borrower furnished the bank with carbon copies of the 
bills that had been sent to those owing the accounts which were 
selected. On each copy was placed the borrower's assignment to 
the bank of all interest in the amount due, together with the 
borrower's guaranty of full payment. 2 In addition the borrower 



1 In a good many cases the bank accepted all the current accounts that its cus- 
tomer offered. 

2 The form of assignment was as follows: 

KNOW ALL MEN BY THESE PRESENTS that we, of , Illinois, for 

value received hereby sell, assign, and transfer to the LOOP BANK AND TRUST 
COMPANY the claims or accounts described and set forth in the above statement, the 
goods covered by or described therein and all moneys due or to become due thereon 

(Continued on page 142) 



142 CURRENT ASSETS AND CURRENT LIABILITIES 

certified to the bank that the company's ledger had been marked 
to indicate the accounts which had been assigned. 

The bank followed the policy of not giving notice of the assign- 
ment to those owing the accounts unless it was decided to with- 
draw aid to the borrower because of insolvency or some other 
reason. Were notice given, there would be a tendency for debtors 
to transfer future purchases to another concern. Debtors did not 
wish to be indebted by assignment to an institution which had no 
interest in them other than the current claim, nor were they willing 
to accept the risk that delivery of goods might be delayed by 
insolvency. Furthermore, any notification invariably led to 
diffusion of the fact throughout the trade that the accounts of the 
borrower had been hypothecated. The effect of this knowledge 
was a shortening of the credit terms available to the borrower for 
its purchases. For these reasons borrowers believed that giving 
notice of an assignment of accounts would do more harm than 
could be offset by the benefits obtained from the funds advanced. 
Since the bank had been advised that delay in giving notice of 
assignment did not jeopardize its rights over the assigned accounts, 
it was willing to accede to borrowers' wishes. 1 

In making loans on the security of assigned accounts, the bank 
usually deducted 6 per cent of the amount of an account as an 
interest charge and advanced 80 per cent of the amount remaining, 
thus carrying a margin, when the loan was first made, of 25 per cent 
of the amount loaned on each account, exclusive of interest and 
subject to a small reduction if any debtor took advantage of the 
seller's terms of discount. 

It was desirable, for reasons having reference to the creation of 
preferences in anticipation of bankruptcy, that payments of 

(Continued from page 141} 

with full power to compromise and collect the same in our name and as our attorney, 
irrevocable, hereunto authorized to its own use. 

We hereby certify that said account is a bona fide and correct account for goods 
actually sold and delivered, that there are no offsets or credits, that the consider- 
ation of this assignment is based upon the truthfulness of all statements herein con- 
tained, and we guarantee its payment in full. WITNESS our hand and seal this 
day of 1934. 

1 Quite frequently the Loop Bank and Trust Company would receive inquiries 
from other banks which requested information about customers who had assigned 
accounts as security for loans. Usually such an inquiry was made on behalf of one 
of the customers of the inquiring bank. In such cases the answer was phrased to con- 
vey adequate information without compromising the interests of the borrower. For 
example, the reply might state, "We have been glad to make secured advances to 
assist in carrying inventory." 



C. F. HARTSHORN AND SONS, INC. 143 

assigned accounts should not pass through the borrower's deposit 
account. Therefore, as the borrower received a check in payment 
of an account that had been assigned, it would be endorsed to the 
order of the Loop Bank and Trust Company, and sent to the bank's 
loan and discount department. That department entered the 
payment as a credit to the amount of the loan on the books of the 
bank. Since the entire amount of each payment was credited to 
the loan, the bank's margin of security increased as payments were 
received. If assigned accounts became overdue, the borrower was 
asked to take action to obtain payment. The bank reserved the 
right to demand substitution for any account that might at any 
time be considered undesirable by them. 

After consideration of the request of C. F. Hartshorn and Sons, 
Inc., the Loop Bank and Trust Company, in November, 1934, 
determined to make use of the procedure that it had developed for 
other purposes in making new loans to borrowers whose credit 
position was weak. Consequently, the bank signified its willing- 
ness to lend the Hartshorn company up to $15,000 on the security 
of tax-paid rum valued at $2 per gallon and assigned accounts 
receivable valued as described above. The first advance was made 
during November when the full amount of the commitment was 
extended. In February, 1935, the bank was considering a request 
that the line of credit be extended to $30,000 secured in the same 
way as prior loans. 

At the end of February, a difficulty arose. Previous to Decem- 
ber 31, 1934, the monthly statements had been used only by the 
management and by the bank. During January, other creditors 
had asked the Hartshorn company for copies of its statements. 
The auditors, who previously had certified the statements with 
reluctance and only after being assured that the only outside 
user was the bank, insisted that unless the pledged inventory 
and receivables were clearly segregated in the statements for 
February 28, the certificate of the auditors would have to be 
qualified in a way which would reveal the facts as to pledged 
assets. 



144 CURRENT ASSETS AND CURRENT LIABILITIES 



EXHIBIT i 

FINANCIAL STATEMENTS OF C. F. HARTSHORN AND SONS, INC., AS OF 
OCTOBER 31, 1934, AND MONTHLY TO JANUARY 31, 1935* 





October 
3i, 1934 


November 
30, 1934 


December 
3i, 1934 


January 
3i, 1935 


ASSETS 
Cash 


$ 3,747 


$ 12 , ^03 


$ 29,565 


$ 3,060 


Accounts Receivable 


381 


24,8Q4 


32 .487 


3O. I7O 


Raw Material 


13, <?24 


II , 2O6 


12 .633 


l6. S3O 


Goods in Process 


7 sgC 




cr,i87 


22 7 <\O 


Finished Goods 


30,866 


7 3 , 44Q 


78,084 


81 ,084 












Current Assets 


$60 . 003 


$1 22 , 142 


$1^8 8<;6 


Si 64 4O3 


Capital Assets, Net 


231 .O4.7 


24O, 233 


244.674 


243 3Q2 


Deferred Charges, Etc 
Unamortized Organization Ex- 
pense 


18,778 
4.7 . 324 


18,514 
. 40 . 733 


21 ,182 

^3 . IO3 


2 3,34 
1 7 . 064 


Goodwill ... ... 


46 ,47O 


46 . 620 


47 . 03I 


47 . O3I 












Total Assets 


$405 ,122 


$477,242 


$525,746 


$496,094 


LIABILITIES 
Notes Payable Banks ... . 
Trade Acceptances. . . . 


$ .... 

9. 2OO 


$ 15,000 
11,368 


$ 795 

I 4 . OOO 


$ 8,250 
IO.o6o 


Accounts Payable Merchan- 
dise 


27 .76l 


34 . 3l6 


32 46^ 


31 O46 


Accounts Payable Machinery 
Notes Payable Capital f 
Accruals and Mortgage Pay- 
able within 30 Days . 


56,961 
34,620 

5,746 


47,901 
54,626 

8,962 


23,490 
67,584 

9,108 


23,490 
57,657 

7,200 


Current Liabilities 
Mortgage on Plant 
Paid-in Capital and Surplus 
Undivided Profits 


$134,378 
270,744 


$172,233 

5 , 760 
298,496 

7^3 


$M7,532 
5,730 
375,744 
3 , 260^ 


$138,603 
5,700 

354,359 
2,568^ 












Total Liabilities 


$405,122 


$477,242 


$525,746 


$496 , 094 


Sales, Monthly 




23 . 76lt 


33 . 482 


28,634 


Net Profits, Monthly 




7^3t 


4,OI3</ 


602 


Current Ratio 


O.4 1 ? 


o. 71 


I. 08 


I . IO 


Net Worth Debt 
Net Worth Fixed Assets 
Merchandise Receivables 


2.OI 
I.I7 
149.02 


1.74 
1-25 
3-40 


2 . 52 

1-52 
2.98 


2-54 
1-45 
3.10 



Payable March i, IQ3S, 



* Audited. 

t Funds advanced against a stock subscription of equal amount, 
when stock subscription also was to be paid, 
t Last two weeks of November. 
d = deficit. 

The president of the Hartshorn company discussed the problem 
with another firm of public accountants who refused to undertake 
the engagement unless they were free to segregate the pledged 
assets clearly. The president felt that this would make it more 
difficult to obtain credit from suppliers through trade acceptances 



BOWERS RUBBER MANUFACTURING CORPORATION 145 

and on open account. Since he and the auditor who had previ- 
ously certified the statements were unable to agree, the president 
asked the auditor to join him in a conference with a vice-president 
of the Loop Bank and Trust Company in order to develop a solu- 
tion which would facilitate the granting of a $30,000 line of credit 
by the bank. 

BOWERS RUBBER MANUFACTURING CORPORATION 

REVOLVING CREDITS CARRIED AS ACCOUNTS RECEIVABLE 

The company distributed its products through exclusive 
agents, many of whom did not have sufficient capital to carry the 
rather extensive inventories necessary to stock a full line. It was 
customary in the industry for manufacturers to render some assist- 
ance to distributors in carrying these inventories, and the Bowers 
company followed this practice. 

Prior to 1929 the company had consigned to each agent who 
needed the assistance a portion of the goods which he was expected 
to carry. A number of difficulties developed and a new system of 
revolving credits was instituted. Under this method title to the 
goods passed to the distributor, and if he had had a consignment 
of $10,000 to help him in carrying a full line of inventory, he was 
extended credit of that amount as an open account. 

It was necessary for the jobber to carry the remainder of the 
inventory himself. On this extra amount and for purchases to 
replenish his inventory, the agent was expected to pay by the 
tenth of the month following purchase. 

As long as a distributor continued to serve as an exclusive 
agent, the revolving credit had no maturity. 

When the revolving credit was first adopted in 1929, the 
company made no detailed agreement with the various jobbers con- 
cerning its use. Soon thereafter misunderstandings arose concern- 
ing its operation, and formal agreements clearly defining the 
revolving credit arrangements were included in the exclusive 
agency contracts with individual jobbers. 

No two agreements were identical. All had the force of a 
contract and explained clearly the undertakings of both parties 
with respect to the revolving credit. In general, the Bowers 
company undertook to contribute a specified amount of credit 
which would aid the jobber in obtaining a complete stock; the 



146 CURRENT ASSETS AND CURRENT LIABILITIES 

jobber agreed to use the credit only for inventory purposes and to 
pay the account when due. The revolving credit became due 
immediately upon termination of the exclusive agency contract, 
which contained definite stipulations as to when the contract 
could be ended. All the agreements contained the provision that 
the revolving credit was payable immediately upon the breach of 
any of the jobber's undertakings under the agreement. 

It had not been customary to charge interest on these revolving 
credits, but under a ruling of the N.R.A. Rubber Manufacturing 
Code Authority, rubber manufacturers were required after 
July i, 1934, to charge interest at 5 per cent on credits of this 
nature outstanding at the end of each quarter. 

According to the president, two objections to the revolving 
credit method remained after July i, 1934. First, since the 
Bowers company no longer kept records of the physical units of 
its distributors' inventories, it could not be sure that a jobber was 
using the revolving credit as intended; namely, to supply stock 
which in addition to that financed by the agent would be adequate 
to serve his territory properly. If a jobber used the revolving 
credit to provide most of his inventory and did not maintain an 
adequate stock by supplementing it with inventory that he himself 
financed, the purpose of the revolving credit was frustrated. In 
this instance, the jobber was using the Bowers company's money to 
finance his own business. Furthermore, the company could not 
determine by inquiry to what extent the jobber was maintaining 
an adequate inventory without antagonizing the customer. 

The second objection was that the credit risk of the revolving 
credit plan was greater than under the consignment method. 
Accounts receivable were large, and in the event of the failure of a 
customer, the company's position was only that of a general 
creditor. To agents whose credit ratings appeared doubtful, 
therefore, the company refused to extend revolving credits, but 
dealt with them instead on a consignment basis. 

The president stated that because the profit margins on the 
company's products normally were small, a revolving credit, or a 
consigned goods arrangement, was unprofitable unless the jobber 
enjoying its benefits gave the company a large volume of business. 
From its experience the company had found that a stock turn of 
five times a year was necessary before the jobber's business 
justified the cost of extending him financial assistance. 



PENDAR PAPER COMPANY NO. 2 147 

In 1935 the revolving credit method was used for most of the 
distributors who needed financial assistance, but a few remained 
on a consignment basis. 



1. Should the receivables arising under the revolving credit 
arrangement have been reported on the statements as short-term 
trade receivables? 

2. How should the consigned goods have been reported? 

PENDAR PAPER COMPANY No. 2 

TERMS OF SALE. THE CONTROL OF ACCOUNTS RECEIVABLE 

The Pendar Paper Company was a large wholesale distributor 
of fine-texture paper in the trade area surrounding Seattle, Wash. 
During 1934, sales, which annually averaged $1,500,000, were 
made to approximately 2,500 customers who ordered from the 
company at least once every three months. At the end of any 
month there were typically between 1,700 and 1,850 accounts with 
unpaid balances on the books. 

The stated credit terms extended by the company were 2 per 
cent/30 days, net 31 days, if payment was made by invoice, or 
2 per cent/i 5th proximo, net i6th proximo, if payment was made 
on monthly balances. Most of the customers used the proximo 
terms. As was customary in the trade, the Pendar Paper Com- 
pany did not hold all customers to these stated terms, however. 
For several years certain large vendees had been given the privilege 
of taking the cash discount on monthly balances if paid before the 
25th proximo. The stated net terms were enforced only against 
weak customers. The actual net terms implied were net 60 days 
in the case of invoice payment and net i5th of the second month 
following date of sale in the case of monthly payment. No 
account was considered overdue until it was at least 60 days old on 
the last day of the month when the accounts were being aged. 

Approximately 2 per cent of sales were for cash and on 65 to 
75 per cent the cash discount was taken. 

Accounts Receivable Control Sheet. In the control of accounts 
receivable, the credit manager of the Pendar Paper Company kept 
monthly figures of the volume and age groups of overdue accounts, 
that is, those which were more than 60 days old. In addition, the 



148 CURRENT ASSETS AND CURRENT LIABILITIES 

number of days' sales represented by the total receivables on the 
books of the company was computed. From the latter figure and 
that of the volume of overdue accounts, the credit manager was 
able to get a picture in terms of sales volume of the condition of the 
receivables as a whole. By comparing recent figures with those 
for the corresponding months of previous years, he could eliminate 
the effect of seasonal variations and appraise more accurately the 
volume of accounts outstanding. If at any time it appeared that 
the volume of overdue accounts or the number of days' sales on the 
books was too large in view of past experience, the credit manager 
knew that he ought to press collections intensively. 

To find the number of days' sales on the books, the sales of a 
given month, January, for example, were divided by the actual 
number of working days within the month to obtain the average 
daily sales during that period. The average daily sale of the most 
recent month, January, was added to a similar figure for the month 
preceding, December, and the average daily sales for two months 
obtained. Upon dividing this latter figure into the total receiv- 
ables outstanding as of February i, 1934, the number of days' sales 
outstanding on the books at that time was obtained. 

Aging Statement. The credit manager had the accounts 
receivable aged as of the last day of each month to provide the 
data on overdue accounts for the control sheet and to provide in 
the aging schedules information for credit and collection control of 
individual accounts. No account was shown on the statement 
unless a part of its outstanding balance arose from a sale made in 
the third month previous to the date of aging. In other words, no 
account was aged unless part of its balance was at least 60 days old. 

As a by-product of the operation in which debits and credits 
were posted to the customers' ledger, the bookkeeping machine 
used by the company aged the unpaid invoices composing the 
balance of an account as of the month in which they were dated. 

When postings were completed at the end of the month, each 
account in the customers' ledger therefore showed the total 
balance owed by the customer and also a breakdown of this balance 
on the basis of the months in which the related sales were made. 
At January 31, 1934, the accounts of two customers showed the 
following: 



PENDAR PAPER COMPANY NO. 2 



149 



Customer 


Account 
No. 


Total 


January 


Decem- 
ber 


Novem- 
ber 


October 


Pennwell Company. . 
John Aberdeen 


58 

^0 


$158.06 
64.40 


$92.57 
i $ . 76 


$65.49 

2O. OS 


$ 
28.SQ 


$ 

















The balance owed by the Pennwell Company arose out of sales 
of $92.57 during January and $65.49 during December. Since 
accounts were not considered overdue unless they were over 60 
days old, no part of the Pennwell balance was overdue. The 
balance of the Aberdeen account arose from sales in the amounts 
indicated during January, December, and November. Since part 
of the balance arose from a sale in November and was, therefore, 
overdue at January 31, the account was classified as overdue even 
though part of the balance arose from sales in the last two months. 

At the end of each month all overdue accounts were listed on 
an aging schedule similar to Exhibit i. This provided a column 
for the total balance and columns for the breakdown by the months 
in which the related sales were made. The Aberdeen account 
No. 59 is the first listed on the exhibit. The list included several 
hundred accounts, but only a few are shown in detail. 

To complete the aging schedule footings were taken for each of 
the columns. At January 31, 1934, $44,751.40 was the total of 
accounts receivable at that date standing in accounts some portion 
of the balance of which was overdue. Of this total $10,359.84 
arose out of sales made during January and $8,768.76 from sales 
during December. It is important to note that these amounts 
were not overdue even though they were in accounts each of which 
did have some overdue amounts. The other totals showed the 
amounts of receivables which were over 60 days old, $9,628.39 
of which arose out of sales in November which had not yet been 
paid for, $2,212.79 from sales in October, etc. The miscellaneous 
column included all amounts 10 months old and older. 

The totals on the aging schedule were used in setting up the 
monthly figures on the control sheet, Exhibit 2. The figures for 
the aging schedule illustrated are those which appear on the 
control sheet for January 31. The total balance of overdue 
accounts, $44,751.40, was subtracted from the total of all accounts 
receivable, $142,823.37, to give $98,071.97, which was the amount 



ISO CURRENT ASSETS AND CURRENT LIABILITIES 

of receivables standing in accounts all of the balances of which 
were less than 60 days old like that of the Pennwell Company. 
This figure could be checked, if necessary, by taking a total of such 
accounts directly from the customers' ledger. 

The total amount of overdue accounts was broken down on the 
control sheet by months as a summary of the aging schedule. It 
may be observed that receivables of $8,768.68, arising from 
December sales which were two months old at January 31, had 
risen to $14,120.42 at February 28 when they were three months 
old, probably because additional accounts had become overdue. 
At March 31 all but $199.10 had been collected, but the next month 
the amount rose to $666.96 because a note receivable was not paid 
at maturity and was charged back to accounts receivable. The 
amount of receivables 10 months old and older declined sharply at 
December 31, 1934, because several large accounts were written 
off at that time. 

The figures for a particular month were available by the tenth 
of the succeeding month. No records had been kept of the cost of 
obtaining these figures, but they were a by-product of the machine 
bookkeeping system in use for receivables and were obtained at 
very slight additional cost. 

Copies of the control sheet were provided for the president, 
the treasurer, and the credit manager, and were referred to the 
directors whenever credit problems were under discussion. Unless 
good judgment was used in extending credit and collections were 
pushed actively, there was a danger that receivables would absorb 
too much working capital and bad debt losses would become too 
high. The executives wanted to be in a position to detect tend- 
encies in that direction before they became serious. 

In addition to its use for purposes of control of receivables, the 
figures on the control sheet were used to set the amount of reserve 
for bad debts. Each month bad debt expense was debited and 
the reserve was credited in the amount of ^ per cent of sales for 
the month as described in Pendar Paper Company No. i. This, 
however, was only an approximation used to facilitate drawing up 
monthly income statements. At December 31 after bad debts 
charged off and recoveries had been closed into the reserve, the 
aging data on the control sheet were used to set the reserve to 
appear in the annual balance sheet. The directors had established 
a policy of keeping the reserve at the end of each year at the 



PENDAR PAPER COMPANY NO. 2 151 

following percentages of the aged accounts. No percentage was 
used for the balances in current accounts which were not aged. 

Per Cent 

Accounts over i year old 100 

January-March 100 

April- June 50 

July-September 25 

October 3 

November i 

December }< 

If the amount in the reserve was lower than that indicated by 
this computation, it was increased and bad debt expense was 
debited. If the reserve was above the figure indicated, it was 
debited and bad debt expense was credited. 



1 . Trace all amounts in the column for January 3 1 on the control 
sheet (Exhibit 2), and determine how the amounts were developed. 

2. Was this method of controlling receivables well adapted to 
the needs of the company? 

3. Was the policy used in setting the reserve sound? 



152 CURRENT ASSETS AND CURRENT LIABILITIES 



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1 54 CURRENT ASSETS AND CURRENT LIABILITIES 

MCKESSON & ROBBINS, INC. No. I 
CONTROL OF RECEIVABLES 

The company was organized in 1928 as a consolidation of 15 
drug wholesaling establishments distributed throughout the 
United States and a manufacturing concern located in Connecticut. 
The organization grew to include 76 wholesale houses located in 
the major markets of 42 states, territories, and countries, handling 
its own manufactured goods, crude drugs sold to outside cus- 
tomers, liquor, and products of independent drug manufacturers. 
Between 60 and 70 per cent of the total sales were made on account 
to independent drugstores through the wholesale houses. 

Late in 1933, the comptroller of McKesson & Robbins, Inc., 
came to the conclusion that a more definite control over the 
receivables of the branch houses was needed. Most of the branch 
houses originally had been independent concerns and when con- 
solidation took place, authority had been allowed to remain 
largely decentralized. Each house had a manager who was, in 
some instances, also a vice-president of McKesson & Robbins, Inc. 
Every house maintained its books according to the manual of 
accounts set up by the comptroller and sent in to the main office a 
standard monthly report listing the receivables, reserve for doubt- 
ful accounts, and current provision for doubtful notes and accounts 
receivable, but responsibility for matters relating to the extension 
of credit, 1 collections, write-offs of doubtful receivables, and main- 
tenance of an adequate reserve, rested with the branch managers. 

Policy formulation for the business as a whole was carried out by 
the central officers and the board of directors, of which the divi- 
sional vice-presidents were members. The comptroller had charge 
of accounting practices and determined the form and content of 
reports which were submitted by the branch houses. 



1 Terms varied with the type of merchandise sold. In some sales, terms were net 
with no cash discount. In others, i or 2 per cent was given as a cash discount for 
payment before the due date. 

Due dates and billing dates were arranged according to the two main divisions 
of the business drugs and liquor. Liquor billing days were the first, tenth, and 
twentieth of each month. Drug sales were billed on the first and fifteenth. In 
each case an account was due on or before the billing date following the date of 
record. For example, a drug sale made on the twenty-eighth would be billed on the 
first of the next month and would be due on or before the fifteenth. 



MCKESSON & ROBBINS, INC. NO. i 155 

The problem of controlling receivables was important from 
several standpoints. It was desirable that the branch houses 
remit cash arising from profits to the main office as promptly as 
possible. This was difficult to do if receivables were allowed to 
absorb too much of the working capital. Net sales, receivables, 
and net profits are shown in Exhibit i for the years 1928-1934. 

The comptroller believed that collections were not always 
handled with proper dispatch. The personal relationships which 
existed between the branch managers and many of the customers 
influenced the decisions of the executives. Basing his action upon 
his own evaluation as to the reliability and honesty of the firm or 
individual, a manager might allow collections to slide and delay 
writing off the account as a bad debt. In consequence of this 
situation, the receivables reported by the branches were not so 
clean and current as the comptroller desired for balance sheet 
purposes. 

Accuracy in reporting net income was affected by failure to 
reserve adequately against bad debts. An examination of the 
situation in 1932 had disclosed that numerous accounts still on the 
books should be written off. The reserve for doubtful accounts 
was not adequate for the eliminations anticipated and it was 
necessary to set up, out of earned surplus, a special reserve of 
$4,000,000 which was applied as a reduction in the net book value 
of receivables. In 1933, $2,679,301.69 of this reserve was specifi- 
cally applied against bad debts. A further application of $320,- 
698.31 was made in 1934, bringing the total of receivables written 
off against this reserve in the two years to $3,000,000. 

The comptroller of McKesson & Robbins, Inc., made personal 
contacts with the branches as often as possible, but by reason of 
the distances to be covered and the limited time available he was 
unable to handle the problem satisfactorily in this manner. 
Because of the decentralization of authority, he realized that it 
would be unwise to enforce complete and rigid standardized 
procedures. Nevertheless, he believed that reports from the 
branches furnishing him with detailed and classified data would be 
both practical and desirable. He also believed that the annual 
provision for doubtful receivables, bearing as it did upon the 
reporting of income, should be subject to close supervision by his 
office. He therefore determined to outline a series of reports and 



156 CURRENT ASSETS AND CURRENT LIABILITIES 



procedures dealing with receivables which would supply him with 
the significant facts necessary to proper treatment of the problem. 



In view of this situation what action should be taken by the 
comptroller of McKesson & Robbins? 

EXHIBIT i 

MCKESSON & ROBBINS, INC. 
RECEIVABLES, SALES, AND INCOME FOR YEARS 1928-1934 



End of year 


Receivables net 
of reserve* 


Net sales 


Net income 


1928 


$11,687,444.25 


$ 83,867,835.09 


$3,741,281.50 


1929 


22,361,080.78 


140,635,026.49 


4,109,872.92 


1930 


24,962,747.29 


134,865,440.02 


2,629,196.46 


1931 


22,816,155.45 


119,967,384.71 


1,845,739.39 


1932 


20,935,567-87 


104,227,131.31 


921,641 62d 


*933 


19,813,375-42 


104,961,034.34 


304,248.97 


1934 


20,901,773.37 


124,452,631.14 


1,720,259.78 



* Receivables reported included: Accounts receivable, customers, Installment notes and 
other notes due in the following year, Due from officers and employees, Miscellaneous. 
d deficit. 
Source: Company reports. 



XI. INVENTORIES 
A. COST, MARKET, AND COST OR MARKET, WHICHEVER IS LOWER 

THE AMERICAN TOBACCO COMPANY 

VALUATION OF INVENTORIES 

The accounting procedures of The American Tobacco Com- 
pany, in the treatment of tobacco inventories, have been followed 
consistently for many years. 

Manufacturers of tobacco products carry stocks of tobacco 
large enough to meet their contemplated future manufacturing 
requirements. 

It is a recognized practice in the tobacco industry to use cost 
in the valuation of inventories, and cost includes carrying charges 
incurred in storing tobacco from the time it is purchased in its 
green state until it is ready for use. This practice has been recog- 
nized by the Treasury Department for the purpose of computing 
taxable income, and the public accountants who audit tobacco 
companies believe the accounting practices in use to be sound. 

Public accountants recognize as a sound practice the addition 
of carrying charges as a cost of inventory in all cases where it is 
necessary to subject commodities to an aging treatment. In 
the liquor industry, for example, the addition of carrying charges 
during the aging period is an accepted and universal practice. 

There is no basis upon which to follow the cost or market, 
whichever is lower theory of inventory valuation for tobacco 
because there is no market in which the particular needs of the 
company may be purchased in the quantities required. Wheat, 
corn, cotton, and other staple commodities, having a wide market, 
are unlike tobacco. There are market prices for those commodities 
but not for aged tobacco. 

The American Tobacco Company manufactures a variety of 
tobacco products which require the purchase of numerous grades 
of American-grown tobacco and the importation of some foreign- 
grown varieties. Throughout the accounting procedures, records 

157 



158 CURRENT ASSETS AND CURRENT LIABILITIES 

are kept in detail for each individual grade, type, and crop year. 
With minor variations, the procedures described in the following 
paragraph are typical for domestic tobaccos. 

The company purchases tobacco at auction sales warehouses 
which are located throughout the tobacco-producing areas. Sev- 
eral auction sales warehouses are located in each of the central 
points at which tobacco is sold. Farmers bring their tobacco to 
these sales warehouses for sale at auction to representatives of 
foreign and domestic tobacco companies and dealers in leaf 
tobacco. The tobacco is placed in baskets in rows on the ware- 
house floor and an auctioneer employed by the sales warehouse 
company conducts the auction sale, at which the buyers may bid 
on each individual basket of tobacco and the final bid on a par- 
ticular basket represents the purchase of the tobacco from the 
farmer. The farmer considers the price offered and, if in his 
judgment it is not satisfactory, the farmer has the privilege of 
rejecting the bid; in which case the tobacco is again offered for 
sale. If the farmer is satisfied with the offer, the tobacco is sold 
to the company whose representative made the final bid. It is of 
interest to observe that the transaction is entirely between the 
farmer who grew the tobacco and the purchasing company. The 
transaction occurs shortly after the maturity of the tobacco crop 
and long in advance of the time when the tobacco will be required 
for manufacturing purposes by the purchasing company. 

Wheat, corn, cotton, and other staple commodities are dealt 
in on commodities exchanges. It is possible to purchase these 
commodities in large quantities through these exchanges and it is 
even possible to deal in futures. In the case of tobacco, however, 
each individual purchase represents a personal selection by a 
company buyer. 

From the auction floor baskets of tobacco are moved to a 
central point in the market town where they are sorted by grades 
and packed into hogsheads ready for shipment to a redrying plant 
of the company. The plant at which this packing takes place is 
called a prizery. At points where the company operates redrying 
plants, the tobacco is moved directly from the auction sales floor 
to the redrying plants. 

The moisture content of tobacco at the time it is purchased 
varies, contingent upon current climatic and other conditions. 
Tobacco is subjected to the redrying process for the purpose of 



THE AMERICAN TOBACCO COMPANY 159 

establishing a uniform moisture content, which will render it best 
suited for the aging process that follows. After passing through 
the redrying machine, tobacco is packed into hogsheads which hold 
approximately 1,000 lb., and moved to storage warehouses. 

The storage promotes mellowness by removing certain of the 
harsh irritants, which are found in all tobacco. A natural process 
of sweating (fermentation) occurs twice each year, in the early 
summer and early fall. Two years constitutes the minimum stor- 
age period and three years is considered the ideal period for most 
tobacco, after which time it is ready for manufacture. 

The stemming process has as its purpose the removal of the 
middle rib or stem from each tobacco leaf. A small portion of 
tobacco is stemmed before it is redried, but as to the bulk of 
tobacco, the stem is removed immediately preceding the use of 
the tobacco in the manufacture of finished products. 

A typical cigarette blend used by The American Tobacco Com- 
pany contains four types of tobacco, namely, Flue-Cured, Burley, 
Maryland, and Turkish. 

All of the costs in connection with buying, redrying, and storing 
tobacco are considered to be additions to the cost of the tobacco 
inventory. The cost of stemming is added to the value of that 
portion of the inventory which is stemmed. Although stemming 
cost is reflected as part of the cost of tobacco used in manufacture, 
only a relatively small amount of stemming cost is reflected in the 
value of the leaf tobacco inventory. All additions to inventory 
values represent actual cost, and the accounting transfer from the 
raw material inventory to cost of manufacture is based upon 
the average cost of all tobacco of the particular grade on hand at 
the beginning of the month. 

The cost of the tobacco at this point represents an accumula- 
tion which includes the following elements: 

A. Price paid for green tobacco at auction, 

B. Buying costs: 

1. Salaries of buyers and supervising buyers; wages of foremen and 
employees who handle the tobacco at the country markets. 

2. Cost of hogsheads used as containers in transporting tobacco. 

3. Cost of transportation to redrying plants. 

4. Overhead at buying points including rent of the central prizery, 
salaries of bookkeepers, and other overhead expenses. 

C. Redrying expenses including steam, labor, and overhead incurred in 
respect to redrying leaf tobacco prior to storage. 



160 CURRENT ASSETS AND CURRENT LIABILITIES 

D. Carrying expenses: 

1. Rent (or depreciation, local property taxes, and maintenance). 

2. Labor salaries of employees at the storage plant. 

3. Insurance. 

4. Taxes. 

5. Overhead incurred in respect to storage. 

In order to establish a reasonable basis for the distribution of 
buying costs to a crop of tobacco, prior to the opening of the 
markets each year an estimate is made of the total buying expenses 
and of the total number of pounds of tobacco to be purchased from 
the crop. From this budget the buying expense rate is set and 
buying expenses are added to the cost of leaf as it passes through 
the redrying process. Redrying expenses are allocated to cost of 
leaf on the basis of a similar budget for those expenses. The 
estimates contain only a small margin of error and, since the entire 
crop is placed in storage during the buying season and none is used 
before the season ends, the variations between the estimate and 
actual costs are adjusted by increasing or decreasing the inventory 
accounts at the end of the season so that the actual buying and 
redrying costs are added to each crop on a per pound basis. 

Carrying expenses are added to the cost of the leaf inventory 
monthly as incurred. Rent and labor charges are distributed on 
the basis of the number of pounds of tobacco stored, whereas 
insurance and taxes are applied according to the value of each 
grade of tobacco on hand. The company uses an average cost 
basis (in contradistinction to the use of the cost of specific lots or a 
first-in first-out method) for the reason that, in the various proc- 
esses through which tobacco passes, it is impossible to keep track 
of specific lots. For example, in the redrying process the identity 
of specific lots is lost and shipments of the same grade from several 
buying points are mingled. An average price for a grade is the 
logical cost basis, since all tobacco of one grade serves the same 
purpose. 

From the time the tobacco is purchased green until it is ready 
for use (while it is being redried, stored, and stemmed) there is a 
loss in the weight of the leaf. This loss is recognized in the 
accounting procedures by decreasing the number of pounds of the 
particular grade in question but permitting the accumulated cost 
to remain intact; hence, the number of pounds to which costs 
apply will decrease as the tobacco passes through the various 



THE AMERICAN TOBACCO COMPANY 



161 



stages of treatment, but the accumulated cost of the tobacco as it 
passes into the final processes represents the accumulated cost 
for the particular grade. 



1. What are the significant differences between the practices 
in inventory valuation of The American Tobacco Company and 
the Herendeen and Haply Woolen Mills (page 31)? 

2. Do these differences represent adaptations of the policies 
to conditions peculiar to the industries involved? 

3. Does the fact that there is no organized market for aged 
tobacco preclude the use of cost or market, whichever is lower? 

4. Should either company adopt a policy more similar to that 
of the other? 

EXHIBIT i 

THE AMERICAN TOBACCO COMPANY 
(ooo omitted) 



Year 


Inventory* 


Net income 


1927 


$ 85,820 


$23,258 


1928 


91,3^5 


25,014 


1929 


102,542 


30,178 


1930 


108,238 


43,295 


1931 


98,i37 


46,189 


1932 


H4,i37 


43,267 


iQ33 


115,480 


17,401 


1934 


121 ,6l2 


24,084 


J 935 


120,902 


24,282 


1936 


121,152 


20,184 


J937 


137,422 


26,197 



* Includes Leaf Tobacco, Manufactured Stock, Operating Supplies, etc., at cost. 
Source: Company reports. 



162 CURRENT ASSETS AND CURRENT LIABILITIES 

WARNER BROS. PICTURES, INC. 
VALUATION AND AMORTIZATION OF FILM INVENTORIES 

Inventories in the film industry possess certain peculiar charac- 
teristics which require specialized accounting treatment. Positive 
prints derived from the original negative are rented or leased to 
exhibitors. The income received from these rentals parallels the 
receipt of admissions in the exhibiting theaters to the extent that 
the films are leased based on a percentage of the box office receipts. 
Therefore, although films remain physically intact, except for 
wear, in the producer's inventory, their earning capacity declines 
as the play-off progresses. These circumstances give rise to the 
problem of what portion of cost should be charged against income 
during each accounting period. 

The amortization methods used by Warner Bros. Pictures, 
Inc., are described as follows in the company's annual report 
(Form lo-K) to the Securities and Exchange Commission for the 
fiscal year ended August 28, 1937. 

The method employed by the registrant in the amortization of the 
costs of the released productions consists in writing off the costs in 
proportion to the receipt of income derived from the exhibition of its 
pictures throughout the world. 

In conformity with good accounting practice, the amortization 
table is revised to reflect such changes as the most recent complete 
experience of film rental income from distribution throughout the world 
indicates in the trend of film rental income. While no portion of the 
negative costs is assigned, as such, to the foreign territories in which the 
registrant's pictures are released, the income derived from distribution 
in foreign territories is included among the statistics used in determin- 
ing the amortization table. 

Periodically the company prepared a table showing the com- 
bined experience of films for which amortization had been com- 
pleted and also noted the trend for other pictures which had not 
completed their earning life. This was compared with the amorti- 
zation rates in effect, and whenever the percentage of total revenue 
received varied from the percentage of cost amortized sufficiently 
to affect seriously the accuracy of the income statement, the 
controller adjusted the amortization rates to parallel the new 
rental experience. 



WARNER BROS. PICTURES, INC. 



163 



The following table, prepared from the company's annual 
reports to stockholders for the years 1932-1937, illustrates the 
changes in amortization which took place during that period. 



Weeks 




Positive 


z prints 






Negatives 




after 
release 


Prior to 
1932 


1932 


1934 


1937 


Prior to 
1932 


1932 


1937 


A 






17% 


22% 




13% 


ic% 


8 






4.c% 


<J2% 




32^% 


l6^% 


13 
26 

2O 


49% 
78% 


64^% 
90% 

02^% 


74% 
96% 
1 00% 


75% 

96% 

100% 


4*K% 
65%% 


SiH% 

73% 
77% 


53% 
7oJ^% 
74% 


39 

5 2 
6s 


93^% 
100% 


96%% 
100% 






79% 
86^ % 

Q7% 


8 4 M 
93%% 

I OO% 


83% 
95% 
100% 


88 










IOO% 























Changes in the over-all length of a film's rental life and in the 
rate of rental inflow might have been caused by changes in methods 
of distribution and exhibition. Two possibilities are suggested: 

1. Double feature billing has caused the production of a large 
number of second-rate feature pictures. The life expectancy of these 
films might be lower than that of regular features with a corresponding 
effect upon the average life expectancy of all films. 

2. Sales departments of the film corporations have endeavored to 
secure as many day and date showings as possible. As this policy has 
been realized, more positives have been exhibited at the same time, and 
the inflow of rentals has shifted accordingly. 

The methods of amortization employed by Warner Bros. 
were not universally accepted in the film industry. Procedures of 
Columbia Pictures Corporation are indicated below through 
excerpts taken from a prospectus issued by the company in 1935. 

The method employed by the registrant in the amortization of the 
cost of released productions consists of writing off the cost, as closely 
as possible, in proportion to the receipt of income derived from the 
exhibition of pictures in the various territories. Adjustments are made 
from time to time in the proportion of negative costs allocated between 
domestic and foreign territories, and in the percentages used in the 
amortization tables, in order to reflect changes in the trend of film 
rental income from the several territories where the pictures are dis- 
tributed. These amortization tables are based on averages obtained 



164 CURRENT ASSETS AND CURRENT LIABILITIES 

from the play-off experience of all pictures of each particular class, 
viz., features, westerns, and shorts. 



The negative cost of features and westerns are apportioned 75% to 
domestic territories and 25% to foreign territories, the latter being 
subdivided 20% to Great Britain and 5% to other foreign territories. 
No portion of the negative cost of shorts will be allocated to foreign 
territories. 

Because of the difference in the rate of play-off of features, westerns 
and shorts, separate tables are used for these three types of pictures 
in the territory of the United States and Canada, which in summarized 
form are as follows: 





Features 


Westerns 


Shorts 


13 weeks 


57>% 


30^% 


32^% 


26 weeks . . .... 
3Q weeks 


87^% 
Q6^% 


6oK% 
70% 


61% 
78 % 


52 weeks . . 
78 weeks . . . 


100% 


9i H% 

100% 


*9M% 
100% 



The quotation below, also taken from the 1937 report of Warner 
Bros. Pictures, Inc., to the Securities and Exchange Commis- 
sion, presents the elements of cost included in the company's 
films. 

The costs of producing motion picture negatives include: (i) cost 
of stories and of scenarios and continuities prepared therefrom; (2) 
salaries of directors, camera men and the cast of players; (3) cost of 
sets, wardrobe and all accessories; (4) cost of negative and positive 
film excluding cost of positive prints used in film distribution; (5) costs 
of synchronization; and (6) general studio overhead and depreciation 
and amortization of studio properties, apportioned over the motion 
picture negatives produced during each production year upon the basis 
of direct costs. 

The items of direct cost listed by Warner Bros, were com- 
mon to the industry. Treatment of indirect cost, however, varied 
both as to the proportion of total indirect costs charged against 
films and the basis of allocation. Four methods of allocating 
indirect costs to films were in use : 

i. Distribution to picture costs on a " shooting" day basis; that is, 
a flat charge per day for each day that the cameras were in actual 
operation. 



WARNER BROS. PICTURES, INC. 165 

2. Distribution according to the ratio that the estimated direct 
cost of each picture bore to total production cost for the year. 

3. Actual weekly overhead distributed equally to all productions in 
process during that period. 

4. Distribution of total overhead equally to pictures completed 
within the year. 

Of these methods, the second was most commonly used, and was 
basically the procedure employed by Warner Bros. 



1. Do the methods used by Warner Bros. Pictures, Inc., in 
accounting for film inventories accomplish the objectives which 
have led companies in many other industries to use cost or market, 
whichever is lower? 

2. When the books of a motion-picture-producing company are 
being audited, what examination of inventories should be made 
by the public accountants? 



166 CURRENT ASSETS AND CURRENT LIABILITIES 

WARNER BROS. PICTURES, INC. 

CONSOLIDATED BALANCE SHEET AT AUGUST 28, 1937 

(ooo omitted) 

ASSETS 
Current and Working Assets: 

Cash $ 4 , 058 

Accounts and Notes Receivable, Net i , 787 

Inventories: 

Released Productions at Cost, Less Amortization. . . $ 7,821 
Productions Completed but Not Released, at Cost . . 8,025 
Productions in Progress and Charges To Future Pro- 
ductions, at Cost 3>956 

Rights and Scenarios Unproduced, at Cost Less 

Reserve 2 , 083 

Raw Materials, Accessories, Supplies, etc 484 22,369 

$ 28,214 
Net Current Assets of Subsidiaries Operating In Foreign 

Territories Having Exchange Restrictions ... . . 214 

Investments in Affiliated Companies: 

Investments at Cost Less Reserves $ 975 

Advances Less Reserve. . . 285 

Investment in Stocks, Bonds and Receivables 313 i,573 

Fixed Assets: 

Properties Owned and Equipment at Cost Less Reserve $120,804 
Properties Leased and Equipment at Cost Less Reserve 15,073 135,877 

Other Assets: 

Mortgages, Long Term Notes and Special Accounts Re- 
ceivable, Less Reserve $ 511 

Accounts Receivable from Officers . no 

Deposits to Secure Contracts, Less Reserve i ,313 

Sinking Fund Deposits 93 

Shares in Building and Loan Associations 45 

Miscellaneous Investments, Less Reserve . 161 2,233 

Deferred Charges: 

Prepaid Taxes, Insurance, Rent, etc i , 134 

Goodwill 8 , 300 



Total Assets $177,545 



WARNER BROS. PICTURES, INC. 167 

WARNER BROS. PICTURES, INC. 

CONSOLIDATED BALANCE SHEET AT AUGUST 28, 1937. (Continued) 

(ooo omitted) 

LIABILITIES 
Current Liabilities: 
Notes Payable: 
Secured 

Banks $ 1,775 

Others 100 $ 1,875 

Unsecured 

Banks $ 1,952 

Others 332 2 , 284 

Accounts Payable 4,915 

Interest Accrued i ,422 

Other Accrued Liabilities 3 , 057 

Reserve for Federal Income Taxes 3 ,013 

Long Term Debt Maturing Within One Year 4, 7 78 

Owing to Affiliated Companies 109 

Royalties and Participations Payable i , 169 

Advance Payments For Film Deposits, etc 478 



$ 23,100 

Net Current Liabilities of Subsidiaries Subject to Ex- 
change Restrictions .... 49 

Funded and Other Long Term Debt: 

6% Convertible Debentures Due 1939 $ 29,413 

Bonds & Mortgages Maturing After One Year . . 39,408 

Bonds & Mortgages Subject in Part to Renewal. . . 3,638 

Purchase Money and Contractual Obligations 557 

Notes Payable 377 73 > 393 

Deferred Credits: 

Discount on Subsidiary Treasury Stock and Bonds. ... $ 871 

Foreign Subsidiary Remittances in Abeyance 598 

Miscellaneous 492 i ; 961 

Reserve for Contingencies $ i , 270 

Minority Interest Capital Stock 168 

Minority Interest Surplus 70 

Preferred Stock Issued and Outstanding 5,671 

Common Stock Issued and Outstanding 19,007 

Capital Surplus 57 ,044 83, 230 

$181,733 

Less Deficit 4, 188 



Total Liabilities $177,545 



i68 CURRENT ASSETS AND CURRENT LIABILITIES 

WARNER BROS. PICTURES, INC. 

STATEMENT OF CONSOLIDATED PROFIT AND Loss AND DEFICIT FOR THE 

YEAR ENDING AUGUST 28, 1937 

(ooo omitted) 

Net Income (after deducting $25,445,916.48 representing 
amortization of film costs, including depreciation of studio 
properties) before other income and charges shown below. $16,719 

Deduct: 

Amortization and Depreciation of Properties (other than 
$991,453.13 hi respect of studio properties charged to 

film costs) $ 4,771 

Interest Expense 4, 574 

Provision for Investment in Affiliated Companies 291 

Provision for Contingencies 200 9,836 

Profit Before Other Income and Charges $ 6,883 

Other Income: 

Interest & Discount Earned $ 251 

Dividends Received. . 237 

Additional Proceeds Under Settlement Made in 1934 44 

Miscellaneous Income 27 559 

Profit Before Minority Interest and Federal Income Taxes. . . $ 7,442 

Add Proportion of Loss Applicable to Minority Stockholders 

(Net) 4 

Profit Before Federal Income Taxes $ 7 ,446 

Provision For Federal Income Taxes 

Normal Income Taxes $ i , 260 

Surtax on Undistributed ^Profits 310 i , 570 

Net Profit Carried to Deficit $ 5 , 876 

Deficit, August 29, 1936 $10,469 

Deduct: 

Redemption Discount on Bonds of Subsidiaries .... $563 

Credit Resulting From Exchange of Bonds of Sub- 
sidiary 240 

Adjustments of Reserves and Accruals of Prior Years 97 900 



. . . 
Add: 

Additional Provision for Federal Income Taxes in 

Respect of Year Ending August 31, 1930 $166 

Losses and Provisions for Losses of Capital Assets . 329 495 10,064 



Deficit, August 28, 1937, Carried to Balance Sheet $ 4,188 

STATEMENT OF CAPITAL SURPLUS FOR THE YEAR ENDING 

AUGUST 28, 1937 

(ooo omitted) 

Capital Surplus, August 29, 1936 $56, 774 

Add: Appropriations authorized by the Board of Directors as of August 

27, 1932 not required in respect of: 
Investment in Participation of Profits, License Rights, etc. . . 270 

Capital Surplus, August 28, 1937 $57,044 



Source: Company report. 



WARNER BROS. PICTURES, INC. 



169 



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* Includes $604,839.44 profit 
t Amortization of film costs 
Source: Company reports. 



170 CURRENT ASSETS AND CURRENT LIABILITIES 





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DELTA PACKING COMPANY 



171 



DELTA PACKING COMPANY 
THE PRICING OF INVENTORIES IN THE MEAT-PACKING INDUSTRY 

The Delta Packing Company, an affiliate of one of the major 
packing concerns, was located on the eastern seaboard. The 
company was devoted entirely to the production of fresh pork and 
allied products, such as hams, bacon, sausage, lard, etc. Corn-fed 
hogs were shipped in from the Middle West and slaughtered, so 
that within 24 hours the fresh meat would be available to con- 
sumers in the metropolitan district served. Since fresh pork 
declined rapidly in taste and appearance, the ability of the com- 
pany to provide pork so soon after killing was the principal eco- 
nomic reason for its survival in such a highly competitive field. 

The processing of pork is not a complicated procedure and 
may be illustrated by the diagram given below: 



LIVE 
HOGS 



KILLING 

AND 
DRESSING 



CHILLING 

AND 
CUTTING 



[FRESH PORK TO MARKET] 



PICKLING 

AND 
SMOKING 



s 




Unlike the beef-packing business, wherein common practice 
was to sell the whole beef carcass, the hog business dealt only in 
cut products. Since these cuts were all major parts of the hog 
carcass, the situation gave an excellent illustration of joint prod- 
ucts. Because of the difficulties involved in accounting for joint 
products, the Delta company treated each department as a sepa- 
rate business and drew up a form of loss and gain statement by 
departments each month. This statement was based upon the 
following departmental debits and credits, any balance remaining 
being transferred to Loss and Gain. 



Debits 

Opening Inventory 
Transfers from Other Departments 
Purchases 
Plant Expense 



Credits 

Transfers to Other Departments 
Net Sales 
Closing Inventory 



172 CURRENT ASSETS AND CURRENT LIABILITIES 

For the purpose of simplification, this case will consider only 
the problem of pricing bacon. This inventory existed in the 
pickling department, where the complete process of converting 
fresh hog bellies into bacon was performed. The inventory of 
bacon in process or completed was of considerable size. Several 
circumstances accounted for this. First, the primary aim of the 
company was to produce fresh pork. Hog bellies were not much 
in demand as fresh meat but did sell well in the form of bacon. 
Thus the pickling department served in one sense as a reservoir 
for excess fresh pork slaughtered. Second, the curing process 
required 30 to 45 days for bacon. Third, although fresh pork 
moved very slowly during the high-temperature season, bacon was 
consumed most heavily during the summer months, and an inven- 
tory to meet this demand had to be built up in advance. Inven- 
tories of cured meats were accumulated largely during November, 
December, and January and were liquidated most extensively 
during June, July, and August. Fourth, profit in the meat-pack- 
ing business depended to a large extent upon market conditions, 
and consequently, packers generally slaughtered heavily when 
live-animal prices were favorable and curtailed operations when 
those prices were too high. This procedure led to fluctuations in 
volume of operations, and inventories had to be maintained to 
absorb this variation in production. The figure for hams and 
bacon in the pickling department in June, 1937, was in excess of 
$1,000,000. 

Inventory control was maintained through a perpetual inven- 
tory system based entirely on weight. A careful record of the 
weights of all products entering and leaving each department 
was maintained. Thus it was possible to calculate the percentage 
of shrinkage which was comparable to a figure set as a standard 
by the controlling packing corporation. Every three months a 
complete physical inventory was taken. At this time the manage- 
ment compared actual shrinkage with standard as a check on the 
departmental foremen. Generally, these men kept shrinkage close 
to the standard set. 

In pricing the inventory of bacon, the general concept of cost 
Dr market could not be used. Accurate costs were known for the 
live hogs in the pens and for the hog carcass up to the beginning 
D the cutting operations. From that point on costs were not 
recorded because there was no feasible way in which to allocate 



DELTA PACKING COMPANY 173 

carcass cost among the several joint products derived therefrom. 
Further, hogs were purchased in lots at different prices, and it 
would be difficult to identify the various cuts with any particular 
lot of hogs after the meat had progressed beyond the cutting 
operation. Finally, once a hog was slaughtered, all meat products 
had to be sold within a very definite time limit, and the determina- 
tion of accurate costs for each cut, even if possible, would have 
been of little use to the management in regulating its marketing. 
Costing for control purposes was carried out upon the basis of one 
day's operations for the killing and cutting departments. Once 
each week a weight check was made upon the products derived 
from some particular day's kill. Through the use of such data a 
set of percentages was computed, and these figures represented 
the portion of the total live weight going into each type of product. 
These percentages were applied to a hundredweight of live hogs, 
and the results priced at current market quotations. From the 
total return thus obtained, the purchase price and the processing 
cost of the hundredweight were subtracted. The result repre- 
sented the margin of gross profit or loss realized per hundredweight 
on the day's operations. This procedure is illustrated in Exhibit i . 
The margin of profit or loss realized was a small percentage of the 
packer's market price and generally ran between 50 cts. loss and 
25 cts. profit per hundredweight. 

In determining the inventory of bacon for the semiannual 
financial statements, the number of pounds was taken from per- 
petual inventory cards and included all bacon in the pickling 
department regardless of the stage of completion. The price 
used was the current market price at which fresh bellies were being 
sold by the Delta company at the date of the balance sheet. It 
was possible to buy and sell all products of the various depart- 
ments, and, if it proved possible to buy bellies at a lower price, this 
replacement cost was used. Processing costs in the pickling 
department were approximately i ct. per pound but, since the 
price of fresh bellies was used, these costs were not included. The 
inventory of bacon and hams at June 30, 1937, was over $1,000,000 
and the bacon inventory included the following items: 



174 CURRENT ASSETS AND CURRENT LIABILITIES 



Description 


Size 


Quantity, 
pounds 


Price 


Extension 


Cured fancy bellies 


8/10 


67. ^62 


24 


$16,214.88 


Cured fancy bellies . ... 


IO/I2 


04., 374. 


2 3 y 2 


22,177 89 


Cured fancy bellies 


12/14. 


86, (HI 


2* 


10,004-. 13 













Accountants outside the industry had suggested to the manage- 
ment of the Delta Packing Company that the methods used 
resulted in taking up unrealized profits on the books in any period 
in which prices were advancing. 1 Under the conditions of June 30, 
1937, an increase of 2^2 cts. would have involved an unrealized 
profit in inventories of 10 per cent. Between April and July, 1937, 
bellies in the Chicago market as quoted in the National Provisioner 
advanced from 18% to 20 cts. and changes in other years had been 
greater. It was suggested that market at time of acquisition, or 
market at balance sheet date, whichever was lower, would be more 
conservative. The management did not consider that a change 
from the market method of valuing inventories was feasible in 
view of the existence of joint costs in the packing industry. 



1 For the relation between inventories and income in the packing industry see 
The Cudahy Packing Company, pp. 9-16. Also see Swift & Company, especially 
pp. 238-240. 



DELTA PACKING COMPANY 



175 



EXHIBIT i 

DELTA PACKING COMPANY 
TEST ON LOT or HOGS 



Product 


Average 
weight 


Per cent 
of live 
weight 


Current 
market 
price, 
cents 


Exten- 
sion 


Fresh hams 


16-18 


13^ 


13 


$1.76 


Fresh shoulders 


12 I 1 ? 


10 


ioM 


I .O< 


Fresh bellies 


I4l6 


12 


17 


2.04 


Fat backs 


8-10 


7 


7 


o 4.0 


Pork loins 


8-10 


IO 


14^ 


1 .415 


Spare ribs 




I 


II 


O II 


Prime steam lard 




U U 


8 


1 . 1$ 


Trimmings .... 




2 


7 1 A 


O l< 


Tankage and miscellaneous 
Shrink . .... 




J* 


2 

o 


0.06 












Yield and gross value 
Processing costs per 100 Ib 




100 




8 26 
o 62 












Cost of live hogs per 100 Ib 








7 64 
7.68 












Gross profit or loss per 100 Ib 








o O4f 













* The allowance for shrinkage was based upon the estimated difference between the live 
weight of the hogs purchased and the weight of the products sold. This difference was accounted 
for by the following factors: 

a. Elimination of waste at time of slaughter. 

b. Dehydration of by-products. Blood and tankage were sold in dried form. 

c. Dehydration of carcasses in cold storage caused both by natural evaporation and by 
action of the refrigerating surfaces. 

d Dehydration of cuts of meat in storage, for similar reasons. 

t Adjustment to be made on this figure for administrative and selling expense before net 
profit or loss. 



176 CURRENT ASSETS AND CURRENT LIABILITIES 

SOUTHERN PEANUT PRODUCTS COMPANY 
REPORTING OF INVENTORY LOSSES 

The Southern Peanut Products Company produced peanut 
butter, salted peanuts, peanut confections, and peanut bars. 
Although the candy business in general was seasonal, many of 
the products of this company, such as peanut butter, showed no 
marked seasonal demand and helped to even the flow of production. 

As with all agricultural products, the supply of peanuts was 
seasonal and could not be readily adjusted to demand. In order 
to be sure of an adequate supply, the company purchased heavily 
from the growers during the fall. The market price of peanuts as 
of December 31 varied from the fall price according to the trend 
of demand and the supply of peanuts at that time. Over a long 
period the price, of course, was affected by the general trend of 
prices. 

As of December 31, 1932, the market had dropped to i ct. per 
pound, which was less than the cost of growing the peanuts. If 
the company followed its usual practice of writing down the inven- 
tory to the lower of cost or market for balance sheet purposes, a 
heavy loss would be realized, which would be charged to the 
operations of 1932. 

Because of custom, the retail price of such items as peanut bars 
remained fixed at 5 cts. A considerable part of the sales volume 
was represented by sales of this product. Thus to the extent that 
these selling prices remained stable, the operations of 1933 would 
result in profits, a large part of which would be merely offsetting 
the losses taken in 1932. The operations of both years would be 
so influenced by the book profits and losses that the true profits or 
losses would be obscured. 



1. Were these inventory losses to be followed by increased 
profits merely book figures or actual losses and profits? 

2. The following recommendations were made by officers of the 
company with respect to inventories: 

a. Value the ending inventories at the lower of cost or 
market and thereby allow the inventory loss to affect the 
cost of raw materials used, cost of goods manufactured, 
and cost of goods sold in the income statement. 



CHURCHILL PUBLISHING COMPANY NO. i 177 

b. Value the ending inventories at cost in the income state- 
ment, and show the inventory loss as a special item in 
computing the cost of goods sold. 

c. Value the ending inventories at cost in the income state- 
ment for the purpose of finding the gross profit and then 
deduct from this gross profit the inventory loss as a 
special item. 

d. Compute both gross and net profit from operations using 
inventories valued at cost and then deduct inventory loss 
from the net profit as thus figured. 

Which one of these recommendations do you prefer? Give 
reasons. 

3. If the company used either 6, or c, or d y how could it explain 
the differences between the ending inventories shown on the 
income statement and those on the balance-sheet? 

4. What advantages might result, if any, from changing the 
company's fiscal year so that the yearly financial statements could 
be drawn up in the fall prior to the heavy commitments in raw 
materials? 

B. THE CONTROL OF INVENTORIES 

CHURCHILL PUBLISHING COMPANY No. i 

INVENTORY CONTROL AND VALUATION OF FINISHED GOODS 

The normal inventory of the Churchill Publishing Company, 
publishers of textbooks, contained a larger quantity of books than 
could be found in any single library in the world. In part, this 
large inventory resulted from spreading production in economical 
lots throughout the year in preparation for the rush season which 
came prior to the opening of schools in the fall. A further cause 
was the production of a two or three years' supply of certain books 
in order to realize the economies of production in large lots. It 
was possible to do this because, for the majority of the books, the 
demand could be estimated with a high degree of accuracy. The 
remaining inventory consisted of books for which the demand had 
declined and which were being retained in the hope that they might 
eventually be sold. The company devoted considerable attention 
to the judicious selection of books to be printed; otherwise the 
inventory would have included a large supply of unsalable books. 



178 CURRENT ASSETS AND CURRENT LIABILITIES 

New books originated in three ways: (i) The company received 
unsolicited manuscripts. (2) The company sensed the need of a 
particular book and approached an author or authors to write it. 
(3) The company sensed the need of a book or series of books along 
certain lines and arranged with authors to write under direction 
and in accordance with plans laid out by the company. 

The final decision with respect to the publication of a new book 
was made by an executive committee of six individuals who were 
considered to be the best informed on the various aspects of the 
business. 

Unsolicited manuscripts were passed upon by the editorial 
department. If a given manuscript was found to be suitable, 
subject to necessary or desirable corrections and changes, the 
department submitted a recommendation for publication to the 
executive committee. 

Suggestions for new books were made from time to time by 
individuals in the various departments of the company. These 
suggestions were cleared through the editorial department which 
selected the suggestions that appeared to be of merit and laid 
tentative plans as to the nature of the proposed books and the 
authors who might be asked to write them. The plans, in the form 
of recommendations, were submitted to the executive committee 
for approval before further action was taken. 

The aid of the managers of the company's various sales offices 
was enlisted in determining the quantity of a new book to be 
printed by asking them to estimate the quantity which they could 
sell in the months remaining to the first of November. This 
estimate was only for the purpose of determining the production 
requirements on a new book for the current year. Thereafter 
estimates were submitted by the sales offices as described below 
for old books. 

Decisions as to the quantity of old books to be printed at any 
one time depended upon the following factors: (i) The quantity 
on hand at the plant and at the various sales offices. (2) The 
annual orders, and revisions of these orders, received from the 
sales offices. (3) Economical production lot size. (4) The ability 
of the company to finance the inventory without excessive loans 
from banks. 

Perpetual inventory records were maintained at the plant for 
books stored there. Quantities only were shown on the cards, 



CHURCHILL PUBLISHING COMPANY NO. i 179 

dollar values being considered unnecessary. Each sales office 
maintained its own stock records and each month reported to the 
home office at the plant the quantity of each title on hand on the 
last day of the month. 

Annually, during October, each sales office sent an order to the 
home office covering the expected requirements for each title, for 
the year beginning November i. The orders were also broken 
down by three periods, the first from November i through January 
31, the second from February i through July 31, and the third 
from August i through October 31. These orders were subject 
to revision during the year. Shipments were made on the basis of 
requisitions received from the sales offices. Frequently orders 
were received directly from customers and shipments were made 
to them. In other cases requisitions were received from the sales 
offices, but shipment was made directly to customers. 

The perpetual inventory cards maintained at the plant not 
only showed additions to stock, shipments, and balance on hand 
for each title, but also showed the shipments, current orders, and 
future orders of each sales office and totals for all offices. From 
November i to January 31, " current orders" included only the 
winter portion of the annual order, and " future orders" included 
the spring-summer and fall portions of the annual order. From 
February i to July 31, " current orders" included only the spring- 
summer portion of the annual order, and " future orders" included 
only the fall portion of the annual order. 

This knowledge of quantity on hand and expected require- 
ments formed the major basis of decisions with respect to the 
quantities to be published. There was a marked seasonal trend 
in sales, and the estimates of expected requirements enabled the 
company to spread its production over the year and to build up 
inventories in preparation for the most active selling season. 

The matter of production in lots of economical size played a 
part in the determination of the quantity of a given book to be 
produced at any one time. An economical lot size often exceeded 
the sales requirements of a single year. In years when the com- 
pany had ample working capital, production in economical lots 
was the major factor in deciding production quantities on books 
that were certain to be sold in the future. Investment in books 
of this type had proved to be sound since their known salability 
assured within reason that they would eventually be converted 



i8o CURRENT ASSETS AND CURRENT LIABILITIES 

to cash, and the realized economies in production represented a 
good return on the investment. The company, however, placed 
a definite limit on its loans from banks and in years when the 
company's own working capital was not so plentiful, a definite 
limit was set on the total investment in inventory and production 
was reduced to smaller lots. 

Part of the inventory consisted of printed sheets ready to be 
bound. Out of a total yearly production of about 8 million books, 
approximately 6^ million were bound at the time of printing, and 
\Yi million were stored in sheet form to be bound later. The 
maintenance of a stock of books in sheet form minimized both the 
investment and the possible losses through failure of a book to 
sell. The cost of binding a book was about as much as the cost of 
the paper and printing combined. In addition, this reservoir 
enabled the bindery to develop its production schedule with less 
dependence upon the current output of the pressroom. 

There were over 3,000 perpetual inventory cards for the finished 
goods inventory. The production department notified the inven- 
tory control department as each lot of books was completed, and 
proper entries were made on the perpetual inventory cards. The 
shipping department sent the inventory control department a 
notice covering each shipment. This shipping notice showed, 
among other things, the quantity of each title shipped and the 
sales office to which shipment had been made, or the sales office 
to be given credit for the sale in the event the shipment had been 
made directly to the customer. The receipts and shipments of 
books were recorded on the perpetual inventory cards in physical 
quantities only, through the use of mechanical equipment. This 
equipment made it possible to develop sales and inventory sum- 
maries with almost any breakdown desired. 

The clerks in charge of the storerooms were required to make a 
physical count of a few items each day. The count was then 
checked with the stock on hand as shown by the inventory cards, 
these cards being kept by a separate clerk. This method utilized 
the time of the inventory clerks to good advantage, maintained 
the accuracy of the inventory cards in showing what was actually 
on hand, and overcame the necessity of taking a complete physical 
count at any one time. 

In addition to the constant check provided by the perpetual 
inventory system, the entire inventory list was reviewed three 



CHURCHILL PUBLISHING COMPANY NO. i 181 

times a year by a special committee. For the purpose of the first 
review, a list was drawn up from the inventory cards, from cost 
records, and from sales records; this showed the quantity and cost 
of each title on hand at the beginning of the year, the production 
and cost since the first of the year, the quantity sold, and the cur- 
rent inventory quantity. For the remaining two reviews it was 
necessary only to place on the same sheet the quantity produced, 
production cost, sales for the period since the prior review, and the 
current inventory quantity. 

The main purpose of the first two reviews was to compare the 
inventory of each book with the sales of that book and to note the 
trend of sales as shown by comparison with the review lists of other 
years, as a guide to plans for future production. The review at the 
end of the year included the problems of valuation for the balance 
sheet and of dealing with old books which could not be sold and 
which were eating up their value through carrying costs. 

The general policy had been to make a five-year estimate of 
sales for each book in the inventory which was not being currently 
produced. If the inventory on hand exceeded the five-year sales 
estimate, the excess was written off, and, if the eventual sale of 
this excess appeared to be hopeless, books to this amount were 
actually destroyed. 

The remaining inventory had been valued at the lower of cost 
or market. Market represented the replacement cost as currently 
estimated by the cost department. Cost represented the actual 
cost of materials, printing, and binding, and an arbitrary charge 
for factory overhead. 



1. What were the objectives sought by the executives of this 
company in decisions concerning inventories? 

2. Were the accounting methods and control devices well 
adapted to facilitate the attainment of these objectives? 



182 CURRENT ASSETS AND CURRENT LIABILITIES 

WHITMAN TIN PLATE COMPANY 

INVENTORY IN EXCESS OF CURRENT REQUIREMENTS 

The Whitman Tin Plate Company was a relatively small manu- 
facturer of tin plate, making only a small percentage of the total 
tin plate production of the country. It had, nevertheless, been a 
profitable enterprise, largely as a result of friendly relations with 
several consumer companies in different industries, with which 
it had for many years carried on mutually satisfactory business. 

As a result of unsettled business conditions, the price of pig tin 
dropped steadily throughout 1930; towards the close of that year 
the price struck a new low point for all time. Since pig tin was 
one of the major raw materials of the company, both in quantity 
and value, any fluctuation in tin prices greatly influenced both 
the profits of the company and the value of its inventories. In 
the opinion of officials of the Whitman Tin Plate Company, the 
low point for pig tin late in 1930 was near, if not below, the out-of- 
pocket costs of the producers. If so, the mines would shut down 
rather than sell at a lower price. Believing this to be the case, 
they thought that the price would not drop much lower and, if it 
did, that such a price could prevail only for a short time, after 
which it would again rise, with improved business conditions, to a 
more normal point. Without attempting to pick the very bottom 
of the market, but simply wishing to make what seemed to the 
executives a conservative and yet highly favorable commitment, 
they contracted during the last few weeks of 1930 for more than a 
year's supply of pig tin. Not all the tin was purchased at one 
price, but the average price was near the lowest quoted for many 
years. As was customary in the trade, the contracts were made 
for future delivery, so that materials might be received as manu- 
facturing requirements demanded. 



What were the significant differences in the nature of the 
decisions with respect to inventories in this case and those in the 
Churchill Publishing Company case? Were there differences in 
the extent to which accounting data could be used in facilitating 
these decisions? 



TEXAS GULF SULPHUR COMPANY, INC. 



183 



EXHIBIT i 
WHITMAN TIN PLATE COMPANY 

PIG TIN PRICES 
(In cents per pound at New York) 



Year 


Jan. 


Feb. 


Mar. 


Apr. 


May 


June 


July 


Aug. 


Sept. 


Oct. 


Nov. 


Dec. 


Av. 


1920 


62 74 


59 8? 


61 93 


62.12 


54 99 


48 34 


49 29 


47 60 


44 43 


40 47 


36 97 


34 04 


50 23 


1921 


35 94 


32 16 


28 76 


30 36 


32 50 


29 39 


27 69 26 35 


26 70 


27 70 


28 93 


32 41 


29 91 


1922 


32 03 


30 74 


29.14 


30 58 


30 92 


31 46 


31 67 32 36 


32 36 


34 61 


36 76 


37 48 


32 Si 


1923 


39 16 


41.98 


48.61 


45.84 


43.ii 


40 97 


38.47 39 33 


41 .60 


41 80 


44 09 


47 16 


42 68 


1924 


48 70 


53.41 


55-03 


50.02 


44.08 


42.74 


46 29 


51 89 


49 24 


50.60 


54 25)56.03 


50 19 


1925 


58 26 


57-09 


53 67 


52 27 


54 65 


55 93 


58 05 


58.12 


58.27 


62 24 


63 30 


62 .94 


57 90 


1926 


62 31 


63.63 


64 58 


63.44 


62.69 


60 68 


63 03 


65 33 


69.25 


70 41 


70 70 


68.28 65 36 


1927 


66 S3 


68.75 


69.28 


68.22 


67.35 


67.28 


64 3i 


64.45 


61 50 


57 03 


57 68 


58 47 


64 24 


1928 


55 56 


52.47 


52 n 


52 28 


51-53 


47-92 


47 oi 


47 97 


48 06 


48 99,50 76 


50 23 


50 41 


1929 


49 21 


49-39 


48.85 


45 93 


43 88 


44 20 


46 29 


46.60 


45 32 


42.25140 18 


39 87 45 16 


1930 


38.84 


38.63 


36.76 


35 90 


32.16 


30 26 


29 76 


30.00 


29.59 


26 76 


25 87 


25 oi 


31 63 



Source: Standard Statistics Company, Inc., Standard Trade and Securities, Vol. 80, No. 29, 
Sec. 5. 

TEXAS GULF SULPHUR COMPANY, INC. 



INVENTORY CONTROL AND VALUATION 

Of the world's known deposits of natural sulphur, the largest and 
richest is that occurring on the Boling Dome property, located in 
Wharton and Fort Bend counties of Texas, controlled by this company 
under leases. . . . Aggregate reserves at active deposits are estimated 
to have a life of more than 40 years. Company is the largest producer 
of sulphur, accounting for around 60% of domestic output, which in 
turn represents from 70% to 75% of the world's total production of 
native sulphur. 

Originally held by Gulf Production Co. (subsidiary of Gulf Oil 
Corp.) under lease, Boling Dome was initially developed by Texas 
Gulf Sulphur in 1927 under an agreement by which company was first 
to reimburse itself in full, out of profits arising from sales of all sulphur 
produced therefrom, for development costs and operating expense 
incurred in getting property on a paying basis, and thereafter Gulf 
Production^ was to receive 50% of net profits. Because of the com- 
plexities of operating and accounting problems under this contract a 
new arrangement was effected in September, 1934. Under this plan, 
Texas Gulf Sulphur issued 1,300,000 shares of capital stock, repre- 
senting 33.85% interest, plus $650,000 in cash, for entire assets of 
Delaware Gulf Oil Co. (another subsidiary of Gulf Oil Corp.) to which 
Gulf Production Co. had transferred all its interests in above contract; 
and in addition, certain other sulphur properties and rights located in 
Texas, including an option by which Delaware Gulf Oil had right for 
10 years, from July 4, 1934, to acquire without additional consideration 
all sulphur interests of Gulf Production Co. in Texas. 



i8 4 CURRENT ASSETS AND CURRENT LIABILITIES 

Only other major domestic producer of sulphur is Freeport Texas 
Co., owning two deposits in Texas, and one in Louisiana, producing 
about 30% of domestic output. Several smaller companies together 
produce remaining 10% of native brimstone. Manufacture of sulphur 
from pyrites, and from smelter gases, to date has not challenged impor- 
tantly the entrenched position of mined sulphur. 



The peculiar geological structure of the Texas deposits'has permitted 
recovery at relatively low cost. Extraction is by method known as 
Frasch Process. 1 Water at a temperature of 33oF. is pumped through 
the sandy soil into sulphur horizon, melting sulphur underground; 
melted product is then pumped to surface by use of compressed air, 
and collected for storage in great bins where, upon cooling, it solidifies 
into massive blocks of 99)^ per cent pure sulphur, impervious to action 
of the elements. This process, although it involves a high initial 
plant investment, requires comparatively few workers and therefore 
cost of production in the United States is lower than in other countries 
where physical structure of deposits makes it necessary to use regular 
mining methods followed by comparatively costly refining. 

Sulphur in some form is said to touch nearly every industrial 
process. Three principal users are manufacturers of acids and chemi- 
cals, fertilizer companies and paper and pulp makers, consumption of 
native sulphur in the United States by these three groups in order 
named being about 55, 20, and 15 per cent of the total. Remainder 
is used in connection with manufacture of dyes, rubber, pharmaceutical 
preparations, and a great variety of other miscellaneous products. 

The domestic price of sulphur has been maintained at $18 a ton 
(f.o.b. mines) since October, 1927, and is reported to be controlled 
largely by the price of pyrites. Because of the convenience and 
various economies resulting from its use, native sulphur commands a 
slightly higher price than the equivalent sulphur in pyrites. As the 
price of pyrites has been reasonably constant for a number of years, it 
has had a stabilizing effect on sulphur quotations. . . . 2 

The income statement for 1937 and the portion of the balance 
sheet for that year dealing with inventories arc given below. Prior 
to 1934 materials and supplies were included with sulphur inven- 
tories in a single figure and miscellaneous income was included 
with sulphur sales. It was the practice of the company to show 



1 In the Frasch Process, each pipe is expected to bring up from 70,000 to 100,000 
tons of sulphur before it has to be replaced. The limited life of the pipes is due to 
earth slips caused by the melting out of the underlying supporting layer of sulphur. 
The pipes are expensive, and each is used until it fails, since, if the heating is inter- 
rupted, the chances are that the sulphur may " freeze" in such a way that the pipe 
cannot be used again. 

2 Standard Corporation Records, Individual Reports Section, July 6, 1937. 



TEXAS GULF SULPHUR COMPANY, INC. 185 

the inventory of sulphur as a working asset but to exclude it from 
the total of current assets. The inventory of sulphur, gross 
revenue from sulphur sales, and net income, for the years 1927- 
1937 are shown in Exhibit i. 

Since it was stated above that sulphur was sold for $18 a ton 
beginning in 1927, it is possible to compute the number of tons 
sold by dividing gross revenue from sulphur sales by $18. This 
method is subject to some inaccuracy, especially prior to 1934, but 
it gives at least a rough indication of the number of tons sold. 
These figures are included in Exhibit i. 

It was stated in the balance sheets that the inventory of sulphur 
was carried at cost. The 1934 report included the following 
statements: 

The sulphur inventories (sulphur above ground) consist mainly of 
sulphur at Gulf, Newgulf and Long Point. Sales from these inven- 
tories are determined by actual weight. In the past however, the 
quantity of sulphur produced and added to inventory at Gulf had been 
estimated as accurately as possible after making numerous tests to 
determine the weight of a cubic foot of solid sulphur. Sulphur ship- 
ments from Gulf, where there has been no production since September 
1932, made it possible during 1934 to calculate with greater accuracy 
the tonnage on hand in inventory there. From these calculations it 
appeared that the weight per cubic foot used in computing production 
at Gulf had been too low, resulting in an underestimate of the sulphur 
tonnage. Accordingly, an adjustment was made in the number of 
tons in inventory at Gulf to reflect this overage, which, with a 
reduction in tonnage to provide for sulphur contained in vat bottoms 
and for shortages due to over-estimates elsewhere, automatically 
resulted in a net increase in the total number of tons carried in inven- 
tories and in a decrease in the average cost per ton of such inventories. 
Production taxes on account of the said overage have been paid to the 
State of Texas, subject to audit. 



It should be noted that the reserves for both depreciation and 
amortization are created by charges against inventory per ton of sul- 
phur produced and that as sulphur is sold the income account is 
charged with the average depreciation and amortization per ton of 
sulphur in inventories. 

On the assumption that the items included in the cost of inven- 
tory were operating costs and charges for depreciation and amorti- 
zation, it is possible to compute the approximate cost of sulphur 



186 CURRENT ASSETS AND CURRENT LIABILITIES 

by adding these items and dividing by the indicated tons sold. 
For 1937 the computation was as follows: 

Operating costs $10,112,328 

Depreciation 630, 056 

Amortization 815 , 177 

Total $11,557,561 

Indicated tons sold i ,446,576 

Indicated cost per ton $7-99 

Similar figures for 1934-1936 were $8.60, $8.55, and $7.96, respec- 
tively. These figures are only approximate because, among other 
things, changes in the volume of inventory were not taken into 
consideration, but apparently the average cost per ton was about 
$8.25. Therefore, if the inventories at cost for each year were 
divided by $8.25, the indicated tons in the inventories were as 
shown in Exhibit i. 



1. Do you agree with the practice of the company in excluding 
inventories from current assets? 

2. Do you agree with the practice of stating inventories at 
cost? 

3. In what respects did the problems of inventory control in 
this case differ from those in the case of the Whitman Tin Plate 
Company? Were there differences in the type of accounting data 
necessary to the control of inventories? 

TEXAS GULF SULPHUR COMPANY, INC. 

INCOME ACCOUNT FOR THE YEAR ENDED DECEMBER 31, 1937 
Gross Revenue from Sulphur Sales $26,038,375 

Costs and Expenses: 

Operating and Delivery Costs $10, 112,328 

Selling, General and Administrative Expenses i ,410,007 

Provision for Contingencies ... 300,000 

Depreciation 630,056 

Amortization 815,177 

Total Costs and Expenses $13,267, 568 

$12,770,807 
Miscellaneous Income 188,403 

$12,959,210 

Provision for Current Federal Income and Capital Stock Taxes 
(The Company has no liability for surtax on undistributed 
profits) 1,369,929 

Net Income for the Year Carried to Earned Surplus . ... $11,589,281 



TEXAS GULF SULPHUR COMPANY, INC. 



187 



TEXAS GULF SULPHUR COMPANY, INC. 
BALANCE SHEET AS AT DECEMBER 31, 1937 

ASSETS 
Current Assets: 

Cash on hand and on demand and time deposit. . $ 9,815,616 
U. S. Treasury Notes at cost (Market Value De- 
cember 31, 1937 $2,234,250) 2,200,000 

Accounts Receivable Customers 2,023,413 

Notes and Trade Acceptances Receivable 37>93i 

Miscellaneous Receivables and Advances 69 , 466 

Total Current Assets $14, 146,426 

Working and Trading Assets at Cost: 

Inventories of Sulphur above ground $15,059, 271 

Inventories of Materials and Supplies 3 79 , 569 15,438,840 

LIABILITIES, CAPITAL STOCK AND SURPLUS 
Current Liabilities: 

Accounts and Wages Payable $ 803 ,214 

Provision for Current Taxes 2 , 192 , 847 

Total Current Liabilities $ 2 ,996 , 061 



Source: Company report. 

EXHIBIT i 
TEXAS GULF SULPHUR COMPANY, INC. 



Year 



Inventory 

of 
sulphur 



Mate- 
rials and 
supplies* 



Gross rev- 
enue from 
sulphur 
sales 



Miscel- 
laneous 
incomet 



Net 

income 



Indicated 
tons 
sold 



Indicated 
tons in 
inven- 
tory 



1927 
1928 
1929 
1930 
1931 
1932 
1933 
1934 
1935 
1936 
1937 



$ 8, 

7, 
8, 



665,879$ 

893 , 947 

731 ,96o 

928,750 

192, 158 

443 , 803 

817,018 

521,459 

322,597 

627,817 

059,271 



440,531 
402,304 
403,178 
449,079 
379,569 



$22,328,199 
26,083,613 
29,883,243 
25,815,550 
18,213,807 
13,487,538 
17,818,345 
16,733,654 
17,755,050 
22,o8o, 137 
26,038,375 



298, 192 

78,472 

171,080 

188,403 



$12,099 

14.517 

16,247 

13,972 

8,942 

5,910 

7,443 

6,958 

7,468 

9,853 

11,589 



,374 
,619 
,478 
,085 
,602 
,492 
,613 
,476 
,017 
,015 
,281 



,240,455 
,449,089 
, 660 , 1 80 
,434. 197 
,011,878 

749, 307! I 

989,908!! 

929,647!! 

986,392 i 
I , 226,674 
1,446,576 



,050,409 
956,842 
,058,419 
,445,909 
,720,261 
,750,764 
,553,578 
,638,065 
,614,860 
,651,857 
,825,366 



* Until 1933 these items were included in sulphur inventory. 

t In 1934 a change in the form of statements occurred which caused miscellaneous income to 
be set out as a separate item. In years previous to 1934 this item was included in gross revenue. 
Source: Company reports. 



i88 CURRENT ASSETS AND CURRENT LIABILITIES 

CLARK WHOLESALE PAPER COMPANY 

THE CONTROL OF INVENTORIES IN A WHOLESALE PAPER COMPANY 

The Clark Wholesale Paper Company purchased from paper 
mills a wide range of paper, varying in type and quality, which it 
sold to printers, stationers, and small jobbers, and to large business 
concerns for their own use. Sales could be classified by these 
types of customers and also by the methods of sale which were as 
follows : 

Warehouse sales, representing sales from stock physically stored 
and recorded on perpetual inventory cards. 

Indirect sales, covering goods received but distributed immediately 
to customers without entry on perpetual inventory cards. 

Direct sales, covering goods shipped directly from mill to customer 
without having been physically handled by the Clark Wholesale Paper 
Company. 

Warehouse sales could be further classified as full lots and 
broken lots. Broken lot sales were made when a printer wished 
to buy only the number of sheets required for a definite job. Fre- 
quently, paper was cut by the wholesaler to a size ordered by a 
printer. Broken lot prices were sufficiently above full lot prices 
to allow for a few extra sheets, the extra expense involved, and 
the inevitable losses from dirt and spoilage once a package had 
been opened. 

Perpetual inventory cards (Forms i and 2) were maintained for 
inventory control purposes and figures were kept for quantities 
only, though the unit cost of each purchase was indicated. Forms 
i and 2 were both on one sheet folded so that when filed, Form i 
came prior to Form 2, and Form 2 extended sufficiently above 
Form i so that the items Line, Size, Color, and Finish were visible. 

The perpetual inventory cards provided the following informa- 
tion: 

1. The name of the item and its size, color, finish, and location in 
the storeroom. 

2. The source of supply, the quantity in each package, the minimum 
number of packages to be stocked, and the number to be ordered at the 
time of each purchase. 

3. The quantities ordered and received, and the dates on which they 
were ordered and on which they were received. 



CLARK WHOLESALE PAPER COMPANY 189 

4. The balance at the beginning of the period, additions, subtrac- 
tions, and running balance. (In quantities only) 

5. The unit cost of each lot purchased. 

A complete physical inventory was taken twice each year, once 
as of June 30 and again as of December 31, in connection with the 
preparation of semiannual financial statements. Perpetual inven- 
tory cards were corrected in accordance with the physical count, 
the corrections involving for the most part minor adjustments for 
losses on items of stock from which broken lot sales had been 
made. It was very rare to find any significant difference between 
the physical count of an item and the amount shown on its per- 
petual inventory card, though not infrequently there were differ- 
ences which, after a recount, were found to have been errors in 
taking the physical inventory. 

The business was departmentalized according to classes of 
customers served and the heads of the various departments did 
their own purchasing. They established minimum and ordering 
quantities which were entered on the perpetual inventory cards, 
and one of their responsibilities was the maintenance of an ample 
quantity of stock without excessive investment. 

Each department head also was responsible for the supervision 
of salesmen and for pricing, but major changes were decided in 
consultation with the president, treasurer, and assistant treasurer. 

For some time the executives had been considering the advis- 
ability of strengthening centralized control in order to meet com- 
petition more effectively and to take more complete advantage of 
opportunities in the industry. The treasurer suggested that it 
would be possible, through a development of figures already avail- 
able to obtain turnover data for each item in stock on an annual or 
monthly basis, and also to cost invoices so that gross profit could 
be obtained on each sale. Many of the expenses could be allocated 
to individual sales or types of sales so that an indication could be 
obtained of the net profit on each. 

It was the opinion of the treasurer that the development of 
this information from the accounts should precede any steps in the 
centralization of executive responsibility because he believed that 
changes of that order should be based on the most complete 
information available. 



i 9 o CURRENT ASSETS AND CURRENT LIABILITIES 

FORM i* 



Ord. from X Paper Co. Unit Pkg. 6 Rms. Ordering Quan. IO Ctns. Min. 30 Rms. 




Cost 


ORDERED 


INVOICED 


LOCATION 


Date 


Order 
No. 


Quan- 
tity 


Date 


Quan- 
tity 


Rec'd 


Case 


Amount 


Sec- 
tion 


9.09 Cwt. 


12/10/36 


13640 


10 Ctns. 


12/12 


60 R 


12/15 


10 Ctns. 


60 R 


R-4 



















































































































































































































































FORM 2* 



X Bond 17 X 22 40 M White Bond 


LINE SIZE COLOR FINISH 


Rec'd 


Date 


Sold 


Bal- 
ance 


Rec'd 


Date 


Sold 


Bal- 
ance 


Rec'd 


Date 


Sold 


Bal- 
ance 








44 R 




















12/8 


4 


40 




















12/8 


4 


36 




















12/10 


6 


30 




















12/14 


2 


28 




















12/14 


4 


24 




















12/15 


12 


12 


















00 


12/15 




72 




















12/19 


3 


69 




















12/24 


12 


57 




















12/30 


4 


S3 


















Inv. 


12/31/36 




53 



















































































































* Paper purchased from the mills was priced by weight, the cost in this example 
being $9.09 per 100 Ib. as shown in the first column in Form i. The company sold 
this type of paper by the ream (500 sheets) and recorded the receipt, issue, and bal- 
ance in reams as shown on Form 2. The size of this paper is shown on Form 2 as 
17 X 22 in., 40 Ib. per 1,000 sheets. The ordering quantity as shown on Form i was 
10 cartons, there being 6 reams to each carton; the weight being 120 Ib. per carton. 
Ten cartons (1,200 Ib.; were ordered on December 10 and received on December 15 
(Form i). This purchase was recorded as 60 reams on Form 2. The company was 
endeavoring to change to a weight basis in recording and selling paper, but to date 
had not overcome the resistance of printers and other customers who were accus- 
tomed to purchasing on a ream basis. 



MCKESSON & ROBBINS, INC. NO. 2 191 

MCKESSON & ROBBINS, INC. No. 2 

CONTROL OF INVENTORIES 

The chief executives of McKesson & Robbins, Inc., regarded 
inventory control as one of the important problems involved in the 
proper operation of their business. 1 Emphasis in this respect had 
been placed upon personal supervision, but the comptroller 
believed that the accounting department could prepare data which 
would be useful in judging the results achieved. 

The difficulties involved in inventory control were accentuated 
by the structure of the organization and the nature of the mer- 
chandise handled. Drug items carried by the branch wholesale 
houses were shipped from the McKesson & Robbins plant in 
Bridgeport, Conn., and from the plants of independent manu- 
facturers located in the East. It was the purpose of the company 
to serve through its wholesale branches as a source of supply for 
independent druggists, and to accomplish this it was necessary 
to stock between 40,000 and 50,000 items. 

The company's line of liquors included well-known brands of 
wines, champagnes, gins, and whiskies, which were produced in 
distilleries owned by the company or were purchased from inde- 
pendent sources in the United States and foreign countries. After 
the repeal of prohibition, the liquor business grew rapidly until the 
company came to be the largest distributor of wines and liquors 
in the United States. These products were handled through 
combination wholesale branches as well as those confined wholly 
to the sale of liquors. 

Both the background of the organization and the variation of 
the problems to be met in the territories served made decentraliza- 
tion of authority advisable. Consequently, responsibility for 
inventory control rested largely on the branch managers. Super- 
vision was exercised by the divisional vice-presidents who traveled 
over their respective territories and were able to gain firsthand 
knowledge of branch house operations. 2 Much information 
reached the chief executives through these channels, but the 
comptroller believed that there was a need for concrete data. 

1 The organization and growth of the company have been described in a previous 
case, McKesson & Robbins, Inc. No. i. 

2 See Exhibit 2 for organization chart of company. Divisional vice-presidents 
were also directors. 



192 CURRENT ASSETS AND CURRENT LIABILITIES 

To accomplish this purpose, the comptroller decided to have 
the monthly reports include figures on turnover and on the number 
of days 7 sales outstanding in inventories. Accordingly, he issued 
the following instructions to all branch house accountants : 

The inventory turnover to be shown at the bottom of the monthly 
balance sheet will be computed in the following manner: 
i. Compute average inventory as follows: 

Inventory on hand at end of 

December (previous year) $ 

January (current year) 

February (current year) 

Etc. 



Total 



Divide total as shown by the number of months listed and the 
amount obtained will represent the average inventory for the year to 
date. 

2. Into the cost of sales divide the average inventory as outlined 
above. This will give the inventory turnover from January i to date. 

In computing the number of days' sales outstanding 1 (in connection 
with the monthly financial statements) proceed as follows: 

1. Divide the cost of sales for the previous three calendar months 
by 90 in order to obtain the average daily cost of sales. 

2. Divide the average daily cost of sales as above into the inventory 
on hand as of the last day of the month. 

The above calculations were to be performed for liquor and 
drug inventories separately. 

In addition, branch houses were required to report on inven- 
tory and its relation to sales and purchases according to the follow- 
ing form : 

1 As \\ill be noted, this figure refers to inventory and should be distinguished 
from figures concerning receivables, often described under a similar title. 



McKESSON & ROBBINS, INC. NO. 2 



193 



Sales Inventories Purchases 




Sales less returns 


Inventories, current 
year 


Purchases 


This This year 
month to date 


This Per cent 
month to sales 


This year Per cent 
to date to sales 


Drug 
Liquor 














Total .... 




















Liquor inventory as at 
McKesson imported brands 
McKesson domestic brands preferr 
Other controlled brands 
National distillers 
Seagram Calvert 
Scotch 
Fleischmann gin 








p.H 






, 






Stamps 








Aging 








To 


hal 







The comptroller realized that an accurate comparison among 
branches could not be based upon the number of days' sales with- 
out making allowances for differences in operating conditions. 
Variations in the markets served and in the development and 
purposes of the branches were factors which could not be reduced 
to figures. The executives were acquainted with the circum- 
stances of each case and presumably would make the proper 
allowances. Nevertheless, the comptroller believed that some- 
thing could be done in the nature of establishing standards. The 
most influential factor in determining the size of inventories other 
than the volume of sales was the distance from sources of supply. 
Obviously, a house in San Francisco would be obliged to carry a 
heavier inventory than one in Boston, since the latter could replen- 
ish its stock on comparatively short notice. 

In cooperation with other divisions of the organization the 
comptroller developed par figures. These figures represented the 
standard number of days' sales which should be included in inven- 



i 9 4 CURRENT ASSETS AND CURRENT LIABILITIES 

tories after making the proper allowances for the differences in the 
time required to replenish stock. These standards were developed 
for both drug and liquor inventories and were presented with the 
actual figures as periodic reports to the executives. A portion of 
one of these reports covering the period from July 31 to Decem- 
ber 31, 1937, is reproduced in Exhibit i. 



1. What are the functions which inventory control should 
perform in this case? 

2. Is the use of par figures based upon the number of days' 
sales a satisfactory control device? 

3. Do you believe that the company could profitably improve 
and extend its inventory control procedures? 



MCKESSON & ROBBINS, INC. NO. 2 



195 



EXHIBIT i 

MCKESSON & ROBBINS, INC., AND SUBSIDIARIES 
INVENTORIES DAYS' SALES ON HAND MONTHLY FROM JULY 31 TO 

DECEMBER 31, 1937 





Par 
figures 


July 
31 


Aug. 
31 


Sept. 
30 


Oct. 
31 


Nov. 
30 


Dec. 
31 


Eastern Division: 
















Drugs, etc., Dept. 
















Albany 


47 


Si 


53 


52 


58 


60 


48 


Boston . 


47 


58 


59 


53 


Si 


58 


52 


Brooklyn 


47 


53 


54 


46* 


Si 


57 


52 


Buffalo ... . 


47 


73 


71 


56 


69 


79 


68 


Newark 


47 


54 


53 


57 


48 


63 


53 


New Haven 


47 


64 


71 


65 


66 


79 


67 


New York City . . . 


47 


144 


163 


52 


58 


61 


66 


Providence ... 


47 


89 


87 


83 


87 


98 


90 


Rochester 


47 


78 


72 


60 


68 


67 


56 


Springfield . . 


47 


82 


88 


80 


76 


77 


65 


Syracuse . . . 


47 


88 


71 


69 


72 


84 


8l 


Yonkers 


47 


55 


56 


61 


57 


60 


52 






69 


69 


59 


61 


68 


64 


Liquor Dept. 
















Albany 


48 


38* 


38* 


36* 


43* 


48 


48 


Boston 


50 


51 


58 


47* 


57 


70 


64 


Buffalo 


SO 


64 


71 


56 


48* 


53 


59 


Newark 


45 


70 


77 


72 


66 


56 


30* 


Atlantic City 


45 


28* 


30* 


36* 


45 


54 


30* 


Neptune City 


45 


34* 


24* 


22* 


22* 






New Haven 


46 


55 


65 


66 


79 


84 


64^ 


Hartford 


46 


69 


79 


57 


39* 


35* 




Providence 


45 


99 


IOO 


IOO 


82 


80 


67 


Rochester 


48 


59 


68 


58 


54 


57 


50 


Springfield 


48 


127 


IOO 


74 


105 


92 


78 


Syracuse 


48 


69 


66 


68 


54 


57 


47* 






59 


61 


55 


56 


58 


47 


Combined Drugs and Liquor 




63 


66 


57 


60 


65 


57 


South Atlantic Division: 
















Drugs, etc., Dept. 
















Augusta 


60 


151 


ISO 


136 


141 


146 


116 


Columbia 


60 


104 


117 


96 


106 


91 


66 


Jacksonville 
Macon. . 


60 
60 


105 
99 


103 
104 


99 
90 


108 
88 


92 
93 


11, 


Miami 


60 


125 


128 


124 


109 


81 


62 


Orlando 


60 


138 


135 


123 


113 


105 


86 


Roanoke . 


60 


97 


90 


79 


73 


74 


63 


Tampa 


60 


122 


no 


IOO 


90 


84 


65 






III 


in 


IOO 


IOO 


90 


79 


Liquor Dept. 
Columbia 


45 


53 


39* 


41* 


44* 


46 


56 


Jacksonville 


45 


99 


81 


60 


65 


73 


57 


Miami 


48 


109 


91 


95 


84 


8l 


44* 


Tampa. . 


48 


92 


70 


8! 


75 


61 


56 






84 


67 


63 


64 


67 


S3 


Combined Drugs and Liquor . 




101 


93 


85 


86 


80 


66 



* Indicates better than par figures. 



196 CURRENT ASSETS AND CURRENT LIABILITIES 





h- 




i/ 

2 
C 

u. 

Q. 
C 

_J 
_ 


) 






T5 
(L> 

4- 
4- 



c 
o 

00 
H 


s. .^ 


FEDERAL AND STATE INCOME TAXES 
ALL OTHER TAXES 


VICE-PRESID 
IN CHARGE 
CONNECTICUT DIV 


g 8 


h- 
tft - 


1 


REIGN DEPARTMENTS 


Ii 
o 
o 


Pi 


ALL FOREIGN SUBSIDl 










a: 

UJ 
LU ^j 

fe| 


LU z 

il 







VICE-PR 
INCH 
klOITINGAND 












uj x 
2 o 

CD 2 


_ n?i F 7 
SH I E 

< ^ LLJ 2 

n a < on ^ 
" M 5 


1 j iN3cm 




1 




:-PRESIDENT 
N CHARGE 
ERAL SALES 
PURCHASES 
SAND LIQUOR* 




* 
LU Si 




i<l 






^ 8 








Sulg 


u_ ^ O 


o 


UJZ 2 










ill 


o 


vD^i 




sil 


ESIDENT 
ARGE 
OR RELATION 
SIGN 


1 

HUNTER-BALTIM 
DISTILLERY 
ALL DISTILLIN 
RECTIFYING AT 
BLENDINGOPERAT 




* 
< 


iS 


H *^ ?; n- LU 
S<o- > 


LJ 

o: 
a 




i ZoO 

> ^ 




EF EXECUTIVES 
:H MANAGERS 


3 2 Q ^ 

^z f < | g 

CD LJ 






DIVISIONAL 
VICE-PRESIDENTS 




OFFICE OF SECRETARY 
OF 
CORPORATION 


o o ' ' ' 

CO tt 
(/> o 
LJ 

I J 


z 

aJ 
O 

~S> 
jj 

I 




ALL HOUSE CH 
ALL BRANC 




LU 



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to 

UJ 


INCHARC 
GENERAL DRU 
SUNDRY BUY 


fe s 

UJ UJ 


i 
i 

c 
i 


Jj 
J 

> 

/) 

i: 


QL 

CL 

LJ 

y 




Q-5 ^ 

> d 


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RESIDENT 


IN CHARGE 
GENERAL DRUG AND 
1 SUNDRY SALES 




jjl 




Q. 

UJ 
O 




EXECUTIVE VK 
INCH/* 
AUWHOLESAL 
BOTH DRUGS /> 




111 






fel 



HASTINGS AND EAU CLAIRE PRINT 197 

C. THE DETERMINATION OF COST 

HASTINGS AND EAU CLAIRE PRINT 

THE COST ACCOUNTING METHOD OF COMPUTING THE COST 

OF GOODS SOLD 

Previous cases involving the use of work sheets and the prep- 
aration of financial statements have required the use of inventory 
figures in computing the cost of goods manufactured and the cost 
of goods sold. This is an indirect method known technically as 
the inventory method of preparing financial statements. 

Under this method, it is necessary at the close of an accounting 
period to take a physical inventory of raw materials, work in 
process, and finished goods. This involves counting and listing 
the quantities on hand. Cases will be presented later illustrating 
this procedure and showing that in some instances physical quan- 
tities can be established only by estimation. The ascertainment 
of correct physical quantities is of paramount importance. The 
values of individual items which are summarized to obtain the 
inventory figures for the financial statements are found by the mul- 
tiplication of quantity by price. There is no point in making fine 
distinctions in matters of price if quantities are not established 
with a reasonable degree of accuracy. 

The list of raw materials is priced at cost by reference to the 
costs shown on purchase invoices and the quantities of work in 
process and finished goods are priced at cost by the use of whatever 
information a company has with respect to the manufacturing 
cost of its various products. In companies where a complete cost 
accounting system is not used, the manufacturing cost of a given 
product is established by estimation or through cost studies of 
trial runs. 

When inventories are to be shown in the financial statements 
on the basis of cost or market, whichever is the lower, it is neces- 
sary to establish the market value of each item on the inventory 
list. Establishing cost and market values for inventories is a 
difficult task involving a wide area of accounting custom, judg- 
ment, and opinion. 

Having established the value of the closing inventories, the 
cost of goods manufactured and the cost of goods sold can be 



i 9 8 CURRENT ASSETS AND CURRENT LIABILITIES 

found by deduction. The beginning inventory of raw materials, 
plus purchases, minus the ending inventory of raw materials gives 
the cost of raw materials used. The beginning inventory of work 
in process, plus raw materials used, plus manufacturing expenses 
(labor and factory overhead) minus the ending inventory of work 
in process gives the cost of goods manufactured. The beginning 
inventory of finished goods, plus the cost of goods manufactured, 
minus the ending inventory of finished goods gives the cost of 
goods sold. 

In summary, the inventory method requires the taking of a 
physical inventory, the pricing of quantities by the use of supple- 
mentary cost and market information not available in the books 
of account, and the computation of cost of goods manufactured 
and cost of goods sold by deduction. 

In most manufacturing companies it is not feasible to take 
monthly physical inventories, with the result that either the 
preparation of financial statements takes place only semiannually 
or annually, or records are kept so that inventory figures can be 
obtained without the necessity of taking a physical inventory. 
Such records are called perpetual inventory records and may cover 
all or only part of the inventory. At the close of an accounting 
period the quantity of any inventory not covered by the perpetual 
inventory records must be established by physical count or by 
estimation. In a complete perpetual inventory system it is 
customary to maintain a card for each type of raw materials, semi- 
finished goods, and finished goods. Among other things, an 
inventory card provides space for recording the input, output, and 
balance on hand for the item being covered. 

In many companies it is customary to carry perpetual inven- 
tory figures in quantities only, while in others both quantity and 
cost are recorded. When quantities only are carried, it is neces- 
sary to price the quantity of each item on hand at the close of the 
accounting period to obtain inventory figures for the financial 
statements. Having established the closing inventories, the cost 
of goods manufactured and cost of goods sold can be found by 
deduction. This procedure is still essentially the inventory 
method, the only difference being that inventory quantities are 
established by records rather than by taking a physical inventory. 

If perpetual inventory records are kept for both quantity and 
cost of goods, it is possible in many types of business to find the 



HASTINGS AND EAU CLAIRE PRINT 199 

cost of goods sold by direct methods. Thus in a wholesale business 
a summary of the output figures on the perpetual inventory cards 
for the month would provide the cost of goods sold. In some 
wholesale establishments perpetual inventory cards are maintained 
for quantities only, but the per unit cost is stated on each card. 
These unit costs are used in computing the cost of goods sold in 
each sale, or the cost of the total of each type of product sold 
during the month. The cost computations are then summarized 
to determine the total cost of goods sold for the month. The 
primary purpose of such detailed computations is for managerial 
control. For example, the cost computations when subtracted 
from sales figures could be used to determine, in so far as gross 
profit is concerned, the profitability of each type of product, each 
sale, each class of customer, each sales division, and each salesman. 
Under these conditions the computation of the total cost of goods 
sold for use in the income statement is incidental. Unless the 
figures can be used for other purposes, there is no point in comput- 
ing the cost of goods sold by direct methods for use in the income 
statement. The figure can be found much more easily by 
deduction. 

In a manufacturing business the cost of goods sold includes 
not only the cost of raw materials in the goods sold, but also the 
labor and factory overhead expended in producing them. It is 
possible by means of perpetual inventory records of raw materials 
to compute directly the cost of raw materials entering production 
during the accounting period. The methods used are similar to 
those described above for determining the cost of goods sold in a 
wholesale business. However, accounting by direct methods for 
the cost of labor and factory overhead in the cost of goods sold is 
much more involved and requires the use of procedures that come 
under the heading of cost accounting. As a matter of fact, any 
method of finding the cost of goods sold directly, as distinct from 
the process of deduction used in the inventory method, is known 
as the cost accounting method. 

It is not desired to explain cost accounting procedure in full in 
this case, nor, indeed, in the first-year course in Accounting. Cer- 
tain of the essentials will be indicated, however, and it should be 
understood at the outset that cost accounting is primarily an 
instrument of control. An incidental part of cost accounting is 
the finding of the cost of goods sold by direct methods. 



200 CURRENT ASSETS AND CURRENT LIABILITIES 

There are two major systems of cost accounting. One, known 
as job costing, involves the costing of each job or production lot 
as it passes through the factory. A job cost sheet is used on 
which are recorded the cost of materials and labor expended on 
the job and a charge or charges for the estimated factory overhead 
that should be borne by the job. The cost of goods sold can be 
found directly by summarizing the job cost sheets on jobs com- 
pleted and shipped to customers during the accounting period. 
The cost of the finished goods inventory can be found by sum- 
marizing the job cost sheets on jobs completed but not shipped as 
of the close of the accounting period. The cost of work in process 
at the close of the accounting period can be found by summarizing 
the job cost sheets of jobs in process. 

The other major system of cost accounting is known as process 
costing. This system is used where the products are alike, at 
least with respect to the operations performed upon them. Under 
this system a cost sheet is used for each process on which is recorded 
the cost of materials, labor, and factory overhead expended in the 
process for a definite period of time, such as one month. The 
number of units handled is also recorded on the process cost sheet, 
and the unit cost is found by dividing the total cost of the process 
for the period by the number of units processed during the period. 
Due allowance must be made for goods only partially processed, 
but the procedure for this is too involved for discussion here. By 
means of the process cost sheets it is possible to find the cost of 
goods that have passed from one process to another and the cost of 
goods manufactured during the period. In turn, it is possible to 
find the cost of the goods which have entered the finished goods 
storeroom during the month and the cost of goods sold during the 
month. 

The allocation of costs under either job costing or process cost- 
ing involves judgment, particularly in the allocation of factory 
overhead. The description of the cost accounting procedure in 
the Hastings and Eau Claire Print, described below, shows how 
this company allocated its factory overhead to products on a 
machine-hour basis. Various bases of allocation are in use, the 
machine-hour rate being a common basis, as also are the labor-hour 
rate, and overhead charged as a percentage of the direct labor 
cost. Such rates must be used either because there is no other 
way of determining the actual cost, or because the actual cost is 



HASTINGS AND EAU CLAIRE PRINT 201 

not currently ascertainable. The use of various bases of cost 
allocation and overhead rates results in discrepancies between 
the total material, labor, and overhead costs of a period and the 
total material, labor, and overhead charged on the cost sheets. 
These discrepancies arise from changes in prices of material and 
labor rates without corresponding changes in charges to products, 
differences in yield, and variations in the efficiency and volume of 
operations. The analysis of these variations to determine and 
correct their causes is one of the major aspects of cost accounting 
control. In many companies these variances are closed to cost of 
goods sold, while in others they are shown as separate items in the 
income statement below the computation of gross profit. 

Hastings and Eau Claire Print operated under a simple but 
effective job cost system. The principal feature of this system 
was a cost sheet (Form i) prepared for each job put through the 
shop. Briefly, this cost sheet showed the following items: (i) in 
the supplies column, the cost of all paper and other materials 
issued for the job; (2) in the column headed labor, the cost of all 
hand composition and other direct labor done on the job; (3) in 
the same column, the cost of all work done on the job by the 
various machines. Items 2 and 3 were charged at hourly rates 
which had been carefully figured out to include hand labor plus all 
manufacturing expenses. 1 

These expenses were divided into two groups: Those in the first 
group were called space charges, which included all the expenses 
of providing room in which to work, such as depreciation, taxes, 
insurance, interest, and maintenance and upkeep of the building. 
Those in the second group were called machine charges and 
included the same items of expense for the machine itself, together 
with the labor of operating the machine. In the former group, the 
total amounts of the expenses named were found for the entire 
building, after which a proper share of the total expense was allo- 
cated to the machine. Thus if the total expenses of a shop 
amounted to $12,000 and the area was 2,400 sq. ft., the charge was 
$5 per square foot; if, then, a machine occupied 180 sq. ft., the 
space charge for it would be $900 for a year. If the machine 
charges allocated directly amounted to $1,500, the total annual 



1 The combining of labor and manufacturing expenses into one rate was peculiar 
to this company. Though some companies follow this procedure, the use of separate 
rates is more common. 



202 CURRENT ASSETS AND CURRENT LIABILITIES 

charge would be $2,400. If this machine was, on the average, 
operated for 2,000 hours per year, the hourly rate would be $1.20. 
This amount represented the cost of owning and operating the 
machine for one hour. All work which was done on the machine 
would therefore be charged at this rate for the number of hours 
which the machine was occupied. 

Form i shows the typical items commonly included in the cost 
sheet for a job. In the supplies column was an item Body Stock, 
$3.12; the explanation indicates that this was the charge for 650 
sheets of canary bond paper at 15 cts. per pound. The figures 
17 X 22 1 6 indicate that the paper was in sheets measuring 
17 by 22 in. and weighing 16 Ib. to the ream of 500 sheets. Ink 
was charged at 50 cts., and small operations like punching and 
wrapping at 75 and 40 cts., respectively. In the labor column, 
the first item was for Hand Composition, the work of setting type 
by hand; the rate charged for this was $2.55 per hour which 
included the labor of the man who actually did the work, plus a 
proportionate share of manufacturing expenses. On this job, 
there was no actual typesetting by hand, since the type was set 
by machine, as shown below. There were, however, a number of 
adjustments to be done by hand, which were charged at the hand- 
composition rate as follows: The time was stated in hours and 
tenths of an hour; thus for Office Corrections, the time was % o 
hour and the cost therefore was 75 cts. For Make Up, that is, 
preparing the frame of type to go in the press, 2 hours were charged 
amounting to $5.10. At the botton of this column was Machine 
Composition, that is, setting type on a linotype machine. The 
rate for this was $3.50 per hour, which included the direct labor 
charges, the expenses of the machine, and a proper share of all the 
manufacturing costs or factory overhead. For 5.4 hours the cost 
was $18.90. Office Corrections required %o hour, or $1.05. The 
actual printing was done on cylinder presses 7 and 8, the rate for 
which was $3 an hour. Make Ready, or preparing the press to 
run, took 1.3 hours, costing $3.90; actually running the machine 
took 2 hours, costing $6. When all these costs were added 
together, the total cost of job 20135 was found to be $41.22; the 
customer was quoted $56.75 for the job, which would therefore 
show a profit of $15.53. 

In order to find the cost of goods sold for a month, the cost 
sheets -for all jobs completed and billed during the month were 



HASTINGS AND EAU CLAIRE PRINT 203 

taken. The total cost of each was listed, and the total of all jobs 
was the cost of goods sold. 

All these charges were entered promptly on the cost sheets 
when the various time tickets and material requisitions came into 
the office from the shop; the cost sheets, therefore, represented a 
continuous and up-to-date record of the cost of all work in process 
in the shop. Whenever a job was completed and the work shipped 
to the customer, the cost sheet was totaled and provided the basis 
for debiting Cost of Goods Sold and crediting Work in Process. 
This was made on the work sheet only, at the end of every month, 
in preparation of the monthly statements, by using in the work 
sheet a manufacturing section entitled " Operations for year." 
Closing entries were not made monthly in the ledger accounts, 
because it was desired to let them accumulate until the end of the 
year and thus show the yearly totals. 

Similarly the amounts of paper and other materials used on 
jobs, as recorded in the cost sheets, were totaled every month to 
give the amounts which were shown on the work sheet as credits 
to the Paper and Other Materials account and debits to Work in 
Process. At the same time, the two Purchases accounts were also 
closed out to Paper and Other Materials in the work sheet. In 
the same way, all strictly manufacturing expense accounts were 
closed out monthly in the work sheet to the Work in Process 
account. But none of these transfers were made in the ledger until 
the end of the year, for the reason given above. 

As already stated, the summation of the cost sheets for jobs 
finished gave directly the cost of all goods sold. When this 
amount had been credited to Work in Process, the balance in that 
account should represent the inventory of work still in the shop. 
This balance, however, could be checked by adding up the costs 
so far recorded in the cost sheets for unfinished jobs still in the 
shop. In the preparation of both monthly and annual financial 
statements the cost as shown by the summary of the job cost sheets 
on unfinished jobs was taken as the inventory of Work in Process. 
At the close of the year the difference between the balance in the 
Work in Process account and the inventory revealed by the cost 
sheets was closed to Cost of Goods Sold. 



204 CURRENT ASSETS AND CURRENT LIABILITIES 











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HASTINGS AND EAU CLAIRE PRINT 205 

HASTINGS AND EAU CLAIRE PRINT 
TRIAL BALANCE, JUNE 30, 1932 

Cash $22, ooo 

Accounts Receivable 45 ,000 

Reserve for Bad Debts 

Paper 20, ooo 

Other Materials 5 , ooo 

Work in Process 15 ,000 

Land 5 , ooo 

Buildings 15,000 

Machinery and Equipment 65 , 500 

Reserve for Depreciation $ 21 ,000 

Accounts Payable 28,500 

Notes Payable 5, ooo 

Mortgage on Real Estate 10,000 

Capital Stock 100,000 

Surplus 33 ,000 

Loss and Gain 

Sales 215,500 

Sales Discounts and Allowances . . . . . . 4,250 

Cost of Goods Sold 

Purchases Paper . . . 70,000 

Purchases Other Materials . . 1 1 , 300 

Labor Pay Roll . . . . 70, ooo 

Depreciation 5 ,000 

Property Taxes . . . 3 , ooo 

Insurance 300 

Heat, Light, and Power ... 3 , 250 

Other Manufacturing Expenses 6, 500 

Salaries Officers' 13 , ooo 

Office Expense 7 , 400 

Sales Salaries 8 , ooo 

Selling Expense 12, 500 

Advertising 6 , ooo 

Loss from Bad Debts 



$413,000 $413,000 



206 CURRENT ASSETS AND CURRENT LIABILITIES 
LIST OF JOBS UNFINISHED, JUNE 30, 1932 



Job number 


Materials 
charged 


Labor and 
burden charged 


Total 


864 
867 
871 
873 
877 
870 


$ 860 
600 
700 
1,500 
700 
200 


$ 850 
870 
200 
800 
800 


$ 1,710 

i,47o 
900 
2,300 
1,500 
200 


880 

88 1 
882 
884 
885 
886 
887 
880 


725 
975 
535 
175 
375 
875 
i95 
6^0 


565 
675 
260 
1 60 
1 80 
375 
255 


1,290 
1,650 
795 
335 
555 
^250 

450 
6zo 


890 


117 


128 


245 


Totals 


So. 182 


$6,118 


$!<?. 3OO 











When the cost sheets were summarized for the year on June 30, 
1932, the following information was obtained: 

Paper transferred to process . . . . 



ap< 

thi 



$ 75,ooo 

Other materials transferred into process 13 ,000 

Total cost of all work completed and billed to customers 174, 550 

The summation of the jobs unfinished on June 30, 1932, was as 
shown above. 

In addition, it was desired to provide a reserve for bad 
debts amounting to 5 per cent of the total accounts receivable 
outstanding. 

Depreciation had already been recorded by regular monthly 
entries. 

i. Prepare a work sheet for June 30, 1932, using the cost 
accounting method as described above. For this purpose a work 
sheet, arranged as shown on page 207, is most convenient. 

Under Operations for year, which really shows only the manu- 
facturing operations for the year, show the debits and credits 
(a) to add the purchases of paper and other materials to the respec- 
tive inventories at the beginning of the year; (#) to transfer paper 
and other materials used, direct labor, and all the other manufac- 
turing expenses to Work in Process; (c) to credit Work in Process 
and charge Cost of Goods Sold with work billed to customers; 



HARMON COAL COMPANY 



207 



(d) to adjust Work in Process to agree with the total cost as shown 
in the List of Jobs Unfinished, June 30, 1932, and to make a con- 
comittant adjustment to Cost of Goods Sold; and (e) to charge 
Loss from Bad Debts and credit Reserve for Bad Debts. 

2. Prepare an income statement for the year ended June 30, 
1932, and a balance sheet as of that date. 





Trial 
balance 


Operations 
for year 


Loss and 
gain 


Balance 
sheet 





















HARMON COAL COMPANY 
INVENTORY RECORDS 

The Harmon Coal Company was located in a New England 
city where it owned a wharf, storage yards and bins, delivery 
trucks, and other equipment necessary to its business. It sold 
anthracite coal, bituminous coal, and coke to a wide variety of 
buyers both large and small. Any user of coal in the territory 
was a potential customer. 

This case is concerned for the most part with problems in 
establishing the inventory value of bituminous coal and the cost 
of such coal sold during the accounting period. 

Much of the difficulty lay in the fact that bituminous coal 
was stored in huge piles out in the open, different kinds and sizes 
being kept in separate piles, 1 from which deliveries were made each 
day and to which new purchases were added as received. Until 
a pile was worked down to a very low point, which happened only 
infrequently, it was impossible to take an accurate physical inven- 
tory. Some times the company operated for a period of over two 
years before a given pile was worked down to a point where it 
could be physically inventoried. At the end of the month when 
inventory figures were necessary for balance sheet purposes, and 

1 Coal is named according to the area and seam from which it is obtained. The 
coal from each area has its own particular characteristics. The sizes of bituminous 
purchased by the Harmon Coal Company were run of mine nut and slack, and 
slack. 



208 CURRENT ASSETS AND CURRENT LIABILITIES 

the company was trying to determine the cost of coal sold during 
the month, the various piles might be 400 or 500 ft. long, 
might vary in width, and might have many peaks and valleys in 
contour. Coal near the bottom of a pile would be more solidly 
packed than that near the top. The extent to which the weight 
was affected by the accumulation of moisture was unknown. 
These factors combined made the physical inventory largely a 
matter of guesswork, although the estimate of an experienced and 
capable coalyard superintendent was more accurate than that of 
an inexperienced person. 

At one time the company had called in consulting engineers 
to survey the quantity of coal on hand as a means of establishing 
the physical inventory in preparing the annual financial state- 
ments. This was quite expensive and since the management did 
not have much more confidence in the results than when the figures 
were pure estimates, the method was abandoned. 

Under the conditions stated above, it was decided that book 
figures for inventories were more accurate than physical inventories 
for purposes of monthly and annual financial statements. At any 
time when a given pile was worked down to a low point, it 
was physically inventoried and the inventory records were 
adjusted to agree with the physical inventory. After some experi- 
ence under this procedure, it was found that such adjustments 
were not large in the case of bituminous coal because losses, 
which resulted from handling and from coal being blown away, 
were offset to a considerable extent by increased weight through 
absorption of moisture between the time of purchase and the time 
of sale. 

In addition to a general ledger control account for bituminous 
coal, the company kept inventory sheets, one for each kind and 
size of coal, which represented in effect a subsidiary ledger (Form 
i). The cost of coal recorded on this form in the first main column 
represented the cost at the loading point which, for bituminous 
coal, was either Newport News or Norfolk, Va. The weight 
recorded was the railroad weight, established by the railroad which 
brought the coal from the mine to the loading point, and this 
weight was accepted by both buyer and seller. Quantities less 
than a ton were expressed in decimals. The price per ton was the 
price f .o.b. loading point. In other words, it represented the mine 
price plus railroad freight to tidewater. 



HARMON COAL COMPANY 209 

The freight column in Form i represented the ocean freight 
and the insurance was marine insurance while the coal was aboard 
ship. The cost alongside was the total cost of the coal at the 
discharging point. (In this case the Harmon Coal Company's 
wharf.) The column entitled Discharging was for recording the 
cost of discharging the coal from the boat and was computed by 
applying a standard rate per ton to the tonnage discharged. The 
total cost of the coal, then, included cost at mine, plus railroad 
freight to tidewater, ocean freight, marine insurance, and cost of 
discharging. 

The inventory subsidiary ledger was started each year with 
new sheets and the first item recorded was the inventory as of 
January i. For this item only the following columns were used: 
Tons, Cost alongside (amount and per ton), Discharging (amount 
and per ton) and Total cost (amount and per ton). Each ship- 
ment received was entered on the sheet as soon as possible after 
the load had been discharged. All columns except that for dis- 
charging were filled out for each load received. After all receipts 
had been recorded for a month, the discharging cost was computed 
by applying the standard rate per ton to the total tons received. 
After this item had been recorded, totals were computed for all 
amount columns to show the total receipts for the month. Aver- 
age per ton costs were then figured on cost alongside and total 
cost. The beginning inventory was then added to the monthly 
totals to arrive at totals for beginning inventory plus purchases. 
Using these totals the average per ton costs were figured on cost 
alongside and total cost. 

During the month, daily sales sheets were prepared for statis- 
tical and control purposes, and at the end of the month these were 
summarized to obtain the total tons sold for the month by kind and 
size of coal. The tons sold were then entered on the inventory 
sheets and priced by applying the average per ton cost computed 
for the beginning inventory plus purchases. In this way the 
cost of coal sold was computed. The quantity and amounts for 
coal sold were then subtracted from the totals of the beginning 
inventory plus purchases to arrive at the closing inventory. 

The following figures apply to one item known as New River 
bituminous of a size entitled "nut and slack. " The inventory 
January i was as follows: 



2io CURRENT ASSETS AND CURRENT LIABILITIES 



Tons 


Cost alongside 


Discharging 


Total cost 


Amount 


Per ton 


Amount 


Per ton 


Amount 


Per ton 


1,790.00 


$8,745.22 


$4-8856 


$240.58 


$0.1344 


$8,985.80 


$5-02 



Receipts during the month were as follows: 



Date 


Tons 


Price 


Amount 


Freight 
rate per ton 


Insurance 


4 


1,696.50 


$4.20 


$7,125.30 


$1 00 


$47-03 


12 


1,562.00 


4.20 


6,560.40 


0.70 


7.22 


18 


448.00 


4.20 


I, 881.60 


I. 00 


12.42 


26 


653-00 


4.i3 8 4 


2,702.37 


I. 00 


17.84 



The standard rate for discharging was $0.1344 per ton. 
Sales during January amounted to 3,187.10 tons. 
These figures, together with cost computations, appear in the 
illustrative inventory sheet, Form i. 

1. What would have been the cost of January deliveries and 
the cost of the inventory of January 31 had the first-in first-out 
method been used instead of average cost? 

2. What account would be credited at the time the inventory 
was debited for the cost of discharging? 

3. Assume that at a later date the pile of this kind and size of 
coal has been worked down to a point where a physical inventory 
is practicable and the physical inventory shows a shortage of 
15 tons. Assuming the average cost per ton on the books to be 
$5.15, prepare the journal entry to make the proper adjustment. 

4. What other types of business might find it difficult to estab- 
blish accurate physical inventories? 

5. What factors would have to be taken into consideration in 
deciding upon the quantity of coal that should be on hand at any 
given time? 

6. The Harmon Coal Company was one of the subsidiaries of a 
company that owned other subsidiaries operating coal mines and 
boats carrying coal. In what respects might this intercompany 
relationship affect the inventory control problems of the Harmon 
Coal Company? 



HARMON COAL COMPANY 



211 







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212 CURRENT ASSETS AND CURRENT LIABILITIES 
CHURCHILL PUBLISHING COMPANY No. 2 

DEPRECIATION ON A PER UNIT OF PRODUCTION BASIS 

The largest asset of the Churchill Publishing Company was its 
investment in printing plates. This was slightly larger than 
the investment in inventories and was nearly twice as large as the 
investment in plant, including both buildings and equipment. 
The proper amortization of the investment in plates presented one 
of the most acute problems in operating the business. It was of 
importance both from the viewpoint of sound valuation for balance 
sheet purposes and in the determination of the operating profit 
or loss for a specific period. It was also an important factor in 
the measurement of the success or failure of a given book. That 
is, inadequate amortization of plate cost during the early years of a 
given book title resulted in an overstatement of the profitableness 
of the book during those years. This not only meant that the title 
would be carried along for several years under a false impression 
as to its profitability but also the apparent profitability encouraged 
the production of additional books of a similar type. 

The investment in plates was carried under the account title, 
Plate Cost, which was somewhat of a misnomer in that it included 
not only the cost of the plates but all of the cost in bringing out a 
new publication. For instance, it included such items as the cost 
of illustrations, the cost of permission to reprint copyright mate- 
rial, and experimental work. Plate Cost did not include any of 
the cost of the company's editorial department, however, since 
much of the work of this department was negative in character, 
involving rejections and corrections that would be difficult to 
apportion to any one book. The cost of this department was, 
therefore, charged off to operations each year and appeared as a 
separate item in the income statement after the computation of 
gross profit. In other words, it was not treated as part of the cost 
of goods sold and no part of it entered the valuation of inventories. 

For many years it had been the custom of the company to 
depreciate plate cost on a straight-line basis. Rates used were 
10 per cent for high school and elementary school books, and 20 per 
cent for college books. In 1934 government income tax agents 
questioned the justification of these rates. The company coop- 
erated with the agents in an investigation to determine what the 



CHURCHILL PUBLISHING COMPANY NO. 2 



213 



actual life of representative plates had been. It was discovered 
that the actual physical life was something over 30 years. Accord- 
ingly, the government agents insisted upon a depreciation rate of 
3% per cent. 

The company objected to this rate in part because there had 
been a tendency in the past to carry plates in storage longer than 
was warranted, but more because the economic life of the plates 
and not their physical life was the important factor. Plates were 
scrapped not because they could no longer be used physically, but 
because there was no longer any demand for the books printed by 
them. The company came to the conclusion that regardless of 
the size of the rate, the straight-line basis of depreciation was not 
a satisfactory basis for amortizing the cost of a plate over its 
economic life. 

After some study it was decided to amortize this cost on a per 
unit of production basis and after investigation by government tax 
authorities, this basis was allowed for tax purposes. 

The unit of production selected was 1,000 books. The method 
involved an estimate of the lifetime production in thousands of 
each book (the estimated number of books that would be published 
during the economic life of the plates). The cost of the plates for 
a given book, divided by its estimated lifetime production in 
thousands, gave the unit charge. The number of units produced 
during the year, multiplied by the unit charge, gave the amount 
of the plate cost of this particular book to be charged to the opera- 
tions for the year. For example, the computations of plate cost 
on one book were as follows: 



Year 


Cost and 
additions 


Lifetime 
production, 
in 
thousands 


Plate 
charge per 
thousand 


Annual 
production 
in 
thousands 


Annual 
charge 


Remain- 
ing cost 
at end of 
year 


1934 


$6,374.98 


40 


$159-37 


18 


$2,868.66 


$3,506.32 


1935 




22 




10 


i ,593. 70 


1,912.62 


1936 




12 




4 


637-48 


1,275.14 


1937 




8 




4 


637.48 


637-66 






4 






1 





In explanation of the above figures, the plates for this book 
were made in 1934 at a total cost of $6,374.98. The financial 



214 CURRENT ASSETS AND CURRENT LIABILITIES 

department of the company, with the aid of the editorial depart- 
ment, estimated at that time that during the economic life of the 
plates, 40,000 books would be published. The total cost of 
$6,374.98 divided by 40 gave a rate per 1,000 books of $159.37. 
There were 18,000 of these books produced in 1934. The plate 
charge rate of $159.37 multiplied by 18 gave the plate charge for 
this book for the year 1934. This amounted to $2,868.66, and, 
when this figure was subtracted from the cost of $6,374.98, there 
remained $3,506.32 to be amortized in future years in accordance 
with the production of those years. 

Since the company prepared financial statements only once a 
year, it was not necessary to break down the plate charge to cover 
shorter periods. 

The annual plate charges computed on the cards as shown 
above were summarized and the total was entered in the books of 
account as a debit to Plate Charges and a credit to Plates (the 
asset account). 



1. Should the unamortized investment in plates have been 
included as a part of the inventory in preparing the balance sheets? 

2. Should the expense, Plate Charges, have been included as a 
manufacturing expense, and thus as a component element in the 
cost of the inventory of goods in process and finished goods? 



GRANT RUBBER COMPANY 215 

GRANT RUBBER COMPANY 

THE MEANING OF COST OF WORK IN PROCESS AND FINISHED 

GOODS WHEN INVENTORIES ARE VALUED AT COST OR MARKET, 

WHICHEVER IS THE LOWER 

The purpose of this case is to raise certain questions pertaining 
to cost and to illustrate the various elements of cost and the diffi- 
culties involved in determining cost in the specific case of the 
Grant Rubber Company, manufacturer of some 3,000 types of 
rubber footwear such as rubber boots, rubbers, sneakers, and 
overshoes. A brief description of the production processes is 
presented to facilitate an understanding of the operations from 
which costs arise. 

Milling, Compounding, Mixing. Raw rubber was washed and 
dried and then run many times between two rolls (milling) to 
make it more plastic and in a better condition to take up the 
chemicals with which it was later to be compounded. The milling 
process also served as a means of blending rubber from the various 
lots purchased. 

Compounding consisted of weighing out the rubber and various 
chemicals called for in the formula for the particular rubber com- 
pound required. The quality of the finished product depended to 
a considerable extent upon the formulas used for the various parts 
that went into it. The chemicals made it possible for the shoe to 
be vulcanized in a later process, lengthened its life, and supplied 
the desired color and other qualities of appearance. 

In the mixing operation the rubber was placed in a mill or 
mixer consisting of two rolls side by side but running in opposite 
directions, one roll traveling faster than the other. The mill was 
heated by steam and hot or cold water could be run through the 
rolls, which were hollow, to keep the mill at a certain temperature. 
The combination of heat and friction kneaded the rubber and 
when it was in proper condition the chemicals were added and the 
whole mass was kept on the mill until a thorough mixing had taken 
place. 

Calendering. From the mills the mass of plastic compounded 
rubber was fed to the calenders where it passed through a series of 
three or more rolls and came out in flat sheets from which the 
different patterns and shapes were later cut. The rolls were 



216 CURRENT ASSETS AND CURRENT LIABILITIES 

adjustable so that sheets of different thickness might be produced. 
For certain products the calenders included impression rolls which 
marked out on the finished sheets the outline of the patterns or 
shapes to be cut. 

In this department also fabric for the upper parts of shoes, and 
insoles, was coated with rubber compound. Thin sheets of rubber 
compound were rolled onto the fabric under heat and pressure, by 
which the rubber compound was pressed firmly into the cloth. 

Cutting. The sheets of gum and rubberized fabric were then 
ready for cutting, an operation performed either by machine or by 
hand; in general, the machine method was tending to supplant 
hand cutting, which was done chiefly on a few special kinds of 
work where the volume of work was not enough to warrant the 
setting up of a machine. 

All gum scrap remaining after cutting was thrown back into 
the calendering process; so long as the rubber had not been vul- 
canized, it could be used again. All labor for cutting, both 
machine and hand cutting, was paid on piece rates. 

Making. After being cut, the various parts went through 
preparatory processes such as cementing and stitching and were 
then sent to the making department where they were allotted to 
the makers in accordance with a production schedule of manu- 
facturing orders. Lasts were also furnished to the workers who, 
working singly or in groups, pieced together the various parts on a 
last. 

The lasts containing the shoes were placed on a bar and after 
inspection the bars of lasts and shoes were placed on trucks for 
transportation to the curing room where the rubber was vulcanized. 

The labor in the making process was in most instances paid 
on piece rates. 

Curing, or Vulcanizing. In the curing of the shoes, dry heat 
and steam under pressure were used. Most of the company's 
products required curing in large ovens in which the trucks con- 
taining the bars were placed. Certain types of rubber boots 
needed to be cured both on the inside and on the outside; these 
were made on hollow lasts which could be connected to a steam 
line. This method of curing was faster than the slow process of 
curing in the ordinary ovens. 

Before the shoes were cured, they were varnished or dusted 
with talc, depending upon whether the finish desired was bright 



GRANT RUBBER COMPANY 217 

or dull. The dusting was done by hand; varnishing was done by 
placing the shoe bar on a revolving drum which dipped it into 
the varnish solution. After curing and before packing, each shoe 
was inspected thoroughly. 

Labor in the curing room was paid mostly on a day basis, 
though some of the operations, such as varnishing and dusting, 
were paid on piece rates. 

Packing. After the curing had been completed, the shoes 
were ready for packing. Each pair was wrapped in tissue and then 
packed in individual boxes, one pair to a box; the boxes were then 
packed into cases. From the packing room, the cases went to 
the finished goods warehouse, where they were stored until wanted 
for the filling of customers' orders. 

Packers were paid on piece rates. 

Cost Accounting. The company could have operated under a 
system of job order costs similar to the system described in the 
Hastings and Eau Claire Print case. This, however, would have 
involved a prodigious amount of record keeping and consequent 
expense. The company wished to keep the expense of gathering 
historical cost data to a minimum and was more interested in 
spending time and money on cost accounting for control purposes. 
For example, no record was kept of the actual cost of the fabric 
parts of a particular type cut for a given production order. Cut- 
ting records were kept, however, showing the quantity of material 
furnished to the cutter on this order, the quantity returned uncut, 
the quantity used, the number of parts cut, the number of parts 
that the quantity used should have yielded in accordance with 
predetermined standards, the standard percentage of waste, and 
the actual percentage of waste. Thus a considerable body of cost 
and statistical data was built up for control purposes. 

Cost Entries in the Books of Account. Perpetual inventory 
records were maintained for raw materials and finished goods by a 
material control department. At the close of each month this 
department supplied cost and quantity figures on materials which 
had entered production during the month. 

Pay-roll records were summarized by departments to provide 
figures for the cost of labor. 

The various items of factory overhead were allocated each 
month to both direct producing departments and to indirect 
(service) departments. The costs of the indirect departments 



2i8 CURRENT ASSETS AND CURRENT LIABILITIES 

were then reallocated to the direct producing departments. The 
bases of allocation for the various items of burden are presented 
later in the case. 

Records were kept of shoes completed and monthly summaries 
were prepared to show the total number of pairs of each type of 
shoe completed during the month. The cost of goods manufac- 
tured was then computed by applying predetermined unit costs 
to these quantities. The method of establishing these unit costs 
will be described below. Suffice it to say here that although they 
were standard costs they were changed frequently, in line with 
changes in actual costs of materials or labor and with changes in 
methods of production, and were looked upon by the management 
as the actual costs of the products concerned. 

This computation provided the debit to the finished goods 
account, but because the company wished for control purposes to 
localize variations between the cost of goods manufactured as 
established by the use of predetermined unit costs, and the actual 
material, labor, and overhead costs for the month, it was neces- 
sary to establish several credits. This was done by computing, 
by the use of a breakdown of the predetermined unit costs, the 
cost of material, the cost of labor by departments, and the cost 
of overhead by departments, in the goods produced. An entry 
could then be made as follows: 

Dr. Finished Goods 

Cr. Raw Material In Process 
Labor in Process Dept. A 
Dept. B 

Overhead in Process Dept. A 
Dept. B 
Etc. 

At this stage the Raw Material in Process account would show 
a debit for the raw material cost of the beginning inventory of 
work in process; a debit for the total raw material that had entered 
production during the month; and a credit for the raw material 
element of cost in the goods completed during the month. It was 
then necessary to establish the value of the raw material in the 
closing inventory of work in process. The production process was 
of short duration and at the close of work on any day there was 
only a small quantity of work in process. At the close of each 
month it was not difficult for the company to take a physical 
inventory of the work in process and to price it by the use of 



GRANT RUBBER COMPANY 



219 



predetermined unit costs in accordance with the stage of comple- 
tion. The value of the closing inventory was then credited to the 
Raw Material in Process account and a corresponding debit was 
entered below the account as the beginning inventory for the new 
period. Since the two credits to the account were based on pre- 
determined unit costs, there was likely to be a balance in the 
account representing raw material cost underabsorbed or over- 
absorbed by the charges to goods completed and to goods remain- 
ing in process. This balance was closed to the Cost of Sales 
account and was shown as a separate item of loss or gain in the 
cost of sales section of the income statement. 

Values for the cost of labor and overhead in the closing inven- 
tory of work in process in each department were also computed 
by the application of predetermined unit costs to the quantities 
established by a physical inventory. The balances in these 
accounts, representing labor and overhead costs underabsorbed or 
overabsorbed by charges to production were likewise closed to the 
Cost of Sales account and were shown as separate items in the cost 
of sales section in the income statement. Apart from the books 
of account, the manufacturing variances were subjected to analysis 
and were reported in detail to departmental foremen who had to 
explain the variances with the assistance of the cost accounting 
department. By this method the various causes and responsi- 
bility for over- or underabsorption were established. 

Establishing Unit Costs. The unit on which costs were estab- 
lished was 100 pairs of the average size. The average size was a 
weighted average determined by a study of sales records. The 
average sizes used were as follows: 





Canvas 
shoes 


Boots 


All other 
gum shoes 


Men's 


8 


o 


o 


Boys' 


*U 


c 


t 


Youths' 


13 J 


13 


17 


Women's 


c 


6 


6 


Misses' 


I3H 


is 


"H 


Children's . 




o 


ioU 











Specifications. The cost department received printed speci- 
fications from the factory covering the various parts and operations 
called for in making each type of shoe. All changes in specifica- 



220 CURRENT ASSETS AND CURRENT LIABILITIES 

tions were sent to the cost department and unit costs were refigured 
in line with the changes. 

Scheduled Material Prices. Price schedules were prepared for 
fabrics and rubber compounds called gum and were changed 
periodically in line with significant changes in the cost of materials 
purchased. The scheduled fabric prices represented for each kind 
of fabric the average invoice price per running yard, before cash 
discounts, plus freight and dye charges and a charge for purchasing 
and warehousing. 

Similarly scheduled gum prices were figured on a pound basis 
which included: (i) average dry invoice price of rubber, before 
cash discounts, plus freight charges and a charge for purchasing 
and warehousing; (2) compounds at average invoice price, before 
cash discounts, plus freight charges and a charge for purchasing 
and warehousing; (3) a charge for mixing labor and overhead. 

Cost Cards for Gum-coated Fabrics. A cost card was pre- 
pared for each type of gum-coated fabric. The scheduled prices 
for the type of fabric and gum required were entered on this card. 
Fabrics purchased by weight were first entered at the scheduled 
cost per pound which was then converted to the cost per running 
yard. Gum was first entered at the scheduled cost per pound 
which was then converted to the cost per running yard, taking into 
account the width of the completed coated fabric and the thick- 
ness of the gum coating required. A credit was then entered 
on the card to allow for the estimated quantity and scrap value 
of scrap to arrive at a net cost per running yard. This cost was 
then transposed to the cost per 100 sq. ft. Since the credit for 
scrap stated above assumed ideal cutting conditions, the cost per 
100 sq. ft. was increased to allow for normal cutting conditions. 

Computing the Fabric Parts Cost per Unit of 100 Pairs of 
Shoes. All patterns for fabric parts had a factor in square feet 
of material required per 100 pairs of shoes. The specifications for 
each shoe showed the types of coated fabric required and the 
patterns to be used in cutting them. For a given pattern the 
factor applied to the cost per 100 sq. ft. of the particular coated 
fabric required gave the cost of this fabric part per 100 pairs of the 
shoe being costed. 

A separate unit cost sheet was used for each type of shoe and 
the cost of each of the fabric parts called for per 100 pairs of shoes 
was entered thereon, as were the remaining costs described below. 



GRANT RUBBER COMPANY 221 

Gum Parts. The loo-pair unit cost of each gum part required 
(outsoles for example) was computed by applying the scheduled 
gum price per pound to the weight of the gum parts called for per 
100 pairs of shoes according to the specifications. 

Extra Material. Extra materials were findings and packing 
material. Examples of these items were as follows: 

Buckles Eyelets 

Rivets Laces 

Paper Thread 

Carton Bindings 

Can Tape 

Sealing Tape Buttons 

The cost of extra materials per loo-pair unit was the quantity 
of each item called for in the specifications, priced at the average 
invoice price before cash discounts, plus freight, plus a charge for 
purchasing and warehousing, plus a charge for estimated waste. 

Direct Labor. Mixing labor was included in gum material 
costs as stated above. All other direct labor costs were figured 
departmentally on a loo-pair basis using established time stand- 
ards furnished by the time study department and established 
piece rates or hourly rates of pay. 

Indirect Labor. All labor costs that could not be computed 
on a unit basis were classed as indirect labor and were figured 
departmentally on the unit cost sheet by applying a percentage 
to the direct labor cost computed as stated above. The percent- 
age used in figuring the unit cost in a given department was based 
on past experience with respect to the percentage relation between 
the total direct labor and total indirect labor of that department. 

Overhead. This element of cost was considered to be very 
important because unit costs could vary considerably depending 
upon the methods of overhead allocation used. At the Grant 
plant it had been found practical and necessary to apply overhead 
by departments. Results obtained had proved that in this way a 
more correct unit cost could be obtained. 

In some of the departments it was found necessary to go even 
further and apply overhead by sections within a department. For 
example, the calender department was separated into four sections : 

1. Fabric calender. 

2. Outsole calender. 

3. Upper and plain sheet calender. 

4. Spreader. 



222 CURRENT ASSETS AND CURRENT LIABILITIES 

It had been found that, in applying overhead on a direct labor 
basis for the entire department, fabric calendering was charged 
unduly, resulting in a higher cost on waterproof footwear calling 
for many fabric parts and reducing calender costs on outsoles and 
plain sheets. 

Again, calender speeds varied with the gauges and number of 
operators called for in producing each type of stock and this caused 
considerable variation in unit costs for one shoe compared to 
another. In order to arrive at as true a unit cost as possible, 
machine-hour rates were established for calenders and mills. 

Basis of Overhead Allocation. For each six months' period a 
production estimate was made based on a sales forecast for the 
same period. This production estimate was broken down depart- 
mentally in dollars of direct labor. Overhead expenses fell in one 
of three classes: variable, semi-variable, and fixed. From past 
experience and analysis, estimates were made of expected overhead 
expenses by departments for the coming six months' period. 
Schedules were then set up departmentally showing the percentage 
relations of the dollars of overhead to the dollars of direct labor. 
These scheduled percentages were used in computing the unit 
overhead cost by departments. The schedules were checked very 
carefully against actual performance and were revamped from 
time to time. 

Each department had its own overhead account with a column 
for each type of overhead expense incurred by or chargeable to the 
department. Columnar headings of these accounts are shown 
below at the left, and the explanation or basis of allocation is 
shown at the right: 

Salaries Superintendents 

Stationery and Supplies Office supplies used directly by the depart- 
ment 

Travel Expense Travel expense chargeable directly to the 

department 

Experimental Expense Cost of labor on experiments 

Industrial Trucking and Eleva- All trucking labor, trucking overhead, includ- 
tors. ing maintenance of trucks, etc. Same on 

elevators. 

Auto Trucking Chargeable direct to department 

Wrappers Expense Chargeable direct to department. Used for 

interlaying in rolls of stock 

Engineering Service Engineering service required by the depart- 
ment, charged directly for service rendered 

Moulds Expense Repair and maintenance of moulds 

Dies and Patterns Repairs and maintenance on dies and pat- 
terns 



GRANT RUBBER COMPANY 223 

Moving Expense Charged directly, covers cost of rearranging 

departments 

Lubrication Lubricating the machines in a department, 

includes material, labor and overhead 

Rents and Royalties On machines and processes used in or by the 

department 

Tools and Supplies Wax paper, tools, knives, etc. Miscella- 
neous material not chargeable to Direct or 
Extra Material 

Last Expense . ... Repairs and cleaning of lasts 

Industrial Relations . . . Charged on an employee basis direct to 

department. 

Insurance . . Chargeable to department 

Taxes . . . Chargeable to department 

Power and Light . Chargeable to department 

Steam . ... Charged directly to department. Metered 

in some cases, prorated in others 

Water and Air Same as Steam 

Rent Equivalent . . Charged directly to departments on basis of 

floor space used. Includes building de- 
preciation and repairs, and all costs inci- 
dental to buildings, such as sanitation, 
insurance, taxes, cleanliness, police and 
fire protection, etc. 

Standards or Rate Setting . . Charged directly as service is required 

Depreciation of Machinery and Charged directly to the department on 
Equipment machines and equipment in the depart- 

ment 

Depreciation of Moulds Cost of moulds is set up in a special mould 

account and depreciated according to a 
set schedule. 

Depreciation of Lasts Cost of lasts is set up in a special last ac- 
count and depreciated according to a set 
schedule. 

Administration. This included all other items of overhead not 
mentioned above and not chargeable to sales expense. Items 
chargeable to labor and overhead were as follows: 

Cost Department 
Pattern Department 
Style Design 
Laboratory 
Technical Service 
Waste Department 
New Dies and Patterns 
New Engraved Rolls 
Factory Pay Roll Department 
Factory Accounting 
Telephone and Telegraph 
Engineering Process Service 
Special Machine Shop 
Special Experimental Work 

These were applied to direct producing departments on a per- 
centage of direct labor basis. 



224 CURRENT ASSETS AND CURRENT LIABILITIES 
Waste. There were two kinds of waste: 

1. Defective Waste 

a. Process Scrap. This was an allowance for fabric that had 
been processed but was defective as received from the manu- 
facturer, or fabric that was spoiled because of poor workman- 
ship. This loss was determined as a percentage of the cost of 
direct material. 

b. Condemned Stock. This represented gum stock losses from 
burnt or lumpy stock, loss caused by the use of a more expen- 
sive gum then specified, and loss incurred by the necessity for 
recalendering or remilling. This loss was determined as a 
percentage of the gum stock cost, exclusive of gums used for 
processing fabric parts. 

c. Lacking or Odd Shoes Handling. This was the added cost of 
completing cases that were not filled on the originally sched- 
uled packing date. This loss was determined as a percentage 
of the list price. 

2. Finished Goods Waste 

a. Loss on Seconds. This was the estimated loss of imperfectly 
finished articles. This loss was determined as a percentage of 
the list price. 

b. Loss on Returned Goods. This was the loss on goods defec- 
tive either in wear or appearance. These defects generally 
were not detectable in the regular factory inspection. This 
loss was determined as a percentage of list. 

Note. Natural waste was not considered as a defective loss and 
was therefore included in the direct material cost. 

Example of Establishing Cost of a Specific Product. The 
specific product to be costed is a common men's black rubber, 
known in the trade as a men's plain gum shoe over. 

The production of this shoe called for eight separate fabric 
parts, namely, lining, quarter, strip quarter, collar, toe tip, insole, 
heel filler, and friction filler. The shoe required five gum parts, 
namely, toe cap, binder, upper, collar, and outsole. Rubber 
cement was applied to the parts prior to assembly. Extra mate- 
rials were paper, carton, case, sealing tape, and glue. 

Fabric Cost. The computation of cost per yard and cost per 
100 sq. ft. for the coated fabric used in the lining was as follows: 



GRANT RUBBER COMPANY 



225 



Material 


Weight 
per run- 
ning yard, 
pounds 


Price 


Unit on 
which 
price is 
based 


Cost per 
running 
yard 


Net 


o. 64 


$0.6651 


Pound 


$O.4.2tJ7 


No. 1001 


o 64. 


O. 14.8* 


Pound 


O OO4.Q 












Total yard cost 


1.28 






$o. 5206 


Scrap credit 


o. 26 


O. O2OO 




o 0052 












Net yard cost 


1.02 






$0 5154 


Cost per loo sq. ft ... 




(Factor 0.0749) 




$3.86 



(The cloth used was a type of net, 55 in. wide. The gum was 
a mixture of rubber and compounds known as No. 1001.) 

The factor 0.0749 was the figure used to convert the cost per 
running yard 55 in. wide to a cost per 100 sq. ft. and included a 
3 per cent cutting allowance. 

On the unit cost sheet for the men's plain gum shoe over, the 
factor 0.92 was applied to the coated fabric cost per 100 sq. ft. of 
$3.86 to arrive at a cost of $3.56 for the linings required per 100 
pairs of shoes. The factor 0.92 represented the percentage of 
100 sq. ft. of material called for by the given pattern to produce 
linings for 100 pairs of shoes. 

The cost of the seven remaining fabric parts was computed in 
the same manner. Each part called for a different type of coated 
fabric, and each pattern for each part had a different factor. The 
parts and their costs were listed on the unit cost sheets, the total 
fabric parts cost per 100 pairs of shoes being $10.33. 

Gum Parts. The cost of each gum part was computed by 
applying the scheduled gum price of particular type required, to 
the weight of the parts necessary for 100 pairs of shoes. Thus 
the 200 outsoles required in our example weighed 40.5 lb., and 
the gum had a scheduled cost of $0.1342 per pound, giving 
$5.43 as the loo-pair-unit cost of outsoles. 

The total cost of gum parts was $9.55. This together with the 
fabric parts cost of $10.33 made the cost of direct materials $19.88. 

Labor and Overhead. Labor and overhead unit costs were 
computed in accordance with the procedures described earlier in 
the case. This involved a considerable amount of detail which 
need not be reproduced here. In summarizing these costs a 



226 CURRENT ASSETS AND CURRENT LIABILITIES 

separate summary was made of calendering and aproning 1 costs 
as follows: 



Calender 



Apron 



Total 



Direct labor $0.52 $0.22 $0.74 

Total overhead 3.10 1.25 4.35 

$3.62 $1.47 

The cost up to the cutting operation was as follows : 

Direct material $19 88 

Calender and apron 5 09 

$24 97 

Unit direct labor costs in remaining departments: 

Cutting $1.75 

Preparatory i . 20 

Making 5-85 

Vulcanizing i . 04 

Packing o 76 

$10.60 

Unit indirect labor costs in remaining departments: 

Cutting $o. 68 

Preparatory 0.14 

Making o 65 

Vulcanizing 0.26 

Packing 0.42 

$2.15 

Unit overhead costs in remaining departments : 

Cutting $ 2 81 

Preparatory o. 84 

Making 4 . 02 

Vulcanizing 2.42 

Packing o. 84 



1 "Aproning" was the title applied to certain handling and preparatory steps 
between calendering and cutting. 



GRANT RUBBER COMPANY 227 

Unit cost of extra materials: 

Paper .......................................................... $0.08 

Carton ........................................................ i .90 

Case ........................................................ o . 70 

Sealing tape .................................................... o . 03 

Glue ........................................................... 0.02 



Unit costs of waste : 

Defective waste .................................................. $0.41 

Condemned stock ................................................ 1.15 

Total defective waste ........................................... $i . 56 

Total finished goods waste ....................................... o. 75 

$2.31 

Summary of unit costs: 

Direct material, plus calender and apron ......................... $24.97 

Extra material ................................................. 2 . 73 

Waste ............................................... 2.31 

Direct labor ................................................... 10.60 

Overhead .................................................. 10 . 93 

Indirect labor ........................................... 2.15 

Total factory cost .................................... $53.69 

List price ...................................... $100.00 

Percentage of list ...................................... 53 . 7 



1. In what respects would the problems in determining the cost 
per unit of product have differed had the company been manu- 
facturing only one type of product? 

2. How do seasonal and cyclical variations in sales affect the 
actual cost of production per unit of product? What effect might 
these variations have upon the production and cost accounting 
policies of a company such as the Grant Rubber Company? 

3. Did the unit costs constitute a satisfactory basis for estab- 
lishing the cost of work in process and finished goods inventories 
at the close of an accounting period? Under what conditions 
might these unit costs represent both cost and market? 

4. What differences as between one production process and 
another caused differences in the nature of the costs involved and 
complicated or facilitated the computation of departmental costs 
per unit of product? 



228 CURRENT ASSETS AND CURRENT LIABILITIES 

5. The Grant Rubber Company had found it necessary to 
apply overhead by departments. Why? How else might over- 
head have been applied? 

6. The Grant Rubber Company developed departmental over- 
head rates based on the percentage relationship between the 
estimated overhead expense and the estimated direct labor for the 
coming six months' period. In some companies the percentages 
used are based on the average direct labor and overhead costs 
under average or normal conditions, rather than on the fore- 
casted expenses for the coming period. What differences would 
this make in the computation of unit cost? Comment upon the 
justification of one method as against the other with respect to 
(a) inventory valuation, (b) computation of net income, (c) control 
of operations. 

7. What are the differences between natural waste, defective 
waste and finished goods waste in the Grant Rubber Company? 
Should the unit product costs have included charges for each of 
these types of waste? 

8. How frequently should the unit product costs have been 
recomputed? 



NATIONAL LEAD COMPANY 229 

D. THE BASE STOCK METHOD AND INVENTORY RESERVES 

NATIONAL LEAD COMPANY 
THE NORMAL STOCK METHOD OF INVENTORY VALUATION 1 

The general policy of conservatism underlying the normal stock 
method used by this company was expressed in the following 
statement of the late William P. Thompson, who until his death 
in 1896 was president of the National Lead Trust, organized in 
1887, and president of the National Lead Company, which devel- 
oped out of the Trust: 

The policy of this company remains precisely as it has been since 
its inauguration, and is very simple. First, the unqualified protection 
of the property in all its departments and in its business, and second, 
to make fair and reasonable profits, and distribute same among its 
shareholders whenever deemed wise and prudent to do so. 2 

One of the principles of the normal stock method is that the 
normal quantity of stock, which must be on hand in one form or 
another in order to keep operating, shall be priced at an amount 
which is below future expectations of either cost or market. 
Although no mention was made of a normal stock until a later 
date, the annual reports of the company, beginning with the report 
for 1904, indicated unusual conservatism in pricing inventories. 
For example, we find in the report for 1904, " Inventories have 
been taken on a basis so conservative that adequate provision is 
made for fluctuations in the value of raw material." 

Naturally, when assets are understated, claims to the assets 
on the liabilities side of the balance sheet must also be understated; 
corresponding reserves are automatically created. Recognition 
of this was made in the annual report for 1905: 

While raw materials advanced 20% during the year, all inventories 
were taken on the basis of former values. Our practice in this respect 
has the effect of creating a reserve which safeguards against deprecia- 
tion and ensures future profits. 

During the year 1906 raw materials continued to advance and 
reached the highest point in the history of the company up to that 
time. Nevertheless inventories were again maintained at con- 



1 Also known as the base stock method of inventory valuation. 

2 Annual report, 1894. 



2 3 o CURRENT ASSETS AND CURRENT LIABILITIES 

servative figures with the result that though prices fell during 1907 
the president could state in his annual report at the close of that 
year: 

The shrinkage in the value of raw material makes no difference in 
the exhibit, as for a number of years the great stocks which it is neces- 
sary to carry have been inventoried at protective figures, and today 
they could not be replaced at such values. 

The first explanation given to the stockholders regarding the 
normal stock method appeared in the report for 1920 as follows: 

INVENTORY 

Our Normal Stock system of taking inventories has been followed 
in the preparation of this statement, with the exception noted below. 

Prior to the war, the National Lead Company divided its inventories 
into Normal Stocks and Excess Above Normal. The Normal Stocks 
were valued at the lowest price reached by metals in the year 1914. 
The Excess Above Normal were valued at cost. The Normal Stocks 
never change either in quantity or value placed thereon. The Excess 
Above Normal vary in quantity and value according to the facts. In 
case of an encroachment upon the Normal Stock at any branch creating 
a deficiency, a reserve is created in the Normal Stock Inventory suffi- 
cient to buy the amount of such deficiency at the replacement value of 
the metal at that time the first metal purchased being used to make 
good the deficiency in the Normal Stock. 

In fixing the amount of Normal Stocks, we determine the amount 
of metal (whether lead, tin, copper or antimony) in the following 
manner: 

1. The amount of metal normally in transit to our factories. 

2. The amount of raw metal necessary in the factories to prevent 
possible stoppage of manufacturing, due to transportation or other 
difficulties. 

3. The amount of metal in process of manufacture, which in case 
of White Lead extends over several months. 

4. The amount of manufactured products necessary to be carried 
in stock at factories and warehouses, in order to make prompt deliveries. 

The result is that about 80% of our total inventories is in Normal 
Stocks. Inasmuch as the purchases of raw material from month to 
month approximately equal our sales of metal in the form of manu- 
factured products from month to month we adopt the fiction that the 
metal sold in the form of manufactured products during any given 
month was made out of the metal bought during that month, and the 
Normal Stock is never touched, and our inventories, therefore, are 
valued at cost. 

For all practical purposes, the Normal Stock is like a piece of 
machinery which the company has to have always on hand in order to 



NATIONAL LEAD COMPANY 231 

operate. When the price for Pig Lead, for instance, went to i iff a 
pound, ihe National Lead Company could not make an actual profit 
thereon without selling its Normal Stocks but, in that event, it would 
either have to buy back such Normal Stocks at the then market, or 
go out of business. . . . 

This being true we do not deceive ourselves by marking up inven- 
tory values and taking book profits, upon which we could not realize, 
to be followed later by book losses of like amount. Bookkeeping is 
likely to affect policy. By taking book profits on ascending markets 
of raw material, a company is likely to be led into extravagance and 
wastefulness. On the other hand, book losses during a period of declin- 
ing market are likely to be discouraging and may become embarrassing. 
Our stockholders are also likely to be deceived by apparent high earn- 
ings followed by severe losses, if such book profits and losses are 
reported in our published statements. 

The advantage to the company of this safe and conservative method 
of taking inventories has been made manifest during the last few years. 
For instance, the market price of Pig Lead advanced from the low price 
of $3.40 per hundred pounds, at which our normal stock of lead is 
inventoried, to $11 (or higher) during the war years, and on December 
31, 1920, it had fallen to $4.75, inasmuch as we have never taken any 
book profits, we do not now have to take any book losses. It would 
have been just as reasonable to mark up the value of our plants and 
machinery to the replacement value thereof during the war years (with 
a consequent showing of book profits), and then write them down to 
present replacement values (with a consequent showing of book losses), 
as to make similar variations in our Normal Stock. 

Of course, as to our Excess Above Normal Stocks which have 
always been inventoried at actual cost until written down to the market 
on December 31, 1920 we have like all others who have inventoried 
at market or cost (whichever is lower), made profits and losses. But 
these, while serious, are relatively unimportant. 

The government has not allowed the use of the normal stock 
method in statements presented to it in connection with the 
income tax. 1 Explanation of this appeared in the annual report 
of the company for 1922. After dealing with another matter the 
president stated: 



1 In the Revenue Act of 1938 permission was granted to tanners and to processors 
and fabricators of nonferrous metals to use the last-in first-out basis of inventory 
valuation, a basis which, though not exactly similar, follows essentially the normal 
stock principle of income determination. Permission was limited to these industries 
at the request of the Treasury Department because of the impossibility of estimating 
the effect on revenue and the impossibility of drafting adequate safeguarding regula- 
tions if this new basis were allowed indiscriminately to a wide group of taxpayers. 
Permission was further restricted within these industries to inventories of raw 
material not yet included in goods in process or finished goods. 



232 CURRENT ASSETS AND CURRENT LIABILITIES 

It (the government) also refused to approve of our Normal Stock 
system of valuing inventories, in which we adopt the fiction that the 
merchandise we sell in any month is made out of the raw material we 
buy that month; and therefore the material (both raw and in process of 
manufacture) in stock when an inventory is taken consists of the same 
Normal Stock that the company has had in its possession since the 
year 1913, and that the price at which it was inventoried in that year 
represents the "cost" of such Normal Stock for the purpose of inven- 
tories since that date. The government, for the purpose of taxation, 
requires us to adopt the opposite fiction; i.e., that the merchandise sold 
in any month was made out of the oldest raw material that the company 
had in its possession. This ruling of the government will cause great 
fluctuation in apparent profits from year to year but, in the long run, 
will not affect the amount of taxes the company must pay. The 
reason given by the Bureau for the rejection of the Normal Stock system 
of valuing inventories for tax purposes is, that to allow it in the very 
few companies that have adopted it would result in any given year 
in unequal taxation. 

The following paragraph appeared in the report for 1924, with 
a schedule which is presented in the case as Exhibit i : 

For the purpose of the income tax, the reports made to the Depart- 
ment of Internal Revenue show inventories valued at cost or market, in 
accordance with the rules of that department. Hence, reports to the 
government include profits and losses due to changing inventory prices. 
How misleading this may be is illustrated by the table on page 235 
showing profits and losses on 96,000 tons of lead included in our normal 
stock, if valued at market price. 

Exhibits 2 and 3 are presented to give some indication of the 
difference in profits shown under the normal stock method as 
compared with profits when inventories are priced at the average 
market for the year (an approximation of the lower of cost or 
market). Exhibit 2 is an adjustment of the normal stock of lead 
to an average market for the years shown. It should be realized 
that the company also carries large quantities of tin and antimony 
at low prices. No adjustment has been made for these two metals 
in the exhibits, for the quantity carried in stock was not indicated 
except in the later reports beginning with 1930. If adjustment 
were made for these two metals in the exhibits, the differences 
would be even more marked. This is particularly true of tin for 
according to the company's report for 1923: 

. . . the National Lead Company is importing about 1,500 tons of 
pig tin a month, which it consumes in the manufacture of babbitt, 



NATIONAL LEAD COMPANY 233 

solder, type-metals, tin pipe, etc., making it the largest consumer of 
tin in the world unless it is exceeded by the United States Steel Corpo- 
ration in its manufacture of tin plate. 

Exhibit 2 also shows stated earnings adjusted to reflect profits 
with lead inventories priced at an average market, and Exhibit 3 
shows in chart form a comparison of earnings on the two bases. 
The first impression one gains in looking at Exhibit 3 is that the 
method operated according to expectations for the years 1915-1925 
but failed to fulfill its purpose for the period from 1925 through 
1930. This impression is erroneous. The company did not state 
the amount of non-operating profits in 1926 and 1929 but indicated 
that they were quite substantial. If these were removed, the 
peaks would not be so marked. In the report for 1926, for exam- 
ple, the following statement appeared regarding net earnings: 

Net Earnings: A large part of the Net Earnings reported in the 
foregoing statement may be classified as " Non-recurring/' They con- 
sist of the profits realized from the sale of the physical assets of the 
United States Cartridge Company that had been depreciated on our 
books; the net earnings of that company during the year prior to the 
sale; funds received in liquidation of that company; the profits on sale 
of other investments; the profits earned by reason of inventories being 
reduced at many points below normal; and the exceptionally high profits 
in the lead mining and smelting departments during the year by reason 
of the very high price of pig lead. 

The adjusted earnings for 1926 are affected by the lower prices 
prevailing at the close of the year. In fact, in its returns to the 
government for tax purposes, the company reported a loss of 
approximately $2,000,000 in the value of the inventory based on 
the lower of cost or market. 

In the report for 1929 it was stated that: 

The net earnings for the year 1929 were the largest in the history 
of the company. After deducting non-recurring profits derived from 
the sale of capital assets, they are still the largest in the history of the 
company. 

The increased volume of sales during that year was responsible 
in a large measure for the increased profits. 

In spite of the peak in stated profits for 1929, it is to be noted 
that the degree of change from 1928 to 1929, and from 1929 to 
1930, was much less for the stated profits than it was for the 
adjusted profits. 



234 CURRENT ASSETS AND CURRENT LIABILITIES 

The use of the normal stock method does not require that 
inventories shall be kept at fixed quantities. The exercise of 
judgment is still called for in reducing the quantity when prices 
are high and building it up when prices are low. It is a policy 
of the National Lead Company to exercise judgment in this respect, 
as can be seen in the following paragraph which appeared in the 
report for 1927: 

The company reduced its inventories during the period of high 
pig lead prices to the lowest point possible without impairing prompt 
deliveries; this reduction at times being (in lead) as much as 20,000 
tons. Between the period of high prices in 1926 and the relatively low 
price at the end of 1927, when such deficiencies were replaced, the 
company received a profit of approximately $800,000 by reason of the 
lower replacement cost of such deficiencies. This fact will be of 
interest to those of our stockholders and others who have inquired 
regarding the Normal Stock System of valuing inventories, and erro- 
neously believed that a normal stock system of valuing inventories 
necessitated fixed amounts of inventories, regardless of market prices. 
Of course, such profits are nonrecurring and, in case of bad judgment, 
losses could occur. 

If the market falls below the unit price established for the 
normal stock of an item of inventory, it is necessary to establish a 
new base price at or below market if the normal stock method is 
to be continued; otherwise the inventory would be priced above 
market, which would defeat the conservative purposes of the 
normal stock method. Thus on December 31, 1930, the market 
price of tin was 26.25 c ts per pound and the company stated in its 
report for that year: 

Inasmuch as the Normal Stock of tin has for many years been 
inventoried at 27^ cts. per pound, it has been deemed proper to reduce 
the inventory price, for the purpose of Normal Stock, to 25 cts. per 
pound; the loss resulting therefrom being a charge against net earnings 
for the year 1930. 

In 1931 the price used for tin in the normal stock system was 
further reduced to 21 cts. a pound, and in 1932 the price used for 
lead was reduced to 3 cts. a pound from 3.4 cts. which had been 
used since 1913. These prices continued to be used in the com- 
pany's report for 1933 and it was evident that the company 
expected to continue its use of the normal stock method of inven- 
tory valuation. 



NATIONAL LEAD COMPANY 



235 



EXHIBIT i 

NATIONAL LEAD COMPANY 
(ooo omitted) 



Date of 
Price Change 


Nor. Stock 
Invent'y 
Tons 


Com'n Lead 
Price per 
100 Ib. N. Y. 


Mkt. Value 
of Normal 
Stock Inv. 


Book Profit 
or Loss upon 
Basis of Mkt. 


No. of Days 
Since Last 
Price Ch'g 


12- 1-23 


96 


$ 7 oo 


$13,440 


$ 




12- 5-23 


96 


7 25 


13,920 


480 


4 


12-19-23 


96 


7 40 


14, 208 


288 


14 


12-29-23 


96 


7 50 


14,400 


192 


10 


i- 2-24 


96 


7 75 


14,880 


480 


4 


1-10-24 


96 


7 90 


15,168 


288 


8 


1-18-24 


96 


8 oo 


15,360 


192 


8 


2- 1-24 


96 


8 is 


15,648 


288 


14 


2- 7-24 


96 


8 25 


15,840 


192 


6 


2-14-24 


96 


8 40 


16,128 


288 


7 


2-15-24 


96 


8 50 


16,320 


192 


i 


2-21-24 


96 


8 70 


16,704 


384 


6 


2-27-24 


96 


8 90 


17,088 


384 


6 


2-28-24 


96 


9 oo 


17 ,280 


192 


i 




Total Book Profit from 12-1-23 to 2-28-24 


$3 , 840 


89 


4- 3-24 


96 


8 75 


16,800 


480* 


35 


4- 9-24 


96 


8 50 


16,320 


480* 


6 


4-11-24 


96 


8 25 


15,840 


480* 


2 


4-24-24 


96 


8 oo 


15,360 


480* 


13 


5- 5-24 


96 


7 75 


14,880 


480* 


II 


5- 7-24 


96 


7 50 


14,400 


480* 


2 


5-15-24 


96 


7 25 


13,920 


480* 


8 


5-22-24 


96 


7 oo 


13,440 


480* 


7 




Total Book 


voss from 2-28- 


24 to 5-22-24 


$3.840* 


84 


7-23-24 


96 


7 25 


13,920 


480 ~ 


62 


7-29-24 


96 


7 50 


14,400 


480 


6 


8-11-24 


96 


7 75 


14,880 


480 


13 


8-15-24 


96 


8 oo 


15,360 


480 




10-20-24 


96 


8 25 


15,840 


480 


66 


10-23-24 


96 


8 40 


16,128 


288 


3 


10-25-24 


96 


8 50 


16,320 


192 


2 


10-27-24 


96 


8 65 


16,608 


288 


2 


12- 8-24 


96 


8 75 


16,800 


192 


42 


I2-IO-24 


96 


8 90 


17,088 


288 


2 


12-11-24 


96 


9 oo 


17,280 


192 


I 


12-15-24 


96 


9 25 


17,760 


480 


4 


I2-I8-24 


96 


9 35 


17,952 


192 


3 


12-23-24 


96 


9 50 


18,240 


288 


5 


12-26-24 


96 


9 60 


18,432 


192 


3 


I- 2-25 


96 


9 75 


18,720 


288 


7 


I- 5-25 


96 


10 OO 


19, 200 


480 


3 


I- 8-25 


96 


10 25 


19,680 


480 


3 


1-12-25 


96 


10.50 


20, 160 


480 


4 




Total Book Profit from 5-22- 


24 to I-I2-25 


$6,720 


235 


1-21-25 


96 


10 00 


19, 20O 


960* 


9 


1-30-25 


96 


9 75 


18,720 


480* 


9 


2-13-25 


96 


9 50 


18,240 


480* 


14 


2-17-25 


96 


9 25 


17,760 


480* 


4 




Total Book Loss from 1-12-25 to 2-17-25 


$2,400* 


36 







* Loss. 

Source: Company report. 



236 CURRENT ASSETS AND CURRENT LIABILITIES 



EXHIBIT 2 

NATIONAL LEAD COMPANY 

APJUSTMENT or INVENTORIES AND PROFITS FROM NORMAL TO COST 

OR MARKET BASIS 
(ooo omitted) 







Wholesale 


Basic 














Basic 


price of 


inven- 


Excess 


Total 


^Total 


Re- 


Net profits 


Vpar 


inven- 


lead 


tory at 


over 


inven- 


inven- 


ported 


inventory 


x Car 


tory 


per Ib. 


year's 


basic 


tory as 


tory 


net 


at average 




lead* 


yearly 


average 


value 


reported 


adjusted 


profits 


market 






averagef 


price 












1913 


$5 , 440 


$o 0437 


$ 7,000 


$ 1,500 


$ 730O 


$ 8,800 


$ 


$ , . 


1914 


5,440 


o 0386 


6,200 


700 


7,200 


7,900 


2,500 


1,700 


I9IS 


5,440 


o 0467 


7,500 


2,000 


6,300 


8,300 


2,700 


4,000 


I9l6 


5,440 


o 0686 


ii ,000 


5,500 


7,300 


12,800 


3,ooo 


6 , 500 


1917 


5,440 


o 0879 


14, 100 


8,600 


8,200 


16,800 


4,900 


8,000 


1918 


5,440 


o 0741 


11,900 


6,400 


15,000 


21 ,400 


4,700 


2 , 500 


1919 


5,440 


o 0576 


9, 2OO 


3,8oo 


16,000 


19,800 


4,600 


2,000 


1920 


5,440 


o 0796 


I2,70O 


7,300 


19,600 


26,900 


4,700 


8,300 


1921 


5,440 


o 0455 


7,300 


i, 800 


20,600 


22,400 


3,500 


2,000d 


1922 


5,440 


o 0573 


9, 20O 


3,700 


19,600 


23,300 


4,900 


6,800 


1923 


5,440 


o 0727 


II ,600 


6,200 


19,400 


25,600 


5,300 


7,800 


1924 


6,528 


o 0810 


15,000 


9,000 


18,500 


27,500 


4,500 


7,300 


1925 


6,528 


o 0902 


17,300 


10,800 


17,700 


28,500 


4,600 


6,400 


1926 


6,528 


o 0842 


16, 200 


9,700 


16,400 


26, IOO 


9,000 


7,900 


1927 


6,528 


o 0676 


13,000 


6,400 


17,300 


23,700 


4,900 


1 ,700 


1928 


6,528 


o 0631 


12, IOO 


5,6oo 


18,200 


23,800 


5,900 


5,000 


1929 


6,528 


o 0683 


13, loo 


6,600 


18,300 


24,900 


10,200 


ii , 200 


1930 


6,401 


o 0552 


10,400 


4,000 


17,400 


21 ,40O 


4,700 


2, IOO 


1931 


6,401 


o 0424 


8,000 


i ,600 


14, 100 


15,700 


4,000 


1 ,600 


1932 


2,981 


o 0318 


3 , 200 


200 


14,300 


14,500 


3,300 


1,900 


1933 


2,981 


o 0387 


3,900 


900 


16,200 


17, ioo 


3,800 


4,500 



* In short tons: 1913-1923, 80,000 at $0034 per pound; 1924-1929, 96,000 at $0.034 P er 
pound; 1930-1931, 94,133 at $o 034 per pound; 1932-1933, 49,68?^ at $0.03 per pound. 

t Desilverized, New York. 

d = deficit. 

Sources: Company reports; U. S. Department of Commerce, Survey of Current Business* 
1936. 



NATIONAL LEAD COMPANY 



237 




238 CURRENT ASSETS AND CURRENT LIABILITIES 

SWIFT & COMPANY 

RESERVE FOR INVENTORY PRICE DECLINE 

In 1933 the company adopted a policy of carrying a reserve 
against future declines in inventory. The policy is described in 
quotations from the annual reports, which in the case of this 
company are called year books, and from the prospectus of the 
First Mortgage Sinking Fund 3%% Bonds of 1950. 



INVENTORY PROFITS 

Some of our products made profits due to rising inventory prices. 
While the prices of our products were lower on an average than in 
previous years, some products advanced during the year, enabling us 
to earn a profit on part of the inventory. Properly speaking, such 
profits are capital gains rather than merchandising profits and should 
be preserved to take care of inventory losses. We have therefore set 
up a reserve of $4,267,000 on our Balance Sheet against possible future 
losses due to declining inventory prices. 

I think it would be well, in explaining this subject further, to point 
out, as I have on previous occasions, that Swift & Company always 
has to keep on hand, in process of cure, in storage, and at distributing 
centers, a sufficient quantity of meat, produce, and other items to take 
care of the requirements of our customers. As our products are sold 
seasonally, they must be replaced seasonally. We cannot sell our goods 
and then take our profits in cash and discontinue buying livestock. 
We have to put a part of all cash profits obtained through rising 
inventory prices back into new inventories, which may or may not be 
stable in value. 

Years of experience in the packing business have shown conclusively 
that profits due to rising inventory prices should be treated as capital 
gains and not as real earnings of the business. 

We believe our action in establishing a reserve against future 
declines in inventory values is constructive and conservative. 1 

PROFITS 

This year our total profit on shareholders 7 investment was 5.25 per 
cent, which is a slight improvement over last year. Owing to the rise 
in meat prices and the increase in inventory values, your directors have 
thought it wise to add $6,500,000 to our inventory reserve. 

I wish particularly to stress the point that profits on inventory, 
due to rising prices, disappear quickly when prices fall. Experience 



1 Year Book, 1934, which included a report on the fiscal period ending October 
28, 1933. 



SWIFT & COMPANY 239 

has shown that they can go as unexpectedly as they come. During 
the period they stand on our books, they provide no additional cash 
for the payment of dividends, for the maintenance of property, or for 
plant extensions. On the asset side of our balance sheet, they are in the 
inventory account in the form of higher-valued products. While it 
is true that inventories are constantly being sold and cash is realized, 
the cash so obtained must be reinvested in new inventories at the higher 
level of prices if our trade is to be taken care of. 

We are, of course, glad to have inventory profits; in fact, we must 
have them in a period of rising prices if our working capital is to be 
preserved. But inventory profits are really capital gains, part of 
which should remain in the business as insurance against losses resulting 
from falling prices. Had the financial and business community given 
proper recognition years ago to the real nature of inventory profits and 
the distinction between such profits and cash profits, all of us would 
be better off to-day. 

What we need and are seeking most of all is cash profits, profits that 
can be paid out in dividends or reinvested in the business as occasion 
requires. 1 

EARNINGS 

In accordance with the fundamental principle that a large portion 
of the profits on inventory due to a rise in prices should be retained in 
the business until they automatically disappear as the result of falling 
prices and inventory losses, your directors have transferred $6,000,000 
of the year's profits to the account known as " Reserve for Inventory 
Price Decline/ 72 

AUDITOR'S NOTES APPENDED TO STATEMENTS 

The quantities and condition of the inventories were ascertained 
by the employees of the companies and were certified to by responsible 
officials of the companies. The prices and computations were tested 
by us. The product items, where cost was not ascertainable, and which 
represent approximately three-fourths of the whole product inventory 
were valued at or based on approximate market prices allowing for 
estimated selling expense, and the other items of product and ingre- 
dients and supplies were valued at cost or market, whichever was 
lower. 

The inventory values based on market take up most, if not all, 
of the profit that may be realized on ultimate sale. They allow, in 
large part, for the cost of distribution and sale through the margin 
allowed below the quoted market price and by taking wholesale 
markets. The selling branches under average conditions are able to 



1 Fiftieth Anniversary Year Book, which included a report on the fiscal period 
ending October 27, 1934. 

2 Year Book, 1935, which included a report on the fiscal period ending October 26, 
1935. 



240 CURRENT ASSETS AND CURRENT LIABILITIES 

absorb their expenses without loss. This basis of inventory valuation 
followed is similar to that followed by the industry generally. It has 
been consistently followed for the beginning and end of each of the 
three fiscal years ending with October 27, 1934. 

This method of valuing inventory in a period of rising prices has 
produced an unrealized profit in the inventory of October 27, 1934 to the 
extent of the commodities included therein purchased at a lower market 
than prevailed at the inventory date. This method increases profits in 
a period of rising prices and decreases profits in a period of declining 
prices. 

In this connection, reference is made to the appropriations made 
out of profits by the Company for price decline of $4,267,000 in the 
fiscal year ending in 1933 and $6,500,000 in the fiscal year ending in 
1934. These reserves were not made as against inventory carrying 
values at the close of the fiscal year to bring these values to cost, thus 
eliminating unrealized profits contained therein. They were primarily 
made as an appropriation out of profits earned in a period of rising 
prices as a carry forward to offset future losses or reduced profits in a 
period of declining prices when and if such a condition should eventuate. 1 

Inventories were shown as follows in the balance sheet for 
October 30, 1937, and this was typical of the practice from 1933 
to 1937. 

Inventories Products where cost was not ascertainable were 
valued at approximate market prices, allowing for estimated 
selling expenses; other products and ingredients and supplies 
at the lower of cost or market 

Product .. . . $101,631,434 

Ingredients and supplies 7 , 664 , 461 

$109,295,895 

During the period from 1933 to 1937, the reserve was shown on 
the liability side of the balance sheet under the general heading of 
Reserves with the title, Reserve for Inventory Price Decline. In 
Exhibit i inventories and net income are given for 1919-1937 
and the reserve for the years in which it was carried. Figures 
from the Department of Labor, Bureau of Labor Statistics Index 
of Wholesale Meat Prices are given to indicate changes in the 
prices of products which constituted a large part of the inventory. 
Income statements are given in comparative form for the years 
1932-1935. There was no provision for the reserve in 1936 or 

IQ37- 



i. What are the significant differences between the inventory 
reserve policy of Swift & Company and the normal stock policy 

1 Prospectus, March 27, 1935; $43,000,000 First Mortgage Sinking Fund 
Bonds. 



SWIFT & COMPANY 



241 



of the National Lead Company in terms of the effect on the current 
position and the net income? 

2. On what facts should decisions as to the amount of the 
reserve and of debits and credits thereto be based? 

3. Would you advise a continuance of the reserve policy in its 
present form or in a modified form? 

SWIFT & COMPANY 
COMPARATIVE CONSOLIDATED INCOME ACCOUNTS 





Oct. 29, 
1932 


Oct. 28, 
1933 


Oct. 27, 
1934 


Oct. 26, 
1935 




$ 


$ 


$ 


$767,227,313 
732,308,689 


Cost of Goods Sold, including oper- 
ating costs, buying and selling 
expenses, advertising and general 
administrative . . 

Operating Income before Deprecia- 
tion and Interest. . 














$5,379,647 


$21,093,392 


$22,721,739 


$ 34,918,624 

3,414,538 
6,565,345 
2,585,214 
899,216 


Deduct: 
Taxes other than income and 
processing taxes. ... ... 


Depreciation . . 
Contributions to Pension Trust 
Provision for Doubtful Accounts 

Total Deductions 


7,539,770 


7,470,892 


7,078,751 










$7,539,770 


$ 7,470,892 


$ 7,078,751 


$ 13,464,313 


Operating Income before Interest 
and Other Income 
Add: Other Income 

Deduct* Interest Charges 


$2, l6o,I23<f 


$13,622,500 
1,533,135 


$15,642,988 
1,637,924 


$ 21,454,311 
1,186,759 


$2,160, 1230? 
3, 177,666 


$15,155,635 
2,870,501 


$17,280,912 
2,620,430 


$ 22,641,070 
2,479,977 


Less: Provision for Income Taxes. 

Add Special Credits: 
Discount on Funded Debt Retired 
through Sinking Fund 


$5,337,789d 


$12,285,134 
1,987,756 


$14,660,482 
3,058,326 


$ 20, 161,093 
2,509,641 


$5,337,789^ 


$10,297,378 
21,659 


$11,602,156 
31,465 


$ 17,651,452 


Deduct: Special Debits: 
Loss on Sale of Securities 
Loss on Disposal of Fixed Proper- 
ties, Net 
Write-off Unamortized Balance 
of Discount and Expense on 
Funded Debt Retired This Year 
Write-off All^ Intangible Assets 
Contained in Acquisition of 
Properties and Businesses in 
Prior Years 






$5,337,789^ 


$10,319,037 
43,471 
125,984 


$11,633,621 
195,627 
5,502 


$ 17,651,452 






1,962,835 
921,315 








Total Special Deductions 








$ 


$ 169,455 


$ 201,129 


$ 2,884,150 


Net Income for Year 
Less: Appropriation for Inventory 
Price Decline 




$5,337,789</ 


$10, 149,582 
4,267,000 


$11,432,492 
6,500,000 


$ 14,767,302 
6 , ooo , ooo 


Balance to Surplus 




$5,337,789d 


$ 5,882,582 


$ 4,932,492 


$ 8,767,302 













d = deficit. 

Source: Company reports. 



242 CURRENT ASSETS AND CURRENT LIABILITIES 



EXHIBIT i 
SWIFT & COMPANY 



Date 


Inventories 


Reserve for 
inventory 
price decline 


Net profits 
before 
dividends 


Index of 
wholesale 
meat 
prices* 


Nov. i, 1919 


$101 .800.84.0 


$ 


$13,870, 181 


117. 6 


Oct. 30, 1920 


151,305,085 




S, 170. 382 


108 o 


Nov. 5, 1921 


Q3.77I J.64. 




7.8l2 . 2Q2d 


77 4. 


Nov. 4, 1922 


86. 4.24.. 820 




1 3 . O4.Q .217 


76.6 


Nov. 3, 1023 


00,6^3,067 




13, 184,610 


74. I 


Nov. i, 1924 


ICK. 124.. 2Z2 




14.. I2< .088 


80.6 


Oct. 31, IO2< 


106. 2?i . <6z 




1C .37Q .1^2 


IO4.. 2 


Nov. 6, 1926 


ii3. 6?s . 387 




IS .64S, 24.2 


OO.O 


Nov. 5, 1927 


ii ;, 230, *?i6 




12, 202,493 


IOO O 


Nov. 3, 1928 


124.. 236. IO6 




I4.8l3. 182 


108.7 


Nov. 2, 1929 


127. ^6l . 14.7 




13. 076. Si 1 ? 


IO2. ? 


Nov. i, 1930 


101 , 764,921 




12,401 , I 80 


01 .4 


Oct. 31. io3i 


7S.4.64.. 777 




8 23"? 3OI 


67 7 


Oct. 20. 10^2 


<6, 746, 680 




^.337. 78o d 


^3. 7 


Oct. 28, 1933 
Oct. 27, 1934 
Oct. 26, 1935 
Oct. 31, 1936 
Oct. 30, 1937 


72,981,625 
100,506,172 
97,983,420 
105,064,272 
109,295,895 


4,267,000 
10,767,000 
16,767,000 
16,767,000 
16,767,000 


5,882, 5 82t 

4,932,49 2 t 
8,767,302! 
12,103,751 
8,880,496 


48.2 
68.4 

94-3 
85-2 

98.3 



* U. S. Department of Labor, Bureau of Labor Statistics; average of monthly figures 1919 
1922; November figures, 1923-1937. 

t After appropriation for inventory price decline. 

d = deficit. 

Sources: Company reports; U. S. Department of Commerce, Survey of Current Business, 
Annual Supplements, 1932, 1936, March issues, 1937, 1938. 



INTERNATIONAL HARVESTER COMPANY NO. i 243 

INTERNATIONAL HARVESTER COMPANY NO. i 

INVENTORY AND GENERAL CONTINGENCY RESERVES 

Prior to 1931 there was no reference to an inventory reserve 
either in the financial statements or in the text of the annual 
reports. Thereafter there was a development, both in the policy 
with respect to the reserve and in the degree of disclosure, as 
indicated in excerpts from the annual reports. 

Reserves established in prior years for the protection of the business 
in adverse times were drawn upon to the extent of $11,000,000, thus 
limiting the call upon Surplus Account to $4,412,000, for the pay- 
ment of dividends declared in 1931. 



The physical inventories of raw materials and supplies, work in 
process of manufacture, and finished goods have been priced at cost or 
market, whichever was lower, and substantial reserves, accumulated 
from earnings in prior years, have been deducted from the values so 
determined. 1 

The deficit for the year made it necessary to transfer $10,000,000 
from general reserves to surplus. These reserves, on which we also 
drew heavily in 1931, were established from earnings of prior years 
as a blanket protection against market declines in inventories through- 
out the world, decline in dollar exchange value of current assets in 
foreign countries, and other unforeseen contingencies. Years of experi- 
ence have shown that a world-wide business such as ours is subject to 
many contingencies and losses not predictable as to time, place, nature 
or extent. This policy of providing general blanket reserves has 
seemed to the management the best protection against such con- 
tingencies, and we are fortunate in having them available at this time; 
they are necessary insurance, operating for the benefit of both stock- 
holders and customers and should be renewed when earnings again 
permit. The balance of these blanket reserves not yet used is 
$15,000,000. This has been applied in the balance sheet as a deduc- 
tion from inventories, such inventories having been valued at cost or 
market, whichever was lower. How much of these reserves may be 
required to meet further declines in prices and foreign exchange rates 
depends, of course, on the economic conditions prevailing during the 
next few years. 



The inventories of raw materials and supplies, work in process of 
manufacture, and finished products, have been priced at cost or market, 



1 Annual report, 1931. 



244 CURRENT ASSETS AND CURRENT LIABILITIES 

whichever was lower, and from such valuation there has been deducted 
the remainder (after transfers of $3,800,000 to the reserves for losses 
on receivables during the current year) of general blanket reserves 
provided from earnings of prior years for possible decline in market 
values and foreign exchange, the remaining amount so deducted 
being $15, 000,000. 1 

Following the policy pursued in the two preceding years, $10,000,000 
was transferred from general reserves to surplus. This course appeared 
to be warranted by the cessation of declines in raw material prices and 
in foreign exchange rates, and by the apparent upward trend in busi- 
ness. There now remains $5,000,000 in the general or blanket reserves, 
and this amount is applied in the balance sheet as a deduction from 
inventory values. 



The inventories of raw materials and supplies, goods in process of 
manufacture, and finished products have been priced at the lower of 
cost or market, and from such valuation there has been deducted the 
$5,000,000 remainder of general blanket reserves provided from earn- 
ings of prior years for possible declines in market values and foreign 
exchange. 2 

The Company's inventory reserve of $5,000,000 has been increased 
to $8,500,000, making the total reserve about 8% of the closing inven- 
tory, valued at cost or market. Material and labor costs have increased 
and low-cost goods in the inventory have been and are being replaced 
by similar higher-cost goods. This apparent profit in the constant 
minimum inventory which must be maintained to carry on business 
can never be realized and experience has shown that it is ultimately 
wiped out when the economic pendulum swings in the other direction. 
Sound accounting requires the building up of an adequate inventory 
reserve during periods of rising costs to offset the inevitable inventory 
shrinkage during periods of falling costs and prices. Recognition of 
this fact has been largely responsible for the Company's ability to 
weather the several economic crises in its history, and this policy will 
be continued. 3 

The Company has continued its practice of building up a general 
inventory reserve during years of advancing material prices and produc- 
tion costs to provide against corresponding inventory shrinkage to be 
expected and heretofore experienced during periods of falling costs 
and prices. The amount provided out of 1935 earnings for this purpose 
is $5,000,000, bringing the total inventory reserve to $i3,5oo,ooo. 4 

Owing to the necessarily slow turnover in our business, the Com- 
pany must constantly maintain a large investment in inventories of 



1 Annual report, 1932. 

2 Annual report, 1933. 

3 Annual report, 1934. 

4 Annual report, 1935. 



INTERNATIONAL HARVESTER COMPANY NO. i 245 



raw materials and finished products. Consequently, the effect of com- 
modity price fluctuations is more severe in our industry than in many 
other lines of business. We have followed the policy for many years of 
building up general inventory reserves during periods of price advances 
to meet losses which are inevitably experienced during periods of falling 
costs and prices. No provision for general inventory reserve was made 
from 1936 earnings, inasmuch as the reserve was increased as of 
October 31, 1936, by special adjustments resulting chiefly from the 
change in fiscal year as set out in the surplus account. The total 
general inventory reserve at October 31, 1936, amounted to 

$2 2, 500,000. X 

Inventories were reported on the balance sheets for the six- 
year period as shown below: 

December 31 





J 93i 


1932 


1933 


Raw Material, Work in Process, 
Finished Products, etc 


$ 78,658,932 


$ 76,347,673* 


$ 85,690,105* 






December 31 


October 31, 
1936 


1934 


1935 


Raw Material, Work in Process, 
Finished Products, etc., at 
lower of cost or market 


$100,768,358 
8,500,000 


$111,743,686 
i3,5oo 


$i39>3 2 9>70 
22,500,000 


Deduct* Inventory Reserve . . 




$ 92,268,358 


$ 98,243,686 


$116,829,070 









* At lower of cost or market, less reserves. 

The income and surplus statements for 1931 are reproduced in 
full. In 1932 and 1933 there was no reference to the reserve in 
the income statement, reserve released being shown in each year 
as an addition to surplus. In 1934 provision for the reserve in 
the amount of $3,500,000 was included as an expense on the income 
statement before net profit, which was $3,948,637. In 1935 a 
similar procedure was followed, but in 1936 there was no charge 
before net profit, an addition of $9,000,000 to the reserve being 
shown as a deduction from surplus. 



1 Annual report, 1936. 



246 CURRENT ASSETS AND CURRENT LIABILITIES 

INTERNATIONAL HARVESTER COMPANY 
INCOME ACCOUNT FOR 1931 

Gross Earnings before deducting Interest on Loans, 

Depreciation, etc $12,859,391 

Deduct: 

Interest on Loans $ 75 , 713 

Ore and Coal Depletion 113,017 

Plant Depreciation 5 , 639,987 

Special Maintenance 232 ,322 

Provision for Losses on Receivables 5,451,814 $11,512,853 

Profit for year 1931 $ 1,346,538 

Add: 

Reserves from prior years' earnings for decline in 
market values, etc., released to Income n ,000,000 

Balance carried to Surplus $12,346,538 

SURPLUS DECEMBER 31, 1931 

Balance at December 31, 1930 $59, 108, 107 

Add: 

Profit for year 1931 $ 1,346,538 

Reserves released, as shown above 1 1 ,000,000 1 2 , 346 , 538 

$71,454,645 
Deduct: 
Cash Dividends: 

Preferred Stock $ 5,735,947 

Common Stock 11,022,962 16,758,909 



Surplus at December 31, 1931 $54,695,736 



Source: Company report. 



1. Determine the amount of reserve deducted from inventory 
in 1931, by figuring back from the first year for which the balance 
in the reserve was given. Determine the amount of inventory in 
that year before the deduction of the reserve. 

2. What are the significant differences between the inventory 
reserve policy of the International Harvester Company and that 
of Swift & Company? If the International Harvester Company 
is to continue its inventory reserve, should it use a method more 
similar to that of Swift & Company? Should the inventory 
reserve be continued? 



XII. BUDGETARY CONTROL OF FUNDS 
GLENWAY COMPANY 

CASH BUDGETS 

Until 1933, the Glen way Company had prepared its cash 
budget on the customary basis of estimating total receipts and 
total disbursements for the period of the forecast. The executives 
took into consideration all factors of receipts and disbursements 
indicated in the expected profit and loss operations for the period 
of the budget, as well as those factors indicated by the expected 
changes in the balance sheet position of the business from the 
beginning to the end of the budgetary period. This general 
procedure gave rise to a form for the cash budget substantially as 
shown in Exhibit i. 

In connection with the form, a Daily Operation Sheet, illus- 
trated in Exhibit 2, was used to assist in checking the progress 
of the budgetary estimates during the course of the period of the 
forecast. 



247 



248 CURRENT ASSETS AND CURRENT LIABILITIES 



EXHIBIT i 

GLENWAY COMPANY 
Cash Budget Month of January 1936 



Banks 



XXX 
XXX 
XXX 

Total. . 



Expected Collections: 
Cash Balance at be- 
ginning of year 
(See report of Credit 
Department) . . . 



i-io 
10-20 
2o-end 



Total 

Total Cash 
Available . 

Cash Requirements: 
Pay Rolls 
Administrative Cash 
Raw Materials. . 

Supplies 

Fuel 

Capital Expendi- 
tures . 
Maintenance 
Cash Investments. . 
Notes Payable 



Total Estimated 
Disburse- 
ments 

Cash Balance 

Balance Required. . 

Loans 

Remarks: 



Amount 



Trans- 
fers 



Ad- 
justed 
Balance 



Annual Budget $_ 



Annual Budget 
Annual Budget 



Annual Budget $_ 
Annual Budget 
Annual Budget $_ 
Annual Budget $_ 



GLENWAY COMPANY 



249 



EXHIBIT 2 

GLENWAY COMPANY 

Daily Operation Sheet 



Cash in Banks 


Notes Payable to 
Banks 


Due This 
Week 


Due This 
Month 


* $ 


X... . $ 






V 


Y 






7 


7 






Total . $ 


Total $ 















Budget Month End $ Budget Month End $_ 



Vouchers Payable 



Collections (Cumulative 
for Month) 



Amount 



Due This Week 



Due This Month 



Today $_ 

Cumulative. . . $_ 

Budget for 

Month $_ 



Disbursements to Date for Month 



Sales Billings 



Pay Roll 

Raw Materials. . . . 
Supplies, Fuel. . . . 
Payments on Loans . 



Total 

Budget for Month. 



Budget for Month. 

Actual to Date 

Receivables Outstanding. 
Short-term Investments. . 

Maturing This Week 

Inventory Month End . . 



$ 



Late in 1933, however, it was decided to change the principle 
on which the main cash budget was constructed, in accordance 
with a so-called differential short-cut or balance sheet method for 
cash planning. This method took into consideration only net 
profit from the profit and loss budget, adding plus or minus varia- 
tions in the items of the balance sheet, as indicated by the balance 
sheet changes from the beginning to the end of the period for 
which the budget was prepared. The form chosen to reflect this 



CURRENT ASSETS AND CURRENT LIABILITIES 



change in policy as to the construction of the cash forecast was as 
follows: 

EXHIBIT 3 
GLENWAY COMPANY 

Forecast of Cash by Weeks for Four Months Ended 19 





ISt 

Week 


2d 1 5th 
Week Week 


1 6th 
Week 


4 Mos. Ended 
T 9 












Cash, U. S. Securities, and Other Market- 
able Securities at beginning of period . . . 
Less: U. S. Securities 




I 






Other Marketable Secunties 











Cash Position at beginning of period (in- 
cluding time deposits, etc.) 




8 






Receipts: 
Net Income 




| 






Increase in Reserve for Depreciation 
(Gross) 




| 






Increase in Reserve for U. S. Income 
Taxes 




j> 






Sale of U. S. Securities 




V 






Sale of Other Marketable Securities . . . 
Miscellaneous 















/( 






Total Receipts 











Disbursements : 
New Construction 




?> 






Payment of U S. Income Taxes 




V( 






Preferred Dividend 




y 






Common Dividend 




A 






Purchase of U. S. Securities . ... 




X 






Purchase of Other Marketable Securities 
Miscellaneous 















cc 






Total Disbursements 




\< 






Changes in Working Capital Accounts: 
Decrease in Notes Receivable 




c 






Decrease in Accounts Receivable. . . . 
Decrease in Inventories 




$ 






Increase in Accounts Payable 




l\ 






Increase in Accrued Liabilities 











Total Changes in Working Capital 




? 






Cash Position at end of period (including 
time deposits, etc.) 




$ 






Add: U. S. Securities. ... 




?) 






Other Marketable Securities 




(S 










C\ 






Total Cash, U. S. Securities, and Other 
Marketable Securities at end of penod 
Previous Forecast of Total Cash and Cash 
Investments. . . 




1 






Desirable Minimum Cash Balance 




?s 










V 







The form shown as Exhibit 3, which was prepared monthly, 
was used for projecting the cash operations, by weekly intervals, 
for four months in advance of the budgeting date. Each week, the 
cash account was brought up to date as indicated in Exhibit 4. 



GLENWAY COMPANY 



251 



EXHIBIT 4 
GLENWAY COMPANY 

Weekly Cumulative Consolidated Cash Account 



Figures from beginning of month through . 



(date) 



Current 
Estimate 



Previous 
Forecast 



Variance of 

Estimate from 

Forecast 



Cash at beginning of month 

Receipts : 

Net Income 

Increase in Reserves: 

Depreciation (gross) 

Sale of Cash Investments 

Miscellaneous 

Total Receipts 

Disbursements : 

New Construction 

Payment of U. S. Income Taxes 

Payment of Dividends 

Purchase of Cash Investments 

Miscellaneous 

Total Disbursements 

Balance 

Changes in Working Capital Accounts: 
Decrease in Notes Receivable 

Decrease in Accounts Receivable 

Decrease in Inventories 

Increase in Accounts Payable 

Increase in Accrued Liabilities 

Balancing Figure 

Total Working Capital Changes . . . 

Cash at Close of Week 

Total Cash and Cash Investments. . 



(Front) 



252 CURRENT ASSETS AND CURRENT LIABILITIES 

EXHIBIT 4. (Continued} 
GLENWAY COMPANY 

Net Working Capital Estimated 
As of (date) 



Current Assets: 

Cash 

U. S. Securities 

Other Marketable Securities .... 

Total Cash and Cash Investments . . 

Notes Receivable 

Accounts Receivable 

Inventories 

Balancing Figure . . 

Total Current Assets 

Current Liabilities: 

Accounts Payable 

Notes Payable 

Taxes, Pay Rolls and Sundry Accrued Items. 

U. S. Income Taxes. ... 

Accrued Dividends on Preferred Stock 

Total Current Liabilities 

Net Working Capital 

Forecast of Inventories at (date) 



(Reverse side) 

As will be seen, this form provided for comparing the current 
estimate with the previous forecasts taken from the regular four- 
monthly projection. In the use of the second procedure in the 
control of cash, the company set up what it called automatic local 
controls, such as maximum and minimum inventory limits, collec- 
tion time control, control as to time for paying invoices, and the 
like. The so-called automatic local controls were counted on to 
make purchases, production, payments on accounts payable, and 
collections vary as sales varied, to the end that the only variations 
affecting cash were such changes in the balance sheet position as 
were possible within the leeway established by such controls. 



Discuss the advantages, if any, which you may see in the 
change adopted for budgetary control of cash operations. 



XIII. AN INTRODUCTION TO SPECIAL JOURNALS 
KIRKWELL MANUFACTURING COMPANY No. i 

THE USE OF A SPECIAL JOURNAL IN RECORDING SALES 

The Kirkwell Manufacturing Company made abrasives of 
several specialized types which were sold from stock to wholesalers 
and large industrial users. Practically all sales were made on 
account to regular customers. The company carried 122 active 
accounts, although half the sales were made to 30 of these accounts. 
Ninety per cent of the purchases were made from five vendors. 

The bookkeeping system of the company was essentially simi- 
lar to thousands of other systems, but in some particulars it was 
different. It was developed by the executives in conference with 
the auditors who examined the books every three months and was 
devised to meet the needs of this particular business. 

FORM i 







KIRKWELL MANUFACTURING COMPANY 






Date Received 7/11/32 Our No. 1619 


Bill of Lading 
Number 
15312 




For T. H. Rogers 


Terms 2/10 n/3O Wisconsin Avenue, Milwaukee, Wis. 






How Shipped N. Y. C. Chi., M.. & St. P. R R. When AfterAug. i 






Sold by Swanson Their No. A 143 Date of Shipment 8/2/32 












Price Per Doz. 


Ext. 


Total 


10 


Doz. 


Kirkwell "Special" at 2.50 


25 oo 




10 


Doz. 


Kirkwell #3 at 2.00 


20 OO 


45 oo 






Approved by H. M. 
Billed by E. R. 










Packed by F. N. 










Examined by G. W. 










Shipped by J. B. 










Weight 250 







The company was small enough so that all the books were kept 
by a single bookkeeper who was directly under the supervision of 
the treasurer. The books of original entry consisted of a general 
journal and four special journals, one being provided for each of 
the following types of transactions : sales, purchases and expenses, 
cash receipts, and cash disbursements. Postings were made to a 
general ledger and an accounts receivable ledger. Each of the 
seven books was a separate loose-leaf volume which could be 

253 



254 CURRENT ASSETS AND CURRENT LIABILITIES 



expanded or contracted at will by putting in or taking out appro- 
priate forms, except that a locking device prevented the insertion 
or removal of sheets without the approval of the treasurer, who 
held the key. The bookkeeper recorded each day on an average, 
ii transactions in the sales book, 5 in the purchase and expense 
book, 12 items of cash receipts, and 7 of cash disbursements. 
Entries in the general journal averaged less than one a week. 

When an order was received, a shipping order (Form i) was 
made out in triplicate. In the upper part of this form were entered 
the name and address of the customer, his order number, the date 
received, the date shipment was to be made, the name of the sales- 
man taking the order, and the terms; and, in the lower part, a 
description of the items to be shipped, the amount of each item, the 
price, and the extension, that is, the amount times the price. The 
extended amounts were then added to give the total. Each ship- 
ping order had a serial number which appeared on all copies. One 
copy was retained in the accounting department as a record of 
orders to be shipped, another was sent to the shipping clerk, and a 
third, which was used only for statistical purposes, was filed in a 
geographical file, through the use of which information could be 
obtained as to the business done in any particular city simply by 
running a total of the shipping orders for that city. 

FORM 2 



KIRKWELL MANUFACTURING COMPANY 
August 2, 1932 No. 4844 

Sold to T. H. Rogers 

Bill of Lading 
No. 15312 



Wisconsin Avenue, Milwaukee, Wis. 



TERMS : 

i Per Cent, 10 Days; 
Net 30 Days: 
from Date of Invoice 

The count and condition of this invoice of goods have been verified. No 

Allowance for Shortage 



10 
IO 


Doz. 
Doz. 


Kirkwell "Special" at 2.50 
Kirk well #3 at 2.00 


25.00 

20.00 


45.00 





KIRKWELL MANUFACTURING COMPANY NO. i 255 



The detailed information regarding the shipment, that is, as to 
pkcking, route, etc., which was called for on Form i was entered 
only on the shipping room copy. The most important item to be 
entered was the number of the bill of lading, which was prepared in 
triplicate by the shipping clerk at the time of shipment. The 
bill of lading was signed by the carrier's agent, who retained one 
carbon copy. The original and the other carbon were attached to 
the shipping order and sent to the office. The bookkeeper then 
prepared an invoice (Form 2) in duplicate, the original being 
mailed to the customer. If requested, the original bill of lading 
was also mailed; otherwise both the original and the carbon were 
filed with the shipping order. The invoice was the only billing 
made to the customer unless payment was not received within 
60 days, at which time a complete statement of his account (Form 
3) was mailed. 

From the office copy of the invoice, the sale was entered in the 
sales book. The invoice was then filed alphabetically. 

FORM 3 



Peter Monks 



Olive St., St. Louis, Missouri 



August i, 1932 



In Account With 

KIRKWELL MANUFACTURING COMPANY 

Terms: 2 Per Cent. 10 Days; Net 30 Days from date of invoice 



April 
May 



30 
13 



2 Doz. Kirkwell #6 
4 Doz. Kirkwell #3 



10 

8 



oo 

00 



18 



OX) 



The sales book, which is illustrated as Form 4, was simply a 
summary of sales. Columns were provided for the date of the 
invoice, the name of the customer, the invoice number, the account 
number, and the total amount of the bill. Sales were entered 
daily so that the record was kept up to date. 

The items were currently posted to the debit of the customers' 
accounts in the accounts receivable ledger, and the account number 



256 CURRENT ASSETS AND CURRENT LIABILITIES 



was entered in the sales book to show that the item had been posted 
and also to show where the full account might be found. The 
accounts receivable ledger is illustrated in Form 5. 

At the end of the month, the total of the amount column was 
posted to the general ledger as a credit to Sales and a debit to 
Accounts Receivable. At the time of posting, the numbers of 
these accounts in the general ledger were entered in the appropriate 
column, preceded by the letter G to show that they referred to the 
general ledger. 



FORM 4 
SALES BOOK 



Page 98 



Date 
1932 


Customer 


Sales 
Invoice 

No, 


Account 
No. 


Amount 


Aug i 


Bidwell & Company 
McSweeney, Jones & Company 
Glasdale-Hope, Inc. 

S^r^'^S>* 1 /-**s***S~>*S^^*s^s^s~vr>*s~^^ 


4841 
4842 
4843 


123 

257 

2OI 

XNy-N-'NXXXX/X^ 


$ 132.00 
4.28 
134-25 

^^x^^xXNxxy^^vxxxv^ 


Aug. 31 


T. Rozzini & Son 

Accounts Receivable, Dr. 
Sales, Cr. 


5102 


306 

G 18 
G 32 


27,44 


$8,34I.8l 
8,34L8l 



FORM 5 

ACCOUNTS RECEIVABLE LEDGER 
Account No. 123 



Rating 
Business 



AA 

Hardware Wholesaler 



Name Bidwell & Company 

Address Pine Street, Philadelphia, Pennsylvania 



Date 
1932 


Items 


Invoice 
No. 




Debits 


Date 
1932 


Items 




Credits 


Aug. i 




4841 




132.00 













































! 



















On September i, 1932, four typical customers had debit bal- 
ances as follows: 



KIRKWELL MANUFACTURING COMPANY NO. i 257 






Account number 


Debit balance 


T H Rogers 


343 


$181.00 


\Vadsworth & Hening 


iii 


46.00 


Packard Machine Tool Company 


204 


246. 72 


Eliot Hardware Company 


icg 


16.41 









The sales account had been closed as of August 31 and had no 
balance. 

During the month, sales to these customers were as follows: 







Invoice 
number 


Amount 


September 3 


Packard Machine Tool Company 


^136 


$IO7. 32 


8 


Wads worth & Hening 


<a68 


21.72 


ii 


Eliot Hardware Company 


^184 


16. ii 


20 
26 


Packard Machine Tool Company. . . . 
T. H. Rogers 


5217 
5286 


9-94 
06. i ^ 











1. Open accounts for these customers in the accounts receivable 
ledger and for Sales and Accounts Receivable in the general ledger, 
and enter the indicated balances in these accounts. Set up a 
sales book according to the form used and enter the sales. Post 
to the accounts receivable ledger, take a total as of the end of the 
month and post to the general ledger. Ignore sales to other 
customers and collections on account. The latter will be con- 
sidered in a subsequent case. 

2. If the treasurer wished to know, as of the first of any month, 
the total amount of Accounts Receivable outstanding, where 
might the information be found? 

3. If he wished to know the amount of any particular account, 
where might the information be found? 

4. If a question arose as to the amount of a particular item 
shipped to a customer, how might the information be found? 

5. What is the relation between the balance of Accounts 
Receivable in the general ledger and the balances of the several 
accounts in the accounts receivable ledger? 

6. Can the books be kept in balance when there are two debits 
posted, one to the individual account and one to Accounts Receiv- 
able, and a single credit, that to Sales, for each transaction? 



258 CURRENT ASSETS AND CURRENT LIABILITIES 

7. How may a trial balance be taken when books are kept in 
this way? 

8. What are the advantages and the disadvantages of this 
method as compared with a simple two-column journal ? Are the 
relative advantages affected by the number of open accounts, or 
by the number of sales per day? 

9. Assume that the product was divided into six different lines 
and that it was desired to keep a record of the sales of each line. 
Set up a sales book adapted to this purpose. 

KIRKWELL MANUFACTURING COMPANY No. 2 

THE USE OF A SPECIAL JOURNAL IN RECORDING PURCHASES 

AND EXPENSES 

The customary procedure of the Kirkwell Manufacturing 
Company in purchasing raw material was to issue a purchase 
order, illustrated as Form i, after receiving quotations on the 

FORM i 



KIRKWELL MANUFACTURING COMPANY 

Oak Harbor, N. Y. 



August 2, 1932 _ 
PURCHASE ORDER NO. 1843 

TQ Atwood Container Corporation _ 

PLEASE FURNISH US THE FOLLOWING 
SHIP VIA P. M. & Q. R. R. WHEN Immediately 



10 gross special crates our specification #140 quoted July 26 at 19.80 per gross 198 .00 




^N^>^O'NS^^>^^^XXXXX^>^^XXN^\XN^X^XX^X7v^XXV^^ > ^ 

Our order number must appear on invoices 

and shipments 
Please acknowledge receipt of this order and KIRKWELL MANUFACTURING Co. 

state when you will ship By J. Sherwood 



material desired. A copy of this was filed in the office, but no 
entry was made in the books when a purchase order was issued. 
When an invoice was received from the vendor, it was held until 
the arrival of the goods and was then checked against them as to 
amount and condition of the shipment and was checked against the 
original quotation as to price and terms of discount. The exten- 
sions and additions were then checked, and the purchase was 
entered in the purchase book, illustrated as Form 2. Extensions 
were made to the raw material columns depending on the kind of 
material included on the invoice. After being entered, the invoices 



KIRKWELL MANUFACTURING COMPANY NO. 2 259 



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O 



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acturers Supply Compai 


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itulation of Sundries: 


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260 CURRENT ASSETS AND CURRENT LIABILITIES 



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KIRKWELL MANUFACTURING COMPANY NO. 2 261 

were filed in a tickler file under date of payment, which was usually 
the last day on which discounts were available. Invoices were 
entered at the gross amount, cash discounts, if any, being handled 
at the time of payment. 

Purchases of packing materials, labels and printing, and 
supplies were entered in a manner similar to that used for raw 
material. 

Although this was called a purchase book, expenses were 
entered and classified here when they were incurred. Bills were 
checked as to amounts and were entered and extended to the 
appropriate columns as illustrated in Form 2 in the case of the 
telephone bill, entry being made upon receipt of the bill. Bills 
were then filed in the tickler file under date of payment. 

When a purchase was made or an expense was incurred for 
which there was no appropriate column, it was entered in the 
total and extended to the sundries column. 

No posting of the individual items was made to a subsidiary 
ledger as in the case of accounts receivable. At the end of the 
month, each column was totaled; the first was posted to the credit 
of Accounts Payable in the general ledger, the others, except that 
for sundries, were posted to the debit of material or expense 
accounts in the general ledger as indicated by the headings of the 
columns. In each case, the account number was entered immedi- 
ately below the total posted. 

A recapitulation of the items in the sundries column was made 
below the totals in order to provide for the posting of these items. 
In each case the account to be charged was entered in the explana- 
tion column, the amount in the sundries column and the account 
number immediately to the left. 



i. Draw up a purchase journal in this form and enter the 
following transactions. It may be assumed that the invoices have 
been checked and are ready to enter. Titles in parentheses are 
those of accounts to be charged. Post to appropriate accounts in 
the general ledger. 

September 

i. Received invoice from Sells and Company, terms 2/10, n/3o, for 
cartons, $105. (Packing Materials.) 

i. James Rose presented a bill for $14.50 for hauling several ship- 
ments to the freight station. (Freight on Sales.) 



262 CURRENT ASSETS AND CURRENT LIABILITIES 

2. Received bill from Bowers Furniture Company for office chair 
$20. (Furniture and Fixtures.) 

2. Received invoice from May Manufacturing Company, $210. 
(Raw Material No. i $60; Raw Material No. 2 $150.) 

2. Received bill from City Power and Light Company for elec- 
tricity furnished in August, $74.60. (Light, Heat, and Power.) 

3. Received bill from Mid-way Garage for gasoline and oil, $95.60. 
In accordance with the company's request, the name of the person 
signing for each purchase was furnished. The bill showed purchases by 
salesmen amounting to $64.10, and by the company driver to $31.50. 
(Salesmen's Expenses Autos; Auto and Delivery Expense.) 

2. Should the company carry a subsidiary accounts payable 
ledger? 

3. Can you suggest desirable changes in the methods used? 

KIRKWELL MANUFACTURING COMPANY No. 3 

THE USE OF SPECIAL JOURNALS TO RECORD RECEIPTS AND 
DISBURSEMENTS OF CASH 

Most of the cash received by the Kirkwell Manufacturing 
Company was in payment of accounts receivable and usually such 
payments covered a particular invoice. This permitted the use of 
a simple cash receipts book, which is illustrated as Form i. Typ- 
ical entries were made as shown for Bigelow and Dawson. 

The Kirkwell Company offered terms of 2 per cent 10 days, net 
30, that is, 2 per cent would be deducted from the amount of the 
invoice if the customer paid within 10 days of the invoice date. 
This introduced a slight complexity, for Accounts Receivable in 
the general Tedger and the individual account in the accounts 
receivable ledger had to be credited for the full amount of the 
invoice, since the customer's debt to the company was fully extin- 
guished. On the other hand, Cash was debited only for the 
amount received. The difference was a debit to Discount on 
Sales, which was often referred to as a part of collection expense. 

A column was provided for the date of the invoice in order that 
this might be compared readily with the date of payment. The 
debits were then divided between the cash and discount columns 
and the credit was entered in the accounts receivable column. 

In the case of payments not of this type, as illustrated by the 
tax refund, the amount was entered under cash received and 
extended to the general column. 



KIRKWELL MANUFACTURING COMPANY NO. 3 263 



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264 CURRENT ASSETS AND CURRENT LIABILITIES 



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KIRKWELL MANUFACTURING COMPANY NO. 3 265 

All cash received, whether in the form of checks or currency, 
was deposited daily in the bank. After the payments were all 
entered, the bookkeeper prepared a deposit slip in duplicate. One 
copy was kept by the bank; the other was initialed by the teller and 
returned to the company where it was filed by date. The deposit 
slip and the records of the bank thus gave a valuable check on the 
cash receipts record which assisted the public accountants in their 
quarterly audit. 

Postings of the credits to customers' accounts in the subsidiary 
ledger were made currently, and it is important to observe that the 
proper amount to be posted was that in the accounts receivable 
column. The account number was entered as a check to show that 
the posting of that item was complete. Items appearing in the 
general column were posted currently to the general ledger. 

At the end of the month, the total of cash received was posted 
to the debit of Cash, the total of discounts was posted as a debit to 
Discount on Sales, and the total of the accounts receivable column 
was posted as a credit to Accounts Receivable. In each case, the 
account number was entered under the total when posting was 
completed. 

All disbursements of cash were made by check and each check 
had a printed serial number, which had to be accounted for even 
if the check was later voided. 

In a previous case, the filing of bills by date of payment was 
described. Each day the bookkeeper took from this file the bills 
to be paid that day, which had already been verified as to amounts, 
extensions, and additions, and prepared the checks to cover them. 
The checks were signed by the treasurer, who also initialed the 
accompanying bills. 

After the checks were signed, and before they were sent out, 
each one was entered in the cash disbursements book (Form 2). 
In the case of a bill on which a discount was taken, the gross 
amount of the bill was entered in the accounts payable column, the 
net amount, which was the amount of the check, in the cash 
column, and the difference in the discount column. 

Since no accounts payable ledger was kept, there was no cur- 
rent posting from this journal, except in the case of items entered 
in the general column. When these items were posted, the account 
number was entered in the column at the left of the general column. 
At the end of the month, the totals of the columns were posted to 



266 CURRENT ASSETS AND CURRENT LIABILITIES 



the credit of Cash and Discount on Purchases and to the debit of 
Accounts Payable, Pay Roll, and Salesmen's Traveling Expenses. 
It was not the custom of this company to enter pay rolls and sales- 
men's traveling expenses in the purchase and expense journal 
when they were incurred; therefore they were not entered here as 
a debit to Accounts Payable. 

In addition to the special journals described in this and the 
preceding cases, the company maintained a general journal illus- 
trated as Form 3 in which entries were made which did not fall into 
any of the classes for which provision was made in the special 
journals. Only occasional entries were made in the general 
journal. 

FORM 3 
GENERAL JOURNAL 



Date 


Account 


Folio 


Debit 


Credit 


Aug. i 


Reserve for Bad Debts 


62 


63.10 






Accounts Receivable 


H 




63.10 




James Roswell Company $ 63.10 


A.R. 426 








To charge off account deemed 










uncollectible 








Aug. 16 


Notes Receivable 


i5 


200.00 






Accounts Receivable 


H 




200.00 




Campbell Brothers $200.00 


A.R. 143 








Received go-day note of 










Campbell Brothers dated 










Aug. 15, 1932, rate 6% 








Aug. 31 


Depreciation 


57 


362.00 






Reserve for Depreciation 


26 




362.00 




Provision for August, 1932 









i. Open a cash book in the form described above, enter the 
following transactions, and post to the accounts receivable and 
general ledgers. Assume for purposes of posting that these were 
all of the transactions to be entered during September and take 
totals and post as of the end of the month. The debit balances 
of the customers' accounts which were affected by the transactions 
were on September i : 



KIRKWELL MANUFACTURING COMPANY NO. 3 267 





Account 
number 


Debit 
balance 


Eliot Hardware Company 


158 


$ 16.41 


Thompson and Best 


?8o 


123 <*? 


Wadsworth and Hening 


^n 


46.00 









September 

i. Issued check 7448 for $14.50 to James Rose in payment of charges 
for hauling (see entry Kirkwell Manufacturing Company No. 2). 

i. Paid invoice of Swift Manufacturing Company, $96, less i per 
cent (check 7449). 

1. Received payment from the Eliot Hardware Company on invoice 
dated August 24, $16.41, less 2 per cent. 

2. Drew check 7450 to meet factory pay roll for week, $265. 

2. Gave F. W. Hopson, salesman, check 7451 in payment of com- 
missions earned by him in August, $176.43. 

2. Received $12 cash from sale of scrap material. 

3. Received check for $24.71 from receiver for Thompson and Best, 
who owed the Kirkwell Manufacturing Company $123.55, in final 
settlement of the claim. 

3. Received check for $45.08 from Wadsworth and Hening in pay- 
ment of following invoices: 

August 24 . . $30. 20 

August 25 . . . .... 11.44 

August 30 4.36 

2. If the treasurer wished to obtain the balance of cash on 
hand as of the third of the month, how could this information be 
obtained? 

3. Devise a change in this form of cash book whereby a daily 
balance of cash will appear. 

4. Can you suggest any improvements in this method of 
accounting for cash? 



268 CURRENT ASSETS AND CURRENT LIABILITIES 



DAVIS AND WALL, INC. 

SPECIAL JOURNALS 

Davis and Wall, Inc., manufactured two types of industrial 
goods. For the purposes of this case, it is sufficient to designate 
these two product groups as A and 5, manufactured in Divisions 
A and 5, respectively. All of the products were sold as fabricated 
parts, supplies, or fixtures to industrial users. Occasionally, job 
orders were received for such items as castings, which were handled 
as special orders. 

The accounting was performed by the office manager with 
the assistance of two clerks. The books of original entry con- 
sisted of a general journal and four special journals, one for each 
of the following types of transactions: sales, purchases and 
expenses, cash receipts, and cash disbursements. A petty cash 
system was also used. 

SALES BOOK 

When goods were shipped to a customer, the accounting depart- 
ment prepared an invoice in duplicate. The original was sent to 
the customer and the duplicate was posted to the customer's 
account in the accounts receivable subsidiary ledger. The dupli- 

FORM i 



SALES SUMMARY 
Month of September 






Invoice 
No. 


Accts. 
Rec. 


Division 
A 


Division 
B 


Castings 


Misc. 


Shipping 


Office 


J. P. Smith 


1106 


241 


05 


240 


00 














I 


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cate was then filed permanently in an invoice book. This invoice 
book was called a sales book by the company because it represented 
the details of sales that had been made. At the convenience of 
the accounting department, the invoices were entered on a sum- 
mary sheet (Form i) for the purpose of classifying the sales accord- 
ing to types. At the end of each month, the totals of the columns 
in the summary sheets were posted to the accounts affected in the 



DAVIS AND WALL, INC. 269 

general ledger. The columns for shipping and office on Form i 
were for shipping expenses or postage paid by the company and 
included in the invoice. The totals of the columns were credited 
to the Shipping Expense and Office Expense accounts. 

ACCOUNTS PAYABLE REGISTER 

Upon the receipt of goods by the shipping clerk, the items and 
quantities were compared with those shown on the duplicate copy 
of the purchase order in his possession. Any discrepancies were 
noted and the duplicate was sent to the accounting department. 
When the invoice was received from the vendor, the quantities and 
extensions were checked and the total was then entered in the 
accounts payable register (Form 2). The page and line of the 
register on which the entry was made were indicated on the invoice, 
and the invoice was filed with other unpaid bills. No subsidiary 
accounts payable ledger was maintained. 

The accounts payable register provided space for entering 
the date of the transaction and the name of the vendor at the left 
of each page. The next column, headed accounts payable, was 
for the entire amount of the transaction and was the credit entry. 
The remaining columns were debit columns and served to dis- 
tribute or classify the total purchase according to type. All 
expenses, even though paid immediately, were entered in the 
accounts payable register. The purpose of this was twofold: first, 
to have uniformity in recording purchases and expenses and, 
second, to provide a distribution of purchases and expenses so 
that they might be summarized and posted in total at the end of 
each month. 

CASH BOOK AND PETTY CASH RECORD 

All receipts and disbursements of cash by Davis and Wall, 
Inc., were entered in a bound book called the cash book. The 
left-hand pages of this book were for receipts (Form 3), and the 
right-hand pages were for disbursements (Form 4). 

The majority of cash received came from customers; therefore, 
a column was provided for accounts receivable, the total of which 
was posted at the end of the month as a credit to Accounts Receiv- 
able in the general ledger. Individual postings to the customers' 
accounts were also made from the cash book. These postings 



270 CURRENT ASSETS AND CURRENT LIABILITIES 




























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DAVIS AND WALL, INC. 271 

were made daily since it was important to keep the customers' 
accounts up to date. 

Since customers were allowed a 2 per cent discount if they 
made payment within 10 days from the date of the invoice, a 
column was provided in the cash book to cover such discounts. 
This was necessary, for the customer was given full credit for 
payment and the debit to cash plus the debit to discounts brought 
the entry into balance. Occasionally, cash was received from 
sources other than customers, such as receipts from the sale of 
scrap, bank interest, and cash returned from advances to salesmen. 
The general ledger column was used for the credit of these items 
and they were posted individually at the end of the month. To 
indicate that posting had been made, the number of the page in 
the general ledger containing the account it was posted to was 
placed in the folio column beside the item posted. The bank 
column was used as a book record of bank deposits, though dupli- 
cate deposit slips were kept for future reference. It started with 
the balance of cash in the bank at the beginning of the period. 
Each deposit was shown in this column, as was bank interest, and 
at the end of the period it was totaled and the total of cash dis- 
bursements was subtracted from it in arriving at the balance of 
cash that should be in the bank at that time. This balance was 
reconciled with the bank statement by adding to it the amount of 
any checks outstanding. 

All disbursements were paid by check, with the exception of 
petty cash items which will be considered later. The office man- 
ager saw to it that all invoices on which a cash discount could 
be taken were paid within the time allowed. The checks were 
signed by either Mr. Davis or Mr. Wall. The check number for 
each disbursement was entered in the cash book as was the net 
amount of the check, the discount taken, if any, and the total debit 
either to accounts payable or to an account in the general ledger. 
The cash, discount, and accounts payable columns were posted in 
total at the end of the month to accounts bearing the same names 
in the general ledger. Inasmuch as no individual accounts were 
kept with creditors, no individual postings of accounts payable 
were made. When an invoice was paid, it was stamped as paid 
and the check number and page number of the cash book were 
placed upon it. After invoices were paid, they were filed under 
the creditors' names. Pay-roll sheets were treated as invoices 



272 CURRENT ASSETS AND CURRENT LIABILITIES 

FORM 3 



Month September Year 1932 Cash Book Receipts 


Date 


Name 


Cash 


Dis- 
counts 


Accounts 
Receiv- 
able 


Folio 


General 
Ledger 


Bank 


Sept. i 


James Sawyer 


100 


00 






IOO 


OO 











_ 


i 


Milton Hill 


i47 


oo 


3 


00 


150 


00 








2 


Kennie Manu- 
facturing 
Company 


196 


oo 


4 


oo 


2OO 


oo 










2 


Grossman Sal- 
vage Com- 
pany 


26 


oo 










32 


26 


00 








Bank Deposit 


















469 


00 











































































































and after payment were filed for later reference. Occasionally, 
payment was made for some item that did not pass through the 
accounts payable register, such as advances to salesmen and 
the purchase of major plant equipment. In these instances, the 
items were entered in the general ledger column and posted indi- 
vidually to the account affected in the general ledger. The folio 
column was used to indicate the number of the page in the general 
ledger to which such posting had been made. When a salesman 
returned from a trip, he turned into the accounting office an 
expense sheet and any money that he had left. The money was 
deposited in the bank, the offsetting credit being to the account 
for advances to salesmen. The total of the expense sheet was 
entered in the general journal as a debit to Salesmen's Expense and 
a credit to Advances to Salesmen. 



DAVIS AND WALL, INC. 

FORM 4 



273 



Month September Year 1932 Cash Book Disbursements 


Date 


Name 


Check 

No. 


Cash 


Dis- 
counts 


Payable 


Folio 


General 
Ledger 


i 


Murphy Manu- 
facturing Com- 
pany 


2156 


128 


00 






128 


00 








2 


Factory Supply 
Company 


2i57 


25 


oo 






25 


oo 








2 


White Brothers, 
Inc. 


2158 


61 


64 


i 


36 


63 


00 








3 


Harrison Machine 
Shop 


2iS9 


159 


00 










46 


i59 


oo 


































































































PETTY CASH 

Small local expenditures were accounted for by the petty cash 
fund, or imprest, system. A small amount of cash was kept by 
the office manager and paid out by him in return for vouchers 
signed by the persons making the expenditures. This fund was 
started originally by drawing a check and setting up a Petty Cash 
account for the amount drawn. At the end of each month, or 
more often if necessary, the office manager entered the vouchers 
on a petty cash disbursements sheet (Form 5) and entered the 
totals of this sheet in the accounts payable register just as though 
the sheet were an invoice from an outside company. A check 
was then drawn to reimburse the petty cash fund and this check 
was entered in the cash book. Form 5 was then filed for future 
reference. 



274 CURRENT ASSETS AND CURRENT LIABILITIES 

FORM 5 



Petty Cash Disbursements for the Month Ending September 


Date 


Explanation 


Total 


Office 


Shipping 


Factory 


Factory 
Super. 


Sept. i 


Car fare 




20 




20 














i 


Postage 


2 


00 


2 


00 














3 


Local Express 










i 


50 











3 


Oil for Shafts 
















80 
































































































On the following pages appear transactions which occurred 
during the first 10 days of September, 1932. 

1. Enter the transactions in the journals required. 

2. Assume September 10 is the end of the month. Make all 
necessary postings to general and subsidiary ledgers. 

September i Started with a cash balance of $8,470. 

Sales made to A. R. Parrish, including $5 shipping 

expense, $1,005; Division A, Invoice No. 1001. 
Sales made to Jordan Jones Company, $600; castings, 

Invoice No. 1002. 
Purchased from Hughes Lumber Company lumber for 

woodshop, $250. 
Received from customer, Parkman Manufacturing 

Company, $196; discount amounting to $4 had been 

taken. 

Received interest on bank deposit, $9.52. 
Paid M. Douglas Company $280 due them, less 2 per 

cent discount; check No. 2160. 
September 2 Paid Hughes Lumber Company $250 due them, less 

i per cent discount; check No. 2161. 
Received from J. Roisen $28 for scrap sold to him. 

(This item did not pass through the sales book.) 



DAVIS AND WALL, INC. 



275 



Received $200 from Budd Insurance Company in 
settlement of damages caused by a small fire in the 
woodshop. 

Deposited $424 in the bank. 

Factory pay roll for week ended September i. Direct 
labor $450. Indirect labor: Division A, $36; Divi- 
sion B, $36; Foundry, $36; Woodshop, $36; Factory 
Superintendence, $70; Shipping Expense, $25. 

Purchased materials from Canton Supply Company for 
Division ^4, $1,600. 

Sales made to Oakland Supply Company, $202.50, 
including office expense of $2.50; Division A, 
Invoice No. 1003. 

Sales made to Carl Peterson, $300; Division B, Invoice 

No. 1004. 

September 3 Paid Dow Materials Supply Company $1,100 due them, 
less 2 per cent discount; check No. 2162. 

Received from customer, Hope Manufacturing Com- 
pany, $500; no discount allowed. 

Received from customer, C. A. Bonney, $156.80; dis- 
count amounting to $3.20 had been taken. 

Sales made to Pinkham Company, $150; castings, 
Invoice No. 1005. 

Sales made to Horgan Supply Company, $450; Division 

B, Invoice No. 1006. 

September 5 Received bill from New England Telephone and 
Telegraph Company, $34. 

Received bill from Harrison Power and Light Company 
for electric light and power, $94. 

Paid factory pay roll, $689; check No. 2163. 

Received from J. L. Rollins, salesman, $23, representing 
residue of money advanced to him for travel. 

Sales made to P. J. Pestoni & Company, $505, includ- 
ing $5 shipping expense; castings, Invoice No. 1007. 

Sales made to Arthur Stockton Company, $753.50, 
including $3.50 office expense; Division A, Invoice 
No. 1008. 

September 6 Paid New England Telephone and Telegraph Company 
$34 due them; check No. 2164. 

Paid Harrison Power and Light Company $94 due 
them; check No. 2165. 

Purchased materials from General Metals, Inc., for 
foundry, $4,000. 

Received from Lloyd Brothers, Inc., $400; no discount. 

Received from customer, A. A. Hobson Company, 
$507.50 in settlement of note for $500 held by Davis 
and Wall, Inc. The $7.50 represented interest on 
the note. 



276 CURRENT ASSETS AND CURRENT LIABILITIES 



Deposited in bank $1,587.30. 

Sales made to Harrison Company, $100; castings, 
Invoice No. 1009. 

Sales made to C. A. Bonney, $210; Division A, Invoice 

No. 1010. 

September 7 Purchased materials from Canton Supply Company for 
Division B, $2,000. 

Received from customer, Carl Peterson, $294; dis- 
count amounting to $6 had been taken. 

Sales made to A. Collamore Company, $375; Division 
B, Invoice No. ion. 

Sales made to Henshaw Electric Company, $650; cast- 
ings, Invoice No. 1012. 

September 8 Received from Walton Supply Company $56 for pur- 
chases returned to them. 

Purchased new machine from Hood Machine Shop for 
use in Division B, $600. 

Purchased stationery from Cullman Print for office 
use, $40. 

Sales made to Appleton & Harvey, $1,251, including $i 
for office expense; Division B, Invoice No. 1013. 

Sales made to J. P. Smith & Company, $75; Division 

A, Invoice No. 1014. 

September 9 Received bill from Cullman Print for advertising 
folders, $60. 

Factory pay roll for week ended September 8. Direct 
Labor, $450. Indirect labor: Division A, $36; 
Division B y $36; Foundry, $36; Woodshop, $36; 
Factory Superintendence, $70; Shipping Expense, 
$25. 

Sales made to E. G. Paige, $50; castings, Invoice No. 

1015. 

September 10 Purchased materials from Dwyer & Company for 
Division A , $600. 

Purchased materials from Duxbury Brothers for Divi- 
sion B, $1,000. 

Purchased from Davis Oil Company oil for lubricating 
machinery and driving shafts, $10. 

Purchased fire insurance from Budd Insurance Com- 
pany, $1,000. 

Received from customer, Orde Manufacturing Com- 
pany, $500; no discount. 

Received from customer, Jordan Jones Company, 
$588; discount of $12 had been taken. 

Deposited ;n bank $1,418. 

Paid Canton Supply Company, $2,000 due them, less 
2 per cent cash discount; check No. 2166. 



MAYBERRY BAG COMPANY 277 

Paid Budd Insurance Company $1,000 aue them, no 

discount; check No. 2167. 
Paid Carpenter Construction Company for repairs to 

woodshop, $200; check No. 2168. 
Reimbursed Petty Cash Fund, $25; check No. 2169, 
for following expenditures: 
Office, $7 
Shipping, $10 
Factory, $2 

Factory Superintendence, $6 
Sales made to Walker & Edy, $480; Division A, 

Invoice No. 1016. 

Sales made to Haskins & Ball, $260; Division B, 
Invoice No. 1017. 

MAYBERRY BAG COMPANY 

VOUCHER SYSTEM 

The company manufactured paper and cloth bags, printed 
tags, and other specialties such as napkins and paper dishes, and 
small cartons of the types which were delivered flat and folded in 
the plant of the customer. About half of the sales were made from 
stock, the rest being on special order. Ninety per cent of the 
business was done on open account, and this included all large 
orders, but many small sales of stock items were made to regular 
customers and others for cash. 

Purchases were usually made on orders issued by the purchas- 
ing department, one copy being filed in the office as a record of 
orders outstanding. No entry was made in the books until the 
invoice was received from the vendor, when a voucher was made 
out as illustrated in Form i . As soon as the goods were received, 
the approvals indicated were obtained, except that for payment. 
The voucher was then entered in the voucher register (Form 
2). The amount of the invoice was entered in the vouchers pay- 
able column and also in one or more of the debit columns according 
to the distribution indicated on the voucher. 

The amount of the invoice for materials purchased for use in 
manufacture was entered in the materials column. Expense items 
were also recorded in the voucher register. When an expense was 
incurred, a voucher was prepared and recorded in a manner similar 
to that used for purchases, except that the extension was to an 
expense account. Whenever an account for which there was no 



278 CURRENT ASSETS AND CURRENT LIABILITIES 

FORM i 



MAYBERRY BAG COMPANY 

Voucher No. 693 


Invoice of Thomas Watkins & Co. 


Dated Aug. 28, 1932 


Philadelphia, Penn. Date Due Sept. 30, 1932 


Vendor's Invoice No. H 9146 Terms 2/30 e.o.m. 




Description Amount 


Goods as per invoice attached i , 1 28 . oo 


Date Received Aug. 26, 1932 


Purchase Order No. 1208 








Approved: 
Prices C. F. A. 


Charge 


Title of Account 


Amount 


Purchasing Dept. 
Extensions J. S. G. 


Materials 


1,128.00 


Chief Clerk 
Material Received P. M. F. 


Storekeeper 
Distribution T. C. H. 


Asst. Comptroller 
Payment 


Asst. Comptroller 


Datp PaiH 


Check No. 









debit column was to be charged, the title of the account and the 
amount were entered in the miscellaneous accounts section. 

Just before the expiration of the discount period, the voucher 
was presented to the proper officer for approval of payment. A 
check (Form 3) was then issued, ordinarily on the last date on 
which the discount was available, the date of payment and check 
number were entered in the voucher register, and the paid voucher 
was filed alphabetically. 

Checks drawn were entered in the check register (Form 4). 
Ordinarily checks were drawn only in payment of vouchers, but 
occasionally, as illustrated by the advance to J. S. Mayberry, 



MAYBERRY BAG COMPANY 



279 



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280 CURRENT ASSETS AND CURRENT LIABILITIES 



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282 CURRENT ASSETS AND CURRENT LIABILITIES 

checks were drawn without covering vouchers. In cases of this 
nature, the title of the account to be charged and the amount were 
entered in the general ledger debit section. 



i. Set up a voucher register and a check register, take totals of 
the columns in Forms 2 and 4, and bring these forward to the 
new sheets. Enter the following transactions and do all posting 
indicated, both in detail and in total at the end of the month. 

ADDITIONAL TRANSACTIONS DURING AUGUST, 1932 

30. Issued check to Pennsylvania Railroad Company in payment 
of voucher 692. 

30. Received invoice dated August 27 from Joseph Perry and 
Company for cardboard stock, $245.50, terms 2/10, n/3o. Voucher 
695 prepared and approved. 

31. Weekly summary sheet for factory pay roll prepared and 
voucher 696 issued. Voucher approved and check for $810.60 issued to 
the cashier. (Enter on the thirty-first.) 

31. Paid vouchers 684, 686, 688. 

31. Prepared vouchers covering commissions due salesmen for 
sales through August 25. Approved and checks mailed. (Charge 
Selling Expense.) 



Voucher number 


Salesman 


Amount of check 


697 
698 
699 


Harry Biller 
John A. Parsons 
Grover C. Carr 


$iS4.3o 
104. 28 
194-56 



31. Received invoice from Philip Hale and Company for type- 
writer purchased, $65, terms 2/10, n/3o. Voucher 700 approved. 

31. Received freight bill from Pittsburgh and Lake Erie Railroad 
for shipment to Stern Brothers, amount $22.10, due September 5, 
terms net. Voucher 701 prepared and approved. 

31. Received invoice dated August 30 from Ames Machine Com- 
pany for one stapling machine, $85, subject to 2 per cent discount if 
paid on or before last day of September, and a credit memorandum 
for $62. Inasmuch as the machine previously delivered (Voucher 685) 
had been found to be too small, the Ames Machine Company had deliv- 
ered a new machine and picked up the old one, on August 29. (Deter- 
mine how this transaction should be entered and assume approval of 
the necessary documents.) 

What is the purpose of the information to be filled in on each 
of the blanks provided in the voucher form? Is any of this infor- 



R. G. CLARKSON AND SONS 



283 



mation unnecessary? Should anything be added to the form? 

2. Is Vouchers Payable a controlling account? 

3. How can information be obtained as to the total amount 
owed to a particular vendor? 

4. Does this system provide a thorough internal check on the 
disbursement of cash? 

5. Should the practice of drawing checks not covered by 
vouchers be continued? 

6. Is this method preferable to that used by the Kirk well 
Manufacturing Company? 

R. G. CLARKSON AND SONS 

VOUCHER SYSTEM 

R. G. Clarkson and Sons began business on January 20, 1936. 
The sales book, cash receipts book, check register, and voucher 
register are reproduced herewith, with all transactions for the 
month of January entered therein. No postings from these books 
have yet been made, either in detail or in total. 



1. Set up ledger accounts for both general and subsidiary 
ledgers, and do all posting which would be necessary. 

2. Take off a trial balance of the general ledger accounts con- 
cerned. Reconcile accounts receivable and vouchers outstanding 
with the balances shown on the general ledger, 

R. G. CLARKSON AND SONS 

SALES BOOK 
FOR THE MONTH OF JANUARY, 1936 



Date 


Customers 


Invoice 
Number 


F 


Amount 


20 


Howard Archer 


2420 




i , 203 . oo 


20 


P. T. Badger 


2421 




1,659.75 


21 
22 


Longman and Scott 
Atkins Company 


2422 
2423 




2,440.25 


24 


Howard Archer 


2424 




225-15 


27 


R. O. Linton 


2425 




2,005.25 


29 


Atkins Company 


2426 




890.65 


30 


James Hanna 


2427 




645-32 


31 


Longman and Scott 


2428 




710.85 










11,125.44 





284 CURRENT ASSETS AND CURRENT LIABILITIES 



R. G. CLARKSON AND SONS 

CASH RECEIPTS BOOK 
FOR THE MONTH OF JANUARY, 1936 









Accounts 


General Ledger 


Sales 


Freight 


Cash 


Date 




F 






Dis- 


Allow- 


Re- 








able 


Account 


F 


Amount 


count 


ance 


ceived 


24 


Howard Archer 




i , 203 . oo 








24.06 


53-13 


1,125 81 


25 


L. A. Tooker 






Misc. 




















Income 




iSS.oo 






155 oo 


29 
30 


P. T. Badger 
Horn and Hardt 




1,659 75 


Misc. 






33-20 


40 65 


1,585 oo 










Income 




52.25 






52.25 


30 
31 
31 


Longman and Scott 
Atkins Company 
W. A. SutcliSe 




2,440.25 
1,345 22 


Rent 






48.81 
26.90 




2,391-44 
i ,318 32 










Income 




175 oo 






175 oo 








6,648 22 






382 25 


132 97 


93 78 


6,803 72 









R. G. CLARKSON AND SONS 

CHECK REGISTER 
FOR THE MONTH OF JANUARY, 1936 



Date 


Name 


Cash 
Paid 


Check 
Number 


Voucher 
Number 


Vouchers 
Payable 


Purchase 
Dis- 
count 


24 


H. R. Eaves 


45.09 


619 


4H3 


45-09 




25 


Pay Roll 


ioS-75 


620 


4114 


105 75 




29 


Atwell and True 


1,460.79 


621 


4111 


1,490.60 


29.81 


30 


Richmond Manufactur- 


3>538.39 


622 


4110 


3,610.60 


72.21 




ing Company 












3i 


E. R. Stiles 


16.95 


623 


4116 


16.95 








5,166.97 






5,268.99 


102.02 









R. G. CLARKSON AND SONS 



285 



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PARTIV 

ACCOUNTING FOR PERMANENT ASSETS, FUNDED 
DEBT, AND PROPRIETORSHIP 



XIV. PLANT AND DEPRECIATION 

A. THE MEANING OF COST 

NORTHERN ELECTRIC MANUFACTURING COMPANY No. i* 

PURCHASE OF LAND 

In the spring of 1937, the Northern Electric Manufacturing 
Company purchased a plot of land adjacent to one of its plants. 
The total area acquired was made up of two lots purchased from 
separate owners, the Larson Company and a private individual 
named J. O. Sartig. The Larson lot included 10,921 sq. ft. and 
the Sartig lot 11,322.9 sq. ft. 

On March 25, 1937, before making the purchase, the Northern 
company acquired options on the two lots. Each option cost 
$1,500.00 and each contained an agreement that the amount paid 
for the option was not to be considered as a part payment in the 
event that the company exercised the option and took the property. 

The Northern company paid $36,687.90 to the Larson Com- 
pany on April 23, which completed the settlement for that lot, and 
the title was transferred the same day. An old building, which 
could not be used by the Northern company, stood on the lot. 
Arrangements were made with the Arrow Wrecking Company to 
demolish and remove this structure. The wrecking company 
agreed to remove the building, clean up the site, and pay $150.00 
for the right to the materials taken therefrom. This amount was 
received on May 14. 

The Sartig property carried a first mortgage of $30,693.00 upon 
which both back interest and accrued interest were due. It was 
agreed that the Northern company would meet these interest 
payments in addition to the purchase price set by the owner. 

On April 28 accrued interest of $598.51 and back interest of 
$460.40 on the Sartig mortgage were paid. On May 24 the pur- 
chase price of $36,488.25 plus additional interest of $133.00 com- 
pleted payment for the Sartig lot, and title was transferred. At 
that time, J. O. Sartig paid the mortgage in full, so that the North- 

* Fictitious name. 

289 



2 9 o PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

ern company received a clear title. Legal fees involved in acquir- 
ing the two lots were $670.09, and were paid May 29. 

During June and July of the year of purchase, after the Arrow 
Wrecking Company had cleared off the old building, seven elm 
trees were planted at a cost of $245.73, an( l sidewalk and curbing 
were laid at an expense of $1,230.45. The bills were paid upon 
the completion of the work on July 22 and 28, respectively. 

The record on land maintained by the Northern company con- 
sisted of a loose-leaf binder. Data concerning land purchases 
were typed on unruled sheets which were added to the proper sec- 
tion in the binder. The information so preserved in the records 
covered the following points : 

a. Description of land, dimensions, and location. 

b. Nature of the deed. 

c. Name of vendor. 

d. Date of transfer of title. 

e. Amounts and dates of payments. 

/. Amount and nature of all other expenditures and receipts 
incurred in connection with the purchase. 

g. Nature and cost of all expenditures relating to land which 
increased the intrinsic value thereof. 

h. Cost per square foot of each plot of land was computed and 
recorded, and for purposes of comparison, costs per square foot of 
near-by plots of land owned by the company were recorded. In this 
case the costs of the new land were less than similar figures for land 
already owned. 

i. Full plans and blueprints were filed, and the sheets in the 
loose-leaf binder carried references to the file number and listed all 
plans filed. 

The Northern Electric Manufacturing Company used the 
Uniform Accounting Manual 1 for the electrical manufacturing 
industry. The Manual gave the following instructions on the 
subject of land: 

CLASSIFICATION OF ACCOUNTS 
GROUP i ASSETS 

Definitions 

Sub Group 1 1 Manufacturing Plant 
in Land 

(a) Purchase price of land including buildings acquired therewith 
which will not be used less the salvage value of such buildings. 



Accounting Manual for the Electrical Manufacturing Industry, 
6th ed., National Electrical Manufacturers Association, New York, August i, 1931. 



NORTHERN ELECTRIC MANUFACTURING CO. NO. i 291 

(6) Expenditures for reclaiming submerged land. 
The charges to this account for the acquisition of land should not 
exceed the lower of the following: 

Cost of adjoining land owned by the company of equal desira- 
ability (unless such cost is known not to be a real indicator of 
value, e.g. donated land). 
The fair market value. 

Excess cost, if any, is chargeable to 3399 Other Manufacturing 
Expenses or, if the expenditures are sufficient to warrant and where the 
benefits appear to extend beyond the year in which incurred, to an 
account under 174 Other Deferred Charges and liquidated over a 
reasonable period of years by charges to 3399 Other Manufacturing 
Expenses. 

Does not include expenditures incident to acquisition. See No. 112. 
Does not include expenditures for the disposal of refuse even though 
the result of such disposal is usable land. . . . 
112 Grading and Assessments 

Expenditures relating to land which increase the intrinsic value 
thereof, such as: 

Payments of damages and fees for surveying and other expert 

services, incidental to the purchase of land. 
Cost of easements and rights of way. 

Assessments due at time of purchase and for specific improve- 
ments. 

Cost of clearing purchased land. 

Cost of removing or demolishing buildings acquired therewith. 
Expenditures for the initial grading of land but not those inci- 
dental to the ordinary disposal of refuse. 

Note: Expenditures which do not increase the intrinsic value of 
land may be charged direct to indirect manufacturing expense, 3399 
Other Manufacturing Expenses, or if they are sufficient to warrant and 
where the benefits appear to extend beyond the year in which incurred, 
they may be charged to 174 Other Deferred Charges and liquidated 
over a reasonable period of years by charges to 3399 Other Manu- 
facturing Expenses. 



1. Following the instructions presented in the National Elec- 
trical Manufacturers Association Manual, prepare journal entries 
to record the land acquisition described above. 

2. Do the methods followed provide adequate accounting 
records with respect to plant? 



292 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

LINCOLN COMPANY 

ACCOUNTING FOR NEW BUILDING AND EQUIPMENT 

During 1937 a contracting firm constructed for the Lincoln 
Company a concrete and steel building of modern design with the 
most recent type of equipment available for factory buildings. 
The building contract was on a fixed fee and guaranteed maximum 
basis under which the Lincoln Company paid the cost of labor and 
materials, plus a fixed fee as compensation for the services of the 
contractor, who guaranteed that costs would not exceed a specified 
limit. 

The costs of constructing the building and equipping it for 
operation were as follows: 

Building Materials $181 ,056 

Labor 132,829 

Fixed Fee Commission . . 33 , 213 

Architects' Fee . . . . 13,938 

Two Elevators 22, 124 

Heating System . . . 36, 142 

Sprinkler System . ... . -. 8,946 

Lighting Fixtures ... 10,572 

Lockers ... 3 ,400 

$442,220 

Since the labor item referred to labor on the main structure 
only, amounts for items such as the sprinkler system and heating 
system included labor costs. 

The company had previously carried equipment like elevators, 
heating systems, and wiring systems in the Building account. At 
the time the new building was built, however, an issue arose as to 
whether this practice should be continued or whether separate 
accounts should be set up for these items. The company owned 
three other buildings which had been built some time previously 
and it did not have complete figures as to the cost of comparable 
types of equipment in the other buildings. 



HALSTEAD COMPANY 293 

HALSTEAD COMPANY 1 

PURCHASE AND INSTALLATION OF MACHINERY 

In August, 1937, the Halstead Company purchased and 
installed a new planer. The expenses involved were as follows: 

1. Acquisition of Planer 

60" X 48" X 25' Branton Widend Pattern, Hypra 
Double Housing Planer with 2 heads on the 
cross part and 2 side heads with dual control, 
tool lifter for all heads, power cross-feed, 2 side 
heads, herringbone gear transmission, reversi- 
ble steel tie plates, one-piece table and two-piece 
bed, arranged for reversing motor drive. In- 
cludes motor for elevating crossrail but does 
not include main drive motor and control 
equipment $24,502.50 

Freight on i table, i rail, i motor base, i detail 

box, and i end section $ 264. 79 

Freight on planer and 2 leveling blocks 257. 26 

Express on motor 1.21 

Total . . . $ 523.26 

2. Construction of Guards and Steel Floor to Go around 
Planer 

Sheet metal . . $ 32 . 03 

125 Ib. No. ii gauge sheet iron 5-n 

Miscellaneous 2 . 01 



Material .. . $ 39. 15 

Machine shop 126.4 hours 2 . 160 10 



Total . . ... . . 

Construction of Foundation 

Lumber $ n-55 

Machine steel . . 3.72 

% reinforcing rods. . . 21.38 

21 yards stone and sand ... 40.98 

80 bags of cement . 5 2. 51 

Miscellaneous .... . i 64 



Material . $ 131.78 

23 . o hours engineering ... $ 43-3 

92.6 hours carpenter . 116.93 

104 8 hours yard laborers . . . 97 .05 

4 5 hours yard autos 5-5 2 

7 . 6 hours maintenance labor 6 83 

Labor and Burden $ 269 . 63 

Total $ 401 . 4i 

1 All figures in this case have been multiplied by a constant for purposes of dis- 
guise, but the proportionate relationship of the figures was not affected. 

2 In this and similar items below the amount included direct labor, and burden 
or overhead applied as a percentage of direct labor. 



294 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

4. Motor 

1 35 hp. semienclosed D.G. reversing motor, 

230 Volts, 200-1200 r.p.m., P.O. 66484, 
frame 50 P., Type T, 133 Amp., Serial 
366765 $3,718.00 

2 Switches (1-200 amp. + 1-30 amp.) 28.94 

i Safe to fuse unit 200 amp., 250 volts 20.46 

Wire 132 . 28 

Miscellaneous *4-37 

Material $3,914.05 

25.0 hours machinist $ 33.46 

222.0 hours electrician 285.40 

n.o hours yard laborers 13.46 

. 8 hours maintenance labor .78 

Labor and Burden $ 333 . 10 

Total $ 4, 247 . 15 

5. Installation of Planer 

Steel $ 13 . 91 

Conduit pipe 31 . 77 

18 No. 6312 plater 52.86 

40 gal. machine oil 9.28 

i Y Gate valve i . 33 

Miscellaneous 20-35 

Material $ 1 29 . 50 

7 . 5 hours machine shop $ 8.62 

4 . o hours electrician 5 . 40 

ii 2 hours piping. . 15.32 

10.4 hours yard laborers 12.37 

105 o hours carpenter 111.08 

11.7 hours planing. 14.70 

357.5 hours maintenance 34i-3i 

7 . 5 hours chipping 5 . 40 

8. 2 hours toolmaking 10.87 

6 . 5 hours heat-treating 9 . 68 

15.5 hours planing and demonstrating 19. 75 

Labor and Burden $ 554.50 

Total $ 684.00 

In this case a description of the accounting system used by the 
company has intentionally been omitted, in order that the prob- 
lems presented by the acquisition and installation of this machine 
may be considered in terms of the nature of the facts involved 
and the accounting structures and procedures necessary to preserve 
the records needed by the management. 



i. Trace the probable source of representative items in the 
accounts. At what point and on what evidence were the initial 
entries made in the books? What intermediate accounting steps, 



HARVARD COOPERATIVE SOCIETY 295 

if any, were necessary in obtaining the amounts? For instance, if 
metal under No. 2 was taken from stock, what records were neces- 
sary in order to obtain the amount? 

2. What accounting structure and procedures were necessary 
in order to obtain the figures as to labor and burden ? 

3. In what account or accounts in the general ledger should the 
addition to assets arising from the acquisition of the planer be 
recorded? 

4. What detailed records in the form of plant ledger cards or 
otherwise were advisable? 

HARVARD COOPERATIVE SOCIETY 

THE COST OF LAND AND BUILDINGS. THE DISTINCTION 
BETWEEN MAINTENANCE AND IMPROVEMENTS 

Two buildings were erected by the Harvard Cooperative 
Society in 1924 and 1925, a combined store and office building 
on Massachusetts Avenue and a garage and warehouse at 8-10 
Palmer Street, immediately behind the store property. The costs 
of constructing these buildings are indicated in Exhibit i. They 
were built on a cost-plus contract. The costs of each building 
were kept separate, and a distinction was drawn between the 
buildings and their equipment. Equipment included such items 
as the heating, plumbing, and electrical systems. Showcases 
and similar items were included under Fixtures. 

In 1906 the Society bought the land on which the front of the 
present building rests, with a building thereon which was used 
from 1906 until it was torn down to make way for the new building 
in 1924. In 1913 the Society bought a lot on which the rear of 
the present building rests, and in 1921 it bought the property at 
8~io Palmer Street. When construction started in 1924, real 
estate appeared on the books as follows. There was at that time 
no reserve for depreciation since all depreciation had been credited 
directly to real estate. 

Land and Buildings, Massachusetts Avenue $60,000. oo 

Land and Buildings, 8-10 Palmer Street 12, 002 . 50 

$72,002.50 

The directors decided that, of the $60,000 at which the property 
on Massachusetts Avenue was carried, $51,600 represented the 



296 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

value of the land and $8,400 the value of the old building. Simi- 
larly they decided that the land at 8-10 Palmer Street was worth 
$5,300 and that a portion of the old warehouse, which was to be 
retained and made part of the new building, had a value of $3,900. 
The latter amount is included on Exhibit i as part of the cost of the 
new building. The figure of $56,900 for the land was conserva- 
tive, for negotiations were opened with the Society in 1924 for 
the purchase of the property by an offer of $100,000 for the land. 
The Society was not interested and it was not known how much 
more might have been received if the sale had gone through. 

In order to carry out the decision of the directors, the two Land 
and Buildings accounts were closed out and two accounts for land 
were opened. 

Land, Massachusetts Avenue $51,600.00 

Land, 8-10 Palmer Street . 5,300.00 

The value of the old warehouse, $3,900, was added to new 
construction as mentioned above, and the balances of the two 
old accounts were written off by charging $11,202.50 to Surplus 
as a book loss due to the removal of old buildings. The cost of 
tearing down the old building, $1,200, was charged to the cost of 
the new building as one of the audited statements of the builders. 
After the new buildings were completed, separate accounts were 
carried for each of the two plots of land, for each building, and for 
the equipment in each building. 

It had been the policy of the management to charge all expendi- 
tures on the old building and its equipment as maintenance, an 
expense of the year in which the expenditures were made. The 
management expected to apply the same policy in dealing with 
the new buildings, but the disposition of the following items as 
between a charge to the asset or to maintenance raised some 
question. 

A. After the building was completed, moisture came through 
the ceilings immediately below the roof. Investigation revealed 
that there were no leaks, but that the difficulty was caused by 
salt in seaweed used for insulation. The surface of the roof was 
removed, the seaweed insulation was replaced with cork, and the 
roof was relaid. The cost of approximately $6,000 was charged 
to maintenance. 



HARVARD COOPERATIVE SOCIETY 297 

B. Moisture seeped through the north wall. The difficulty 
was partly caused by the contraction of the mortar in drying which 
left cracks between the bricks and mortar. Also, there were a 
few overburned bricks in the wall which were cracked. 

The wall was sprayed with an oil mixture at a cost of $400, 
but the treatment proved ineffective. The wall was then pointed 1 
and a few of the worst bricks were removed, the cost being $750. 
This stopped the seepage of moisture. 

C. In order to prepare the building for use at the opening of 
college, the interior was painted two weeks after plastering was 
completed. Both the builders and the management knew that 
paint applied before the plaster was thoroughly dry would peel. 
The interior was repainted the next year and again four years later, 
and in each case the cost of approximately $2,500 was charged to 
maintenance. The first painting was charged to the cost of the 
building. 

D. The matter of a finish for the cork floors proved to be a 
troublesome problem. The floors were finished soon after 
completion of the building at a cost of $400, and very soon there- 
after $50 was spent to remove the finish. A certain section of the 
basement floor was then set aside for experimental purposes. 
Contractors who had the one and only finish for cork floors 
were permitted to work on the experimental section at their own 
expense, and the cost of removing the materials applied was 
absorbed as maintenance. One such experiment succeeded and 
the contractor was engaged to refinish all the cork floors. 



1. Were the types of items included in the cost statement 
properly a part of the cost of the new building? 

2. Did the figures arrived at by the directors with respect 
to land record the cost of the land? 

3. Should the expenditures after completion have been treated 
as improvements or as maintenance? 



1 Pointing means the reworking of the mortar joints by the application of a thin 
coating of fresh mortar. 



298 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 



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NORTHERN ELECTRIC MANUFACTURING CO. NO. 2 299 

NORTHERN ELECTRIC MANUFACTURING COMPANY No. 2 

DETAILED PLANT LEDGER RECORDS 

As indicated in a previous case, the company used the Uniform 
Accounting Manual 1 for the electrical manufacturing industry. 
In accounting for plant, a distinction was drawn between cata- 
logued and uncatalogued items with reference to the type of 
detailed records maintained. For machinery a separate card was 

FORM i 



Cat. Machine No. (B) 
3355 


Description of Machine 
Jackson A-4 Geared Press 


o 
i 

2 

3 

4 
5 
6 

7 


Date Purchased (C) 
February 8, 1938 


Maker 
Jackson 


Corporation 


First Cost (D) 

$2,IOI 


Purchased from 
Forsythe and Briggs 


Bldg. No. (E) Dept. No. (F) 
14 6 


Maker's 
15164 


No. 


Transferred from 


Bldg. 
No. 


Dept. 
No. 


Date 


Voucher No. 
4-2108 


B.W. No. 

1174 










Connected to 
5 hp. 1800 r.p.m. motor No. 827 


Machine Code No. (A) 
6-48 






123456789 10 ii 


(A) 
Code 

12 13 14 


(B) 
Cat. No. 

i? 6 


(C) 
Yr. 
Pur. 

8 69 70 


(D) (E) (F) 
First Cost Bldg. Dept. 
No. No. 

71 72 73 74 75 76 77 78 79 80 





provided for each machine which was thus treated, for purposes 
of accounting, as a unit of property. Land and buildings were 
similarly handled by parcels of land and separate buildings. Thus 



1 Uniform Accounting Manual for the Electrical Manufacturing Industry, 6th 
ed., National Electrical Manufacturers Association, New York, August i, 1931. 



300 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

portions of total plant which were handled in this way, that is, 
by separate units of property, were referred to as catalogued 
items. This type of property accounting is illustrated in the 
present case with respect to machinery. 

For types of property such as small tools the company did not 
carry detailed records because of the clerical expense involved in 
the vast amount of bookkeeping which would be required. These 
types of property were referred to as uncatalogued and were 
accounted for by classes in a manner described in a later case. 

The plant ledger maintained by the Northern company for 
catalogued machinery consisted of Hollerith cards kept on file in 
each department. Form i is an illustration of these records. 
Information was listed under the appropriate headings both in 
writing and through a series of punched holes which made it 
possible to summarize the information recorded on a large number 
of cards by running them through tabulating machines. 

The catalogue machine number was the accounting identifica- 
tion number and corresponded to the number appearing on a 
brass tag attached to the machine. First cost was taken from 
the invoice and corresponded to the first cost described in the 
Uniform Accounting Manual. Building number and department 
number gave the location of the machine. Voucher number 
referred to the authorization of the expenditure incurred in pur- 
chasing the machine. The term, connected to, applied to the 
motor which furnished power to the machine. Machine code 
number was an identification mark which served to classify the 
machine according to its function. Other sections on the card 
served the purposes indicated by their titles. 

Motors were catalogued separately on cards identical in form 
to those used for machinery but differentiated by a green stripe 
along the upper border. 

The Uniform Accounting Manual contained six main divisions 
of accounts. Of these the first was Assets which contained sub- 
groups broken down into divisions. Each division included 
several accounts. For example, Subgroup n under Assets was 
entitled Manufacturing Plant and contained nine divisions of 
which No. 114 was Machinery and Tools. Among the eight 
accounts listed under Division 114 was Machinery, account No. 
1141. The detailed instructions concerning No. 1141 and 
certain other related accounts are furnished below. 



NORTHERN ELECTRIC MANUFACTURING CO. NO. 2 301 

1141 Machinery 

(a) First cost, including cost of transportation, of standard 
machines which have comparatively long useful lives, including only 
attachments which are necessary for the proper functioning of the 
machine, such as centers and oil and water feeds and safeguards which 
are a permanent and integral part thereof. 

(b) The sound utility value of special machines built by the com- 
pany using them, or designed by the company and built by outside 
machinery manufacturers, when put into service. The excess cost is 
chargeable to 172 Unliquidated Development and Complaints to be 
liquidated against the lines of product for which the machinery was 
designed. 

Does not include: 

Permanent installations of conveying apparatus which according 

to the fifth and prior editions of this manual were here included. 

See 1144 Conveyor Equipment 
Attachments and auxiliary devices of a semidurable character 

purchased with units, the specific use of which is not necessary 

to their proper functioning. 

See 1145 Small Tools 
Safeguards for machines (unless an integral part), hoods over 

grinders, nor oil and water feeds which are not integral parts 

of the machines. 

Charge 1161 Factory Fixtures and Equipment 
Rolling stock. 

See 1173 Rolling Stock 
Automobiles and electric vehicles. 

See 1174 Automobiles and Trucks (Gas) 

See 1175 Electric Vehicles and Trailers 
Motors used with but not inseparably attached to machinery. 

See 1142 Electrical Apparatus 

Does not include the cost of foundations nor the expenditures for 
installation. See 115 Foundations and Installation Machinery and 
Electrical Apparatus. 



1142 Electrical Apparatus 

First cost, including cost of transportation, of substantial and expen- 
sive electrical apparatus, used for testing or general manufacturing 
purposes, such as: 

Generators 

Induction regulators, 20 KW and over 

Motors (i HP and over), direct connected, geared, belted and 
shaft connected 

Motor-generator sets 

Marine engine generator sets 

Rotary converters 

Switchboards (power station) 



302 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

Transformers, 20 KW and over 
Turbo-generator sets 
Does not include: 



Motors which are inseparably attached to machinery, electric 
hoists and other portable tools, rolling stock and electric 
vehicles. 



1146 Electrical Accessories 

(a) First cost, including cost of transportation and installation, of 
electrical accessories of a semidurable character but which have a 
comparatively long term of effective life. 

(b) First cost of wiring and wiring devices used to connect tools 
and benches with main outlets; also that incidental to the installation 
of specific machines and units of electrical apparatus. 

115 Foundations and Installation Machinery and Electrical Apparatus 

1151 Foundations for Machinery and Electrical Apparatus 

First cost of foundations for machinery and electrical apparatus, 
as defined in 1141 Machinery and 1142 Electrical Apparatus. 

Note: The cost of removing old foundations preparatory to the 
installation of new ones should be charged to 3391 Rearrangement 
of Equipment. 

1152 Installation of Machinery and Electrical Apparatus 

First cost of installation (including engineering) of machinery and 
electrical apparatus as defined in No. 1141 and No. 1142. 

Does not include the cost of wiring in connection with the installa- 
tion of units. See 1146 Electrical Accessories. 

Note: The cost of reinstalling units incidental to the rearrange- 
ment of equipment is chargeable to 3391 Rearrangement of 
Equipment. 

3391 Rearrangement of Equipment 

Cost, including transportation, new foundations and reinstallation 
of rearranging equipment within a department or building, of trans- 
ferring individual units of equipment between departments and of 
dismantling equipment removed from service; also cost, including trans- 
portation, but exclusive of new foundations and reinstallation, of mov- 
ing a department or line of products from one location to another 
within the same plant, or from one city to another. . . . 

Note: The cost of new foundations and reinstallation in connection 
with moving an entire department or line of products is chargeable 
to manufacturing plant accounts under 115 Foundations and Installa- 
tion Machinery and Electrical Apparatus. 

The cost of original foundations and installation, less depreciation 
accrued thereon, should be charged as a part of the cost of moving. 



NORTHERN ELECTRIC MANUFACTURING CO NO. 2 303 

On June 15, 1938, the Northern Electric Manufacturing 
Company made the following additions to its machinery: 

i No. 2 Universal Milling Machine complete, exclusive of motor, 

control, arbors, and cutters $ 5 , 275 . oo 

i i5-hp. motor and control separate from milling machine 65 oo 

Freight in 28 . oo 

Cost of installation (no special foundation required) 22.00 

Cost of wiring 31 . oo 

i Universal Cutter Grinder with built-in motor and control 1,245.00 

Cost of installation (no special foundation required) 14 oo 

Freight in ... . 13 oo 

i No. 2, 4 Spindle Upright Drilling Machine with built-in motor 

and control 3 , 186 . oo 

Cost of installation (no special foundation required) 16.00 

Cost of wiring 24 oo 

Freight in 1750 

i 84 in. Vertical Boring Mill, exclusive of motor and control 10,435 oo 

i 5o-hp. motor and control 154 oo 

Cost of preparing foundation . . i, 18000 

Wiring costs 178.00 

Freight in ... 75 . oo 

Installation costs . 336.00 

Expenditures incurred in clearing space and relocating other 

facilities in connection with installation of new boring mill. . . 2,118.00 



Prepare journal entries to record the purchase of new machin- 
ery in a manner consistent with the instructions given in the 
National Electrical Manufacturers Association Manual. 



304 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 



EDINBURGH GAS AND ELECTRIC COMPANY 

ACCOUNTING FOR IDLE PLANT 

The Edinburgh Gas and Electric Company manufactured 
gas in a coke oven plant with a daily capacity of 3,500,000 cu. ft. 
and a book value of $2,500,000. Condensed accounting state- 
ments are given to show the relation of this plant to the general 
assets of the business, and the relation of the retirement expense 
to other expenses. The company rendered both gas and electric 
service, and both types of plant were recorded on the balance 

EDINBURGH GAS AND ELECTRIC COMPANY 
CONDENSED BALANCE SHEET AS OF DECEMBER 31, 1934 

ASSETS 

Current Assets $ 555 , 965 

Fixed Assets 16,621,008 

Unamortized Debt Discount, etc 304,305 

$17,481,278 
LIABILITIES 

Current Liabilities $ 313 ,945 

Funded Debt 5,092,820 

Retirement Reserve 1,281, 882 

Miscellaneous Credits 161 , 526 

Preferred Stock 2,141,520 

Common Stock 2 , 1 53 , 600 

Capital Surplus 5 , 948 , 1 79 

Surplus ... 387,806 

$17,481,278 

CONDENSED INCOME STATEMENT 
FOR THE YEAR ENDING DECEMBER 31, 1934 

Operating Revenues: 

Electric $1,821,061 

Gas 646,017 

Total Operating Revenues $2,467,078 

Maintenance . ... $ 237 , 793 

Retirement Expense* . . . 196,021 

Other Operating Expenses i ,675 , 454 2 , 109 , 268 

Operating Income $ 357, 8l 

Other Income i ,657 

Gross Income $ 359,467 

Interest and Amortization Expense 311 , 160 

Net Income $ 48 , 307 

Preferred Dividends 139,544 

Deficit after Preferred Dividends . $ 91,237 

* 1931, $213,337; 1932. 202,594; 1933, 195,943. 



EDINBURGH GAS AND ELECTRIC COMPANY 305 

sheet. It used retirement accounting, with a retirement reserve 
which was a provision for future retirements, but was not allocated 
to any particular assets. 

The Edinburgh territory was near the edge of one of the large 
natural-gas districts of the United States. Natural gas had been 
used extensively for several years within 60 miles. In 1930 
natural gas was discovered within 15 miles of Edinburgh by the 
Caledonia Gas and Oil Company, a subsidiary of a large corpora- 
tion with extensive holdings of natural gas and oil properties in 
different parts of the country. As a result of experience in other 
fields, it was possible to estimate with some confidence that this 
field would supply the entire requirements of the Edinburgh 
company for 15 to 20 years. In making such estimates, engineers 
relied on rock pressures and changes in rock pressure after a 
certain volume of gas had been reclaimed. 

The Caledonia field was not tied in with other fields at that 
time, but the Caledonia company would have to lay only 60 miles 
of pipe line to make reserves in other fields owned by the same 
parent company available, and it was expected that this line 
would be completed within a few years. When that was done, the 
supply of natural gas would probably be sufficient for 50 years or 
longer. 

Negotiations were opened relative to a contract to supply 
the entire requirements of the Edinburgh area. There were 
three reasons why the executives of the Edinburgh company were 
reluctant to change to natural gas. There were more heat 
units in natural gas 1,028 B.t.u. per cubic foot instead of 537 
so that a customer would need less cubic feet to do the same 
amount of cooking or water heating. For that reason, the volume 
of gas consumed in the area would decline unless the customers 
extended their use of gas. If rates per thousand feet remained 
at or near the level of the manufactured gas rates previously used, 
gross revenue would decline because of a decrease in the volume 
of consumption. This would be offset in part by increased use as 
a result of decreased cost of heat units. If rates per thousand 
were raised, the customers might still be getting a reduction in 
the cost of 1,000 B.t.u., but they did not understand such matters 
fully and probably would object to an increase in rates per thou- 
sand feet. With rates which were feasible in the light of public 



306 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

opinion, the return on the property of the company was likely 
to be unreasonably low. 

In addition, the change required an adjustment of all gas 
apparatus in the community, and the customers could not be 
expected to stand this charge. The company would probably 
have to absorb the cost of $3 to $4 per customer. If any of the 
appliances failed to work well after the change, the customers 
would hold the company responsible. Adjusting the appliances 
was a considerable task because it had to be done for the entire 
group of customers in a very short time. A similar adjustment 
would be necessary if the company ever changed back to manu- 
factured gas. 

Furthermore, the change would require shutting down the 
manufactured gas plant and throwing 125 men out of work. 

In 1932 the Edinburgh company entered into a contract 
to purchase gas for one part of its area near the gas wells and 
the change to natural gas worked out favorably. Negotiations 
with respect to gas for the rest of the area were intentionally 
delayed in the hope that it would not be necessary to make the 
change, but in the fall of 1933, the Caledonia company obtained 
a right of way for a pipe line to the city limits of Edinburgh, 
and indicated that gas would be offered to the city at very low 
wholesale rates in such a way that the public would draw unfavor- 
able comparisons between the rates actually being charged and 
those at which natural gas was available. 

A franchise prevented actual competition within the city, 
but the effect on public opinion would have been unfortunate, 
and the Caledonia executives used this fact in negotiation. 

A contract was signed in March, 1934, to take effect in August. 
The contract provided for the supply of gas required by the 
Edinburgh company at stipulated rates and was to run for 10 
years. At that time a new contract was to be negotiated. 

The manufactured gas plant was shut down in August, 1934. 
Every effort was made to keep the plant in condition to be service- 
able at the expiration of the contract in 1944. The brickwork 
of the coke ovens was sealed with asphalt to eliminate contact 
with the air as much as possible. The piping equipment and 
structures were painted to reduce corrosion. Approximately 
$25,000 was spent the first year in this way and it was estimated 
that the same amount would have to be spent on maintenance 



EDINBURGH GAS AND ELECTRIC COMPANY 307 

of the idle plant each year. This maintenance and taxes of about 
$18,000 per year were the principal expenses anticipated with 
respect to the idle plant. 

It was the intention of the management in 1934 to attempt 
to keep the plant in condition to reopen in 1944 when the contract 
expired, since otherwise the utility would be in a weak bargaining 
position in negotiating a new contract. The president believed 
that the utility commission of the state would permit the adoption 
of any policy which would be wise from the point of view of the 
company and its customers. Several proposals were advanced 
as to the best method of accounting for the property. One was 
that the gas plant should be retained in the accounts and reported 
in the statements as if it were in active use. A second was that 
it should be segregated and reported as idle plant and that a 
reserve should be set up from surplus to absorb the entire charge 
when and if it became necessary to write the plant off. A third 
suggestion went further, indicating that from an economic point 
of view the value of the plant was already exhausted because of 
unusual obsolescence, and that it might as well be charged off 
immediately. The proponent of this plan also urged that all 
portions of the plant which could not be used for other purposes 
should be retired physically to get the advantage of any salvage 
and to reduce annual costs of maintenance and taxes. 



308 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 
TRUNDELL POWER COMPANY 

THE COST OF PLANT AND EQUIPMENT 

During 1908 a group of small operating electric companies, 
locally controlled and managed, opened negotiations with the 
Endler Management Company, with a view to selling their 
properties. At that time, the management company was engaged 
in buying such properties for the public utility holding company 
with which it was affiliated. 

After extensive investigations, D. J. McClellan, acting as 
agent for the Endler Company, obtained options on the properties 
in question and prepared a plan for certain transmission lines 
and other construction necessary to make a single operating unit 
of the group. 

McClellan and two associates organized the Trundell Power 
Company and as agents for the Endler Management Company, 
which held a majority of the common stock, elected the board of 
directors. McClellan became the treasurer and general manager 
of the new corporation. 

In October, 1909, McClellan offered to transfer to the Trundell 
Power Company the properties and new construction for cash and 
securities as indicated in the following schedule. The offer 
was accepted by the directors and the plant account of the 
Trundell Power Company was debited $8,067,626 to record 
the acquisition. 



TRUNDELL POWER COMPANY 309 

CONSIDERATION CHARGED TO PLANT AND 
INVESTMENT ACCOUNT FOR PROPERTIES ACQUIRED 
UNDER THE McCLELLAN PROPOSITION ($8,067,626) 

Paid to D. J. McClellan and/or Endler Management Company: 
Securities of the Trundell Power Company: 

Common Stock $3,00x3,000 

Preferred Stock 3,000,000* 

First Mortgage Bonds 1,350,000 $7,350,000 

Cash: 

Cash paid to Endler Management Company for 
additional construction at Ontario power plant, 
and for " tying in," not contemplated under the 
McClellan Proposition 377,678 

Total paid to D. J. McClellan and/or Endler 

Management Company $7,727,678 

Liabilities Assumed: 

Liabilities of Beulah Power Company Assumed 

Funded Debt $ 345,000 

Less: Sundry net assets 4, 284 340, 716 

Salvage : 

Miscellaneous salvage from sale of certain property 

of Genesee Light and Power Company 768f 

Total charged to Plant and Investment 

account $8,067,626 



* Note. Of the $3,000,000 par value of preferred stock issued, $1,996,100 par value was 
subsequently returned to the Trundell Power Company, but said returned stock was not 
credited back to the Plant and Investment account; $100,000 par value of bonds also were 
subsequently returned, but we are unable to determine that they were credited back to Plant 
and Investment account. 

t Figures in red. 

In 1931 the public service commission of the state audited the 
books of the company to determine the cost of its plant. The 
facts of this case were taken from the audit report. The expendi- 
tures made to acquire the property sold to the Trundell Power 
Company are indicated in the following schedule: 



3 io PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

Outlays of Endler Management Company or McClellan in Cash or Securities to 
Acquire and Construct the Properties Turned over to the Trundell Power Com- 
pany under the " McClellan Proposition," which are shown in the records at 
Monroe: 

1. To acquire property of Monroe Light, Power and Water Com- 

pany: 

Under the contract for acquisition of this property the pur- 
chase price was to be paid in bonds of the company or one to 
be organized to the par value of $ 120, ooo 

2. To acquire property of Genesee Light and Power Company: 

Under the contract for acquisition of this property the pur- 
chase price was 34 , 902 

3. To acquire property of Beulah Power Company: 

In addition to the liabilities of this company which were 
assumed by the Trundell Power Company there were 
delivered to the stockholders of this company the following 
securities of the Trundell Power Company which were 
received under the McClellan Proposition: 

Common Stock $300, ooo 

Preferred Stock 200,000 

First Mortgage Bonds 100,000 600,000 



4. To acquire four parcels of land : 

The deeds from the grantors of these parcels show the follow- 
ing considerations: 

Ontario site $ 14,400 

Riga site . . 500 14,900 

5. For construction of Ontario and Riga Plants: 

The construction ledgers and supporting vouchers cover- 
ing construction of these plants are on file at Monroe and 
have been audited by us. The total construction costs, as 
determined from this audit (including construction costs 
for additional construction and for " tying in," for which 
reimbursement was made by the Trundell Power Company 
in cash) were i , ooo , 402 

Total Outlays, Cash, and Securities recorded at Monroe, 

by Endler Management Company or McClellan $i ,770,204 

Outlay by Trundell Power Company: 
Liabilities of Beulah Power Company 

assumed (net) $340, 716 

Salvage realized from property of Genesee 
Light and Power Company 768* 339,948 

Totalf $2,110,152 



*Red. 

t Note. In addition to the outlay recorded at Monroe, Endler Management Company 
undoubtedly made expenditures for preliminary investigations, engineering and legal services, 
and for similar purposes, which are not shown in the records at Monroe. 



1. What was the meaning of cost of plant assets which was 
applied when the plant account of the Trundell Power Company 
was debited $8,067,626 to record the acquisition of these assets? 

2. Is it possible to frame a definition of the cost of assets 
acquired through the issuance of stock, which would lead to a 
sound determination of cost in a case such as this? 



BLAW-KNOX COMPANY 311 

BLAW-KNOX COMPANY 

ACQUISITION OF PROPERTY FOR STOCK 
A. 

The Board of Directors of the Company at a meeting on April 26, 
1937 approved a contract of April 8, 1937 between the Company and 
the Peoples-Pittsburgh Trust Company of Pittsburgh, Pennsylvania, 
pursuant to which, and for the consideration of $252,000 therein 
stated, the Company is purchasing from said bank all of the real estate, 
plant, equipment, inventory, supplies, uncomplete contracts and other 
assets heretofore operated by Power Piping Company and Power Piping 
Construction Company, as going concerns, excepting only the corporate 
franchises of said concerns, their notes and accounts receivable and 
such of their assets, if any, as may not be inherently a part of or neces- 
sary incidents to the business of designing, producing, marketing and 
erecting power and process piping and sprinkler systems. All assets 
heretofore owned by Power Piping Company and Power Piping 
Construction Company and all properties heretofore operated by those 
concerns are being turned over by them to their sole stockholder and 
principal creditor, namely, the bank mentioned above which will 
apply the assets and properties to the satisfaction of their indebtedness 
to the bank and others, settle their corporate affairs and surrender 
their franchises. Title to those assets above described as being 
acquired from the bank will be taken by the applicant Company in 
the name of a newly organized and wholly owned subsidiary incor- 
porated in Pennsylvania under the name of Power Piping Corporation. 
Everything so being acquired, at the time of acquisition, will be free 
of liens, encumbrances, indebtedness, taxes and other obligations of 
any other nature of the Power Piping Company and of Power Piping 
Construction Company now in liquidation. 

The aforesaid consideration of $252,000 is to be paid in no par 
capital stock of the Company figured at $27.50 per share, that is, 
9,163 shares and $17.50 cash in lieu of a fractional share. The 9,163 
shares are to be drawn from heretofore authorized but unissued stock 
of the Company and on April 26, 1937 the Board of Directors of the 
Company authorized issuance of that number of fully paid and non- 
assessable shares and directed delivery thereof together with $17.50 
cash in exchange for the real and personal property being acquired 
under the aforesaid contract of April 8, 1937. No other authority 
is required for issuance of these shares. 1 



1 New York Stock Exchange Listing Application, A-io8g2, April 26, 1937. 



3 i2 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

POWER PIPING CORPORATION 
PRO-FORMA BALANCE SHEET AS AT APRIL 8, 1937 

Reflecting purchase for cash by Blaw-Knox Company of authorized 
capital stock, namely, 10,000 shares par value $1.00 a share, and the 
contribution by Blaw-Knox Company of additional capital represented 
by properties formerly operated by Power Piping Company and Power 
Piping Construction Company. 

ASSETS 

Cash $ 10,000 

Inventories 62 , 568 

Land, buildings and equipment 190,000 

Prepaid insurance, expense, etc i ,059 

Total assets $263,627 

LIABILITIES AND CAPITAL 

Reserve for uncompleted contracts $ i , 627 

Capital Stock (authorized and issued, 10,000 shares, par value $1.00 

each) 10,000 

Capital surplus (paid-in) 252,000 

Total liabilities and capital $263,627 



Source: New York Stock Exchange Listing Application, A- 10892. 



BLAW-KNOX COMPANY 313 

BLAW-KNOX COMPANY AND SUBSIDIARIES 
CONSOLIDATED BALANCE SHEET AS AT MARCH 31, 1937* 

ASSETS 
Current assets: 

Cash on hand and in banks $ 762 , 543 

Securities 33 , 162 

Notes receivable Trade $ 121 , 778 

Accounts receivable Trade i ,942, 167 

$ 2,063,945 
Less Reserve for doubtful notes and accounts 

receivable Trade 54,518 

2,009,427 

Accrued interest receivable 200 

Inventories (lower of cost or market) 27606,335 

Other current assets !4,559 



$ 5,426,226 
Investments: 

Unconsolidated foreign subsidiaries (Stated at 
net worth in foreign currency at exchange rates 

at December 31, 1936) $ 412,382 

Other i5>55i 

427,933 
Fixed assets: 

Property, plants and equipment 1 $i 7,857, 75 7 

Less Reserve for depreciation 4,983,017 



12,874,740 

Patents, trademarks and development (at cost, .... $ 655 ,019 
Less Reserve for amortization 67,825 

587,194 
Advances to employees and due from officers and 

employees under stock purchase plan 9,821 

Deferred charges 64 , 750 

Total assets $19,390,664 



* Footnotes 2-5 omitted. 

1 Property, plants and equipment are stated at appraised values for Blaw-Knox Company 
and Hoboken Land Company (1924), Lewis Foundry and Machine Company, Union Steel 
Casting Company, and Pittsburgh Rolls Corporation (1926); with subsequent additions at cost. 



3 i4 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 



BLAW-KNOX COMPANY AND SUBSIDIARIES 
CONSOLIDATED BALANCE SHEET AS AT MARCH 31, 1937. (Continued) 

LIABILITIES AND CAPITAL 
Current liabilities: 

Accounts payable $ 742 , 890 

Accrued expense 123, 166 

Accrued social security taxes, and Federal and 
Pennsylvania State capital stock and income 

taxes 554,489 

Dividends payable 264,479 

Total current liabilities $ i ,685 ,024 

Other liabilities: 

Miscellaneous reserves $ 79,867 

Minority interest, Pittsburgh Rolls Corporation io,5 J 3 

90,380 

Reserve for contingencies 261 , 717 

Capital stock and surplus: 

Capital stock $11,019,970 

Earned surplus ... 2,291,037 

Capital surplus 4,042,536 

Represented by 1,322,395 shares of no par value 
stock outstanding (authorized 1,500,000 
shares) 17, 353, 543 

Total liabilities and capital $19,390,664 



Source: New York Stock Exchange Listing Application, A- 1089 2. 

EXHIBIT i 

BLAW-KNOX COMPANY 
PRICE RANGE OF CAPITAL STOCK 



High 



Low 



I 934- 
1935- 
1936. 



January . . 
February 

March 

April .... 



24% 
1937 
26% 
28% 

29% 
28% 



22% 
25% 



Source: Bank and Quotation Record. 



B. 



On August 27, 1937, the Board of Directors of the Company 
approved a contract of August 2, 1937 and supplement of August 12, 
1937 between the Company and R. M. Gordon and Company pursuant 
to which the Company is purchasing all of the assets, business and 
goodwill of R. M. Gordon & Company as a going concern engaged in 



BLAW-KNOX COMPANY 315 

manufacturing and selling devices for automatic pressure lubrication 
of machinery. On the same date the Board of Directors directed the 
payment of 1,900 shares of no par Capital Stock of the Company to 
R. M. Gordon & Company as the consideration agreed in said contract 
and supplement to be paid for the assets, business and goodwill which 
are being acquired subject to all liabilities of R. M. Gordon & Company 
except liabilities for taxes. . . . l 

The value of the assets acquired as determined by the Board of 
Directors and to be set up in the books of the Company are as follows: 

Debits to: Cash $ 6,582 65 

Accounts receivable 470. 92 

Inventories 6 , 663 48 

Patents, patterns, moulds, etc 8,043 <> 8 

Goodwill 28, 702 94 

Credits to: Accounts payable 2 , 874 88 

Taxes 88.19 

Capital stock (1,900 shares at stated value of $8.33^ 

per share) 15,833 33 

Capital surplus 31 ,666.67* 



* New York Stock Exchange Listing Application, A- 11008, August 27, 1937. 



1. Prepare journal entries to record the transactions described 
in A above on the books of the Blaw-Knox Company and on 
the books of the Power Piping Corporation. 

2. If, after the terms of the contracts of acquisition in A and B 
had been established, you had been asked to determine the figure 
at which each of the several assets involved was to be taken up 
on the books, either of the parent or of the subsidiary, how would 
you have proceeded? 



1 The rice range of Blaw-Knox stock from May through August was for May, 
; June, 25^-22^; July, 25^-22%; August, 25^-21%. 



316 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 
B. THE MEANING OF COST OF REPRODUCTION 

CHELMSFORD KNITTING COMPANY No. 2 

APPRAISAL OF PLANT ON A REPLACEMENT COST BASIS 

The company was organized shortly after the Civil War and 
from that time until 1920 had a record of successful operation 
in the production of women's seamless hosiery. Beginning about 
1916, styles of women's hosiery changed, with growing demand 
for full-fashioned hosiery, principally in silk, and decreasing 
demand for staple seamless cotton hose in the production of 
which the Chelmsford company had specialized. A technical 
note on the difference between the two types is included below 
as Exhibit 3. 

The following figures indicate the changes in the volume of 
full-fashioned and seamless hosiery produced in this country from 
1919 to 1927 inclusive. The figures for the seamless type include 
children's and infants' hosiery because the Census of Manufac- 
tures did not give separate figures on women's seamless hosiery 
before 1927. 

DOMESTIC HOSIERY PRODUCTION 1 
(Dozen pairs) 



Women's full-fashioned hose 


Seamless hose 2 


1919 
1921 
1923 
1925 
1927 


6,323,934 

7,589,9*3 
9,817,996 
12,291,219 
19,771,030 


45,101,406 
44,490,667 

49,797,393 
47,306,165 
45,918,828 




1927 in detail 


Women's 24, 04. ^,008 


Children's 14,169 137 


Infants' . 6 , 803 , 693 





1 TAYLOR, G. W., Significant Post-War Changes in the Full-Fashtoned Hosiery Industry 
University of Pennsylvania Press, Philadelphia, 1929, pp. 12 and 15. Derived from Biennial 
Census of Manufactures for the years indicated. 

2 Includes women's, children's, and infants' hose. 

The management of the company was conservative and since 
it had specialized in staple lines, it did not immediately follow 
the trend toward the new type. In 1926 its plants had a gross 



CHELMSFORD KNITTING COMPANY NO. 2 317 

book value of $4,164,367, reserve for depreciation was $1,136,923, 
and net book value, $3,027,444. All of the machinery was 
designed for the production of seamless hosiery, except for one 
installation of full-fashioned machinery, costing $88,121, which 
had been put in for experimental purposes. 

The company had heavy losses in 1920 and 1921, which con- 
tinued after the recovery in business in 1922 and 1923. Delayed 
adaptation to the underlying change in the industry toward 
full-fashioned production was an important factor, but not the sole 
factor involved. Costs, even in staple cotton lines, were high 
relative to those of competitors, and the company had been slow 
in adapting its merchandising methods to changes in market 
conditions. 

The continuing losses in operation were so severe that a group 
of directors proposed in 1926 that the business be liquidated. The 
company was financed largely by common stock, so that even 
with a very low recovery in liquidation no loss would fall on 
creditors. The decision therefore affected primarily the stock- 
holders and the personnel engaged in the enterprise. 

In order to obtain a basis for a decision on the question of 
liquidation, the directors engaged the Eastern Appraisal Com- 
pany 1 to appraise the entire fixed assets. The records of the 
Chelmsford company were very incomplete as to units of plant 
on hand, dates of acquisition, and original cost, so incomplete 
in fact that it had frequently been necessary to book retirements 
of machinery at estimated cost because no records of cost were 
available. 

The Eastern Appraisal Company recommended a complete 
detailed appraisal on a reproduction cost basis, and it was author- 
ized to proceed. The first step was the preparation of a complete 
plan or map of the plants and detailed blueprints of all buildings. 
A careful inventory was then taken of all component parts of 
the buildings, such as the cubic yards of excavation, number of 
brick in walls, and board-feet of lumber of various types. Each 
item in the inventory was then priced on an original cost basis 
by estimating the date of acquisition, when it was not known, and 
applying a cost per unit which in the opinion of the appraisers 
represented probable cost at that time. For example, the inven- 
tory gave the number of common brick in certain walls built in 

1 Fictitious name. 



318 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 



1884. By applying a figure representing the cost of brick laid 
in walls of that type in 1884, the original cost of the brickwork 
was determined. Each item was also priced at replacement cost 
by applying current costs per unit for similar work in 1926. A 
rate of depreciation was set by inspection, and depreciated value 
was determined by applying this rate to the replacement cost. 
The results are illustrated by excerpts shown in Exhibit i from 
the schedules for building No. i. 

A similar inventory was taken of machinery and equipment, 
and each unit was priced on estimated original cost where actual 
cost was not known, and on the cost of replacement for new 
machines of the same type. The extent of depreciation was 
estimated by inspection and a rate was applied to replacement 
cost to obtain depreciated value. The results are illustrated in 
Exhibit 2 as applied to 280 Scott and Williams knitting machines. 

The results of the appraisal were summarized as follows and 
indicated a depreciated value somewhat above the $3,027,444 at 
which the plants were carried on the books of the Chelmsford 
company. 





Original 
cost 


Replace- 
ment 
cost 


Depreci- 
ated 
value 


Buildings and Building Equipment 


$1 . Il8.07O 


$2. 2O2.423 


$i . 28^ . J.IQ 


Machinery and Equipment 
Railroad Siding and Trestle 


2,368,974 
0,818 


3,358,039 
I <s . 3J.O 


1,843,856 

ii .8?^ 


Water Power Development 
Tenements . ... . . ... 


57,247 

2IS. <I2 


II5,66o 
<2Z OS2 


62,936 

7 1 cr 737 


Automobiles 


2^,837 


24..0OI 


1 7. Q4.tr 










Total 


$3,794,358 


$6,242,315 


$3,537,3^8 











1. Did this appraisal give the directors a substantial basis of 
fact for a decision as to liquidation? 

2. Would another type of appraisal have been more service- 
able? 



CHELMSFORD KNITTING COMPANY NO. 2 



EXHIBIT i 
CHELMSFORD KNITTING COMPANY 



Classification CONSTRUCTION 


Building Nn T F1nr>r Nn Dppt 




Orig. date 








Replace- 


Depre- 


Depre- 


of acquisi- 


Quantity 


Description 


Original 


ment 


cia- 


ciated 


tion 






cost 


cost 


tion 


value 


1884 




Material and labor used in 






% 








the construction of a five 














(5) story & basement brick 














building, 46' o" X 188' 6" 














six (6) story & basement 














stair and elevator tower, 














20' o" X 23' o" 














UNBURNABLE 














PORTION 














MASON WORK 












1,260 


cu. yd. area excavation 


441 


1,890 








320 


cu. yd. wall trench & pier 














excavation 


128 


560 








8,544 


cu. ft. rubblestone in wall 














pier footings 


1,281 


3,4i8 








4,965 


cu ft rubblestone retaining 














walls (laid dry) 


745 


1,986 












2,595 


7,854 










Designing & Supervision 


156 


471 












2,751 


8,325 


77 


1,915 






INSURABLE PORTION 














MASON WORK 














Basement 












164,000 


common brick in walls 


1,968 


9,020 








8,464 


cu. ft. rubblestone, laid in 














lime and cement mortar 














in walls 


1,270 


3,809 








239 


lin. ft. 3' o" X 10" granite 














underpinning 


311 


956 








1,330 


sq. ft. onck noor, laid flat 


93 


332 








100 


sq. ft. tar concrete floor 


6 


18 










First Floor 












183,000 


common brick in walls 


2,196 


10,065 








42 


sq. ft. Mastic floor in Toilets 


10 


13 










Second Floor 












178,500 


common brick in walls 


2, 142 


9,8i7 








42 


sq. ft. Mastic floor in Toilets 


IO 


17 












8,006 


34,047 







320 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 



EXHIBIT i. (Continued) 
CHELMSFORD KNITTING COMPANY 



Classification CONSTRUCTION 


Rmlrting Nn T TMonf Nr. Dppt 




Ong. date 
of acquisi- 


Quantity 


Description 


Original 
cost 


Replace- 
ment 


Depre- 
cia- 


Depre- 
ciated 


tion 








cost 


tion 


value 






CARPENTER WORK 










1884 




TIMBER & LUMBER 






% 






16,800' 


b.m. 14" X 1 6" yellow pine 














floor beams 


806 


2,016 








360' 


b.m. 6" X 8" yellow pine 














floor beams 


14 


34 








360' 


b.m. 8" X 8" yellow pine 














posts 


14 


34 








320' 


b.m. 10" X 10" yellow pine 














posts 


13 


32 








20,400' 
6,850' 


b.m. 3" plank floor 
b.m. J's" dm. & b. pine 


653 


1,632 










sealed ceiling 


233 


582 








800' 


b.m. J-'s" d.m. & b. sealed 


27 


68 










walls 














STAIRS 










1922 


I 


flight of stairs from Base- 














ment to First Floor, 16- 














2" X 6'6", maple treads 














and winders, i" X 1" risers, 














10" diameter, yellow pine 














center post, 1-3" X 12" 














stnnger, i line i" pipe rail- 














ing, posts and fittings, i 














line \y" pipe rail, fastened 














to wall, painted lead and oil 














(2 sides) 


53 


105 










PAINTING 












5,230 


sq. yd. lead & oil painting 


1,046 


1,831 








204 


squares cold water painting 


204 


306 












1,250 


2,137 










Brought forward 


44,527 


125,193 










Designing & Supervision 


2,672 


7,511 












47, 199 


132,704 


77 


30,522 






Unburnable Portion 


2,751 


8,325 




i,9i5 






Insurable Portion 


47,199 


132,704 




30,522 






Total Building #i 


49,950 


141,029 




32,437 


Date 


Quantity 


Description 


Original 
cost 


Replacement Depreciated 
cost value 






(Headings of the Credit 










Side of the Plant Ledger) 







CHELMSFORD KNITTING COMPANY NO. 2 321 

EXHIBIT 2 
CHELMSFORD KNITTING COMPANY 



Classification MACHINERY 6 


Building No. i A Floor No. 4 Dept. Knitting 




Ong. date 
of acquisi- 


Quantity 


Description 


Original 
cost 


Replace- 
ment 


Depre- 
cia- 


Depre- 
ciated 


tion 








cost 


tion 


value 




280 


Scott and Williams hose 






% 








knitting machines, Model 










1915 




E5, size 3%", 220 needles, 
.shion mark attachment 


53,200 


107,800 










(numbers omitted) 














Freight & Installation 


2,240 


4,200 










i-io" X 3" steel pulley 


526 


I>33 










7'-%" single leather belt 


137 


294 












56,103 


113,632 


55 


5i,i35 



EXHIBIT 3 

CHELMSFORD KNITTING COMPANY 
TECHNICAL NOTE 1 

For Seamless or " Round-knit" Hosiery, the machines are small 
individual knitters or auxiliary machines, not sensitive to floor align- 
ment. The ribbed tops of the seamless hose are knit on a "ribber" 
in the form of a continuous tube with dropped stitches at intervals 
showing where the rib is to be cut. These ribbed tops are cut off and 
set up on the circular knitting machine, sometimes called the " footer." 
This automatically knits the cylindrical leg, the heel and the foot, 
sometimes knitting in a "high splice," and a double or triple sole. 
It does not close the toe, and this joining or looping is done on the 
"looper," a circular machine which joins the edges of the open-knit 
toe. If a doubled-over top or "welt" is provided, as it is on some 
women's hosiery, this doubling is done on a special sewing machine 
called a welter. These operations are followed by trimming off threads, 
inspecting and mending, dyeing, usually in a specially adapted dyeing 
machine, boarding, where the stockings are stretched and dried on a 
form shaped like a conventionalized foot and leg, sometimes pressing 
between pressboards in a hydraulic press, and finally pairing, stamping, 
folding and boxing. 

There are four general types of circular knitting machines for pro- 
ducing women's seamless hosiery, classified according to the fineness of 
the knitting process. They are known as i76-needle, 22o-needle, 
26o-needle, and 3oo-needle (the number of needles in the circumference 
of the machine, and therefore, the number of horizontal threads in the 
leg of a pair of hose). Most purchases of recent years have been in 
260- and 300-needle types to meet the tendency on the part of women 
to wear sheerer hosiery. It is impossible to knit a fine cotton or rayon, 
(as well as silk), hose on a coarser machine than a 22o-needle. 



1 Notes on the Hosiery Industry, IM 8o2a; a case prepared by the Industrial 
Management Department of the Harvard Business School. 



322 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

Circular knitting machines for men's hosiery are of two types and 
two gauges (i76-needle and 22o-needle), one type capable of knitting 
plain hose and the other both plain and fancy hose. Most of the new 
equipment is 220-needle of the latter type. 

The Full-Fashioned Knitting Machine is strikingly different from 
the round or seamless knitting machine. Full-fashioned hose are knit 
flat, and the flat knitting machines making them are of two kinds, the 
"legger" and the " footer." 1 Each is a long, heavy composite machine 
of many sections, each of which is in fact an individual knitting machine 
working in synchronism with all the other sections. As many stockings 
are knitted simultaneously as there are sections, and all the sections 
have in common certain actuating and controlling parts, so that all 
the stockings on one machine are at the same stage of advancement at 
any given time. It takes about three times as long to knit the leg as 
to knit the foot. "The full-fashioned machine is probably the most 
delicate and complicated piece of mechanism now in use in any type of 
industrial establishment. The machine has 50,000 parts and all of 
them must be in perfect order or the stockings will have a defect and 
will lack the proper appearance." 2 Each unit of four machines (3 leg- 
gers and i footer) involves an investment of $25,000 to $30,000. 

The legger knits the stocking flat from the top to the widest part of 
the ankle, narrowing to the desired conformation. Commonly the top 
starts with a "welt" involving doubling. The finished leg is removed 
and sent to the footer; there the operator called a "topper" places the 
last course of the leg stitch by stitch on the needles of a bar that will 
be so placed as to transfer the leg to the needles of the footer. This 
operation requires high skill, sensitive fingers and good eyesight. The 
foot is formed flat with both heel and toe open, and the next operation 
is closing these on the looper, quite as was done with the toe of seamless 
hose. The stocking is next sent to the seamer, which is a highly special 
sewing machine that forms the seam up the back, that converts the 
previously flat leg and top fabric into a stocking. The next operations 
are much as in seamless trimming, inspecting and mending, dyeing, 
boarding, pairing, stamping, folding, and boxing. 

In order to meet the demand for sheer hosiery, the full-fashioned 
equipment in recent years has been of finer gauges. The 42- and 
45-gauge equipment (needles to each ij^ inches of the needle bar) 
predominates whereas the 3Q-gauge used to be common. "Service" 
weight can be produced on the 42 -gauge whereas only the cheapest 
service type can be knit on the 39-gauge. The 42-gauge can also 
produce a fairly satisfactory "service sheer" by the use of finer silk 
although the best service sheer is produced on 45-gauge. "Sheer" 



1 Combined leggers and footers have been built, but they are slow and so far 
have received no commercial acceptance. Frequent announcements have been 
made of circular knitting machines producing form-fitting hosiery, but nothing 
that has been produced has been practicable. 

2 Quoted from Gustave Geiges, Bulletin of the Taylor Society for June, 1927. 



BOREN STEAMSHIP COMPANY NO. i 323 

hosiery is usually made on 48-gauge, although 45 can be utilized to some 
extent for this also. There is some 54-gauge equipment in use for sheer- 
est chiffons retailing about $3.50 per pair. 

The legger is usually constructed in 18, 20, or 24 sections while the 
footer may have as many as 28 or 30 sections. Recent purchases by 
hosiery mills have been mostly in the leggers with 20 or 24 sections. 
The additional number of sections per machine tends to reduce the 
knitting labor cost. 

C. METHODS OF DETERMINING DEPRECIATION 

BOREN STEAMSHIP COMPANY No. i 

DEPRECIATION OF STEAMSHIP 

The Boren Steamship Company of San Francisco, Calif., 
owned and operated a fleet of ships which were engaged in carrying 
freight and passengers in Pan-American trade. The fleet con- 
sisted of 75 ships of various types such as tankers, refrigerated 
boats for carrying agricultural products, and ships designed to 
carry freight, passengers, and mail at faster schedules than 
those assigned to ordinary freight boats. These ships represented 
an investment of $82,541,650 and constituted the major portion 
of the fixed assets owned by the company. 

The Boren company was founded in 1903 and began the 
operation of four ships under the supervision of the man responsi- 
ble for its organization, Mr. Adolf Boren. The business of 
ocean transportation was more profitable at the beginning of 
the century than it is today, and the company experienced very 
satisfactory returns. As the result of the conservative inclina- 
tion of the first president, in relation to accounting, the original 
ships of the company were assigned service lives of 10 years and 
were depreciated on a straight-line basis with no allowance for 
salvage. 

In 1910 the estimated service life to be assigned to new ships 
was extended to 15 years, although ships in service remained on 
a lo-year basis. This change was brought about through the 
insistence of other executives that a service life of 10 years was 
far too conservative. By 1910 it had become evident that 
soundly designed and well-constructed ships would be serviceable 
for a period of time considerably in excess of the estimated life 
originally adopted. 



324 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

For similar reasons, a second revision in depreciation account- 
ing took place in 1916 when the estimated service life was extended 
to 20 years. At this time the government was becoming more and 
more stringent in its control of accounting practices used in the 
development of income figures for tax purposes. The adoption 
of a 20 year life brought the books of the company more nearly 
into line with the depreciation charges allowed by the government, 
but a small discrepancy still existed. In 1921 the company 
decided to incorporate into its own books the depreciation used 
for government reports, and in accordance with this decision 
the service life applicable to new boats was extended to 25 years. 

During the years previous to 1921 the Boren company had 
not found it necessary to engage in extensive overhauling of 
its ships. Each ship had been dry-docked at regular intervals 
for cleaning, repainting, and repairs. The cost of such work 
had been charged as maintenance against the income of the period 
during which it was performed. This procedure was altered in 
1921 and the practice of distinguishing between repairs and 
renewals or additions was adopted. In accordance with the new 
practice all ordinary repairs and replacements of small equipment 
were charged to maintenance. The cost of major replacements 
and additions, such as the installation of a new propellor shaft or 
the addition of refrigeration equipment, was capitalized. These 
additions to the asset accounts were depreciated over the remain- 
ing service life assigned to the ship unless the expenditures were 
of such a nature as to extend that life. In the latter case, the 
general manager estimated the extended service life, and the total 
of undepreciated cost on the books plus the cost of the new 
additions and /or replacements was depreciated on a straight-line 
basis over the extended life so estimated. A system of detailed 
record cards was set up so that all information pertaining to 
original cost, depreciation, repairs, betterments, additions, and 
retirements on each ship in service was readily accessible. Esti- 
mated scrap value was not considered in any calculation of 
depreciation charges. 

The new procedures did not eliminate the cost of replaced 
parts from the asset accounts. However, government income 
tax representatives were constantly objecting to the inclusion 
of items which had been physically retired. Partly as a result 
of this pressure and partly because of a natural desire to improve 



BOREN STEAMSHIP COMPANY NO. i 325 

its accounting procedure, the company instituted in 1931 the 
practice of eliminating such items. The cost of replaced parts 
was estimated by the general manager. These costs were then 
eliminated from both the asset account and the depreciation 
reserve. In the event that the ship was not fully depreciated, a 
percentage of the costs corresponding to the ratio of the deprecia- 
tion reserve to the asset account for the ship as a whole was charged 
against the reserve, and the balance was included in the expenses 
of the period during which the retirements took place. 

The decision to rebuild a ship for further service rested upon 
several considerations. Costs of operation were an important 
factor. The older ships were more expensive to operate, but 
shipbuilding costs had increased so tremendously since the early 
part of the century that depreciation charges on the new ships 
exerted no small influence upon cost comparisons. At various 
times the government surveyed the ships of the Boren company 
and reclassified them according to marine regulations. If a ship 
no longer met the standards for one class of service (for example, 
passenger service), the company had to decide whether to rebuild 
her to meet the standards or shift her down to a lower classifica- 
tion and allow her to wear out completely. Such decisions were 
made by the general manager in consultation with the controller. 

The following material presents the accounting history of one 
of the original ships of the Boren company. In Exhibit i, gross 
book value, depreciation charges, reserve for depreciation, and 
net book value are listed for the years 1904-1938. 

Name: S. S. Adolf Boren 

Type : Freight 

Date: Completed and placed in service January, 1904 

Cost: Fully equipped and ready for service, $446,000 

Specifications: 

Capacity 151 ,000 cu. ft. 

Length 330 ft. 

Width 44 ft. 

Moulded depth 31 ft. 

Plimsoll line* 23 ft. 

Dead- weight tonnage 3 , 470 tons 

Fuel consumption 24 tons per day 

Speed 12.5 knots 

* In shipbuilding, a conspicuous mark required by law to be placed on the outside of 
the hull of a vessel to indicate what depth of submergence will be allowed. 

The S. S. Adolf Boren was assigned a lo-year life and was 
depreciated on a straight-line basis so that its net book value 



326 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

ran out at the end of 1913. No depreciation was taken on the 
ship from the end of 1913 to the middle of 1922. In June, 1922, 
a reconditioning job on the S. S. Adolf Boren was completed. 
This job included a complete refitting, new plating, new decks, 
and a general overhauling at a cost of $214,760. This expenditure 
was capitalized and the general manager estimated the extension 
of service life resulting therefrom at seven years. 

In 1926 the S. S. Adolf Boren was changed from a coal burner 
to an oil burner. The cost of this change was $97,500, which 
amount was capitalized. The change to oil-burning equipment 
did not of itself extend the life of the ship, but the management 
was influenced in its decision by the fact that the ship might last 
beyond 1929. The cost of conversion to oil fuel was depreciated 
over the remainder of the life assigned in 1922. 

In June, 1929, the book value of the S. S. Adolf Boren ran 
out again, and no depreciation was taken for the next 3> years. 
In 1931, however, when the company adopted the policy described 
above, of eliminating from the asset account the cost of parts 
retired in the course of rebuilding operations, $75,280 was credited 
to the asset account for the S. S. Adolf Boren and charged to the 
reserve accumulated on the ship. 

During 1932 a second though less thorough reconditioning 
job was performed. The cost of this work was $115,440 and 
the estimated cost of retirements involved was $38,460. Retire- 
ments were again charged against the reserve for depreciation, 
and the general manager estimated the extended service life and 
set it this time at six years. 

Depreciation on the new life began in January, 1933, and was 
to continue up to December 31, 1938. By the spring of 1938, 
it was evident that the S. S. Adolf Boren was approaching the 
end of her life. The chief accountant stated that in his opinion 
the general manager would allow her to wear out in the least 
exacting type of freight service and then retire her some time in 
1940 or 1941. 



BOREN STEAMSHIP COMPANY NO. i 327 

1. When may a ship be said to be at the end of its life? Upon 
what factors does this condition depend? 

2. To what extent were the factors affecting the termination 
of the economic life of the S. S. Adolf Boren known or reasonably 
foreseeable in 1904? 

3. Should the relative profitableness of the shipping business 
of the Boren company at the several stages in the life of this 
vessel have affected the amount of depreciation charged? Should 
the earnings on the operation of this particular vessel have 
affected the charge for depreciation? 

4. Did the great increase in the cost of construction of new 
ships over the period from 1904 to 1938 affect the actual deprecia- 
tion which occurred on this vessel? 

5. Considering the facts which were available when the several 
decisions were made affecting the gross and net book value of the 
S. S. Adolf Boren, were these decisions sound? 



328 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 



EXHIBIT i 

BOREN STEAMSHIP COMPANY 
BOOK RECORD OF S. S. ADOLF BOREN 



End of 
year 


Gross book 
value 


Annual de- 
preciation 
charges 


Reserve for 
depreciation 


Net book 
value 


1904 

1905 
1906 
1907 
1908 
1909 
1910 
1911 
1912 

IQI3 


$446,000 
446,000 
446 , ooo 
446 , ooo 
446,000 
446,000 
446,000 
446 , ooo 
446,000 
4.4,6.000 


$44,600 
44,600 
44,600 
44,600 
44,600 
44,600 
44,600 
44,600 
44,600 

44., 6OO 


$ 44,600 
89, 200 
133,800 
178,400 
223,000 
267,600 
312,200 
356,800 
401 , 400 
4.4.6,000 


$401 , 400 
356,800 
312,200 
267,600 
223,000 
178,400 
133,800 
89,200 
44,600 


IOI4. 


4.4.6 OOO 




4.4.6 . OOO 




IQI ^ 


4.4.6.000 




4.4.6,000 




1916 


44.6 OOO 




4.4.6 OOO 




IOI7 


4.4.6 OOO 




4.4.6 . OOO 




1918 


4.4.6 OOO 




4.4.6 . OOO 




IOIO 


4.4.6 . OOO 




446,OOO 




IQ2O 


4.4.6. OOO 




446,OOO 




1921 


44.6 OOO 




4.4.6 . OOO 




1922 
1923 
1924 

1925 
1926 
1927 
1928 
IO2O 


660,760 
660,760 
660,760 
660,760 
758,260 
758,260 
758,260 

7^8. 260 


15,340 
30,680 
30,680 
30,680 
46,930 
63,180 
63,180 
31 . ZQO 


461,340 
492,020 
522,700 
553,380 
600,310 
663,490 
726,670 

7^8. 260 


199,420 
168,740 
138,060 
107,380 
157,950 
94,770 
3!,590 


TQ7O 


7^8. 260 




7^8. 260 




TQ2 T 


682 980 




682 980 




IQ32 


682,080 




682,980 




1933 
1934 
1935 
1936 

1937 

IQ?8 


759,96o 
759,96o 
759,96o 
759,960 
759,96o 

7 CQ . 060 


19,240 
19,240 
19,240 
19,240 
19,240 
IO . 24.O 


663 , 760 

683 , ooo 

702,240 
721,480 
740,720 

7 ^O . 060 


96,200 
76,960 
57,7 2 o 
38,480 
19,240 













BOREN STEAMSHIP COMPANY NO. 2 329 



BOREN STEAMSHIP COMPANY No. 2 

DEPRECIATION AND REVALUATION OF A NEW STEAMSHIP 

Early in 1932 construction of a new steamship was completed. 
The S. S. Karl Boren, as the new ship was christened upon 
launching, had been constructed in the United States with the 
specifications listed below : 

Length 415 ft. 

Moulded depth 60 ft. 

Plimsoll line 43 ft- 

Cargo capacity . 1 76 , ooo cu. ft. 

Passenger capacity 113 

Gross tonnage 6 , 983 tons 

Speed 1 8 75 knots 

The S. S. Karl Boren had been designed and built specifically 
for use in carrying United States mail, a service for which the 
Boren company had obtained government contracts. She was a 
relatively fast boat, modern in every respect, and possessed 
commodious passenger accommodations. Construction of a 
boat of this type had been necessary to meet the requirements of 
government mail contracts. 

The contract price for the S. S. Karl Boren was $4,762,000. 
Before she had been put into service on May i, 1932, the company 
had added certain special equipment at a cost of $7,000. This 
brought the total investment in the new ship to $4,769,000, and 
she was entered in the books at that figure. In accordance with 
the policy of the Boren company with regard to new ships, she 
was assigned a 2 5-year life and was depreciated on a straight-line 
basis with no allowance for scrap value. Exhibit i furnishes a 
record of depreciation up to December 31, 1937. 

Many of the ships owned by the Boren company were con- 
structed in European shipbuilding yards because costs there were 
considerably lower than they were for comparable work in the 
United States. Mail boats, however, had to be built in this 
country to meet government standards. The Boren company 
estimated that the cost of building the S. S. Karl Boren abroad 
would have been approximately $3,200,000. 

In cases of this nature where the original cost of a ship was 
considerably larger than its replacement cost, the Boren company 
had adopted the practice of setting up a revaluation reserve to 
bring net book value down to a more representative figure. This 



330 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 



reserve was set up out of earned surplus and appeared on the 
balance sheet, along with the reserve for depreciation, as a deduc- 
tion from the related fixed assets. Depreciation was calculated, 
as described above, on the gross book value. But, after the 
regular entry debiting depreciation expense and crediting reserve 
for depreciation had been made, a second entry was recorded 
which credited depreciation expense and debited the revaluation 
reserve for a proportional amount. This so-called proportional 
amount was calculated by dividing the original amount set up 
in the revaluation reserve by the number of years or months in 
the estimated service life of the ship. In this manner the revalua- 
tion reserve was reduced so that it would be completely extin- 
guished at the end of the estimated service life. The effects of 
this procedure may be traced in Exhibit i. 

The S. S. Karl Boren was kept in constant service and up to 
December 31, 1937, no extensive repairs, replacements, or addi- 
tions had been necessary. Twice a year she had been placed 
in dry dock, cleaned, repainted, and given a complete going over. 
Unless her service life should be extended through rebuilding 
sometime in the future, her book value would expire on April 



1. Show journal entries for 1937 affecting the reserve for 
depreciation, the reserve for revaluation, and depreciation 
expense. 

2. Was this use of a revaluation reserve sound in terms of its 
effect on the book value of the asset and the amount of deprecia- 
tion expense? 

EXHIBIT i 

BOREN STEAMSHIP COMPANY 
BOOK RECORD OF S. S. KARL BOREN 















Revaluation 


End of 


Gross 


Reserve for 


Gross de- 


Net book 


Net de- 


reserve 


year 


book value 


depreciation 


preciation 


value 


preciation 


assigned to 














future years 


1932 


$4,769,000 


$ 127,173-34 


$127,173 34 


$4,641,826 66 


$ 85,333 34 


$1,527, 160 oo* 


1933 


4,769,000 


317,933 34 


190,760 oo 


4,451 ,066 66 


128,000 oo 


i , 464 , 400 oo 


1934 


4,769,000 


508,693 34 


190,760 oo 


4, 260,306 66 


128,000 oo 


i ,401 ,640 oo 


1935 


4,769,000 


699,453 34 


190,760 oo 


4,069,546 66 


128,000 oo 


1,338,880 oo 


1936 


4,769,000 


890,213 34 


190,760,00 


3,878,786 66 


128,000 oo 


1,276, 120. OO 


1937 


4,769,000 


I,o8o,973 34 


190,760 oo 


3,688,026 66 


128,000 oo 


1,213,360.00 



* The ship was acquired May i, 1932. The revaluation reserve at that time was 
$1,569,000. 



NORTHERN ELECTRIC MANUFACTURING CO. NO. 3 331 

NORTHERN ELECTRIC MANUFACTURING COMPANY No. 3 

DEPRECIATION ON MACHINERY 

The company used in depreciation the rates indicated below 

in an excerpt from the National Electrical Manufacturers Associa- 
tion Manual. 1 

NORMAL RATES OF DEPRECIATION 

The rates shown in this table are the recommended, normal, 2 
annual rates and should be applied to the first costs of facilities in the 
respective asset accounts. 

Per Cent 

Land o 

Grading and Assessments . 10 

Building and Structures 

1131 Buildings, wood, sheet iron, and stucco. .. 10 

Buildings, brick and wood . . . 4 

Buildings, steel and concrete. . . . 2% 

1132 Structures . 8^ 

1134 General Service Piping and Wiring . . . . 6^ 

Machinery and Tools 

1141 Machinery ... 8^ 

1142 Electrical Apparatus. ... . 8^ 

1143 Ovens and Furnaces . 10 

1144 Conveyor Equipment .... . . 16% 

1145 Small Tools . . 20 

1146 Electrical Accessories .. ... . . . 16% 

1147 Molds, Jigs, Dies, and Special Tools * 

1148 Metal Flasks 

Cast Iron and Steel . 12% 

Channel and Rolled Steel . 20 

Aluminum 10 

Foundation and Installation 

1151 Foundations Machinery and Electrical Apparatus 16% 

1152 Installations Machinery and Electrical Apparatus . .. 16% 
Furniture and Fixtures 

1161 Factory Fixtures and Equipment 20 

1162 Furniture and Appliances in Factory Offices 10 

Transportation System 

1171 Roads and Sidewalks .. 12^ 

1172 Railway Tracks and Overhead Equipments 6)4 

1173 Rolling Stock 6 Ji 

1174 Automobiles and Trucks (Gas) 25 

1 175 Electrical Vehicles and Trailers 16% 

1 1 ; 6 Other Conveyances 25 



1 Uniform Accounting Manual for the Electrical Manufacturing Industry, 6th 
ed., National Electrical Manufacturers Association, New York, August i, 1931. 

2 In the case of extraordinary wear and tear due to regular multiple shift opera- 
tions the manual provided for the use of special rates. See National Electrical 
Manufacturers Association Manual Part I, Sec. 4, p. 6. 



332 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

Per Cent 
Patterns and Drawings 

1181 Patterns * 

1182 Drawings * 

Unfinished Plant o 



* It is contemplated that the cost of molds, jigs, punches, dies, and special tools and cpsts 
of patterns and drawings will be charged to 172 Unliquidated Development and C9mplaints 
and liquidated by charges to the cost of production to which they apply. At the option of the 
company, these expenditures may be entered direct against indirect manufacturing expense 
under the proper headings. 

On January i, 1937, the Machinery account of the Northern 
company carried a balance of $4,248,738.58. During the year 
additional machinery was installed at a cost of $202,599.25, and 
retirements were made to the extent of $128,266.42. Net salvage 
realized from these retirements came to $7,468.50. 

In accordance with the recommendations of the Manual, 
depreciation on machinery was based upon an estimated life of 
12 years. On January i of each year a beginning balance was 
recorded which represented the balance of the previous year 
adjusted for additions and retirements. This formed the deprecia- 
tion base for the following 12 months, each one of which was 
charged with one-twelfth of the annual depreciation calculated as 
8H per cent of the base figure. Additions to the Machinery 
account were not depreciated until the year following their 
acquisition. This practice did not distort depreciation charges 
to any large extent because retirements made during the year 
remained in the depreciation base until they were eliminated on 
January i following, so that depreciation charged on the retired 
units approximated that not charged on additions. 

The National Electrical Manufacturers Association Manual 
included the following instructions on the subject of depreciation: 

Sub Group 25 Reserves for Depreciation 

251 Depreciation on Manufacturing Plant 

Amounts entered periodically to provide for depreciation of 
manufacturing plant on account of exhaustion, wear and tear, and 
obsolescence, less amounts representing the first cost (less salvage 
value, if any) of items of manufacturing plant scrapped or retired 
from service. 

Note: Offsetting charges to the credits to this account are to 361 
Depreciation. . . . 



NORTHERN ELECTRIC MANUFACTURING CO. NO. 3 333 

252 Depreciation on Property Other than Plant 

Amounts entered periodically to provide for depreciation of prop- 
erty other than manufacturing plant. . . . 

Note: Offsetting charges to the credits to this account are to 564 
General Expenses Depreciation. 



361 Depreciation 

Pro rata amount, applicable to current period, of accrued deprecia- 
tion on account of manufacturing plant used by direct and indirect 
manufacturing departments, as credited to 251 Depreciation on 
Manufacturing Plant, except amounts chargeable to specific accounts, 
such as depreciation of: 

Hospitals 

Power plants 

Restaurants 

Fire protective equipment 

Telegraph and telephone equipment 

Part I, Section 4, Page 9 

Accounting for Fixed Assets Scrapped or Sold 

Inasmuch as the reserve for depreciation has been credited with 
amounts determined by the application of a composite rate of deprecia- 
tion to the total value in the account for a group of assets, rather than 
by use of an individual rate for each unit (e.g., each building or 
machine) applied to the cost of that unit, it follows that when units 
are removed from service, because of wear and tear, obsolescence or 
inadequacy, the entire first cost (or value at which capitalized) less 
salvage value, should be charged to such reserve. 



1. Using the instructions taken from the Manual and other 
information given above, prepare journal entries to adjust the 
Machinery account for the correct balance as at January i, 1938, 
and to record depreciation on machinery as at January 31, 1938. 

2. Would a more detailed classification improve the deprecia- 
tion accounting? 

3. Does the practice of charging the full difference between 
cost and salvage to the reserve, regardless of the amount accumu- 
lated with respect to the machines retired, introduce an element 
of distortion of the reserve? 



334 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 
NORTHERN ELECTRIC MANUFACTURING COMPANY No. 4 

ACCOUNTING FOR SMALL TOOLS 

As explained in a previous case, uncatalogued units were those 
for which the company did not maintain detailed records by 
separate units of property. Methods used in accounting for 
property of this type are illustrated with respect to small tools. 

When small tools were acquired, the asset account of that 
name was charged to record the cost, the total acquisitions of each 
year being kept separate in the records. At the beginning of the 
fifth year after the year of acquisition, the tools were assumed 
to have been disposed of and the asset account was credited for 
the total amount of acquisitions in the year in question regardless 
of whether individual tools had been discarded or not. No 
entry was made when tools were scrapped. Any salvage arising 
from discards was treated as a deduction from the gross expendi- 
ture for small tools of the current year. 

Depreciation was charged in the amount of 25 per cent of the 
total acquisitions in a year, beginning the year after the acquisition 
and continuing for four years. The total charge for depreciation 
and credit to the reserve in any year was thus based on the acquisi- 
tions of four years. In agreement with the practice described 
above, on January i of each year the net additions of the fifth 
year preceding were charged against the reserve. The entire 
method was an approximation based on the assumption that it 
was not worth while to keep records of individual units. 

At times a departure was made from the practice of charging 
only normal depreciation on small tools. This occurred when 
certain departments, which used large numbers of small tools, 
carried on operations for more than the normal number of hours 
per day over a long period of time. Double-shift operations over 
the greater part of one year were considered sufficient to justify 
special depreciation charges. These charges were run through 
expense in the usual manner and served to increase the reserve for 
depreciation. At other times it was thought advisable to charge 
less than the normal depreciation. Such variations from the 
normal charge were comparatively small and infrequent, however. 

Acquisitions and salvage for a series of years ending in 1933 
are given below for the Bronson division, one of the three plants 
operated by the company. 



NORTHERN ELECTRIC MANUFACTURING CO. NO. 4 335 



Year 


Acquisitions 


Salvage 


Net additions 


1928 


$189,587 97 


$205 80 


$189,382.17 


1929 


220,O8T O7 


267 15 


219,813 92 


1930 


204,804 10 


241 29 


204,562 81 


IQ3 1 


176,494 06 


185 80 


176,308.26 


1932 


44,554 8 i 


64 76 


44,490.05 


IQ33 


42,171 85 


75 42 


42,096.43 



Quotations from the Uniform Accounting Manual 1 for the 
electrical manufacturing industry are given below. 

MANUFACTURING PLANT CATALOG 



Uncataloged units are those for which it is impractical to maintain 
individual records because they may be difficult to identify after once 
installed. Electrical accessories and various items of factory equip- 
ment may be of this type. Others are difficult to identify because they 
are moved about frequently or their values are too small to warrant 
the expense of maintaining the records. Small tools 2 may be of this 
type. 



Uncataloged Units 3 

It is impractical to obtain a record of all units of Uncataloged equip- 
ment removed from service and to ascertain the original cost thereof, 
and the date put in service. Hence, the following procedure is neces- 
sary to adjust the ledger accounts so that their balances will represent 
only the cost of assets in service. 

Each class of assets subject to this method of procedure has been 
found by experience to have average lengths of life as follows: 



1 Uniform Accounting Manual for the Electrical Manufacturing Industry, 
6th ed., National Electrical Manufacturers Association, New York, August i, 1931. 

2 Small tools are defined in Sec. 3, Assets Sub Group n of the Manual as, "the 
smaller and less important standard tools and equipment of a portable character, 
which have a comparatively long term of effective life, either purchased separately 
or as attachments and auxiliary devices to machine units, the specific use of which is 
not necessary to their proper functioning." 

3 Part i, General Accounting, Sec. 4, p. 9. 



336 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

Years 

Grading and Assessments 10 

Buildings and Structures 

1132 Structures 12 

1134 General Service Piping and Wiring 16 

Machinery and Tools 

1144 Conveyor Equipment 6-8 

1 145 Small Tools 4 

1146 Electrical Accessories 6 

1148 Metal Flasks 

Cast iron and steel 8 

Channel and rolled steel 5 

Aluminum ... 10 

Foundations and Installation Machinery and Electrical Apparatus 

1151 Foundations for Machinery and Electrical Apparatus 6 

1152 Installation of Machinery and Electrical Apparatus 4 

Furniture and Fixtures 

1161 Factory Fixtures and Equipment 5 

1162 Furniture and Appliances in Factory Offices 5 

Transportation System 

1171 Roads and Sidewalks 8 

1172 Railway Tracks and Overhead Equipment. ... 16 

1175 Electric Vehicles and Trailers 6 

1176 Other Conveyances 4 

The accounts for such uncataloged assets should be so maintained 
that the acquisitions for each year are kept separate. When uncata- 
loged units are scrapped, the salvage value, if any, should be credited 
to the ledger account concerned. However, as the year of acquisition 
of the unit scrapped is seldom known, the credit for salvage will apply 
to the year in which the unit is scrapped. 

The charge for acquisitions for any year is thus reduced by the 
salvage value of the units scrapped during the year. The balance is 
designated as the net value of additions. 

Credits to the reserve for depreciation for any year are determined 
as follows: The amount of the net additions for the preceding year is 
multiplied by the rate of depreciation applicable to the type of assets 
under consideration. The amount thus determined is the portion of 
the total credit that pertains to that year. Similarly the portion of 
the credit for the second preceding year is determined. 

Thus amounts are obtained for each of the years on which the 
depreciation rate is based. Obviously no amounts are computed for 
the net additions of years prior to the earliest year included in the 
normal length of life contemplated by the rate. Such practice would 
result in allowances for depreciation in excess of the total value of the 
net additions. 

The total credit to the reserve for depreciation for the year is thus 
made up of the separately determined amounts for each of the several 
years included in the normal life. 

Each year the reserve for depreciation is charged with the total 
of the net additions of the year which by the process just described has 
become fully depreciated, i.e., for the first of the series of years making 
up the normal life of the particular class of assets. 



NORTHERN ELECTRIC MANUFACTURING CO NO. 4 337 

A specific illustration is as follows: 



First-Cost Account 


1926 


1927 


1928 


Gross expenditure 


$42,000 

2,000 


$40,000 
8,000 


$ 21,000 
1,000 


Salvage or scrap value of equipment disposed of dur- 
ing year 


Net Additions 


$40 , ooo 

1929 


$32,000 
1930 


$ 20,000 

Total 


Gross expenditure 


$34,000 
2,000 


$25,000 
5,000 


$162,000 
18,000 


Salvage or scrap value of equipment disposed of dur- 
ing year 




$32,000 


$20,000 


$144,000 
40,000 


At December 31, 1930, credit 1145 Small Tools with amount of net 
additions in 1926 which have become 100% depreciated. The 
balance will represent the cost of small tools in service on January i, 

IQ2I 




$104,000 



The reserve 251 Depreciation on Manufacturing Plant will show 
the following: 


Annual accruals each year 


Total 
Depreciation 
Accrued at 
Dec. 31, 1930 


Net Additions 


1927* 


1928 


1929 


1930 


1926 ($40,000) 
1927 ($32,000) 
1928 ($20,000) 
1929 ($32,000) 
1930 ($20,000) 


$10,000 


$10,000 
8,000 


$10,000 
8,000 
5,000 


$10,000 
8,000 
5,000 
8,000 


$40,000 
24,000 
10,000 
8,000 
o 


















$10,000 


$18,000 


$23,000 


$31,000 


$82,000 
40,000 


At December 31, 1930, charge 251 D( 
turing Plant with the net additions i] 


ipreciation on Manufac- 
i 1926 




$42,000 





* Depreciation allowances commence in the year following that in which additions were 
made. 



338 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

1. Determine the amount standing in the asset account and in 
the reserve with respect to small tools of the Northern Electric 
Manufacturing Company at January i, 1933, after all entries 
called for. 

2. Show summary journal entries to record the acquisitions of 
small tools in 1933 and salvage realized. Show entries as of 
December 31 to record depreciation for 1933, and determine the 
balance of the asset and reserve accounts as of that date. 

3. Show entries to record the retirements to be booked as of 
January i, 1934, and determine the balance of the asset and reserve 
accounts after the retirements. 

NEW ENGLAND TELEPHONE AND TELEGRAPH COMPANY 

THE DETERMINATION OF DEPRECIATION EXPENSE 
ON EXCHANGE POLE LINES 

The company followed in accounting the Uniform Classifica- 
tions prescribed by Federal regulatory bodies. 1 The methods 
used in determining the rates of depreciation differ somewhat 
among the several classes of depreciable assets; they are described 
in the case as applied to exchange pole lines. The total cost of 
both exchange and toll pole lines owned by this company at 
December 31, 1936, was $30,313,059.80. Assets in this classifica- 
tion included the original cost 2 of poles, crossarms, guys, other 
material, and labor and other expenses used in the construction of 
pole lines. 3 

The intent in determining the depreciation rate on pole lines* 
was to record on a straight-line basis in each year's operating cost 



1 Uniform System of Accounts for Telephone Companies Prescribed by the 
Federal Communications Commission. Issue of June 19, 1935. Effective January 

if 1937- 

2 Instruction 3, S. i, p. 5, F.C.C. Uniform System of Accounts. "Original Cost 
or Cost as applied to telephone plant, franchises, patent rights, and right-of-way 
means the actual money cost of (or the current money value of any consideration 
other than money exchanged for) property at the time when it was first dedicated 
to the public use, whether by the accounting company or by a predecessor public 
utility." 

8 Account No. 241 Pole Lines is given in detail in Exhibit i. 



NEW ENGLAND TELEPHONE AND TELEGRAPH CO. 339 

the amount of loss in service value. 1 The depreciation rates were 
based on estimates of average service life and average net salvage 
expected to be realized at time of retirement expressed as a 
percentage of original cost. Percentage net salvage was the 
difference between the estimated percentage gross salvage and the 
estimated percentage cost of removal. The depreciation rate as 
a percentage basis was 

100 per cent (original cost) percentage net salvage 
Average service life 

These estimates upon which the depreciation rates were based 
were developed by the general engineering department which 
maintained a staff of employees at work upon the preparation 
of statistical analyses. Depreciation rates were reviewed annually 
by the chief executives. 

The first step in the determination of the rate was an exhaus- 
tive analysis of experience with respect to poles already retired 
in relation to the poles still in service. The purpose of this study 
was to determine the average life of poles during the past experi- 
ence of the company. Appendix I contains exhibits and descrip- 
tive material pertaining to this analysis. 

It was impossible to base the depreciation solely on an examina- 
tion of physical life experience because other factors had to be 
considered. For example, types of poles had changed considerably 
since the decade of the twenties. Up until about 1929 the com- 
pany had used cedar and chestnut poles, the butts of which had 
* in some cases been treated to make them more resistant to decay. 
Since 1929 many of the new and replacement poles had been of 
creosoted southern pine. 

Poles of southern pine were treated over their entire length by 
forcing into the wood under pressure an average of 6 Ib. of creosote 
per cubic foot. Experience with experimental lines had indicated 
that the expected physical life of this type of pole should be 



1 Instruction 8i-A, p. 23, F.C.C. Uniform System of Accounts. "Charges for 
currently accruing depreciation shall be made monthly to account 608, ' Depreciation ' 
and to clearing accounts, as appropriate, and corresponding credits shall be made to 
account 171 ' Depreciation Reserve.' In computing the current monthly charges, 
one-twelfth of the composite annual percentage rate applicable to the primary 
accounts covering depreciable telephone plant shall be applied to the average of the 
balances, as of the first and last of the current month, in each such primary account." 



340 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

approximately 35 years, a figure well in excess of the life experi- 
enced with cedar and chestnut poles. 

The company did not expect that the average service life of 
these pine poles would equal the estimated physical life. For 
one thing the account, Pole Lines, included in addition to poles 
other items, such as crossarms, which had a shorter life than 
poles and therefore caused the average life applied to the com- 
posite whole to be lower than that for poles alone. In addition 
retirements were made necessary by factors other than age and 
decay. 

Storms often shortened the service life of poles. If a storm 
characterized by sleet or wet snow and a sudden drop in tempera- 
ture was followed by a wind, the effect on pole lines of the accumu- 
lated weight and added air resistance was often disastrous. 
Accidents and floods were other unforeseeable causes of early 
retirements. 

In some cases it was necessary to relocate entire pole lines in 
order to make way for some public work such as a new highway. 
In certain instances this required only the moving of existing 
poles where the change of a few feet in the location was involved. 
For other changes the original poles were retired and returned 
to storage if reusable. 

Public requirements exerted no small influence upon retire- 
ments. It was often required that only one pole line border a 
particular highway. In case the electric light company operating 
in that area had a pole line which was more suitable, the telephone 
company removed its poles altogether and transferred its wires 
or cables to those of the other utility. 

Conditions which might require the company to place a larger 
part of its lines underground would affect the service life of poles. 

Growth of the telephone business frequently affected the 
service lives of poles. When the traffic in any particular district 
became so heavy that an excessive number of aerial wires had to 
be installed to carry the load, cables were used to eliminate the 
necessity for too great a number of overhead wires. When this 
was done, new poles were installed when required. 

On the other hand, it was possible at times to extend the life 
of poles. If changes in the clearance of aerial wire permitted, 
the decayed butt of the pole was cut off and the remaining portion 
which was still sound was set up again in the original position. 



NEW ENGLAND TELEPHONE AND TELEGRAPH CO. 341 

The executives in the general engineering department who were 
in charge of setting depreciation rates were well acquainted with 
the various influences bearing upon the length of service life which 
could be expected from pole lines. They realized that the weight 
of the majority of these influences could not be assessed through 
mathematical computations. Consequently, they employed the 
average life determined from mortality studies as a starting point 
and made adjustments for the other factors which in their judg- 
ment influenced the situation. 

A pole reached the end of its service life when it was removed 
for any of the above reasons and was not sufficiently sound to 
warrant reinstallation or when decay had progressed to a point 
where an adequate margin of safety was not afforded. At regular 
intervals inspectors looked over all poles, removed decayed wood 
and measured the sound wood remaining. If a pole was not safe 
for its load for at least two years, it was scheduled for retirement. 

The capitalized value of a new pole was made up of its cost laid 
down at the location where it was to be installed plus the cost of 
labor for installation, other expense, such as vehicles, board and 
lodging, and a charge for general overhead. When retirements 
were reported to the accounting department by the foreman, 
however, the poles were credited out at a predetermined unit 
cost. This predetermined figure represented a moving average 
of the cost of poles installed in that particular area. 

Poles removed with the intention of re-using them elsewhere 
were credited out of the plant account as retirements and the 
corresponding debit was made to the reserve for depreciation. 1 
Their value for re-use was then determined and entered as a debit 
to poles in storage and a credit to the reserve. This procedure 
included only the material worth of the poles as salvage value. 

Maintenance was recorded by charging the expenses involved 
to accounts designed to give a breakdown which would facilitate 
control. Federal regulatory bodies had drawn a very definite 



1 Instruction 83, F.C.C. Uniform System of Accounts. "The service value of 
depreciable telephone plant retired shall be charged in its entirety to account 171 
1 Depreciation Reserve.' If the cause of retirement is not a recognized factor in 
depreciation and the loss is not covered by insurance, the company may upon proof 
that the charge to the depreciation reserve will result in undue depletion thereof, and 
with the approval of this commission, credit account 171 'Depreciation Reserve' and 
charge account 138 ' Extraordinary Maintenance and Retirements' with the unpro- 
vided for loss in service value and distribute it from that account to account 609 
'Extraordinary Retirements,' over such period as this commission may approve." 



342 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

line of distinction between items which should be capitalized and 
those which should be charged to maintenance. Units of property 
were established and when a whole unit, such as a pole, was 
retired, it was charged to the reserve for depreciation, and the new 
pole was capitalized. Items not classified as units of property 
were charged to maintenance, when replaced. 1 

The company maintained no breakdown of the depreciation 
reserve according to the accounts for depreciable assets. It was 
possible that a breakdown of the reserve would be made sometime 
in the future. To accomplish this an estimate upon a historical 
basis involved the consideration of all additions, betterments, 
retirements, and rates of depreciation which had applied to a 
particular classification of assets. Changes which had occurred 
in the past made this difficult to accomplish for all but a very 
small part of the total. Also, it had been proposed that the 
criterion for division should be reserve requirements. These 
requirements at any date represented the proper provision for 
service loss at current rates of depreciation. Using this method, 
the reserve balance would be allocated to the various classes of 
depreciable assets in the proportion that the estimated reserve 
requirement of each such asset bore to the total reserve require- 
ment of all. In its 1937 report to the Massachusetts Department 
of Public Utilities, the New England Telephone and Telegraph 
Company presented the following explanation of its position with 
regard to a breakdown of the depreciation reserve: 

The respondent has over the years maintained a composite deprecia- 
tion reserve in respect of its investment in depreciable property as a 
whole. In maintaining such a reserve, accounting procedures have 



1 Instruction 25, Item A-2, F.C.C. Uniform System of Accounts, Minor Items. 
"This group includes any part or element which is not designated as a unit of prop- 
erty. The original cost of any minor item of property retired and not replaced shall 
be credited to the plant account and charged to account 171, except that if the 
original cost of a minor item of property is accounted for through the retirement of 
units of property, no separate credit to the telephone plant account is required 
when such an item is retired. Except as provided in note under account 231 
'Station Apparatus/ if minor items of property are retired and replaced (apart from 
the unit of property of which they form a part or with which they are associated) no 
adjustment shall be made in account 171. The cost of the replacement shall be 
charged to the account appropriate for the cost of repairs of the property, except that 
if the replacement effects a substantial betterment (the primary aim of which is to 
make the property affected more useful, of greater durability, of greater capacity, 
or more economical in operation) the excess cost of the replacement over the esti- 
mated cost at current prices of replacing without betterment the minor items retired 
shall be charged to the appropriate telephone plant account." 



344 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

tion parallel to that applied to the assets, so that the reserve 
applicable to pole lines could be compared with that asset? 

If a breakdown of the reserve were to be undertaken, should 
it be based on a reclassification of all debits and credits to the 
reserve since the beginning, or should it be a segregation of the 
present gross reserve on the basis of an analysis of reserve 
requirements? 

2. Was the method used in estimating depreciation on pole 
lines sound in view of the characteristics of the property 
concerned? 

3. To what extent was a method comparable to this applicable 
to other classes of utility and industrial property? 

EXHIBIT i 

NEW ENGLAND TELEPHONE AND TELEGRAPH COMPANY 
ACCOUNT No. 241 POLE LINES 

This account shall include original cost (note Instruction 3 S.i) of poles, cross 
arms, guys, and other material used in the construction of pole lines. 

Items 
Anchors 

A and H fixtures 
Bolts 

Braces, pole and back 
Bridge fixtures 
Cable arms 

Clearing routes and tree trimming except maintenance of previous clearings 
Crossarms 
Extension arms 
Guard arms 
Guy clamps 
Guy stubs 
Guy wire or strand 

Painting, treating, gaining roofing, shaving, and stenciling poles 
Permits and privileges for construction 
Pins 

Pole brackets, wooden 
Poles 
Pole steps 

River crossing and long span fixtures 
Strain insulators 
Towers 



Source: Uniform System of Accounts for Telephone Companies Prescribed by the Federal 
Communications Commission. Issue of June 19, 1935- 



NEW ENGLAND TELEPHONE AND TELEGRAPH CO. 345 



Depreciation 


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346 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

APPENDIX I 

The New England Telephone and Telegraph Company began the 
analysis of life expectancy with relation to pole lines in ig24. 1 Records 
which had been maintained on pole lines were sufficiently detailed to 
permit compilation of the necessary statistics. 

All pole lines were recorded on forms which gave the location of 
each pole, its identification number and the date of its installation. 
When removals were made, the field engineer drew up a report of the 
poles to be removed, their size and wood characteristics, and the dates 
of their installations. The foreman in charge of the job also made out 
a report when poles were actually removed, and the number of these 
poles were compared with the number estimated to be removed by the 
engineer in charge. From these reports and from its records of new 
poles installed, the accounting department prepared an annual sum- 
mary of poles in service and removed, the latter being broken down 
according to dates of installations. This summary was forwarded to 
the general engineering department which was charged with the task of 
preparing the life tables. Exhibit A shows the basic summary of 
these data. 

In Exhibit A the upper figure in each rectangle (in column 0) 
represented the poles installed during the year and (in other columns) 
the poles remaining in service the first, second, third, etc., year after 
installation. The lower figure represented poles retired in each year 
following installation. For example, Exhibit A, rectangle a, shows 
that in 1929, $1,684,624 of poles were installed and that of these $3,466 
worth had to be removed during the year of installation. Moving 
horizontally away from 1929 on this chart and through the rectangles 
b, c, d, e,f, and g, it was possible to determine the number of the original 
1929 replacements remaining in service the beginning of each year and 
the number removed during any given year. In rectangle g the data 
given showed that of all placements made in 1929, $1,613,172 remained 
at the beginning of 1935 and $18,008 was removed during the year 1935. 

The dollar figures used in Exhibit A resulted from the application of 
unit costs to the poles in service and removed, grouped according to 
size and wood classifications. Since the mortality data do not 
include 100 per cent of the pole plant because of incomplete installation 
dates, and since items such as crossarms and guys are excluded, the 
value of pole lines in service shown on the mortality study differs from 
the value placed on the same asset in the balance sheet. 

It may be seen in Exhibit A that the total value of all poles in 
service in 1935 could be obtained by adding together all the upper 
figures in the rectangles on the bottom of the band of figures and mov- 
ing away from 1935 at an angle of 45 degrees in the direction indicated by 
the letters r, s, /, u, v, w, g, #, y, and z. Likewise these figures gave the 
age distribution of all poles in service at the beginning of 1935. Using 
these facts but basing the studies upon bands of three years rather 

1 In the books of the company pole lines were handled in two divisions exchange 
and toll. The material here described pertains to exchange poles only. 



NEW ENGLAND TELEPHONE AND TELEGRAPH CO. 347 

than upon a single year, the general engineering department derived 
charts such as that shown in Exhibit B. 

These charts were prepared for overlapping bands of years. The 
chart preceding Exhibit B was for 1927-1929 and that following 
Exhibit B covered the years 1931-1933. This practice was followed 
to eliminate any marked variations caused by changing conditions. 

The dark line in Exhibit B represented actual experience and was 
developed from Exhibit A as follows. Starting with the years 1929, 
1930, and 1931 (column 0, Exhibit A) and following this band diag- 
onally upward at an angle of 45 degrees, retirement rates (ratio of retire- 
ments to in service for the three years combined) were determined for 
poles of each age. Then starting with the initial placement of 100 per 
cent and applying the retirement rate for year o, the percentage remain- 
ing at the end of year o (or at age ) year, assuming all placements 
concentrated at the middle of the year) was obtained. Similarly by 
applying to the latter the retirement rate for the year i, the per- 
centage remaining at the end of year i (age i% years) was found. 
This operation was continued until all known data were exhausted. 
Each one of these percentages was plotted on the grid of Exhibit B 
and the solid curve was constructed connecting them. 

The dotted line in Exhibit B represented the mortality curve for 
the years 1929-1931. This curve was derived from the actual experi- 
ence curve through mathematical calculations based upon the 
Gompertz-Makeham formula. It was necessary to develop this 
theoretical curve because data were not available for an actual experi- 
ence curve covering the complete life span. 

From the theoretical mortality curve (dotted line on Exhibit B) 
the average life was developed. This was accomplished by dividing 
the total " per cent years " by an initial placement of 100 per cent. The 
total "per cent years" is the summation of the computed percentages 
remaining for all years up to the year 45, the point where the theoretical 
curve reaches the horizontal axis. The result was expressed in years 
and represented the average life for the band of years under con- 
sideration. In Exhibit B this computation produced an average life 
of 17.2 years. 

The average lives obtained for different bands of years were plotted 
on Chart A of Exhibit C and were connected by the heavy solid line. 
On Chart B of Exhibit C the retirement rates for each band of years 
as determined from the life study data were plotted and connected 
by a heavy solid line. Retirement rates developed from accounting 
data for actual retirements were also plotted on Chart B and connected 
with a broken line. The variation between the two lines was caused 
principally by the fact that only poles with known placement dates 
were included in the study data while all poles as well as crossarms, 
guys, etc., were included in the accounting data. 

Using the broken line of Chart B an adjustment was made in Chart 
A to correct the solid line. The broken line in Chart A which resulted 
from these procedures represented the final mathematical determination 
of indicated average lives. 



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NEW ENGLAND TELEPHONE AND TELEGRAPH CO. 349 

EXHIBIT B 

NEW ENGLAND TELEPHONE AND TELEGRAPH COMPANY 
EXCHANGE POLES LIFE TABLE 



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80 

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Experience for years 1929- 1930- 1931 
Average life 17.2 years 




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350 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 



EXHIBIT C 
NEW ENGLAND TELEPHONE AND TELEGRAPH COMPANY 

EXCHANGE POLES* 

RESULTS OF ANALYSES OF MORTALITY DATA OF SUCCESSIVE THREE- 
YEAR PERIODS 
35 

30 
25 



15 




do/justed to * 
accounting data 



1910 1912 1914 1916 1918 1920 1922 1924 1926 1928 1929 1930 1931 1933 

1911 1913 1915 1917 1919 1921 1923 1925 1927 1929 1930 1931 1932 1934 

1912 1914 1916 1918 1920 1922 I9Z4 1926 1928 1930 193F 1932 1933 1935 




1910 1912 1914 1916 1918 1920 1922 1924 1926 1928 1929 1930 1931 1933 

1911 1913 1915 1917 1919 1921 1923 1925 1927 1929 1930 1931 1932 1934 

1912 1914 1916 1918 1920 1922 1924 1926 1928 1930 1931 1932 1933 1935 
* Excludes crossarms. 



HENLEY RADIO COMPANY 351 

HENLEY RADIO COMPANY 

THE DETERMINATION OF THE RATE OF DEPRECIATION UNDER 
CONDITIONS OF RAPID OBSOLESCENCE 

Since the entry of the Henley Radio Company into the 
radio tube manufacturing business in 1928, there had been an 
unusually rapid development in the processes and machines 
involved in production. Originally, most of the operations had 
been performed by hand, but, as is typical of a new mechanical 
process, machines were soon devised which were capable of per- 
forming many of these hand operations. These machines were 
then outmoded by others which combined several operations into 
one, and the latter equipment in its turn became obsolete because 
of its inability to meet new standards for quality and productivity. 

Most of this machinery had a physical life of at least 15 years 
but it became outmoded so rapidly that in many cases the equip- 
ment was replaced after 18 months, and the average service life 
experienced was only three years. Not only were new machines 
constantly being introduced, but the cost of each successive design 
exceeded the capital expenditures necessary to carry on production 
under the old methods. In one particular instance, the original 
equipment necessary for a group of hand operations had cost $i ,000. 
New machines had been installed at this point in the production 
process on three occasions and the cost, which had jumped from 
$1,000 to $6,000, and then to $16,000, had been $22,000 for the 
last installation. 

The speed of technical and manufacturing development was 
reflected in the product price changes. The Henley Radio Com- 
pany had maintained a record of the prices which had applied 
to its line of products, and an index is presented on page 352 which 
represents these prices in terms of the 1928 price taken as 100. 

In order to reduce costs sufficiently to meet this drastic decline 
in prices and to maintain a margin of profit, the company had to 
keep in the forefront of technical advance in products and in 
manufacturing processes. To accomplish this objective, it 
maintained a well-equipped and well-staffed research laboratory 
and had developed well-defined procedures for coping with the 
complex problems arising in connection with design and acquisi- 
tion of machinery, retirement of old machinery, depreciation, and 
cost control. 



352 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 



Date 




Price Index 


Average 


1928 


100.00 


January 


1929 


86.00 


February 


1930 


76 54 


June 


1930 


53.58 


July 


1930 


42 86 


April 




30.00 


May 


1931 


27.30 


October 


1931 


21.57 


July 


1932 


22.44 


January 


1933 


20.42 


March 


1933 


18 79 


June 


1933 


17 10 


December 


1933 


16.59 


July 


1934 


14 10 


April 


1935 


12.69 



The company used blanket depreciation rates which applied 
to the various groups of depreciable assets. In the case of manu- 
facturing machinery, the blanket rate applied to the gross amount 
in the asset account with no allowance for salvage. Although 
additions were depreciated only over the remaining service lives 
of the machines to which they were attached, they were debited to 
the asset account for manufacturing machinery and were subject 
to the regular blanket depreciation rate. During the years from 
1928 through 1930, the company had charged depreciation upon 
manufacturing machinery at the rate of 33^ per cent annually. 
As this field became more thoroughly explored, however, the speed 
with which new processes and new equipment were introduced 
slowed down perceptibly, and the rate of depreciation was adjusted 
accordingly. In 1931 a reduction to 25 per cent was made, and 
this figure was cut to 20 per cent in 1932. The last rate reduction 
was made in 1935 when depreciation on manufacturing machinery 
was established at 16 per cent. In all this series of reductions 
the effort was to record in the depreciation charged the extent 
to which the service capacity of the machinery was being exhausted 
by obsolescence. No attempt was made to relate depreciation 
charges to the average service life of similar equipment used in 
the past. The management realized that the rapid technical 
advances taking place rendered any comparison between the old 
and the new unsuitable for the purpose of policy formation. 
The Henley Radio Company was also definitely opposed to the 
establishment of any relationship between earnings and deprecia- 
tion rates. The executives believed that accounting practices 



HENLEY RADIO COMPANY 353 

should be designed to determine income and should not be altered 
to fit the earning capacities of various periods. Since the company 
based its determination of depreciation upon such a realistic 
approach supported by complete records, and because machinery 
actually was retired within the span of service life indicated, the 
rates used by the company were almost all allowed by the tax 
authorities. 

In setting rates on tube manufacturing equipment, no allow- 
ance was made for salvage. Machines retired were broken up 
and any junk value was carried to other income. When retire- 
ments took place, the full cost was charged to the deprecia- 
tion reserve even though the individual machine was not fully 
depreciated. 

In its accounting records the Henley Radio Company grouped 
its assets according to function. This resulted in the eight classes 
which are listed below: 

1. Land 

2. Buildings 

3. Building equipment 

4. General machinery 

5. Manufacturing machinery 

6. Factory fixtures 

7. Office furniture and fixtures 

8. Engineering laboratory and equipment 

The distinction drawn between general machinery and 
manufacturing machinery was based upon a real need for differ- 
ence in accounting treatment. General machinery applied to 
the auxiliary, nonfabricating machinery which, in a general 
way, was common to all factories. Manufacturing machinery 
included all those machines which were engaged in the actual 
fabrication of the product and which, therefore, presented the 
most difficult problems to the management. 

In the plant records machines which cost over $1,000 were 
listed on cards. One card was made out for each machine showing 
the date of purchase, original cost, and cost of any additions made 
after the time of the original installation. All cards for one 
type of asset were filed, together with a card bearing the various 
rates of depreciation which had been applied to that class of 
equipment and the date when each rate had gone into effect. 



354 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

Using this information, the accountant was able to calculate the 
reserve for depreciation accrued upon any one machine as at any 
particular time. 

The invoices on all equipment purchases were kept on file and 
indexed according to a number system which was also used to 
identify the machines. Whenever it was necessary to book the 
retirement of equipment for which a record card was not main- 
tained, it was possible to obtain the necessary information from 
the purchase invoice. 

The central feature of the control exercised over plant was a 
plant budget which was prepared for each calendar year and which 
was revised whenever circumstances warranted. In preparing 
this budget, the works accountant consulted the plant engineers 
and foremen in order to draw up preliminary figures on new equip- 
ment to be installed in the ensuing year. Since most of the new 
equipment was intended to displace machines then in service, the 
budget included figures on the gross book value of estimated 
retirements. These figures were then revised in a conference 
of the general manufacturing superintendent, the superintendent 
of the plant, and the works accountant. Research engineers 
described new methods proposed or in the development stage and 
sought to estimate when their use would become advisable. 
Operating men who were qualified to advise on questions of capac- 
ity and product quality were also freely consulted during these 
conferences. The works accountant, in certain instances, pre- 
pared cost studies designed to show costs of production with new 
machinery as compared to costs with the old. Thorough con- 
sideration was given to all sides of the problem before the revised 
figures were drawn up. 

These revised estimates were next examined by the vice- 
president in charge of manufacturing who went over each item 
of new equipment proposed in the light of trends and general 
conditions prevailing in the industry. 

Final approval rested with the directors. All but one of 
these men were operating executives and their familiarity with all 
branches of the business enabled them to consider the proposals 
from all points of view. For example, the sales manager, who was 
a director, might object to the proposed purchases on the ground 
that they would increase capacity when a decline in sales volume 
was expected. In such instances, the budget provision for new 



HENLEY RADIO COMPANY 355 

machinery was revised downward and the depreciation rates 
adjusted accordingly. The management of the Henley Radio 
Company believed that the thorough and well-rounded considera- 
tion of all decisions affecting purchases of new equipment and 
depreciation, which centered around the preparation of the plant 
budget, was of the utmost importance in the maintenance of the 
firm's competitive position. 

At the end of 1937 the investment of the Henley Radio Com- 
pany in tube manufacturing machinery was $1,545,000, and a 
reserve for depreciation had been accrued to the extent of $1,114,- 
500. The budget for 1938 provided for new equipment purchases 
totaling $154,600 and retirements of $84,500. This budget had 
been finally approved late in the fall of 1937 when it was 
generally expected that the " recession" would end in a sharp 
upturn early in 1938. By March of 1938, it became apparent 
to the executives that an immediate upswing in business activity 
was not probable and the budget estimates were revised pending 
developments in the business situation. The revised estimates 
provided for new equipment amounting to $32,000, which would 
involve retirements with a gross book value of $19,000. Both 
additions and retirements were to be booked as of June i, 1938, 
and the additions were to be depreciated over the remaining six 
months. With these changes and with the depreciation rate of 
16 per cent applying through the remainder of 1938, the net 
book value of tube manufacturing machinery would be $214,260. 

When the revised plant budget for 1938 was adopted, the 
general manufacturing superintendent raised a question as to 
the advisability of revising the depreciation rate. He believed 
that although the net book value at the end of 1937 was a very 
conservative figure, it was not unreasonable. A continuance of 
the 1 6 per cent rate would give a figure in 1938 which would 
be unjustifiably low. He believed the net book value at that 
time should be somewhat lower than the 1937 figure but not 
much lower. As a result of these considerations, the general 
manufacturing superintendent recommended that a rate of 12 
per cent be used for depreciation on manufacturing machinery 
during the remainder of 1938. 



1. Should the rate have been reduced? 

2. Was the method of determining depreciation used by this 
company sound? 



356 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

UNITED STATES STEEL CORPORATION No. i 

POLICIES IN THE DETERMINATION OF THE COST OF PLANT 
AND THE AMOUNT OF DEPRECIATION 

One may distinguish in the history of the United States Steel 
Corporation, as far as problems in accounting for plant are con- 
cerned, five episodes which are related but bear evidence of a 
gradual change in corporation policy over a period of 36 years. 
The five episodes were: the acquisition of plant and properties in 
1 901 in connection with the organization of the corporation; the 
later acquisition of a group of companies in 1930; the practice 
followed for a number of years of writing off intangible values 
against earned surplus and of the construction of plant through 
the appropriation of surplus; the increase in depreciation and 
related reserves through a charge of $270,000,000 to surplus in 
1935; and the segregation of a remaining intangible element in 
plant in 1936 and its proposed elimination in 1938 through an 
adjustment of the stated value of common stock. These episodes 
are described in sections I-V below. 

The United States Steel Corporation was organized in 1901 as 
a holding company, its securities being exchanged for those of a 
group of steel companies already in operation. The first report 
of the new corporation was issued as of November 30, 1901. The 
balance sheet and a portion of the text describing the exchange of 
securities are reproduced below, at page 359. The basis used in 
determining the cost of plants in 1901 was not described fully in 
the first report, but the following statement appeared in later 
reports : 

The Gross Property Investment Account, inclusive of Intangibles 
... as carried in the consolidated balance sheet, is based on the 
amount of capital stock and bonds of the Corporation issued for the 
acquirement of the subsidiary companies and cash, plus cash expendi- 
tures made for additional property acquired since the organization of 
the Corporation. . . . 1 

Only in one year since 1901 has stock been issued in the 
acquisition of property. In that year the Atlas Portland Cement 
Company, the Columbia Steel Corporation, and the Oil Well 
Supply Company were acquired. Excerpts from the reports for 

1 Annual report, 1935. 



UNITED STATES STEEL CORPORATION NO. i 357 

1929 and 1930 describing these transactions are included at page 

364- 

During the years preceding 1929, the corporation wrote off 
$508,302,500 for intangible values, the charge being to earned 
surplus. It is difficult to trace these transactions in the reports, 
but evidently what occurred was a series of entries on the books 
of the holding company debiting surplus and crediting investments 
in subsidiaries, the results being reflected in the consolidated 
balance sheets as a decrease in surplus and in plant. It is interest- 
ing to observe that the amount $508,302,500, written off for 
intangible values and charged to earned surplus, was equal to 
the amount of common stock in the period from 1901 to 1927. 
The intangible value had previously appeared in plant on the 
consolidated balance sheet so that this process was in substance a 
write-down of plant against earned surplus. 

The corporation had also constructed plant through appropria- 
tions of earned surplus. The amount increased to $270,000,000 
in 1926, at which figure it was carried until the restatement in 
1935. Stated in other terms, this meant that funds arising from 
earnings had been invested in plant extensions in the amount of 
$270,000,000. The corresponding credit in the surplus account 
might have been allowed to stand in earned surplus or a stock 
dividend might have been declared, transferring the credit from 
surplus to capital. Instead the corporation set up the amount as 
Surplus Appropriated for and Invested in Capital Expenditures. 
The effect of the appropriation was to express the intention of the 
management not to pay dividends therefrom. The amount was as 
much a part of earned surplus after the appropriation as before, 
and was so recorded on the balance sheet. The annual report of 
1934 included for the first time a comprehensive statement as to 
the basis of valuation used in reporting property investment. 
This statement is given on page 367, together with plant and 
surplus as reported on the consolidated balance sheet for 1934 and 
a schedule giving additional detail with respect to property 
investment. It may be observed that the three phases in the 
development of plant accounting by the corporation described so 
far occurred before the depression or in its very earliest phases. 
The next two phases were part of the adjustment of corporation 
policy to new conditions brought about by the depression and by 
resultant changes in the steel industry. 



PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

In 1935 the net book value of plant was reduced $270,000,000 
by transferring that amount from appropriated surplus to reserve 
for depreciation and other offset reserves. This adjustment was a 
recognition of the fact that depreciation had occurred in prior 
years in an amount greater than had been reflected in the deprecia- 
tion charges of those years and that additions to the reserves 
were therefore needed to show fully the extent of depreciation. 
Excerpts from the report for 1935 describing this adjustment are 
included on page 369. 

In 1936 intangibles in the amount of $260,557,544 were shown 
as a separate element in the property investment section of the 
balance sheet, as indicated at page 371. 

In a letter from the chairman of the board to the stockholders 
prior to the meeting of stockholders on April 4, 1938, it was 
proposed that the stated value of the stock be reduced and that 
the intangible elements be written off against surplus so created. 
A summary of the proposed capital change, from the annual report 
for 1937, is given at page 373. In a sense this proposed elimination 
of intangibles in 1938 completed a cycle, because it was related to 
the occurrences of 1901 and was the culmination of a change 
which began in the early years of the corporation when a portion 
of intangibles was written off against earned surplus. 

It is the intention at this point to raise issues only in connection 
with plant accounting. In later chapters other issues involved 
in the facts will be raised in connection with capital and surplus, 
consolidations, and the determination of income. 



i Upon what basis was the cost of plant acquired in 1901 
determined? Was the same basis used in determining the cost 
of plant acquired through the issuance of stock in 1930? Should 
the corporation in 1901 have set up its plant on the basis of the 
tangible values involved? 

2. If, after the elimination of a large amount of initial surplus 
in 1902, and the writing off of intangibles against surplus in the 
period prior to 1929, a substantial amount of intangibles still 
existed in plant, what was the probable amount of the tangible 
element in plant in 1901? 

3. Did the charge to surplus of $270,000,000 in 1935 indicate 
that depreciation expense in prior years had been understated? 
What was the effect on reported income? 



UNITED STATES STEEL CORPORATION NO. i 359 

4. Were the several changes in policy with respect to plant and 
depreciation from 1901 to 1938 wise? In view of the situation 
existing in 1938, what action should the management have taken 
in establishing policies concerning plant and depreciation for 
the ensuing period? 

I. THE ACQUISITION OF PLANT AND PROPERTIES IN 1901 

These acquisitions were described in the first annual report 
of the corporation. 

BALANCE SHEET 

The date of this report renders it impracticable to give a complete 
balance sheet as of December 31, 1901, and consequently a balance 
sheet showing the condition of the companies at November 30, 1901, 
is submitted. It exhibits the assets and liabilities represented by the 
capital stocks of the Corporation and by outstanding stocks of sub- 
sidiary companies except that, for simplicity, it omits indebtedness 
from one company to another, as such sums though assets of one com- 
pany are liabilities of some other company. 

UNITED STATES STEEL CORPORATION 

CONDENSED GENERAL BALANCE SHEET 

NOVEMBER 30, 1901 

ASSETS 
Property Account Cost of properties owned 

and operated by the several companies. . . . $1,437,494,863 

Deferred Charges to Profit and Loss Ex- 
penditures for Improvements, Explorations, 
Stripping and Development at Mines, and 
for advanced Mining Royalties, which are 
to be charged to Future Operations of the 

Properties 3,256,774 

Investments: 

Outside Real Estate and other property. . . 429,613 

Current Assets: 

Inventories $ 95 , 603 , 998 

Stocks, Bonds and Securities of Outside 

Companies 7> 2 5 I >3 2 9 

Accounts Re- 
ceivable $45,269,453 

Bills Receivable 2,821,464 $48,090,917 

Cash 55,3 I 5528 

103 , 406 , 445 206 , 261 , 772 



$1,647,443,022 



360 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

UNITED STATES STEEL CORPORATION 

CONDENSED GENERAL BALANCE SHEET. (Continued) 

NOVEMBER 30, 1901 

LIABILITIES 
Capital Stock of U. S. Steel Corporation: 

Common $508,212,544 

Preferred 510,173,778 $1,018,386,322 

Capital Stocks of Subsidiary Companies Not 
Held by U. S. Steel Corporation (Par Value) : 

Common Stocks $ 365 ,436 

Preferred Stocks 293 , 300 

Lake Superior Consolidated Mines Sub- 
sidiary Companies 113,189 771,925 

Bonded and Debenture Debt: 

United States Steel Corporation Bonds $303,450,000 

Funded Debt of Subsidiary Companies held 

by the Public 59>349> 8 39 

Debenture Scrip 41 , 845 362,841,684 

Mortgages and Purchase-Money Obligations 
(Subsidiary Companies) : 

Mortgages $ 3>457>O38 

Purchase-Money Obligations 15,610,754 19,067,792 

Current Liabilities: 

Pay Rolls and Accounts Payable $ 22, 228,344 

Bills and Loans Payable (Subsidiary Com- 
panies) 12,653,744 

Special Deposits due employees and others 5,435,342 

Accrued Interest and Unpresented Coupons 4,870,410 

Common Dividend No. 2, payable Dec. 20, 

1901 5,081,790 50,269,630 

Contingent Liability: 

Payment contingent upon retention of leases 525, 399 

Sinking Funds and Reserves for Depreciation . 21 , 236 , 041 

Surplus of U. S. Steel Corporation and Sub- 
sidiary Companies 1 74 , 344 , 229* 

$1,647,443,022 
E. SHE ARSON, 
Comptroller 



* The surplus reconciliation statement of December 31, 1902 showed only $25,000,000 of 
initial surplus. In the balance sheet of December 31, 1902, plant was reported as follows: 

PROPERTY ACCOUNT: 

Properties owned and operated by the several com- 
panies $1,453,635,551 

Less Surplus of Subsidiary Com- 
panies at date of acquirement of 
their Stocks by U. S. Steel Corp- 
oration, April I, 1901 $116,356,111 

Charged off to Depreciation and 

Extinguishment Funds 12,011,857 128,367,968 

$1,325,267,583 

Note. The change in 1902 involved a decrease, both in consolidated surplus and in the book 
value of property, which served to eliminate from consolidated surplus the surplus of subsidiary 
companies at acquisition. 



UNITED STATES STEEL CORPORATION NO. i 361 

ORGANIZATION AND THE ISSUE or STOCKS AND BONDS 

The United States Steel Corporation was incorporated under the 
laws of the State of New Jersey, the original certificate of incorporation 
having been filed at Trenton, February 25, 1901, and the amended 
certificate, April i, 1901. By the amended certificate, the authorized 
capital stock of the Corporation was fixed at 11,000,000 shares of the 
par value of $100 each, equally divided into 5,500,000 shares of seven 
per cent, cumulative preferred stock (preferred as to both dividends 
and capital), and 5,500,000 shares of common stock. 

Of the total authorized capital stock, there have been issued, and 
at this date (January 10, 1902) are outstanding 5,102,056 shares of 
preferred stock, and 5,082,273 shares of common stock. The Corpora- 
tion also has issued $303,450,000 of five per cent, bonds secured by a 
Trust Indenture, dated April i, 1901, to the United States Trust 
Company of New York as Trustee. 

Substantially all of these bonds and shares have been issued to 
acquire the bonds and stocks of the subsidiary companies which were 
held by the public, as well as considerable amounts thereof, which 
belonged to members of the Syndicate and to the Syndicate Mana- 
gers, viz.: (i) the bonds and stock of the Carnegie Company and the 
capital stocks of the several other companies under the original agree- 
ment of March i, 1901, with J. P. Morgan & Co., Managers of a 
Syndicate which includes among its members and participants officers 
and directors of this Corporation; (2) the stocks of the American Bridge 
Company and the Lake Superior Consolidated Iron Mines under the 
agreement of April i, 1901, with J. P. Morgan & Co.; (3) the stocks of 
the Oliver Iron Mining Company and of the Pittsburg Steamship 
Company; and (4) the stocks of the Shelby Steel Tube Company, for 
which a contract was negotiated in June, 1901, with representatives 
of the stockholders of that company. 

DETAILS OF ISSUE OF STOCKS AND BONDS 

(i) 4,247,688 shares of the common stock and 4,249,716 shares 
of the preferred stock and $303,450,000 face value of bonds of the 
Corporation were issued in payment for the $25,000,000 in cash, paid 
to the Corporation by the Syndicate Managers, and for the stocks and 
bonds set forth in the following table, excepting 1,644 shares other- 
wise acquired, and directors' qualifying shares, viz.: 



362 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 



Federal Steel Company 


( Common Stock 


$ 46,483,700 


National Steel Company 


1 Preferred Stock 
( Common 


53,260,200 
31,970,000 


National Tube Company. . 


I Preferred 
( Common 


26,996,000 
40,000,000 


American Steel and Wire Company of New 
Jersey 


I Preferred 
( Common 


40,000,000 
49,981,400 


American Tin Plate Company 


I Preferred 
( Common 


39,999,000 
28,000,000 


American Steel Hoop Company 


I Preferred 
f Common 


18,325,000 
19,000,000 


American Sheet Steel Company 


V Preferred 
( Common 


14,000,000 
24,499,600 


Carnegie Company 


I Preferred 
( Common Stock 


24,499,600 
160,000,000 




I Bonds 


159,450,000 



(2) 722,025 shares of common stock, and 741,915 shares of pre- 
ferred stock of the Corporation were issued for the acquisition of 
$29,413,905 par value of stock of the Lake Superior Consolidated Iron 
Mines and $30,946,400 of common stock and $31,348,000 of preferred 
stock par values of the American Bridge Company; 

(3) 92,500 shares each of common and preferred stock of the 
Corporation were issued for the acquisition of an outstanding one- 
sixth interest in the Oliver Iron Mining Company and in the Pittsburg 
Steamship Company, thus securing the ownership of all of the stock 
of those two companies not owned by the Carnegie Company except 
directors' qualifying shares; and 

(4) 20,045 shares of common stock and 17,910 shares of preferred 
stock of the Corporation were issued for the acquisition of $8,018,200 
of common stock and $4,776,100 of preferred stock, par values, 
of the Shelby Steel Tube Company under the contract above mentioned. 

The Aragon Iron Mines leasehold and the stock of the Bessemer 
Steamship Company have been purchased for cash paid and payable 
by this Corporation or by some of the subsidiary companies above 
mentioned. 

All of the bonds of the Carnegie Company and all of the stocks of 
the companies acquired as above mentioned by the United States 
Steel Corporation, have been lodged with the United States Trust 
Company, as Trustee, for the benefit of the Corporation and its stock- 
holders, and to secure the payment of the $304,000,000 bonds of the 
Corporation authorized by the deed of trust of April i, 1901. This 
deposit affords security to stockholders as well as bondholders against 
diversion or depletion of these important assets of the corporation. 

Circulars, dated March 2, and April 2, and 8, 1901, addressed to 
the holders of shares of the several companies therein specified were 
issued and published by the Syndicate Managers. At the rates 
offered in the circular dated March 2, 1901, the Syndicate acquired 



UNITED STATES STEEL CORPORATION NO. i 363 

* 

the common stocks and preferred stocks of the seven companies (other 
than the Carnegie Company) as above mentioned, and thereupon sold 
and transferred the same to this Corporation under the contract of 
March i, 1901. The Syndicate delivered to the holders of such stocks 
of said seven companies in the aggregate of 2,694,909 shares of common 
stock and 2,616,957 shares of preferred stock of this Corporation. The 
Syndicate acquired sixty per cent. ($96,000,000) of the stock of the 
Carnegie Company, and $159,450,000 face value of the five per cent, 
bonds of the Carnegie Company by delivering to the holders thereof 
said $303,450,000 of bonds of this Corporation and $1,200,000 in cash; 
and the Syndicate acquired the remaining forty per cent. ($64,000,000) 
of the stock of the Carnegie Company by delivering to the holders 
thereof 982,771 shares of preferred stock and 902,790 shares of the 
common stock of this Corporation. 

The residue of the common and preferred stock of this Corporation 
delivered to the Syndicate under the contract of March i, 1901, and 
not used for the acquisition by it of the stocks of the specified com- 
panies, being the shares which, as stated in the Syndicate circular of 
March 2, 1901, were to be retained by and to belong to the Syndicate, 
amounted to 649,987 shares of preferred stock, and 649,988 shares of 
common stock. This residue of stock or the proceeds thereof, after 
reimbursing the Syndicate the $25,000,000 in cash which it paid to 
the Corporation, and approximately $3,000,000 for other Syndicate 
obligations and expenses, constituted surplus or profit of the Syndicate. 

The transactions between this Corporation and the Syndicate hav- 
ing been concluded, an agreement of final settlement and mutual 
release, dated January 3, 1902, was executed between this Corporation 
and the Syndicate Managers. 

It will be noted that this Corporation has received and now owns 
in the aggregate more than ninety-nine and three-fourths per cent, of 
the shares of all the specified companies. The acquisition of so large 
a proportion of the shares had enabled the Corporation promptly to 
enter upon the accomplishment of the principal objects which induced 
its formation, and has facilitated the fulfilment of the original expec- 
tations of large reductions in expenditures for improvements, of 
increased earnings applicable to dividends, and of greater stability of 
investment, without increasing the prices of manufactured products. 



364 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

II. THE ACQUISITION OF A GROUP OF COMPANIES IN 1930 

PURCHASE OF THE ATLAS PORTLAND CEMENT COMPANY AND COLUMBIA 
STEEL CORPORATION PROPERTIES 1 

During the year the Corporation after extended negotiation and 
investigation entered into contracts for the purchase of the properties, 
assets and business of The Atlas Portland Cement Company and of the 
Columbia Steel Corporation. The properties were transferred to the 
Corporation in January, 1930, and payment was made for same wholly 
in shares of Common stock of United States Steel Corporation, 176,265 
shares having been delivered for the Atlas and 251,771 shares for the 
Columbia Steel properties. The total cash value of the properties, 
assets and business of these companies acquired as stated was appraised 
by the Corporation at not less than $31,137,000 in the case of the 
Atlas and not less than $41,375,000 in case of Columbia. Further 
particulars respecting these properties, including the division of the 
respective total values between fixed property and net liquid assets, 
will be submitted in 1930 annual report. 

The Atlas Portland Cement Company owned and operated six 
cement plants located at Northampton, Pa., Hudson, N. Y., Hannibal, 
Mo., Leeds, Ala., Independence, Kan., and Waco, Texas, with many 
years supply of raw material for manufacture of cement located con- 
tiguous to these plants. The plants have an annual capacity of 
t8,ooo,ooo barrels. The plants, it will be observed, are all located in 
and serve territories almost wholly far removed from the territories 
(Pittsburgh, Chicago and Duluth) in which are located the cement 
plants previously controlled by the Corporation. The acquisition of 
the Atlas plants, accordingly, broadens widely the territory served by 
the Corporation in the marketing of Cement and without in any 
appreciable degree enlarging its product available for distribution in 
territory heretofore supplied. The Atlas Portland Cement Company 
was one of the oldest producers of Cement in the United States, its 
brands and service are highly esteemed by consumers and it is believed 
that the acquirement of its properties and their operation by the 
Corporation's subsidiary, Universal Atlas Cement Company, will 
prove satisfactory in every way to consumers and the Corporation. 

The Columbia Steel Corporation owned and operated steel pro- 
ducing plants and rolling mills at Pittsburg, Cal., (30 miles from San 
Francisco), at Torrance, Cal., (on the outskirts of Los Angeles), a steel 
foundry at Portland, Ore.; and a blast furnace and by-product coke 
plant at Provo, Utah, (40 miles from Salt Lake City). It also owned 
extensive iron ore, coal and limestone deposits in Utah. The annual 
capacities of these plants are: Coke, 297,000 tons; Pig Iron, 175,000 
tons; Steel Ingots, 340,000 tons; Finished Rolled Steel Products, 
286,000 tons; Steel Castings, 25,000 tons. The principal rolled steel 
products manufactured are: Merchant and Reinforcing Bars, Light 

1 Annual report, 1929. 



UNITED STATES STEEL CORPORATION NO. i 365 

Structural Shapes, Wire Mill products, Sheets (black and galvanized) 
and Tin Plate. 

For several years the United States Steel Corporation has had under 
consideration the establishment of steel producing and manufacturing 
operations in Pacific Coast territory, the better to serve its existing 
trade as well as to prepare for the future growth of both domestic and 
foreign trade by service from coast plants. The manufacturing opera- 
tions of substantial character which it had nearest to the Pacific Coast 
in respect of cost of delivery were at Birmingham, Ala., and in the 
Pittsburgh, Pa., District. The steel consumption in the Pacific Coast 
territory is important and it was economically logical, therefore, that 
the Corporation establish producing plants in that territory. 

The properties of Columbia Steel Corporation having been offered 
to the Corporation on terms considered reasonable and on which it 
was felt a satisfactory return would immediately be earned by the 
properties, their purchase was decided upon after an extended and 
exhaustive examination, inspection and study of the properties and 
their possibilities. This purchase of the Columbia properties affords a 
nucleus from which it is confidently believed the productive capacity 
on the Pacific Coast can be expanded from time to time to the interests 
of consumers, of the territory and of the Corporation. 



PURCHASE OF OIL WELL SUPPLY COMPANY'S PROPERTIES 1 

The properties and business of the Oil Well Supply Co. (a Penn- 
sylvania corporation) were acquired as of October i, 1930. These 
were acquired free from obligations except as to current liabilities 
which were largely exceeded by current and working assets received 
in the purchase. Such acquirement furnished to the United States 
Steel Corporation an established organization operating throughout 
the United States and abroad as a medium for the distribution to 
consumers, and under the special conditions attaching to the develop- 
ment and operation of oil and gas properties, of a large quantity of 
steel pipe, wire rope and other products of the subsidiary companies 
used in the oil and gas fields. In addition the Oil Well Supply Com- 
pany handles a complete line of equipment and machinery of its own 
manufacture and of the production of others, likewise sold for similar 
use. The Oil Well Supply Company has manufacturing plants at 
Oil City, Pa., (Imperial Works), Bradford, Pa., Braddock, Pa., (Wilson- 
Snyder Manufacturing Company), Oswego, N. Y., Poplar Bluff, Mo., 
Tulsa, Okla. and Los Angeles, Cal. It has also 17 general repair 
shops and 89 distributing stores located throughout all oil and gas 
producing fields in United States and Canada. These properties 
together with the net working assets of Oil Well Supply Company were 
acquired at the inventoried appraised value of $19,057,930. 



Annual report, 1930. 



366 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

The gross property investment account was increased during the 
year by amounts as follows: 

Investment cost of fixed properties, plants and business of The 
Atlas Portland Cement Co., Columbia Steel Corporation and Oil Well 
Supply Co. acquired by purchase during the year and paid for by 
issue of Common stock therefor . . . $50,519,537 

CAPITAL STOCK 

Shares Par Value 

Issues of additional Common Stock were made in 
the purchase of properties, plants, business and 
net current and working assets during the year 
as follows: 

Atlas Portland Cement Company 176, 265 $ 17,626,500 

Columbia Steel Corporation 251 , 771 25, 177, 100 

Oil Well Supply Company 108,402 10, 840, 200 

536,438 $ 53 > 6 43 > 8 <*> 

To employes of United States Steel Corporation 
and its subsidiary companies upon full pay- 
ment by them for shares subscribed for under 
the Employe's Stock Subscription Plan 18,157 1,815, 700 

Total issues in the year 554,595 $ 55>459>5o 

The foregoing shares were issued in consideration 
of value received for the same, as follows: 

Value of properties, plants and business of the 

three companies acquired as above $50, 519, 537 

Value of net current and working assets of such 

companies acquired in their purchase 41 ,050, 798 

Payments made by employes for the subscrip- 
tion price of stock subscribed for as stated ... 3 , 029 , 873 94 , 600 , 208 

Excess of value received over par value of the 
shares issued, carried in balance sheet in 

"Premiums on Capital Stock" $ 39,140,708 

Total Capital Stock outstanding, December 31, 
1930: 

Common 8,687,435 $868,743,500 

Preferred 3,602,811 360,281,100 



UNITED STATES STEEL CORPORATION NO. i 367 

III. THE REDUCTION OF INTANGIBLE VALUES 

ANNUAL REPORT FOR 1934 



The gross Property Investment Account, inclusive of Intangibles, is 
stated in the assets as shown by the consolidated balance sheet, based 
on the valuations represented by capital stock and bonds of the Corpo- 
ration issued for acquirement of the subsidiary companies and cash, 
plus cash outlays made for additional property acquired since the 
organization of the Corporation, and less (a) the sum of $508,302,500 
written off for Intangible values, as heretofore shown in previous 
annual reports, and (b) credits for investment value or cost of property 
sold, retired or otherwise disposed of. In addition, as shown in table 
on page 368, the sum of $833,232,096 has been provided from income 
for account of accrued depletion, depreciation, obsolescence and 
amortization of the present gross investment value or cost at which 
existing property is carried. 



CONSOLIDATED GENERAL BALANCE SHEET 

ASSETS 

Property Investment Accounts 
Properties Owned and Operated by the Several Companies, 

per Table on Page 368 

Balance of this account as of December 31, 1934, less 
Depletion, Depreciation and Amortization Reserves ... $i , 626 , 143 , 782 



LIABILITIES 



Reserves and Surplus 
Contingent, Miscellaneous Operating and Other Reserves $ 23,764,236 

Insurance Reserves 46,129,371 

Earned Surplus 
Undivided Surplus of United States Steel 

Corporation and Subsidiary Companies. $258,575,628 
Appropriated for and invested in Capital 
Expenditures 270,000,000 

528,575,628* 



* This Balance of Surplus is subject to revision upon completion during 1935 of an analysis 
of Investment in Physical Property now in progress, involving also revision of depreciation 
accruals for previous years. 

That part of the Surplus of Subsidiary Companies representing Profits on sales of materials 
and products to other subsidiary companies and on hand in latters* Inventories is, in this Balance 
Sheet, deducted from the amount of Inventories included under Current Assets. 

Cumulative preferred Dividends Unpaid at December 31, 1934 amount to il\i% or $40,- 
531,624. 



368 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

PROPERTY INVESTMENT ACCOUNT, DECEMBER 31, 1934 

Gross Fixed Property Investment Account, 
December 31, 1933, inclusive of balance of 
Intangibles but exclusive of Stripping and 
Mine Development and Structural Erec- 
tion Equipment $2,430,633,695 

Add: Property Investment accounts of con- 
trolled companies which have not hereto- 
fore been included in the consolidated 
organization's accounts (covers princi- 
pally the minority proportion of the fixed 
assets of Pittsburg, Bessemer & Lake 
Erie R. R. Co.) . . .^ 10,861,259 

Net of sundry adjustments to Property 

Account in 1934 849 , 807 

$2,442,344,761 
Capital Expenditures on Property Account in 

1934 (ex. Stripping and Development). . . $ 9,777,895 
Less, Realizations from Sales and Dismantle- 
ment of property creditable Investment 
Account 1,511,100 



Net Expenditures for new construction 

in the year 8,266,795 

$2,450,611,556 

Less, Amounts written off in year 1934 to 
Depletion and Depreciation Reserves for 
investment cost of natural resources ex- 
hausted and of improvements, equipment 
and facilities abandoned and retired 28, 1 18 , 5 15 

Gross Fixed Property Investment De- 
cember 31, 1934-. . -. $2,422,493,041 

Less, Balances in Depletion, Depreciation, 
Obsolescence, Amortization and Current 
Maintenance Reserves, at December 31, 
1934 833,232,096 

Net Fixed Property Investment De- 
cember 31, 1934. . . $1,589,260,945* 

Investment in Stripping and Development at 
Mines and Structural Erection Equip- 
ment: 

Balance at December 31, 1933 $37 , 835 , 840 

Expended during the year 1934 i ,429,386 

$39,265,226 
Less, Charged off in 1934 in operating 

expenses 2,382, 389 

Balance December 31, 1934 36,882,837 

Total of Property Investment Account, 
December 31, 1934, inclusive of balance 
of Intangibles, per Consolidated General 
Balance Sheet $1,626,143,782 

* The reported balance of Net Fixed Property Investment at December 31, 1934, is subject 
to possible adjustment of depreciat^n accruals upon completion during 1935 of the Analysis of 
Physical Property Investment now in progress. 



UNITED STATES STEEL CORPORATION NO. i 369 

IV. THE ADJUSTMENT OF PROPERTY INVESTMENT THROUGH A 
CHARGE TO APPROPRIATED SURPLUS 

The following statement appeared in the annual report of the 
United States Steel Corporation for December 31, 1935: 

There was completed during the year a detailed analysis of the 
investment in depreciable property, which, as stated in the annual 
report for 1934, had been undertaken by the subsidiary companies. 
This analysis resulted in adjustments of the Property Investment 
account effecting a reduction of net book values. Broadly, these 
adjustments are attributable to the developments in the art and 
mechanics of steel making which have operated to reduce the normally 
expected life of such facilities, and to changes in plant location based 
upon shifting markets and transportation facilities. The factors 
involving present or prospective abandonments of obsolete units, 
from time to time, impose unusual depreciation charges which the 
property survey has attempted to record as reflecting present condi- 
tions. The above adjustment, amounting to a net of $88,720,028, has 
been effected by transferring that amount from the Surplus account 
termed " Appropriated for and Invested in Capital Expenditures/' 
which heretofore was carried at $270,000,000. The remainder of the 
account, $181,279,972, has been transferred to and converted into a 
general reserve for amortization of property investment valuations. 

In view of the fact that the surplus account " Appropriated for and 
Invested in Capital Expenditures" was invested in fixed property, it 
was considered advisable that the adjustment and transfer as described 
should be made as indicated. Capital investment expenditures to the 
amount of $181,279,972 having heretofore been financed specifically 
by such segregated surplus account, it follows that future depreciation 
allowances should not be made therefor in reporting consolidated net 
income. This reduction in annual depreciation allowances will, how- 
ever, be offset, in part at least, by increased allowances in calculated 
future depreciation charges which will result from the revised deprecia- 
tion rates indicated by the analysis above mentioned. 

The gross Property Investment Account, inclusive of Intangibles, 
... as carried in the consolidated balance sheet, is based on the 
amount of capital stock and bonds of the Corporation issued for the 
acquirement of the subsidiary companies and cash, plus cash expendi- 
tures made for additional property acquired since the organization of 
the Corporation and less (a) the sum of $508,302,500, heretofore written 
off for Intangible values which was provided from Earned Surplus, 
and (b) credits for investment value of property sold, retired or other- 
wise disposed of. ... the balance of the reserves provided from 
income and surplus for accrued depletion, depreciation, obsolescence 
and amortization of the present gross investment in plant and property 
amounts at December 31, 1935, to an aggregate of $1,124,107,708. 



370 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

These reserves include the adjustments of $88,720,028 and the transfer 
of the $181,279,972 mentioned in the preceding paragraphs. 

The following quotation is from the Wall Street Journal, 
April 4, 1936: 

The steel plants of the United States should be replaced every 18 
or 20 years, President W. A. Irvin of U. S. Steel Corp., told the Senate 
Interstate Commerce Committee Friday. Although his company 
last year set aside $47,000,000 for obsolescence and depletion, in the 
past companies have been rather remiss in failing to lay aside sufficient 
funds for rebuilding and replacing plant and equipment. 

This was just one of the many phases of the industry that the 
president of the world's largest steel company discussed with com- 
mittee members. Primary purpose of the meeting was to ascertain 
his views on the effect of outlawing the basing point system. 

V. THE SEGREGATION AND ELIMINATION OF INTANGIBLES IN THE 

PLANT ACCOUNT 

A statement from the text relative to plant, excerpts from the 
balance sheet, and a detailed schedule on the property investment 
account are given for 1936. 

The gross Property Investment Account (inclusive of Intangibles) 
as shown in table on page 372 and as carried in the consolidated bal- 
ance sheet, is based on the amount of capital stock and bonds of 
United States Steel Corporation issued for the acquirement of the 
subsidiary companies and for cash, plus expenditures made for addi- 
tional property acquired since the organization of the Corporation 
and less (a) the sum of $508,302,500 which was provided from earned 
surplus and heretofore written off for account of intangible values, and 
(b) credits for investment value of property sold, retired or otherwise 
disposed- of. As shown also in table on page 372, the balance of the 
reserves provided from income and surplus for accrued depletion, 
depreciation, obsolescence and amortization of the present gross invest- 
ment in plant and property, amounts at December 31, 1936, to an 
aggregate of $1,142,337,830. 



UNITED STATES STEEL CORPORATION NO. i 371 

UNITED STATES STEEL CORPORATION AND SUBSIDIARY COMPANIES 
COMPARATIVE CONSOLIDATED GENERAL BALANCE SHEET 

December 31, 

1936 
ASSETS 
Property Investment Account 

Properties Owned and Operated by Subsidiary Companies, 
per Table page 372 

Tangible , $2,231,817,568 

Intangible 260,557,544 



$2,492,375,112 

Less, Depletion, Depreciation, Obsolescence, Amor- 
tization and Current Maintenance Reserve Balances 1,142,337,830 

$1,350,037,282 
LIABILITIES 



Reserves and Surplus 

Contingent, Miscellaneous Operating and Other Reserves $ 32,120,693 

Insurance Reserves 45,937,646 

Undivided Earned Surplus of U. S. Steel Corporation and 

Subsidiary Companies 252,660,717 

$ 330,719,056 



372 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

UNITED STATES STEEL CORPORATION AND SUBSIDIARY COMPANIES 

PROPERTY INVESTMENT ACCOUNT 

DECEMBER 31, 1936 



Property 
Classifications 


Gross Property 
Investment 
December 31, 
1935 


Capital Expendi- 
tures on Property 
Account in 
1936 (Net) 


Write-offs to 
Depletion, 
Depreciation 
and 
Amortization 
Reserves and 
Other 
Adjustments 


Gross Property 
Investment 
December 31, 
1936 


Real Estate 


$ 108,218,056 
1,720,453,500 

337,918,302 
260,579,477 


Cr. $ 463 , 397 
60,801,637 

12,394,508 
Cr. 19,523 


$ 145,557 
32,684,703 

6,844,379 
2,409 


$ 107,609,102 
1,748,570,434 

343 , 468 , 432 
260,557,544 


Plant, Mineral and 
Manufacturing 
P rope r t ic s and 
Equipment (a) ... 
Transportation Prop- 
erties Railroads, 
Lake and Ocean 
Steamships 
Intangibles (see note). 

Total 


$2,427,169,335 


$72,713,225 


$39, 677, 048 (b) 


$2,460,205,512 
1,142,337,830 




Less, Balances at Dece 
Obsolescence, Amort 

Net Fixed Propert 
Investment in Strippm 
tion Equipment: 
Balance at Decembe 
Expended during the 

Less, Charged off in 
Balance December 

Property Investm 
Intangibles) per 


mber 31, 1936, ... in Depletiot 
zation and Current Maintenance '. 

y Investment December 31, 1936 
g and Development at Mines and 

r 31 1935 . 


i, Depreciation, 
Reserves 


$1,317,867,682 
32, 169,600 


Structural Erec- 

Skt C Aftt -7-2 T 


year 1936 . 2.1 70 . 076 


1936 to operating expenses 


' *-* ' * ' 


$37,601,207 
5,431,607 


31, 1936 . . . 

ent Account, December 31, 1936 (inclusive of 
Consolidated General Balance Sheet 


$1,350,037,282 



(a) Includes Dock and River Transportation equipment auxiliary to and a part of manu- 
facturing properties. 

(b) Includes: 

Write-offs to Depletion, Depreciation and Amortization Reserves.. $38,441,150 

Write-offs charged to Profit and Loss and/or operating expense for 

facilities abandoned or retired and not replaced .. .. ... 1,402,903 

Net of Sundry Adjustments to Property Account Dr. 167,005 

$39,677,048 

Note. Following the completion of the detailed analysis of the investment in depreciable prop- 
erty, which was referred to in the annual report for the year ended December 31, 1935, a calcula- 
tion has been made of the amount which is comprehended in the combined assets of the Corpora- 
tion and the subsidiary companies as represented in the Consolidated Balance Sheet, for the 
investment cost of the capital stocks of tne subsidiary companies in excess of their own invest- 
ments in tangible assets. This calculation is based in part on the valuations assigned to the 
tangible assets as estimated by the United States Bureau of Corporations in its survey and 
report on the formation of the Corporation in 1901, and in part upon net book values of the 
tangible assets of companies subsequently acquired. It is subject to possible adjustment as 
further continuing investigations under way indicate may be necessary. 



UNITED STATES STEEL CORPORATION NO. i 373 

ANNUAL REPORT, 1937 

Changes Proposed In Capital Structure 

At the annual meeting on April 4th, 1938, the stockholders of the 
Corporation will be asked to authorize certain changes in the Corpora- 
tion's capital structure. In a letter dated February 21, 1938, addressed 
to the stockholders, the object and scope of the proposed changes were 
set forth. The changes are in the form of two amendments to the 
certificate of incorporation, and may be summarized as follows: 

1. To change each share of authorized common stock of the Cor- 
poration with par value ($100) into one share of common stock without 
par value; to decrease the capital of the Corporation by reducing to $75 
the capital represented by each share of the issued and outstanding 
common stock as so changed; and to increase the authorized common 
stock as so changed from 12,500,000 shares to 15,000,000 shares. 

2. Without impairing any of the charter restrictions as to the 
issuance of secured obligations, to confer on the Board of Directors 
authority to issue, at such times and for such consideration as the 
Board of Directors may determine, bonds, debentures and other 
obligations of the Corporation convertible into common stock of the 
Corporation. 

The Board of Directors believes it is important and in the best 
interests of the stockholders that the capital structure of the Corpora- 
tion be made more flexible so as to give the Board a wider choice in 
selecting from time to time the method of financing most suitable to 
the particular occasion. The Board cannot now authorize the issue 
and sale of the common stock for less than $100 per share or the issue 
and sale of any bonds, debentures or other obligations convertible into 
common stock. When the proposed amendments shall have become 
effective, the issue and sale of common stock without par value or of 
bonds, debentures or other obligations convertible into common stock 
will be legally possible at such price as the Board may, from time to 
time, deem advisable. However, the common stockholders will have 
pro rata subscription rights as to any common stock or any obliga- 
tions convertible into common stock hereafter issued and sold for cash. 

Although it is proposed that the now outstanding 8,703,252 shares 
of common stock with a par value of $100 per share be changed into 
common stock without par value, share for share, it is necessary to 
name some amount as the stated capital for each such share of common 
stock without par value. The Board of Directors have accordingly 
proposed that such stated capital for the outstanding common stock 
without par value shall be $75 per share. This will effect a decrease 
of the capital of the Corporation to the extent of $217,581,300, this 
sum being the difference between the capital represented by the 
8,703,252 shares at the stated value of $75 per share and the aggregate 
par value of the now outstanding 8,703,252 shares of common stock of 
the par value of $100 each. This decrease. of $217,581,300 in capital 



374 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

will add an equal amount to the capital surplus of the Corporation 
(which now amounts to $81,250,021, representing the premium above 
par heretofore received by the Corporation upon the issuance of certain 
shares of its par value common stock), thereby increasing the capital 
surplus to $298,831,321. 

It is contemplated that as soon as the amendment with respect to 
common stock without par value has become effective, the item of 
intangible assets which appears as $260,368,522 in the consolidated 
balance sheet at December 31, 1937, will be reduced to $1.00, the dif- 
ference of $260,368,521 to be charged against the above-mentioned 
capital surplus of $298,831,321. The value of these intangible assets 
will not be affected by the change of the amount at which they are 
carried on the consolidated balance sheet; nevertheless it seems 
advisable in view of their intangible character, to carry them on the 
consolidated balance sheet, at the nominal value of $1.00. When such 
readjustment shall have been made, the balance sheet will show a 
capital surplus of $38,462,801, in addition to earned surplus, which at 
December 31, 1937, amounted to $280,356,144. 

The proposed amendments will effect no change in the intrinsic 
value of the Corporation's assets or in the number of shares or intrinsic 
value of the common stock now outstanding. No change is made 
in the preferred stock. However, additional common stock without 
par value or obligations convertible into common stock, to which the 
common stockholders will have the right to subscribe if sold for cash, 
may thereafter be issued and sold as above stated. 

The adoption of each of these amendments requires the approval 
of holders of record at the close of business March 5, 1938, of two- 
thirds of each class of the then outstanding shares of preferred and 
common stock. These amendments have been declared advisable by 
the Board of Directors, who recommend that they be approved and 
adopted by the stockholders at the annual meeting. 

Exhibit i gives figures relative to the stock outstanding, 
earnings, dividends, and market prices. Exhibit 2 has been 
prepared to show certain figures concerning plant on as nearly 
comparable a basis as possible. At a number of points, especially 
in the earlier years, a different interpretation of the data available 
would have yielded somewhat different figures. The figures are 
all taken from the reports and anyone interested in a more detailed 
analysis may trace therein those selected. Subject to these 
qualifications, it is possible to obtain for the United States Steel 
Corporation data on the administration of plant for a longer period 
than is possible for most other large corporations. 



UNITED STATES STEEL CORPORATION NO. i 375 



EXHIBIT i 

UNITED STATES STEEL CORPORATION 
(ooo omitted) 



Year 


Com- 
mon 
stock 


Pre- 
ferred 
stock 


Net 
income 
before 
divi- 
dends 


Divi- 
dends, 
pre- 
ferred 


Divi- 
dends, 
com- 
mon 


Surplus 


Preferred 


Common 


Yearly high and low, New 
York Stock Exchange 


High 


Low 


High 


Low 


11/30/01 
1902 
1903 
1904 
1905 


$508,212 
508,302 
508,302 
508,302 
508,302 


$510,174 
510,281 
360,281 
360,281 
360,281 


$ 61,420 
90,307 
55,417 
30,268 
68,585 


$26,753 
35,720 
30,404 

25, 220 

25,220 


$15,228 
20,333 
12,707 


$174,344 
77,875 
66,097 
61,365 
84,738 


101% 
97% 
89% 
95% 
107 


69 
79 
49% 
5i*4 
90 H 


% 

39% 
33% 
43% 


2 4 
29% 

10 

8 tl 
24% 






1906 
1907 
1908 
1909 
1910 


508,302 
508,302 
508,302 
508,302 
508,302 


360,281 
360,281 
360,281 
360,281 
360,281 


98, 129 
104,566 
45,729 
79,074 
87,407 


25,220 

25,220 
25, 22O 
25,220 
25.22O 


10, 166 
10,166 
10, 166 
20,332 
25,415 


97,721 
122,645 
133,415 
167,735 
204, 143 


113*4 

107% 

114*6 
131 
125% 


98% 
79*1 
87% 
I07 J 4 
110% 


50*4 
50% 
58% 
94% 
91 


32% 
21% 

25% 

4I*i 
6l% 


1911 
1912 
1913 
1914 
1915 


508,302 
508,302 
508,302 
508,302 
508,302 


360,281 
360,281 
360,281 
360, 281 
360,281 


55,300 
54,240 
81,217 
23,497 
75,834 


25,220 
25,220 
25,220 
25,22O 
25,220 


25,415 
25,415 
25,415 
15,249 
6,354 


173,691 
176,716 
206,798 
190, 204 
235,025 


120% 
117 
rio% 

112% 

117 


103 
107 

102% 

103*4 

IO2 


82% 

80% 
69% 
67*4 
89*1 


50 

5M 
49% 
48 
38 


1916 
1917 
1918 
1919 
1920 


508,302 
508,302 
508,302 
508,302 
508,302 


360,281 
360,281 
360,281 
360,281 
360,281 


271,532 
224,220 
137,532 
76,795 
109,694 


25,220 
25,220 
25,22O 
25,22O 
25,220 


44,476 
86,411 
71 , 162 
25,415 
25,415 


436,361 
541,661 
577,787 
603,947 
664,354 


123 

I2IW 

H3*I 
H7% 
H5% 


115 

102% 

108 

111% 
104% 


129% 
136% 
116% 

ns*i 

109 


79% 
79*i 
86% 
88% 
76% 


1921 
1922 
1923 
1924 
1925 


508,302 
508,302 
508,302 
508,302 
508,302 


360,281 
360,281 
360,281 
360,281 
360,281 


36,617 
39,653 
108,707 
85,067 
90,603 


25,220 
25,22O 
25,220 
25,220 
25,22O 


25,415 
25,415 
29,227 
35,58i 
35,581 


649,826 
640,038 
693,650 
7i7,96o 
761,863 


us 

123 

123% 

123 

126% 


IQ 5 
H3% 
116% 
"8*g 

122% 


86% 
1 1 1*| 
109*6 
121 
139% 


70% 
82 
85% 
94% 

112% 


1926 
1927 
1928 
1929 
1930 


508,302 
711,623 
711,624 
813,284 
868,744 


360,281 
360,281 
360,281 
360,281 
360,281 


116,667 
87,897 
114,174 
197,592 
104,422 


25,220 
25,22O 
25,220 
25,220 
25,220 


35,581 
49,814 
49,814 
63 , 849 
60,366* 


823,502 
633,045 
680,277 
704,711 
741,783 


130% 
141*1 
147*4 
144% 
151*4 


I24K 
129 

138*3 
137 
140 


160% 
160*121 
172% 
261% 
198*2 


117 
IIl**t 
132*6 
150 
134** 


I93i 
1932 
1933 
1934 
1935 


870,325 
870,325 
870,325 
870,325 
870,325 


360,281 
360,281 
360,281 
360,281 
360,281 


13,038 
71, 176^ 
36,501^ 
2i,668d 
1,147 


25,220 
2O,7l6 
7,206 
7,2O6 
7,206 


36,984 


691,837 
599, 100 
557,331 
528,576 
252,517 


150 
H3 
105% 
99*i 
119*4 


S* 

I?M 

73*1 


152% 

52** 
67% 

59% 
50% 


36 

21*4 

23*2 
29% 
27 *i 










1936 
1937 


870,325 
870,325 


360,281 
360,281 


50,583 
94,944 


50,439 
58,546 




252,661 
280,356 


154% 
ISO 


ii sH 

ioo>i 


79% 
126% 


46% 
48** 


8,703 



* Includes $11,373.25 for March 30, 1931, dividend on common stock issued in January 
and February, 1931, under Employes' Stock Subscription Plan. 

t This represents new common after 40 % stock dividend. Stock dividend paid June I, 1927. 

d - deficit. 

Sources: Company reports and Bank and Quotation Record. 



376 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 



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UNITED STATES STEEL CORPORATION NO. i 



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377 



378 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 
AMERICAN TELEPHONE AND TELEGRAPH COMPANY No. 2 

THE RELATION BETWEEN DEPRECIATION AND WORKING CAPITAL 

The following statement was made concerning the dividend 
policy of the company during the period from 1932-1935: 

Despite charges against surplus of approximately $55,800,000, 
$67,600,000, $56,800,000, and $35,000,000 in 1932, 1933, 1934, and 
1935 respectively, as a result of dividend payments in excess of earn- 
ings, consolidated net working capital of the company showed increases 
in the last two years. On December 31, 1935, cash and temporary 
cash investments alone totaled more than $267,000,000 as compared 
with $219,000,000 at the end of 1933 and $204,000,000 at the end of 
1932. That maintenance of the regular dividend rate did not bring 
about any depletion of the company's working capital was a result 
of the fact that the annual provisions for depreciation were in excess 
of the amounts by which the company failed to earn its full dividend 
requirements. 

A consolidated income statement for the Bell System for 1935 
is given at pages 552-553 and a consolidated surplus statement 
at page 554. 



1. Did each item of income recorded on the income statement 
imply an equivalent increase in working capital? Did each item 
of expense which appeared there imply that working capital 
decreased in an equivalent amount? 

2. As far as the facts recorded on the income statement are 
concerned, what was the indicated amount of change in working 
capital during 1935? 

3. How were these facts related to the ability of the American 
Telephone and Telegraph Company to pay dividends in excess 
of net income? 



PULLMAN, INC. 379 

PULLMAN, INC. 

THE RELATION OF DEPRECIATION POLICY TO WORKING CAPITAL 
AND CAPITAL STRUCTURE 

Pullman, Inc., is engaged in the operation of sleeping and 
parlor cars, in the manufacture and repair of cars for its own use, 
and in the manufacture of cars for sale to railroads. It has 
pursued consistently for many years a policy with respect to 
depreciation which led to a reserve in 1936 of 51.9 per cent of 
total plant. The policy in depreciation has differed radically 
from that of the railroad industry with which the company is 
closely associated. The company has also operated without 
funded debt and in 1936 had no securities outstanding other than 
common stock. At that time common stock and surplus were 
87.1 per cent of total assets. 

The balance sheet, income statement, and surplus statement of 
Pullman, Inc., for 1936, together with the certificate of the 
public accountants from the annual report of that year, are shown 
below. 

Pullman, Inc., was organized in 1927 in pursuance of a plan 
of reorganization to take over the Pullman Company and the 
Pullman Car and Manufacturing Company. 1 There was an 
adjustment of plant upward, based on appraisal, when the new 
corporation was formed, which was related to the Initial Surplus 
of $101,095,746 shown in the balance sheet for December 31, 
1927. A write-down of plant and of certain other assets occurred 
in 1932. Excerpts from the annual report of 1932 concerning the 
write-down of that year are shown below. 

Each of the annual reports included a schedule in comparative 
form giving traffic and operating statistics for Pullman Company. 
These figures are included in Exhibit i on an annual basis for 
1932-1936 and triennially for 1923-1929. 

Several exhibits below give amounts taken from the annual 
statements relative to the construction and retirement of plant, 
depreciation, dividends, and the accumulation of surplus. The 
figures are not entirely comparable for different years because of 
the reorganization in 1927 and the acquisition of the Standard 



1 Annual report, 1927. 



380 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

Steel Car Company and Osgood Bradley Car Company in 1929, 
but they reflect the changes involved in the development and 
application of the depreciation policy. The figures are relatively 
complete for the four years 1933-1936. As in the case of most other 
companies, it is difficult to obtain from the reports readily com- 
parable figures for earlier years. This is in large part a reflection 
of developments in plant accounting and the reporting of financial 
condition in recent years. In Exhibits 2 to 5 figures taken from 
the annual reports or computed from figures therein are given. 
Many of the figures are not available for earlier years. Data for 
the years during and immediately after the war are not comparable 
and for that reason are not included. In developing these exhibits 
from the annual reports, those figures were selected which indicate 
the broad effects of the depreciation policy and the relation of 
depreciation to other policies. 



1. If in preceding years the charges for depreciation had 
been lower so that with the same retirements the reserve had been 
20 per cent of gross plant in 1936 and other things such as the 
dividend policy had remained the same, how would the balance 
sheet of 1936 have been affected? 

2. If with a reserve of only 20 per cent, sufficient additional 
dividends had been paid to reduce surplus to the figure actually 
shown in 1936, how would the balance sheet have been affected? 

3. What relations, if any, exist between the policy of this 
company in not carrying funded debt, its dividend policy, and its 
depreciation policy? 

4. Did the fact that a reserve of 51.9 per cent had been accumu- 
lated make the task of the management easier in adapting the 
business to the changed conditions existing after 1929? 



PULLMAN, INC. 381 

PULLMAN, INC. 

CONSOLIDATED BALANCE SHEET 
DECEMBER 31, 1936 

ASSETS 
Current Assets: 

Cash $ 26,857,608 

U. S. Government Securities (1936 Market value $14,087,- 

820) 12,774,475 

Accounts and Notes Receivable 9,024,522 

Equipment Trust and Other Deferred-Payment Car Accounts 9 , 705 , 700 

Marketable Securities (1936 Market value $2,392,198) 2,385,877 

Inventories at Cost 12, 463 , 849 

$ 73*212,031 

Investment in Affiliated Companies and Other Securities at Cost 3 ,990,341 
Special Deposits with Various States under Compensation Acts 238,390 

Reserve Fund Assets: 

U. S. Government Securities held to fund Pension and Insur- 
ance Reserves 8,854,200 

Deferred Charges Applying to Future Operation of the Proper- 
ties 582 , 293 



$ 86,877,255 

Equipment and Property: 

Balance, beginning of Year $364,490, 222 

Additions during Year 9,727,833 

$374,218,055 
Less : 

Retirements during Year 3,526,377 

$370,691,678 

Deduct 
Depreciation Reserves: 

Balance, beginning of Year $180,080,566 

Additions during Year 14 , 342 , 180 



$194,422,746 
Less: Charges on Account of Retirements during Year 2 ,088,627 

$192,334,119 

Balance, end of Year, less Depreciation Reserves $i 78,35 7, 559 

$265,234,814 



382 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

PULLMAN, INC. 

CONSOLIDATED BALANCE SHEET 
DECEMBER 31, 1936. (Continued) 

LIABILITIES 
Current Liabilities: 

Current Accounts Payable and Pay Rolls $ 9,547, 782 

Accrued Taxes, not yet due, including provision 
for Federal Income and Undistributed Profits 
Taxes 5,7554?8 



$ 15,303,260 

Reserves: 

Pension and Insurance Reserves $ 8,956, 164 

Reserve for Contingencies 3 , 350, coo 

Other Reserves 3 , 193,956 

$ 15,500,120 

Deferred Credits Applying to Future Operation of 
the Properties $ 3,456,468 

Capital Stock: Shares 

Pullman Incorporated 1936 

Authorized 3*875,000 

Unissued 485 

Issued 

At stated value of $50 per share 3,874,515 $i93>725>75o 

Reacquired 

(In Treasury) at stated value of $50 per share 54 , 359 2,717, 950 

Outstanding 
At stated value of $50 per share 3,820,156 $191 ,007,80x3 

The Pullman Company (a subsidiary) 
Outstanding 
At par value of $100 per share 88.105 8,810 

$191,016,610 

Surplus: 
Excess of value of property acquired by issue of 

shares of capital stock over the stated value of 

$50 per share, less subsequent write-downs on 

said property out of this surplus as authorized 

by the Board of Directors $ 88,419,519 

Net profits earned since April 30, 1927 (date of 

reorganization) 64 , 287 , 254 

$152,706,773 

Deduct: Dividends paid during the period from 
April 30, 1927 to date 112,748,417 

Balance, at December 31 $ 39>958, 35$ 

$265,234,814 



PULLMAN, INC. 383 

PULLMAN, INC. 

CONSOLIDATED SURPLUS ACCOUNT 
YEAR ENDED DECEMBER 31, 1936 

Balance of surplus, as at December 31 $39 , 556,495 

Balance from income account for year ended 

December 31 $6,347,107 

Adjustment on account of disposition of Lyndora 

Hotel property 29 , 207 

6,376,314 



$45,932,809 
Less: 

Adjustment on revalued property units retired ... $ 243,857 
Dividends declared and paid 5, 730, 596 

5 974, 453 



Balance of surplus, as at December 31 $39,958,356 

PULLMAN, INC. 

CONSOLIDATED INCOME ACCOUNT 
FOR THE YEAR ENDING DECEMBER 31, 1936 

Earnings: 
From sleeping car business of The Pullman Company after 

deducting all expenses incident to operations $16,032,327 

Less: Charges and allowances for depreciation n ,839,003 

$ 4,193,324 

From all manufacturing business, Pullman Railroad, and other 
miscellaneous properties, after deducting expenses incident to 
operations $ 5> 2 47>953 

Less charges and allowances for depreciation 2,503, 177 

$ 2,744,776 



From security investments, etc., less administration expense of 

Pullman Incorporated $ 892,598 

Total earnings from all sources $ 7,830,698 



Less: Provision for Federal Income Tax $ i ,414,319 

Provision for Federal surtax on undistributed profits. ... 69, 272 

Balance carried to surplus $ 6,347,107 



Source: Company report. 

To The President and Board of Directors, Pullman, Incorporated: 1 

We have made an examination of the Consolidated Balance Sheet 
of Pullman Incorporated (a Delaware corporation) and Subsidiary 
Companies as at December 31, 1936, and of the Consolidated Income 
and Surplus Accounts for the year 1936. In connection therewith, we 
examined or tested accounting records of the Company and its domestic 

i Annual renort. 



384 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

subsidiaries and other supporting evidence and obtained information 
and explanations from officers and employes of these companies; we 
also made a general review of the accounting methods and of the 
operating and income accounts for the year, but we did not make a 
detailed audit of the transactions. We have had submitted to us 
audit report by independent accountants covering the examination of 
the accounts of the foreign subsidiary. . . . 

The " Equipment and Property " in the Consolidated Balance Sheet 
are carried at values which represent appraisal for the property 
acquired under the Plan of Reorganization of 1927 by exchange of 
capital stock and through purchase by issue of capital stock, less the 
subsequent write-down of parts of these properties to fair value as 
authorized by the Board of Directors, with subsequent additions at 
cost. Depreciation has been provided on all depreciable assets on the 
same basis as previous years. In respect to the manufacturing prop- 
erties, depreciation is being provided on the basis of recovering, over 
usual or normal life expectations, the values carried. In regard to the 
properties of the carrier subsidiary (The Pullman Company), deprecia- 
tion is being provided to recover over the period of certain fixed life 
expectations only the cost of these physical properties to The Pullman 
Company as per its books, which, at December 31, 1936, was 
$36,759,636 less than as represented in the said carrying value. In 
the accounting under the Interstate Commerce Commission rules, 
depreciation may be provided only to recover the cost of the properties 
to the carrier, and depreciation on any increased valuation is not 
deductible as an expense in Federal income tax returns under the 
regulations of the Internal Revenue Bureau. Under authorizations 
by the Board of Directors, such excess value has from time to time been 
reduced by charges to initial surplus (i) in the amount of $7,050,676, 
being the entire increase in value arising from the 1927 appraisal of 
all of the composite (wood and steel) general service cars and (2) 
$5,599,124, representing the increase in value from appraisal of steel 
cars retired from service. . . . 

In our opinion, based upon such examination and subject to the 
foregoing, the accompanying Consolidated Balance Sheet and Con- 
solidated Income and Surplus Accounts fairly present, in accordance 
with accepted principles of accounting consistently maintained by the 
companies, the consolidated financial position at December 31, 1936, 
and the consolidated results of operations for the year ended that 
date. 

ARTHUR YOUNG & COMPANY, 
Chicago, 111., March 9, 1937. Certified Public Accountants. 

ADJUSTMENT OF ASSET VALUES 1 

On recommendation of the Management, supported by opinion of 
technical advisors on valuation, accounting and legal questions 
involved, the Board of Directors at its meeting held on March 15, 1933, 

1 Annual report, 1932. 



PULLMAN, INC. 385 

authorized appropriation out of surplus as of December 31, 1932, in 
total amount of $23,445,016 to adjust the values of assets as nearly as 
may be to the basis of real worth. It should be understood that this 
adjustment has no effect upon the relative position of stockholders but 
in fact benefits all concerned by revising asset values to accord with 
present conditions. 

Summarized, the effect of these adjustments on the valuation basis 
of the various classes of property and the amount of adjustment on each 
class of property are as follows: 

Amount of 
Adjustment 

1. Manufacturing Properties $11 ,935, 260 

Plants placed on uniform basis of sound value as determined 
by outside appraisals for the larger plants and on basis of 
actual cost for recently built smaller plants, with depreci- 
ation reserves properly adjusted to present expectation of 
useful life. 

Adequate reserves provided against investment in manu- 
facturing facilities, such as dies, patterns, templates, 
drawings, etc., which may or may not be used in later 
production. 

2. Carrier Equipment 7,050,676 

All composite wood-and-steel Pullman general service cars 
(1,386 in number) still remaining on active list, placed on 
basis of original cost less regular depreciation charges, 
thereby eliminating appreciation on these cars included in 
Pullman reorganization of April 30, 1927. 

3. Non-operating Real Estate i ,950,482 

Property of this nature placed on basis of estimated present 
value, consisting of (a) Pullman Building at Chicago, 
(b) housing and industrial properties of Pullman Land 
Association, (c) labor tenements, hotel and apartment 
buildings operated in connection with shops, coal lands, 

etc. ^ 

Total adjustment on equipment and property $20,936,418 

4. Non-marketable Securities ' 843 , 154 

Investment in affiliated-company and in other non-market- 
able or not readily marketable securities, acquired in con- 
nection with the Pullman reorganization of April 30, 1927, 
or in the purchase of the Standard-Osgood Bradley sub- 
sidiaries as of March i, 1930, placed on basis of estimated 
present value. 

5. Marketable Securities 79>547 

Listed and readily marketable securities, including U. S. 
Government issues, placed on basis of cost by elimination 
of all appreciation included in Pullman reorganization of 
April 30, 1927. Any further write-down necessary to 
reduce individual lots to a lower year-end market value 
charged against 1932 operations. 

6. Treasury Stock 874,897 

Company holding of 54,320 shares of its own capital stock 
acquired in connection with Employe Stock Sale Plans 
reduced to stated capital value and held in Treasury sub- 
ject to cancellation or for such use as may be authorized by 
Board of Directors for benefit of the corporation. 

Total of all adjustments $23,445,016 



386 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 



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PULLMAN, INC. 



391 



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392 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 



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393 



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I 

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394 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 



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PULLMAN, INC. 



395 



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396 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 
D. RETIREMENT ACCOUNTING 

BOSTON EDISON COMPANY 

THE RELATION BETWEEN DEPRECIATION AND RETIREMENT 

ACCOUNTING 

The Boston Edison Company maintained its books of account 
in accordance with the instructions issued by the Massachusetts 
Department of Public Utilities. 1 Although, as in the New Eng- 
land Telephone and Telegraph Company case, accounting methods 
used differed somewhat for the various classifications of assets, 
the methods described in this case, as applied to poles, were 
typical of the company's accounting procedures with respect to 
plant and depreciation. 

Poles were classified in Account E 125 Poles, Fixtures, and 
Overhead Conductors. 2 The cost of new poles installed was 
debited to Account E 125 and included the cost 3 of the poles 
laid down at the point of placement, plus charges for the labor 
and burden involved in installation. 



1 Uniform System of Accounts for Gas and Electric Companies Prescribed by the 
Department of Public Utilities of Massachusetts, revised ed., January i, 1934. 

2 Exhibit i presents Account E 125 in detail. 

3 Uniform System of Accounts, Massachusetts Department of Public Utilities 
Basis of Charges to Plant Investment Accounts, Instruction 4, p. 19. "The charges 
to the accounts of this classification on account of expenditures for the acquisition 
of property and for improvements shall be based upon the cost of the property and 
the improvements, and the property shall be carried in the plant accounts at no 
more and no less than its actual cost unless, or until, such property is abandoned, 
replaced, reconstructed or converted. When the consideration given for the pur- 
chase of property or for the improvement of property chargeable to the accounts of 
this classification is anything other than money, the money value of the consider- 
ation at the time of the transaction shall be charged to these accounts, and the 
consideration shall be described in the record with sufficient particularity to iden- 
tify it. 

"Charges for materials and supplies shall be based upon the cost thereof at the 
places where they enter into construction, including cost of transportation and 
inspection when specifically assignable. If materials and supplies are passed 
through storehouses, their cost entered in these accounts may include the cost of 
handling said materials. . . . 

" No adjustment of any plant accounts shall be made on the basis of any appraisal 
value. Should the department at any time find a certain value of the property for 
rate making or other purposes, such finding does not warrant changing the books of 
account (unless specifically so directed). The books are intended to show at all 
times the original cost to the company of its existing property less such credits as 
may have been made on account of property abandoned, sold, reconstructed or 
converted." 



BOSTON EDISON COMPANY 397 

Credits to Account E 125 for pole retirements involved an 
estimate of original cost. 1 The company had maintained neither 
accounting records nor engineering data which enabled it to 
determine original cost for poles retired. It resorted therefore 
to an estimate based upon the assumption that the average age 
of poles removed was 15 years. Annually the company examined 
price levels in existence 15 years previous to the current year and 
with reference to these determined removal prices for the various 
types and sizes of poles in service. These prices were used to 
book the retirements which took place during the ensuing 
year. 

Removal of poles with the intention of installing them else- 
where was handled in a somewhat different manner. Public 
requirements in connection with the construction of new highways 
often made changes necessary in the location of poles, and the 
accounting treatment followed under these circumstances involved 
a credit to Account E 125 at current prices. Upon subsequent 
reinstallation the same account was debited at current prices 
and the cost of moving was charged to the reserve for 
depreciation. 

Periodic provisions for depreciation were accomplished through 
an entry debiting Account No. E 678 Depreciation 2 and crediting 



1 Property Retired, Uniform System of Accounts, Department of Public Utilities 
of Massachusetts, Instruction 3, p. 19. "When property, the cost of which has 
been charged to plant accounts, is abandoned, sold or otherwise retired from serv- 
ice, whether replaced or not, the appropriate plant investment account shall be 
credited with the amount at which such property stands charged therein at the time 
of retirement. If the books do not show the cost thereof at the time of such retire- 
ment, the amount shall be estimated, and that fact and the basis of the estimate 
shall be noted in the entry. Concurrently, balance sheet Account No. 319 
Depreciation Reserve shall be charged to the extent that the total balance in the 
reserve is sufficient to cover the cost of property retired; proper account shall be 
taken of salvage and insurance, and the remainder, if any, together with expenses 
incident to the abandonment, shall be charged to Profit and Loss Account No. 415 
Appropriations of Surplus for Depreciation." 

2 Account E 678 Depreciation, Uniform System of Accounts, Department of 
Public Utilities of Massachusetts, "This account shall include monthly or periodic 
charges of the amount estimated to be necessary to provide for the retirement of 
property no longer used or useful in the conduct of the company's business, and for 
losses in value due to wear and tear not covered by current repairs. 

"Note, Until otherwise ordered, the amount estimated to cover the cost of 
property no longer used or useful in the conduct of the company's business, or for 
losses in value due to wear and tear, shall be determined by the accounting utility, 
based upon its best knowledge and experience in operation. A detailed statement of 
the basis used in determining the amount of such charge will be called for in the 
annual return to the department," 



3Q8 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

Account No. 319 Depreciation Reserve. 1 Although the instruc- 
tions contained in the description of Account 678 specifically 
stated that provision should be made for losses in value due to 
wear and tear, and notwithstanding the fact that the account 
titles involved indicated that the commission had intended to 
institute depreciation accounting, during the years preceding 
1934 the practice of the company had corresponded more closely 
to retirement accounting. Credits to the depreciation reserve 
had been determined with reference to estimated future retire- 
ments from the depreciable assets of the company as a composite 
whole. No statistical records nor mathematical analyses were 
used to facilitate judgment as to the exhaustion of service life 
with respect to poles. 

In addition to the regulations concerning Accounts E 678 
Depreciation and 319 Depreciation Reserve, the Massachusetts 
Uniform System of Accounts provided for appropriations of 
surplus to increase the depreciation reserve. 2 The nature of the 
retirement accounting practiced by the Boston Edison Company 
is further revealed by the liberal use made of Instruction 415. 
Exhibit 2 shows that during the years 1921-1934 practically all 
the credits made to the depreciation reserve were derived from 
corresponding debits to the surplus account. Determination 
of the amount to be credited to the reserve was based upon 
consideration of probable future retirements, current earnings, 
and dividends. Preservation of capital through adequate pro- 
vision for exhaustion of service capacity was not the primary 
objective of this type of accounting. The following statement 
taken from the company's 1933 return to the Massachusetts 
Department of Public Utilities is representative of the procedure 
used to determine credits to the depreciation reserve during 



1 Account 319 Depreciation Reserve, Uniform System of Accounts, Depart- 
ment of Public Utilities of Massachusetts. "To this account shall be credited the 
amounts charged to operating expense or other accounts for the retirement of prop- 
erty no longer used or useful in the conduct of the company's business, and for 
losses in value due to wear and tear not covered by current repairs." 

2 Appropriations of Surplus for Depreciation, Uniform System of Accounts of 
Massachusetts, Instruction 415. "When the balance shown on balance sheet 
Account No. 319 Depreciation Reserve, is less than is necessary to provide for the 
retirement of property no longer used or useful in the conduct of the company's 
business, and for losses in value due to wear and tear not covered by current repairs, 
the company may charge this account and concurrently credit balance sheet Account 
No. 319 Depreciation Reserve, with such amounts as shall be deemed necessary 
to cover such deficiency." 



BOSTON EDISON COMPANY 399 

the period 1921-1934: "The Company has no fixed 'rule' or 'rate' 
for determining the amount to be credited to the Depreciation 
Reserve, but at the end of each fiscal year transfers to the credit 
of this account whatever amount is authorized by the Executive 
Committee of the Company." 

In 1934 the Massachusetts Public Utilities Commission, in 
connection with a rate case, issued an order requiring the Boston 
Edison Company to comply with certain regulations regarding 
accounting for depreciation. Subsequent to the issuance of this 
order, the company altered its accounting practice and in the 
1934 return to the Department of Public Utilities presented the 
following statement concerning depreciation: 

The Company has agreed with the Department of Public Utilities, 
until otherwise ordered, to credit its depreciation reserve not less than 
$865,000 quarterly, beginning with the quarter ended September 30, 
1934, before declaration or payment of dividends for the quarter. The 
Company understands that this credit includes the amortization of an 
investment in lamps on consumers' premises at the rate of $250,000 
per year for a period of approximately ten years. The Company 
charged operating expenses and credited to its depreciation reserve a 
total of $1,730,000 in the latter two quarters of the year, and at the 
close of the year, so charged and credited an additional amount of 
$1,190,000 bringing the total credited to the reserve for the year to 
$2,920,000. 

The $250,000 item referred to in the statement was not true 
depreciation, but more closely resembled the amortization of an 
expense incurred in the past. At one time the company renewed 
worn-out electric light bulbs with no charge to the customer. 
An investment of over $2,000,000 had been accumulated in lamps 
on consumers' premises when the practice was discontinued. 
The commission allowed the company 10 years in which to write 
off this investment, and amortization began in the quarter ending 
with September, 1934. 

Since the reserve maintained by the Boston Edison Company 
was primarily a provision for future retirements, and since its 
function was principally that of equalizing the charges to expense 
occasioned by the scrapping or sale of depreciable assets, it was 
actually a segregation of surplus rather than a reduction in the 
asset values. Because of these characteristics of the reserve, 
the company had not considered a breakdown according to 
property classifications. 



400 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

Under the circumstances, specific provision of a reserve to 
apply against Account E 125 would have been of little value. 
Assets in this account 1 consisted of a very large number of units 
so that poles removed in any particular year did not constitute a 
large percentage of the total. Furthermore, in an asset made up 
of a large number of units, replacements tended to occur in a 
uniform manner. For these reasons, charges against earnings 
for pole retirements were of manageable proportions and a reserve 
was not considered necessary, since the function of the reserve 
was to equalize charges for retirements over a series of periods. 

In the company's own calculations and in its relations with the 
state commission, depreciation had not been thought of as a set 
percentage of the cost of depreciable assets. Difficulties had 
arisen, however, in connection with the depreciation charge to 
be allowed for Federal income tax returns. To settle this question, 
the company had gone before the Board of Tax Appeals at Wash- 
ington to determine what a fair rate would be, and the board had 
set 2.33 per cent to apply as a composite rate on depreciable 
assets. Subsequently, in the records maintained for income tax 
purposes, the company adjusted the annual charge to operations 
and credit to depreciation reserve in an amount equal to the 
difference between the product of 2.33 per cent times depre- 
ciable assets and $3,460,000, the annual charge set by the state 
commission. 

The Boston Edison Company was one of the largest inde- 
pendent companies operating completely within the boundaries 
of one state and as such did not fall under the jurisdiction of the 
Federal Power Commission. However, in its effort to cooperate 
with the government, it had undertaken the preparation of a 
report according to forms and instructions issued by the Federal 
Power Commission. Data called for in this report involved a 
breakdown of the reserve according to classes of depreciable 
assets. In the past the company had maintained plant ledgers 
only with respect to power plants and buildings. It was possible 
to tell exactly what changes had taken place in these accounts, 
while it was very difficult to trace transactions and balances in 
the other asset groups. Therefore the controller was forced to 
rely upon estimates and judgment to obtain the breakdown 



L See Exhibit 3. 



BOSTON EDISON COMPANY 401 

called for. The Massachusetts commission did not require a 
reserve breakdown, and the company did not believe that rear- 
rangement of its accounting to accomplish segregation would be 
expedient. 



In what important particulars did the methods used by this 
company in accounting for poles differ from those of the New 
England Telephone and Telegraph Company (pp. 338-350)? 

EXHIBIT i 

BOSTON EDISON COMPANY 
ACCOUNT E 125 POLES, FIXTURES, AND OVERHEAD CONDUCTORS 

This account shall include the cost of poles and fixtures used for the purposes of 
transmission and distribution systems, including the cost of all towers, poles, cross 
arms, insulator pins, braces, brackets, and other pole fixtures and appliances, guys 
and other tower and pole supports. 

This account shall also include the cost of all cables, wires, lightning arresters, 
insulators and devices installed on poles or other overhead fixtures and used for 
transmission and distribution purposes, including wires to the first point of attach- 
ment on the customer's premises. 

When a company owns a joint interest in any poles and fixtures includible in this 
account, the amount representing the cost of such interest shall be carried in a sub- 
account hereunder. This applies only to actual joint ownership and not to pay- 
ments made for the right to use the property. 

Note. Separate subaccounts shall be set up to show the cost of transmission and 
distribution lines. The cost of lines constructed subsequent to January i, 1934, 
shall be so set up and the cost of lines constructed prior to that time as near as may be. 

a. Transmission Lines: Lines used for transmitting electric energy in bulk 
between stations or between points of generation, purchase, or sale, and points of 
transformation or distribution. 

b. Distribution System Lines: 

1. Distribution System Supply Lines: Lines used for receiving electric energy 
from transmission stations or points of generation for transmission to 
distribution or customers' stations and lines used to deliver electric energy 
between distribution or customers' stations. 

2. Distribution Lines: Lines used entirely for distributing electric energy 
from distribution stations to consumers. 

c. Poles for multipurpose use, i.e., for supporting conductors of more than one 
classification. 



Source: Uniform System of Accounts prescribed by the Department of Public 
Utilities of Massachusetts. 



402 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 



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BOSTON EDISON COMPANY 



403 



EXHIBIT 3 

BOSTON EDISON COMPANY 
DISTRIBUTION SYSTEM OVERHEAD POLES 



Height 


Owned exclusively by 
company 


Jointly owned* 


Wooden 


Iron or steel 


Wooden 


Iron or steel 


15 
18 
20 
25 
27 
30 
35 
40 

45 
50 

55 
60 

65 
70 

75 

Totalf 
Last Year 


24 

202 
1,322 

14,446 
27,296 

4,79i 
1,089 

365 
i39 
80 

36 
16 

7 


i3 
36 

iQ 

12 


4 


9 

22 

2 
2 


56 
600 


7,574 
50,158 
6,066 
1,097 
205 
76 

45 
16 
i 


498i3 
51,151 


80 

68 


65,898 
62,880 


35 
23 





* Refers to cooperative use of poles with telephone company. See New England Telephone 
and Telegraph case for explanation of this arrangement. 

t Total of poles in distribution system only. Poles for transmission lines and for multi- 
purpose use constituted a very small portion of the total number of poles in service. 

Source: 1937 return of Boston Edison Company to Massachusetts Department of Public 
Utilities. 



404 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

LONG POINT GAS COMPANY 

THE EFFECT OF DEPRECIATION POLICY ON THE INTERESTS 

OF INVESTORS 

Although in conformity with Massachusetts practice its 
reserve was called a depreciation reserve, this company used 
retirement accounting. The amount of depreciation charged 
for the last few years has been low in comparison with other 
companies in the industry, but it has been sufficient to cover all 
retirements and leave a balance in the depreciation reserve greater 
than that of 1924. 

A condensed balance sheet, income statement, and profit 
and loss statement are given, together with a series of exhibits, 
the figures for which have been taken from data on file in the 
Massachusetts Department of Public Utilities. 

In Exhibit i, figures are given showing depreciation and 
maintenance charged since 1922, and the relation of these amounts 
to plant, operating revenues, gross income, and reserve for 
depreciation. 

It is possible from these figures to compute what the results 
would have been if the company had charged 3, 4, or 5 per cent 
of its total cost of property as depreciation each year since 1922. 
For this purpose it is assumed that additions to plant, retirements, 
maintenance, and other expenses, except interest, remained as 
shown in Exhibit i. Presumably the amount of interest would 
have been changed because the operation of depreciation would 
have retained more current assets in the business. The results 
under these assumed conditions are indicated in Exhibit 2. 

Exhibit 3 shows income reported, dividend payments, and 
funds derived from the issue of stocks or bonds. It also gives 
plant additions and retirements since 1922. 

For comparative purposes the plant, operating revenues, 
maintenance, and depreciation figures in 1934 for 28 other Massa- 
chusetts gas companies are given in Exhibit 4. 

In 1935, after a re-examination of the depreciation policy, two 
proposals were made: One was that the company should increase 
its retirement expense moderately, looking toward the accumula- 
tion of a substantial reserve of the order of 30 per cent over a 
period of approximately 15 years. It was suggested that the 



LONG POINT GAS COMPANY 



405 



company be somewhat more vigorous during this period in retiring 
plant items no longer fully useful so that at the end of the period, 
all property, the economic life of which was exhausted, would be 
retired physically and credited out of the plant records. A second 
proposal was that the company should create immediately a 
reserve sufficient to record accumulated depreciation in full. 
It was realized that this probably would require a write-down 
of the par value of the capital stock. It was contemplated 
under the second proposal that after this change, sufficient 
depreciation would be charged to keep the reserve at a point at 
which it would record at all times the full amount of accrued 
depreciation. Any property no longer useful and which had not 
yet been retired was to be retired as a part of this restatement. 
In addition, provision was to be made for keeping the property 
fully maintained, and all costs connected therewith were to be 
charged annually to operations. 

Many directors objected to both proposals and maintained 
that the company should continue in maintenance and deprecia- 
tion the policy it had followed from 1927 to 1934. 

What policy should the corporation follow with respect to 
depreciation and related matters of maintenance and retirement? 
Consider the effects of the policy you advocate on the book value 
of assets, income, working capital position, and capital structure. 

LONG POINT GAS COMPANY 
CONDENSED BALANCE SHEET AS OF DECEMBER 31, 1934 



ASSETS 

Total Cost of All Property $6,475,670 
Other Investments. . 30,101 



LIABILITIES 

Capital Stock $4,770,320 

Bonds Payable 1,360,000 



Total 



$6,505,771 



Cash $ 79,498 

Notes and Accounts Re- 
ceivable 264,393 

Materials and Supplies. .. 282,050 

Total Current Assets. $ 625,941 



Total 

Accounts Payable. . . 
Consumers' Deposits. 



$6,130,320 

$ 40,893 
io,439 



Total Current Lia- 
bilities $ 51,332 



Prepaid Accounts and 
Other Unadjusted 
Debits $ 15,682 

Unamortized Debt Dis- 
count and Expense. . . . 14,600 



Accrued Liabilities and 

Unadjusted Credits . . $ 20,829 

Other Reserves 59,984 

Depreciation Reserve. . . 308,678 

Profit and Loss Balance . . 590 , 85 1 



$7,161,994 



$7,161,994 



406 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

CONDENSED INCOME STATEMENT 
FOR THE YEAR ENDING DECEMBER 31, 1934 

Operating Income 

Operating Revenues $i ,415,898 

Operating Expenses 927, 535 

Net Operating Revenues $ 488,363 

Uncollectible Operating Revenues $ 16,000 

Taxes 209,655 

Net Operating Income $ 262, 708 

Nonoperating Income. . . 470 

Gross Income $ 263 , 178 

Interest on Bonds 55 , 293 

Amortization of Discount 8,550 

Miscellaneous Deductions 6, 101 



Income Balance $ 193,234 

PROFIT AND Loss STATEMENT 
FOR THE YEAR ENDING DECEMBER 31, 1934 

Credit Balance at Beginning of Fiscal Period. . $659,929 

Credit Balance Transferred from Income Account 193 , 234 

Miscellaneous Credits i . oio 



$854,173 
Dividend Appropriations of Surplus 263,322 

Balance Carried Foward to Balance Sheet $590,851 



LONG POINT GAS COMPANY 



407 



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Per cent of 
operating 
revenues 


r-.MIOOONMOOO^^POONt^ 
M M t O* M t^.>O OH O ^-O Tl" O 

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operating 
revenues 


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Per cent of 
total cost of 
all property 


OOPOOPNt s -po 
tOO too O tto 

t t t- O\ M W O t 
M M M 


POOO OOO t^ 
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to to to t fr 


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too cs POO 


^ 


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11 


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g o a 


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Sll 






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CB 


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Per cent of 
total cost of 
all property 


O PO O PO POOO t O\ 


1 1^ O 00 t 


ill 


roooatt-MOto 


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4 o8 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 



EXHIBIT 2 
LONG POINT GAS COMPANY 



Dec. 
3i 


Depreci- 
ation 


Gross 
income 


Rate of 
return 
on total 
assets 


Reserve 
for depreci- 
ation 


Per cent of 
reserve to 
total cost 
all prop- 
erty 


Total cost 
of all prop- 
erty net of 
reserve 



Depreciation at 3 Per Cent of Total Cost of All Property 



1922 


$101,026 


$334,857 


8.09 


$ 187,308 


5.56 


$3,180,225 


1923 


102,411 


343,200 


7-73 


227,314 


6.66 


3,186,376 


1924 


107,456 


309,228 


6.68 


202,144 


5.64 


3,379,738 


1925 


116, 127 


313,825 


6.63 


185,311 


4-79 


3,685,603 


1926 


127,929 


3 8,i45 


6.04 


162,520 


3.8i 


4,101,765 


1927 


131,886 


241,025 


4-36 


251,337 


5-72 


4,144,852 


1928 


148,747 


191,360 


3-14 


353,665 


7.13 


4,604,575 


1929 


172,213 


257,052 


3-81 


491,779 


8.57 


5,248,650 


1930 


185,152 


238,005 


3-24 


674,504 


10.93 


5,497,245 


1931 


191,270 


281,370 


3-83 


829,454 


13.01 


5,546,226 


1932 


192,776 


248,992 


3-32 


990,363 


15-41 


5,435,499 


1933 


193,565 


159,046 


2.23 


1,178,696 


18.27 


5,273,486 


1934 


194,270 


71,297 


i .00 


1,370,577 


21.17 


5,105,093 



Depreciation at 4 Per Cent of Total Cost of All Property 



1922 


$134,701 


$301,182 


7.28 


$ 220,983 


6.56 


$3,146,550 


1923 


136,548 


309,063 


6.96 


295,126 


8.65 


3,118,564 


1924 


143,275 


273,743 


5-91 


305,441 


8.53 


3,276,441 


1925 


154,837 


275,115 


5.81 


327,318 


8.46 


3,543,596 


1926 


170,571 


265,503 


5-21 


347,169 


8.14 


3,917,116 


1927 


175,848 


197,063 


3.56 


479,948 


10.92 


3,916,241 


1928 


198,330 


141,777 


2.33 


631,859 


12.74 


4,326,381 


1929 


229,617 


199,648 


2.96 


827,377 


14.41 


4,913,052 


1930 


246,870 


176,287 


2.40 


1,071,820 


17-37 


5,099,929 


1931 


255,027 


217,613 


2.97 


1,290,527 


20. 24 


5,085,153 


1932 


257,034 


184,734 


2.47 


1,515,694 


23-59 


4,910,168 


1933 


258,087 


94,524 


1.32 


1,768,549 


27.41 


4,683,633 


1934 


259,027 


6,540 


0.09 


2,025,187 


31-27 


4,450,483 



Depreciation at 5 Per Cent of Total Cost of All Property 



1922 


$168,377 


$267,506 


6.46 


$ 254,659 


7 56 


$3,112,874 


1923 


170,685 


274,926 


6. 19 


362,939 


10.63 


3,050,751 


1924 


179,094 


237,590 


5-13 


409,407 


H.43 


3,172,475 


1925 


193,546 


236,406 


4-99 


469,993 


12.14 


3,400,921 


1926 


213,214 


222,860 


4-37 


532,487 


12.49 


3,731,798 


1927 


219,809 


153,102 


2.77 


709,227 


16.13 


3,686,962 


1928 


247,912 


92,195 


I-5I 


910,720 


i8.37 


4,047,520 


1929 


287,021 


142,244 


2. II 


1,163,642 


20.27 


4,576,787 


1930 


308,587 


114,570 


1.56 


1,469,802 


23.81 


4,701,947 


1931 


318,784 


153,856 


2.10 


1,752,266 


27.48 


4,623,414 


1932 


321,293 


120,475 


1.61 


2,041,692 


31-77 


4,384,170 


1933 


322,609 


30,002 


0.42 


2,359,069 


36.56 


4,093,113 


1934 


323,784 


58,217** 


o.&id 


2,680,464 


4L39 


3,795,206 



d deficit. 



LONG POINT GAS COMPANY 



409 



EXHIBIT 3 
LONG POINT GAS COMPANY 



Dec. 31 


Net 
income 
(after 
interest) 


Dividends 
paid 


New 
capital 
stock 
issued 


Bonds 
issued 


Additions 
to total 
cost of 
all prop- 
erty 


Retire- 
ments 
from 
total 
cost of 
all 
prop- 
erty 


1922 
1923 
1924 

1925 
1926 
1927 
1928 
1929 
1930 

1931 
1932 

1933 
1934 

Total 


$ 329,886 
338,883 
237,869 

267,454 
275,482 

307,574 
262,403 

37i,77i 
367,826 

378,742 
334,598 
275,358 
193,234 


$ 110,664 
159,848 
196,736 

2i3,i33 
262,323 
262,323 
262,323 
365,528 
367,251 
367,251 
377,9*7 
333,922 
263,322 


$ 


$ 


$ 213,394 
120,534 
184,526 
302,784 
420,707 
211,149 

592,587 
908 , 906 
518,421 
279,048 

59,499 
62,122 
40,128 


$ 3,043 
74,379 
16,333 
13,752 
27,336 
79,245 
30,536 
126,717 
87,099 

75, "8 
9,3i5 

35,802 
16,640 










819,840 










1,225,440 
86,160 












179,680 


I , 200 , OOO 




160,000 




$3,941,080 


$3,542,541 


$2,311,120 


$1,360,000 


$3, 9^,805 


$595, 3 X 5 



4 io PLANT, FUNDED DEBT, AND PROPRIETORSHIP 



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4 i2 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 
DETROIT EDISON COMPANY No. 2 

DEPRECIATION ACCOUNTING POLICY 

The Detroit Edison Company was incorporated under the 
laws of the State of New York in January, 1903, for the purpose, 
among other things, of engaging in the manufacture, distribution, 
and sale of electricity in the City of Detroit, the State of Michigan 
and elsewhere; in the same month it was licensed to do business 
in Michigan. In 1937 the operations of the company were carried 
on solely by the Detroit Edison Company, certain of its sub- 
sidiaries having been merged with the parent company and certain 
others existing as inactive subsidiaries owning electric distribution 
franchises. 

The capitalization of the company was represented in 1937 (i) 
by common capital stock which had been sold in most part for 
cash at its par value of $100 per share and (2) by general and 
refunding mortgage bonds secured by a lien on all the properties 
of the company under an "open end" indenture; there was no 
preferred stock nor any subsidiary or underlying stocks or bonds 
except $320,000 bonds of Great Lakes Power Company due in 
1941. This simplicity in capitalization reflected a series of steps 
consolidating and refunding earlier issues. For all security issues 
since 1909 the regulatory body had set a minimum price and 
required (i) the showing of necessity for the issue and (2) an 
accounting for the proceeds. 

The franchise area of the company in 1937 was about 7,630 sq. 
miles and the population served approximated 3,000,000. The 
company properties included four large steam-electric plants and 
164 electric substations, together with the necessary transmission 
and distribution lines, four steam heating plants in downtown 
Detroit, and a gas plant supplying gas service in Port Huron 
and St. Clair River towns. 

In 1915 the Michigan Railroad Commission ordered an 
appraisal of all company properties for its guidance in considering 
security issues. When an inventory and valuation were made by 
engineers employed by the commission, several differences in detail 
appeared, but in total the appraised value somewhat exceeded 
the book value, and no change of the books was ordered or made. 
Subsequently the company had reported to the commission in 



DETROIT EDISON COMPANY NO. 2 413 

detail at six-month intervals all additions to the property invest- 
ment account and all retirements of property items. Thus there 
was a complete record on file with the commission by reference to 
which the property investment account could be verified or 
reconstructed. 

The plant investment figure shown upon the balance sheet 
as at December 31, 1936, represented largely historical cost 
to the present company, approximately nine-tenths of the total 
plant having been purchased or installed by it. The property 
account was, however, not entirely a record of the cost of 
physical items of property, new, less retired items, since the 
company had during its life purchased some 40 going concerns, 
the price in each case including going value and goodwill as well 
as physical assets. The practice had been to examine all physical 
assets purchased in such cases and value them, item by item, 
according to expectancy of their continuing usefulness. When 
original cost to the vendor was available, however, that figure 
less depreciation had been placed upon the company's books. 
The sum of the differences between net inventory value and 
purchase price was included as a separate item in the plant invest- 
ment account and represented less than 2 per cent of the total 
figure. 

In 1937 approximately 94 per cent of the gross revenue of the 
company was derived from its principal business electricity; 
steam heating accounted for about 4 per cent and gas business in 
the Port Huron area for about i per cent. 

The policy of the company with respect to depreciation is 
reflected in the following excerpts from Detroit Edison annual 
reports. 

Retirement Reserve Depreciation 1 

Another question which has been asked is what our policy is with 
respect to depreciation. The Uniform Classification of Accounts 
provides for our charging a monthly item of Retirement Expense as 
part of the cost of doing business, which item is transferred into a 
Retirement Reserve. Against that Retirement Reserve there is written 
off, at the time of retirement, the book value of each item of plant or 
property retired from service for any cause whatsoever. There is no 
mandate by the Commission as to the amount which shall be put into 
the Reserve monthly. We, of course, observe literally the rule about 



1 Annual report, 1926. 



414 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

writing off all retired property, and we have exercised our best judgment 
as to the amounts which should be put into reserve to provide for 
prospective retirements. But we have refrained from setting up any 
mathematical rule which would bind us to make monthly charges 
according to the estimated life of any piece or part of our plant. We 
have increased or supplemented our monthly appropriations to Retire- 
ment Reserve, 

(a) when we foresaw earlier retirement of any large item or class of 
property, 

(b) when and as the total investment in depreciable property was 
increased, and further, 

(c) when we had good years we have made further supplemental 
additions to the Reserve. 

Conversely, we have revised our estimates of requirements in the 
direction of a decrease when apparatus in service proved to be more 
durable than we had expected, and we have made smaller appropria- 
tions when net earnings for the time being were definitely less than we 
had anticipated. 

The condition of affairs at the end of 1926 is that the Retirement 
Reserve has a balance of $14,078,828.41 which, when compared to the 
observed condition of our depreciable property, is enough to take care 
of the retirements expected in the next few years, even though we 
should be unable to make intended additions to the Reserve in those 
same years. 

We are aware of a theory which would require us to make a calcu- 
lated addition to a Reserve as a yearly or monthly expense item, 
whether the net earnings for the period were adequate or otherwise. 
That theory provides a reserve to meet the Retirement charges as 
they actually arrive, but it does not allow the Reserve to serve its 
equally useful purpose of allowing the fat years of business to make 
provision against the lean years. Instead of a Reserve, that theory 
sets up an Encumbrance. 

Our use of a Reserve does not stop us from recognizing by special 
accounting the fluctuating value of exceptional items of our plant 
investment; for instance, automobiles. Our practice is to take auto- 
mobiles (including trucks) into our investment account at 50% of 
purchase price. Inasmuch as we have in effective use 425 automobiles 
of all sorts and of all ages, from one month up, it is a safe method which 
carried the lot at half price. 

This discussion can be summed up by saying that all of our Com- 
pany's property is in first class condition; that the daily maintenance 
charged directly to operation is ample; that the provision made for 
the retirement of property because of cumulative wear and tear or 
obsolescence is adequate for any retirements reasonably to be expected 
in the next few years; that our method is to keep well informed as to 
the actual condition and probable usefulness of all apparatus and to 
treat calculations of accruing depreciation solely as intelligent estimates, 
which must be revised by actual experience; and that our policy is to 



DETROIT EDISON COMPANY NO. 2 415 

increase the present margin of Retirement Reserve when and as it is 
timely to do so. 

Discussion of the relation of the Maintenance and Retirement 
Reserve accounts was included in the annual report for 1929: 

There is no present occasion for extra appropriations into Retire- 
ment Reserve (Depreciation). 



The charges to maintenance increased more than proportionally 
the figure being $3,589,251, while the 1928 figure was $3,017,398. 
The explanation is that we are rebuilding certain wire lines . . . and 
that the rebuilding includes work which would have become charge- 
able to maintenance during subsequent years. In dividing the cost 
between Retirement Reserve and Maintenance Account, we observed 
that good accounting required a charge to be made to Maintenance 
Account according to these forestalled costs. To do otherwise would 
have made a deceptive reduction in the charged maintenance costs. 

Further outlines as to depreciation policy were made in the 
1934 report: 

We seek to provide for retirement as we foresee it is likely to occur. 
This year, when actual retirements were unexpectedly large, we made 
an extraordinary appropriation out of earnings to retirement reserve. 
In good years we set aside more and in poor years less, realizing that 
it is the pressure of good business which above all accelerates retire- 
ments. We believe our method is sound, and it depends upon judg- 
ments based on intimate knowledge of the property. The federal tax 
officials who can have no such knowledge on which to base judgment, 
require, for tax purposes, the use of a uniform "rule of thumb " method, 
and we have conformed to their requirement. This means that our 
federal income tax returns show as " depreciation" sums which vary 
considerably from our appropriations to "Retirement Reserve." In 
some years our appropriations have been larger, but the aggregate of 
"depreciation" reserves conforming to the Government's theory sub- 
stantially exceeds our own "Retirement Reserve." 



It should be remembered that Maintenance is designed to keep up 
original operating efficiency. It is an entirely separate account from 
the Retirement Reserve, which through its credits and charges provides 
for the discarding of property from service. 

A study conducted by the company showed that in the 1 1 years 
preceding 1932 almost two-thirds of all retirements were due to 
inadequacy and only in small part to the physical wearing out of 
apparatus or buildings. For example, in 1903 a power house was 



4 i6 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

built to replace an existing one which had become inadequate; 
the probable life of the new unit might conservatively have been 
estimated at 20 to 25 years. This unit was built at four times the 
capacity of the original unit but in 1910 it was replaced as inade- 
quate because of the requirements of population growth upon 
serviceable size. An example of entirely unforeseeable obsoles- 
cence occurred with a group of oil circuit breakers (automatic 
switches for cutting out the line). For the protection of the 
equipment these switches had been immersed in an oil bath in 
order to quench the arc when the circuit was broken, but they 
were necessarily taken out and replaced by direct cables to the 
tanks when the oil in several cases had caused an explosion 
by becoming ignited. 

During the depression the executives stated that the cessation 
of plant expansion had " lessened the requirements for appropria- 
tions into and out of the Retirement Reserve and that Reserve 
has continued to increase so as to cover careful estimates of the 
next few years. " 

In short, the company's policy might be summarized according 
to one of the executives as being based upon "good sense and 
judgment and what the earnings will stand expressed in a round 
figure." The reserve was looked upon as a purely equalizing 
reserve and not as a measure of accrued depreciation. No com- 
plete life expectancy records were maintained by the company, 
and a lump-sum reserve was maintained, there being no breakdown 
by classes of property. 

The Control Department prepared for the executive committee 
each year, on a five-year cumulative basis, a schedule of antici- 
pated retirements. This report, entitled " Estimated Retirement 
Charges" (Exhibit i), presented in detail the items which the 
operating heads believed should be retired within the succeeding 
five years. These estimates were based upon careful physical 
examination, as well as evaluation of obsolescence and inadequacy 
possibilities. For example, as to poles, which were identified 
by numbers, tests for butt rot, etc., were made. In 1933 an 
entire Delray Power House, shown on the books at approximately 
$4,000,000, was to be retired and was included in this report as 
a single retirement unit. A comparison of the report total for 
the ensuing five years was then made with the Retirement Reserve 
balance, and consideration was given to the probable annual 



DETROIT EDISON COMPANY NO. 2 417 

expense charge and reserve credits necessary during that period 
to insure the continued " adequacy of the reserve balance." 

The funds provided by operating charges to retirement expense 
were not segregated, but were regarded as general funds at the 
service of the company's properties and business. This deprecia- 
tion policy was believed to be sanest and most expedient. For 
Federal income tax purposes a 3.48 per cent depreciation rate was 
allowed and taken. 

The company had never had a rate base formally determined 
by the Michigan regulatory body; it was generally assumed that 
the rate base was equal to the sum of working capital and gross 
plant, less some depreciation. In a hearing during 1936 a 10 
per cent depreciation deduction was suggested by an engineer 
of the commission on the grounds that a plant maintained at 90 
per cent represented the satisfactory average situation. A 
5>^ per cent to 6>^ per cent rate of return had been allowed by 
the commission. A company executive characterized the rela- 
tions with the commission as based upon " frank statements of 
fact plus common sense" and a mutual attitude of " comparative 
informality." 

The balance sheet of the Detroit Edison Company at December 
31, 1936, is given below. Exhibit i shows the estimated retire- 
ment charges; Exhibit 2 presents a comparative statement of 
Profit and Loss for the period 1903-1936, inclusive; and Exhibit 
3 is a statement of Operating and Nonoperating Expenses for the 
same period. Exhibit 4 represents a running analysis of the 
Retirement Reserve 1922-1936, inclusive. 



1. Comment on the method of keeping the property account 
employed by the company. 

2. Do you consider the Detroit Edison depreciation policies 
satisfactory from the point of view of the parties at interest? 

3. Do you agree with the proposition that because of decreased 
retirements in depression years lower charges to operations in 
respect of retirement expense (depreciation) are feasible? 



4i8 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

THE DETROIT EDISON COMPANY 

(A NEW YORK CORPORATION) 

BALANCE SHEET 

ASSETS 

As at December 

3*> 1936 
Fixed Capital:* 
Utility properties 

Tangible $292,488,284 

Intangible 7,476,631 

Other properties 

Tangible 287,858 

Total Fixed Capital $300,252,773 

Current and Working Assets: 

Cash on hand and on deposit in banks $ 4, 244,845 

Notes and accounts receivable, trade 

Billed 6,388,760 

Unbilled (estimated accrual since latest meter readings) . 2,223,100 
Other notes and accounts receivable. . . . 387,482 

Inventories quantities and condition determined by the 
management 

Merchandise for resale, at average cost 332 ,677 

Coal, at average cost i ,838,044 

Construction and maintenance materials, at average cost or 

Jess 3,722,385 

Prepaid insurance 400,463 

Total Current and Working Assets $ 19,537,756 

Miscellaneous Assets: 

Investments in and advances to subsidiary companies, con- 
solidated 

Capital stocks $ 874,049 

Indebtedness not current . . 848,906 

Loans to employes (less reserve) . . 132,789 

Other investments 

At cost (quoted market values not readily obtainable). . 252,419 

Casualty and contingency investment fund 

Marketable securities, at cost (aggregate quoted market 

value $1,357,154) . 1,292,898 

Annuity cash surrender value . ... 250,000 

Cash, and accrued interest purchased. . . . 6,736 
Long term contracts receivable and other miscellaneous assets 194,492 
Deposits in banks and trust companies closed or under restric- 
tion ^ 1,744,431 

Less reserve for undetermined losses 497,981 

Total Miscellaneous Assets $ 5 ,098 , 739 

Suspense Items: 

Debt discount and expense $ 7 ,052 , 738 

Miscellaneous undistributed charges 144,831 

Total Suspense Items $ 7,197,569 

Reacquired Securities: 

Capital stock reacquired for sale to employes, 1,479 shares, at 

cost $ 186,764 

Total Assets $332,273,601 

* Note. The amounts at which Fixed Capital is carried represent the historical cost thereof, 
and do not purport to represent or determine present sale value, replacement cost or reproduc- 
tion cost. 



DETROIT EDISON COMPANY NO. 2 419 

THE DETROIT EDISON COMPANY 

(A NEW YORK CORPORATION) 

BALANCE SHEET. (Continued) 

LIABILITIES 

As at December 

3i, 1936 
Capital Stock: 
Authorized 1,500,000 shares of a par value of $100 a share 

Outstanding 1,272,260 shares $127,226,000 

Premium on Capital Stock 758,038 

Long Term Debt: 

The Detroit Edison Company 

General and Refunding Mortgage Bonds 

Series D, 4}^%, due February i, 1961 $ 50,000,000 

Series E, 5%, due October i, 1952 15,000,000 

Series F, 4%, due October i, 1965 49,000,000 

Series G, 3}^%, due September i, 1966 20,000,000 

Total $134,000,000 

Great Lakes Power Company Mortgage Bonds, 6%, due 

April i, 1943 320,000 

Total Long Term Debt $134,320,000 

Current Liabilities: 

Accounts payable 

Trade $ i , 1 29 , 097 

Sales and excise taxes 176, 163 

Payrolls ^ .. 44^,574 

Accrued liabilities 

Taxes, including provision for Federal income taxes 3,097,208 

Interest on funded and unfunded debt i ,935,754 

Miscellaneous accruals 75 , 250 

Other current liabilities 

Dividend payable January 15. . . . . 2,544,520 

Consumers' deposits 689,877 

Deposits by employes on account of options to purchase 

capital stock reacquired by the company 53 , 840 

Miscellaneous items 26,328 

Total Current Liabilities . . . $ 10,176,611 

Reserves: 

Retirement reserve . $33,513,020 
Casualty and contingency reserve . . . 1,549,633 
Less allocated to reserve for undetermined losses in re- 
spect of deposits in closed banks 497,981 

Miscellaneous reserves . 121,854 

Total Reserves $ 34,686,526 

Unadjusted Credits: 

Customers' deposits for line extensions $ 15,667 

Appliance rentals and other items 9,977 

Total Unadjusted Credits $ 25,644 

Earned Surplus $ 25,080,782 

Total Liabilities, Reserves and Capital $332,273,601 



Source: Company report. 



420 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 



EXHIBIT i 

DETROIT EDISON COMPANY 

ESTIMATED RETIREMENT CHARGES 

FIVE YEARS, 1937-1941 





IQ37 


1938-1941 


Total, 
I 937-iQ4i 


Summary* 
Conners Creek Power Plant (see note i 
under Conners Creek detail) 


$ 5i3,5oo 
440,900 
30,300 

75,000 
322, 800 
275,000 
995,000 
18, 100 
91,000 
5,000 
5,000 

178,000 
358,8oo 


$ 2,452,600 
673,000 
255,000 

410,000 
1,319,900 
i , 080 , ooo 

3,590,000 
157,500 
524,000 
76,500 

20,000 
712,000 

I , 200 , 000 


$ 2,966,100 
1,113,900 
285,300 

485,000 
1,642,700 
1,355,000 
4,585,000 
175,600 
615,000 
81,500 
25,000 

890,000 
1,558,800 


Delray Power Plant 


Trenton Channel Power Plant 


Miscellaneous All Steam and Hydraulic 
Power Plants 


Substations 


Underground Lines 


Overhead Lines (including Meters) 


Heating Plants 


Steam Distribution System . . 


Port Huron Gas Division 


Warehouses . 
Equipment (Automobiles, Furniture, 
etc.) 


Miscellaneous . 


Grand Total . 


$3,308,400 


$12,470,500 


$15,778,900 





* Each of the items on this summary statement was supported by statements in greater 
detail. The one related to the Conners Creek power plant is given on page 421. 



DETROIT EDISON COMPANY NO. 2 



421 



EXHIBIT i. (Continued) 

DETROIT EDISON COMPANY 

ESTIMATED RETIREMENT CHARGES 

FIVE YEARS, 1937-1941 



Description of item 


Total 
property 
value 


Esti- 
mated 
salvage 
value 


Esti- 
mated 
cost of 
removal 


Estimated 
total 
retirement 
charge 


Estimated retirement 
charges 


1937 


1938-1941 


Detail 
Power Plants 
Conners Creek 
Mam Unit No. 4, 
including piping 
and electrical 
equipment (in- 
cludes recondi- 
tioning of sal- 
vaged parts and 
auxiliaries)*. . . 
Main Unit No. 6, 
including piping 
and electrical 
equipment (in- 
cludes recondi- 
tioning of sal- 
vaged parts and 
auxiliaries)* 
House Alternator No. 
4 and control equip- 
ment 
House Alternators 
Nos. 5 and 6* . . 
Boilers Nos 9 and 10 
and piping 
Boilers Nos. 5. 6, 7, 
and 8 and piping. 
Transformers and cms 
from units Nos. 4 
and 6* 


$ 515,000 

829,000 

34.900 
66,500 
390,000 
681,000 

116,000 

50,000 
175,000 

31,600 
35 , 400 


$ 15.000 

I5.00O 

6,500 
10,000 
20,000 
40,000 

5,ooo 

12,000 


$ 20,000 

20,000 
500 

1,100 

22,000 
44 , ooo 

S.ooo 

25,000 
52,000 


$ 520,000 

834,000 

28,900 
57.600 
392,000 
685,000 

116,000 

63,000 
227,000 

31,600 

I I , OOO 


$ 


$ 520,000 
834 , ooo 




28,900 


57,600 


392,000 


685,000 

116,000 

63 , ooo 
177,000 




Turbine room struc- 
tures* 
Boiler room structures 
Air cooler, old unit 
No 8 


50,000 
31,600 

I I , OOO 




Essex Replace unit 
No 8 circuit breaker 
and cables 

Total, Conners 
Creek .... 


24,70O 


300 




$2,924.400 


$I48,2OO 


$189,900 


$2,966, 100 


$513,500 


$2,452,600 



* The removal of units 4 and 6 and their auxiliaries during the next five years is only a 
possibility. It is now planned to furnish steam for these units through desuperheaters from 
the new high pressure boilers. Replacement of the units with larger ones depends upon eco- 
nomic and Toad conditions. There is also a possibility that one of these units may be moved to 
Delray Power House No. 3. 



422 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 



EXHIBIT 2 

DETROIT EDISON COMPANY 

(INCLUDING CONSOLIDATED SUBSIDIARY UTILITY COMPANIES) 
PROFIT AND Loss, THIRTY-FOUR YEARS ENDING DECEMBER 31, 1936 

(ooo omitted) 



Year 


Surplus 
at 
first 
of year 


Net 
income* 


Total 
surplus 
avail- 
able 


Appropriations from Surplus 


Surplus 
at 
end 
of 
year 


For re- 
tirement 
reserve 
(depreci- 
ation) 


Property 
retirals 
charged 
to profit 
and loss 


Other 
appropri- 
ations 
or 
write- 
offs 


Divi- 
dends 
de- 
clared 


1903 
1904 
1905 
1906 
1907 

1908 
1909 
1910 
1911 
1912 

1913 
1914 
1915 
1916 
1917 

1918 
1919 
1920 
1921 
1922 

1923 
1924 
1925 
1926 
1927 

1928 
1929 
1930 
1931 
1932 

1933 
1934 
1935 
1936 


$ 


$ 56 

90 
58 
137 
199 

167 
368 
625 
74i 
591 

1,027 
1,334 
1,732 
2,432 
2,354 

2,138 
2,337 
1,837 
2,545 
3,259 

5,148 

6,102 

8,390 
9,798 
IO.I52 

12,644 
13,146 
II.H7 
".429 
6,632 

5,708 
6,906 
9,863 
10,691 


$ 56 

94 
152 
289 
488 

242 
592 
1,016 
1,248 
1,125 

1,619 
2,166 
2,922 
3,990 
4,260 

4,441 
4,738 
4,497 
4,199 
5,225 

7,765 
10,201 
13,996 
17,341 
I9,58o 

24,541 
28,854 
31,604 
33,120 
26 , 240 

23,947 
25,806 
28,881 
32,736 


$ 52 


$... 


$ 


$ 


$ 4 

94 
152 
289 
75 

224 
391 
507 
534 
592 

832 
1,190 
1,558 
1,906 
2,284 

2,368 
2,660 
1,535 
1,964 
2,617 

4,099 
5,6o6 
7,543 
9,429 
I I , 898 

15,708 
20,487 
21,692 
19,608 
18. 138 

18,900 
18,968 
22,044 
25,027 


4 
94 
152 
289 

75 
224 
391 
50? 
534 

592 
832 
it I9O 
1,558 
1,906 

2,303 
2,401 
2,660 
1,654 
1,966 

2,617 
4.099 
5,606 
7,543 
9,428 

11,897 
15,708 
20,487 
21,691 
19,608 

i8,239t 
18,900 
19,018 
22,045 
























413 

18 
IOO 

250 
300 














i 
8 

7 

14 
34 
90 
159 




IOO 

250 
414 
525 

774 
942 
1,215 
1,488 
1,967 

2,056 
2,059 
2.2O2 
2,234 
2,599 

3,062 
3,968 
5,472 
6,354 
6,973 

7,198 
8,331 
9,897 
10,151 
8,851 

5,047 
5,066 
6,345 
7,623 
















59 

215 

9 

16 
19 
59 

i 

9 

173 
204 
34i 
578 
164 

135 
36 
15 
1,862 
749t 


222 


7OO 

430 

423 

640 
980 
545 

1,500 
1,500 


.... 


1,457 


;;;; 


315 

18 



* Including minor adjustments to surplus. 

t Credit. 

After credit adjustment of $101,052.71. 



DETROIT EDISON COMPANY NO. 2 



423 



EXHIBIT 3 

DETROIT EDISON COMPANY 

OPERATING AND NONOPERATING EXPENSES 

(INCLUDING CONSOLIDATED SUBSIDIARY UTILITY COMPANIES) 

(ooo omitted) 









Retirement 






Year 


Maintenance 
expense 


Per cent of 
gross 
revenue 


reserve (de- 
preciation) 
charged against 


Per cent of 
gross 
revenue 


Total 
expenses 








operations 






lOOl 


$ 40 


Q. 11 


$ 




$ 361 


7 \J 

1004 


ir ty 
60 


7 o 
8.79 






ir O 
4CI 


y*r 
lOOS 


64 



i y 

7. 10 






T^ J * 
<OI 


y v> 
IOO6 


77 


/ \j 
6. 27 






jy 

754 


y 
I OO7 


/ / 
104 


/ 
6.44 






/ j^ 
068 


y 
IQ08 


118 


yf 
6.62 






y 

1,106 


y 
I OOO 


142 


6.44 






1 .27> 


y y 

1910 


^ 
196 


6.46 


60 


1.98 


, / j 
1,780 


1911 


265 


7.36 


60 


1.67 


2,121 


1912 


347 


7.91 


460 


10.49 


2,987 


1913 


410 


7.40 


5io 


9.19 


3,732 


1914 


429 


6.60 


520 


8.01 


4,195 


19*5 


464 


5-98 


600 


7-73 


4,811 


1916 


606 


6. 02 


782 


7-77 


6,271 


1917 


709 


5.78 


782 


6-37 


8,616 


1918 


737 


5-34 


782 


5-67 


10,054 


1919 


974 


5-90 


860 


5-21 


12,220 


1920 


1,170 


5-32 


400 


1.82 


17,457 


1921 


i, 34 


5.58 


1,460 


6.24 


17,099 


1922 


1,601 


6.06 


2,415 


9.14 


19,239 


1923 


2,iSS 


6.79 


3,025 


9-54 


22,364 


1924 


2,467 


7. 22 


3,5oo 


10. 24 


23,898 


1925 


2,568 


6-59 


4,5i5 


n-59 


26,339 


1926 


2,971 


6.62 


5,5oo 


12.26 


30,86l 


1927 


2,807 


5-93 


5,950 


12.56 


32,156 


1928 


3,oi7 


5.76 


6,550 


12,51 


34,102 


1929 


3,589 


6-35 


7,400 


13-08 


37,58o 


1930 


3,199 


5-96 


6,900 


12.85 


36,566 


i93i 


2,898 


5.89 


4,000 


8.12 


31,811 


1932 


2,457 


5.58 


5,5oo 


12.48 


3i,M3 


1933 


2,098 


5-o6 


4,032 


9-75 


28,657 


1934 


2,493 


5-53 


4,625 


10.25 


31,733 


1935 


2,558 


5-15 


5,4i8 


10.92 


33,449 


1936 


3,362 


6.10 


6,688 


12.14 


38,280 



424 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 



EXHIBIT 4 

DETROIT EDISON COMPANY 

RETIREMENT RESERVE (DEPRECIATION), 1922-1936 
(ooo omitted) 





Appropriated 










to retirement 


Net charges 


Balance re- 




Year 


reserve (oper- 
ating expenses 


against 
retirement 


maining in the 
retirement 


Per cent of 
plant 




and surplus 


reserve 


reserve 






charges) 








1922 


$2,415 


$i,559 


* 3,704 


3-88 


1923 


3,455 


1,316 


5,843 


5-33 


1924 


3,923 


i,7i7 


8,049 


5.98 


i9 2 5 


5,i55 


2,176 


11,028 


7.21 


1926 


6,480 


3,430 


14,078 


7 69 


1927 


6,495 


4,035 


16,539 


8 05 


1928 


8,050 


4,014 


20,575 


8.96 


1929 


7,400 


4,233 


23,742 


9.17 


1930 


6,900 


4,886 


25,755 


9.42 


i93i 


5,500 


3,966 


27,289 


9.78 


1932 


5,500 


3,220 


29,569 


10.39 


1933 


4,032 


3,182 


30,419 


10.46 


1934 


6,082 


6,464 


30,037 


10.37 


1935 


5,4i8 


4,432 


31,022 


10.45 


1936 


6,898 


4,119 


33,8oi 


11.13 



Note. The funds corresponding to the balance in the Retirement Reserve have been invested 
in plant. 



XV. INTANGIBLES 
WINBIGLER TEXTILE MILLS COMPANY 

DETERMINATION OF THE VALUE OF A GOING BUSINESS 

In the early part of 1922, the stockholders of the Winbigler 
Textile Mills Company desired to liquidate their investment 
in that company. The stock had been closely held since the time 
of organization in 1913, but due to various unrelated reasons, 
all of the stockholders concluded it was a propitious period for 
them to dispose of their interests. 

An opportunity to accomplish this end was found about two 
months later, when it was learned that a much larger textile 
company with mills in both the New England and southern states 
had decided to expand its activities. The Winbigler Textile 
Mills, being located in North Carolina and equipped to manu- 
facture specialized fabrics, nearly fulfilled the requirements that 
were being sought by the executives of the larger company. 
Consequently the directors of the Winbigler Textile Mills were 
asked to quote a price at which they would sell all the capital 
stock. There were 10,342 shares of the common stock, and 
6,883 shares of the preferred stock outstanding. Ninety- two 
per cent of the former and 74 per cent of the latter were owned by 
the directors, and the remainder was held by people who would 
unquestionably accept any decision of the directors. 

There had never been an open market for the stock, neither 
on an exchange nor at a public auction. The only sale on record 
took place on April 16, 1921, when one of the directors sold 40 
shares at $625 a share. 

To determine the value of the stock, the directors revised the 
latest balance sheet to make it more accurately reflect actual 
conditions. 



435 



426 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 



WINBIGLER TEXTILE MILLS COMPANY 
BALANCE SHEET, JULY 31, 1921 





Book 
figures 


Adjusted 
figures 


Fixed Assets 


* 225,563 
3,780,981 
2,691,265 
2,088,830 
101,274 


$ 2,500,000 
3,780,981 
2,691,265 
2,088,830 
101,274 


Investments . ... 


Accounts Receivable 


Inventory 


Cash .... 


Preferred Stock 


$8,887,913 


$11 ,162,350 


$ 688,300 
1,034,200 
5,730,321 
29,076 
i5,3i7 
8,497 
80,000 
2,460 
235 
309,739 
615,000 

4,725 
370,000 

43 


$ 688,300 
1,034,200 
8,620,021 
29,076 
i5,3i7 
8,497 

2,460 
235 
39,739 
449,737 
4,725 


Common Stock 


Surplus . . . . . 


Accounts Payable 


Accrued Wages 


Legal and Auditors' Fees 


Commissions Payable . . . 


Wellington Club 


Dividend Declared 


Accrued Preferred Dividends 


Reserve for Taxes 


Reserve for Litigation . 


Reserve for Contingencies 


Accrued Interest 


43 


Net book value of Common Stock per Share 


$8,887,913 


$11,162,350 


$ 654 


$ 933 





Since its organization, the company had used excessive 
depreciation rates, making the book value of the fixed assets 
much less than the reproduction value less reasonable deprecia- 
tion. The Reserve for Taxes was deemed to be $165,263 greater 
than even conservative accounting warranted, and the Reserve 
for Contingencies account was transferred to the Surplus account 
because the directors believed it to be purely a proprietorship 
reserve. 

On an earning capacity basis, the value of each share of com- 
mon stock was estimated to be $1,117. This figure was deter- 
mined as follows: 



WINBIGLER TEXTILE MILLS COMPANY 



427 



Year 


Operating earnings, 
excluding investment 
income 


Income tax 


Net 


1917 
1918 
1919 
1920 
1921 


* 9n,iS3 
775,166 

774,772 
1,459,532 
i , 498 , 066 


$170,724 

171,519 
159,124 

429,884 
396,307 


$ 740,429 
603,647 
615,648 
1,029,648 
i,ioi,759 


$4,091,131 



Average yearly income. 
Less preferred dividend 



Capitalized on 10 per cent basis 



Value per share 

Value of investments per share. 

Total value per share 



$ 818,226 
41,298 

$ 776,928 
$7,769,280 



366 
$ 1,117 



Believing that the company unquestionably had a valuable 
asset in its goodwill, another attempt was made to find the value 
of the stock by considering that element. This was done by 
determining the following facts: the average investment required 
for the operations of the business, exclusive of the investment in 
securities; the average net earnings during that period; the excess 
of the net earnings over a reasonable return on the investment; 
and the value of that excess on the basis of an assumed five-year 
purchase. The calculation was as follows: 



428 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 



Date 


Total 
surplus 


Less invest- 
ments in 
securities 


Net surplus 
investment 
in operations 


December 31, 
December 31, 
December 31, 
December 31, 
December 31, 


1917 
1918 
1919 
1920 
1921 


$1,298,019 
2,044,890 
2,760,301 
2,803,967 
4,52i,i3S 


$ 924,104 
1,326,856 
1,813,710 

2,684,877 
2,762,837 


$ 373,915 
718,034 

946,591 
119,090 

1,758,298 


$3,915,928 



Average surplus applicable to operations $ 783 , 186 

Common stock i ,034, 200 

Total average investment in operations $i ,817,386 

Average net income $ 776,928 

Reasonable net income (10 per cent of investment) 181 ,739 

Excess over reasonable return $ 595, 189 

Taken on basis of 5-year purchase . 5 

Value of goodwill $2,975,945 

Value of goodwill per share $ 287 

Adjusted book value per share 933 



Total value per share of common stock. 



I ,220 



The goodwill was figured on a five-year purchase basis because 
the directors believed that the company manufactured what was 
essentially a staple commodity. Even though the company 
was open to competition, it had been able to maintain the excess 
return on the invested capital. 

A comparison was then made of the various methods of 
computation. 

Book value unadjusted $ 654 

Book value adjusted 933 

Capitalizing earnings at 10 per cent 1,117 

Goodwill added to adjusted book value i , 220 

Of these four, the earning capacity basis was considered the most 
accurate. 

The preferred stock was valued at par, plus the $309,739 or 
45 per cent of accrued dividends which had been allowed to 
accumulate. In setting a price, therefore, the directors used 
the following values: 



WINBIGLER TEXTILE MILLS COMPANY 429 

6,883 shares of preferred stock at $145 $ 998,035 

10,342 shares of common stock at $1,116 11,541,672 

Total $12,539,707 

The prospective purchasers, believing this to be excessive, 
made another analysis to refute it. In due time, they gathered 
the following information which they believed to be pertinent 
to the problem. 

While the dividends on the preferred stock had not been 
paid for several years, there was little doubt that the stock com- 
prised a good investment. Not only had the earnings of the com- 
pany been more than sufficient to justify the payment of the 
dividends, but the financial position of the company also warranted 
such action. The company had a large surplus of funds invested 
in securities, which could have been liquidated at any time to 
pay all the accumulated dividends, without hampering the regular 
operations of the mills. However, Mr. Beste, who was treasurer 
of the larger corporation, argued that the preferred stock should 
have been valued at only $85 per share because similar preferred 
stocks of other textile companies were at that time selling in the 
open market at more than a 7 per cent yield. Furthermore, he 
did not believe that the accumulated dividends should have been 
given a 100 per cent valuation. In the event that the accumu- 
lated dividends were paid, the holders of the preferred stock 
would be subject to a large income tax. No definite percentage 
could be stated for this because it would vary under different 
conditions, but Mr. Beste maintained that the average open 
market purchaser would deduct at least 25 per cent of the book 
value before making a bid. Therefore he recommended that the 
directors accept the following as being a logical value for the pre- 
ferred stock of the company: 

6,883 shares at $ 85 $585,055 

Accumulated dividends at 34 234,022 

$119 $819,077 

In arriving at a proper value for the common stock, a number 
of factors were considered. In the first place, Mr. Beste believed 
that 25 per cent of the value of the securities account applicable 
to the common stock should have been deducted for the same 
reasons that it had been done for the accumulated dividends on 
the preferred stock. In a sense, these securities were capital 



430 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

available for dividends, but the stockholder would not receive 
their full face value due to the income tax which would have to 
be paid. For this reason, the securities account was deemed 
to have the following value, from the common stockholders' 
viewpoint. 

Total market value of securities $3 , 780,981 

Less reserve for preferred dividends .... 309, 739 

Equity of common stock $3 ,471 , 242 

Probable tax if distributed (25 per cent) 867,811 

Net value to stockholder $2 , 603 , 431 

Value per share $ 252 

The basis which should have been used to capitalize the 
earnings was the point about which the greatest difference of 
opinion arose. The directors used a 10 per cent basis but Mr. 
Beste asserted that there was no justification for this valuation. 
To support this assertion, he quoted market values of the common 
stocks of textile mills which were engaged in the manufacture of 
staple products. In general, the earnings of these companies 
varied between 16 and 22 per cent of the market value. He 
believed the Winbigler Textile Mills did not make staple goods, 
but goods which were singularly subject to quick changes of 
demand. They made highly specialized yarns, which varied in 
color, design, and type. It was only through the keen foresight 
of the management that the earnings of the company had been 
maintained at such favorable levels. 

A large portion of the profits of the company had been due 
to the purchasing policies. Mr. A. D. Winbigler, who had resigned 
in August, 1921, had always directed the purchasing activities. 
His home had been in Boston where he had been able to keep in 
close touch with market conditions. He also had had very 
valuable contacts with brokers in England who had kept him 
posted with the latest market news. An analysis of the purchases 
made during the preceding 10 years revealed that the largest 
purchases were almost consistently made near the low prices. 

After the resignation of Mr. Winbigler, it was seriously 
doubted whether as experienced a manager could be found to 
take his place. A Mr. Dixon, who had been in charge of the mill 
operations and to whose efforts their efficiency was due, had been 
performing this function since Mr. Winbigler had left, but it was 



WINBIGLER TEXTILE MILLS COMPANY 431 

not expected that he could so efficiently conduct both activities 
at the same time. In fact, there was some question whether the 
Winbigler Textile Mills Company would be able indefinitely to 
retain his services. He was not bound by contract, and there 
existed the ever-present danger that some other textile company 
would offer him a bigger salary than the Winbigler Textile Mills 
could afford to pay. 

Mr. Beste pointed out these facts to indicate that the past 
earnings of the company were due to a very able management 
and not to goodwill. He maintained that any company which 
had to change the nature of its product so frequently did not have 
the opportunity to build up goodwill. 

Due to the change in the management, he contended that the 
past earnings could not be used as a reliable guide for present 
values. At any rate, he believed that the earnings should not 
be capitalized at less than 20 per cent. He asserted that the 
unstable condition in which the company found itself did not 
warrant a higher valuation. Using this basis, he computed the 
following value for the common stock. 

Average net earnings, 5 years $ 818, 226 

Capitalized on 20 per cent basis $4,091 , 130 

Less preferred stock at 85 585 ,055 

$3,506,075 

Value per share (divide by 10,342) $ 339 

Value of investments per share . . 252 

Total value, including investments $ 591 

As a total value of the securities of the Winbigler Textile 
Mills Company, Mr. Beste presented these figures: 

6,883 shares preferred stock at $119 $ 819,077 

10,342 shares common stock at $591 6,112,122 

Total value $6,931 , 199 



Criticize the two methods of determining the value of the 
stock. If you had been asked, as an independent consultant, to 
recommend a fair price for the stock and to present a report 
supporting your figures, what additional facts, if any, would you 
have considered and what methods would you have used? 



XVI. INVESTMENTS 
MANGER MANUFACTURING COMPANY 

INVESTMENTS IN SECURITIES 

A public accounting firm was engaged to audit the books of 
this company and prepare statements as of December 31, 1933. 
An examination of the company's security investment accounts 
disclosed the facts given in the paragraphs below. 

On the balance sheet of December 31, 1932, prepared by 
another accounting firm, the securities had been shown at cost 
with a footnote giving market value. The statements were to be 
prepared on a non-consolidated basis. 



1. How should security investments have been shown on the 
balance sheet of December 31, 1933? 

2. Should the basis of valuation of the prior balance sheet have 
been continued? If not, where should the resulting adjustment 
have appeared on the income statement or surplus statement? 

3. Which of the items were marketable securities? Which 
were current assets? 

a. The company owned 1,000 shares of United States Steel 
Corporation common stock, for which it had paid $67,500. On 
December 30, 1933, the market value of this stock was $47,750. 

b. The company held also $20,000 par value of Cleveland and 
Pittsburgh Railroad, General "B" 4% per cent bonds of 1942, 
which had cost $18,200. Upon consulting Fitch's Bond Record, 
the auditors found that these bonds were listed on the New York 
Stock Exchange and that the last sale had taken place on June 15, 
I 933> a t 98. The principal, interest, and sinking fund of these 
bonds were guaranteed by the Pennsylvania Railroad. 

c. National Dairy Products Corporation had outstanding 
December 31, 1933, $69,623,500 of an issue of 5 J per cent Deben- 
ture Gold bonds of 1948. The Manger Manufacturing Company 
owned $100,000 par value of these bonds at a cost of $80,250. 

432 



MANGER MANUFACTURING COMPANY 433 

They were listed on the New York Stock Exchange, sale quota- 
tions for December 30 being 79. l 

d. The Llewellyn Manufacturing Company had outstanding an 
issue of $2,000,000, 5^ per cent First Mortgage bonds, due in 
1953. The Manger Manufacturing Company held $750,000 of 
these bonds at a cost to them of $585,000. Local December 30 
market quotations indicated a bid price of 80, with 81}^ being 
asked. 

e. For temporary investment, the Manger Manufacturing 
Company had purchased 250 of its own 4 per cent Gold Deben- 
tures, $1,000 denomination, due in 1950, at a cost of $154,375. 
The company held also 1,525 shares of its common stock, $50 par 
value, for resale to employees at $25 per share, purchased at a cost 
of $36,981.25. Market quotations indicated a December 30 value 
for the bonds of $155,000, and for the stock, $40,412.50. 

/. A subsidiary of the Manger Manufacturing Company, the 
Hartman Castings Company, had outstanding an issue of $1,000,- 
ooo, 5^ per cent bonds due in 1942. These bonds were listed and 
the December 30, 1933, sale price was 74^- The Manger 
company owned $300,000 par value of these bonds, acquired at 
92 at the time they were issued. 

g. Another subsidiary, the Northwest Tool Works, Inc., had 
outstanding an issue of $800,000, 4 per cent bonds, all of which 
were owned by the Manger Manufacturing Company. These 
bonds had been bought in the open market at a cost of $623,815. 

h. Some years previously the Manger company had acquired 
60,000 out of a total issue of 110,000 shares of the no par stock 
of the Hartman Castings Company. The transaction had 
involved the transfer of an unused plant at an agreed figure of 
$430,000 and $200,000 in cash. The auditors were unable to 
determine whether the stated figure for the plant was reasonable, 
since by reason of its location the Hartman company had been 
the only logical purchaser. There was no current market for the 
minority shares. 

i. The company owned $100,000 par value of Universal Pipe 
and Radiator Company Debenture 6 per cent bonds of 1936, which 



1 If a company with a larger investment in securities had held $20,000,000 of 
this issue, would it have been as current an asset as the $100,000 held by the Manger 
company? 



434 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

had cost $51,500. The market quotation on December 30 was, 
bid gM, asked 19. The issue was rated by the Standard Statistics 
Company, Inc., as Uncertain Conditional rating because of 
insufficient data (formerly rated Very Weak). 

j. One investment of the company, that of the Francisco 
Sugar Company, 20-year 7^ per cent bonds of 1943, had defaulted 
on its November 15, 1933, interest payment. The Manger 
Manufacturing Company held $5,000 par of these bonds, which 
had cost $3,475. The market sale price on December 30 was 
20^. Receivers had been appointed November 16, 1933, and 
the issue was rated as Weak by Standard Statistics. 

k. The company owned 1,500 shares of American Woolen 
Company, $100 par, Cumulative Preferred stock. Cost price 
was $60,000 and market price on December 30, 1933, was $97,125. 
At this time there were accumulated dividends on this stock of 
$49 per share. 

GENERAL MANUFACTURING CORPORATION 
THE TREATMENT OF PREMIUM AND DISCOUNT ON BONDS 

The company, with total assets of $2,000,000, had built up an 
investment fund of $60,000 to provide for the replacement of some 
of its plant when retired and for future expansion if and when 
expansion seemed wise. It was not known when the funds would 
be required, but approximately half the investment was held in 
short-term bonds. It was the intention of the management to 
hold eventually about $200,000 in the fund. 

Two bonds, each of $1,000 denomination, were bought on 
June 29, 1927. The bonds were delivered to the company's 
broker on July i, and accrued interest was computed as of that 
day by the two brokers. The seller kept the coupon for the 
interest due July i, and since the bonds were delivered on the 
coupon date there was no accrued interest. The company paid its 
broker on July i, so the broker did not charge accrued interest, as 
he might have done, if he had been paid the next day. 

A description of each bond is given below: 

a. Brooklyn Edison Company, 6 per cent, General Mortgage, 
Series B bonds; due January i, 1930; interest payable January and 
July i; price paid, 104^. 



GENERAL MANUFACTURING CORPORATION 435 

b. Pressed Steel Car Company, 5 per cent Convertible Gold bonds; 
due January i, 1933; interest payable January and July i; price paid, 
94. 

On January i, 1928, when the first interest payment was 
received, a problem arose as to the treatment of premium and 
discount. The management wished to establish a general policy 
in accounting for these items. Four suggestions were made : 

a. At the time of purchase Investment in Bonds should be debited 
for the price paid, accrued interest, if any, being debited to Accrued 
Interest on Bond Investments. The bonds should be carried at the 
price paid until they matured or were sold. At that time Investment 
in Bonds should be credited for the original price, any difference, other 
than interest, being carried to Loss or Gain on Investments. 

b. Premium should be written off to Loss or Gain on Investments 
at the time of purchase. Discount should be treated as in a above. 

c. The premium or discount should be written off on a straight-line 
basis. In the case of the Brooklyn Edison bond the premium of $45 
should be written off in equal installments of $9 at the end of each of the 
five interest periods until maturity. 

January i, 1928 Cash $30.00 

Investment in Bonds $9.00 

Interest on Bond Investments 21 .00 

The discount of $60.00 on the Pressed Steel Car Company bond 
should be accumulated and added to the asset account in equal install- 
ments of $5.45 ($5.46 for five periods) over the n interest periods 
until maturity. 

January i, 1928 Cash $25.00 

Investment in Bonds 5-45 

Interest on Bond Investments $30. 45 

In both instances the bonds would be brought to par at maturity. 
If sold before maturity, the difference between the book value and the 
price received, after allowance for accrued interest, should be carried 
to Loss or Gain on Investments. 

d. Both bonds should be brought to par at maturity, but by a 
method more exact mathematically than the straight-line method. 
The reason a 6 per cent bond sold above par was that in the market 
appraisal a rate below 6 per cent (in this case 4.088 per cent) was deter- 
mined as adequate for a bond of that degree of risk. 

The amortization should be so arranged that the investor would 
always receive 4.088 or 2.044 per cent semiannually on the book value. 
The method is shown in the accompanying table. 



436 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

BROOKLYN EDISON COMPANY 







Interest at 


Interest on 
last book 


Amorti- 


Book 






coupon 


value at 


zation 


value 






rate 


market rate 










(3%) 


(2.044%) 




$1,045.00 


January i, 


1928. . 


$30 


$21.36 


$8.64 


1,036.36 


Tul v i . 


1028 


10 


21. 18 


8 82 


I ,O27. ZA 


January i, 


1929 


30 


21.00 


9 oo 


I,0l8.54 


Julv i. 


IO2O. . . 


10 


20.82 


18 


I ,OOO. ^6 


January i, 


IQ1O. . . . 


30 


20.63 


Q. 36 


I , OOO . OO 















The investor should receive in each period the market rate of 
interest on the last book value, and the difference between this and the 
interest actually received is the amortization which serves to write the 
bond down to par at maturity. The entry to record the first interest 
received should be 

January i, 1928 Cash $30.00 

Interest on Bond Investments $21 . 36 

Investment in Bonds 8. 64 

The Pressed Steel Car Company bond was available at a discount 
because the market had appraised it and established a rate of 6.308 
per cent, 

PRESSED STEEL CAR COMPANY 







Interest at 


Interest on 
last book 


Accumu- 


Book 






coupon 


value at 


lation 


value 






rate 


market rate 










(2%%) 


(3.154%) 




$ 940.00 


J 


r anuary i 1928. . . . 


$25 


$29.65 


$4.65 


944.65 


' 


[uly 1928 


2 ^ 


2O 7Q 


4.. 7O 




r 







~y / y 


t / y 


v/T^y . *}*} 




anuary 1929 






4CK 




. 








* yo 




' 


!uly 1929 


2 ^ 


30 10 


5 10 


on ACI 


; 


anuary 1930 . . . 


25 


30.26 


5.26 


964.75 


j 


uly 1930 


25 


30 43 


5-43 


970. 18 




anuary 1931 




30. 60 


< 60 


n*7 1 *7^ 




uly I93 1 - 


25 


30.78 


o * vw 

5.78 


981.56 




anuary 1932 


2 ? 


30. 96 


506 


n87 C2 





ulv 1012. 


2^ 




. y \J 

6 . 15 


001 67 





***./ x yo* 

anuarv i 1011 


25 


11 . id. 


6 33 


I OOO. OO 








O O" 







If the market rate of interest remained the same, the bond would 
become more valuable as it approached maturity. Income therefore 
arose from two sources, the interest received and the increase in the 



GENERAL MANUFACTURING CORPORATION 437 

value of the bond. In this accumulation table the income in each 
period is at the market rate on the last book value. The difference 
between the income so determined and the interest received is the 
accumulation. The entry to record the first interest received should be 

January i, 1928 Cash $25.00 

Investment in Bonds 4-65 

Interest on Bond Investments $29.65 

If the bonds were sold before maturity, the difference between 
the price received and book value at the time of sale, other than accrued 
interest, should be carried to Loss or Gain on Investments. 



1. Prepare journal entries to record the payment of each bond 
at maturity under each of the methods suggested. 

2. Assume that both bonds were sold with delivery July i, 
1929, the company retaining the coupons due on that date, and 
that prices received were 99% for the Brooklyn Edison Company 
bond and 90 for the Pressed Steel Car Company bond. Prepare 
journal entries to record the transaction under each of the methods 
suggested. 

3. The interest and principal on the Pressed Steel Car Com- 
pany bonds were defaulted at the date of maturity, January i, 
1933. Prepare any journal entries which seem necessary. 

4. What policy should the company have adopted in account- 
ing for premium and discount on bonds held as investments? 

5. Are there any reasons why one method should be used in 
accounting for premium and another for discount? 

6. Was the quality of the bonds an important factor in the 
determination of the treatment of discount and premium? If the 
policy of the company had been to hold first grade bonds or, on 
the other hand, to hold a distinctly speculative list, should this 
have affected the choice of a policy or its administration ? 

7. In what ways, if at all, would the situation have been 
different if the investor had been an individual, an investment 
trust, a bank holding the bonds as its own investment, a trust 
company holding them as trustee for an individual beneficiary, or 
an insurance company? 



XVII. FUNDED DEBT 



DETROIT EDISON COMPANY No. 3 



ACCOUNTS USED IN REPORTING FUNDED DEBT 

DETROIT EDISON COMPANY 

AND SUBSIDIARY UTILITY COMPANIES 

CONSOLIDATED BALANCE SHEET 

ASSETS 





As at Dec. 
3i. I93i 


As at Dec. 
31, 1930 


Fixed Capital: 
Plant investment: 
Real Estate, Buildings, Fixtures and Grounds 
Power Plant Equipment, Transmission and Distnbution 
System . ... 


$ 61,307,323 
217,625,866 


$ 59,815,428 
213,458,026 


Current Assets: 
Construction Materials, Coal and Other Supplies on hand 
and in transit (at cost or less) 


$278,933,189 


$-273,273,454 


$ 5,632,874 
2,736,579 
79,198 
8,721,801 

1,121 ,664 


$ 6,090,078 
3,634,752 
20,693 
8,280,895 
693,165 


Cash 


Notes Receivable 


Accounts Receivable 


Prepaid Accounts 


Miscellaneous Assets: 
Stocks of Subsidiary Companies (Note) 


$ l8,292,Il6 


$ 18,719,583 


$ 990,049 

6,811 ,911 
4,452,901 
1,329,558 
2,600 


$ 1,195,049 
6,325,639 
556,020 
1,255,365 
2,620 


Advances to Subsidiary Companies (Note) 


Bonds and Other Investments 




Special Deposits 


Suspense: 
Debt Discount and Expense (amortized during life of bonds) 
Deferred Charges, amounts in suspense and liquidation .... 

Adjustment Accounts: 
Reacquired Securities in excess of subscriptions accepted 
against the same 


$ 13,587,019 


$ 9,334,693 


$ 4,294,691 
54,385 


$ 3,769,255 
125, 148 


$ 4,349,076 


$ 3,894,403 


$ 47,996 


$ 2 , 884 




$315,209,396 


$305.225,017 







Note: These companies have no part in our public utility business or earnings, and their 
accounts are therefore not consolidated with ours in these statements. 



438 



DETROIT EDISON COMPANY NO. 3 



439 



DETROIT EDISON COMPANY 

AND SUBSIDIARY UTILITY COMPANIES 

CONSOLIDATED BALANCE SHEET. (Continued) 

LIABILITIES 





As at Dec. 
31, 1931 


As at Dec. 
31, 1930 


Capital Stock (Authorized 1,500,000 shares, $100 par value) 
Outstanding ... 


127,226,000 
796,189 


127,060, 100 
796,189 


Premium on Capital Stock. 


Long Term Debt: 
First Mortgage 5s due January i 1933 


$ 10,000,000 


( IO,OOO", OOO 

4,000,000 
16,665,000 
18,319,000 
26,016,000 
23 , ooo , ooo 
20,000,000 


Eastern Michigan Edison Company First Mortgage 5s, due 
(and paid) November I, 1931 


First and Refunding Mortgage 5s, Series A, due July I, 1940 
(redeemed March i, 1931) .... ... 




First and Refunding Mortgage 6s, Series B, due July i, 1940 
(redeemed March i, 1931) 




General and Refunding Mortgage ss, Series A, due October 
I, 1949 . . . . . 


26,000,000 
23,000,000 
20,000,000 
50,000,000 


General and Refunding Mortgage ss, Series B, due June i, 
1955 


General and Refunding Mortgage 5s, Series C, due August 
i 1962 


General and Refunding Mortgage 4^s, Series D, due 
February i 1061 . 


Convertible Debenture 6s, due December 15, 1932 
(redeemed December 15, 1931) 


133,900 


Current Liabilities: 
Notes Payable . . 




$129,000,000 


$118,133,900 


200,000 
3,710,359 




Accounts Payable 


3,918,855 


Accrued Liabilities: 
Taxes Accrued 


$ 3,910,359 


$ 3,918,855 


$ 2,591,720 
2,069,450 
95,875 


$ 3,432,100 
1,805,009 
99 , 999 


Interest Accrued. . . . 


Miscellaneous Accrued Liabilities 


Reserves: 
Retirement Reserve (Depreciation) 


$ 4,757,045 


$ 5,337,io8 


$ 27,289,574 
1,336,122 
923,323 


$ 25,755,328 
1,255,044 
791,821 


Casualty and Contingency Reserve 


Miscellaneous Reserves 


Miscellaneous Unadjusted Credits . . ... 


$ 29,549,019 


$ 27,802,193 


$ 363,228 
19,607,556 


$ 485,224 
21,691 ,448 


Profit and Loss (Surplus) 




$315,209,396 


$305,225,017 







Source: Company report. 

BALANCE SHEET LIABILITIES 1 

Important changes have been made in the Long Term Debt. The 
entire First and Refunding issue which was due in 1940, amounting to 
$34,984,000, was called for redemption on March ist, at a premium 
of 5%. More than half of this issue ($18,319,000) bore interest at 
6%, and the remainder bore 5%. The 6% bonds were sold in the 



1 Annual report, 1931. 



440 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

DETROIT EDISON COMPANY 
CONSOLIDATED INCOME ACCOUNT 

For the Year 1931 
Gross Earnings from All Operations: 

Electricity $46,573,482 

Steam 2,150,487 

Gas 464,440 

Miscellaneous 44,092 



Expense of All Operations, Including Maintenance $22,044,278 

Retirement Reserve (Depreciation) 4,000,000 

Federal Income and Other Taxes 5,767,000 

31,811,278 

Balance, Being Net Earnings from All Operations $17,421 , 223 

Interest on Funded Debt . . . . ... $ 6,068,717 

Interest on Unfunded Debt. 94,564 

$ 6,163,281 

Less Amount Charged to Property Account for 
Interest on Money Borrowed for Construction 
Purposes 394,973 



5,768,308 

Net Income $11,652,915 

Deductions: 

Extinguishment of Discount on Securities $ 185,129 

Miscellaneous . . . 38,650 



223,779 



Balance, Being Net Income Carried to Profit and 
Loss .... . . . $11,429,136 

Profit and Loss (Surplus) at Beginning of Period. . 21,691,448 

$33,120,584 
Appropriations from Profit and Loss: 

Dividends paid and declared . . . $10, 151 , 200 

Appropriations to Retirement Reserve (Depreci- 
ation) additional to current appropriations 
from earnings i , 500,000 

Unamortized Debt Discount and Expense on 
First and Refunding Mortgage Bonds, re- 
deemed March i, 1931 2,221,573 

Miscellaneous Adjustments of Profit and Loss 

(Net to Profit) 359, 745 

13,513,028 
Profit and Loss (Surplus) as per Balance Sheet . . . $19,607,556 



Note: Subsidiary companies whose accounts are not consolidated in the above income 
account have no part in our public utility business. The net income of such subsidiary com- 
panies amounted to $10,426 for 1931. 

Source: Company report. 



DETROIT EDISON COMPANY NO. 3 441 

troubled years 1920 and 1921, when they brought very low prices 
notwithstanding their high rate of interest. On February i, we sold 
4M% bonds to the same principal amount as the bonds called this 
4/4% series being Series D, General and Refunding Bonds due in 1961, 
but payable at par if called during five preceding years. This substi- 
tution of a 4^2% issue makes a decrease by $358,110 of annual interest 
charge on the same par value. The unamortized remainder of the 
selling discount and expense of the First and Refunding Bonds was 
$2,221,573, which has been written off against Surplus. 1 This is its 
proper disposition and it occasions the reduction of Surplus which is 
shown. On the issue of the like amount of General and Refunding 
Bonds, the State fees and recording tax were paid to the amount of 
$227,396, which amount likewise has been written off out of Surplus, 
according to our custom. The discount on the sale of this lot of 4%% 
bonds, and the premium paid on the call, are charged to Debt Discount 
and Expense, to be amortized in equal monthly charges over the long 
life of the new bonds. 

The second bond transaction of the year was the sale in July of an 
additional $15,016,000 of the same Series D, 4K%> General and 
Refunding Bonds. The proceeds thereof were used to retire short- 
time bank loans and to increase cash balance, and for the payments 



1 Although the $34,984,0x^0 of bonds sold February i were offered at 100 and 
interest, it is stated that the discount on the sale of this item was charged to Debt 
Discount and Expense. The discount involved represented the bankers' margin. 
The corporation received in cash the offering price less the margin. 

The price actually received by the corporation is not given, but most of the 
other entries to Debt Discount and Expense are given so that, by reconstructing this 
account, it is possible to get some idea of the amount of the discount on the $34,984,- 
ooo of bonds sold. 

DEBT DISCOUNT AND EXPENSE 



a. Dec. 31, 1930 Balance $3,769,255 
x, Feb. i, 1931 General & 

Refunding Bonds, 

Series D 1,182,268 

b. Mar. i, 1931 Premium 

on Call i , 749 , 200 

c. Dec. 15, 1931 Premium 

on Call 670 

$6,701,393 
Dec. 31, 1931 Balance $4,294,691 



d. Mar. i, 1931 Unamor- 

tized Debt Discount 

and Expense $2,221,573 

e. Dec. 31, 1931 Extin- 

guishment of Dis- 
count on Securities 185,129 
/. Dec. 31, 1931 Balance 4,294,691 



$6,701,393 



a. This is the balance of the account on December 31, 1930, given in the balance sheet. 

b. As indicated in the text, a premium of 5 per cent was paid on the First and Refunding 
Bonds, and this premium was charged to Debt Discount and Expense. 

c. A premium of % per cent was paid on the Convertible Debentures. 

d. As indicated in the text, this amount was written off. 

e. This amount is given in the income account, and represents the regular writing off o! 
Debt Discount and Expense against operations. 

/. The final balance of the account on December 31, 1931, is given in the balance sheet of 
that date. 

If no other entries were made in the account, item x, the discount on the General and Refund- 
ing Bonds, Series D, sold on February i was $1,182,268. This was at the rate of 3-379 per cent. 
The indicated cash received from this issue was the par less the discount. 



442 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

recited in the next two paragraphs. The State fees and recording tax 
on this lot have likewise been written off. 

The third transaction was the paying off at maturity (November i) 
of $4,000,000 Eastern Michigan Edison 5% bonds, followed by the 
discharge of the mortgage. These Eastern Michigan bonds were the 
last outstanding bonds of any subsidiary. All our remaining bonds are 
Detroit Edison issues namely, the original First Mortgage Bonds of 
$10,000,000, due January i, 1933, and the four Series of General and 
Refunding Bonds. 

In December we bought and cancelled $16,000 of the General and 
Refunding, 5%, Series A Bonds. This purchase was made to bring 
Series A to an even figure of $26,000,000. As of December 15, we also 
called for payment, one year ahead of maturity and at a premium of 
, the last remainder of 6% Convertible Debentures. 



1. Did the refinancing result in a net saving of $358,110 in 
the cost of the funds involved? 

2. Do you agree with the accounting disposition of the 
unamortized discount and expense on bonds called, the premium 
paid on the call, the state fees and recording tax, and the dis- 
count and expense on the new issues? 

NORTHERN STATES POWER COMPANY 

BOND DISCOUNT AND EXPENSE 

On November 19, 1934, application was made to the Securities 
and Exchange Commission by the Northern States Power Com- 
pany (a Minnesota corporation) for an order making its previously 
filed registration statement 1 effective as of November 21, 1934. 
While granting the application, the commission announced that a 
difference of opinion existed among the commissioners as to the 
treatment of certain items in the registration statement. In 
this connection, the commission's public statement 2 read in part 
as follows: 

The circumstances giving rise to difference of opinion among the 
commissioners were, speaking generally, as follows: In 1924 the Com- 
pany had on its books more than $8,000,000 of unamortized bond dis- 
count and expense. In that year it wrote up its fixed capital and invest- 
ment accounts approximately $15,876,596 on the basis of an appraisal 
by an affiliate, crediting about $7,784,949 thereof to a Retirement 

1 The registration statement referred to was filed in connection with a new 
$10,000,000 issue of 5 per cent Refunding Mortgage Bonds due in 1964. 

2 Securities and Exchange Commission, Release 254, November 21, 1934. 



NORTHERN STATES POWER COMPANY 443 

Reserve and about $8,091,647 to a Capital Surplus account. There- 
upon it charged off during 1924 and 1925 $8,070,208 which was sub- 
stantially all of its then unamortized bond discount and expense to the 
Capital Surplus account and thereafter to that extent made no annual 
charges against earnings or earned surplus for amortizing said discount 
and expense. 

Three of the commissioners thought that these circumstances were 
sufficiently disclosed in the registration statement and prospectus as 
amended, while two thought that adequate disclosure and treatment 
required that the balance sheets, the earnings, the earned surplus 
accounts and statements of dividends paid should be restated and 
should be accompanied by a statement of the company's past account- 
ing practices. 

Included in the auditors' certificate which appeared in the 
company's registration statement were the following two para- 
graphs concerning the matter referred to by the commission : 

As of December 31, 1924, there were reflected on the books of the 
Company the cost of reproduction new (including going-concern value 
and water-power value aggregating $6,768,464) and the accrued 
depreciation of the properties of the Company, as determined by an 
appraisal made by Byllesby Engineering and Management Corporation 
(an affiliated interest). The accounts of the Company have also been 
adjusted to reflect the value of the investments of the Company in its 
subsidiary companies (exclusive of values attaching to surplus earned 
since dates of acquisition of these companies), as determined upon the 
basis of this appraisal which also included the properties (including 
intangibles) of its subsidiary companies. Additions to property, 
plant and equipment and intangibles resulting from certain major 
acquisitions of properties made in 1926 were recorded at their net cost 
plus the amount ($2,398,212) of accrued depreciation indicated by an 
appraisal of these properties as of that date. As a result of recording 
these appraisals and acquisitions, the balance sheets of the Company as 
of December 31, 1933, and August 31, 1934, reflect gross increases in 
property, plant and equipment and intangibles of $5,515,801.15 and 
in investments of $10,360,794.87 making a total of $15,876,596.02 
of which $7,784,949.20 was credited to retirement reserve and the net 
appreciation of $8,091,647.00 was credited to capital surplus. Prior 
to August 31, 1934, the amounts of $5,515,801.15 and $7,784,949.02, 
respectively, were reduced by an amount of approximately $2,123,000 
representing the excess of the appraised value of property retired over 
the original cost thereof. 

Substantially all ($8,070,208.16) of the then unamortized debt 
discount and expense of the Company was charged off during 1924 and 
1925 against the capital surplus arising from the appraisal. Premium 
and duplicate interest on refunded issues were charged to unamortized 
debt discount and expense on Refunding Mortgage Gold Bonds, 



444 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

Series due 1961, and are in process of amortization over the life of the 
refunding issue. Prior to the making of these charges to capital 
surplus the Company had followed the policy of making annual charges 
to income which, in general, were designed to provide for the amortiza- 
tion of debt discount and expense over the lives of the respective issues, 
but on the basis of carrying forward all unexpired discount, premium 
and expense applicable to refunded issues to be spread over the life 
of the refunding issue. Upon this basis, the charges against income 
for amortization of debt discount and expense would have been 
increased by approximately $321,000 for the year 1931, $297,000 for 
the year 1932, $299,000 for the year 1933 and $190,000 for the eight 
months ended August 31, 1934, the total additional charges against 
income for the period prior to August 31, 1934, would have aggregated 
approximately $5,270,000, approximately $2,800,000 of the $8,070,- 
208.16 would have remained to be amortized over future years and 
surplus accounts as of August 31, 1934, would have shown a debit 
balance of approximately $1,104,000 for earned surplus and a credit 
balance of $8,091,647 for the capital surplus arising from the revalua- 
tion of fixed assets and investments. 



1. What is your opinion of the company's treatment of its 
unamortized debt discount and expense in 1924 and 1925? 

2. What difference would it have made in the subsequent 
statements of the Northern States Power Company if the $8,070,- 
208 write-off had been made to earned surplus rather than capital 
surplus? Is it probable that this would have made any difference 
in the commission's attitude on the case? 



XVIII. PROPRIETORSHIP 

A. DEVELOPMENT OF A CORPORATION FROM A SINGLE 
PROPRIETORSHIP 

ABERDEEN AND COMPANY 

PROPRIETORSHIP ACCOUNTS 

A. It is the purpose of this case to illustrate certain changes 
in the proprietorship status of a business, and the accounting 
treatment which these changes require. The statements have 
been simplified in order to bring out the significance of these 
changes more clearly. 

In 191 1 James Aberdeen was the sole proprietor of a woodwork- 
ing establishment manufacturing window frames and sash, doors, 
staircases, and other mill work for local building contractors. 
His balance sheet was as follows: 

JAMES ABERDEEN 
BALANCE SHEET, DECEMBER 31, 1911 

Cash . .. $5,000 Mortgage $30,000 

Accounts Receivable . . . 13,000 Capital 53>ooo 

Inventory. . . 15,000 

Plant ... 50,000 

$83,000 $83,000 

The average net profits for the preceding five years, after 
allowing the proprietor a salary of $3,600 per year, but before any 
allowance for loss on bad debts or for depreciation, had been 20 
per cent on the amount of his capital. The business had reached 
the limits of the local market, but he and two other men, one of 
whom was F. D. Williams, who had been selling building supplies 
in eastern Massachusetts, saw an opportunity for expansion. 
They therefore arranged a partnership under the following 
partnership agreement: 

January 2, 1912 

James Aberdeen, F. D. Williams, and H. C. Carpenter have this 
day entered into an agreement of co-partnership for the conduct of a 
general woodworking and millwork business to be known as Aberdeen, 
Williams, and Carpenter. 

445 



446 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

1. James Aberdeen is to contribute his interest in the assets as 
shown on his balance sheet of December 31, 1911, except that he is to 
set up an allowance of 10% for bad debts and one of 15% for deprecia- 
tion on plant. The goodwill of the present business is valued at the 
difference between his capital after these adjustments and $60,000, 
his agreed share in the partnership. 

2. F. D. Williams is to contribute $30,000 in cash and is to let his 
profits accumulate until his capital is $60,000. 

3. H. C. Carpenter is to contribute the mortgage of $30,000 on 
Aberdeen's plant, which he holds, and $30,000 in cash. 

4. The drawing account of each partner is to be credited with 
$300 on the first of each month in lieu of salary. 

5. All profits and losses are to be equally divided. Before deter- 
mining profits for purposes of distribution, 20% of the original value 
of goodwill is to be written off each year until goodwill is entirely 
eliminated. 

6. This agreement will terminate on the death of any partner and 
may be terminated on December 31 of any year if notice thereof is 
given by any partner six months in advance. In the event of liquida- 
tion each partner is to share in proportion to his capital. 



1. Show the partnership balance sheet as of the date of the 
agreement. 

2. If the operating profits on December 31, 1912, were $15,000, 
how would they be divided? 

3. If there had been an operating loss of $5,000, how would it 
have been divided? 

B. The expansion program of 1912 proved very profitable and 
further expansion was undertaken in 1919 in an effort to sell 
woodwork designed by outstanding architects in a national market. 
The expansion was financed partly from profits but principally 
from borrowing, much of which was on short time. A new plant 
begun in 1919 was finished in the fall of 1921 without adequate 
provision having been made for the financing. At this time, the 
balance sheet was as shown on page 447. 

The general creditors threatened to petition for a receiver 
unless some arrangement was made to pay off a portion of their 
claims and to provide for the eventual payment of the balance. 
H. C. Carpenter had been opposed to the later phases of the 
policy of expansion and wished to incorporate the business in 
order that liability in the event of failure would not involve the 
rest of his estate, since neither Aberdeen nor Williams had sub- 



ABERDEEN AND COMPANY 



447 



stantial funds outside the business. Carpenter was satisfied as 
to the prospects of the business, and he and two friends were 
willing to invest additional money in a corporation if they obtained 
control on sufficiently favorable terms. 



ABERDEEN 
BALANCE 

Cash 

Accounts Re- 
ceivable $275, ooo 

Less: Allow- 
ance 25,000 



Notes Receivable, Wil- 
liams 

Inventory 

Plant $600,000 

Less : Allow- 
ance 50,000 



Undivided Loss. 



, WILLIAMS, AND CARPENTER 
SHEET, DECEMBER 31, 1921 

$ 55,ooo First Mortgage Bonds. .. $ 200,000 

Notes Payable (Bank) . . . 200 , ooo 

Notes Payable (Builders) 175, ooo 

Accounts Payable 150, ooo 

250,000 Notes Payable (Aber- 
deen) 25,000 

Notes Payable (Carpen- 

25,000 ter) 50,000 

250, ooo James Aberdeen, Capital. 150, ooo 
F. D. Williams, Capital. 150,000 
H. C. Carpenter, Capital. 150,000 
550,000 James Aberdeen, Draw- 
ing Account 10, ooo 

150,000 F. D. Williams, Draw- 
ing Account 5 , ooo 

H. C. Carpenter, Draw- 
ing Account 15 , ooo 

$1,280,000 $1,280,000 



Carpenter suggested that a corporation be organized with 
10,000 shares of common stock of $100 par authorized, and that 
each partner should receive stock for his entire interest in the 
business, as shown by the balance sheet of December 31, 1921, 
after sharing the loss. In determining the interest of each partner 
in the business, the note receivable from Williams, the notes 
payable to Aberdeen and Carpenter, and the balances in the 
drawing accounts were to be included. Williams objected, but 
his note, on which he had borrowed for speculation outside, was 
past due, and he had nothing except his interest in the business 
with which to pay it. He finally agreed to the proposal. 

Carpenter then suggested to Henry Lewis and A. B. Gould, 
his friends interested in the business, that each of the three buy 
$100,000 worth of stock and pay $50 a share for it, one-half in 
cash down, and one-half three months later. Lewis and Gould 
objected because the stock would be assessable. They suggested 
that the three buy the notes payable from the banks and builders 
and point out to them that, if the incorporation did not go through, 
the notes could not be paid. Negotiations were opened and it 



448 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

proved possible to buy the notes for cash at 60 cts. on the dollar. 
The three bought the notes of $375,000 with their own money and 
agreed in writing to transfer them to the proposed corporation 
for $300,000 in stock and $75,000 in notes of the corporation. 
Since the proposal was going through, the notes were considered 
good and the stock was to be issued as fully paid. 

On January 10, 1922, a corporation under the name of Aberdeen 
and Company was organized under the laws of Massachusetts. 1 



1. Show the beginning balance sheet of the corporation. 

2. Was the stock fully paid? 



1 Commonwealth of Massachusetts, General Laws Relating to Corporations. 
Chapter 156. Business Corporations, Organization Section 6 through Section 12: 

"Section 6. Three or more persons may associate themselves by written agree- 
ment of association with the intention of forming a corporation under general laws 
for any lawful purpose not excluded by section two. The agreement of association 
shall state: 



" a. That the subscribers thereto associate themselves with the intention of 
forming a corporation. 

"b. The corporate name assumed. 



11 c. The location of the principal office of the corporation in the commonwealth, 
and elsewhere in the case of corporations organized to do business wholly outside the 
commonwealth. 

"d. The purposes for which the corporation is formed and the nature of the 
business to be transacted. 

"e. If only shares with par value are to be issued, the total amount of the capital 
stock of the corporation, which shall not be less than one thousand dollars, to be 
authorized, and the number of shares into which the capital stock is to be divided, 
and the par value of the shares, which shall not be less than five dollars, or, in lieu 
thereof, if any shares without par value are to be issued, the number of shares without 
par value to be authorized, which shall not be less than ten, and the number of shares 
having par value to be authorized, if any, and the par value thereof, which shall not 
be less than live dollars. 

"/. The restrictions, if any, imposed upon the transfer of shares. 



"g. If there are to be two or more classes of stock, a description of the different 
classes and a statement of the terms on which they are to be created and of the 
method of voting thereon. 

"h. Any other lawful provisions for the conduct and regulation of the business 
of the corporation, for its voluntary dissolution, or for limiting, defining or regulating 
the powers of the corporation, or of its directors or stockholders, or of any class of 
stockholders. 

"i. The subscriber or subscribers by whom the first meeting of the incorporators 
shall be called. 

"j. The names and residences of the incorporators and the amount of stock sub- 
scribed for by each. 



ABERDEEN AND COMPANY 449 



" Section 7. The agreement of association of any corporation formed for the 
purpose of acquiring, holding, managing, improving, leasing, buying and selling 
real estate, except a corporation formed for the purpose of owning forest land 
classified under chapter sixty -one, shall state the term of duration of the corporation, 
which shall not exceed fifty years. 



"Section 8. The first meeting of the incorporators shall be called by a notice 
signed by such subscriber to the agreement of association as may be designated 
therein or by a majority of the subscribers to such agreement; and such notice shall 
state the time, place and purposes of the meeting, which shall be held within the 
commonwealth. A copy of such notice shall, seven days at least before the day 
appointed for the meeting, be given to each incorporator or left at his residence or 
usual place of business, or deposited in the post office, postage prepaid, and addressed 
to him at his residence or usual place of business, and another copy thereof, and an 
affidavit of one of the signers that the notice has been duly served, shall be recorded 
with the records of the corporation. If all of the incorporators shall in writing, upon 
the agreement of association, waive such notice and fix the time and place of the 
meeting no notice shall be required. 



"Section 9. At the first meeting of a corporation organized under general law 
or created by special act, or at any adjournment thereof, the incorporators shall 
organize by the choice, by ballot, of a temporary clerk who shall be sworn, by the 
adoption of by-laws and by the election by ballot of directors, of a treasurer, of a 
clerk, and of such other officers as the by-laws require to be elected by the stock- 
holders. The temporary clerk shall make and attest a record of the proceedings, 
until the clerk has been chosen and sworn, including a record of such choice and 
qualification. 

"Section 10. A majority of the directors elected at such first meeting shall 
forthwith make, sign and make oath to articles setting forth: 

"a. A true copy of the agreement of association and the names of the sub- 
scribers thereto, or, if the corporation is created by special act, a copy of the act of 
incorporation. 

"k The date of the first meeting and of the successive adjournments thereof, 
if any. 

"c. Subject to section fourteen, the amount of capital stock then to be issued, 
the amount thereof to be paid for in full in cash, the amount thereof to be paid for 
in cash by instalments and the instalment to be paid before the corporation com- 
mences business, and the amount thereof to be paid for in property. If such prop- 
erty consists in any part of real estate, its location, area and the amount of stock 
to be issued therefor shall be stated; if any part of such property is personal, it shall 
be described in such detail as the commissioner may require, and the amount of 
stock to be issued therefor stated. If any part of the capital stock is issued for 
services or expense, the nature of such services or expenses and the amount of stock 
which is issued therefor shall be clearly stated. 

"d. The name, residence and post office address of each of the officers of the 
corporation. 

"The directors who sign such articles and the officers and directors who sign any 
amendment thereof shall be jointly and severally liable to any stockholder of the 
corporation for actual damages caused by any statement therein which is false and 
which they know, or on reasonable examination could have known, to be false. 



"Section n. The articles of organization, the agreement of association, and 
the record of the first meeting of the incorporators, including the by-laws, shall 
be submitted to the commissioner, who shall examine them and who may require 
such amendment thereof or such additional information as he deems necessary. 
If he finds that the provisions of law relative to the organization of the corporation 



450 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

C. At the end of 1924, the company decided to expand further 
and undertake a campaign of national advertising. Business was 
active from 1922 to 1924 and the temporary difficulties of 1921 
had been overcome. Net profits were $40,000 in 1922, $90,000 
in 1923, and $70,000 in 1924. Dividends of 6 per cent were paid 
in 1923 and 8 per cent in 1924. 

The directors decided to issue $200,000 of common stock and 
opened negotiations with a group of local businessmen who offered 
to buy it at $110, if payment could be made one-quarter at the 
time of subscription and one-quarter at the end of three, six, and 
nine months. It was arranged further that interest would be 
allowed on all amounts paid in at 6 per cent from the time of 

have been complied with, he shall endorse his approval on the articles. Thereupon, 
the articles shall, upon payment of the fee provided by section fifty-three, be filed 
in the office of the state secretary. 

" Section 12. Upon the approval and filing as above provided of the articles of 
organization of a corporation organized under general laws, the state secretary 
shall issue a certificate of incorporation in the following form: 

COMMONWEALTH OF MASSACHUSETTS 

"Be it known that whereas (the names of the subscribers to the agreement of 
association) have associated themselves with the intention of forming a corporation 
under the name of (the name of the corporation), for the purpose (the purpose 
declared in the agreement of association), with a capital stock of (the amount fixed 
in the agreement of association, with a statement of the several classes into which 
the stock is divided and their respective amounts, and of the method of paying 
for such stock, whether by cash in full, cash in instalments, property, services or 
expenses, or partly by one method and partly by another or others), and have 
complied with the provisions of the statutes of this commonwealth in such case made 
and provided, as appears from the articles of organization of said corporation, duly 
approved by the commissioner of corporations and taxation and recorded in this 
office: now, therefore, I (the name of the secretary), secretary of the commonwealth 
of Massachusetts, do hereby certify that said (the names of the subscribers to the 
agreement of association), their associates and successors, are legally organized and 
established as, and are hereby made, an existing corporation under the name of 
(name of the corporation), with the powers, rights and privileges, and subject to the 
limitations, duties and restrictions, which by law appertain thereto. 

" Witness my official signature hereunto subscribed, and the great seal of the 
commonwealth of Massachusetts hereunto affixed, this day of 

in the year (the date of filing of the articles of organization) . 

"If such corporation is organized with capital stock without par value, the 
form of said certificate may be modified to conform thereto. 

"The state secretary shall sign the certificate of incorporation and cause the 
great seal of the commonwealth to be thereto affixed, and such certificate shall 
have the force and effect of a special charter. The existence of every corporation 
organized under general laws shall begin upon the filing of the articles of organization 
in the office of the state secretary. The state secretary shall also cause a record 
of the certificate of incorporation to be made, and such certificate, or such record, 
or a certified copy thereof, shall be conclusive evidence of the existence of such 
corporation/' 



ABERDEEN AND COMPANY 451 

payment till the stock was issued and that the stock subscribed 
for by a particular investor would be issued whenever his subscrip- 
tion was paid in full. 

Williams was the only stockholder who wished to subscribe for 
the new issue. In many states, he would have had a right, known 
as the preemptive right, to subscribe for that percentage of the 
new issue which his holdings constituted of the old stock already 
issued, but this was not true in Massachusetts. The prospective 
investors, however, agreed to permit Williams to take the stock, 
for which he could have subscribed under the preemptive right. 
On December 31, 1924, Williams paid for his stock in full at no 
and the stock was issued on that date. He took only the number 
of whole shares to which he had a right under the agreement. 

On December 31, 1924, George 0. Carter and eight other men, 
who constituted the group which had negotiated for the pur- 
chase of the new stock, subscribed for $200,000 par value, less 
the amount which Williams had taken, under the terms of the 
agreement. 

A controlling account called Stock Subscriptions was opened 
in the general ledger and was debited with the total amount of the 
subscriptions at $110 a share. An account was opened for each 
subscriber in a subsidiary ledger. Stock Subscribed and Premium 
on Stock Subscribed, in the general ledger, were credited for 
the amount of the stock subscribed, at par, and the premium, 
respectively. 

The subscription agreement signed by Carter is given below: 

SUBSCRIPTION FORM 

The undersigned in consideration of the subscriptions of the other subscribers 
hereby subscribes for one hundred shares of common stock of Aberdeen and Com- 
pany and hereby agrees to pay the par value thereof (one hundred dollars per share), 
and ten dollars additional on each share as a premium, both in cash, to the treasurer 
of the corporation as follows: twenty- five per cent on the signing of this subscription, 
and twenty-five per cent on April i, July i, and October i, 1925. The stock will be 
issued when fully paid for, and will participate in dividends on and after the date of 
issue. Interest at the rate of six per cent, computed on the 36o-day basis, on all 
sums already paid in may be deducted from the last instalment due. 

December 31, 1924 GEORGE O. CARTER. 

All the subscribers paid the installments according to the 
terms of the agreement and the stock was issued on October i, 
1925. 

The company already had a stock ledger, controlled by the 
Capital Stock account in the general ledger. When Carter's 



452 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

stock was issued on payment of the last portion of his subscription, 
an account was opened in his name in this stock ledger. It was 
credited with the par value of the shares issued to him. If, sub- 
sequently, Carter sold any shares or surrendered them to the 
company, the account would be debited with the par value. 

The company's stock certificate book was similar to a check 
book. A certificate was detached and sent to Carter and the stub 
filled out to show the following information: the number of the 
certificate, the number of shares represented by it, and Carter's 
name. If the stock should be sold later, the returned certificate 
would be attached to its stub and a new certificate issued. There- 
fore the open stubs in this book showed the amount of stock 
outstanding and the names of the persons who held it. 



1. Show journal entries for all transactions involved in issuing 
the new stock. 

2. What accounting disposition should subsequently be made 
of the premium on this stock? If available legally for dividends, 
would you advise its being used for that purpose? 

3. Were the interests of the creditors and stockholders affected 
by the sale of this stock? If so, in what way? 

D. In 1925 a local firm of investment bankers became inter- 
ested in the company and suggested that a stock dividend would 
make it easier to sell stock later. A commercial banker also 
suggested that his bank would consider the credit of the company 
sounder if a stock dividend were paid. 

On the date of the last subscription payment the previous 
year, enough additional stock had been sold for cash to bring the 
total issued up to $900,000. The condensed balance sheet of the 
company was as follows: 

ABERDEEN AND COMPANY 
BALANCE SHEET, DECEMBER 31, 1925 

Cash $ 150,000 Outside Liabilities $ 250,000 

Other Assets i ,216,400 Capital Stock 900,000 

Premium on Stock 23,000 

Surplus 193,400 

$1,366,400 $1,366,400 

On January 2, 1926, the directors declared a stock dividend 
of 10 per cent, payable February i, to stock of record January 20. 



ABERDEEN AND COMPANY 453 

It was suggested that this be paid in part from premium on stock 
and the legal counsel of the company indicated that this was legal 
in Massachusetts, but not in some other states. It was decided 
to use the entire premium for this purpose. 

The company had appointed the General Trust Company to 
serve as transfer agent, so the latter prepared a transcript of the 
stock ledger, showing the number of shares held by each stock- 
holder as of the close of business on January 20, 1926. The 
treasurer of the company determined the amount of the dividend 
for each stockholder and made out a stock certificate and a warrant 
for each, the stock certificate being for the number of whole shares 
to which the stockholder was entitled under the dividend and the 
warrant entitling him to a fractional share. The warrants were 
transferable and carried a statement that stock certificates would 
be issued against warrants for the total amount of whole shares in 
warrants surrendered. The certificates and warrants were 
countersigned by the American Trust Company which served as 
registrar and were sent to the stockholders. 

1. Show the journal entries involved in the stock dividend. 

2. In what ways were the interests of creditors or stockholders 
affected by the stock dividend? 

E. During 1926 the net earnings before dividends were $190,- 
ooo and dividends were paid quarterly at the rate of 10 per cent 
per annum. The stock issued as a stock dividend on February i, 
1926, received full dividends, since the first quarterly dividend 
was paid March i, 1926, to stock of record February 15, 1926. 

In 1927 net earnings before dividends were $200,000 and 
dividends were paid quarterly at the rate of 10 per cent per annum. 

On January 10, 1928, the directors decided to split the stock 
three for one and issue three shares of no par stock for each share 
of par stock previously outstanding. The stated value of each 
new share was fixed at $40. The charter was amended to provide 
for the additional shares. 

A letter was sent to each stockholder asking him to surrender 
his share certificate properly endorsed on or before February i 
so that new certificates could be issued. When the old certificates 
were received, new certificates were made out by the treasurer 
and certified by the registrar. All the old certificates were 
surrendered. 



454 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

As of February i, the company issued 1,000 additional shares 
of the new no par stock to a group of investment bankers for $40 
per share. This stock was sold by the bankers to the public at $50. 

A quarterly dividend of $i per share was declared February 3 
payable March i, 1928, to stock of record February 15. 



1. Show journal entries to record the change to no par stock, 
the issuance of additional stock, and the declaration and payment 
of the dividend of $i per share. 

2. To what extent were the interests of the creditors and 
stockholders affected by these transactions? 

B. TYPES OF DIVIDENDS 

EASTMAN KODAK COMPANY 

REGULAR AND EXTRA DIVIDENDS IN CASH. WAGE DIVIDENDS 

The balance sheets at December 28, 1935, and December 26, 
1936, and the income and surplus statement for the intervening 
period are given below, as included in the annual report. Those 
portions of the balance sheets not directly concerned with divi- 
dends are condensed. The report also included a schedule show- 
ing earnings and dividends since 1902, and reference in the text 
to the wage dividend. Data concerning the dividends of the 
company are shown in Exhibit i. 



EASTMAN KODAK COMPANY 



455 



EASTMAN KODAK COMPANY AND ALL WHOLLY OWNED SUBSIDIARY 

COMPANIES 
CONDENSED CONSOLIDATED BALANCE SHEETS 





December 
26, 1936 


December 
28, 1935 


ASSETS 


$ 92,134,552 
5,643,600 
71 ,080,712 
984,859 


$ 95,177,148 
6,344,306 
65,831 ,009 
994,564 


Investments and. Advances (at cost, less reserve) . . 


Land, Buildings, Plant and Machinery, at Cost (Net) .... 
Deferred Charges to Future Operations 


LIABILITIES 
Current Liabilities: 
Accounts Payable, Accrued Payrolls, Wage Dividend, etc. . 
Reserve for Taxes ... 


$170,743,723 


$168,347,027 


$ 7,671,960 
7,544,878 


$ 6,268,885 
5,195,951 
2,378,473 

92,486 
3,376,382 


Bills Discounted 


Dividends Payable: 
Preferred 


92,485 
3,376,382 


Common 


General and Contingent Reserves 


$ 18,685,705 


$ 17,312,177 


$ 9,849,246 


$ 9,978,733 


Capital Stock and Paid-in Surplus: 
6% Cumulative Preferred Stock $100 par value: 
Authorized 100,000 shares j 


$ 6,165,700 

22,509,210 
28,617,862 


$ 6,165,700 

22,509,210 
28,617,862 


Issued 61 ,657 shares J 
Common Stock No par value: 
Authorized 2 , 500 , ooo shares 
Issued 2 , 263 , 150 shares 
Less: In Treasury 12,229 shares 


2,250,921 shares at stated value of 
$10.00 per share. . 
Paid-in Surplus* . 


Earned Surplus, as per annexed statement 


$ 57,292,772 


$ 57,292,772 


$ 84,916,000 


$ 83,763,345 




$170,743,723 


$168,347,027 







* The source of the paid-in surplus was described as follows in the report for 1929: 
Paid-in Surplus representing difference between amount received during year 
for 205,590 shares of Common Stock at $150 per share and the stated value 
thereof at $10 per share . . . ... $28 , 782 ,600 



456 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

EASTMAN KODAK COMPANY AND ALL WHOLLY OWNED SUBSIDIARY 

COMPANIES 

CONSOLIDATED STATEMENT OF 

PROFIT AND Loss AND EARNED SURPLUS 

FOR THE YEAR ENDED DECEMBER 26, 1936 

Net sales $119,800,210 

Less: 

Cost of sales and expenses (including depreciation of $6,252,- 

894 in 1936) 97,144,223 

Income from operations $ 22,655,987 

Interest and dividends 979 , 373 

Net profit on sales of securities 128,808 

Other income 162,481 

Total income $ 23,926,649 

Deduct: 

Provision for United States and foreign income taxes $ 4,532,929 

Provision for United States surtax on undistributed profits. . 210,928 

Other charges .... 276,421 



$ 5,020,278 
Net profit for the year $ 18,906,371 

EARNED SURPLUS 

Earned surplus, beginning of year $ 83 , 763,345 

Net profit for the year 18,906,371 

$102,669,716 

Deduct: 

Amount transferred to General and Contingent Reserves $ 2,000,000 
Excess of cost of shares over book value of net tangible assets 
of Kodak (East Africa) Limited (minority interest acquired 

during the year) 190,057 

Dividends: 

Preferred 6% 369 , 942 

Common $6.75 per share 15, 193,71? 

$ i7,753,7i6 
Earned surplus, end of year $ 84,916,000 



Source: Company report. 



EASTMAN KODAK COMPANY 457 

RECORD OF ANNUAL EARNINGS AND THEIR DISTRIBUTION 





Net 
Profits 


Preferred 
Dividends 


Common 
Dividends 


Reserve 
Fund 


Surplus 


1902, 6 months 
1903 
1904 
1905 
1906 
1907 
1908 
1909 
1910 
1911 
1912 
1913 
1914 
1915 
1916 
191? 
1918 
1919 
1920 
1921 
1922 
1923 
1924 
1925 
1926 
1927 
1928 
1929 
1930 
1931 
1932 
1933 
1934 
1935 
1936 


$ 1,488,295 
2,864, 7 1 9 
3,339,148 
4,013,913 
5,415,700 
7,015,423 
7,472,519 
7,852,575 
8,975,177 
11,649, 264 
13,999,047 
14,162,436 
11,313,012 

15,741,454 
17,289,206 
14,542,567 
14,051,969 
18,326, 188 
18,566,211 
14, 105 ,861 
17,952,555 
18,877,230 
17,201,815 
18,467, 114 
19,860,635 
20,142,161 
20,110,440 
22,014,916 
20,353,789 
13,408,786 
6,058,749 
11,119,044 
14,503,247 
15,913,251 
18,906,371 


$ 162,366 
368,059 
360,347 
365,217 
369 , 942 
369,942 
369 , 942 
369,942 
369,942 
369,942 
369,942 
369,942 
369,942 
369,942 
369,942 
369,942 
369,942 
369,942 
369,942 
369,942 
369,942 
369,942 
369,942 
369,942 
369,942 
369,942 
369,942 
369,942 
369,942 
369,942 
369,942 
369,942 
369,942 
369,942 
369,942 


$ 856,930 
i ,867, 205 
i ,921 ,019 
2,348, 197 
3,418,260 
4,891,550 
3,904,140 
5,856,210 
7,806,390 
7,804,905 
7,807,957 
7,810,620 
5,859,840 
ii ,719,680 
13,674,635 
5,861,520 
8,792,280 
7,819, no 
7,865,840 
7,953,215 
12,574,962 
15,678,337 
16, 267,400 
16, 231 ,640 
16, 167,880 
16,209, 200 
16, 224, 700 
16,630, 512 
17,861,380 
18,077,900 
9,008,478 
6,752,763 
10, 129, 145 
12,380,066 
15,193,717 


$ . . .. 


$ 468 , 999 
629,455 
1,057,782 
I , 300 , 499 
1,127,498 
1,003,931 
2,198,437 
626,423 
798,845 
2,974,417 
5,321,148 
4,981,874 
5,083,230 
3,651,832 
3,244,629 
8,311, 105 
4,889,747 
io, 137, 136 
10,330,429 
5,782,704 
5,007,650 

2 ,828,950 
564,473 
1,751,732 
3,095,213 
3,335,419 
3,288, 198 
4,786,862 
1,894,867 
5,039,056* 
3,319,671* 
3,996,339 

4,004, 160 
3,163,243 
1,342,712 


500,000 
750,000 
i ,000,000 

1,000,000 

500,000 
500,000 
i ,000,000 






















113,800 
227,600 
227 ,600 
227,600 
227,600 
227,600 










2,000,000 


Totals . 


$467,074,787 


$12,724,191 


$341,227,583 


$ 8,501,800 
$19,515,155 

190,058 


$104,621,213 
$ 19,705,213 


Deduct: Reserve re 
appropr 
will anc 
Additiona 
1936. 

Balance of earned 


jquired in addition to previous reserves and 
iations to offset entire book value of Good- 
Patents as at December 28, 1935 . . . 
[ reserve for the year ending December 26, 


surplus December 26, 1936 






$ 84,916,000 





* Deficit. 

Source: Company report. 

WAGE DIVIDEND: The payment of a wage dividend on March i, 
1937, was approved by the Board of Directors. This will make the 
twenty-fifth wage dividend payment, one having been made each year 
beginning in 1912, with the exception of 1934. The wage dividend is 
contingent on specific action each year by the Board of Directors, and 
upon declaration of dividends on the common stock of the Company 
in excess of $3.50 per share for the preceding calendar year. Its pur- 
pose is to enable employees to share in the financial success of the 
Company, to recognize the value of trained steady workers, and to 
reward continuous service. The wage dividend is not taken into 
account in establishing wage or salary rates. Employees are urged to 



458 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

regard it, as its name implies, not as extra wages but as dividends upon 
their earnings. The estimated amount payable March i, 1937, was 

$2,220,000. 



To minimize the effects of recent tax legislation, Eastman Kodak 
Company (a New York corporation, the principal operating sub- 
sidiary of your company) was dissolved on September 5, 1936. Its 
operations are now conducted by the parent company, Eastman Kodak 
Company, a New Jersey corporation. For the same reason, eight 
smaller subsidiary units were dissolved during the year, and their 
assets and liabilities were transferred to the parent company. 1 

EXHIBIT i 

EASTMAN KODAK COMPANY 
DIVIDEND DATA 





Preferred 


Common regular 


Common extra* 


1936 


$6.00 


$5.00 


Si- 75 



Approximate Dividend Dates 



Dividend meeting 
preferred & common 


Ex-dividend 
preferred & common 


Dividends payable 
preferred & common 


Novemberf 
February f 
Mayf 
August f 


December 5 
March 5 
June 5 
September 5 


January i 
April i 
July i 
October i 



* $p.- 2 5 each quarter and $0.75 on December 10. 

t Dividends are declared at the Board meeting held on the first Wednesday after the first 
Thursday of these months. 

Source: Standard Corporation Records, September 20, 1937. 



1. What were the significant differences, if any between the 
regular and extra dividends? 

2. Was the wage dividend an expense or a distribution of 
profit? 

3. Were the dividends on the stock of this corporation in 1936 
a distribution of profit? 

4. As far as may be determined from the facts given, what were 
the limits upon dividends which could be declared and paid? 



1 Annual report, 1936. 



A. M. BYERS COMPANY 459 

A. M. BYERS COMPANY 

DIVIDENDS FROM PAID-IN SURPLUS. INTEREST 
ON ACCUMULATED DIVIDENDS 

A description of dividends paid in 1937, the balance sheet for 
that year with the items other than those concerning capital very 
much condensed, and the deficit statement were taken from the 
report of the company for 1937: 

DIVIDENDS PAID 

The undistributed profits tax levied by the Federal Government, 
if no profits are distributed during the taxable year, averages 20^%. 
Therefore a dividend on the preferred stock was paid on September 20, 
1937 as follows: 

$1.25 per share balance accrued for quarter ended April 30, 1933. . . $ 70,930 
$1.25 per share balance accrued for quarter ended July 31, 1933. . . . 70,930 



Total Dividend . $141 ,860 

Interest at 5% accrued on these dividends in accordance with the 

Preferred Stock Provisions ... 30,360 

Total paid to Preferred Stockholders $172,220 

By advice of counsel, and by authority of the Board of Directors, 
this entire amount was charged to Paid-in Surplus because there was 
no available balance in the Earned Surplus account. The Pennsylvania 
laws, under which the company is incorporated, permit the charging of 
dividends on preferred stock to Paid-in Surplus under these conditions. 

The corporation has been advised by counsel that, for income tax 
purposes, the entire amount of the distribution is returnable as a divi- 
dend by the stockholders receiving the dividend. 

DIVIDENDS IN ARREARS 

The total amount in arrears on the Preferred Stock, accrued to 
September 30, 1937, is $1,626,661.33, or $28.67 P er share. 

Accrued interest (at 5%) on these deferred dividends, to September 
30, 1937, is $156,637.09, or $2.76 per share. 



460 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

A. M. BYERS COMPANY 
CONDENSED BALANCE SHEET, SEPTEMBER 30, 1937 

ASSETS 

Current Assets $ 2,834,113 

Capital Assets (net) 13,782,653 

Patents (net) 204, 545 

Goodwill i 

Deferred Charges 31 ,907 

$16,853,219 
LIABILITIES 

Current Liabilities $ 217 ,338 

Reserves 129,949 

Capital (Note A) : 
Capital Stock: 
Authorized : 

63,794 Shares 7% Cumulative Participating 

Preferred Stock of $100 par value .... $ 6,379,400 
325,000 Shares Common Stock of no par value $_ 
Issued: 

63,073 Shares Preferred $ 6,307,300 

266,635 Shares Common 2,666,350 

Stated value of capital stock $8,973,650 

Paid-in surplus (Note B) 9,070,730 

$18,044,380 
Deficit from operations (Note B) i , 688 , 404 

$16,355,976 
Deduct: 

Treasury Stock: 

6,329 Shares Preferred (Par value) $632,900 
2,000 Shares Common (cost) 143, 292 



$776,192 
Dividends (Note B) : 

Payment on account of cumu- 
lative dividends in arrears on 
preferred stock representing 
dividends originally due May 
i, 1933, and August i, 1933, 
amounting in each case to 
$1.25 per share, and interest 
at 5% per annum from date 
dividends were payable to date 
of payment, September 20, 
1937 $172,220 948,412 



^ . * , . . , . ^5,407, 564 

Capital surplus arising from revaluation of capital 

assets 1,098,368 16,505,932 

$16,853,219 



Note A. At September 30, 1937, there were unpaid cumulative dividends on the preferred 
Stock amounting to $1,626,661 and interest contingently payable thereon of $i 6,637. 

Note B. In accordance with resolutions of the Board of Directors, the dividends on the 
preferred stock, together with interest thereon, amounting to $172,220, have been charged to 
paid-in surplus. 



A. M. BYERS COMPANY 461 

A. M. BYERS COMPANY 
STATEMENT OF DEFICIT 

SEPTEMBER 30, 1937 

Deficit, A. M. Byers Company, at September 30, 1936 $ 105,505 

Provision to reduce investment in and advances to 
Orient Coal and Coke Company to book value 
thereof at September 30, 1936 i ,002 ,902 

Deficit at September 30, 1936 $i , 108,407 

Provision to reduce investment in and advances to 

Orient Coal and Coke Company to the nominal 

amount of $1.00 as at October i, 1936 818, 293 



$1,926,700 
Add Amortization applicable to prior years of costs of 

tentative projects 15 , 240 

$1,941,940 
Deduct: 

Transfers from reserve for contingencies $123,630 

Net profit for year ending September 30, 1937 93,223 

Proportion of capital surplus (arising from revalu- 
ation of properties) realized during year . . 36,683 253,536 



Deficit at September 30, 1937 $1,688,404* 



* Before charges in respect of preferred dividends and interest in arrears totaling $172,220, 
charged to paid-in surplus in accordance with resolutions of the Board of Directors. 

Most of the paid-in surplus arose from the issue of common 
stock in 1929 as described in the following excerpt from the report 
for that year. It is impossible to trace the figures exactly but 
apparently there was also a transfer from amounts previously 
carried in the stated value of common stock. 

COMMON STOCK 

The number of shares authorized has been increased from 200,000 
shares to 325,000 shares. On January 10, 1929, 660 shares authorized 
were sold for cash in accordance with authority previously given. On 
January 8, 1929, the preferred and common stockholders were given 
the right to subscribe to 66,635 shares of the common stock of the com- 
pany at $100 per share. All of this stock was subscribed for and was 
issued during the year. The number of common shares issued at 
September 30, 1929 total 266,635 and the number of shares authorized 
but not issued total 58,365. 

In 1930 paid-in surplus was brought to the figure at which it 
appeared in 1936 by a transfer described in the balance sheet for 
that year: 



4 6a PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

Paid-in Surplus October i, 1929 $8, 131 ,000 

Add Net Paid-in Surplus at February, 1925, trans- 
ferred from Capital Surplus arising from revalu- 
ation of Capital Assets 939,730 $9,070,730 



1. Were these dividends a distribution of the profit of the 
enterprise? 

2. Even if these dividends were income for purposes of the 
Federal income tax, were they income in fact? 

THE WESTINGHOUSE AIR BRAKE COMPANY 

REDUCTION OF CAPITAL AND RETURN OF CAPITAL 
TO STOCKHOLDERS 

Wilmerding, Pa., November 20, 1935 
To the Stockholders of 
The Westinghouse Air Brake Company: 

A meeting of the stockholders of the company has been called to 
convene on Friday, December 20, 1935, in accordance with formal 
notice thereof enclosed herewith. 

Your Board of Directors recommends that at this meeting action be 
taken to reduce the stated capital of the company from $47,581,660.80 
to $34,893,217.92 without however changing the number of issued 
shares. If this reduction in the stated capital be authorized by the 
stockholders, the surplus of the company will be increased by the 
amount of $12,688,442.88, which amount will represent paid-in or 
capital surplus. The amount of the reduction and of the paid-in or 
capital surplus thereby created would be equivalent to $4.00 per share 
on the 3,172,110.72 issued shares of no par value stock. 

Your Board further recommends, in connection with such reduction, 
that an amount equivalent to $2.00 per share of such paid-in or capital 
surplus be distributed as a return of capital to the stockholders in the 
manner hereinafter suggested. 

The reasons prompting the aforesaid recommendations are as 
follows: 

Among the consolidated current assets of the company are approxi- 
mately $16,000,000 of marketable securities, carried at cost, which is 
substantially the market value thereof. After a study of the amount of 
working capital that might be required upon the restoration of normal 
business conditions, it is the considered judgment of your Board that 
a reserve fund in marketable securities of $10,000,000 will adequately 
finance your business, and that the proceeds from sale of the remainder 
of these securities can, without effect on the company's ability to carry 
on its operations, be distributed to stockholders in connection with the 
return of capital. Your Board recommends that such distribution 



THE WESTINGHOUSE AIR BRAKE COMPANY 463 

be made in installments over a two-year period in order to assure more 
advantageous liquidation of the large amount of securities involved, 
such installments to be at the rate of 25 cents per share per quarter, 
commencing April 30, 1936, and to be payable to stockholders of record 
thirty (30) days prior to the respective dates of payment. 

During the years 1931, 1932, 1933, 1934, and the nine months of the 
present fiscal year, your company has disbursed to stockholders in 
ordinary dividends $15,628,465.08 in cash, which amount is $11,000,000 
in excess of the net earnings of the company within the period stated. 
As a result of such disbursements the earned surplus of the company 
has been so reduced in amount that in the judgment of your Board it 
is advantageous to establish a paid-in surplus equivalent to $4.00 per 
share, one-half of which will be retained as paid-in surplus, and the 
remaining half distributed to stockholders as suggested. 

After giving effect to the proposed reduction in stated capital and 
distribution of $2.00 per share, the stated capital of the company will 
be reduced to $34,893,217.92 and the surplus will be increased by 
$6,344,221.44 of paid-in or capital surplus, which, however, will not be 
available for ordinary dividends. 

While the expectation of a definite improvement in the business 
situation seems warranted, your Board feels that the continuance of 
ordinary dividend payments after January 31, 1936, must await the 
realization of future earnings, but if these proposals are favorably 
acted upon, the stockholders may expect a payment of at least 25 cents 
per share per quarter for the two years commencing April 30, 1936. 
This is twice the rate of ordinary dividends which have been currently 
paid. 

The suggested reduction in the stated capital of the company 
equivalent to $4.00 per share would in nowise affect the equity of any 
stockholder, but would merely create a paid-in or capital surplus in a 
corresponding amount. However, the suggested distribution to stock- 
holders to the extent of $2.00 per share would, of course, reduce their 
equity in an equivalent amount, just as would ordinary dividends. 

Your Board strongly recommends that you vote in favor of the 
proposed action, and inasmuch as the affirmative vote of the holders 
of a majority of the outstanding shares of the capital stock will be 
required, you are respectfully urged to make sure of being represented 
at the meeting. In the event of your inability to be present in person 
and of your being in favor of the Board's recommendations, it is 
important that the enclosed proxy, which will be voted in favor of the 
proposed action and which is solicited on behalf of your Board, be 
dated, signed and mailed in the enclosed envelope by you to the 
Secretary as soon as possible after receipt of this letter. 

By Order of the Board, 

A. L. HUMPHREY, 

Chairman. 
CHAS. A. ROWAN, 
President. 



464 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

THE WESTINGHOUSE AIR BRAKE COMPANY 
Wilmerding, Pa. 

NOTICE or SPECIAL MEETING OF STOCKHOLDERS 

To the Stockholders of 
The Westinghouse Air Brake Company: 

Notice is hereby given that a special meeting of the stockholders of 
The Westinghouse Air Brake Company will be held at the principal 
office of the Company in the Borough of Wilmerding, Allegheny 
County, Pennsylvania, on Friday, the 2oth day of December, 1935, 
at 1:00 o'clock p.m., for the following purposes: 

i. For the purpose of considering and acting upon the following 
resolution heretofore adopted by the Board of Directors of said 
company: 

"The Board of Directors of The Westinghouse Air Brake Company, 
a Pennsylvania corporation, duly convened in a meeting at the office 
of the Company, Westinghouse Building, City of Pittsburgh, State of 
Pennsylvania, on the i2th day of November, 1935, at 3:00 o'clock p.m., 
do, upon motion duly made and seconded and unanimously carried, 
RESOLVE AND DECLARE that it is advisable and in the best interests of the 
company: 

"That the present stated capital of the company applicable to its 
3,172,110.72 issued no par value shares be reduced from $47,581,660.80 
to $34,893,217.92 without changing the number of said shares; 

"That upon such reduction in stated capital there be transferred 
on the books of the company from stated capital to the account of 
paid-in surplus an amount equivalent to such reduction, viz.: 
$12,688,442.88; 

"That upon such reduction in stated capital there be distributed 
to the stockholders as a return of capital the sum of $6,344,221.44 out 
of paid-in surplus to be created through the proposed reduction in 
stated capital, being equivalent to $2.00 per share thereof, and that 
in order to assure more advantageous liquidation of the large amount of 
securities involved, such distribution be in installments over a two-year 
period at the rate of 25 cents per share per quarter, commencing April 
30, 1936, the respective installments to be payable to stockholders of 
record thirty days prior to the date of payment. 

"The Board of Directors of The Westinghouse Air Brake Company 
do further RESOLVE AND DECLARE that the foregoing matters shall be 
submitted to a vote at a special meeting of the stockholders entitled 
to vote thereon, to be held at the principal office of the Company in 
the Borough of Wilmerding, Pennsylvania, on the 2oth day of Decem- 
ber, 1935, at 1:00 o'clock p.m., and that the secretary of the company 
be and he is hereby directed to cause written notice to be given to 
each stockholder of record entitled to vote thereon of the time, place 
and purposes of said meeting as indicated in the preceding resolution, 



THE WESTINGHOUSE AIR BRAKE COMPANY 465 

such notice to be in conformity with the by-laws of the company and 
the laws of the State of Pennsylvania. " 

2. To transact such other business as may properly come before 
the said meeting in connection with any of the foregoing matters. 

The stockholders of record on the books of the company at the 
close of business on November 30, 1935, will be entitled to vote at the 
meeting. 

By Order of the Board, 
R. O. YEARICK, 

Secretary. 
November 20, 1935. 

THE WESTINGHOUSE AIR BRAKE COMPANY 

CONDENSED CONSOLIDATED BALANCE SHEET 

DECEMBER 31, 1935 

ASSETS 

Current Assets $29,334,118 

Other Notes and Accounts Receivable i ,967,874 

Miscellaneous Investments 7 ,984,460 

Capital Stock of Westinghouse Air Brake Company held for corpo- 
rate purposes in the Treasuries of the companies (65,293 66 2(ooo 

shares at cost) 1,588,846 

Property (net) 10,914,035 

Other Assets and Deferred Charges 79 2 >757 

$52,582,090 
LIABILITIES 
Current Liabilities 

Dividends Payable January 31, 1936 . . $ 388,321 

Amount to be Distributed from Paid-in Surplus 

in 1936 . 2,379,083 

Other Current Liabilities . . 1,052,297 $ 3,819,701 



Amounts to be Distributed from Paid-in Surplus 

Subsequent to 1936 . 3>9 6 5, I 38 

Other Liabilities . i ,463 , 134 

Capital Stock and Surplus: 

Capital Stock Authorized 4 , ooo , ooo 

Shares of no par value ; issued . ... 3,172,111 

Shares Stated Capital . $34,893, 218 

Surplus: 

Earned Surplus (restricted in the amount 
of $251,361, which represents the cost of 
6,845 66 fooo shares of the parent com- 
pany's capital stock reacquired and held in its 

treasury) 2 , 096 , 677 

Paid-in Surplus 6,344,222 43,334,117 

$52,582,090 



4 66 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

THE WESTINGHOUSE AIR BRAKE COMPANY 
CONDENSED STATEMENT or CONSOLIDATED INCOME AND EARNED 

SURPLUS FOR THE YEAR ENDED DECEMBER 31, 1935 
Gross Sales Less discounts, returns, and allowances ......... $ I][ >739>3 2 8 

Cost of Sales (including distribution, administration, and general 

expenses, but before income taxes) ...................... 12, 293 , 260 

Net Loss from Operations ........................... $ 553,932 

Other Income Net ..... ......................... i , 649 , 147 

Net Profit ................. . ......... $ 1,095,215 

Provision for Federal and State Income Taxes .... .... 173, 139 

Net Profit for the Year .............. ..... $ 922,076 

Extraordinary Charges Net.. ... . . . . 619,603 

Net Increase in Earned Surplus before Dividends . . . . $ 302,473 

Earned Surplus, January i, 1935 . . 3,348,036 

Earned Surplus before Dividends . . . $ 3,650,509 

Cash Dividends Declared ............. ......... i, 553 ,832 

Earned Surplus, December 31, 1935 ... . . . $ 2,096,677 

STATEMENT OF PAID-IN SURPLUS FOR THE YEAR ENDED DECEMBER 



. 

Paid-in Surplus Created by Reduction of Stated Value of Capital 

Stock ..................... . . $12,688,443 

Less Amount Authorized to be Distributed to Stockholders 
(included in Liabilities in the Consolidated Balance Sheet at 
December 31, 1935) ..................................... 6,344,221 



Paid-in Surplus, December 31, 1935 $ 6,344,222 



Source: Company report. 



1. Were the dividends of $2 per share a distribution of profit 
or a return of capital? In what respects did they differ from the 
dividends described in the case of the A. M. Byers Company? 

2. Were the dividends of The Westinghouse Air Brake Com- 
pany income to the recipients? 

3. In view of the facts stated was the action of the company 
in reducing its capital and paying dividends from the surplus so 
created wise? 



HAMILTON WOOLEN COMPANY 467 



HAMILTON WOOLEN COMPANY 

ACQUISITION OF TREASURY STOCK 

In April, 1932, the Hamilton Woolen Company, Inc. notified its 
stockholders that it had on hand cash in excess of its estimated require- 
ments for working capital under then existing conditions and that it 
was unable under those conditions to use this cash advantageously. 
The Board of Directors at that time, after carefully considering the 
problem of investing this excess cash in securities, decided that it 
would be advisable to use it for the purchase of stock of the corporation. 
This plan having been approved by the stockholders, the Board of 
Directors invited offers of stock by the stockholders, and. expended 
$422,500 in the purchase of a total of 6500 shares of stock, which are 
now held in the treasury. 

The Directors believe it advisable to again purchase stock of the 
corporation. They are of the opinion that the corporation should not 
go into the open market to buy its own stock without first offering to 
all stockholders an equal opportunity to offer for purchase by the 
corporation all or part of their holdings, should they desire to do so. 

Subject to action by the stockholders, the Board of Directors has 
therefore authorized an invitation to stockholders to offer all or any 
part of their stock for purchase by the corporation at not exceeding $50 
per share. The terms of such invitation, determined pursuant to 
that authorization, are set forth in subparagraphs A to F, inclusive, of 
article 4 of the Notice of the Annual Meeting of Stockholders to be 
held February t, 1933, enclosed herewith. If these terms are approved 
by the stockholders at the meeting, the Board of Directors proposes 
that the corporation invite offers from the stockholders of record upon 
the terms stated, and has authorized an aggregate present expenditure 
for the purchase of stock from stockholders, on the proposed terms or 
in the open market, not in excess of $62,ooo. 1 

A. The corporation proposes to apply not exceeding $62,000 of 
surplus to the purchase of its common stock at not exceeding $50 per 
share. 

B. Stockholders of record may offer to the corporation all or any 
part of their stock for purchase at $50 per share or at any less price. 
Stockholders may offer different blocks of their stock at different 
prices, but no stockholder shall offer more stock than the amount 
standing in his name, and no alternative, conditional or contingent 
offers will be accepted. Offers at the lowest prices will be accepted 
first and, in case not all the stock offered at the same price is accepted 
for purchase, the number of shares purchased at such price will be 
prorated as nearly as possible (avoiding fractions of a share) among all 



1 Company report, November 30, 1932. 



468 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

offers at such price. The corporation reserves the right to reject any 
and all offers. 

C. Offers for purchase hereunder by the corporation shall be sub- 
mitted on forms to be furnished by the corporation, signed by the stock- 
holder of record and enclosed in a sealed envelope; and must be received 
by Messrs. Price, Waterhouse & Company, Auditors, 75 Federal Street, 
Boston, Massachusetts, on or before twelve o'clock noon, February 

25, IQ33- 

D. All offers received will remain sealed until the expiration of the 

period for submitting offers, and at or after that hour will be opened 
and checked by representatives of the corporation's auditors, Messrs. 
Price, Waterhouse & Company, who will report thereon to the Board 
of Directors. The Board will act upon such report as soon as possible, 
but not later than March 4, 1933. 

E. Stockholders will receive prompt notification of the number of 
shares which the corporation has elected to purchase on their respective 
offers and will be requested to deposit with the Transfer Agent stock 
certificates (in form for transfer) for the shares purchased not later than 
ten (10) days after the date of such notice. 

F. This invitation to offer stock hereunder is open to all stock- 
holders including the Directors of the corporation, who may offer 
thereunder stock of the corporation held by them individually or as 
trustees or in other fiduciary capacities. 1 

HAMILTON WOOLEN COMPANY, INC. 
BALANCE SHEET NOVEMBER 30, 1932 

ASSETS 
Current Assets: 

Cash on hand and in banks $ 338,355 

United States Certificates of Indebtedness matur- 
ing within one year and accrued interest 836, 244 
Accounts receivable less reserves . 5 1 7 , 689 
Inventories at cost or market, whichever lower. . $ 492,164 
Less Reserve 75,ooo 417,164 

$2,109,452 

Deferred Charges ... 37 , 843 

Fixed Assets: 
Land, buildings, machinery and equipment at 

adjusted book value . $ 993,495 

Less Reserve for depreciation 473,408 520,087 

$2,667,382 



Company Notice of Annual Meeting of Stockholders, January 16, 1933. 



HAMILTON WOOLEN COMPANY 469 

HAMILTON WOOLEN COMPANY, INC. 
BALANCE SHEET NOVEMBER 30, 1932. (Continued) 

LIABILITIES 
Current Liabilities: 

Accounts payable $ 20, 344 

Accrued pay roll and commissions 17*961 

Provision for state and federal taxes 22, 119 

Provision for loss in finishing unshipped sales 7,627 

Provision for dividend payable January 16, 1933 . 38,730 $ 106,781 

Capital Stock: 
Authorized 45,000 shares of no par value 

Issued 38, 775 shares $1,938,750 

Less In treasury 6,500 shares 325 ,000 

Outstanding 32,275 shares 1,613,750 

Surplus: 

Balance December i, 1931 $1,043,374 

Less Cost of treasury stock in excess of $50 per 

share 97,5o 



$ 945,874 
Add Net profit for the year ending 

November 30, 1932, as per statement 

annexed $39,617 

Less Dividend payable January 16, 

1933 38,640 977 946,851 

$2,667,382 

HAMILTON WOOLEN COMPANY, INC. 
CONDENSED STATEMENT OF PROFIT AND Loss 
FOR THE YEAJR. ENDING NOVEMBER 30, 1932 

Net sales (less discounts and allowances) $3, 710,871 

Cost of sales, expenses, and all other charges, except taxes deducted 

below 3,686,492 

$ 24,379 
Add: Interest received and miscellaneous income 20, 238 

$ 44,6i7 
Deduct: Provision for state and federal taxes 5,ooo 

Net profit for the year $ 39, 617 



Source: Company report. 



In what respects did the acquisition of treasury stock in 1933 
differ from the dividends described in the A. M. Byers Company 
and The Westinghouse Air Brake Company cases? 



470 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

DEERE & COMPANY 

STOCK DIVIDEND PAID ON COMMON IN COMMON. 
THE EFFECT OF TAXATION ON DIVIDENDS 

By amendments to the Articles of Incorporation of the Company 
adopted by its shareholders on September 15, 1937, and filed in the 
office of the Secretary of State of the State of Illinois on September 20, 
1937, it is provided that the unissued shares of Common Stock of the 
Company may be issued at such time or times, in such manner, amounts 
and proportions and for such considerations, as shall be fixed from time 
to time by the Board of Directors and permitted by law. At a meeting 
of the Board of Directors immediately following the above mentioned 
meeting of the shareholders, the Board adopted a resolution declaring 
a Common Stock dividend payable on October 30, 1937, to the Common 
Shareholders of record at the close of business on October 2, 1937, at 
the rate of two shares of Common Stock for each one share of Common 
Stock outstanding (not including shares held in the treasury of the 
Company). The number of outstanding common shares (exclusive of 
3,546 shares in the treasury of the Company) is 1,001,454; the number 
of shares required for the payment of said Common Stock dividend is, 
therefore, 2,002,908. 

Concurrently with the declaration of said Common Stock dividend, 
and for the purpose of providing the capital required therefor, there 
was transferred from the earned surplus account of the Company to 
capital account the sum of $9,979,080. 

The purpose of the declaration of the payment of this Common 
Stock dividend is to effect a wider distribution of Common Stock among 
its Common Shareholders, and to provide additional permanent capital 
to meet the expanding business of the Company. The amount so 
transferred from surplus to capital account will constitute a part of 
the working capital of the Company and the same has not yet been 
allocated to any specific uses. 1 

Excerpts from the balance sheets of October 31, 1936 and 1937, 
and the income and surplus statement for the intervening period 
are included. 



1 New York Stock Exchange Listing Application, A- 11,005, September 22, 1937. 



DEERE & COMPANY 



1. The company paid three types of dividends during 1937. 
What were the significant differences among them in terms of 
the effects on the corporation? 

2. How much income did a stockholder receive who held 
100 shares of preferred throughout the fiscal year ending October 
31, 1937, and 100 shares of common until October 30 at which 
time he received additional shares? 

DEERE & COMPANY 
CONDENSED CONSOLIDATED BALANCE SHEET AS OF OCTOBER 31 





1936 


1937 


Current Assets 


$66 . i 10 . 310 


$ 83.0^8. S22 


Notes and Accounts of Officers and Employes . . 
Claims against Closed Banks 
Cash Deposited with Escrow Agents 
Pension Fund Investments . ... 


93,845 
100,214 

20,000 

O4.3. 3;8 


86,825 
90,101 
20,000 
713 .006 


Company's Capital Stocks Owned at Cost 
Preferred (7,000 shares) 


83,881 


83,88l 


Common (3,546 shares) . 


63, ^48 


63, <u8 


Property and Equipment, net of Depreciation 


17,883, 34.0 


IQ, 723.O4.6 


Investments 


2 .4.O 3. 74.4. 


2.7<O 380 


Deferred Charges 


614,698 


61 tj .670 










$88,415,947 


$108,105,069 


Current Liabilities 
Dividends Payable 


$2,OQ2 . CTOO 


$ S4.O.OSO 


Other Current Liabilities 


6,806, ZQI 


20,464,542 


Reserves ... 


6 . 64.4. .222 


7. 1 70. S2< 


Stated Capital and Earned Surplus 
Preferred Stock* authorized 2,000,000 shares 
of $20 par issued, 1,550,000 
Common Stock authorized 5,000,000 shares 
without par issued 
i , 005 , ooo" shares ... 


31,000,000 
2O, IOO,OOO 


31,000,000 


3 , 007 , 008 shares 




30,070,080 


Earned surplus (including $147,428 applicable 
to the Company's preferred and common capi- 
tal stocks reacquired) 


21 ,682 .634. 


18, 8*0,872 










$88,415,947 


$108,105,069 









* Dividend rate, 7% per annum. 

Note. Dividends on preferred stock were in arrears at October 31, 1936, in the amount of 
$3,642,500, or $2.35 a share. 



472 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

DEERE & COMPANY AND SUBSIDIARY COMPANIES 

SUMMARY OF CONSOLIDATED INCOME AND EARNED SURPLUS 

FOR THE YEAR ENDED OCTOBER 31, 1937 

Net Sales $100,399,710 

Deduct: 

Cost of manufacture, distribution, collection, 
and administrative and general expenses, in- 
cluding provisions for possible losses in 
collection of receivables, for decline in market 
values of inventories, and for contingencies, 

etc. . . . . $78,540, 732 

Depreciation i ,621 ,323 

Provision for Federal income and excess profits 
taxes (including $1,980,000 for surtaxes on 

undistributed profits) 6, 794,351 

Provision for other taxes 1,988,322 88,944,728 

Net Operating Income $n, 454 , 982 

Other Income Net: 

Interest and finance charges on receivables, etc. $ 2,287, 1 5^ 

Cash discounts on purchases 587 ,669 

Retail store profits Net, and miscellaneous in- 
come, less miscellaneous income charges 833, 108 

Total $ 3,707,935 

Less Interest on notes payable and sundry 

obligations 226,441 3,481,494 

Net Income for the Year $ 14,936,476 

Earned Surplus, October 31, 1936 (including 

$147,428 applicable to the Company's preferred 

and common capital stocks reacquired) 21 ,682,634 

Earned Surplus, October 31, 1937, before divi- 
dends $ 36 , 619 , i 10 

Dividends Paid: 
In Cash: 

Preferred stock, $3.75 a share $ 5, 786, 250 

Common stock, $2.00 a share 2 , 002 , 908 

In common stock at the rate of two shares for 

each share of common stock outstanding .... 9 , 979 , 080 1 7 , 768 , 238 

Earned Surplus, October 31, 1937 (including 
$147,428 applicable to the Company's preferred 
and common capital stocks reacquired) $ 18,850,872 



Source: Company report. 



The price range of the common stock during 1937 and preceding 
years is shown in Exhibit i. Dates of dividend payments are 
included in Exhibit 2. 



DEERE & COMPANY 



473 



EXHIBIT i 

DEERE & COMPANY 

PRICE RANGE COMMON STOCK 





High 


Low 


1934 


34M 


ioH 


1935 


58% 


22% 


1936 


io8M 


107 


1937 


143/^2 


68 J^ 




27* 


19^* 



* After 200% stock dividend. 

Source: Standard Corporation Records, Individual Reports Section. 

EXHIBIT 2 

DEERE & COMPANY 

DIVIDEND DATES AND PAYMENTS, 1936-1937 



1936 


Preferred 


Common 


Amount 
$0.35 
o.35 
o.35 
1-35 


Record 
2/15 
5/i5 
8/15 
11/14 


Payable 
3/2 
6/1 
9A 

I2/I 


Nil 


$2.40 









1937 



Preferred 


Common 


Amount 
$0.70 
i-35 
i-35 
o-35 


Record 

2/15 
5/i5 
8/14 

11/15 


Payable 

3/i 
6/1 

9/i 

I2/I 


Amount 

$i .00 

I .00 

200% Stk. 


Record 

8/14 

IO/2 
10/2 


Payable 
9/i 

IO/2O 
10/30 


$3-75 



Source: Standard Corporation Records, Main Dividend Sections; monthly, 1936, annual, 
1937. 



474 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 
CALIFORNIA PACKING CORPORATION 

STOCK DIVIDENDS PAID IN PREFERRED ON COMMON. THE 
EFFECT OF TAXATION ON DIVIDENDS 

Consent to the following amendment of the Certificate of 
Incorporation of the California Packing Corporation was given 
by the stockholders on December 29, 1936, pursuant to a resolu- 
tion adopted by the directors on November 3O. 1 

1. To increase the present authorized shares of stock of the Corpora- 
tion from 1,500,000 shares without par value to 1,700,000 shares, of 
which 1,500,000 shares being the present authorized shares, shall be 
without par value, and 200,000 new shares shall have a par value of 
$50 each; 

2. To classify said 1,700,000 shares as follows: 1,500,000 shares 
without par value as Common Stock, and 200,000 new shares with a 
par value of $50 per share as Preferred Stock; 

3. To provide that such Preferred Stock shall, among other things, 
be cumulative, with dividends at the rate of five per cent (5%) per 
annum, redeemable at par, plus accrued unpaid dividends, at thirty (30) 
days' notice; be preferred as to earnings and assets, and receive par plus 
accrued dividends, in the event of liquidation, dissolution, or winding 
up of the Corporation; have no voting power until in arrears in the 
payment of four (4) quarterly dividends; and have no pre-emptive 
right; 

4. To change the additional statement with respect to the minimum 
amount of capital of the Corporation so as to provide that the same 
shall not at any time be less than the sum of the aggregate par value 
of all issued shares having par value, plus thirty million dollars 
($30,000,000). 

The following paragraph appeared in the annual report for the 
year ended February 28, 1937: 

The Federal Tax Law of 1936 imposes a graduated tax ranging 
from 7% to 27% on the undistributed earnings of corporations. The 
Corporation was advised by its Counsel that if preferred shares were 
created and thereafter a dividend was paid to its common stockholders 
payable in the alternative at the option of each stockholder, either in 
cash or preferred shares, and if thereafter a further dividend was 
paid to the common stockholders in such preferred shares, both of 
these dividends would comply with the prerequisites of the Federal 



1 New York Stock Exchange Listing Application, A-io8o7, January 29, 1937. 



CALIFORNIA PACKING CORPORATION 475 

Tax Law of 1936 as to distribution of earnings, and the Corporation 
would receive credit therefor in the same manner as though cash had 
been distributed. A Special Meeting of the Stockholders was held on 
December 29, 1936, at which meeting 200,000 shares of preferred stock 
of the Corporation, at $50.00 par value per share, was authorized, of 
which 51,644.65 shares having a par value of $2,582,232.50 were issued 
during the year in the form of two dividends. Dividend No. yoA 
under which the stockholders were offered at their option a cash divi- 
dend of 50^ a share or its equivalent in preferred stock, resulting in the 
issuance of 3,391 shares of preferred stock of par value $169,550.00 
and cash payments amounting to $312,986.50. Dividend No. yiA 
under which the stockholders received preferred stock at par at the 
rate of $2.50 per share of common stock. The number of shares of 
preferred stock issued in payment of this dividend was 48,253.65 having 
a par value of $2,412,682.50. The fractional share was acquired at 
par for cash and retired. In addition to the aforementioned, five (5) 
cash dividends of 37^^ eac h P er share were paid, amounting to 
$1,809,511.88. Common stockholders, therefore, received during the 
fiscal year, in the form either of cash or preferred stock, the equivalent 
of $4.87^2 per share. A dividend of 15^ per share was paid on 3,391 
shares of preferred stock outstanding on January 25, 1937, amounting 
to $508.65. . . . 

Dividend No. 7oA was declared December 30, 1936, payable 
January 25, 1937, to stock of record January 9, 1937. Dividend 
No. 71 A was declared January 26, 1937, payable February 20, 
1937, to stock of record February 5, 1937. 

The balance sheets as of February 29, 1936, and February 28, 
1937, are given in condensed comparative form, together with 
the income and surplus statement for the intervening period. 



What were the differences in the effects of the stock dividends 
on the corporations concerned and on the interests of stockholders 
in this case and in that described in the Deere & Company case? 



476 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

CALIFORNIA PACKING CORPORATION 
CONDENSED CONSOLIDATED BALANCE SHEETS 





February 29, 
1936 


February 28, 
1937 


Current Assets 


$27. 24.6.872 


S^<\. 301 .610 


Growing Crops and Advances to Producers .... 
Employees* Stock Subscriptions, balance 


1,922,335 
164,689 


1,647,648 
33,007 


Investments 


9,467, 265 


0,400,807 


Capital Assets, net of depreciation 


17. 14,2 .8^2 


17. 2 SI . 2OO 


Deferred Charges 


380.036 


492,390 










$56,333,949 


$64,217,760 


Current Liabilities 
Dividends Payable, March 16, 1936 


$^6l .OO2 


$ 


Other Current Liabilities 


6,841,148 


II ,0?2.667 


Funded Indebtedness , 


7 , tJOO . OOO 


7. SOO.OOO 


Capital and Surplus 
Preferred Stock 5% $50 par* 




2, 582 . 2OO 


Stated capital f 


30 , ooo , ooo 


3O,OOO,OOO 


Earned surplus 


II ,630,800 


12,182,893 


Contingent Liability 
1936 IQ37 
$96,462 $51,323 








$56,333,949 


$64,217,760 









* Authorized 200,000 shares; issued 51,644 shares. 

t Represented by 965,073 shares of no par value stock (authorized 1,500,000 shares of which 
there are 93,750 shares available for conversion of debentures). 
Notes: 

A. It is the practice of the Corporation to take up in its books annually, its proportionate 
share of profits (or losses) of the Alaska Packers Association (based upon that company's fiscal 
year ended December 31) by charge (or credit) to investment in this company, and credit (or 
charge) to profit and loss; dividends received are credited directly to the investment account to 
reflect the resulting reduction in net asset value of such company. Dividends received in the 
year ended February 28, 1937, amounted to $388,610 as compared with proportionate share of 
profits included above of $441,637. Consolidated surplus includes $151,654 credit resulting 
from adjustment of investment in Alaska Packers Association to the prop9rtio t nate share of 
book value of underlying net assets of that company, not actually received in dividends as at 
February 28, 1937. 

B. No provision has been made for surtax on undistributed profits since dividends paid are 
in excess of the taxable net income used as a basis for estimating the provision for Federal 
income tax. 

C. Depreciation provided on plant and property charged to profit and loss during the year 
amounted to $1,033*278. 



CALIFORNIA PACKING CORPORATION 477 

CALIFORNIA PACKING CORPORATION 

AND WHOLLY OWNED SUBSIDIARY COMPANIES 

CONSOLIDATED STATEMENT or PROFIT AND Loss AND EARNED SURPLUS 

YEAR ENDED FEBRUARY 28, 1937 

Sales $61,750,118 

Cost of goods sold 48, 244,818 

Gross profit $13,505,300 

Selling, administrative and general expenses $8, 108,082 

Interest on debentures 375>ooo 8,483,082 

$ 5,022,218 
Other Income: 

Dividends received from companies less than 50% 

owned $ 38,096 

Miscellaneous 26 , 509 64 , 605 

$ 5,086,823 

Proportionate share (84.5%) of profits and credits to 
surplus of Alaska Packers Association for year 
ended December 31, 1936 (Note A) 441 ,637 

$ 5,528,460 
Provision for Federal income tax (exclusive of 

$26,129 shown below) (Note B) 781 , 191 

Net profit from operations and share of profits of 

Alaska Packers Association $ 4,747,269 

Adjustment credits considered to relate mainly to 
prior years, less payment of $1,995,410 to insurance 
company in connection with Annuity Plan for 
employees of the Companies, less Federal income 
tax thereon of $26,129 148,062 

Balance added to surplus $ 4,895,331 

Earned surplus, February 29, 1936 n ,630,900 

$16,526,231 
Dividends Paid: 

Nos. 67-7 1 A on common stock $4.87^ P er share 
($2,122,498 in cash and $2,582,233 in preferred 

stock) $4, 704, 731 

No. i on preferred stock $0.15 per share (in cash) 509 

$4,705,240 

Less No, 67 on common stock liability for which 
was set up in previous fiscal year, $0.37^ per 
share (in cash) 361 ,902 4,343*338 

Earned surplus, February 28, 1937, per balance 

sheet (Note A) $12,182,893 



Source: Company report. 



A schedule on earnings and dividends which was a part of each 
report is given as it appeared in the report for 1937. 



478 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

CALIFORNIA PACKING CORPORATION AND SUBSIDIARY COMPANIES 
COMPARATIVE STATEMENT OF EARNINGS AND DIVIDENDS PAID 



Year Ended 
February 28 


Net Earnings after 
All Charges 


Dividends Paid 


Added to 
Surplus 


1917 
1918 
1919 
1920 
1921 
1922 
1923 
1924 

i9 2 5 
1926 
1927 
1928 
1929 
1930 

1931 
1932 

1933 
1934 
1935 
1936 

1937 


$ 1,086,522 
6,147,940 
3,689,279 
7,242,402 
4,253,015 
2,240,591 
6,168,383 

5,319,351 
6,150,479 
6,014,851 

5,057,353 
3,439,685 
6,233,021 
6,024,349 
91,180 
4,877,595t 
4,52i,ooif 
4,131,863 
3,240,704 
2,542,248 
4,895,330 


$ 111,089* 
1,418,228* 
1,926,566* 
2,071,271* 
2,830,248 
2,830,248 
2,830,248 
2,830,248 
2,920,248 
3,163,602 
3,909,664 
3,909,664 
3,909,664 
3,909,664 
3,909,664 
977,416 


$ 975,433 
4,729,712 
1,762,713 
5,i7i,i3i 
1,422,767 

589,657t 
3,338,135 
2,489,103 
3,230,231 
2,851,249 
1,147,689 
469,979t 
2,323,357 
2,114,685 

3,818,484}: 
5,855,011! 
4,52i,ooiJ 
3,890,595 
1,793,095 
1,094,638 

55i,993 


241,268 
1,447,609 
1,447,610 
4,343,337* 


$74,569,950 


$50,937,556 


$23,632,394 
$11,449,501 






May 18, 1926, Tran 
for Stock Divident 
Years Ended Februa 
tal Stock retired- 
February 29, 1932, P 
Capital Assets, etc 
February 28, 1933, I 
pense unamortiz< 

February 28, 1935 ] 
February 28, 1934 

Surplus per Balance 


sferred to Capital Account 
i. $8.O4^.<i^ 


ry 28, 1932 and 1933, Capi- 
-i 2,343 shares 4.87.827 


revision for obsolescence of 
; A.OOO.OOO 


)ebenture discount ai 
sd balance written of 

Depreciation adjustm 


id ex- 

2/17.4,82 




$12,880,824 
ent to 
i, 43^323 




Sheet, February 28, 1937 


$12,182,893 





* Includes Dividends on Preferred Stock then outstanding. Dividends paid in year ended 
February 28, 1937, include $2,582,233 paid in preferred stock, 
t Loss, 
t Deducted from surplus. 



PLYMOUTH OIL COMPANY 479 

PLYMOUTH OIL COMPANY 

DIVIDENDS FROM TREASURY STOCK 

In the last quarter of 1934, [November 21, 1934], the Board of 
Directors authorized the distribution of 40,384 shares of common stock 
of the Plymouth Oil Company [costing $913,980] in the form of a 4% 
stock dividend [payable December 22 to stock of record December 3]. 
This was treasury stock which had been accumulated in the open 
market over a period of years. By reason of restrictions imposed by 
the Federal Securities Act in the disposition of treasury stock, the Board 
of Directors deemed it expedient to make distribution of this stock for 
the benefit of all the stockholders. No other treasury stock is held by 
the Company. Cash dividends in the amount of seventy-five cents 
per share were paid during the year. The added value of the stock 
dividend, on the basis of the selling price on the date of dividend 
declaration, of $8.50 per share, gave to stockholders dividend income 
for the year of approximately $1.10 per share. 1 

In the consolidated balance sheet as of January i, 1934, 35,- 
918 shares of treasury stock of the Plymouth Oil Company were 
shown under Investments as a noncurrent asset at $871,524. As 
of that date, capital stock authorized and outstanding consisted 
of 1,050,000 shares of $5 par at $5,250,000. Total consolidated 
earned surplus was $4,937,715. 

The dividends during 1934 were recorded in the consolidated 
surplus statement for that year. 

PLYMOUTH OIL COMPANY 
RECONCILIATION OF SURPLUS 

Surplus, Consolidated Balance Sheet, January i, 1934. . $4>937 >7*5 

Add: Net Earnings, January i to December 31, 1934. . 1,006,326 
Dividends from Plymouth Oil Company Treasury 

Stock 26,939 



Less : Cash Dividends $5 , 970 , 980 

Paid to Minority Interests by Big Lake Oil Co. $475,000 

Paid by Plymouth Oil Company 787,500 

Stock Dividend 

Cost of 40,384 Shares of Re-acquired Treasury 
Stock Distributed by Plymouth Oil Company 913,980 2,176,480 

Surplus, January i, 1935 $3,794,5QQ 

The price range of the stock during 1933 and 1934 is shown in 
Exhibit i. 



1 Company report, 1934. 



480 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

EXHIBIT i 

PLYMOUTH OIL COMPANY 
PRICE RANGE OF STOCK 





High 


Low 


Year 1033 


17% 


6% 


Tan. Oct. 1034 


16% 


8 


October 


9 


8K 


November 


9% 


8K 


November 30 


8K* 




December 


8% 


1 1 A 









* Ex-dividend. 
Source: Bank and Quotation Record. 



1. In what respects did this dividend in stock differ from the 
more usual type of stock dividend involving the issue of new stock? 

2. Was the amount of income received by stockholders equal 
to the charge to surplus by the corporation? 

GENERAL ELECTRIC COMPANY 

DIVIDENDS IN THE STOCK OF ANOTHER CORPORATION 

In 1932 the General Electric and Westinghouse companies 
held large blocks of common stock of the Radio Corporation of 
America. The terms of a consent decree entered in the United 
States District Court for the District of Delaware on November 
21, 1932, provided among other things that these companies should 
" divest themselves of their stock of Radio Corporation by dis- 
tribution to their stockholders and otherwise." 

Regarding this provision, it was stated in the annual report of 
the General Electric Company for 1932 that: 

. . . pursuant to the decree, your Directors voted [probably December 
2, 1932] to distribute on February 20, 1933, 4,807,320% shares of the 
5,188, 755 shares of Radio Corporation common stock owned by your 
Company as a dividend to its common stockholders of record on 
December 16, 1932, on the basis of Y of one share of Radio Corporation 
common stock for each share of common stock of General Electric 
Company. The balance of your Company's holdings was left to be 
disposed of by your Directors within three years from the date of the 
decree. 

The 4,807,320% shares of Radio stock were shown as an asset 
in the balance sheet of the General Electric Company for Decem- 



GENERAL MOTORS CORPORATION 481 

her 31, 1932, at $26,440,264.58. The rest of the Radio stock was 
evidently included under " Associated companies and miscellaneous 
securities." The following item was included after current lia- 
bilities in the balance sheet: 

Dividend payable in common stock of Radio Corporation of 

America (per contra) $26 ,440, 264 . 58 

The surplus statement of that year included a deduction for the 
dividend, in the amount of $26,440,264.58. 

Radio Corporation common stock was quoted on the New York 
Stock Exchange at 5%-5M on December 2, 1932, at 53^-5/4 o n 
December 16, 1932, and at 3^-4 on February 20, 1933. 



1. Was this a stock dividend? 

2. Was it income to the recipients in the amount charged to 
surplus by the corporation? 

GENERAL MOTORS CORPORATION 
DIVIDEND POLICY 

In mailing dividend checks in September, 1935, the following 
letter was sent to stockholders of General Motors Corporation: 

GENERAL MOTORS CORPORATION 

Broadway at 57th Street 

New York, N. Y. 

September n, 1935 
To our stockholders: 

Enclosed please find check covering the dividend payable on the 
common shares of the General Motors Corporation standing in your 
name under date of August 15, representing a regular quarterly divi- 
dend of $.50 per share and an extra dividend of $.25 per share. At the 
time of the declaration of this dividend, a statement was made with 
respect to same which is repeated below for your information. 

"As to the increase in regular dividend rate from $.25 to $.50 per 
quarter, I might state that it has been a long standing policy of the 
Board to establish a normal or regular rate of dividend as generous as 
possible, and one that can be reasonably counted upon by the stock- 
holders, while at the same time reflecting the financial position of the 
Corporation, the current rate of earnings, and the future trend, so 
far as that can ever be discerned. The increased rate ordered at this 
time reflects the judgment of the Board with respect to all these factors. 

"It must be recognized, however, that with things as they are, 
there may be injected into the situation, at any moment, unusual cir- 
cumstances that can not be foreseen, such as may entirely alter the 



482 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

case. In such an event, the Directors will not hesitate to re-appraise 
their position, and act accordingly. 

"The regular dividend declared today represents a rate of dis- 
bursement two-thirds of that of the pre-depression period." 

Perhaps this might be an appropriate opportunity to elaborate 
somewhat on certain phases of the dividend question. 

The Directors of General Motors Corporation have consistently 
taken the position that there should be only two considerations in 
determining dividend action first, earnings which alone make divi- 
dends possible, present as well as future; second, the future needs of 
the business. Generally speaking, any business, if it performs a 
useful service to the community, and is properly administered, must 
continually develop. This does not mean that it must necessarily 
grow in size, but it must at least keep pace with the evolution of 
things if it is to continue to exist. This principle applies importantly 
to a highly technical business, such as that of General Motors. 
Machinery and plant quickly become inefficient and must be replaced 
with the new and better or the efficiency of the business is impaired. 
New models involving large expenditures are yearly required to main- 
tain the competitive position of the products manufactured. All this 
is necessitated by a continually advancing technology a highly 
essential process. 

No business is safe, and as a matter of fact, no business should be 
safe if it stands still, because progress is essential in all things. To 
go ahead usually involves some capital outlay. There is available 
for this the amount set aside yearly for depreciation and obsolescence, 
but frequently that is not sufficient, especially when applied to any one 
year, or in the event of any unusual circumstances. Still again, even 
if the business is not expanding, changed circumstances may require 
additional working capital to carry on its day to day operations. 
The necessity for providing for capital needs out of earnings is today a 
most important consideration on account of the obstacles and hazards 
that exist with respect to the flow of additional capital into industry. 

I make this explanation to reach the point that it is not always 
desirable, in fact, it is usually not either desirable or even possible over 
the years to pass out all the earnings of a business; some should be set 
aside for the purposes above mentioned. On the other hand, condi- 
tions do arise where it is entirely justifiable and to the interest of the 
stockholders to pay out in any one year more than that year's earnings. 
General Motors, during the depression from which we are just emerging, 
did that very thing as a result, it was able to maintain payments to 
the stockholders during the entire depression. A reduced volume of 
business releases working capital which can be made available to the 
stockholders for their use. Again, the necessity for capital expendi- 
tures such as plant and machinery is minimized. When the amounts 
we are dealing with are large, as in the case of General Motors, an 
appreciable contribution is made in maintaining the purchasing power 
of the community. This is a highly desirable consideration as the 
public is importantly served. 



GENERAL MOTORS CORPORATION 483 

Applying the above thinking to the case of General Motors, it may 
be interesting to point out that if we consider the ten year period, 
beginning in 1925 and ending in 1934, five years fairly representing a 
period of unusual prosperity and five years representing a period of 
unusual depression, there was disbursed to the stockholders 77% of 
the earnings, leaving 23% for the purposes of the business itself. If we 
take the first five years, the proportion disbursed as dividends was 63%; 
for the second five years, 113%. 

The recent announcement made by General Motors, that the 
management felt conditions had sufficiently adjusted themselves to 
warrant the belief that there was an opportunity for profitable invest- 
ment, and that an expenditure of $50,000,000 would be made to 
improve and expand the Corporation's productive facilities, both at 
home and overseas, is another illustration of the point. This highly 
essential development became possible because of the accumulation 
of earnings. 

Therefore the problem of dividend policy is not always a simple 
one. A rate of dividend when once declared carries with it the desira- 
bility of continuity. The declaration must reflect not only the current 
condition of the business but there must be considered the future trend, 
especially with respect to prospective earnings and possible capital 
needs. Under conditions existing today such an appraisal is difficult. 
There is involved unusual uncertainty. This must be appreciated by 
the stockholders. 

The most important point I want to make is that General Motors 
stockholders can rely upon the Directors to pass on the largest possible 
share of the earnings consistent with the needs of the business. Other 
considerations, such as essential progress of the business, the main- 
tenance of an efficient and effective plant, an aggressive organization, 
and adequate protection against such hazards as the political tendency 
of today to penalize business bigness through discriminatory taxes 
and otherwise, are in times like these very real and must be given proper 
consideration as applied to any business. 

The answer to the problem of dividend distribution depends upon 
the determination of an equitable balance. The judgment of the 
Directors of General Motors Corporation on this point is expressed in 
the action referred to at the beginning of this message. 

ALFRED P. SLOAN, JR., 
President. 



This is a statement of dividend policy. There was at the time 
of this statement a limit on dividends which could legally be paid. 
What were the differences between the determination of the prob- 
lem of policy and the determination of amounts legally available 
for dividends in terms of the facts on which decisions would be 
based, the methods used in coordinating and interpreting those 
facts, and the persons or groups by whom decisions would be made? 



484 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 
AMERICAN TELEPHONE AND TELEGRAPH COMPANY No. 3 

DIVIDEND AND RELATED POLICIES 

Despite the failure of the company, by a substantial margin, 
to earn the full dividend requirements on its capital stock in 1932, 
1933, and 1934, the directors of the American Telephone and Tele- 
graph Company continued dividend payments in those years at the 
annual rate of $9 per share established in 1922. With respect to 
this dividend policy, the following statement was made in the 
company's annual report for the year 1933: 

. . . while due to the reduced volume of business the System's earnings 
of 3.7 per cent on the cost of plant and other assets were inadequate, the 
past financial policy made it possible to continue the dividend to stock- 
holders at the usual rate. 

Prior to 1932, the Company had never in any year paid out all of 
its earnings in dividends. Thus, in its nearly fifty years of existence, 
it accumulated a surplus, which together with its proportion of the 
surplus of its Associated Companies and the Western Electric Com- 
pany amounted to $31 per share of its stock outstanding. In the past 
two years $6.66 per share of this surplus, $3.04 in 1932 and $3.62 in 
1933, has been used in order to maintain the dividend on the stock. 
The Company has no " watered stock" but, on the contrary, has 
received an average of $114 a share for the 18,662,275 shares of stock 
outstanding. The dividend of $9.00 a share was therefore at the rate 
of 6.4 per cent and the 1933 net income of $5.38 per share was 3.8 per 
cent on the stockholders' investment, including the surplus. 

As stated in the 1932 Annual Report, " during the boom period, 
culminating in 1929, in spite of considerable pressure growing out of the 
speculative fever, the Company paid no extra or stock dividends and 
did not split up its stock." This was in accord with the policy followed 
for many years and formally stated in 1927 " there is not only no 
incentive but it would be contrary to sound policy for the management 
to earn speculative or large profits for distribution as 'melons' or extra 
dividends. On the other hand, payments to stockholders limited to 
reasonable regular dividends with their right, as the business requires 
new money from time to time, to make further investments on favorable 
terms, are to the interest both of the telephone users and of the stock- 
holders." 

This policy has enabled a stability of return to stockholders during 
the depression that has in thousands of cases helped to provide the 
bare necessities of life for those who have invested their savings in the 
business. Of the 681,000 stockholders, 381,000 are women and about 
115,000 are Bell System employees. No stockholder owns as much as 
one per cent of the stock outstanding, the average holding per stock- 
holder being 27 shares. 



AMERICAN TELEPHONE & TELEGRAPH CO. NO. 3 485 

Despite charges against surplus of approximately $55,800,000, 
$67,600,000, $56,800,000, and $35,000,000 in 1932, 1933, 1934, and 
1935 respectively, as a result of dividend payments in excess of 
earnings, consolidated net working capital of the company 
showed increases in the last two years. On December 31, 1935, 
cash and temporary cash investments alone totaled more than 
$267,000,000 as compared with $219,000,000 at the end of 1933 
and $204,000,000 at the end of 1932. That maintenance of the 
regular dividend rate did not bring about any depletion of the 
company's working capital was a result of the fact that the annual 
provisions for depreciation were in excess of the amounts by which 
the company failed to earn its full dividend requirements. 

In accordance with the requirements of the Interstate Com- 
merce Commission, 1 the company makes monthly charges against 
its earnings in an amount sufficient to provide for current depre- 
ciation accruing in its investments in depreciable fixed assets 
from losses due to wear and tear (not covered by current main- 
tenance) ; from losses due to obsolescence or inadequacy resulting 
from age, physical change, supersession by reason of new inven- 
tions and discoveries, changes in popular demand or public require- 
ments; and from losses suffered through destruction of property 
by extraordinary casualties. These monthly charges against 
earnings are in such amount as will distribute and include in the 
expense accounts, as nearly as may be, evenly throughout its serv- 
ice life, the cost of property used up in rendering service, and 
provide a reserve account in the balance sheet for meeting the 
full loss of investment in depreciable fixed capital upon its ulti- 
mate retirement. In the nine years 1929-1937, inclusive, the 
company's annual consolidated provisions for depreciation were 
as follows: 

1929 $164,376,990 

193 182,400,230 

1931 192,307,175 

1932 181,312,237 

1933 171,846,193 

1934 153,474,643 

1935 171,681,516 

1936 160,963 , 777 

1937 161 ,601 , 522 



1 As of January i, 1936, these requirements were superseded by those of the 
Federal Communications Commission. Under Section 604 (a) of the Federal Com- 
munications Act, which established the new communications commission, all rules 
of the Interstate Commerce Commission were continued in effect until modified, 
terminated, superseded, or repealed by the Federal Communications Commission. 



486 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

In the year 1934, the depreciation expense was reduced by 
$15,948,059 as a result of adjustments made in the accounts of 
two subsidiary companies arising in connection with court deci- 
sions rendered during the year. Had these adjustments not been 
made, the 1934 depreciation expense would have been $169,422,- 
702, or 4.3 per cent of the cost of the average depreciable plant in 
service. Comparable percentages from 1929 to 1937 were: 



TQ2O 


Per Cent 

. . . . c .0 


IO3O 


c.o 


IQ3I 


4..O 


IO32 ... . 


. 4.. < 


IQ77 . 


. . . A. A 


TQ2X ... ... . ... 


.... . . . 1 . O 


IQTT 


4.7 


IQ26 


' A.I 


1037 


4.0 



In Exhibit i the total assets, reserve for depreciation, funded 
debt, capital stock, surplus, net income, and dividends of the 
company on a consolidated basis are given for 1912-1937. During 
this time there were no changes in the par or stated value of the 
stock, there were no stock dividends or splits, and there were no 
reductions in capital with resultant increases in surplus. No 
stock was sold at a discount. All changes recorded in the capital 
stock account were the result of credits arising from the issuance 
of shares of $100 par. Apparently all of this stock was issued for 
cash. Any premiums received were carried to premium on capital 
stock and were not mingled with surplus. 



1. Did the relative simplicity in the administration of capital 
stock and surplus in the period prior to 1930 make easier the task 
of the management in meeting the difficulties of the depression 
years following 1930? 

2. Do you agree with the company's dividend policy from the 
point of view of public service or public relations in time of 
depression? 

3. What other policies of the company facilitated the continu- 
ance of dividends? 



RADIO CORPORATION OF AMERICA NO. i 487 



EXHIBIT i 

AMERICAN TELEPHONE AND TELEGRAPH COMPANY 
(ooo omitted) 



Year 
ended 
Dec. 31 


Total 
assets 


Reserve 
for depre- 
ciation 


Funded 
debt 


Capital 
stock 


Surplus 


Net 
income 


Divi- 
dends 


1912 


$ 924,261 


* 


$ 294,380 


$ 393,210 


$164,237: 


$ 42,681 


$ 29,460 


1913 


980,004 


* 


341,147 


395,225 


174,498:: 


42,037 


30,302 


1914 


1,019,774 




385,352 


393,732 


189,955: 


40,307 


30,304 


1915 


i ,057 ,908 




353,236 


440,711 


223,402:: 


48,086 


32,897 


1916 


i, 198,863 




422,587 


463,102 


262,005: 


57,239 


35,i6o 


1917 


1,276,503 




407,434 


505,404 


303,526:: 


50,714 


36,863 


1918 


1,380,506 




430,992 


513,017 


341,992:: 


5i,94 


39,735 


1919 


1,530,075 




546,203 


512,122 


388,574:: 


5i,958 


39 , 840 


1920 


1,634,250 




585,794 


5H.493' 


444,039:: 


47,785 


40 , ooo 


1921 


1,902,511 




666,741 


632,216" 


506,123:: 


67,425 


47,848 


1922 


2,162,523 




646 , 033 


837,007- 


563,583:: 


86,623 


60,305 


1923 


2 ,400,048 




752,661 


89l,535- 


621,853:: 


99 , 624 


72,429 


1924 


2,664, 195 




752,733 


,093,573' 


678,838:: 


107,246 


82,603 


1925 


2,938,004 




890,337 


, 144,619' 


748,250:: 


136,503 


93 , 243 


1926 


3,256,636 




921,523 


,312,881- 


839,982:: 


155,061 


100,614 


1927 


3,457,467 


$ 600 , 664 


919,790 


,351,940- 


296,953 


166,059 


112,401 


1928 


3,826,684 


650,621 


964,784 


,564,644- 


373,798 


191,088 


119,349 


1929 


4,228,430 


699,035 


, 148,540 


,611,862- 


475,86s 


217, 105 


132,224 


1930 


5,000,196 


740,006 


,115,592 


2,155,053" 


442,442 


201,646 


156,625 


1931 


5,024,336 


788,586 


,054,825 


2,172,897- 


448,372 


193,379 


180,904 


1932 


4,901,576 


820,195 


,043,908 


2,097,348 


401,739 


139,336 


185,032 


1933 


4,907,677 


891,438 


,037,625 


2,097,313 


345,908 


128,585 


183,240 


1934 


4,977,055 


967,713 


,038,825 


1,964,165 


321 ,056 


125,352 


174,385 


1935 


5,059,352 


i ,061 , 102 


,078,377 


2,096,144 


268,943 


147,539 


174,385 


1936 


5,149,309 


1,124,809 


862 ,040 


2,052,340 


246,088 


197,838 


181,174 


1937 


5,057,809 


1,198,516 


871,509 


2,019,619 


249,247 


193,390 


180,228 



* Not reported. 

t Includes installments on stock not yet issued. 

I Including reserves for depreciation and contingencies. 

Source: Consolidated statements from company reports. 

C. REDUCTION OF CAPITAL, CAPITAL SURPLUS, EARNED SURPLUS 

RADIO CORPORATION OF AMERICA No. i 

REDUCTION IN THE STATED VALUE OF NO PAR STOCK 

The following letter to stockholders accompanied the annual 
report for 1931. Balance sheets for 1930 and 1931 are given below 
in comparative form, with that for 1931 reflecting the changes 
indicated in the letter. The income and surplus statements for 
1931 are also given. 



4 88 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

RADIO CORPORATION OF AMERICA 

RCA Building 

570 Lexington Avenue 

New York 

March 14, 1932 
To the Stockholders: 

On November 9, 1931, the Board of Directors of the Company 
appointed a Committee to consider with the executive officers of the 
Company what action should be taken, in the light of present condi- 
tions, to reduce book values of certain assets of the Company and its 
subsidiaries and to establish appropriate reserves. 
The Committee has recommended: 

1. That the 36,100 shares of Class "B" Preferred stock and the 
30,060 shares of Common stock of the Corporation in its treasury 
be retired. 

2. That the capital represented by the Common stock of the 
Corporation be reduced from approximately $4.22 a share to $2.00 a 
share. 

3. That against the Capital Surplus so created and amounting to 
approximately $30,057,400 there be charged a total amount of approxi- 
mately $21,733,500 for reduction of book values of certain plants and 
equipment of subsidiaries and other fixed assets, and reserves for 
certain investments and contingencies of the Company and its sub- 
sidiaries; and that the balance of approximately $8,323,900 of such 
Capital Surplus remaining after the foregoing adjustments be not 
available for dividends but be added to the General Reserve making 
such General Reserve approximately $9,823,900. 

4. That against the Earned Surplus amounting to approximately 
$26,528,600 there be charged a total amount of approximately 
$15,200,800 representing cost of treasury stock retired, write-downs of 
inventories, and reserves for certain investments and contingencies of 
the Company and its subsidiaries after which adjustments the Earned 
Surplus account will amount to approximately $11,327,800. 

The consolidated balance sheet in the annual report herewith gives 
effect to the foregoing recommendations. 

The reduction of capital as proposed requires the consent of the 
holders of a majority of the total number of outstanding shares of stock 
of the Corporation having voting power. The Board of Directors and 
management believe that the proposed action is desirable and in the 
interest of stockholders. 

A form of consent to the reduction of capital is enclosed. If you 
are a holder of "A" Preferred or Common Stock please indicate your 
approval of the proposed reduction by signing said form of consent 
and returning it to the Company in the enclosed envelope as promptly 
as possible. 

By order of the Board of Directors, 
DAVID SARNOFF, 
President. 



RADIO CORPORATION OF AMERICA NO. 



489 



RADIO CORPORATION or AMERICA AND SUBSIDIARY COMPANIES 
CONSOLIDATED BALANCE SHEETS AT DECEMBER 31 





1930 


1931 


ASSETS 
Current Assets: 
Cash in Banks and on Hand 


$ 20,379,115 


$ 23,916,408 


Marketable Securities* 


903 ,425 


613 ,458 


Notes and Accounts Receivable (less Reserves) 


20, 898 ,425 


12,591 566 


Inventories (at the lower of Cost or Market) 


28 , 253 , 713 


8 , 294, 269 








Total Current Assets 


$ 70,434 678 


$ 45 415 701 








Investments: 
Securities and Notes of and Advances to Associated and 
Other Companies (at Cost, less Reserves) 


$ 32,279,526 


$ 26,760,892 








Fixed Assets: 
Factories, Radio Communication and Broadcasting 
Stations, Warehouses, Service Shops, Offices, etc. 
Land, Buildings and Equipment in Operation and 
Construction (at Cost) .... 


$ 97,368,618 


$ 96,919,345 


Less: Reserves 


36,992 , 847 


57 , 540,088 








Patents, Contracts, etc., at Cost, less Reserves 


$ 60,375,771 
3 , 462 ,463 


$ 39,379,257 
4, 863 ,363 








Total Fixed Assets 


$ 63,838,234 


$ 44,242,620 








Deferred Charges: 
Taxes, Insurance, etc., paid in advance 


$ I.995.63O 


$ 641,943 








Total Assets 


$168,548,068 


$117,061,156 


LIABILITIES AND CAPITAL 
Current Liabilities: 
Notes Payable 


$ S.OOO.OOO 


$ 


Accounts Payable ... 
Miscellaneous Accruals and Payables . . . 


7,561,431 ) 
2,031 093) 


6,585,902 


Due to General Electric and Westinghouse Companies 
Dividends Payable 


I8,I82,592T 
I ,304,957 


I7,729.7i9t 
346,005 








Total Current Liabilities 


$ 34,080,073 


$ 24,661 .626 








Funded Debt and Other Liabilities: 
Mortgages Payable 


$ 5,115,869 


$ 3,925,000 


Notes Payable (Serial Notes) 


857,OIO 


677 ,650 








Total Funded Debt and Other Liabilities 


$ 5972 879 


$ 4,602 650 








Reserves for Special Contingencies 


$ 


$ 4,173,277 




4,650,000 


9,823 ,854 


Deferred Income (applicable to future operations) 


I ,305 , 265 










Capital Stock: 
A" Preferred 7 % Cumulative Par Value $50 


$ I9779,87O 


$ I9779,87O 


"B " Preferred Cumulative $5 Dividend, No Par) 
Value, Redemption Value $100 per share > 
Common, No Par Value ) 


72,749,443t 


f 16,430,709 
\ 26,261 ,381 


Total Capital Stock 


$ 92,529,313 


$ 62 ,471 ,960 








Earned Surplus 


$ 30,010,538 


$ II 327,789 








Total Liabilities and Capital 


$168,548,068 


$117,061,156 



* 1930 at Cost, 1931 at Market Value, 
f See footnote on page 490. 



4QO PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

RADIO CORPORATION OF AMERICA AND SUBSIDIARY COMPANIES 
CONSOLIDATED STATEMENT OF INCOME FOR THE YEAR 

ENDED DECEMBER 31, 1931 
Gross Income: 

From Operations $100, 124,847 

Other Income 2 , 520, 573 

Total Gross Income from all sources $102,645,420 

Less: Cost of Sales, General Operating, De- 
velopment, Selling and Administrative 
Expenses 91,099,218 

Net Income for the Year (before Interest, Loss on 

Foreign Exchange, Depreciation, Amortization 

of Patents, and Federal Income Taxes) $ n ,546, 202 

Deduct: 

Interest $ 1,469,181 

Provision for Loss on Foreign Exchange .... 965 , 206 

Depreciation 7,842,912 

Amortization of Patents 400,000 

Provision for Federal Income Taxes 100,000 



Total deductions 10,777,299 

Net Income for the Year, Transferred to Surplus $ 768,903 



t The 803,375.1 shares of "B" Preferred stock listed jointly with the 13,160,750.2 shares of 
no par common stock in 1930 were issued in connection with the acquisition of the outstanding 
common stock of the Victor Talking Machine Company as described on page 3 of the Radio 
Corporation's annual report to stockholders for 1929. In the annual report for 1929, page 4, 
it is also stated that General Electric and Westinghouse advanced $32,000,000 to the Victor 
Talking Machine Company. The arrangements, described on pages 6 and 7 of the 1930 annual 
report, concerning the transfer of manufacturing facilities from General Electric and Westing- 
house to the Radio Corporation 9f America provided for the elimination of this debt. The 
balance, $18,182,592.04, not eliminated by the end of 1930, was listed among the current 
liabilities for that year. 



RADIO CORPORATION OF AMERICA NO. i 



491 



RADIO CORPORATION OF AMERICA AND SUBSIDIARY COMPANIES 
CONSOLIDATED STATEMENT or SURPLUS AT DECEMBER 31, 1931 





Total 
Surplus 


Earned 
Surplus 


Capital 
Surplus 


Surplus at January i, 1931 


$30,010,538 
768,903 

30,057,354 


$30,010,538 
768,903 


$ 


Add: 
Net Income for the year 




Capital Surplus created by retiring 
stated value of Treasury Stock, 
and by reduction of stated value 
of Common Stock to $2.00 per 
share 

Deduct: 
Cost of Treasury Stock to be re- 
tired and cancelled 


30,057,354 


$60,836,795 


$30,779,441 


$30,057,354 


$ 2,838,472 
10,359,000 

16,222,000 
4,891,300 
2,623,500 
8,323,855 


$ 2,838,472 
10,359,000 


$ ... . 


Write-down of Inventories 




Write-down of Fixed Assets (Build- 
ings and Equipment) 


16,222,000 
3,500,000 
2,011,500 
8,323,854 


Write-down of Investments . . 


1,391,300 
612,000 


Reserves for Special Contingencies 
Additions to General Reserve 


Dividends on " A " Preferred Stock 
Dividends on " B " Preferred Stock 

Surplus at December 31, 1931 




$45,258,127 

1,373,907 
2,876,972 


$15,200,772 
1,373,907 
2 , 8 76,973 


S3o,o57,354 






$49,509,006 


$19,451,652 


$30,057,354 


$11,327,789 


$11,327,789 


$ 









Source: Company report. 



1. From the facts given, does it appear that the treasury stock 
was acquired before or after December 31, 1930? Prepare sum- 
mary journal entries to record the acquisition of treasury stock, 
its retirement, and the creation of capital surplus through the 
restatement of common stock. 

2. Did the treasury stock transactions result in a reduction in 
the capital of the company? If so, did the reduction occur at the 
time of acquisition or of retirement? 

3. Did the capital reduction of 1931 imply that income in 
prior years had been overstated ? Do you agree with the classifica- 
tion of surplus at December 31, 1931, as earned? 

4. What was the effect of the capital and surplus adjustments 
of 1931 on the interests of creditors and stockholders? 



492 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

AMERICAN SMELTING AND REFINING COMPANY 
REDUCTION IN THE STATED VALUE OF CAPITAL STOCK 

Statement of President 

in Regard to 
Plan to be Submitted May 21, 1935 to the Stockholders 

of 
AMERICAN SMELTING AND REFINING COMPANY 

New York City, April 3, 1935. 
To All Stockholders: 

A special stockholders' meeting has been called for May 21, 1935, for 
the purposes stated in the enclosed notice. The principal object of 
the meeting is to take action on a proposal to reduce the stated value 
of the outstanding common capital stock of the Company, thereby 
effecting a corresponding reduction in the book value of the property 
account. 

This plan has been recommended unanimously by your Board of 
Directors after mature consideration. The annual stockholders' meet- 
ing held on April 2, 1935, endorsed it, with a recommendation that this 
special stockholders' meeting be called to take final action. . . . 

This action in no way affects stockholders' rights. It does not 
diminish the number of shares owned by each stockholder, which will 
remain as heretofore. It does not alter the no-par status of the present 
stock. The change of figures alters in no degree whatever the actual 
intrinsic net worth of the Company or the intrinsic value of its capital 
assets of any class, and does not diminish to the slightest extent the 
Company's earning power. 

The reasons influencing your Board of Directors and the annual 
stockholders' meeting in recommending this action are: 

(a) It will facilitate the permanent registration of the securities 
of your Company on the New York Stock Exchange in accordance with 
the provisions of the Securities Exchange Act of 1934; 

(b) It will improve the possibility of paying dividends in the future 
on all classes of stock. 

REGISTRATION UNDER THE SECURITIES EXCHANGE ACT 
In order to continue the listing of the stocks and bonds of your 
Company upon the New York Stock Exchange under the Securities 
Exchange Act of 1934, it is necessary that the officers and directors of 
your Company file various statements, particularly the balance 
sheet and current earnings statement. 

Section 18 of the Act provides that any person who shall make or 
cause to be made any statement in any application, report or document, 
filed pursuant to the Securities Exchange Act 

"or any rule or regulation thereunder, which statement was at 
the time and in the light of the circumstances under which it was 
made false or misleading with respect to any material fact, shall 
be liable to any person (not knowing that such statement, was 



AMERICAN SMELTING AND REFINING COMPANY 493 

false or misleading) who, in reliance upon such statement, shall 
have purchased or sold a security at a price which was affected by 
such statement, for damages caused by such reliance, unless the 
person sued shall prove that he acted in good faith and had no 
knowledge that such statement was false or misleading." 

This may be interpreted to mean that your officers and directors 
assume possible liability for the accuracy of statements in the balance 
sheet. As to these, there is no difficulty, with the exception of the 
property account and the stated value of the common stock. As to the 
property account, your Directors are faced with the problem of the 
respective amounts to assign to tangibles and to intangibles. These 
must be segregated under the rules of the Commission, where it is 
practicable to do so. 

Your Company's position as to tangibles and intangibles requires 
the following explanation: 

The Company, at the time of its organization over thirty-five years 
ago in 1899, and on successive occasions in the next ten years, acquired 
the property and business of about twenty separate enterprises in 
various parts of the United States and Mexico, all of which were going, 
prosperous, established concerns. The business and assets so acquired 
necessarily included the element of going concern value, existing con- 
tracts and earning capacity. The acquisitions could not have been 
made unless the Company was prepared to pay, in securities or money, 
or both, a value in excess of that of the tangible properties and assets 
conveyed. It necessarily also had to pay for the intangibles. 

The total amount entered on the books of the Company for prop- 
erty, both tangible and intangible, acquired for stock, after 
elimination of intercompany transactions, was $105,820,657 

Since organization and up to December 31, 1934, your Company 
has written off, for depreciation, ore depletion, amortization, 
and property retirements 164,941 , 153 

Thus, the write-off exceeds the original valuation of both tangi- 
ble and intangible property acquired for stock by the sum of . $ 59, 120,496 

Since organization, your Company has also spent in cash, for new 
construction and additional properties (including $7,346,- 
622.50 spent in cash to complete acquisition of common capital 
stock of American Smelters Securities Company), less amor- 
tized value of properties sold, sales of salvage, etc 159,349,426 

Therefore, the property account stood on December 31, 1934, 

at $100, 228,930 



Note. In the early vears of your Company's life, many expenditures, in accordance with 
practice then considered wise and conservative, were charged off as repairs, which, under the 
strict accounting principles now followed, should have been charged to capital account. Also, 
the proceeds of properties disposed of were credited against current expenditures for property 
additions and betterments. Therefore, in the tabulation given above, it has not been possible 
to include all such items of additions, write-offs and sales. To that extent, the figures with 
respect to the total amounts written off and the total amount expended are partly estimated, 
but it is believed that whatever variation from actual there is in these figures is relatively 
insignificant. 

Notwithstanding that the book value of property acquired for 
stock has been more than written off, a curious situation has arisen 



494 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

because of our tax laws. Depletion and depreciation, in the ta.x 
returns, do not apply to intangibles at all, and amortization applies 
in the main to tangibles and does not reduce appreciably the book 
value of the intangible property. For the first eighteen years of your 
Company's existence, it followed the accounting customary during that 
time, making no distinction in its property account between tangibles 
and intangibles. But with the advent of Revenue laws during 
the war, beginning with the Excess Profits Tax, it became impor- 
tant to make such a distinction. As a higher value placed upon intan- 
gibles results in a higher tax, Government representatives naturally 
strove to increase the valuation placed upon the intangibles and reduce 
that of the tangibles. While your Company struggled as best it 
could, it was forced to compromise on what it believed to be an excessive 
valuation of the intangibles and an undervaluation of tangibles. 

As hereinbefore stated, the property account on the balance sheet 
as of December 31, 1934, including both tangibles and intangibles, has 
a total value of $100,228,929.97. If we are forced to divide this 
amount between tangibles and intangibles on the basis of our Govern- 
ment tax accounting, it will result in valuing the tangibles (plants, 
mines and other physical property) at $52,087,099.26, and the intan- 
gibles (patents, good will, going concern value, etc.) at $48,141,830.71. 
It is this latter amount which the present plan proposes to reduce 
to $4,478,390.71, by reducing the stated value of the common stock from 
$60,998,000.00 to $18,299,400.00 and eliminating the surplus of 
$964,840.00 arising from the acquisition of 16,000 shares of the 6% 
preferred stock held for retirement. This results in a conservative 
valuation of intangibles, since it includes valuable patents and patent 
rights owned by the Company, as well as good will or going concern 
values acquired for cash. 



DIVIDENDS 

Your Company is organized under the laws of the State of New 
Jersey, which provide that dividends may be declared only out of 
surplus, or the net profits of the business; i.e., current and accumulated 
net earnings in excess of capital paid in. Your Company had at the 
end of 1931, in cash and United States Government bonds, nearly 
$21,000,000, and was amply fortified, so far as cash was concerned, to 
continue at least the preferred dividends. But current earnings fell 
below dividend requirements, and an unprecedented fall in metal 
prices and in shipments to its smelting and refining plants raised the 
question of whether further dividends could be paid without impairment 
of capital, in view of the stated value on the balance sheet of the prop- 
erty account and of the common stock. Your Directors had no alter- 
native but to take the conservative view and accordingly declared no 
dividends on the common stock after February i, 1932; and, after June 
i, 1932, none on the preferred stocks. This was the first failure to pay 



AMERICAN SMELTING AND REFINING COMPANY 495 

preferred dividends in the then thirty-three years' life of your Com- 
pany. Payment was not again resumed until December i, 1933, with 
the payment of the equivalent of the current dividend on the 7% 
preferred (all arrearages on which have since been fully paid); and 
until March i, 1935, on the 6% second preferred, with the payment of 
$3.00 per share, and the declaration on April 3, 1935, of $4.50 per share, 
payable June i, 1935. 

But during all the time since 1931, your Company never had less 
than $17,000,000 of cash and United States Governments, as shown by 
its annual and semiannual reports, and owed no floating debts, other 
than current obligations not due and fully provided for. Since 
December 31, 1932, it never had less than $20,000,000, and had no 
borrowings from banks. The maximum arrearage on both classes of 
preferred stock was $6,031,000 on December i, 1933. From a cash 
standpoint, the dividends on both classes of preferred stock, at least, 
could easily have been paid currently, had your Board of Directors 
felt safe in doing so; that is to say, if they had felt certain that a claim 
might not be made that such dividends, if paid, actually were paid out 
of capital and not out of a true surplus or out of accumulated earnings. 
Admittedly, dividends could not have been paid out of current earn- 
ings, since these were not sufficient for the purpose. 

The plan now submitted to the stockholders, if approved, will 
remove such a doubt. Future earnings of the Company, after depre- 
ciation, depletion and amortization allowed under the tax laws, can 
be transferred directly to surplus, thus becoming available for dividends. 
This will establish the surplus on a definitely sound basis and will 
enable the Directors, whenever warranted by the cash position and 
current or accumulated earnings, to declare dividends without fear as 
to impairment of capital. 



RESOLUTIONS ADOPTED AT ANNUAL MEETING OF STOCKHOLDERS, 

APRIL 2, 1935 

RESOLVED, that it is the sense of this meeting that that part of the 
stated capital of the Company which is represented by its outstanding 
shares of no-par common stock be reduced from $33^ per share to a 
stated value of $10 per share, thereby effecting a reduction in the 
outstanding capital stock liability of the Company of $42,698,600 and 
a corresponding reduction in the book value of its property account; 
and 

WHEREAS, the General Corporation Act of New Jersey, as hereto- 
fore revised, supplemented and amended, provides that such a reduction 
may be made if the Board of Directors shall pass a resolution declaring 
that such a change is advisable and calling a meeting of the stockholders 
to take action thereon, and if at such meeting two-thirds in interest of 
each class of the stockholders having voting power shall vote in favor 
of the change, be it 



496 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 



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CAPITAL ASSETS: 
Property Cost of plants, properties of subsidiary companies and additions and improve- 
ments, including patents, licenses, good-will and other intangible assets not segregated, 
less depreciation, ore depletion, amortization and property wntten off to profit & loss 
and to obsolescence reserve 


accompanying 
ion and amor- 


\ry companies 
tion, and cash 


















. . . . 




i : : : : : 


. . 


Property Segregated and re- stated in accordance with plan set forth in 
letter of Apnl 3, 1935, to stockholders: 
(a) Plants, mines, and other tangible properties, less depreciation, depict 
tizatinn . .... . 


(b) Unamortized cash cost to parent company of capital stocks of subsidi 
in excess of latter's book value of tangible property at date of acquisi 
cost of natents. licenses and other intangibles less amnrkizatinn 


8 : : : : : : : 


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Investments Secunties of anc 
Companies controlled . . 
Companies not controlled 




Total 
Less reserve .... 

Total capital assets 
Total current assets 
Total miscellaneous assets 

Total assets 



AMERICAN SMELTING AND REFINING COMPANY 497 



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FUNDED DEBT AND CAPITAL STOCK: 
Bonds Outstanding: 
American Smelting and Refining Company Series "A" 5% First Mortgage Bonds, 
maturing Apnl i, 1947 






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Preferred Capital Stock: 
7% Cumulative Authorized and outstanding, 500,000 shares 
6% Cumulative Second Authorized and issued, 200,000 shar 
Less: 16,000 shares held for retirement 


Common Capital Stock: 
Authorized, 4,000,000 shares without par value Issued and out 
Outstanding, 35 shares of $100 par value not surrendered in < 
shares 




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Total Funded Debt and Capit, 
Total current liabilities 
Total miscellaneous liabilities. 
RESERVES: 
Metal stock 
Extraordinary obsolescence, 
Mine and new business inves 
Other 


Total Reserves 
SURPLUS arising through acqu 
stock held for retirement 
PROFIT AND Loss SURPLUS 

Total Liabilities 



4Q8 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

FURTHER RESOLVED, that the Board of Directors of the Company 
elected at this meeting be and they hereby are requested (subject to 
the exercise of their lawful discretion in the premises) to pass a resolu- 
tion to the foregoing effect, as contemplated by the said General 
Corporation Act, and calling a special meeting of the stockholders to 
take action thereon; and be it 

FURTHER RESOLVED, that the said proposal to reduce the stated 
value of the no-par common stock of the Company as aforesaid be and 
the same is hereby recommended to the favorable consideration of all 
the stockholders of the Company, to the end that at such special 
meeting two- thirds in interest of each class of such stockholders having 
voting power shall vote in favor of the change. 



1. Are there significant differences between this and the pre- 
ceding case in the reasons which apparently impelled the manage- 
ment to seek a reduction in capital? 

2. As far as may be discovered from the facts given, was the 
reduction in this case wise from the point of view of the long-term 
interests of stockholders? 



PACKARD MOTOR CAR COMPANY 499 

PACKARD MOTOR CAR COMPANY 

STOCK SPLIT- UP AND CHANGE FROM PAR TO NO PAR. 
TRANSFERS FROM SURPLUS TO CAPITAL AND FROM CAPITAL 

TO SURPLUS 

A. Change in Capital Structure. 

As you have been advised, the capital structure of the Company 
has been changed. As of September 3, 1929, our stockholders received 
five shares of no par value common stock for each old share of $10 
par value stock held by them. To make this possible, 15,000,000 
shares of no par value common stock were issued to replace the 3,000,000 
shares of $10 par value stock previously outstanding. $20,000,000 was 
transferred out of surplus into Capital Account, bringing the capital 
of the Company to $50,000,000 with a surplus of $19,106,349.45. 

The Balance Sheet as submitted by our auditors gives effect as at 
the close of the fiscal year to these changes in capital structure. 1 

PACKARD MOTOR CAR COMPANY 
AND SUBSIDIARY COMPANIES 

Consolidated Balance Sheet for fiscal years ended August 31, 1928 
and 1929, giving effect at the end of the current fiscal year to the 
authorized issuance to the stockholders of record on September 3, 
1929 of 15,000,000 shares of no par value in exchange of 3,000,000 
shares of $10 each par value and to the transfer, in this connection 
from surplus to capital stock of an amount of $20,000,000. 



1 Annual report, 1929. 



Soo PLANT, FUNDED DEBT, AND PROPRIETORSHIP 



August 31, 
1929 



August 31, 
1928 



ASSETS 

Property Account (Net) 

Rights, Privileges, Franchises and Inventions. 



$36, 39 > 4i 5 



$30,813,670 



Total Property Investment 

Mortgages and Land Contracts Receivable, etc. 

Total Current Assets 

Deferred Charges to Future Operations 



36, 390 

2,578,190 

41,702,982 

355,404 



4i6$3o, 813,671 
2,409,711 
41,680,330 
273,613 



Total Assets 

LIABILITIES 
Capital Stock: 
Outstanding 

Common (Authorized 25,000,000 shares) no par 

value 15,000,000 shares 

Outstanding 

Common (Authorized 5,000,000 shares) par $10 

3,004,264 shares 

Total Current Liabilities 



$81,026,992 



$75,177,325 



$50,000,000 



11,920,642 



30,042,640 
14,705,742 



Surplus : 

Balance at beginning of year 

Add Transfer to Property Account in connection 
with adjustment of Income Tax, of items charged 
to operations in prior years 

Net Profit for the year 



$30 , 428 , 943 $20 , 986 , 439 



728,394 
25,183,257 



21,885,416 



Together 

Deduct Transfer to Capital Stock in accordance 

with Resolution of Board of Directors 

Cash Dividends 



20,000,000 

17,234,244' 



12,442,912 



Total Deductions. . 
Balance at end of year. 
Total Liabilities 



$37,234,244*12,442,912 



$19, 106,350 $30, 428, 943 



$81,026,992175,177,325 



Source: Company report, 1929. Sections other than capital and surplus condensed. 

B. The following statement appeared in the annual report of 
the Packard Motor Car Company for December 31, 1932: 

At a meeting of stockholders of the Company, held June 19, 1929, 
the transfer of $20,000,000 from our Surplus, as it was then, to our 
Capital Account, was approved. At their Annual Meeting April 18, 
1932, the Stockholders approved a reduction in the Capital Account 
of the Company in the amount of $10,000,000 and the increase of the 
Surplus in like amount. The effect of this was to return $10,000,000 
to Surplus from which it was transferred in 1929. These changes in 
capital structure did not affect the total value of the Company's 
assets or the book value per share. 



PACKARD MOTOR CAR COMPANY 501 

The remaining $10,000,000 was returned to surplus in 1935 as 
recorded in the following paragraphs from the reports for 1934 
and 1935, respectively. 

The Surplus which at the beginning of the year stood at $8,904,685 
has been reduced by the losses recorded and chiefly on account of the 
Company's expansion program, to $1,614,136. But it is the expecta- 
tion as forecast in notices calling this meeting that the stockholders 
will return to Surplus the remaining $10,000,000 that was transferred 
some years ago out of Surplus to Capital. With this accomplished the 
Surplus at December 31, 1934 would be $11,614,136 and the Capital 
Stock $30,000,000. 

Capital stock was reduced from $40,000,000.00 to $30,000,000.00, 
$10,000,000.00 being returned to surplus in accordance with the 
resolution of stockholders, April 15, 1935, this being the remainder of 
the amount transferred from surplus to capital in 1929. 

With the exception of the addition of $728,394 to surplus in 
1929, which represented a transfer to the Property Account in 
connection with an Income Tax adjustment of items charged to 
operations in prior years, there were no entries in surplus during 
the entire period 1929 to 1935, except for profit or loss of the 
several years, dividends, and the transfers to and from capital 
described above. 

The capital stock and surplus sections of the balance sheet for 
1935 were as follows: 

Capital Stock: 

Common (Authorized 25,000,000 Shares) No Par 

Value Issued 15,000,000 Shares 
(Includes 8,660 shares issued to Trustee for 
account of company, and not carried as an 

asset) $30,000,000 

Surplus: 

Balance at December 31, 1934 $ 1,614,136 

Add Amount returned to surplus in accordance 
with resolution of stockholders April 15, 
J 935> from amount transferred from surplus 

to capital stock in year 1929 10,000,000 

Net Profit for the Year Ended December 31, 1935 3,315,622 $14,929,758 



1. In what ways did this stock split-up differ from a stock 
dividend? 

2. If the surplus capitalized in 1929 was earned surplus, did 
the amounts returned to surplus in 1932 and 1935 constitute 
earned surplus? 



502 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

3. As far as the facts of this case are concerned, what is the 
fundamental distinction between capital and surplus? What is 
the fundamental distinction between capital surplus and earned 
surplus? 

AMERICAN LOCOMOTIVE COMPANY 
TRANSFER PROM CAPITAL SURPLUS TO EARNED SURPLUS 

The surplus of the company as recorded in the report for 1930 
was $19,759,953 with no differentiation as between earned or 
capital surplus. After certain surplus adjustments described in 
the report for 1931 the balance remaining was shown in separate 
amounts for earned and capital surplus. 

It will be noted that there has been made a surplus adjustment 
whereby the depreciated value ($21,868,203) of existing additions 
to permanent plant property in prior years charged to reserves created 
out of current earnings has been added to the Cost of Property and 
Earned Surplus accounts. Also capital surplus amounting to 
$14,426,998 has been applied as a reduction of the Cost of Property 
account. 

CONSOLIDATED SURPLUS ACCOUNT 

Surplus, December 31, 1930 $iQ 759,953 

Surplus adjustment restoring to cost of property and 
to earned surplus the depreciated value of existing 
additions to permanent plant property charged to 
reserves created out of earned surplus in prior 
years 21,868,203 

Excess of par and stated value over cost of Pre- 
ferred and Common stock in Treasury Net. . . . 776,708 

$42,404,864 

Loss for year ended December 31, 1931 $ 39 2 9,384 

Dividends Preferred stock $2,619,386 

Common stock 767 ,900 

3,387,286 

7,316,670 

$35,088,194 

Capital surplus applied as a reduction of the Prop- 
erty Account 14 , 426 , 998 

Surplus, December 31, 1931 $20,661,196 

Earned Surplus $19,884,488 

Capital Surplus 776, 708 

In 1933 surplus was increased by a reduction in the stated value 
of the no par common stock from $50 to $5 per share, and was 



AMERICAN LOCOMOTIVE COMPANY 



503 



applied in the reduction of the plant and investment accounts, as 
described in the report for that year. Although beginning surplus 
was shown as a single amount in the statement for 1933, the same 
total was recorded at the end of the surplus statement for the prior 
year as follows: 

Earned Surplus $13,425,147 

Capital Surplus i ,018,596 

During the period under review a change was made in the stated 
capital of the Company. By the necessary statutory action of the 
Stockholders at their annual meeting in New York on April 18, 1933, 
the stated value of the no par Common capital stock of the Company 
was reduced from $50 per share to $5 per share, and an amended 
certificate of incorporation, making such change effective, was filed 
with the Secretary of State of New York on June 29, 1933. This 
reduction in the stated value of the Common stock resulted in creating 
Capital Surplus amounting to $34,555,500, of which $32,023,024 
has been applied, under power granted by the Stockholders, to make 
such reductions in the values of the Corporation's properties and 
other investments, as of January i, 1933, as in the judgment of the 
Board of Directors of the Corporation will approximate their present 
sound values, as follows: 





Book Value 
January i, 
1933 before 
Adjust- 
ments 


Revised 
Valuations 
as of 
January i, 
1933 


Reduction 
in Valu- 
ation 
January i, 
1933 


Cost of Property 


$83,832,171 
22,164,410 


$47,645,884 
11,824,368 


$36,186,287 
10,340,042 


Depreciation Reserve 


Net Cost of Property 


$61,667,761 


$35,821,516 


$25,846,245 


Investments 
160,500 shares No par Common 
Stock of General Steel Castings 
Corporation 


$ 8,001,375 
2,447,878 


$ 2,500,000 
1,772,474 


$ 5,501,375 
675,404 


Other Investments 


Total Investments 


$10,449,253 


$ 4,272,474 


$ 6,176,779 








$32,023,024 



As a result of the foregoing revaluations, operating income has been 
relieved of a substantial yearly charge for depreciation on plants and 
equipment. 



504 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

CONSOLIDATED SURPLUS ACCOUNT 

Surplus, December 31, 1932 $14,443,743 

Excess of par value over cost of Preferred stock of 

the Company acquired since December 31, 1932 271,150 

Capital surplus resulting from reducing the stated 

value of 770,000 shares of the no par Common 

stock from $50 to $5 per share $34,650,000 

Less reduction in stated value of 2,100 shares of 

stock held in the treasury 94, 500 

34,SSS,Soo 



$49,270,393 
Less Capital surplus applied in reduction of the 

Property and Investment accounts 32,023,024 

$17,247,369 
Less additional reserve for contingencies created 

from earned surplus 425 ,000 

$16,822,369 
Loss for year ended December 31, 1933 i ,465,504 

Surplus, December 31, 1933 $15,356,865 

Earned Surplus $11,178,615 

Capital Surplus , 4,178,250 



Source: Company report. 



1. Determine as closely as the available facts permit the 
amount of capital surplus at December 31, 1930. 

2. Did the transactions of 1931 change the nature of surplus 
from capital to earned? Do you agree with the classification as 
between earned and capital surplus at December 31, 1933? 

3. If by virtue of reduced depreciation charges after 1933 net 
profits were larger than they otherwise would have been, would 
these additional amounts constitute valid earned surplus? 



ALLIS-CHALMERS MANUFACTURING COMPANY 505 



ALLIS-CHALMERS MANUFACTURING COMPANY 

TREASURY STOCK 

The comparative balance sheet included in the annual report 
for 1929, from which the following excerpt is taken, did not contain 
any reference to treasury securities. The certificate of the public 
accounting firm which accompanied the financial statements 
referred to treasury securities as indicated below. The corres- 
ponding certificate, by the same firm, in the report for 1928 did 
not mention such securities. Current liabilities in 1928 were 
$5,632,585 and in 1929, $8,986,982. 





1929 


1928 


Current and Working Assets 
Cash.. . 
Marketable securities .... 
Notes receivable 


$ 1,615,409 
3,584,929 
-2 ,O3Q, 77$ 


$ 2,541,597 
3,080,009 

I ,Ql6, 2l6 


Accounts receivable ... 
Inventories 


9,392,372 
16 . 1 4.1 . 6^4. 


6,343,999 

13 . SO8. 7Q4. 










$33,774,119 


$27,480,615 



We have examined the books and accounts of the Allis- Chalmers 
Manufacturing Company for the year ended December 31, 1929. The 
marketable securities include investments in bonds and stock of the 
Company costing $2,163,042, which is less than the market value at 
December 31, 1929, and we certify that the foregoing Balance Sheet 
and relative Profit & Loss and Surplus Accounts have been correctly 
prepared from the books, and, in our opinion, fairly set forth the 
financial position of the Company as at December 31, 1929, and the 
results of the operations for the year ended on that date. 

PRICE, WATERHOUSE & Co. 
Milwaukee, March 5, 1930. 

In 1930 investments in bonds and stock of the company were 
shown separately under Current and Working Assets. There was 
no reference to the matter in the audit certificate. 



506 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

Current and Working Assets 1930 

Cash and call loans $ 3 ,035 ,360 

Investments at cost (quoted value approx. $2,890,- 

ooo): 
Debentures of the Company (par $1,114,000) . . $i , 106,961 

1612 shares of the Company 46, 742 

Sundry securities i ,929,391 3 ,083 ,094 

Notes receivable 7, 152 ,846 

Accounts receivable 7 , 243 ,013 

Inventories 14,820,081 



$35,334,394 

In the comparative balance sheet included in the report for 
1931, treasury securities were deducted on the liability side, and the 
change was applied to the figures for 1930. The reduction of 
$729,584 in sundry marketable securities did not appear in the 
surplus statement for 1931. The reserve of $1,188,202 in 1930 
was called, in the statement for that year, a reserve for receivables 
and contingencies. 



ALLIS-CHALMERS MANUFACTURING COMPANY 507 





I93i 


1930 


Current and Working Assets 
Cash 


$ 4,027,596 

i, 939 , 33 2 
6,358,048 
6,179,021 

13,834,216 


* 3,03S,36o 

i,9 2 9,39i 
7,152,846 

7,243, OI 3 
14,820,081 


Sundry Marketable Securities (Reduced to market 
value December 31, 1931, by charge against Sur- 
plus Reserves of $729,584) 


Notes Receivable 


Accounts Receivable 


Inventories of Work in Process, Manufactured 
Stock, Materials, Supplies and Consigned 
Stocks at cost or market, whichever is lower . . . 


$32,338,213 


$34,180,691 

$ 1,188,202 
539,398 


Reserves 
For Receivables 


$ 59^,664 
162,283 


For Employer's Liability Insurance 


Funded Debt 
Ten-year 5% Gold Debentures due May i, 1937. . 
Deduct In Treasury 


$ 760,947 

$15,000,000 
1,004,000 


$ 1,727,600 

$15,000,000 
1,106,961 


Capital Stock (Common) 
Authorized 2,000,000 Shares No Par Value 
Issued 1,360,000 Shares 


$13,996,000 

$40,171,768 
708,661 


$13,893,039 

$36,083,768 
46,742 


Deduct In Treasury at cost 48,348 


1,312,252* 
Earned Surplus 


$39,463,107 
$16,840,314 


$36,037,026 
$17,399,111 





* As at December 31, 1931; 1612 shares in treasury in 1930. 



1. Were the several changes in the treatment of treasury 
securities wise? 

2. Did the acquisition of treasury stock constitute a reduction 
in the capital of the enterprise? If so, was the amount of the 
reduction measured by the cost of the treasury stock or by the 
number of shares in the treasury times the stated value per share? 
Was the treatment in 1931 consistent with your opinion as to the 
amount of capital? 



So8 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

COCA-COLA COMPANY 
TREASURY STOCK 

The capital stock of the company at December 31, 1927, con- 
sisted entirely of common stock 1,000,000 shares without par 
value stated at $25,000,000. In the report for 1928, capital 
stock was stated on the same basis, but a footnote to the balance 
sheet and a paragraph from the text of the report described a 
stock dividend declared in Class "A" stock. 

Note. On December 8, 1928, a Stock dividend of 1,000,000 shares 
of Class "A" stock was declared payable to stockholders of record as 
at January 15, 1929. 



The action of the stockholders in declaring a stock dividend, in 
the form of Class "A" stock (callable at $52.50 per share and carrying 
a preferential cumulative dividend of $3.00 per share per annum) 
furnishes an opportunity for the small investor which cannot help but 
improve the stability and investment characteristics of our security 
structure. 

The surplus statement for the year ended December 31, 1929, 
is given in full: 

Profit and Loss Surplus Account 

Balance December 31, 1928 $14,395,197 

Net Profits from Operations for year ended 
December 31, 1929 12,758,276 

$27,153,473 
Deductions for Dividends: 

Nominal Amount transferred from Surplus and 
assigned to Class "A" Stock distributed as a 

Dividend on Common Stock . $5,000,000 

Dividends Paid in Cash: 
Class "A": 

June 28, 1929 $1,500,000 

Less: Dividend on 
Stock owned by 
Company 211,966 $1,288,034 

December 28, 1929. . $1,500,000 
Less: Dividend on 

Stock owned by 

Company 280,770 1,219,230 2,507,264 

Common: 

March $i ,000,000 

June 28, 1929 i ,000,000 

September 28, 1929 i ,000,000 

December 28, 1929 1,000,000 4,000,000 11,507,264 

Balance December 31, 1929 $15,646,209 



COCA-COLA COMPANY 



509 



In the balance sheet for 1929 the Class "A" stock was shown on 
the liability side at a stated value of $5,000,000, and an investment 
in that stock was shown on the asset side as a separate classifica- 
tion immediately below current assets. The company evidently 
purchased a large block of the Class "A" stock soon after it was 
issued and continued to acquire additional shares. 

Asset side: 

Investment in Company's Own Class "A" Stock at Cost $ 9 > 433 > 733 

Liability side: 
Capital Stock: 

Class "A" 1,000,000 Shares No Par Value. $ 5,000,000 

Common i ,000,000 Shares No Par Value ... 25, ooo , ooo 

$30 , ooo , ooo 
Profit and Loss Surplus 15,646,209 $45,646,209 

The common and Class "A" stock were stated on the liability 
side as above through 1933. The investment in the company's 
own Class "A" stock was shown as an asset in the following 
amounts. Common stock was first included in 1933. The 
number of shares in 1929 and 1930 was computed from dividend 
data. 





Shares 


Cost 


IQ2O 


187,180 


$0.4.33.733 


IQ3O 


210. 74.6 


II . I4.I . 3O< 


IQ3I 


308,620 


1C, 2QI .OO6 


IO32 ... 


121 . <?2O 


16 056 658 


IQ33 


^27,820 


l6 . 2 34. 3 


*933 Common . 


4.. IOO 


374. 712 









A change in treasury stock in 1934 was described in the text 
of the report for that year and was reflected in the proprietorship 
section of the balance sheet and in a deduction included in the 
surplus statement. 

The attached consolidated balance sheet and statement of opera- 
tions, is drawn to conform to suggestions of the Securities & Exchange 
Commission and the New York Stock Exchange. Of the Company's 
investment in its own stock, 200,000 Class "A" Shares have been retired 
and cancelled, and remaining holdings of Class "A" and Common Shares 
are shown as a deduction from capital and surplus at cost. 



S io PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

Capital Stock 

Class "A" $3.00 preference cumulative Re- 
tirable at $52.50: 

800,000 shares No par value $ 4,000,000 

Common 1,000,000 shares No par value 25 ,000,000 

$29,000,000 
Profit and Loss Surplus 24, 762 ,053 

$53,762,053 
Less: Stock owned by Company At cost: 

1 2 7, 820 shares of Class "A" $6,486,883 

14,100 shares of Common 1,319,712 7,806,595 $45>9S5>458 

DEDUCTION ON SURPLUS STATEMENT 

Cost of 200,000 shares Class " A " stock retired $9 , 767 , 1 10 

Less: Nominal value $5.00 per share 1,000,000 $ 8,767,110 



Somewhat similar transactions occurred in 1935, which served 
to eliminate all Class "A" stock owned by the company. In addi- 
tion, the common stock was split four for one. There was a deduc- 
tion on the surplus statement for Class " A" stock retired, but there 
was no entry there for the stock split since the amount of capital 
was not changed. 

The Company's one million shares of common stock have been 
divided into four million shares. Additional Class "A" stock acquired 
during the year brought treasury holdings to 200,000 shares, which 
were retired and cancelled, leaving 600,000 Class " A" shares outstand- 
ing in the hands of the public. 



Capital Stock 

Class "A" No par value: $3.00 preference divi- 
dend cumulative 
Callable at $52.50 per share 
Authorized and originally issued 1,000,000 

shares 
Outstanding December 3 1 , 

1934 800,000 shares 

Less: Retired in 1935 200,000 shares 

Issued and outstanding 600,000 shares $ 3,000,000 

Common No par value: 
Authorized and issued 4 , ooo , ooo shares 2 5 , ooo , ooo 

$28,000,000 
Surplus Earned 20,379, 100 

$48,379,100 
Less: Common stock owned by Company 

At cost 8,100 shares 189,533 $48,189,567 



COCA-COLA COMPANY 



DEDUCTION ON SURPLUS STATEMENT 

Cost of 200,000 shares Class "A" stock retired . . . $10,369,615 
Less: $5.00 per share charged against capital stock 

liability 1,000,000 $ 9,369,615 



1. Did the issuance of the stock dividend in 1929 and the sub- 
sequent expenditure of $9,433,733 in the acquisition of a portion 
of that stock result in a net increase or decrease in the capital of 
the company? 

2. As far as the facts given permit, indicate the amount of 
income received by stockholders in connection with Class "A" 
stock and the years in which the income was received. 

3. What apparently were the objectives of the management in 
issuing and reacquiring the Class "A" stock? Was the policy fol- 
lowed well advised? 

EXHIBIT i 

COCA-COLA COMPANY 
STOCK QUOTATIONS 





Class "A" 


Common 




High 


Low 


High 


Low 


1928 






180^ 


127 


1929 


50^ 


44% 


I54M 


IOI 


1930 


53 


48^ 




133^4 


193 1 




45% 


170 




1932 


50 


41% 


120 


Oo/o 


X 933 


51 


44 


I0 5 


7 ^x2 


J 934 


57 


5/^j 


i6ij^ 


95^4 


1935 


58% 


53% 


298^ 


161% 








93* 


72^* 



* After issuance of three additional shares for each share held. 
Source: Bank and Quotation Record. 



5i2 PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

ALLIED CHEMICAL & DYE CORPORATION 

DISCLOSURE IN RELATION TO TREASURY STOCK, 
CONTINGENCY RESERVE, AND SURPLUS 

The Allied Chemical & Dye Corporation was organized in 
the latter part of 1920 as a merger of five firmly entrenched non- 
competing chemical companies. Prior to that date, the United 
States had been almost entirely dependent upon Germany, domi- 
nant in the chemical industry, for its supply of many important 
chemicals and almost all of its dyestuffs. When the war cut off 
importations from Germany, the textile industry, as well as other 
industries in the United States, suffered from an inability to obtain 
the various chemicals required. It was with a view of combating 
the postwar competition from foreign companies, such as the I. G. 
Farbenindustrie in Germany, that the consolidation resulting in 
the formation of the Allied Chemical & Dye Corporation was 
effected. At the same time, it was believed that this consolidation 
would enable the United States to become independent of foreign 
countries for various chemical supplies. Under these circum- 
stances, the management of the Allied Chemical & Dye Corpora- 
tion believed that it was unwise to make known to the public, and 
thus to European competitors, the company's potentialities as 
reflected in plant capacity and the nature of the equipment and 
processes used. 

It was said that the five companies which consolidated were 
not competitors in any way but were engaged in specific branches 
of the chemical industry. The following information relative to 
the activities of each of these five companies was given in the Allied 
Chemical & Dye Corporation's statements of application to the 
Committee on Stock List of the New York Stock Exchange: 

General Chemical Company The largest producer in the United 
States of heavy acids and other chemicals. 

Solvay Process Company The largest manufacturer of alkalis 
and soda products in the United States. 

Semet-Solvay Company A manufacturer of coke and its by- 
products and by-product coke ovens. Among its products are sali- 
cylic acid, caustic potash, benzaldehyde, protective paints for iron 
and steel. 



ALLIED CHEMICAL & DYE CORPORATION 513 

Barrett Company Manufacturer of roofing materials, " Tar via" 
for roads and pavements, insulating compounds, coal tar pitch, creosote 
products, flotation and lampblack oils, chemicals for dyes tuff manu- 
facturers, paint and rubber specialty manufacturers and manufacturing 
chemists. 

National Aniline and Chemical Company, Inc. The largest dis- 
tributor of coal tar derivatives and dyes tuffs in the United States. 1 

The management of the Allied Chemical & Dye Corporation 
was unusually secretive in all matters pertaining to the company's 
activities and operations. Beyond announcements relating to 
the declaration of dividends, the company did not issue any official 
statements or in any other manner divulge information to stock- 
holders other than that published in its very brief annual reports. 
It was said that among the factors contributing to the company's 
adoption of such a secretive policy were the domestic and interna- 
tional competitive conditions prevailing in the chemical industry 
at the time the company was formed. 2 

As may be seen from an examination of balance sheets for 1932 
and 1933 below, reserves were large and substantial amounts of 
funds were held in marketable securities. 

The common stock of the Allied Chemical & Dye Corporation 
was known as a " mystery" stock. The mystery lay not only in 
the secretive policies of the company in so far as the publicity of 
its activities and operations was concerned, but also in the alleged 
understatement of the company's earnings, and in the attitude of 
the board of directors toward the matter of dividends. From the 
time of the company's organization, the dividend action of the 
management was the subject of discussion and rumors in financial 
circles and, until announced, was always a matter of great conjec- 
ture. This situation, in conjunction with the company's policy 
of aloofness toward the usual channels for the dissemination of 
information, was largely responsible for the circulation of numerous 
unofficial reports concerning such matters as dividends and the 
redemption of the preferred stock. The nature of some of these 
speculative reports is illustrated by the following statement given 
in an analysis (April, 1931) of the Allied Chemical & Dye Corpora- 
tion by Spencer Trask and Company : 



1 A-5i;8, March 25, 1920; and A-5345, December 21, 1920. 

2 Harvard Business School, Business Policy case, BP-II, 286, 



PLANT, FUNDED DEBT, AND PROPRIETORSHIP 

. . . Futile speculation as to Allied's manufacturing costs of ferti- 
lizer; fears as to its ability to compete with Chile or with other synthetic 
producers; and preposterous estimates as to the size of its present 
plant investment at Hopewell, Va., have all served to exaggerate this 
phase of Allied's business. No additional capital liabilities have been 
assumed for its construction and the $125,000,000 which is reported 
to have been spent at Hopewell could more accurately be written down 
to about $40,000,000. Furthermore, it is hardly logical to assume 
that, after a year of actual operations Allied would continue its expan- 
sion at Hopewell unless the results had demonstrated conclusively the 
Corporation's ability to meet any competition that may arise. . . . 

. . . It is our opinion that Allied Chemical & Dye, strengthened by 
the economies which always come with business depressions, will emerge 
from the present period of unsettlement to continue the progress that 
has long distinguished its past record. 

Since the reserves built up by the management appeared to 
the stockholders as more than adequate to provide for contin- 
gencies, it was hoped that the management would (i) discontinue 
the setting aside of further large reserves; (2) show the company's 
true earnings; and (3) increase the dividend on the common stock. 
The management, however, continued to strengthen the company's 
financial position by the accumulation of still larger working capi- 
tal and reserves in order to compete effectively with the European 
chemical companies in all branches of the trade. 1 Dividends on 
the preferred stock were $7 per share from 1926 through 1935. 
On February 14, 1936, the preferred stock was retired at $120 per 
share (345,540 shares outstanding) plus accrued dividends of 
$0.85^. Regular dividends on the common stock were $6 per 
share from 1926 through 1937, with an additional payment of 
$1.50 in 1937. 

One of the reasons for the retention of large reserves was the 
policy of the company in providing for expansion from its own 
resources. The nature of the chemical industry with the constant 
development of new processes made it essential that the manage- 
ment be in a position to retire old properties and replace them with 
new plants when the need arose. 

In 1932 there was an extensive correspondence between the 
officials of the New York Stock Exchange and the management of 
the company concerning the extent of the disclosure in the annual 



1 Harvard Business School, Business Policy case, BP-II, 286. 



ALLIED CHEMICAL & DYE CORPORATION 515 

report. The following letter of June 23, 1932 stated the opinion 
of the exchange authorities: 1 

Mr. Orlando F. Weber, President 
Allied Chemical & Dye Corporation 
New York City 
Dear Sir: 

Since writing you on March 22, 1932, in reference to complaint 
from a stockholder regarding the lack of adequate information in your 
annual reports, this Committee has received complaints from other 
stockholders believed to hold substantial amounts of your stock. 

These complaints appear to us to be well grounded. When a 
corporation voluntarily applies for the listing of its securities, it incurs 
an obligation to provide present and prospective investors with suffi- 
cient information upon which to base their actions. The reports of 
Allied Chemical & Dye Corporation do not appear to us to meet this 
obligation in the following particulars: 

The Balance Sheet should show, in addition to the present 
information : 

(a) The basis of valuation of the Property Account, United States 
Government and Other Marketable Securities, and Inventories. Pre- 
ferably, United States Government Securities should be separated from 
Other Securities. 

It is recognized that the basis of valuation of two of these items 
was stated in the text of your report. It would be simpler and more 
informative to include the information in the Balance Sheet. 

(ft) There should be a footnote to the Balance Sheet stating the 
current market value of the item United States Government and 
Other Marketable Securities. 

(c) In view of the large total of the Reserve for General Con- 
tingencies some information should be given as to any large amounts 
included for specific purposes. It is now open to question as to 
whether this is in the main, an appropriation against the ordinary 
contingencies of operations, or a reserve against depreciation in 
security values. No opinion can be formed as to whether the reserve 
is either excessive or inadequate. 

(d) If " Further Surplus" is entirely Earned Surplus, that fact 
should be indicated by including that word in the title as, " Further 
(earned) Surplus/' If the item is not entirel