Henry Rand Hatfield.

Modern accounting, its principles and some of its problems online

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mation, requiring as it does more books and more clerks,
is greater than the value of the information thus gained.
Somewhat before this point the process should stop.

In certain incomplete systems of accounts not only is a
differentiation made of particular assets, but these selected
assets are alone considered, all other Goods being altogether
excluded from the account books. Thus in that bane of
domestic peace, the household expense book, as it is gener-
ally kept, Cash is practically the only asset considered.
No difference is made between a diminution of Cash which
represents an actual loss, as when it is dropped on the
street, given in charity, or paid for taxes, and one which
is an exchange as when paid for a permanent asset, for in'


stance a diamond. Cash only is considered; other assets,
so far as the account book is concerned are nonexistent.
Another stage is in the accounts frequently kept by small
traders by so-called single entry, in which the only assets
shown are Cash, and the claims against persons. Other
assets are entirely excluded from the books. But in sys-
tematic accounting while differentiation of assets may be
carried to any extent, everything owned must be shown in
the books and must balance with the items representing

The line of differentiation of Goods accounts may be
represented as follows:

Mer- f Class A

.. T}

chan- -s l( Q

I etc.

C In Till











Bank^ B



C Accounts
Com- I Receivable
mercial 1 Bills ("Time

t Receivable -i De-
I mand




Bonds-^ B



Mortgages-? B

Accounts Payable
Current*^ Bills Payable

Demand Loans.
1 etc.


This scheme is merely illustrative, and is not univer-
sally applicable. Not only do different enterprises, say a
bank and a railroad, require different systems of classifi-
cation, but the individual establishments in a given trade,
say two dry-goods stores, also need, each its own system,
adapted to its particular organization and business meth-
ods. For the sake of completeness the above scheme sub-
divides Goods into Positive and Negative Goods. The
latter term has not yet been used in the text, but the
subject is discussed at some length on page 13.

On the other side a similar division of the Proprietor-
ship account appears. The first and most obvious division
is between the capital at the beginning of the business and
subsequent additions and subtractions, or between the
Capital and Profit and Loss. This distinction is of funda-
mental importance as it indicates the degree to which the
enterprise is successful. As the measure of success is ex-
pressed in the percentage which the profits gained in a
single year bear to the initial capital, tlje Profit and Loss
Account is ordinarily a temporary one. At the end of each
fiscal period it is added to the main Proprietorship account,
or otherwise cleared from the books. During the fiscal
period the Profit and Loss account may be further subdi-
vided into accounts representing items which decrease the
net wealth and those which cause an increase, that is, into
accounts which show expenses, or losses, and those which
show earnings.

Thus there may be a general expense account, or this
may be divided into Wages, Rent, Interest, Light, Fuel and
so forth. Each of these may be subdivided to correspond
with subdivisions of the business. Profit, too, is divided
into its various elements, such as Interest, Profit on sale of
Dry Goods, Profit on sale of Groceries, and so on ad
libitum. Such a division of the elemental Proprietorship
account is indicated in the following diagram :



{Contributed by A
" " B

" C

C Surplus

Accumu-J Reserve for A
lated 1 Reserve for B
I etc.

& -



r fDept.A
On Sales \ Dept. B
t Dept. C

Other gains

(Losses) *

General Expense

Business Losses,

It should be noted that there are two distinct types of
differentiation of accounts. In one class a subdivision is
made into several coordinate groups, as when a Merchan-
dise account is divided into Groceries, Dry Goods, Hard-
ware, etc. In the other the subdivision of an account is
such that all negative items are placed in one account,
all positive items in another. This is done where a gen-
eral Profit and Loss Account is temporarily split up into
two accounts, one showing Losses and the other Gains.

The division of accounts into two distinct groups, one
representing Goods and the other Proprietorship, consti-
tutes the very essence of double entry bookkeeping. Yet
the clear enunciation of this principle seems not to have
been made until about 1830 when it was set forth by
Thomas Jones, an American accountant, in lectures deliv-
ered in New York. He showed plainly the two sets of ac-
counts and pointed out that they are distinct in both
content and purpose. The Goods accounts make record of


the various items of wealth positive and negative, showing
all the details of assets and liabilities. But the other set,
consisting of the original Proprietorship and the Profit and
Loss accounts, serve to exhibit the amount of capital in-
vested at the beginning of the period and the gain or loss
accruing during that period. By means of the various sub-
divisions, as shown in the above diagram, the second set of
accounts shows not merely the total net profits or loss, but
as well the various sources of profit, the different lines of
expense. These two distinct sets of accounts must, how-
ever, agree in their results. Evidently the original capital
plus the net profits, which is the showing of the Proprie-
torship accounts, must at all times agree with the net assets,
which are shown by the Goods accounts. It is this agree-
ment between the Proprietorship and Goods accounts
which serves as an evidence of accuracy, and constitutes
the characteristic merit of double entry bookkeeping.
Books might be kept containing only one or the other of
these two opposed sets of accounts. Single entry book-
keeping contains certain Goods accounts but omits all Profit
and Loss items. On the other hand, the bookkeeping of
governments and of charitable organizations have for their
main, if not their sole purpose, the exhibition of income and
expenses, that is, of certain Proprietorship accounts. But
in systematic commercial bookkeeping a double record is
kept, both Goods and Proprietorship are shown in full, and
the two sets of accounts by agreeing serve to verify the

The accounts presented have thus far been either pure
Goods accounts or pure Proprietorship accounts. Each
account showed either unmixed Assets or unmixed Proprie-
torship. But in business practice many transactions are
Mixed Transactions falling under class c, page 2. where
there is both an exchange of goods and an element of profit.
To illustrate: A purchase of goods is a pure exchange


transaction, for the value of the goods is uniformly taken
as equaling the cash paid therefor, say one hundred dol-
lars. A receipt of interest is a pure profit transaction,
for the lender still holding his right to the principal in
undiminished value receives an additional Good, that is,
ten dollars cash paid him as interest. But the sale of
merchandise should be a mixed transaction, for the mer-
chant exchanges merchandise costing him only $100 for
cash amounting to $110. 1

The mixed transaction can be correctly portrayed by
the use of unmixed accounts as was done in the accounts
on page 5. Here the $3,000 cash received is in fact divided
into two constituent parts: return of cost price of horses
$2,000 and additional cash received as profit $1,000. The
" Miscellaneous Assets " account therefore represented
that horses worth $2,000 were parted with, the cash ac-
count showed the receipt of $3,000 and Proprietorship
was at once credited with $1,000 Profit. The tendency to
keep fhe Goods accounts thus unmixed is increasing in
business practice, but it is by no means universal, nor even
preponderant. When goods are sold it is frequently impos-
sible, and generally difficult, to determine how much the
sold goods cost and how much of the selling price repre-
sents profits. The salesman knows definitely the price
called for by the bill of sale, but it would often take much
complicated reckoning to determine the actual cost of the

1 Theoretically it may be held, that the profit transaction preceded
the exchange, that just before the sale the merchandise appreciated to
the extent of ten dollars, and the increased value of the goods must
be balanced by taking recognition of the profits. After this there is a
pure exchange; merchandise worth $110 being exchanged for an equal
value in cash. But such a conception is at variance with ordinary com
mercial expression, and is thoroughly opposed to what is a cherished
precept of accounting practice (even though it is not a principle of
accounting theory) namely: that it is dangerous to recognize apprecia-
tion of goods in the owner's hands.



miscellaneous assortment of merchandise sold. Conse-
quently the custom in ordinary mercantile establishments
is to treat the Mixed Transaction as if it were a pure Ex-
change Transaction, and in the accounts to represent it as
though the goods parted with were of the same value as the
cash received, neither profit nor loss being shown at the
time. Thus a merchant having capital of $2,500 all in-
vested in merchandise, and selling for $110 a bill of goods
which cost him only $100 would, if his account were kept
unmixed, show,







Starts in business with
Sells Mdse. at profit

+ $2,500

+ $110

= +$2,500

+ $10

Closing condition

+ $2,400

+ $110

= +$2 500

+ $10

But in ordinary practice the accounts would appear







Starts in business with
Sells merchandise

+ $2,500
- 110

+ $110

- +$2,500


Cfosing condition

+ $2,390

+ $110

= +$2,500

The Capital account here stays unchanged at $2,500
and no entry at all is made in the Profits account. The
correct equation is really

Merchandise $2,400 + Cash $110 = Capital $2,500 -|-
Profits $10.

The equation shown by the book is :

Merchandise $2,390 -f Cash $110 = Capital $2,500 -f-
Profit 0.


which is incorrect in two particulars. It shows merchandise
worth $2,390 instead of $2,400, and the total proprietor-
ship, that is, Capital -j- Profits, as $2,500 instead of $2,510.

It is only for convenience' sake that this confessedly
incorrect statement is made. It is necessary at some later
time to correct the errors. This is ordinarily done by
' ' taking stock, ' ' that is, ascertaining the amount and value
of the merchandise actually on hand and making an entry
in the books to correct the wrong showing of the merchan-
dise account. This, of course, necessitates another entry
at the same time in the Profits account in order to main-
tain the proper equation, or balance of the books. In the
example given above, inspection of the cash drawer shows
$110 as called for by the Cash account. But an inventory
of the merchandise on the shelves shows so many yards
and so many pounds all which at cost are worth $2,400.
But the Merchandise Account in the books shows $2,390,
a misstatement which must be corrected by increasing the
sum $10. Here the book value of the assets is increased
by $10. Clearly there is no exchange. Nothing else is
diminished, and an increase in the total book value of all
the good accounts must, if the equation is to be maintained,
be accompanied by a corresponding increase in one of the
Proprietorship accounts, in this case evidently in the Prof-
its account. The significance to bookkeeping of thus rely-
ing on an inventory to secure correct results is extremely
great, and the principles of making such an inventory are
discussed at length in Chapter IV.

So far the discussion has been based on the assumption
that the merchant does business entirely on his own capi-
tal, that he has not borrowed money, nor incurred any
other obligation. In actual business this is seldom true,
and it is accordingly necessary to see how liabilities of the
proprietor are Created in accounting. If one has a stock
of merchandise on hand, worth $10,000, half of which was


.paid for in cash and the other half bought on credit, the
equation cannot stand:

Goods on hand $10,000 Proprietorship $5,000.
It is however perfectly correct to make the statement :

Total goods on hand $10,000 Amount due to creditor
$5,000 = Proprietorship $5,000.

Proprietorship represents the net wealth, not the gross
assets of the proprietor. It is true that legally the goods
bought on credit or with borrowed money are the property
of the purchaser, belonging absolutely to him. But eco-
nomically there is a divided ownership and the credit in-
strument is merely a form of title to an undivided half of
a certain mass of valuable goods. Liabilities, that is,
debts of any kind, may therefore be considered as Nega-
tive Goods, the assets being Positive Goods. While the pro-
prietor holds and legally owns $10,000 worth of assets he
also has $5,000 worth of Negative Goods which must be
subtracted from the Positive Goods to determine the net
proprietorship. But just as in algebraic equations a nega-
tive term in one member may be transferred to the other
member thereby becoming positive, so in the bookkeeping
equation the form is ordinarily

Goods $10,000 = Proprietorship $5,000 + Debts $5,000.

This simple conception of negative items is of great impor-
tance to bookkeeping, applying not alone to the relation-
ship of debts, but to other subtractions which are made fop
technical purposes. In accounting, it is always legiti-
mate, whenever a sum is to be subtracted from an amount
appearing on one side of the equation, to place it instead
as a positive item on the other side. It is entirely imma-
terial whether one writes

a b = c or a = c b.


On these few principles rests the whole structure of
double entry bookkeeping. Summing up :

1. There is an initial equation made between Goods
possessed and Proprietorship.

2. Either side of this equation may be ramified indefi-
nitely to suit the needs of the individual business.

3. Negative items appear, which instead of being im-
mediately subtracted may be placed as positive items on
the other side of the equation. Thus e. g., items repre-
senting Negative Goods or debts are not subtracted from
the Positive Goods (assets), but are transferred to the
other side of the equation and added to the items repre-
senting Proprietorship.

4. In all subsequent transactions it is necessary to pre-
serve the equation as follows:

(a) An addition to one of the Goods account may be
offset by a subtraction from andther Goods account.

(6) An addition to, or subtraction from one Goods ac-
count may be offset by a similar addition to, or subtraction
from a Proprietorship account.

(c) Addition and subtraction are here used in the
algebraic sense, a subtraction from a negative account be-
ing equivalent to addition.



THE discussion has thus far been in most general terms
and with no reference to the details of bookkeeping tech-
nic. This has been done advisedly, in order that the prin-
ciples might be presented unrelated to conventional prac-
tice. In just what form the equation described is to be
written, how the books are to be* ruled and paged, how
items are to be gathered together for adding, whether
columns are to be run perpendicularly or horizontally,
whether items are to be entered directly into a particular
book or to be transferred to it from another book of origi-
nal entry ; all these and many other details may be impor-
tant in securing efficient bookkeeping. They may affect the
ease with which the record of business operations is made
and transcribed, or the readiness with which certain facts
are ascertained from an inspection of the books ; they may
aid in preventing error and detecting fraud. But after
all. these are variations in technic, not matters of princi-
ple. The essential thing in any form of double entry book-
keeping is that there is somewhere a number of items rep-
resenting what are here called Goods accounts, and some-
where in the books another set of items which are here
called Proprietorship accounts. The sum of these Goods
items, taking in account the Negative Goods, or debts,
must equal the algebraic sum of the Proprietorship items.

Nevertheless the points of more general acceptance in
bookkeeping convention should not be neglected, although *
it must be remembered that even the most deepseated con-



ventions in bookkeeping could all be violated without, in
the least, affecting the essentials of the system.

In whatever form the first record of the transaction is
made, it is customary to have the items of similar nature
gathered together on a page of a book (which may indeed
be loosely bound, or even consist of unbound sheets or
cards) which is called the Ledger. Although legally the
ledger is treated as an inferior book, its validity in court
being less than that of the books from which the ledger
entries are ordinarily transferred, it is in bookkeeping the
most important, the essential book, as is indicated by the
names which have been given it in other tongues, Libro
Mcestro, Grand Livre, Hauptbuch. It is possible to use
the ledger alone. This was customary among the earlier
Venetian accountants and even to-day it is the method oc-
casionally employed, with correct results, for keeping sim-
ple accounts.

But in a large business the use of a ledger alone is
clearly impossible, and even in a small establishment such
a system, while possible, is unsatisfactory. The chief trou-
ble is the difficulty of detecting errors. The use therefore
of some chronological record of transactions, in contradis-
tinction to the ledger where entries are classified, while
multiplying the writing to be done is really an economy.
It is easier to make the original entries in such a book;
the entries are less liable to error ; an error once made can
more easily be detected.

In each of the ledger accounts there will be certain
items to be added, certain other items to be subtracted. In
early bookkeeping these items were all listed in a single
column, addition or subtraction being indicated. This is
the form which has thus far been used in the pages of this
treatise ; it is in some cases still used in modern bookkeep-
ing practice where the items to be subtracted are generally
differentiated by being written in a different colored ink.



But it is apparent that with a single column there is a
great danger that the bookkeeper will make the mistake of
adding where he should subtract or of subtracting where
he should add. It was therefore a very valuable, though
a simple device, to separate the items to be added from
those to be subtracted. Thus the cash account given on
page 5 instead of appearing as it does there in the form :

Cash Account.

Amount with which business started +$5,000

Paid for Horses 2,500

Paid for Farm 2,000

Received for Rental + 100

Received for Horses + 3,000

Amount on hand +$3,600

is presented with positive and negative items separated

Cash Account.

Amount with which started

business $5,000

Received for Rental 100

Received for Horses 3,000

Total.. ..$8,100

Paid for Horses $2,500

Paid for Farm 2,000

Balance 3,600


Balance $3,600

The word " Balance " as here used signifies merely
the difference between the sum of the positive and the sum
of the negative items, or the algebraic sum of all the items.
It is customary, but by no means necessary to add the
' ' Balance ' ' to the smaller of the two sides so as to produce
the same total at the foot of each column. This is less
rigidly done in recent years than formerly, as in many
ledgers special column rulings (described in Chapter XIX)
render the formal balancing of the accounts unnecessary.


Certain of the accounts thus presented in double col-
umn will represent positive Goods or Assets. It is a con-
vention well-nigh unbroken, although its violation in no
way affects the results to be gained by double entry book-
keeping, to list the items representing Goods on hand, or
subsequently acquired, in the first or left hand column,
the subtractions therefrom in the second, or right hand col-
umn. In all Assets accounts the left hand column is there-
fore the positive column, the right hand column containing
the negative entries.

It is a further convention applicable to all accounts to
call the left hand column ' ' Debit ' ' and the entries therein
Debit entries. The act of making a Debit entry is called
Debiting or charging an account. The right hand column
is called " Credit," the entries therein Credit entries, and
the act of making such an entry Crediting an account.

Furthermore the normal condition of all Asset accounts
is to have positive that is, a Debit excess of values. As-
sets, things which one possesses evidently are positive.
One may lose them all, or pay them all away but normally
the limit is zero. Fire may burn all but not more than all
of the merchandise; one may pay out all the Cash in the
drawer, but it is difficult to squeeze it so as to make it pay
out more than was put in. Thus, while in rather technical
bookkeeping entries an asset account may show an excess
on the credit side, such is not the normal condition, and
always requires interpretation. 1

Another class of accounts will represent the Proprietor-
ship accounts and these too will be divided into two col-
umns. The Proprietorship account presented on page 5

1 A good illustration is where the cash account is kept so as to include
not merely cash in the till, but also cash deposited in the bank. Now,
while the till cannot give out an excess, it is sometimes possible to pay
out by check in excess of the amount on deposit. In such a case the
Cash account, normally the highest type of a pure positive Goods
(Assets) account may show a negative balance.



Proprietorship Account.

Original capital +$5,000

Loss by death 500

Profit by rental + 100

Profit by sale + 1,000

Net proprietorship + $5,600




Proprietorship Account.

Cr. (+)

Loss by death $500

Balance 5,600

Total $6,100

Original capital $5,000

Profit by rental 100

Profit by sales 1,000

Total.. ..$6.100

Balance $5,600

A striking contrast between the account showing an
asset and one indicating Proprietorship is to be noted. In
the former the positive items appear in the left hand col-
umn and are hence Debits ; in the Proprietorship accounts
the positive items appear in the right hand column and are
hence Credits. In one class of accounts therefore Debits
are positive and in the other class they are negative. This
confusing use of the terms Debit and Credit has been one
of the most perplexing points in accounting practice.

Undoubtedly the terms were originally used in their
strict sense of indicating a Debtor or a Creditor and in
accounts showing such relationships they still maintain
their original meaning in full force. If an advance of
$100 is made to A it constitutes him a Debtor to that
amount, and this is shown by charging or Debiting hi
account, which is conventionally done by an entry in the
left hand side. Should A repay the $100 it of course can-
cels the charge, which is shown by entering $100 in the


right hand column. If he in turn advances more than the
$100 it transforms him from a Debtor to a Creditor, so
that it is not unnatural that with Debits on the left hand
the right hand column should be called Credit. This orig-
inal meaning of Debit and Credit is still preserved in per-
sonal accounts. But the application of Debit and Credit to

Online LibraryHenry Rand HatfieldModern accounting, its principles and some of its problems → online text (page 2 of 27)