Henry Rand Hatfield.

Modern accounting, its principles and some of its problems online

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Subsidiary Companies' Bonds, not included in this Balance Sheet as either a

Liability or an Asset $10,222.00000 _ _ _


Mortgages '. $2.135440.38

Purchase Money Obligations 3.258.700.65


Current Accounts Payable and Pay Rolls $22,506,488.45

Bills Payable (of Tenn. Coal, Iron & R R. Co.) 1,052.747.59

Special Deposits or Loans due employes and others 1.057,495 - 58

Accrued Taxes not yet due. 3.7J6.747 8

Accrued Interest and Unpresented Coupons 7,863.913.57

Preferred Stock Dividend No. 27, Payable February 29, 1068 6^04^19.25

Common Stock Dividend No. 17. Payable March 30. 1908.... 2,541.512.50 4606382474

Total Capital and Current Liabilities : Cl,619,tttt8,446.36


Sinking. Depreciation and Replacement Funds, per table on page lo $41,360,655.10.

General Construction Fund for authorized appropriations (see page 12) 3&3&8I4-96

Special Construction Fund for account Gary, Ind, Plant (see page 12) 26,051,242.62

Contingent and Miscellaneous Operating Funds 7,991.275 89

Insurance Funds 4.648.358 57

83,975,347 .23


Represented by Cash (and by redeemed bonds not treated as assets See Contra).


Capital Surplus provided in organization $25,000.000.00

Balance of Surplus accumulated by all companies from April 1, 1901, to Decem-
ber 31, 1907, per table on page 34 69,736,490 77

Total Surplus exclusive of Subsidiary Companies' Inter-Company

Profits in Inventories $94J36^oo.77

Undivided Surplus of Subsidiary Companies, representing Profits accrued on
sale of materials and products to other subsidiary companies and on hand

in tatter's. Inventories 27 008 /*,-> 8,


1,7C8,1 13,018.86




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FORM 32.
Balance Sheet of a German Manufacturing Corporation.
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FORM 26. This form divides the Assets into four, the
Liabilities into seven groups. Some of the items listed under
Unadjusted Debits are similar to those generally called
Deferred Assets. The title, Deferred Liabilities as here
used, is somewhat meaningless. The separate item, Govern-
mental Grants, is a distinct innovation. It represents a
contribution which does not come from the stockholders, yet
is not a debt. The treatment of Corporate Surplus and of
Depreciation is particularly to be noted.

FORM 27. This Balance Sheet is in the Double Account
form, although the two portions are not separately headed
as is customary in the statements of Parliamentary com-
panies. Attention is also called to introduction of the fig-
ures of the preceding year's Balance Sheet for the sake of

FORM 28. This Balance Sheet of the London and West-
minster Bank not only arranges the assets with the most
liquid form coming first, but logically observes a similar
arrangement of the liabilities. Other features of interest
are : The treatment of unpaid capital, tha showing of liabil-
ities for endorsement, etc., and the divergent methods used
in showing Depreciation of Government Securities and the
amount written off of Bank Premises.

FORM 29. This Balance Sheet has many points of in-
terest among which are : The consolidation in one state-
ment of the assets and liabilities of the subsidiary compa-
nies as well as those of the Steel Corporation, the treatment
of Depreciation, the differentiation of the various Reserves
and of their corresponding assets, and the treatment of
the Bond Sinking Fund.

FORMS 30-31. These two Balance Sheets represent the
condition of the Chemical National Bank of New York.


The first is in the form furnished the Comptroller of the
Currency and by him published in the annual report. The
second, is a condensed form used as an advertisement ap-
pearing in the Commercial and Financial Chronicle. The
difference in the figures is due to leaving the overdrafts
out of the condensed form and showing only the net sum
due depositors. Strictly this is incorrect. It involves the
cancelation of assets against liabilities, which is opposed
to the general principle that both must be shown in full.
The small amount involved however furnishes sufficient
justification for the omission.

FORM 32. This form (taken from Rehm's, " Die Bilan-
zen ") is a typical German Balance Sheet. Points of spe-
cial interest are: The arrangement of assets from fixed to
liquid, the inclusion of unrealizable assets at a nominal
value of 1 mark (such items being technically called
" memoriter accounts "), and the inclusion of many of
the details of the Profit and Loss Account in the Balance
Sheet. Item 17 " Delkredere Account " is a term seldom
used in English accounting literature although occasion-
ally found. It signifies about the same as " Reserve for
Doubtful Debts " or for some similar uncertain asset.

FORM 33. This form has doubtless had a great effect
on English practice as its use was for many years obliga-
tory for all companies which did not specifically adopt
other articles. The British custom of placing the assets on
the left hand side has been due largely to this legal form.
Under the modification of Table A made in 1906 the use
of this particular form is, however, no longer prescribed.
Other points , of interest are : The minute details regard-
ing the issue and payment of shares, the addition of con-
tingent liabilities as a supplement to the Balance Sheet
proper, the classification of items in seven heads, and the
arrangement of assets with cash last.



BROAKER & CHAPMAN. The American Accountants' Manual. I,
pp. 83-108. New York, 1897.

CHARPENTIER, J. Etude juridique sur le bilan dans les societes
par actions. Paris, 1906. [A good presentation of French
law and custom, containing also a bibliography.]

A CHARTERED ACCOUNTANT. How to Understand the Balance
Sheet. London, 1903.

GOUGH, T. H. Balance Sheets and How to Read Them. London,

KEEN, F. N. The Balance Sheet of a Limited Company. Ac-
countant, XXIV, p. 399.

LISLE, G. Balance Sheets. Article in Encyclopaedia of Account-
ing. I, p. 203.

Accounting in Theory and Practice, pp. 69-82. Edin-
burgh, 1903.

PIXLEY, F. W. How to Read a Balance Sheet. Accountant,
XXXV, p. 511. [A valuable article by the former president
of the Institute of Chartered Accountants.]

REHM, H. Die Bilanzen der Aktiengesellschaften. Munich, 1903.
[The most comprehensive work on the subject, dealing how-
ever with the details of German law.]

SIMON, H. V. Die Bilanzen der Aktiengesellschaften. 3te Aufl.
Berlin, 1899. [A work similar to Rehm's. Although less
comprehensive it is perhaps more valuable to the general
student of accounting. While dealing with German law the
discussion of theoretical matters is of general interest.]

VIGEON, H. Balance Sheets. Accountant, XXV, p. 29.

An interesting collection of various forms of Balance Sheets with

critical comments is found in Encyclopaedia of Accounting, VIII,

pp. 249-326.



IN the preceding chapter it was shown that where the
ledger is properly closed so as to eliminate expense and
other loss items, the left side of the Balance Sheet con-
tains only two classes of items: (1) those indicating
assets, and (2) those indicating Valuation Accounts that
is, technical accounts whose object is to indicate a subtrac-
tion to be made from items listed on the other side of the
Balance Sheet. But this latter class of accounts is always
small in number, and in the more approved Balance Sheet
the Valuation Accounts, too, are eliminated from the left
side by being listed in an interior column of the right
side, the exterior column showing the remainder after de-
ducting the indicated amount. The left column of the
Balance Sheet containing, then, in most cases, nothing but
asset items, and in any event having few accounts other
than these, that column has generally been called by its
characteristic feature, and is labeled " Assets " or " Re-
sources. ' '

But while negative items, whether representing actual
losses, or mere technical Valuation Accounts, appear infre-
quently in a properly prepared Balance Sheet, the impor-
tance of distinguishing all such items from asset items
proper cannot be overemphasized. A failure to do so
causes most of the misrepresentations or misunderstand-
ings of corporation accounts. Thus, with a given sum, say
$50,000 worth of unquestioned assets, there may appear in
the Balance Sheet another item of $10,000 of indeterminate



character. If it proves to represent Goods the concern
then is possessed of $60,000 gross assets with which to
secure its creditors and indemnify its stockholders. But
if the $10,000 item is merely a Valuation Account, or one
representing a loss, it is a serious error to add it to the
real assets, for the false estimate of this additional prop-
erty may mislead the creditor or investor. Frequently
Loss items are thus carried in the Balance Sheet with some
colorless or misleading title, and a gross misconception of
the actual status of the concern is the result. Thus a man-
ufacturing concern engaged in making harvesters, carried
in its Balance Sheet the following items: Moving account,
Fair machines account, Material and labor expended on
self-binder, Bindery account. In each of these instances
the court decided that the item represented an expense
and not an asset, and the confusion in this case amounted
to a positive fraud on the creditors of the company. To
one interpreting a Balance Sheet, or to one charged with
the duty of preparing it, the first duty is to distinguish
properly between assets and the negative items which ap-
pear in the ledger, and which if not correctly treated will
appear on the debit side of the Balance Sheet, in the goodly
company of the assets. The better rule is to eliminate
such altogether from the asset side of the Balance Sheet,
but where for some reason this is not done, it is indis-
pensable that they be so labeled and distinguished that
there may be no uncertainty as to their real nature.

The difficulty in making proper discrimination is
greater because the ledger itself, of which the Balance
Sheet is an abstract and epitome, does not immediately
serve as a guide. The original transaction was a payment
of cash for services rendered or material supplied. Cash
being diminished, the cash account was properly credited
and some other special account, " Bindery account " in
the instance cited, was debited. But exactly the same


booking might legitimately be made whether the payment
was a loss transaction, or an exchange ; whether the amount
standing to the debit of " Bindery " represents an expense
or an asset. Nor can the proper determination be based
on the crude fact of whether or not there was an actual
purchase of material. For convenience in accounting it is
customary to treat some purchases, such as stationery, fuel,
oil, or material or equipment needed for replacements as
an immediate expense ; and on the other hand certain pay-
ments such as wages, and interest, for which nothing tangi-
ble is received in exchange, are at times legitimately
treated as representing the cost price of some tangible or
intangible asset. "Whether a given payment is an expense
(Loss or " Negative Proprietorship " transaction) or
whether it is the means of securing an equivalent asset
(Exchange transaction) is a fundamental problem, but one
sometimes difficult of determination. In either case it first
appears upon the books as a Debit entry in some account,
and may, therefore, ultimately be found among the items
which appear on the Debit side of the Balance Sheet.
Confusion may result either from purposeful deception,
or from the misunderstanding of ambiguous or doubtful

The difficulty of distinguishing between these two
classes of transactions has been made prominent in railway
accounting. To use the technical terms, it is an ever-recur-
ring problem whether a given expenditure is a Revenue
Expenditure or a Capital Expenditure, whether it goes
into Operating Expenses or into Construction Account. If
regarded as a Revenue Expenditure it works as a charge
against earnings and so reduces the net profits. If a Cap-
ital Expenditure, the Construction Account, that is, the
account representing the cost of the road, is debited and
the equivalent of the money expended is therefore carried
among the assets in the Balance Sheet.


No less than three theories exist as to the proper divi-
sion of expenditures between capital expenditures and
charges against revenue.

(1) The most commonly accepted is that in so far as
the transaction results in an addition of substantial and
permanent character which increases the value of the plant
such increase should be made to the construction account.
(Mackintosh v. Flint & Pere Marquette Ry. 34. Fed. Rep.
609). Or as it is clearly expressed in Hubbard v. Weare:
'* Money paid out should not be reckoned as an asset. If
paid for property that is on hand, the property is an
asset. If expended in a way that has enhanced the value
of the general assets it is included in its valuation. If so
expended as to have brought no property, and no enhance-
ment of that on hand then it is a loss, and should not be
counted as an asset." (79 la. 678.)

(2) A more extreme view is that expressed, for in-
stance, by T. F. Woodlock : ' ' An addition which does not
increase revenue or diminish expenditure is not a proper
capital charge according to the best modern practice in
railroads. That which simply tends to hold business and
not to increase business is a proper charge against operat-
ing expenses. ' ' l

(3) At the other extreme is the view, presented in the
decision by Lord Kyllachy in Cox v. Edinburgh and Dis-
trict Tramways Company, Lim. (6 S. L. T. 63, [1898])
that where an improvement is made in the plant, even
though it be in the nature of the substitution of new plant
for old, the entire cost of the new plant, and not merely
the excess in value of the new over the old may be charged
to Construction account.

Of these three views the first is not only the most gen-
erally accepted but seems to comport best with account-
ing principles. It has furthermore been authoritatively

1 Engineering Magazine, xi, 241.


adopted for railway accounting by the Interstate Com-
merce Commission. The second view, while praised for its
conservatism seems to imply that there nmst be a constant
rate of normal interest or profits, a condition denied by
economic history. If a general decline in profits occurs an
improvement which, in a given enterprise, prevents the
fall and maintains the old rate of profits is clearly a source
of additional value, and would be capitalized in the money
market. The third view is rarely justified by accountants,
but the principle involved is not dissimilar to that con-
cerned in the question of the loss of capital discusr^d fully
in Chapter XII.

Assuming (a) that it has been possible to differentiate
all expense items and (&) that all expense accounts have
been closed into Profit and Loss, and further (c) that all
mere Valuation Accounts are deducted from the appro-
priate account, the Balance Sheet, in its best form, con-
tains on the Debit side a list of all the assets belonging to
the concern and nothing else. In other words it is a com-
plete inventory, and in its preparation enter all the prob-
lems connected with taking an inventory of goods on

The problems of the inventory are three: (1) What
items are to be included in it? (2) What expenditures
are to be considered as entering into their cost price? (3)
In subsequent revaluations are the assets to be continued
at the original valuation or are their values to be estimated
on some new basis ?

These three problems are not entirely distinct. They
may all be implied in the last one, that of the current re-
valuation of assets; for it evidently matters not whether
an object, say a worn-out machine, be excluded from the
list of assets or be valued at zero ; it matters not what was
the original value of an asset if at each new inventory it
must be independently revalued. But in practical ac-


counting the questions are likely to arise somewhat in the
form and order given above.

1. What items are to be included in the inventory?
The underlying principle is that all valuable goods

are to be included. Goods is here used in the proper most
inclusive sense of all desirable things and does not in any
sense imply a discrediting of immaterial or intangible
property. Whether the property be material, consisting of
land, or permanent plant, or of merchandise; whether it
be less tangible credits such as securities, customers' notes,
or merely non-negotiable book-accounts; or whether it be
that most elusive form of property, Goodwill; in any
event, all goods are alike to be included in the inventory.
While Goodwill and the allied immaterial goods such
as patent rights, and trade names are forms of property
to which legal rights adhere, it may even be correct to in-
clude among assets items representing the cost of some
good to one who has no real property right therein. For
instance, the money paid by a railroad company to im-
prove a street giving access to its station, or the contribu-
tion which it has made to the cost of a tunnel are cited as
items which may legitimately be reckoned among the assets
of a company although it has acquired no legal property.

2. What is the cost price ?

At the time of acquiring a new asset it is normally
listed at its cost, even though the purchaser thinks he
has bought it at a great bargain. But oftentimes it is
not easy to determine just which expenditures entered into
the cost of the particular asset. This may well be illus-
trated by the case of a railroad where its principal asset
is the roadway, which in accounting frequently appears
under the title Construction Account. The cost of right of
way, the purchase price of rails and ties, the labor of
engineers, superintendents and laborers are all clearly part
of the cost of acquiring the road, and are to be charged to


the Construction Account. But a more debatable question
arises concerning payments not made in the form of a
direct purchase of property or payment for productive
labor but which may perhaps be construed as the cost
price of acquiring the property. In this class come what
are known as Organization Expenses. For instance, a cor-
poration is started with $100,000 capital, all of which is
paid in cash. In the process of organizing the corporation,
expenses must be incurred for stationery and printing, for
engraving certificates of stock, for fees paid to the state,
and to attorneys. These may amount, say, to $2,500. Is
this sum merely an expense, or does it represent part of
the cost ? If an expense, the corporation is in the position
of having encroached on its capital, for with a capital stock
of $100,000 it has no assets whatever except cash, and of
that it has only $97,500.

Interest charges are normally an unquestioned expense,
but even interest may at times be construed as capital ex-
penditure. Thus a railroad borrows money with which to
construct the road, an undertaking which will require sev-
eral years. During the period of construction interest
must be paid while no revenue is accruing. It is not un-
reasonable to say that the asset which the company is
acquiring is a finished road ready for operation. To secure
such a plant there must be paid not merely the cost of
material and equipment, the salary of engineers and the
wages of laborers, but equally essential is the payment
of interest to the bondholder. Without this latter pay
ment the finished road could not be acquired. To include
it among the costs of construction is, therefore, not illog-
ical, and the custom of so doing is gaining increasing legal
sanction. In an early American case (Gratz v. Redd. 4. B.
Mon. (Ky.) 178) the court held that interest on bonds is
not to be charged to construction, but the present practice
permits the interest paid during the period of construction


to be added to the cost of the road. In England the similar
early opposition on the part of the courts has been re-
moved by the Companies Act of 1907 which virtually
makes, not merely interest on bonds, but even dividends on
capital paid in lieu of interest during construction, a part
of the construction costs. And in Germany, where the
statutory regulation of accounting practice is generally
much more specific than in either England or America,
both interest and dividends thus paid are chargeable to
11 Construction Account." Some have argued that the
discount on bonds sold should also be charged to the cost
of the road. But so far as the bonds run longer than the
period of construction, the justification of such a practice
rests on an illogical distinction between discount paid in
advance, and current interest installments. As is shown
in the Chapter on Liabilities, discount on bonds is prepaid
interest for the entire life of the loan, and it is only inter-
est during construction, not for the later period that can
legitimately be construed as part of the cost of construc-
tion. The Interstate Commerce Commission has ruled that
discount on securities is not properly included in the cost
of property.

A similar problem arises in connection with the ex-
penses incurred in making experiments in search of new
inventions, now a recognized part of many industrial
plants. This may be treated as a part of general expense
but there is colorable argument on the other side. An im-
provement might be secured by purchasing a patent right
from an outside inventor. The alternative plan is to hire
the inventor to work for the company, in which case the
salary and other expenses incurred seem to be the cost of
the secured invention just as truly as the price paid for
the patent right. If this is so, may not expenses be
counted as part of the prospective cost even though the
goal has not been quite reached?


From the foregoing it is seen that it is by no means
easy to lay down a rule by which to determine whether
certain charges are to be treated as expense or whether
they are to be held in the Balance Sheet as representing
the cost of assets. From a purely theoretical view point

Online LibraryHenry Rand HatfieldModern accounting, its principles and some of its problems → online text (page 6 of 27)