Henry Rand Hatfield.

Modern accounting, its principles and some of its problems online

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ing Fund installment being separately handled.

A payment of $1 invested at the end of the first year
will accumulate at compound interest until the end of the
sinking fund period of n years. Its accumulated value
will therefore be (l-f-i) n1 , the second installment will
accumulate for one less year and so on, for a series, the
next to the last installment drawing interest for only one
year, the last installment made at the time when the bonds
' mature, not having any time for investment. The series
then becomes

(1 + i)"- 1 + (1 + i)"- 2 . . . (1 + i) + 1,

which may be simplified to (1 -f- i) n 1. Dividing the


total amount of bonds to be retired (P) by this sum,
the amount of the annual sinking fund installment is

obtained, and

i P
Sinking Fund Installment =

(l + i) n -l

In these calculations the accountant and the investor
must have in mind that there is bound to be some delay
in reinvestment and that the rate to be obtained is almost
certain to decline through any protracted period.

It is however by no means necessary that the Sinking
Fund should equal the entire principal to be retired. A
provision which amounted to eighty, sixty, or any other
considerable proportion of the funded debt would in the


case of a perpetual enterprise, such as a railroad, offer
security sufficient to satisfy the creditor ; for if to-day the
road can borrow $100,000,000, the presumption is that
twenty years hence it will have no difficulty in borrowing
half that sum, if it should prove necessary to refund the
debt not covered by the Sinking Fund. Where the enter-
prise is not perpetual, as where it is dependent on a lim-
ited franchise, the adequacy of the Sinking Fund pro-
vision is more important and the failure to realize the
calculated interest may be a decided injury to the bond-

The relation of the Sinking Fund to Depreciation has
led to protracted discussion, especially in connection with
the legal restrictions on municipal borrowing. The Eng-
lish requirement is that the municipality, desiring to bor-
row for public service utilities must provide out of the
revenue both for a Sinking Fund with which to retire the
bonds at maturity, and also for a Depreciation Fund with
which the plant can be replaced when worn out. But
assuming that the life of the plant and the duration of
the bonds are the same this leads to an exact doubling
of the proper charges against revenue. "Whatever good
effect this may have in preventing reckless undertaking of
municipal enterprises, it clearly does not lead to a correct
showing of the profitableness of the undertaking. The
relation between Sinking Fund and Depreciation is better
understood by accountants. Thus for instance the certifi-
cate of the Public Accountants attached to the Balance
Sheet of the American Hide and Leather Company con-
tains the following : ' ' The appropriation out of profits for
the purposes of the Sinking Fund is in our opinion, suffi-
cient to take the place of provision for Depreciation."



DICKINSON, A. L. Interest and Sinking Funds. Accountant,

XVII, p. 715.
DICKSEE, L. R. Depreciation, Reserves and Reserve Funds, pp.

57-65. London, 1903.

SPRAGUE, C. E. The Accountancy of Investment. New York, 1904.
TURNER, S. H. Depreciation and Sinking Funds in Municipal

Undertakings. Economic Journal, XIV, pp. 47-56.
WALTON, S. Sinking Funds and Reserve Accounts. Journal of

Accountancy, VI, p. 394.



THE profits of a year can be accurately shown without
an elaborate set of books, all that is necessary being a care-
fully prepared annual inventory. The herdsman telling
the tale of his sheep, the miser counting over his hoard,
compares the figures of a preceding period and learns what
has been his annual increase. The contribution which
double entry bookkeeping has made to accounting science
is largely that it has introduced a separate Profit and Loss
account which, though it may not show the net results
any more accurately, does present them in greater detail.
Even the simpler forms of the Profit and Loss account
exhibit such details as the gain from merchandise, the
amount of expenses, the interest paid or received, wages,
rent, and other sources of profit and lines of expense.
With greater complexity of business organization there
comes a demand for a more logical, or at least a more
practical classification of Profit and Loss items. Account-
ing practice of to-day subdivides the old Profit and Loss
account into several sections or even into separate ledger
accounts which not merely show the total profits, but group
the items so as to exhibit the results of each of the parts or
processes which are embraced in the operations of the busi-
ness. The Trading Account, the Manufacturing Account
and the highly developed Income or Revenue account of
railroads are differentiations of the simple Profit and Loss
account and are appropriately discussed in this place.

The Trading account, as the term is ordinarily used, is



a technical device whereby it is sought to differentiate
the elements of gain caused directly by trafficking, from
that which a mercantile establishment derives from other
sources. At the outset the student is confronted with the
difficulty that here, as elsewhere in accounting, terminol-
ogy is but partly crystallized and the words are used loosely
and with divergent connotation. Even yet it is difficult
to say whether the Profit and Loss account is a compre-
hensive statement of which the Trading account is one
part, or whether they are separate accounts, or whether
one should rather speak of a Trading Section and a Profit
and Loss Section of a not definitely named, all-embracing
statement of the results of the business. Furthermore
while there is general agreement that the Trading Section
if so it be called should logically be separated from
other exhibits of Profit and Loss, there is no agreement
as to just what items should be included in that exhibit.
These confusing differences are best illustrated by discuss-
ing a sample form, that given by Lisle in his " Account-
ing ' ' being particularly elaborate may be used as the basis
of comparison. The form with only a few verbal changes
is given on pages 276-277.

It should be noted first, that while the statement as a
whole is called the Profit and Loss account, yet the second,
third and fourth sections are specifically Profit and Loss
accounts in contradistinction to the first section called
Trading Account. Other accountants make a wider sepa-
ration between the first and the subsequent sections, and
apply Profit and Loss account only to the latter group.
Again variance is found in the subdivisions made after
the Trading Account. Lisle gives three subdivisions, one
showing business transactions, with a balance " Profits on
ordinary business ' ' ; the second containing those entries
which relate to the investment of capital, with a balance
" Net Profits "; the last giving the allocation of profits.




FORM 107.
Profit and Loss Account.



To Cost of goods used (in-
cluding freight inward
and after deducting
purely trade discounts) . .
" Expenditure directly con-
nected with sales or
which reduces the price
realized for the goods
such as:

Commission and sala-
ries of travelers and
travelers' expenses. .
Wages of salesmen ....

Wages of porters

Outgoing freight

Cash discount allowed

on sales

" Balance carried down
being gross profits

By Sales (after deducting
purely trade discounts)


To Fixed Charges not directly
connected with sales and
not varjung much with
the turnover such as:

Rents, taxes, etc

Repairs and other

office expenses. ...

Salaries of office staff

and management. . .


:' Business losses such as :

Bad debts


' Balance carried down
being Profit on ordi-
nary business

By Balance brought down

being Gross Profits

" Income not directly con-
nected with sales such as
Rent of stores or prem-
ises let to tenants . . .
Revenue from royal-




To Expenses connected with
Capital, such as:

Interest on loans

" Balance carried down,
being Net Profit

By Balance brought down
being Profit on ordinary


" Income connected with
capital such as:

Revenue from invest-

Interest earned

Cash discounts ob-
tained which depend
on the amount of
capital in the busi-
ness. .


To Allocation of Profit:

Interest on capital ....
Profit allocated to cap-

" Profit unappropriated,
carried forward. . .

By Balance brought down
being Net Profit

So minute a subdivision of the Profit and Loss account
as that shown above is rarely found in accounting practice.
Frequently there is no distinct separation into parts. A
grouping of the items in an inner column, and the intro-
duction of subtotals in the main column enable one to
pick out the facts which by Lisle are more formally pre-
sented by the actual balancing of the various sections. It
cannot be said that there is any universally recognized
form ; indeed there should not be, for a system of account-
ing must be flexible, not tied down to any set formula, if
it is most clearly to present the facts essential to the under-


standing of a particular establishment. This is well recog-
nized by accountants, for not only do the forms used by
other authors differ from the one presented above, but a
glance through Lisle 's most valuable book shows that of
the dozen forms of Trading and Profit and Loss accounts
which he gives, no two are identical in nomenclature, sub-
division and grouping of individual items.

FORM 108.

Gross earnings (whether sales of products, transportation

earnings, professional earnings, etc.) $

Deduct Cost of Manufacture or Operation:

(a) Manufacture (for a manufacturing con-

cern) $



General Manufacturing Expenses

(b) Cost of Operation (for concerns not


(Under suitable headings according to
the nature of the business) $ $

Gross Profits $

Other Earnings


Expenses of sale (manufacturing business

only) $

Expenses of management (if distinct from


Net Profits from Operation $.


Interest on Bonds $

Other Fixed Charges


Surplus for year $.

Extraordinary Profits (detailed)

Surplus brought forward from preceding year



Extraordinary charges not applicable to the

operations of the year $

Interest and Dividends on Stocks

Surplus carried forward $.



A simpler form, suitable for general application is that
suggested by Mr. A. Lowes Dickinson at the Congress of
Accountants, and given on the preceding page.

The Manufacturing account is a further amplification
of the Trading account of concerns which manufacture,
rather than purchase, part or all of their stock in trade.
The Trading account includes as its first item the cost of
purchased merchandise; where merchandise is manufac-
tured the manufacturing account gives a detailed exhibit
of the manufacturing cost of the commodities, which are
then entered in the Trading account and subsequently
treated just as if they had been purchased. Difficulties
exist in determining what items belong in the Manufac-
turing Account similar to those confronting one who forms
a Trading Account. In both cases divergencies in practice
rightfully occur.

An example of a manufacturing account is as follows:

FORM 109.
Manufacturing Account. 1

All direct cost of Manu-
facturing such as:

Raw materials



Packing materials

Heat and Power

Factory expenses

Freight (inward)

Cartage (inward)

Insurance on Plant ....
Depreciation, Machinery

and Tools

Reserve for Taxes on


All reductions in cost of
manufacturing such as:
Discounts on Purchases.


Balance to Trading Account,
representing Manufactur-
ing Cost of goods sold. . . .

For the above form the author is indebted to Mr. E. P. Moxey,
Jr., G.P.A.


The Income or Revenue Account of a railroad is iden-
tical with the expanded profit and loss statements already
described, so far as the difference in the business transacted
permits. Two forms for such an account are given below :

FORM 110.
Income Account.

Gross earnings from operation.
Less operating expenses

Income from operation . . .


Dividends on stocks owned. . .

Interest on bonds owned

Miscellaneous income. .

Income from other sources

Total income


Deductions from income:

Interest on funded debt accrued

Interest on interest-bearing current liabilities, etc.

Interest on real estate mortgages

Rents paid for lease of road


Permanent improvements

Other deductions

Total deductions from income

Net income


Dividends, per cent, common stock

Dividends, per cent, preferred stock

Other payments from net income


Surplus from operations of year ending June 30, 1907.
Deficit from operations of year ending June 30, 1907. .

Surplus on June 30, 1906 [from "General balance sheet,"
1906 Report].

Deficit on June 30, 1906 [from "General balance sheet,'*
1906 Report]

Additions for year

Deductions for year

Surplus on June -30, 1907 [for entry on "General balance

Deficit on June 30, 1907 [for entry on "General balance




Railway operating revenues $102,358,892.95

Railway operating expenses 61,713,161 .02

Net revenue from railway opera-
tions $40,645,731.93

Railway tax accruals $4,449,290.83

Uncollectible railway revenues 9,547 . 58 4,458,838 . 41

Total operating income $36,186,893 .52


Rent $1,300,396.92

Dividend income 10,554 .05

Income from funded securities 39,520 .88

Income from unfunded securities. . . . 1,029,259 .92

Income from sinking fund 2,900 . 10

Miscellaneous income 11,519 .97

Total nonoperating income 2,394,151 .84

Gross income $38,581,045 . 36


Rents $1,585,311 .43

Miscellaneous tax accruals 13,165 .26

Separately operated properties Loss 41,887 . 85

Interest on funded debt 7 038,490 .72

Amortization of discount on funded

debt 55,163.52

Miscellaneous income charges 756.60

Total deductions from gross in-
come 8,734,775.38

Net income $29,846,269 .98


Income applied to sinking funds $1,817,679 .41

Dividend appropriations of income. . 8,867,128.00

Income appropriated for investment

in physical property 4,431,359 .81

Fund for accrued taxes not yet due . 2,400,000 . 00

Miscellaneous appropriations of in-
come 6,000,000.00

Total appropriations 23,516,167.22

Income balance transferred to

credit of Profit and Loss. .... $6,330,102 .70


Profit and Loss Account.

Credit balance at beginning of fiscal period $

Credit balance transferred from income

Profit on road and equipment sold

Delayed income credits

Unrefundable overcharges


Miscellaneous credits. .

Total credits .


Debit balance at beginning of fiscal period $

Debit balance transferred from income

Surplus applied to sinking and other reserve funds

Dividend appropriations of surplus

Surplus appropriated for investment in physical


Stock discount extinguished through surplus ....

Debt discount extinguished through surplus

Miscellaneous appropriations of surplus

Loss on retired road and equipment

Delayed income debits

Miscellaneous debits. .

Total debits $

Balance carried to Balance Sheet $

The first of the above forms is one formerly much used
by American railroads, the second is in accordance with the
improved form established by the Interstate Commerce

In discussing the variations in practice one ruling prin-
ciple is to be kept constantly in mind. The form of the
Profit and Loss statement should be adapted to the needs
of the individual establishment and cannot be prescribed
by any hard and fast rules. Its purpose being to give a
better insight into the operations of the establishment to


the end of enabling the managers to limit waste and pre-
vent unprofitable ventures, the subdivisions to be made
and the decision as to the particular section into which
any one item should appear, turn largely on the particular
information which the management desires to secure, and
on the business and physical organization of the plant
itself. Thus, for instance, of two manufacturing estab-
lishments one may be considering the relative desirability
of increasing its plant or of purchasing, from other manu-
facturers, part of the goods it sells. The other, having no
opportunity to purchase the finished commodities, might,
however, consider whether it is better to continue its sales
department or to turn its entire product over to some job-
bing or commission house. In the first case it is desirable
to show the exact cost of manufacture, to compare it with
the price at which goods can be purchased elsewhere; in
the other the point of emphasis is the cost connected with
selling. It is quite conceivable that the system of account-
ing which best brought out one set of figures would not
most economically give the information desired in the sec-
ond establishment.

Again, the nature of the organization itself is a factor
in determining the form of accounting. The separation
or juxtaposition of the factory and the office, the location
of the warehouses at one or the other place, the degree to
which the labor of employees is specialized, and the num-
ber of branch establishments are 'all examples of facts
which enter into the question of the proper grouping of
items. What is desired is to be able to put the finger on
some point and say, " Here there is relative inefficiency."
If manufacturing is distinct from trading, the separation
of the two in the accounts seems to facilitate the localixa-
tion of responsibility ; if the two are combined, but there
are separate plants each manufacturing and selling, the
line of cleavage is evidently different. As in all account-



ing matters, while certain general principles hold good,
the main difficulty is their application to a particular
problem which must be individual and perhaps unique.

Keeping clearly in mind the limitations of the preced-
ing section the points of more general interest may still
be discussed. 1. The first problem relates to the valuation
at which manufactured goods are to be carried down to
the Trading section, where these sections are kept separate.

Two distinct principles are advanced on this point.
The first is that the manufactured goods should be carried
down to the Trading Account at the net manufacturing
cost. This is shown in Form 109. The other is that goods
should be transferred from the Manufacturing Account to
the Trading Account, not at the actual cost but at a fair
market price, that is, at the figure which would have been
paid had the goods been bought from some other manu-
facturer instead of being produced within the establish-
ment. In favor of the latter view it is urged that by so
doing a distinct showing is made of the profits which
result from efficient manufacturing, as distinguished from
the profits which arise from skillful trading.


FORM 112. .
Manufacturing Account.


To Costs $100,000

" Manufacturing Profits 10,000


By Trading Account . . . $110,000


Trading Account.



To Merchandise at Trade

Price $110000

** Expenses 15,000

M Trading Profits 20,000


By Sales $145,000



This may be illustrated by assuming a manufactory
which produces, at a net cost of $100,000, goods for which
the current wholesale price is $110,000; and that these
goods are sold at $145,000, with trading expenses of
$15,000. If the manufactured goods are carried to the
Trading Account at the market rather than at the cost
price, the accounts appear as on the preceding page.

This exhibits Manufacturing Profits of $10,000 and
Trading Profits of $20,000, while if the merchandise had
been brought down at the cost of manufacture there would
be shown only a single item of profit of $30,000.

The advantage of distinguishing between the two ele-
ments of profit is indisputable, especially where the con-
cern purchases part and manufactures part of the mer-
chandise which it sells. But in so far as the goods are not
all sold during the year in which they are manufactured,
there is the great objection that there is introduced into
the accounts an unrealized and perhaps fictitious profit on


FORM 113.
Manufacturing Account.


To Cost of manufacture.. $100,000
" Manufacturing Profits 10,000


By Trading Account at

market price $110,000



Trading Account.


To Manufacturing Ac-

By Sales $72,500



Less stock on hand . .


" Cost of goods sold . . .
" Expenses

. $55,000
15 000

" Trading Profits. ....





the unsold portion of manufactured goods. This is illus
trated by assuming that only one half of the manufactured
goods are sold for $72,500. "Where goods are carried down
to the Trading Account at cost there will be shown Net
Profits of $7,500. But where goods are brought down at
the market price the accounts will appear as in Form 113,
giving a total profit of $12,500 instead of only $7,500.
The difference, of course, is due to taking credit in the
latter method for $5,000 profits on the unsold half of the

The problem here is the same one that arises when in-
ventorying any merchandise, namely: Shall stock on hand
be taken at cost or at market price ? As has been shown in
Chapter V, the taking of a higher market price is gener-
ally condemned as opening the doors to imaginary profits.
The criticism applies to the taking of an assumed manu-
facturing profit as well as to the profit taken on still un-
sold merchandise purchased. But there is a real advan-
tage in showing the manufacturing as distinct from the
trading profits, in that it gives information which serves
as a guide for future management. And the objection to
showing the unrealized profit may not be conclusive, for
it is possible to put the profits thus shown into a special
reserve, thus removing them from the sum available for
dividends and lessening the danger of overvaluation. As
has been shown, valuation at the present market price is
in reality the logical course in accounting, but in ordinary
cases logical consistency is sacrificed as a practical expe-
dient to prevent overvaluation. In treating the Manufac-
turing Account, the real advantage of distinguishing the
part of the profits derived from manufacturing is so great
as to lead many accountants to return to the logical scheme
of valuation, elsewhere abandoned from motives of con-
servative prudence. This is recommended by both Dicksee
and the " Encyclopedia of Accounting." It is a case


where advantages are to be weighed against dangers, with
the additional complication of logical principles pulling
against consistency of treatment.

2. A second problem relates to the items to be included
in the Trading Account. Ignoring variations in mere de-
tail, two divergent customs are found. One includes in
the Trading Account all the expenses connected with traf-
ficking as distinct from the general expenses of manage-
ment. This is the principle applied in Lisle 's form given
above, Form 107, where commissions and salaries of trav-
eling salesmen, wages of salesmen, wages of porters, etc.,
are charged to the Trading Section. The second more
rigid method excludes from the Trading Account all items
except those representing the direct cost price and the net
selling price of the goods handled. The balance then
carried down is generally called Gross Trading Profits,
although, strictly speaking, the term is incorrect and the

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Online LibraryHenry Rand HatfieldModern accounting, its principles and some of its problems → online text (page 21 of 27)