Henry Rand Hatfield.

Modern accounting, its principles and some of its problems online

. (page 5 of 27)
Online LibraryHenry Rand HatfieldModern accounting, its principles and some of its problems → online text (page 5 of 27)
Font size
QR-code for this ebook


been adopted in the reports of the Atchison, Topeka and
Santa Fe Railway, as shown on page 60.

The Balance Sheet of the company given above, if pre-
sented in the ordinary English form, would be :



FORM 21.
Balance Sheet.



Capital and Liabilities



Assets



Share capital .100,000

Debentures 100,000

Bills payable 10,000

Profit and loss 3,000

,213,000



Cost of property 195,000

Materials, etc 4,000

Accounts receivable 8,000

Cash 6,000

213,000



In discussing the subject of the shrinkage in value of
plant in reference to profits it will be shown that the
double account form of Balance Sheet has had a consider-
able and perhaps baleful influence on the legal interpreta-
tion of accounts. It has indeed been argued that the
placing of the capital in a separate account involves the
principle that changes therein cannot affect the Profit and
Loss account appearing in the Balance Sheet. While the
validity of this inference may be questioned it is true that
the isolation of " capital assets " and " capital liabil-
ities ' ' in the capital account has a tendency to cause them
to be considered as isolated in fact, and has led to some
far-reaching conclusions which might otherwise never have
been reached.



50 MODERN ACCOUNTING

Another question relating to the form of the Balance
Sheet, namely, whether certain items are better shown as
additions on one side or as subtractions on the other side
is of considerable practical importance. This can best be
considered after a discussion of the nature of the various
classes of accounts found on either side of the balance
sheet.

On the Debit side are found the following:

1. Assets, of whatever kind and including whatever
subdivisions such as capital assets, circulating assets, im-
material assets, etc.

2. Loss when the business shows a net deficiency.

3. Debit Valuation Accounts.
On the Credit Side : "

4. Capital in the strict sense of the contributions made
by stockholders or proprietors.

5. Profits in the broad sense of the accumulations or
accretions to the original capital, which may be divided
into various subheads, such as Surplus, Reserve, Undivided
Profits, etc.

6. Liabilities in the strict sense of debts due by the
business.

7. Credit Valuation Accounts.

Of the above groups, (1) and (6) are easily identified
as " Goods " accounts, positive and negative respectively,
while (4), (5) and (2) are Proprietorship accounts, the
last named negative, the others positive.

These are already familiar, but the remaining groups,.
(3) and (7) require further description. These accounts
may be called Valuation Accounts, adopting the German
nomenclature (Bewertungskonten) as there is no well es-
tablished English term. They may be defined as accounts
introduced for the technical purpose of indicating that a
sum is to be subtracted from some other account. Alge-
braically they correspond to a negative item transferred



THE BALANCE SHEET 51

to the other member of the equation with a transformation

of sign. Thus in the equation :

^

4x 2x = 5y iy

the terms 2x and 4y are evidently to be subtracted from
4x and 5y respectively. But the equation is still correct
if it is presented in the form

4x + 4y = 5y + 2x

in which 4y and 2x would correspond to a Debit and a
Credit Valuation account, respectively. They represent,
therefore, not independent values but merely that a sum
is to be subtracted from another item purposely overstated
on the other side of the equation.

This is quite in consonance with practice already ex-
plained. It has been seen that expense is logically a sub*
traction to be made ultimately from the proprietor's Cap-
ital account, or immediately from Profit and Loss. But
instead of entering every expense item at once to the
debit of Profit and Loss, it is placed temporarily in a spe-
cial Expense Account. But these negative Proprietorship
accounts are ordinarily temporary. Before the prepara-
tion of the final Balance Sheet they disappear by being
included with other items in the general Profit and Loss
account. But so long as a balance stands to the debit of
Expense, it indicates that to that extent the showing made
in the Profit and Loss or in the Proprietor's account is
incorrect, that it is overstated because a necessary subtrac-
tion has not yet been made. Valuation accounts are sim-
ilar in origin and purpose but differ in being more perma-
nent in character.

The simplest and best type of a Valuation account is
the Depreciation account. At the beginning of the year a
concern buys machinery for $10,000. This is properly
debited to the Machinery account, and is listed among the



52



MODERN ACCOUNTING



assets. But during the year the value of the machinery
declines because of wear and tear. The machinery in-
stead of being worth $10,000 as shown by the account is
worth only $9,000. Correct accounting demands that this
change be shown just as much as that a payment of $1,000
out of the cash balance of $10,000 be shown. The simplest
and most direct, but not necessarily the best way of show-
ing this decline is to enter the $1,000 depreciation in the
Credit side of the Machinery account thus reducing the
effective balance to $9,000. But it is also permissible to do
here what was done in regard to Expense that is, to indi-
cate the required deduction not by immediate entry in the
minuend account but by establishing an independent ac-
count for the subtrahend. In this case instead of showing
the account thus :



Dr.



FORM 22.
Machinery Account.



Cr.



Cost price $10,000



$10,000
Balance brought down. . . $9,000



Depreciation $1,000

Balance 9,000

$10,000



the ledger shows the following two accounts:



Dr.



FORM 23.
Machinery Account.



Cr.



Cost price $10,000



Dr.



Depreciation Account.



Cr.



On machinery $1,000



THE BALANCE SHEET



53



The resemblance of such accounts to the Expense and
other Negative Proprietorship accounts is clear. But while
the Expense account disappears from the ledger at the
end of the year, when it is closed into Profit and Loss, the
Valuation accounts continue beyond the period for closing
the ledger. It is not for years, and perhaps never, closed
into the account from which it indicates a subtraction.
As a balance showing on the ledger it must therefore be
considered when the formal Balance Sheet is prepared.
Debit Valuation Accounts are similar in their nature, but
of course, indicate a subtraction to be made, from some item
standing on the Liabilities side of the Balance Sheet. An
item representing unissued stock or bonds, or showing a
discount on the issue of capital stock, will serve as an ex-
ample of such an account.

The question of form to which reference was made
above, concerns the treatment of these Valuation Ac-
counts. The point at issue is whether Valuation Accounts
should appear in the Balance Sheet as independent items,
or whether the subtraction which they are designed to
indicate should more clearly be shown. In the illustration
already used it is desirable that the ledger should contain
the two accounts, instead of having the depreciation of the
machinery credited at once to the Machinery Account. But
that does not decide the form in which the Balance Sheet
is to appear and it remains debatable which of the two
forms given below is preferable :



Dr.



FORM 24.
Balance Sheet.



Cr.



Machinery $10,000

Other assets 10,000

$20,000



Capital stock $19,000

Depreciation 1,000

$20,000



54



MODERN ACCOUNTING



Dr.



FORM 25.
Balance Sheet.



Cr.



Machinery

Cost price $10,000

Less depreciation 1,000 9,000

Other assets 10,000

$19,000



Capital stock $19,000



$19,000



While practice is by no means uniform, it is better,
where an account is clearly of the nature of a Valuation
Account, to allow the subtraction to appear in the Balance
Sheet, somewhat in the manner just indicated. This avoids
any danger of its being mistaken for some other class of
accounts, which might lead to an entire misapprehension
of the status of the company. Depreciation and Discount
on Capital Stock are cited here as typical Valuation Ac-
counts ; there are numerous other accounts, however, which
come under the same category.

The purposes of .the Balance Sheet are twofold. Pri-
marily it shows the financial status of the concern, giving
information as to its solvency, and in a less degree it ex-
hibits profits which have been made. The first purpose is
on the face the most evident one. The Balance Sheet shows
a cross section of the business, it presents the status at a
given moment of time ; it is ostensibly a showing of Assets
and Liabilities, not of Income and Expenses. Yet the Bal-
ance Sheet is not without value as an exhibit of profits.
Prepared, as it ordinarily is, at annual intervals it serves,
at least by comparison, to show the flow of income during
the period, as well as the financial status at the moment
of its preparation. Indeed some writers, noticeably Rehm,
maintain that the prime function of the Balance Sheet is
to show the profits of the year and serve as a basis for the
declaration of dividends. It may even be presented in



THE BALANCE SHEET 55

such form as not only to show the profits of the past year,
but also to indicate the proposed distribution of such
profits. This may be done perhaps in the method shown
in the German Balance Sheet on page 65. A somewhat
similar treatment is found in the Balance Sheet of many
English companies as e. g., that of J. & P. Coats, Lim.

For whichever use the Balance Sheet is designed it is
evident that it must give, as far as possible, a correct show-
ing of the facts. High standards have been set in this re-
spect by the statutes. Thus the English Companies Act
provides that the Balance Sheet shall be " drawn up so
as to exhibit a true and correct view of the state of the
company 's affairs ' ' ; and the German Commercial Code
prescribes severe penalties for ' ' untruthf ulness or unclear-
ness ' ' of the Balance Sheet. Nevertheless accountants gen-
erally deny the possibility of strict accuracy in the Balance
Sheet. Thus Dicksee says: " A Balance Sheet is not a
statement of facts, but rather an expression of opinion,"
and another writer has said : ' ' Not more than ten per
cent of the items in any average Balance Sheet are, or
can possibly be facts that are capable of being absolutely
tested."

Unclearness and consequent misunderstanding of Bal-
ance Sheets may be due to several different causes, the
principal ones being: (1) The nature of accounting itself,
which being at basis an estimate can never be absolute or
free from error. (2) The vagueness of the terminology
used and the liability that technical words will be misun-
derstood, even when used in good faith. (3) The purpose-
ful misrepresentation of the condition of the company on
the part of the directors or officers.

1. The uncertainty of all accounting can never be alto-
gether avoided. It appears principally in connection with
the valuation of assets. In many cases there is no outside
criterion of value and no way of insuring against a wrong



56 MODERN ACCOUNTING

estimate. This subject is discussed in the chapters dealing
with assets and their valuation.

2. The vagueness of terminology adds to the difficulty
of presenting a lucid statement. Technical terms such as
Reserve, Reserve Fund, Treasury Stock, Adjustment Ac-
count, and others are used with entirely different mean-
ings by different companies and are given most divergent
definitions by the courts and by the various text-book
writers. Unfortunately there is at present no accepted
authority to whom appeal can be made.

The likelihood of a serious misunderstanding is in-
creased because of the fact that items so widely divergent
in character stand together in the columns of the Balance
Sheet. On the Debit side items representing losses or ex-
penses may be confused with assets. On the other hand,
the Credit column contains such antipodal items as Profits
and Depreciation that is, those showing that there has
been an increase in the value of the assets, and those indi-
cating that the value of some of the assets has declined.
Exactly the same term may be used to indicate these two
categories, for both are frequently covered by what is
called Reserve. Much good will be accomplished by the
action of the Interstate Commerce Commission in prescrib-
ing certain uniformities in railroad accounting. It would
be well for the public accountants of the country to take
even wider action in securing definite and uniform account-
ing terminology.

3. Purposeful misrepresentation in the Balance Sheet
is secured in part by insidiously taking advantage of the
inherent difficulties just referred to, in part by more pal-
pable untruth. Of the latter little need be said. Evidently
if a company deliberately states it has $100,000 cash on
hand when it really has only $10,000 no knowledge of the
principles of accounting will disclose the facts. More in-
sidious are the less open misrepresentations. Sometimes a



THE BALANCE SHEET 57

purposeful grouping together of certain items will conceal
the real condition. Thus a company owning $100 govern-
ment bonds and $100,000 bonds of some wildcat company
lists them under the heading " Government and other
Bonds." Or it lists bonds and stocks together as " Bonds
and Other Investments."

More flagrant is the case where liabilities have been
subtracted from the assets, as for instance where the Bal-
ance Sheet does not show both Bills Receivable and Bills
Payable, but merely the excess of the former over the lat-
ter; or again shows only the equity in Real Estate instead
of both the cost price and the purchase-money mortgage
given in part payment. Even the improper division of an
account may be resorted to in order to hide the fact that a
company is too largely involved in a single line of invest-
ment. A striking example of this came up in connection
with the disastrous failure of the Leipziger Bank, which
divided up among various different accounts the advances
which it had made to an industrial company, hoping
thereby to conceal the extent to which the bank was in-
volved in that ruinous enterprise.

Against the positive misstatements in the Balance
Sheets the outsider is of course defenseless. But assum-
ing that amounts are correctly given and that there is no
gross overstatement, he still needs to be on guard against
a misunderstanding. He should be sure that the ambigu-
ous titles are rightly understood, and that he does not con-
fuse accounts of opposite nature. A most important aid
in this matter is the careful indication of Valuation Ac-
counts in the manner suggested. Further examination of
the Balance Sheet and of the other statements which should
accompany it is then possible. The difficult points, in the-
ory and practice, relate to substance rather than to form
and are discussed in the various chapters following.

Reference has here been made to incorrectness in the



58 MODERN ACCOUNTING

Balance Sheet as being an admitted fault, or even a fraud.
Attention should be called to the fact that many account-
ants and jurists draw a marked line between the incor-
rectness of statement which places the company in a more
favorable light and one which understates its financial
strength -or minimizes its profits. To some the former is
fraudulent, the latter almost a virtue. It suffices here to
call attention to this point, which is discussed at some
length in connection with the subject of Secret Reserves.
To illustrate the variations in form found in account-
ing practice, there are given below a number of Balance
Sheets of different corporations. Descriptive notes on the
forms given are to be found on pages 67-68.



THE BALANCE SHEET



59




o



rH OOS
<CH rH GO
OS t>TH



CO ^t* rH CO O CO

Tt< co m co t>- TJ<

CO TH -* CO CO



OOS



OS IO rH

O5 OiiC

(N TjH OS



CO 1C CO GO C<>

co c^ ^ os 01

CO TH<N t-



..a fe :


: S : s : >| :





....


-S


05 .J .-0 . ft .

1 | '1 II


S


3 *


S













^ S f


a'S


V

a


ijjj


1


VESTMENTS:
Road and equipment
Sinking funds (less Co
sues included) ....
Deposits in lieu of me
t,v sold . .


Miscellaneous physic
Investments in affiliat
Other investments. . .


I
_g

*3
+=
o
H


QRRENT ASSETS
EFERRED ASSETS ....
N ADJUSTED DEBITS:
Insurance paid in ad''
Discount on funded c
Other unadjusted del


1"



K




OQU





FORM 27.

THE ATCHISON, TOPEKA & SANlA
GENERAL BALANCE



Balances
June 30, 1901.


ASSETS.


Balances
June 30, 1902.


-412,361,783.19

3,376,378.88
3,803,278.10
189,669.86


$1,887,595.14
460.611.34
1,028,172.40


RAILROADS, FRANCHISES,
AND OTHER PROPERTY, in-
cluding Stocks, Bonds,
etc. (Kxhibit A)


$2,723,775.51
656,172.99
7,226,772.68


$418,982,696.40

10,606,721. li>
10,321,617.75

5,073,804.67


EXPENDITURES FOR CON-
STRUCTION AND EQUIP-
MENT DURING CURRENT
FISCAL YEAR (Exhibit B)
Improvements


Extensions


Equipment


INVESTMENTS IN OTHER Co.'s
(Exhibit C)


$2,898,496.26
577,126.51


$2,895,896.26
357,066.66


NEW YORK SECURITY AND
TRTIST Co., TRUSTEE :
Cash and Securities in
Special Trust


Balance carried down


BALANCE FROM CAPITAL AC-
COUNT


$419,731,110.03


$444,984,840.00


$4,495,870.03

3,475,622.77
2,293,276.35
32,156.03

242,958.00
257,447.24

5,542,035.68
5,738.54

9.484,200.69


$3,252,962.92
3,403,026.86
32,019.98

252,975.50
548,032.72

6,763,608.33
1,276.06

20,544,405.62


SECURITIES ON HAND (Ex-
hibit D):
Company's Securities (esti-
mated value)


Other Securities (estimated
value)


$1,387,659.94
380,822.09
503,125.97
3,270,427.68


MATERIAL AND SUPPLIES

PREPAID INSURANCE PRE-
MIUM


$1,457,105.87
372,429.30
409,899.80
4,524,173.36


UNION TRUST Co. OF NEW
YORK, TRUSTEE:
Cash deposit under Article
5 of Gen'l Mtge


GUARANTY TRUST Co. or
NEW YORK:
Cash deposit for Fuel Re-
serve Fund


ACCOUNTS RECEIVABLE:
Traffic Balances. . . .


Agents and Conductors. . . .
U. S. Government


Miscellaneous


PRIOR ACCOUNTS IN LIQUID-
ATION






CASH:
On Hand and in Bank


$25,829,306.33


$34,798,307.98



fiO



FE RAILWAY COMPANY SYSTEM.

SHEET, JUXE 30, I9O2.



Balances
June 30, 1901.




LIABILITIES.




Balances
June 30, 1902.


$102,000,000.00




CAPITAL STOCK:
COMMON.-




$102,000,000 00






PREFERRED


$131 486 000 00






. ' -


Less amount in Special
Trust :
For acqui-
sition of
Auxilia-
ry Lines.$10,800,000.00
For Im-
prove-
men ts,
Ex ten-
sions.etc. 6,486,470.00


1 7 *>RR d7f\ nn




114 199 530 00












$138,727,500.00
51,728,000.00

1,500,000.00
250,000.00

6,000,000.00
830,210.00


FUNDED DEBT:
General Mtge 4% Bonds. . .
Adjustment Mtge. Bonds. .
Serial Deben. 4% Bonds. . .
Chicago & St. Louis Ry.
1st Mtge. 6% Bonds
Equipment Tr. 5% Bonds.
The San Francisco <fe San
Joaquin Valley Ry. Co.
1st Mtge. 5% Bonds
Miscellaneous Bonds


138,728,500.00
51,728,000.00
30,000,000.00

1,500,000.00

6,000,000.00
828,810.00




4,495,870.03




Balance carried down






$419731.110.03








$444,984,840.00






BALANCE FROM CAPITAL AC-
COUNT




#5 073 804 67


$1,239,309.18
559 747 39




SPECIAL BETTERMENT FUND.

ROLLING STOCK REPLACE-
MENT FUND




367,079.52
211 687 57


321 860 83




RAIL RENEWAL FUND




366 781 16


59,412 56




TIE RENEWAL FUND








$239,386.58


FUEL RESERVE FUND:
The Atchison Topeka <fe
Santa FeRy. Co


$489,834.90






18,060.66


Cherokee <fc Pittsburg C.
& M. Co


58,197 82














844,290.70


$3,115,305.00


ACCRUED TAXES NOT YET DUE

INTEREST ON FUNDED DEBT :
Accrued, not due


$3,512,275.00


953,103.64




193,630.00


Coupons, not presented.. . .


201,160.00






SI 807,310.16


ACCOUNTS PAYABLE:
Pay Rolls


$1 ,954,254.70






2.428,257.98


Audited Vouchers


3,637,781111






1,488,466.9Q


Traffic Balances


1,452,391.22






139,911.83


Miscellaneous


272,162.34




5 863 946 96








7 01 ft coo 07


268,616.06




PRIOR ACCOUNTS IN LIQUIDA-
TION




220 379 1 1


13,082,740.41




PROFIT AND Loss : Surplus. . .




16,027,415.23


$25,829,306.33








$34,798,307.99



81



62



1

^ 00

.18



o
fe



-73000

co O O



1O O CO O5 O5
(N CO 00 CO O



to oo *o

rj ^ o

T}< i I i I

1C <O~ 00"

t> 1 I f-

^ 00 00





















^ 03 O Hi r ~ X 2 /is ** +a I Ja w

rt ^go"- *- 5 Cjj^Q c d
oSO^^-a,.] pq-gw^^ j g w t



pq



ffl eq



-000



-H 00

to t^

0000



OO



3



jS IN

M+i



S ^^.'OTJ
% | 5 O- *









o
i i

oo

00

i



GO

oo



2 8







Fc



CONDENSED GENERAL



ASSETS
PROPERTY ACCOUNT

Ptoramis OWNED AND OPBTB> BY THE SEVEXAL COMPANIES

Balance of this account as of December 31. 1906 $1,378.185,605 07

Additions during 1907 to foregoing balance (see page 26) . 614^22.63

Tennessee Coal, Iron & R. R Co's Properties, viz.

Cost of Fixed Property as acquired at November I, 1007. $48,961. 308,83

Expended for Construction in November and December 984,886.74

40 046,005 57
Expended for Additional Property and Construction in 1907 other than by or

for account T. C,' I. 4 R. R. Co 65,996^65.73

Las, Charged off to the following accounts, viz.:

To Bond Sinking Funds. . .' $572,500.00

To Depreciation, Extinguishment and Replacement Funds 4680,421 .03
To Funds provided from Surplus Net Income for pay-
ment of capital expenditures (see page 12) 53,949.799. 6

59.202,730.40,

Expenditures for Stripping and Development at Mines, and in-
vestment in Structural Erection and Logging Plants, viz. :

Balance at December 31, 1906 . $5^22340.61

Net Increase during the year 1907 .-.-... 4.575,041 .26

10,207.381 .87

DEFERRED CHARGES TO OPERATIONS 1.44S.S37,O.37
Payments for Advanced Mining Royalties, "Exploration expenses and Miscel-
laneous charges, chargeable to future operations of the properties : . . $6,204,733.85

Less: Fund reserved from Surplus to cover possible failure to real-
ize Advanced Mining Royalties 2.300.000.00

INVESTMENTS 3.7O4.733.WJ

Outside Real Estate and Other Property 1,717,110.87

SINKING AND RESERVE FUND ASSETS

Cash resources held by Trustees account of Bond Sinking Funds $444,200.88

($3'.559.ooo par value of Redeemed Bonds held by Trustees, not

Contingent Fund and Miscellaneous Assets , 1,215322.85

Insurance Fund Assets (at market value).: 4,120.158.63

Depreciation and Extinguishment Fund Assets (at market value) 10741,977.19

Investments (at market value) for Special Construction Fund for Gary Plant.. 15,920.542.14
CURRENT ASSETS 32,448,401. <M>

Inventories* $136,188374-26

Accounts Receivable 58,398^54.36

Bills Receivable, Customers' and Guaranteed Loans : 10,193,706.91

Agents' Balances , 835,369.33

Sundry Marketable Bonds and Stocks _ , : 8,831.154.33

Loans on Collateral 6,000,000.00

Cash, viz.:

In hand and on deposit with Banks, Bankers and Trust

Companies subject to cheque $51,222,305.07

Deposits loaned on call 2.741.453.81

53.9f4.848.88

274,41 1 .308.08



Mory valuation* include profit* accrued



aid to other



r bd



w<



Balance Sheet, and certify that in



audited the abov
Our opinion it is properly dr;
cial position of the United States Steel Corporation and Subsidi-
ary Companies on December 31, 1907

PRICE, WATERHOUSE ft CO.,

Auditors.
NEW You*. March 7. 1908.



*l,75*t,l 13,013. <l



29.
SHEET, DECEMBER 31. 1907.



LIABILITIES

CAPITAL STOCK OF U. S. STEEL CORPORATION

Common , . . ., $508,302, 500 . oo

Preferred , ,.. 360,281,100.03

8868,583,600.00

CAPITAL STOCKS OF SUBSIDIARY COMPANIES NOT HELD BY U. S.

STEEL CORPORATION (Par Va\*t) 761.81O.OO

BONDED AND DEBENTURE DEBT

United States Steel Corporation 50 Year %% Bonds $303,057,000.00

United States Steel Corporation 10-60 Year s% Bonds 200.000,000.00

$503,957,000.00
Less, Redeemed and held by Trustees of Sinking Funds. . 23.758.000-00

Balance outstanding $480,190,000 CO

Subsidiary Cos.' Bds. (Guaranteed by U S. Steel Corp'n). ... $48,036.000 oo
Subsidiary Cos.' Bds. (Not guaranteed by U S. Steel Corp'n). 79,716,004.13

$127,752,904 .13
Less, Redeemed and held by Trustees of Sinking Tunds. . 7,801,003.00

Balance outstanding , 110,951,904 13

Debenture Scrip, Illinois Steel Company 34.366.66

CAPITAL OBLIGATIONS AUTHORIZED OR CREATED FOR CAPITAL 600,186.270.79



Online LibraryHenry Rand HatfieldModern accounting, its principles and some of its problems → online text (page 5 of 27)