Henry Rand Hatfield.

Modern accounting, its principles and some of its problems online

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other classes of accounts is more difficult of explanation.

It may not be unreasonable for the merchant having
become accustomed to list that most important class of
assets, claims against customers, as Debits, to treat other
assets in the same manner. Most writers have gone fur-
ther in attempting an explanation and have assumed that
Debit and Credit in all accounts, whether representing
debt relations, or other Assets, or even Proprietorship,
show a relationship of Debtor and Creditor. This is ac-
complished by a rather forced system of personification.
Thus for instance Cash, or Merchandise is personified as
being a Cashier or a Store Keeper, who is in turn indebted
to the business for all values which have gone into his
hands. On the other hand the Proprietor, contrary to the
legal fact, is assumed to be a Creditor of the business.
These are perhaps not so bad, but when the same theory of
personification is carried to such accounts as Expense,
Profit and Loss, etc., it becomes difficult of application and
of less than doubtful value. The better theory rejects all
this personification and, as is done in this book, treats the
two sets of accounts as representing two different concep-
tions, each of which has its own value and meaning, and in
which Debit and Credit are used conventionally with dif-
fering signification.

Thomas Jones, writing about seventy years ago, said:
" All debits are not sums owing to us, nor are all credits
sums we owe. Some debit items are owing to us, others
(Stock) are sums withdrawn by us; some (Merchandise)
are sums paid, others (Cash) are sums received; and the


credit items also stand for equally dissimilar facts. From
which it must be evident that these terms are used arbi-
trarily, and any attempt to exhibit them in one uniform
relation of indebtedness must necessarily oblige us either
to use language of corresponding ambiguity, or resort to
the personification of things which not only have no exist-
ence but the indebtedness of which cannot possibly have
any apparent influence on the end we aim to accomplish.
As names, enabling us to designate which side of any ac-
count we may refer to or speak of, they answer our pur-
pose ; and so would the terms blue column and red column,
equally well, if custom permitted their use. In personal
accounts they bear a literal meaning ; and by analogy they
have been extended to all other accounts ; but the relations
which constitute that analogy are too obscure to be of use
as a guide to the student, and are more calculated to mys-
tify than explain the subject." 1

And Colonel Charles E. Sprague in his " Philosophy of
Accounts ' ' says that those who make such a personification
of the business have been " misled by the lazy habit of
bookkeepers in calling all Credit balances liabilities al-
though they know that some of those balances are not lia-
bilities. Even admitting that there is a fictitious entity it
owes nothing to the real owners " (p. 33).

While it is true that most of the intervening authors
present unquestioningly the nai've personalistic theory, it
is interesting to note that Jones who was the first, and
Sprague the latest and most penetrating American theoret-
ical writer are thus in accord. And on their side are found
many of the leading European authorities, among whom
may be mentioned Hiigli and Schaer.

Reference has been made to the confusion caused by
Mixed Accounts, that is, accounts in which the element

1 Principles and Practice of Bookkeeping, p. 21.


of Profit is entered without separation from the exchange
element. Thus where merchandise is purchased for $100
the Merchandise account is debited with that amount. If
half the Merchandise is sold for $75 the account is ordi-
narily credited with that entire sum, instead of crediting
Merchandise with $50 and Profit and Loss with $25. This
results in a balance in the Merchandise account which
does not show the value of the unsold stock, but that sum
less the profits on the goods sold. Mixed accounts are
cleared at intervals by crediting the account with the in-
ventory value of goods on hand, leaving a difference be-
tween the total debits and the total credits of the account,
corresponding to the profits realized. The inventory being
brought down as the balance on the new Merchandise ac-
count, that again starts out as a pure Goods account.
This may be illustrated algebraically as follows:

The cost price of the merchandise (C) = Cost of Merchan-
dise sold (S x ) -{-Inventory (I).

Amount received for sales (S) = Cost of Merchandise sold
(SJ+ Profit (P).

Therefore C S = I P. But C S is the Balance (B)
shown in the Merchandise Account before the introduction
of the Inventory. Hence I B = P. The crediting of
the Inventory is equivalent to subtracting the outstanding
balance, so that the remainder indicates the amount of

The reversal of the positive sides in the two classes of
accounts (Goods accounts and Proprietorship accounts) is
of considerable importance in the technic of bookkeeping.
It has already been shown that the fundamental equation
running through all accounting is one in which Goods, or,
ignoring debts, Assets equal Proprietorship. But assets
are conventionally listed in the left hand column and hen 36


show Debit excesses or balances. Proprietorship is con-
ventionally listed in the right hand column and hence the
balances are Credits. Consequently the fundamental equa-
tion is one in which

Assets (Debits) = Proprietorship (Credits)

so that there is an equivalence not merely between Assets
and Proprietorship but also between Debits and Credits.
The significance of this is discussed on a following page.

In addition to the two classes of accounts just men-
tionednamely, accounts showing Assets and normally
having debit excesses, and Proprietorship accounts with a
normal credit excess, the scheme of accounts contains two
other groups referred to on page 13. These are Negative
Goods accounts, of which Debts Payable may be taken as a
'type, and Negative Proprietorship accounts, typified by
the Expense account. Considering first the Negative Goods
accounts it is seen that they are items which might logic-
ally have been entered to the credit of some asset account.
To illustrate: If a piece of real estate is purchased for
$20,000, of which $15,000 is paid in cash and the balance
is still due, it would not be illogical (although the prac-
tice is condemned by accountants, and in cases, is even
considered fraudulent misrepresentation) to record the
transaction thus:

Dr. (+) Real Estate. (-) Cr.

Land and buildings $20,000 Due on purchase price $5,00(1

in which the debt appears as an immediate subtraction
from the total value of the property. But for the sake of
clearly showing the exact status, it is much better to sepa-
rate these two items, thus :



Dr. (+)

Real Estate.


Land and buildings $20,000

FORM 10.

Debts Payable.

(-) Cr.

Due on real estate $5,000

This not only shows the present situation more clearly,
but also allows for further details, for the Credit column
of the Real Estate account can now show other deduc-
tions from the value of the Real Estate quite different
from the unpaid portion of the purchase price. Thus if
fire damages the building to the extent of $1,000 the Real
Estate account will show:

FORM 11.
Real Estate,

Land and building $20,000 Damage by fire $1,000

The Debit column of the Debts Payable account can be
used to show payments on account thus :

Dr. (+)

FORM 12.
Debts Payable.

Paid on account.


Due on real estate $5,000

The showing thus made is much more explicit than if all
four items were lumped together thus:


Dr. (+)


FORM 13.
Real Estate.


Land and building $20,000

Paid on account 1,000

Due on purchase price $5,000

Loss by fire 1,000

although in both methods the net assets must be the same

In so far as debts are considered as subtractions from
assets they must appear in a credit column, for it is in
that column that any deductions from assets appear. But
a cleavage takes place, and a separate account is estab-
lished to represent debts. The mortgage shown in Form 8
no longer appears in the credit column of the Real Estate
account but in the credit column of a separate Debts Pay-
able account. Every new debt incurred or every addition
to outstanding debts necessarily appears in a similar col-
umn, while any debt paid, or otherwise canceled is placed
among the debits, for here as elsewhere in accounting the
two sides of any account are opposed one to the other -and
tend one to cancel the other. A statement of the Goods
would therefore show :

Real Estate $20,000 + ( Debts $5,000) = $15,000
for by the simplest algebraic principle the effect of adding
a negative is the same as subtracting.

But subtraction is at best a clumsy process, and again
by ordinary algebraic principles it is customary to trans-
fer all such negative items to the other member of the
equation with an accompanying change of sign, so that the
equation becomes

Real Estate

FORM 14.

Dr. (+)


Debts Payable

Cr. (-) Dr.(-)

It follows therefore that in all accounts indicating

CV. (+)

Dr.(-) Cr. (+)


debts the balance is normally on the Credit side. And
while it is true that a credit in a debt account indicates a
subtraction from the total assets of the proprietor, yet in
itself the Credit side of the Debt account may be consid-
ered the positive side. This is true in the sense that an
existing debt appears on that side, and that the cancela-
tion of a debt is performed by making an entry among the
Debits. In form therefore the Debt or Liability accounts,
as they are ordinarily called, agree with the Proprietor-
ship accounts, in having normally a credit balance. Agree-
ing thus with the Proprietorship accounts they necessarily
differ from the Asset accounts which normally have a
Debit balance. "While this may be a little confusing at
first to the student it is in perfect accord with algebraic
principles and should offer no permanent difficulty.

The uses of Debit and Credit in the various classes of
accounts may be represented schematically thus:









All that has been said regarding the Negative Goods
accounts can be said, mutatis mutandis,, of the Negative
Proprietorship accounts, of which expense is taken as type.
An expense being an outlay of goods (e. g., cash) without
the receipt of some other equivalent Good * it can only sig-

1 From the economic viewpoint even an expense involves the ex-
change of equivalents, but this is for convenience' sake, disregarded
by the accountant. For instance the wages paid to a watchman is
treated as an expense, for the services which he gives in return, are not
considered as a "Good" to be taken into account. Even when there
is a tangible equivalent received in return for the payment the account-
ant may at times disregard it in his accounts, as for instance, the cost
of repainting a house is treated as an expense, although for part of the
money expended there was received an equivalent value of white lead.


nify that the total Proprietorship has been lessened. A
diminution of the Proprietor's capital can be indicated by
debiting the Capital account thus:

FORM 15.
Dr. ( ) Proprietor's Capital. (f ) Cr.

Expenses paid $500 |j Original capital $15,000

but it is more satisfactory temporarily to segregate such
Expense items, putting them into a separate account, and
transferring this account, which must normally have a
Debit excess, to the left hand member of the equation.
Here it can conveniently be added to the Asset accounts
which similarly have a Debit excess. Thus all Negative
Proprietorship accounts, Expense, Profit and Loss (where
there is a deficiency), and other similar accounts have the
Debits in excess. In this respect they resemble the Asset
accounts, and consequently are in contrast to the Capital
account and to those showing Debts.
The equation of accounts, first given

Goods accounts (Debit) = Proprietorship account (Credit)
becomes :

Assets (Debit) Debts (Credit) = Capital account
(Credit) -f- Profits (Credit) Negative Proprietor-
ship accounts (Debit)

and by transposition :

Assets (Debit) -f- Negative Proprietorship accounts
(Debit) = Capital account (Credit) -f- Profits (Cred-
it) + Debts (Credit)

or finally as values are expressed in figures, and can more
conveniently be added vertically than horizontally, the
equation becomes:


FORM 16.
Debit Credit

Assets Sapital

Expenses Profits

Loss, etc. Debts, etc.

Total Debits - Total Credits

In any set of books therefore the total debits should
equal the total credits and this is true whether the total
of all debits is compared with the total of all credits, or
whether the comparison is made between the sum of debit
balances and the sum of credit balances. In the routine
of bookkeeping this is of great service, furnishing the most
frequently used criterion as to the correctness of the books.
Without inquiring further as to the nature of the accounts,
or the significance of the various outstanding balances, the
bookkeeper ascertains at regular or frequent intervals
whether the Debits and the Credits in his ledger are equal.
If this is the case the ledger is said to balance. For ordi-
nary purposes such a balancing is taken as evidence, in-
conclusive though it may be, that there are no errors in
the bookkeeper 's work.

Certainly a ledger is incorrect so long as it fails to bal-
ance, but the evidence from balancing is not conclusive.
It does show that there has been a Credit for every Debit.
But it does not show whether a transaction which should
have been entered is altogether omitted; it does not indi-
cate transpositions which may have been made, nor errors
of equal amount made in both the Debit and Credit post-
ing. It does not show that an item has not been entered
in Merchandise which should have gone into Real Estate
which would make a wrong showing of the kind of assets
held. More unfortunately it does not show whether items
have gone say into Real Estate which should have been
entered in Expense, which would cause the more important


double error of misrepresenting the total value of Goods
and showing an incorrect net Proprietorship.

A system of accounts in which similar items are classi-
fied and grouped, and in which the Debits always equal the
Credits contains all the formal requirements of double
entry bookkeeping. To keep such a set of accounts it is
necessary to understand clearly the nature of each transac-
tion. If it is an actual business transaction in contradis-
tinction to a mere act of classification, it must affect one of
the Goods accounts, either Assets or Liabilities. If the
total Goods are increased or decreased, one of the Propri-
etorship accounts must be similarly affected. If there is
no change in the total Goods a change in one of the Goods
accounts must evidently be balanced by. a contrary change
in another Goods account. If any one of the assets shows
an increase it must evidently be Debited, which compels a
corresponding credit elsewhere. By keeping clearly in
mind the nature of the accounting system and that it is
attempting to present a true equation between Net Goods
and Net Proprietorship, there need be no great difficulty
in correctly recording any transaction.

This system of double entry bookkeeping, which has
been the recognized form throughout the commercial
world for half a millennium, is to be counted among the
greatest aids to commerce. Perhaps Goethe may be justi-
fied in declaring it " One of the fairest inventions of the
human mind." Nevertheless exaggerated claims are some-
times made in behalf cf double entry bookkeeping, espe-
cially in comparisons made between double entry and the
less systematic form known as single entry bookkeeping.
Not infrequently is the statement made that double entry
bookkeeping possesses the advantage of showing at any
time, not only the amounts of money due on current ac-
counts but also the status of the business, what its profits
and losses have been. This is clearly an exaggeration so far


as concerns the ordinary practice of the art. The system
does attempt to show the status of the business, but breaks
down at one point ; where a mixed account such as an ordi-
nary merchandise account is kept. As purchasers are deb-
ited in this account at cost, while sales are credited at sell-
ing prices, it necessarily follows that the balance shown by
the account at any time represents the value of the mer-
chandise still on hand, less the profit on goods sold or plus
the loss on goods sold. To the extent that such accounts
appear the system is not self-sufficient, and the essential
needed is supplied by a process somewhat outside of the
bookkeeping itself that is, the inspection of merchandise
and the making of an inventory. Or, granting that the
inventory is part of the double entry system, it still remain*
true that the books do not at any given moment show the
status of the business. When that is desired the labor of
making a new inventory must be performed.

Nor is it true that any set of books ever devised shows
with perfect accuracy the state of the business even with
the addition of a merchandise inventory. Inventories, at
best, are approximate, and it will be shown later there are
points of principle in the taking of inventories on which
the best authorities are still in dispute. Nor is it possible
always to determine the exact nature of a business transac-
tion so as to secure its correct entry in the books of account.
A railroad, for instance, replaces an old wooden bridge,
costing when constructed five years before $500, with a
new steel structure costing $2,500. It is evident that the
$2,500 expended is in part an expense (that is, a charge to
some Proprietorship account), and in part an exchange
transaction (that is, an exchange of the asset " cash " for
another asset, " steel girders "). But there is absolutely
no way of determining the exact apportionment of charges
between these diametrically different accounts. Each rail-
road may, it is true, adopt a rule of thumb which it follows


faithfully, and which, at times is dignified with the title
of " Principle of Accounting." But all confess it is still
an approximation, and the fact that in railroad account-
ing, where the system is most elaborated of any business
enterprise, the directors, from time to time, make correct-
ing entries of enormous sums, implies that either before
or after the correction the accounts were in essence incor-
rect, and that the system in reality broke down. 1

Furthermore double entry bookkeeping, as practiced
does not even attempt to show the actual condition of the
business, in that to a large extent it ignores contingent
liabilities. Even where the law prescribes a statement of
such liabilities, as is the case in British companies, it is to
be noticed that the statement of contingent liabilities is
merely appended to the Balance sheet, and not at all a
part of it 2 that is, they are no part of the bookkeeping
system of the company. Occasionally certain contingent
liabilities are booked, as for instance " Bills Rediscount-
ed " in the statements of the National Banks of the United
States, but in no complicated system of accounts is there
any effort to bring into the books all the contingent liabili-
ties and thus to present a full picture of the real status of
the business. Double entry bookkeeping thus being not
self-sufficient as a system, dealing with approximations
rather than certainties, and presenting only a partial view
of the facts it attempts to record, does not deserve the
eulogium of Van de Linde who declares " Bookkeeping is
a science perfect in itself. ' ' Much more correct is the mod-

1 An example of such a procedure is found in the reports of the
C. & N. W. R. Co. which in the fiscal year 1898-9 deducted an even
$5,000,000 from the cost of the road charging the same to the income
account. While such conservative action is highly praised by financial
critics, it must be admitted either that it is a direct violation of book-
keeping principles, or that, even in one of the best managed roads, the
accounting system broke down and had to be patched.

* See model form given on page 66.


erate statement of Rehm that the " principle of truthful-
ness in accounting is only relative and limited."


CARLILL, J. A. Principles of Bookkeeping. London, 1896.

CAYLEY, A. The Principles of Bookkeeping. Cambridge, 1894.

DYER, S. A Common Sense Method of Double Entry Bookkeeping
on First Principles as Suggested by De Morgan. Part I.
Theoretical. London, 1897.

FOSTER, B. F. Double Entry Elucidated. Boston, 1852.

HUGLI, F. Buchhaltungsstudien. Bern, 1900.

JONES, THOMAS. The Principles and Practice of Bookkeeping.
New York, 1841.

LISLE, GEORGE. Accounting in Theory and Practice. Edinburgh,
1906. [This is perhaps the best single volume treating the
entire subject which has appeared in English.]

SCHAER, J. F. Versuch einer wissenschaftlichen Behandlung der
Buchhaltung. Basel, 1890. [In this treatise is presented the
theory of bookkeeping on which Chapter I is based.]

SPRAGUE, C. E. The Philosophy of Accounts. New York, 1908.
[The most important theoretical work which has appeared in

TIPSON, F. S. The Theory of Accounts. New York, 1902. [Con-
tains answers to the questions on Theory of Accounts given in
the New York examinations for Certified Public Accountants.]

The following reference works are also valuable:

The American Business and Accounting Encyclopaedia. Detroit.
Third Edition, 1901. [A comprehensive work of somewhat
mixed character.]

DAWSON, S. S. Accountant's Compendium. Third Edition.
London, 1908. [A valuable reference work in dictionary

Encyclopaedia of Accounting. Edited by George Lisle. 8 vols.
Edinburgh, 1903-8. [A most valuable work of highest scien-
tific standard.]


STERN, R. Buchhaltungs Lexikon. Wien, 1904. [The repre-
sentative German work, but less comprehensive in its charac-

Useful text-books of bookkeeping without especial reference

to theory are:

BOGLE, A. M. Comprehensive Bookkeeping. New York, 1905.
[An admirable little work giving good exercises free from ex-
cessive arithmetical detail.]

DICKSEE, L. R. Bookkeeping for Accountant Students. Fifth
Edition. London, 1906.

Advanced Accounting. Third Edition. London, 1908.

[The above two works form a comprehensive treatise. The
latter contains an admirable collection of bookkeeping

On the History of Bookkeeping, with an extensive bibliography

of the subject, see :

BROWN, R. A History of Accounting and Accountants. Edin-
burgh, 1905.



A LEDGER kept according to the principles of double
entry bookkeeping will at any time show various accounts
in each of which may appear sundry Debit and Credit
items. A list of the totals of the items shown in each ac-
count gives such a Trial Balance of footings as is shown in
column (&) below:

FORM 17.

Title of Account.


Dr. Cr.


Dr. Cr.










Bills Receivable

Bills Payable. . . ,


General Expenses


Proprietor's Account





The characteristic feature here is that the total Debits
of necessity equal the total Credits. Such a balance of
footings is chiefly valuable as furnishing strong, though
not conclusive evidence that entries have been correctly
posted. As an exhibit of the status of the concern it is
made more lucid if, instead of the total footings, only the
excesses of one side over the other are listed, thus forming
a Trial Balance of Balances, as column (c) is somewhat

Online LibraryHenry Rand HatfieldModern accounting, its principles and some of its problems → online text (page 3 of 27)