Henry Rand Hatfield.

Modern accounting, its principles and some of its problems online

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ations from this nominal capital and alterations in it due
to business operations and other changes.

The accounting problems having to do with the Capital
account are therefore, mainly, those connected with the
capital of corporations. They arise generally from a di-
vergence between the nominal or par value of the Capital
Stock issued and the actual net wealth of the corporation.
But even these problems would, in most cases, cause no
difficulty were it not for the further fact that in many
cases the corporation is unwilling to show clearly its exact
condition. It may have done some financing which is
prohibited by law, and it then becomes a problem how to
present the accounts in such a way as to conceal this ille-
gal action. Or it may be that not law, but business pru-
dence, has been violated and again it becomes a problem
how to conceal this fact in the company's Balance Sheet.
The accountant should have no interest in solving such
problems, nor is he, as an accountant, primarily interested
in the exact legal status of certain financial transactions.
For instance, in some states a corporation may legally pur-
chase its own stock in the market, in others this is pro-
hibited. In either case, the accountant, as such, is con-
cerned only in showing that the purchase has been made,
not troubling himself as to the legal problem, and still
less attempting to find a way in which to conceal the fact
that such a purchase has been made. If it is kept clearly
in mind that the only legitimate purpose of accounts is to
show the truth, and if accounts are kept strictly to this
rigid standard, the problems of the accountant will be
materially lessened.

When a new corporation is started, the first step, nor-


mally, is to secure subscriptions for the Capital Stock
authorized by the charter. If such subscriptions are ob-
tained for the full authorized capital of the company the
initial condition is then that the -company begins with an
authorized capital of a given amount, the net wealth which
it represents being composed entirely of promises made
by the subscribers to pay that amount. In this initial
stage, then, the Balance Sheet is:

FORM 45.
Dr. Balance Sheet. Cr.

Subscriptions $100,000 Capital Stock $100,000

This may be assumed to be the normal opening Balance ,
Sheet for a corporation where the stock is fully subscribed.
It is perfectly correct, for while no wealth has been paid
into the treasury of the company, the signing of the sub-
scription list creates an obligation on the part of the sub-
scriber which is legally collectible by the company. It is
as truly an asset, as the accounts receivable or the notes
receivable held by a merchant.

As the subscriptions are called and paid, the treatment
is identical with that of any other form of account receiv-
able when it is paid to the proprietor. The cash received
is debited, the subscription account is credited, and gradu-
ally the item Subscriptions disappears from among the
assets, and there is substituted therefor Cash or some other
form of property.

But not infrequently the incorp orators desire to begin,
business without securing subscriptions for the entire au-
thorized Capital Stock. At the beginning of operations
the entire sum, here $100,000, is not needed, and it is
thought better not to receive subscriptions until later

when it can be profitably used, and when the evidence of



successful operation will perhaps make it easier to secure
the desired subscriptions. Assuming that, of the $100,000
authorized Capital Stock, subscriptions are obtained for
only one-half, or $50,000, the booking of the transaction
is variously made, the more common forms being given

FORM 46.
Dr. Balance Sheet. Cr.

Cash $50,000

Capital paid in $50,000


FORM 47.
Balance Sheet.


Cash $50,000

Unissued Stock 50,000


Capital Stock.


FORM 48.
Balance Sheet.




Unissued Stock



Capital Stock

outstanding. $50,000
In treasury... 50,000


FORM 49.
Balance Sheet.



Cash $50,000


Capital author-
ized $100,000

Ijss amount
held in
Treasury. . . 50,000



Many accountants argue in favor of the first form
given above, saying that $50,000 is all that the company
has received, that it is all that serves as a guarantee to
creditors; and that the unsubscribed and unissued stock
is virtually nonexistent. The same idea is embodied in
some laws. In German law, it is not permissible to show
any capital not subscribed for. In Austria the law relat-
ing to one class of corporations definitely states that un-
issued stock may not appear either in the -Balance Sheet
or in any other statement, and the Companies Act of Que-
bec, passed in 1907, says: " Capital Stock shall consist of
that portion of the amount authorized by the charter,
which shall have been bona fide subscribed for and al-
lotted." Despite such legally authoritative statements
there is some ground for holding that Form 46 is not
altogether sufficient.

The argument that unsubscribed and unissued stock
must not appear at all in the accounts of the company
because it is nonexistent is somewhat specious. The
amount of depreciation of machinery or plant is no less
nonexistent. Indeed, unissued stock has a certain reality,
for it does constitute a means by which, directors can, at
least in times of prosperity, raise funds, while the depre-
ciation of property represents an absolutely nonexistent
quantity. Yet the appearance of depreciation, in the form
of a Depreciation Account, is a recognized and legitimate
convention of accounting.

While unsubscribed stock is not an asset so far as the
creditor is concerned, yet the existence of such stock, sub-
ject to issue at the discretion of the directors, is a matter
of which the stockholder should be informed. Perhaps the
desired information is sufficiently given in a foot-note, or
other memorandum attached to the Balance Sheet, which
is the form used by British companies. But to many ac-
countants it seems desirable to show the total authorized


capital stock as an item entering into the accounts proper,
with the unissued stock as an item appearing elsewhere in
the Balance Sheet.

This may be accomplished in various ways, three dif-
ferent methods of presenting the facts being shown in
Forms 47-49 above. The first of these is one very fre-
quently found in American reports, and exhibits the entire
unissued stock as an asset. Not infrequently the term
" Treasury Stock " is used to designate unissued stock
thus held, a practice which has been severely criticised, on
the ground that the term Treasury Stock should be limited
to stock which has once been issued and subsequently reac-
quired. The objection is, however, made that in this form
the Balance Sheet gives an exaggerated and perhaps mis-
leading statement of the actual capital of the company.
This objection can, however, easily be removed by making
the modification shown in Form 48 where the total author-
ized Capital Stock appears as a significant item in the ex-
tended column of the Balance Sheet, yet attention is called
to the fact that part of the stock is unsubscribed and that
it appears among the assets. But a still better form is
the last one given above, where under the general rule that
a negative item can be shown in the Balance Sheet as a
subtraction (see page 53 above), the Unissued Stock, in-
stead of appearing on the left hand of the Balance Sheet,
is subtracted from the item Authorized Capital. This is
the form used in the Balance Sheet of the Atchison, To-
peka and Santa Fe Railway, as shown on page 61.

It should be noted that while there may be little differ-
ence in the Balance Sheet obtained in Form 46 and that
in Form 49, yet there is a real difference in the ledger
accounts. In the former, the original Journal entry pre-
sumably corresponds with the Balance Sheet given; there
is no account showing Unissued Stock to be found in the
Ledger, and the Capital Stock account, in the ledger shows



only a credit of $50,000. But in all the other forms, al-
though presented differently in the Balance Sheet, the
ledger entries are identical and all differ from Form 46,
for in each instance Unissued Stock, or some other similar
account, is to be found in the Ledger showing a debit bal-
ance of $50,000, and the Capital Stock account proper
shows a credit for the entire $100,000.

Very similar is the problem of the treatment of the
capital stock which after issue has been reacquired by the
company. Aside from the question of the legality of this
action, which is not an accounting question at all, the dis-
cussion turns on whether stock so acquired is a real asset,
and, if so, how it is to be represented in the accounts. The
argument against the legitimacy of showing unissued
stock, is also used, though with less cogency, regarding
repurchased stock. In a certain sense any return of capi-
tal stock to the issuing company may be considered as a
virtual cancelation of that amount of the previously is-
sued stock. That seems to be the distinct attitude of
French law, and, according to Simon, is to be inferred
from, although not clearly expressed in, German law. A
distinction may be made according to the purpose for
which the stock is acquired. If it is done with the inten-
tion of reducing the Capital Stock, certainly the stock so
acquired and canceled should be deducted from the amount
of outstanding stock, and should appear as below:


FORM 50.

Balance Sheet.


Plant and other assets.. . $120,000

Investments '. . 15,000

Cash 5,000


Capital stock

authorized.. . $100,000
Less canceled
stock 10,000

Bonds 50,000




But if the stock is not acquired with the intent of reduc-
ing the capitalization, and is not canceled, accounting
practice in this country certainly justifies and, indeed,
requires that it be shown among the assets. Where this
is the case the best form for presenting the Balance
Sheet is:


FORM 51.
Balance Sheet.


Plant, efc $120,000

Investments 15,000

Treasury Stock 10,000

Cash 5,000


Capital Stock

outstanding.... $90,000
Held in Treasury. 10,000

~ $100,000
Bonds 50,000


which is the form used in the accounts of the Chicago and
Northwestern Railway. There is, however, no criticism of
an alternative form, which indeed some prefer, in which
the item is not listed among the assets, but appears as a
deduction from the total capital stock on the liabilities side,
thus resembling Form 49.

It is, however, misleading, and hence incorrect, to allow
the stock held in the treasury to be included in some gen-
eral designation which does not clearly show that it is
the company's own stock. In the statement above, to in-
clude both Investments and Treasury Stock under the sin-
gle title Investments would be thus misleading. This de-
cidedly objectionable form is not infrequently used, and
occasionally, it may be, to the deception of creditors.

The use of the phrase Treasury Stock to designate live
stock reacquired by the issuing company is thoroughly
recognized in this country, although the term seems not
to be used in England, nor are equivalent terms used in
France and Germany. Some writers claim that this is th<


only proper use of the term, and that to apply it to 'unis-
sued stock is incorrect. An examination of American bal-
ance sheets will give numerous instances where Treasury
Stock is used as including unissued stock. But there is
an important difference between reacquired and unissued
stock in that the former can legally be sold by the com-
pany below par without making the purchaser liable for
the discount. To indicate this distinction would seem de-
sirable in accounting, and this could easily be done by
limiting the term Treasury Stock in the way mentioned - r
and calling stock which has not been issued or subscribed
for by some other designation, e. g., Unissued Stock.

Altogether different from the foregoing cases is the
company which has received subscriptions for all of its
capital but has not yet called for payment of the whole
amount subscribed. If, for instance, the capital stock of
$100,000 has been all subscribed for, but only $50,000 has
been called in, it is really incorrect to present the capital
as only $50,000 and the assets of the same amount without
reference to the uncalled subscriptions. Yet practice is
not uniform on this point, and to what extent the uncalled
subscriptions are to be included in the accounts proper,
and how far they are only to be referred to as an explana-
tory item is not uniformly agreed upon. In England the
standard form for Balance Sheets, that which until re-
cently was given as a model in Table A of the Companies
Act (see page 66), excludes the uncalled subscriptions
from the accounts proper, the form used being:

FORM 52.

Nominal capital (10,000 shares of 10 each) 100,000

Capital called up (5 per share) 50,000

Less calls in arrears 100

Capital paid in 49,900



In this the Nominal Capital is no part of the Balance Sheet
proper, and a distinction is further made between uncalled
subscriptions and those called but in arrears. The capital
actually paid in alone shows in the extended column.

In France, however, the uncalled subscriptions appear
generally as an asset; and in Germany, while not always
shown, the omission is said by Rehm to be contrary to both
law and principle. In this country it is less common to
issue stock not fully paid up, but the propriety of show-
ing the uncalled subscriptions as assets is backed by the
authority of the frequently cited case of See v. Heppen-
heimer stating explicitly that it is a " rule of the common
law that the unpaid subscriptions to the capital stock of
a corporation form an asset for the payment of the debts
thereof." Where the calls are in arrears it may be better
to indicate that fact clearly, as is done in the English form
above, on the principle that a call in arrears is of doubtful
value at best. Either of the forms given below is satisfac-


FORM 53.
Balance Sheet.


Cash $50,000

Uncalled subscriptions . . 50,000


Capital fully subscribed

Paid in $50,000

Subscriptions uncalled 50,000




FORM 54.
Balance Sheet.


Cash $50,000


Capital fully subscribed.. $100,000
Less subscriptions un-
called 50,000

Capital paid in $50,000



It is sometimes stated that it is illogical to include the
contingent asset of uncalled subscriptions in the Balance
Sheet, since, as a rule, neither contingent assets nor lia-
bilities are taken into account. Thus, in the case of a bank,
where the stockholder who has paid up his subscription
in full is liable to a further assessment of 100 per cent, if
that is needed to pay off creditors, this additional contin-
gent asset is never included in the Balance Sheet. But
there is a marked difference ; the additional liability of the
shareholders of a bank is only available in case of insolv-
ency, while the subscriptions are an asset on which the
directors can at any time call, and are therefore more
evidently an item to appear in the Balance Sheet.

Subscriptions to capital stock are not infrequently made
at a premium. This is particularly common in the case
of banks, where for one or another reason the institution
prefers to start in with assets in excess of the nominal
capital. It is also common where an established company
increases its capital stock in circumstances which make
investors glad to pay a premium for a share in an enter-
prise which is already eminently successful. In all such
cases the premium is economically a capital contribution
and nothing else ; but the requirement that the capital ap-
pear at its par value makes it necessary to enter the sum
thus paid under some other head. The customary title is
" Surplus " which is the term always used by National
banks, which frequently capitalize thus in order to escape
the necessity of annually withholding one tenth of the
profits to form a compulsory reserve amounting to twenty
per cent, of the nominal capital. The only alternative to
crediting the premium to Surplus, or some practically
identical account such as Reserve, is to credit it to Profit
and Loss, a procedure which is positively prohibited by
German law, permissible under English law, but in any
case condemned by business prudence in all countries. The


premiums being no part of the real profits of the business
should be specially held in some account which indicates
that it is not intended for distribution in dividends.

At times the accountant meets difficulty in determining
whether or not a premium has been paid on the stock, and
this unavoidable uncertainty is sometimes used as a means
of showing an apparent surplus when none exists. To take
a familiar illustration, a company is organized with Capi-
tal Stock, of $100,000. A contract is made whereby an
owner of a plant agrees to turn over his property valued
nominally at $90,000, and $9,000 cash in return for $90,-
000 stock. The interpretation of this transaction fre-
quently made is that the cash contributed is a premium
on the stock. A more conservative interpretation is that
the real value of both plant and cash is only $90,000, so
that no surplus exists. Sometimes an attempt is made to
base the interpretation of the transaction on the terms on
which the other stock is placed. If this is subscribed for,
the subscription to be paid in cash at the rate of 110, the
presumption is evident that the stock given in exchange
for the plant and cash was also really taken at a premium
of practically that percentage, and that the surplus really
exists. But even this criterion is faulty. The company
might be capitalized say, at $90,100, of which $90,000 is
given in exchange for the plant and $10,000 cash. It
would be a simple matter for the promoters to subscribe
for the remaining $100, at 110, or at any other exorbi-
tant rate, if by so doing they could establish the surplus
which is claimed in the purchase of the property. The
reality of a claimed surplus is, therefore, not to be estab-
lished by any such simple rule of thumb, but can be deter-
mined only by a careful estimate of the real value of that
which is given in payment of the subscription.

Thus far 'it has been assumed that all subscriptions for
Capital Stock are to be paid in full at some time. This


is the well-established principle which has been accepted
by all courts. But in some instances a distinction has been
made between stock subscribed for, and stock sold in the
market. A subscription not paid in full carries with it
a corresponding liability to pay the unpaid portion, which
from the point of view of the corporation constitutes an
asset. Yet in some circumstances the courts have allowed
the sale of stock for less than par, the stock to appear as
full paid. The most important case on the subject is that
of Handley v. Stutz (139 U. S., 417 (1891) ). In this case
an embarrassed company sold some of its stock for less
than par in order to raise funds to enable it to carry on
its business. The court, while upholding the general prin-
ciple that creditors have a right to rely on the subscribers
having paid par for their stock ; nevertheless, in the excep-
tional case of a going concern which cannot place its stock
at par, sanctions selling it at the best price obtainable.
It should be noted that this decision applied only to excep-
tional conditions; that Chief Justice Fuller gave a very
able dissenting opinion; that Justice Brown, who himself
rendered the decision, declared in the later case of Cam-
den v. Stuart (144 U. S., 104 (1892)), that it must not be
used to evade the obligation of subscribers to pay for stock
which obligation " cannot be defeated by a simulated
payment of such subscription, nor by any device short of
an actual payment in good faith ' ' ; and that an able legal
critic has declared that, ' ' the reason and conscience of the
profession have been shocked at the doctrine " enunciated
in Handley v. Stutz. 1

In the state courts, moreover, it has recently been held
that " one who receives stock as full paid without paying
for it occupies the position of a subscriber who has not
paid his subscription." (See v. Heppenheimer, 61, Atl.
859.) In England, too, the highest court has given a most

i E. W. Huffcut, 26 Am. Law Rev. 865.


drastic decision in Ooregum Gold Mining Company of
India v. Roper ([1892] A. C., 125), where the House of
Lords held that when a corporation sells its new stock
below par even though at double what the old stock
commands in the market the purchasers are liable for the
discount to the corporation as well as to the creditors of
the company. In this decision the Lord Chancellor said :
" It may be that such limitations on the power of the
company to manage its own affairs may occasionally be
inconvenient, and prevent its obtaining money for the
purposes of its trading on terms so favorable as it could
do if it were more free to act. But, speaking for myself,
I recognize the wisdom of enforcing on a company the
disclosure of what its real capital is and not permitting
a statement of its affairs to be such as may mislead and
deceive those who are either about to become its share-
holders or about to give it credit."

In England, too, statute law requires the payment of
full cash value for stock, save that when the articles of the
company make special provisions therefor, the Companies
Act of 1900 allows the payment of a commission for the
placing of shares. But in the revision of the Act in 1907
an amendment, which had passed the House of Lords, gen-
erally authorizing the issue of shares of established com-
panies below par, was rejected by the Commons, and with-
drawn by the Lords. ,

But where, for any reason the stock is issued for a less
amount of cash than the par value, and the courts free
the purchaser from any liability for demand for further
payments, the accounting is still a simple matter. If cash
has not been paid in full, and if the remaining percentage
is not a claim against the holder to appear as an asset of
the company, the only alternative is that it must appear
as a discount on the issue of the stock, and must be treated
similarly to the discount taken off a note or bill discounted.


There may be some question as to whether the discount
should immediately be charged to the Profit and Loss ac-
count, or whether it may be placed as a charge elsewhere.
But there is no dispute that a cash discount on stock is-
sued must clearly show in the accounts of the company,
and such is the practice wherever discounting is openly
allowed, as, for instance, in the limited cases in England,
or in certain companies in Austria. The understanding
of this simple statement opens the way for a discussion
of the more difficult problem of the method of treating
stock issued not for cash, but in purchase of property
which is found in the following chapter.

The reduction in the amount of Capital Stock, at least
when performed directly, offers no particular problem of
accounting. If it is decided to reduce the capital, as-
suming that the legal requirements are complied with, the
booking is identical with that in case of the payment and
cancelation of any other credit balance, the cash paid
out and the reduction of the liability balance offsetting
each other. Or, if the stock retired is redeemed not with
cash but with bonds, as was the case in the refunding oper-
ations of the United States Steel Corporation, the bonds
paid out offset the Capital Stock retired, just as in a mer-
chant's books the Bills Payable given to a creditor offset
the amount previously standing as an account payable.
But at times the retirement of the stock is made dependent
on the existence of surplus profits, and the payment to the
stockholders is treated as if it were actually a charge
against profits. Provision for the retirement of stock may
be made in precisely the same manner as is the payment

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Online LibraryHenry Rand HatfieldModern accounting, its principles and some of its problems → online text (page 12 of 27)