Roy Bernard Kester.

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The Profit and Loss account now shows on the credit
side all the items of income, and on the debit side all costs
and expenses applicable to the current period. Its balance
then gives the net profit (or loss) covering the period's
transactions.

Throughout the period, as the profit was accruing, the



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CLOSING BOOKS— SUMMARY STATEMENTS 233

proprietor has been drawing against it for personal use as
shown in his personal account. In order to show the amount
of profit remaining in the business, the balance of the Profit
and Loss account is transferred to the personal account, the
balance of which then gives this amount of undrawn profit.
The balance of the personal account is closed into the capital
account, the credit balance of which then represents the net
worth of the business at the end of this period and at the
commencement of the next.

Effect of Closing the Ledger

This completes the work of closing the ledger. All open
balances now shown on the ledger constitute either assets,
liabilities, or vested proprietorship. After the closing pro-
cess is complete, all temporary proprietorship records for the
current period have been closed out. Having served their
purpose of providing current information for the period,
these accounts have been cleared of their current record and
prepared to receive the record of the next period. The busi-
ness cycle for this particular business has been completed
and its correct history recorded.

Profit and Loss Not an Account for Current Entry

It should be kept clearly in mind that the process of
closing the books is merely a method, a device, by which the
transactions for the year are summarised and the net result
determined. This net result, whether a profit or a loss, be-
longs to the proprietor and must ultimately be shown in his
account. It is, therefore, manifest that the Profit and Loss
account is only a summary account and should never be used
for current entry. It is the medium by which the temporary
proprietorship accounts are summarized and through which
the net result is cleared into some vested proprietorship ac-
count or accounts.



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234 ACCOUNTING— THEORY AND PRACTICE

Making the Closing Entries

The two methods employed for bringing the closing
transactions on the books are the same as for the adjusting
entries, i.e., by entry direct on the ledger or by journal entry
first and then posted to the ledger. The second method has
two important advantages: first, by entering them in the
journal it is possible to add such complete explanation as
may be required in each case, while it is practically impos-
sible to do so in the ledger ; second, by entering all closing
entries in the journal, they are shown together in one place.
The adjustment and closing of the books constitute a most
important and vital process. Consequently, the method
making possible ample explanation and a complete record
in one place is the best.

Closing the Books Illustrated

In order to give full and complete illustration of the
process of adjusting and closing the books through the
journal, a trial balance of M. J. Duncan's ledger is shown,
together with the data for adjustments. The illustrations
given include the adjusting and closing entries, the ledger
Profit and Loss account, the profit and loss statement, and
the financial statement. Arbitrary folio numbers are used
throughout.

Trial Balance, December 31, 1916

Cash $i^5ai9

3 Notes Receivable 1,490.00

4 Accounts Receivable 3t67540

10 Merchandise Inventory ' ^i&^>

10 Delivery Equipment 56075

11 Furniture and Fixtures 432.50

14 Notes Payable $1,000.00

15 Accounts Payable 1,620.15



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CLOSING BOOKS— SUMMARY STATEMENTS 235



Trial Balance — Continued

ao M. J. Duncan, Capital

21 M. J. Duncan, Personal 73L01

35 Sales

1 36 Sales Returns and Allowances 467.70

38 Purchases 16,58020

/ 39 Purchases Returns and Allowances

40 In Freight and Delivery 279.80

45 Clerk's Salary M40.50

y/4/b Delivery Expense 440.90

46 Insurance ^ 5140

47 Office Salafy. 695XX)

47 Light and Heat 40.70

48 Office Supplies 125.60

49 General Expense 590.17

SI Interest and Discount



lo^ooaoo
19,478.90



1,590.10



5ai8



$33,739-3(3 $33,739.33



Adjustment Data, December 31, 1916

Merchandise Inventory. $6, 720.81

Unexpired Insurance /. 15.20

Office Supplies Inventory 30.19

Office Salary Accrued 25.00

Interest Receivable 1041

Depreciation of Delivery Equipment estimated at 16 2^3%.
Depreciation of Furniture and Fixtures estimated at 10%.
Bad Debts estimated at 2% of the outstanding Accounts
Receivable.



1916
Dec. 31



Journal of M. J. Duncan



Purchases 38 $5,187.51'

Merchandise Inventory 10

To transfer initial inventory.

Merchandise Inventory 10 6^7aa8i

Purchases 38

To bring the final inventory
onto the books.



$5,187.51



6,720.81



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236 ACCOUNTING—THEORY AND PRACTICE

Journal of M. J. Duncan — Continued

Insurance (Deferred) 46 15.20

Insurance 46 15.20

To defer the unexpired in-
surance to next year.

Office Supplies (Deferred) 48 30.19

Office Supplies 48 jaip

To defer till next year the cost
of supplies now on hand.

Office Salary 47 25^00

Office Salary (Accrued) 47 25.00

To charge current period with
unpaid salary.
Interest and Discount (Accrued) .... 51 1041

Interest and Discount 51 1041

To credit current period with
interest earned but not yet
due.

Depreciation 53 136.71

Depreciation Reserve Delivery

Equipment 10 93^46

Depreciation Reserve Furniture

and Fixtures 11 43.25

To show the appraisals of the
above assets and charge cur-
rent period with expense of
depreciation.

Bad Debts S3 73.5B

Reserve for Doubtful Accounts. . 4 73.51

To show estimated loss from /
uncollectible accounts. /

Sales 35 467.70

Sales Returns and Allowances... 36 467.70

To show net sales.

Purchases 38 279180

In Freight and Delivery 40 27980

To show full cost of purchases.
Purchases Returns and Allowances.. 39 1,590.10

Purchases 38 l»590.io

To show net purchases and
cost of goods sold.

Sales 35 i9,o"-ao

Profit and Loss 76 19,011.20

To close.



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CLOSING BOOKS-SUMMARY STATEMENTS



237



Journal of M. J. DuNCAN^-Co»/m«^<i

Profit and Loss ^(^ 13,736.60

Purchases 38 i3»736.6o

To close.

Profit and Loss t6 3>^4-I0

Clerk's Salary 45 1,140.50

Delivery Expense 46 440.90

Depreciation S3 136.71

Office Salary. 47 720.00

Light and Heat 47 40.70

Office Supplies 48 * 9541

General Expense 49 590.17

Insurance 46 36.20

Bad Debts 53 73.51

To close.

Interest and Discount 51 60.59

Profit and Loss 76 60.59

To close.

Profit and Loss 76 2,061.09

M. J. Duncan, Personal 21 2,061.09

To transfer net profit.

M. J. Duncan, Personal 21 1,330.08

M. J. Duncan, Capital 20 i,33ao8

To close Personal account



The Profit and Loss Account

The first eight journal entries shown are the adjusting
entries, the others are closing entries. It will be seen that
frequent use is made of compound journal entries; thus a
number of proprietorship accounts are closed into Profit and
Loss by means of one entry. In posting the profit and loss
element of such entries, it is customary, in small concerns,
not to post the single total, but the individual items shown
by the contra side of the journal entry. In this way the
Profit and Loss account in the ledger will show the individ-
ual accounts closed into it, with the corresponding amounts
charged or credited to Profit and Loss. This Profit and
Loss account will then appear as follows;



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238



ACCOUNTING— THEORY AND PRACTICE



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CLOSING BOOKS-SUMMARY STATEMENTS 239

Need for the Summary Statements

The two periodic statements — ^the statement of financial
condition and profit and loss — do not form an integral part
of the books of account. They are drawn up periodically
and submitted to the proprietor, because the latter does not
always have ready access to the books of account and usually
lacks sufficient knowledge of accounting to interpret cor-
rectly the information shown by the journal and ledger.
The periodic statements are intended to shoA^ the results of
the year in a concise, non-technical form, so that a proprie-
tor, even though not versed in the science of accounts, can
readily understand them.

The Financial Statement

The statement of financial condition may be arranged
in either of two forms. The first form illustrated follows
the principles already laid down and is usually called the
"Financial Statement." Reference to Chapter IV will give
explanation of the essential points to be considered in draw-
ing* up this statement. The second form is usually called
the "Balance Sheet:" It shows financial condition by means
of the account form, the subtraction of the liabilities from
the assets being indicated by their respective positions in
the account. It will be noticed, however, that this method
of showing the subtractions is not strictly adhered to, some
deductions being actually performed, as for instance in the
case of Bad Debts which is subtracted from Accounts Re-
ceivable. This is done in order to render the statement
more intelligible. The same principles govern the arrange-
ment of the items and groups of items as in the first form,
viz., degree of liquidity for the assets and a similar arrange-
ment for the liabilities.

Form (i), sometimes called the report or non-technical
form, is perhaps more in favor in the United States because



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240 ACCOUNTING— THEORY AND PRACTICE

it seems more readily intelligible to the man unversed in
technical account-keeping. Form (2) may be called the
account or technical form and is the form used generally in
statements drawn up for publication. These two forms
are illustrated below.

Financial Statement — Report Form
M. J. Duncan
Financial Statement, December 31, igi6

Assets

Cash $1,250.19

Notes Receivable. .' 1,490.00

Accounts Receivable $3»675.40

Less, Reserve for Doubtful Accoimts 73-51 3,601.89

Merchandise on Hand 6,720.81

Insurance Unexpired 15-20

Office Supplies Inventory 30.19

Interest Receivable 10.41

Delivery Equipment $560.75

Less, Reserve for Depreciation 93U46 . 467*29

Furniture and Fixtures $432.50

Less, Reserve for Depreciation 43-25 38925

Total Assets $13,975.23

Ltabiliiies

Notes Payable $1,000.00

Accounts Payable 1,620.15

Office Salary Accrued 25.00

Total Liabilities 2,645.15

Net Worth



M. J. Duncan, Capital, January i, 1916 $10,000.00

Net Profit for the year $2,061.09

Less. Net Withdrawals 73i-Oi i,330-o8

Present Worth $ii.330.o8



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CLOSING BOOKS-SUMMARY STATEMENTS



241



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242 ACCOUNTING— THEORY AND PRACTICE

Balance Sheet and Financial Statement Differentiated

With regard to the two forms under the titles "Financial
Statement" and "Balance Sheet," it will be noticed that
there is no essential difference ; both show assets, liabilities,
and net worth. While the titles as given are usually applied
respectively to forms (i) and (2) as stated above, there
is no reason why they may not be used interchangeably with
either form and they will be so used hereafter. It will bo
noticed that form ( i ) is the expression of financial condition
in accordance with the proprietorship equation stated as,

Assets — Liabilities = Proprietorship

whereas form (2) expresses it as,

Assets = Liabilities + Proprietorship

It is this grouping together of liabilities and pro-
prietorship that has often led to an attempt to find points
of similarity between these two fundamental classes of ac-
counts.

Two Forms for the Profit and Loss Statement

The statement of profit and loss may also be made
up in two forms, called the report and the account form,
based on the same principles as the two forms of balance
sheet just discussed. Explanation of the report form has
already been given in Chapters VI and VII. The account
form is very nearly a rescript of the ledger Profit and Loss
account. It differs chiefly in that the information concern-
ing "sales" which is summarized in the Sales account on
the ledger is here set up in an inner column and shown sum-
marized on the face of the statement. Similarly, the
information developing cost of goods sold is summarized
on the face of the statement. The two forms given below
illustrate.



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CLOSING BOOKS— SUMMARY STATEMENTS 243

Profit and Loss Statement — Report Form

M. J. Duncan

Profit and Loss Statement^ December 31, 1916

'Kales $19,478.90

Less, Returns and Allowances 467.70



Net Sales $19,011.20

Merchandise Inventory, January i,
1916 $5,187.51

Purchases $16,580.20

Less, Returns And Allow-
ances r,590.io



Net Purchases $14,990.10

In Freight and Delivery... 279.80 15,269.90 $20457^^1



Merchandise Inventory, December 31, 1916 6,720.81



Cost of Goods Sold 13,736.60

Gross Profit $5,274.60

Selling Expenses:

Clerk's Salary $1,140.50

Delivery Expense 440.90

Depreciation 136.71 $1,718.11



General Expenses:

Office Salaries $720.00

Light and Heat 40.70

Office Supplies 9541

General Expense 590.17

Insurance 36.20

Bad Debts 7351 i,555-99 3,274-10



$2,000.50
Interest and Discount 60.59



Net Profit for the year $2,061.09



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244



ACCOUNTING— THEORY AND PRACTICE



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CLOSING BOOKS— SUMMARY STATEMENTS 245

In conclusion, k may be remarked that often in practice,
after the adjusting entries are brought on the books, these
periodic statements are first made up before bringing the
closing entries on the books. This makes possible a proof
of the work before any entries are actually made. Where
this method is followed, the profit and loss statement may
be used as a guide in writing up the closing entries on the
journal, because the results shown there have been proven
and the statement sets forth the amounts needed for the
closing entries.



Problems*

(Assignment for Chapter XXX)

Make the adjusting and closing entries through the Journal for
Lindsey's books. Calculate percentage of cost of sales, gross trading
profit, selling expenses, general administrative expenses, and net
profit. (Use "sales" as the basis.)



*Sec Problems at end of Chapter XXIX.



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CHAPTER XXXI

THE CLASSIFICATION OF ACCOUNTS

The Purpose and Method of Account-Keeping

Accounts record the business history of a concern. The
main purpose for which accounts are kept is to secure in-
formation as to the results of business activity and endeavor.
The record required for this purpose can be made very
brief, although the history of every business comprises a
multitude of transactions covering a great mass of details.
.The whole scheme and method of account-keeping is de-
signed chiefly to collect and summarize the detail and thus
lose sight of the many items, using the detail mainly for
the purpose of building up a summary which shall give in
rapid review the entire record for the fiscal period. Account-
keeping is to the bookkeeper what shorthand is to the
stenographer — an abbreviated method of making the record.
The uses to which the records are put, however, differ radi-
cally. Instead of being turned back again to the story in
all its details, as in the case of the stenographer, the account
balance or summary is really the starting point for further
summarization and abbreviation to free the essentials from
their non-essential elements and coverings in order to secure
the bird's-eye view of the whole.

Classification of Accounts

It is evident from the above, that account-keeping,
having so definite a purpose and end, must be carried out
with great care in the original analysis and record. To aid
in securing a record correct in the first instance, certain

246



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THE CLASSIFICATION OF ACCOUNTS 247

fundamental groupings or classifications of accounts have
been made. It is the purpose of this chapter to discuss the
various account classifications proposed and to lay down
fundamental considerations governing them.

Early Classifications

Perhaps, because originally accounts were kept only
with persons, the first grouping, in point of time, was into
personal and impersonal accounts, this being brought about
at the time of the introduction of the present method of
account-keeping as distinguished from the single-entry
systems previously in use. The personal group includes all
accounts with persons — customers, creditors, proprietor, and
certain other accounts such as consignment and venture
accounts which are not so clearly included in the personal
group as the other three examples given. The impersonal
group includes all others, i.e., those with other forms of
assets as cash, merchandise, land; those with other forms
of liability as notes and mortgages payable; those with
expenses; and finally those with earnings or income.

In a controversy arising out of trouble with rival
business colleges, Thomas Jones, writing in 1859 on the
"Paradoxes of Debit and Credit Demolished," suggested a
simple and, in most ways, a satisfactory classification of
accounts. Jones was undoubtedly one of the first writers
to get a true perspective of accounts and their use. Instead
of building up his classification from a study of ledger
accounts as usually kept, and attempting to find the points
of similarity and of difference among them, he attacked the
problem from the viewpoint of the final account summaries
which he called the financial and the business statements,
using the latter term to comprise the statement of profit and
loss. Corresponding to these two summaries and based on
them, all accounts in the ledger were classified by him as



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248



ACCOUNTING— THEORY AND PRACTICE



primary and secondary. Those destined ultimately for the
financial statement were primary; those for the business
statement were called secondary. He even went so far as
to show how business transactions result in increases and
decreases of the two classes, when recording them on the
books. So far as known, his attempt at a scientific classi-
fication was the first made by any American writer.

Recent Classifications

Using the same basis for their groupings as did Jones,
later writers have classified accounts in various ways, re-
ferring to assets and liabilities as real, specific, and exterior ;
and to accounts belonging to the profit and loss statement
and capital items, as nominal or representative, economic,
and interior. All of these classifications are good and bring
out different characteristics of the two groups.

Asset and liability accounts may be called "real" or
"specific," because they represent, in the main, properties
owned or owed which are definite and usually tangible.
Perhaps, in a certain sense, liabilities are more real and
specific fiian are assets. Still, either term connotes a true
characteristic of the items covered. Exterior is used in the
sense that the properties referred to and listed are "material
factors outside of the proprietor, the only thing inhering in
him being a right or claim to ownership in the 'net' prop-
erties." This class of accounts is sometimes further sub-
divided into personal and impersonal accounts, the former
comprising all accounts with persons, i.e., customers, credi-
tors, etc., while the latter include all other asset and liability
accounts. This is the only correct use of these terms,
personal and impersonal; that referred to in the preceding
section being entirely wrong from the accountant's view-
point, as will appear a little later after the fundamental re-
quirements for a correct classification have been laid down.



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THE CLASSIFICATION OF ACCOUNTS



249



The accounts used in the profit and loss statement, which
explain the changes in the assets and Habihties within a
stated period, are nominal in the sense that, in themselves,
they represent nothing real but are only the names given
to the forces and factors which have brought about certain
conditions. In this same sense these accounts may be termed
representative, although this title is also used as an alterna-
tive term for impersonal, this use being based on the per-
sonification theory that "cash" represents the "cashier" and
"sales" the "salesman," etc. A better title is, perhaps,
economic, inasmuch as they make record of the economic
progress, the character of the management and the business
economy practiced in the conduct of the enterprise. The
term interior as applied to these accounts indicates that the
factors recorded are at work inside the business, as dis-
tinguished from the outward or exterior showing of the
real and tangible accounts.

Classification Used Here

The classification of accounts used in this work has been,
in the main, a three-phase one, consisting of an asset, liabil-
ity, and proprietorship nomenclature. The third group of
accoimts, proprietorship, is further divided into the two sub-
classes, temporary and vested,- as explained in Chapter XIII.
At the end of the fiscal period, after the ledger has been
closed, there appear only asset, liability, and vested pro-
prietorship accounts; but during the fiscal period, the tem-
porary proprietorship accounts come into being and certain
asset and liability accounts take on a mixed character result-
ing from the method in which we keep the record. This
method is dictated not by a pure accounting theory, but
by a theory bent to accommodate itself to the practical
requirements of the average business. It is because the
practical method of making the record falls short of a



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250



ACCOUNTING— THEORY AND PRACTICE



theoretically exact method, that adjustments must be made
before summarizing.

Thus, we do not make a daily record of the portion of
our assets which has been consumed that day, but adjust
any particular asset account at the close of each fiscal period,
separating its asset and proprietorship elements. Also, when
our note is discounted at the bank, we set up the face value
as a liability, but from the standpoint of accurate accoimting
the face value of the note overstates the liability for the
current period, unless the note comes due during the period
or at its close. Only at its due date does the record make
a showing of true condition. If the note falls due in a
later fiscal period, the face value overstates the present lia-
bility by the amount of the prepaid interest charge belong-
ing to the next period. Thus, a "practical" method of
keeping the record necessitates the use of certain "mixed"
accounts, but fundamentally the three-group classification
given will answer every purpose.

Fundamentals of a Good Classification

In judging the fitness of a particular classification,
the end and purpose for which the classification is made
must always be the criterion. So, any classification of
accounts must have in view the fact that all accounts lead
up to the balance sheet and profit and loss statement, and
that they must provide the summaries necessary for these
statements. A large number of classifications may be made



Online LibraryRoy Bernard KesterAccounting theory and practice .. → online text (page 17 of 42)