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THE

ARTHUR YOUNG

ACCOUNTING

COLLECTION




Graduate School of
Business Administration

Library of the

University of California

Los Angeles




MMnfr^ UTHERN

UNIVERSITY OP CALIFO*!t

LIBRARY

LOS ANGELES, C,



Library
Graduate Sc^ol of Business Administration

Un i ~rr' ' :/ of California
Los Angeles 24, California



PRINCIPLES OF ACCOUNTING



THE MACMILLAN COMPANY

NEW YORK BOSTON CHICAGO DALLAS
ATLANTA SAN FRANCISCO

MACMILLAN & CO., LIMITED

LONDON BOMBAY CALCUTTA
MELBOURNE

THE MACMILLAN CO. OF CANADA, LTD.

TORONTO



PRINCIPLES OF
ACCOUNTING



BY
WILLIAM ANDREW PATON, PH.D.

Associate Professor of Economics in the University of Michigan
AND

RUSSELL ALGER STEVENSON, PH.D.

Associate Professor of Accounting in the University of Iowa



Weto ffotfc

THE MACMILLAN COMPANY
1920

All rights reserved



COPYRIGHT, 1918,
3v THE MACMILLAN COMPANY.



Set up and electrotyped. Published October, 1918.



J. 8. Gushing Co. Berwick & Smith Co.
Norwood, Mass., U.S.A.







Bus. Admin.
library

HF

5625

P27p



PREFACE



book is intended primarily as a text for general account-
ing courses in colleges and universities/) It may also be of interest
to other readers than college students who wish to understand

^ the fundamentals of accounting. Although new books are now

f\l being rapidly added to the list of general treatises on the subject

tf) the authors feel that no apology need be offered for the appear-
ance of this volume. There has been a dearth of material avail-
able for the student of economics who desires a broad training

^ in accounting principles as a part of a general equipment. The
texts available are, for the most part, too highly professional

\ and specialized for this purpose, and are without adequate* refer-
ence to the background of economic principles underlying all

oj' commercial transactions. In other words, although there are
many books intended for the business man and professional

^ accountant there are few works on accounting which even pro-
fess to be suited to the needs of the student of economics. It is
the aim of this book to present the principles of the subject in
such a way as to meet the needs of the general student as well
as to afford the proper basis for specialized work in professional
accountancy.

An effort has been made to develop principles without dis~
cussing the details of specific systems of bookkeeping and office
methods. This procedure implies that accounting is a science
dealing with logical classifications and embracing a definite
body of doctrine which can be developed independently of mere
clerical routine. Furthermore, since the classroom is not a
laboratory capable of reproducing exact business conditions,
and since bookkeeping methods are constantly changing, a
discussion of clerical details is of minor importance in a treatise
on principles. Once a student is thoroughly grounded a mastery
of the technical details of any particular system of accounts
is easily attained. On the other hand, the important general



vi PREFACE

features of technique have been sufficiently discussed and illus-
trated to familiarize the student with the fundamental types of
books and working papers used in modern practice.

The essential characteristics of modern business organization
and finance have received some consideration because of the
close relation of these matters to accounting. No attempt has
been made, however, to treat these topics elaborately or to refer,
for illustration, to specific legal cases. In the first place a too
full discussion of such subjects tends to leave the student with
a vague impression of the accounting principles involved. In
the second place such details as may be desired can be introduced
more effectively by means of problems and illustrations from
current practice furnished by the instructor. Further, special
courses in commercial law, business organization, corporation
finance, and similar subjects are generally conceded to be an
essential part of the course of study which should be prescribed
for the student of economics and accounting. Accordingly,
although it should be admitted that the professional accountant
requires a rather minute knowledge of these matters, it seems
evident that a lengthy study of such topics cannot properly be
included in a single course in accounting principles.

Although in the exposition of principles in the main part of
the book special systems of accounts are not discussed, it has
seemed advisable in Part Six to present a brief statement sug-
gesting some of the essential features of the more important
special fields. The topics considered have been chosen partic-
ularly because of the fact that in many institutions the ad-
vanced courses in accounting deal with these branches of the
subject. Part Six, then, serves to give to the student who wishes
to pursue special work a glimpse of the more important fields,
and also serves to give to the general student some impression
of the scope of accounting. No mention is made, however, of
the special systems required by banks, insurance companies,
commission merchants, brokerage houses, farm enterprises,
construction companies, etc. It would be out of the question
to include a study of many special systems in a single volume,
and in any case it is doubtful if such material is of much value
to the student of general accounting.

Certain rather important special features of this book should,



PREFACE vii

perhaps, be mentioned in the foreword. In the first place it
has seemed to the authors that the importance of the proprietary
interest, so-called, is unduly stressed in most textbooks. Indeed,
the usual treatment of the subject is so dominated by the doc-
trines of proprietorship that it might well be described as "pro-
prietary accounting." Although this theory of accounts is
not an unreasonable view for the accountant who is dealing
with very simple situations, as applied to the complex conditions
of modern business organization it becomes practically untenable.
Particularly in view of the present and growing importance of
the corporate form of organization, with all its complexities of
ownership, is it becoming more difficult to define proprietorship
on any but a conventional basis. Accordingly, the significance
of the concept of proprietorship in the theory of accounts has been
minimized in this book (although the accounting importance of
this, equity has by no means been neglected). The business
enterprise in its entirety has been emphasized as the accounting
unit of organization, and an attempt has been made to state
the theory of accounts in terms of the needs and purposes of all
the equities in the enterprise rather than from the standpoint
of any particular interest. The adoption of this view has lead
to certain important consequences in connection with the dis-
cussion of interest transactions and other topics.

In the presentation of the theory of valuation this book also
diverges somewhat from current treatments of the subject. A
logical theory of valuation for accounting purposes has been
adopted ; and for the sake of completeness and consistency this
view has been introduced even in the discussion of the elementary
principles of double-entry. It is possible and even advisable,
however, for the instructor to postpone the consideration of the
more difficult points implicit in this matter until they are
specifically taken up later in the text. Further, it should be
emphasized that the authors recognize that there are certain
practical difficulties in the way of the actual adoption, at all
points, of some of the theories presented. It is felt, however,
that the student of accounting should be trained in the logical
analysis of business situations, and that such training will pro-
mote rather than jeopardize his chances for professional success.

The discussion of the interest problem in this volume, partic-



viii PREFACE

ularly the mathematics of interest, is rather elaborate. It is
recognized that the mathematics of interest calculation is a
matter somewhat outside the field of accounting proper. Never-
theless the importance of this subject, particularly in connection
with certain branches of accounting, can hardly be overem-
phasized ; and there can be no doubt that it should form a part
of the regular course of study taken by the accounting student.
Moreover in many cases suitable courses in mathematics are
not available to supply this need. Even if such special courses
are available some review of (or introduction to) this work in
connection with a study of accounting principles seems advisable.
The instructor, however, who for any reason desires to abbre-
viate this part of the course may easily do so. Chapter XV is
designed to give a general view of the interest problem and might
be used, if a short course is desired, without Chapters XVI,
XVII, and XVIII. Or Chapter XVI alone might be omitted
without seriously impairing the availability of the remaining
chapters.

Finally, the terminology employed in this text does not con-
form to current business and accounting usage at all points.
Since this is primarily a book for the student it has seemed legiti-
mate for the sake of clearness to employ some terms which
differ from those in common use. Where the expressions used
here differ noticeably from current practice, however, the con-
ventional terminology is referred to. An attempt has been made
to standardize the nomenclature for ajl important conceptions.
A serious cause of confusion in accounting is the loose terminology
commonly employed. To some extent the terms adopted
by the Interstate Commerce Commission in its prescribed classi-
fications (which represent the most logical system of accounting
phraseology at present developed) have been used.

This book has been planned to suit the needs of the general
course in principles as was stated above ; and it is believed
that it can be used successfully in either one-year or two-year
courses. In many institutions a single course (running from
three to five hours per week through two semesters) is devoted
to the study of principles. In such a course, Part One, supple-
mented by laboratory work, will furnish sufficient material for
the first semester's work. In the second semester the student



PREFACE ix

is able to handle larger reading assignments in the advanced
topics, and the remaining chapters may be conveniently covered.
Where a two-year course of from two to three hours per week is
given, this text may still be used to advantage if supplemented
with considerable practice work in elementary accounting. In
any case, of course, practice work is necessary. The authors
have prepared a book containing about 500 problems and exer-
cises arranged in chapters specifically to accompany this text. 1 It
is probable that many instructors would consider it unnecessary,
if using this exercise book, to introduce other laboratory material.

The authors wish, in conclusion, to acknowledge their indebted-
ness to their instructors and colleagues (former and present) of
the University of Michigan who have furnished, in large meas-
ure, the background of economics and accounting which has
made possible the preparation of this text. Among these
should be mentioned, as having had a particularly important
influence, Professor H. C. Adams, Professor F. M. Taylor, and
Professor David Friday.

A special acknowledgment is due to Professor Friday for
suggestions which were used in the preparation of Chapter I,
and to Professor W. D. Moriarty of the University of Michigan
for reading the manuscript.

W. A. P.

R. A. S.

SEPTEMBER i, 1918.



1 Published by George Wahr, Ann Arbor, Michigan.



CONTENTS

INTRODUCTION

I

PAGE

THE NATURE AND SCOPE OF ACCOUNTING .... 3-13

THE BUSINESS ENTERPRISE 3

THE NEED FOR ACCOUNTING ANALYSIS .... 7

THE GENERAL PROBLEMS OF ACCOUNTING . IO

PART ONE
ELEMENTS OF ACCOUNTING

II

THE THEORY OF BALANCE SHEET ACCOUNTS .... 17-34

THE FUNDAMENTAL CLASSES OF DATA 17

THE ACCOUNTING EQUATION 2O

THE CONSTRUCTION OF ACCOUNTS 24

CLASSES OF TRANSACTIONS 29

DOUBLE-ENTRY DEBIT AND CREDIT 3 1

III

TEE CONSTRUCTION OF SUPPLEMENTARY ACCOUNTS . . . 35-5 5

CURRENT ASSET ACCOUNTS 35

EXPENSE AND REVENUE ACCOUNTS . . . . . 39

SPECIAL EQUITY ACCOUNTS 43

VALUATION ACCOUNTS 47

THE CLASSIFICATION OF ACCOUNTS 5

IV

THE ANALYSIS AND RECORDING OF TRANSACTIONS . . . 56-76

THE BOOKS OF RECORD AND ACCOUNT .... 56

xi



xii CONTENTS

PACE

THE JOURNAL 59

THE LEDGER 62

JOURNALIZING 64

POSTING 75



DEVELOPMENTS IN TECHNIQUE 77-102

THE SPECIAL-COLUMN JOURNAL 77

THE CASH BOOK 85

THE SALES BOOK QO

THE PURCHASE BOOK . . . . . . . . Q2

THE VOUCHERS PAYABLE REGISTER 93

SPECIALIZED LEDGERS 96

VI

THE ASSET ACCOUNTS 103-131

ACCOUNTS WITH FIXED TANGIBLES 103

ACCOUNTS WITH FIXED INTANGIBLES IIO

FUNCTIONAL CLASSIFICATION OF FIXED ASSET ACCOUNTS . 117

ACCOUNTS WITH CURRENT TANGIBLE ASSETS . . . I2O

ACCOUNTS WITH CURRENT RIGHTS 126

VII

FURTHER CLASSIFICATION OF EQUITY ACCOUNTS . . . 132-150

ACCOUNTS WITH FIXED EQUITIES 132

CLASSES OF EXPENSE AND REVENUE ACCOUNTS . . . 136

NET REVENUE AND SURPLUS ACCOUNTS .... 143

ACCOUNTS WITH CURRENT LIABILITIES .... 147

VIII

CLOSING AND INTERPRETING THE ACCOUNTS .... 151-191

THE TRIAL BALANCE 151

THE NECESSITY FOR THE INVENTORY AND APPRAISAL . . 154

CLOSING ACCOUNTS WITH FIXED ASSETS . . . . 157

MATERIALS, SALES AND SUBSIDIARY ACCOUNTS . . . 160

CLOSING MERCHANDISE ACCOUNTS 167

CLOSING ACCOUNTS RECEIVABLE ...... 174

CLOSING OTHER CURRENT ACCOUNTS 177

SUMMARY ACCOUNTS FOR SUNDRY ASSETS AND LIABILITIES 182



CONTENTS



Kill



CLOSING THE EXPENSE AND REVENUE ACCOUNTS
CLOSING THE NET REVENUE AND EQUITY ACCOUNTS

IX

THE PREPARATION OF STATEMENTS ....
THE EXPENSE AND REVENUE STATEMENT
THE NET REVENUE AND SURPLUS STATEMENT

THE BALANCE SHEET

THE TEN-COLUMN STATEMENT

THE WORKING SHEET

X

THE DETERMINATION OF NET REVENUE .
THE SIGNIFICANCE OF NET REVENUE .

THE CASH STATEMENT

DEFERRED CHARGES AND CREDITS

WASTING ASSETS

MAINTENANCE AND IMPROVEMENT
APPRECIATION AND DEPRECIATION



PAGE

184
I8 7



192-219

193
197
2OI
207
215



22O-243
2 2O
224
228
232

234
238



PART TWO
THE EQUITY ACCOUNTS

XI

PROPRIETORSHIP SINGLE-PROPRIETORS' AND PARTNERS' AC-
COUNTS 247-268

PROPRIETORSHIP 247

THE SINGLE-PROPRIETOR ENTERPRISE 250

COPARTNERSHIP PROPRIETARY ACCOUNTS . . . . 2$5

SPECIAL PROBLEMS IN PARTNERSHIP ACCOUNTING . . 260

XII

CORPORATE PROPRIETORSHIP CAPITAL STOCK . . . 269-293

CORPORATE PROPRIETORSHIP 269

THE TRANSITION FROM PARTNERSHIP TO CORPORATION . 276

ORGANIZATION STOCK ISSUED FOR CASH .... 280

DONATED AND TREASURY STOCK 285

SUBSIDIARY PROPRIETARY RECORDS ..... 290



xiv CONTENTS

XIII

PAGE

CORPORATE PROPRIETORSHIP SURPLUS ACCOUNTS . . . 294-312

CAPITAL SURPLUS AND DEFICIT 294

ACCUMULATED PROFIT AND LOSS 297

DIVIDEND APPROPRIATIONS 300

SINKING FUND APPROPRIATIONS 305

MISCELLANEOUS SURPLUS TRANSACTIONS AND APPRO-
PRIATIONS 308

XIV

THE LIABILITIES 313-327

ACCOUNTS AND NOTES PAYABLE 313

ACCRUED, DEFERRED AND CONTINGENT LIABILITIES . . 318

MORTGAGES AND BONDS 322



PART THREE
THE INTEREST PROBLEM

XV

A GENERAL ANALYSIS OF THE INTEREST PROBLEM . . . 331-348

THE INTEREST PHENOMENON 331

COMMERCIAL INTEREST 334

LONG-TERM SECURITIES 339

INTEREST IN VALUATIONS 344

XVI

INTEREST CALCULATIONS 349-386

THE ACCUMULATION OF PRINCIPAL 349

THE PRESENT VALUE OF A FUTURE SUM . . . . 355

THE ACCUMULATION OF AN ANNUITY 360

PRESENT WORTH OF AN ANNUITY 365

SINKING FUND CONTRIBUTIONS 372

THE ANNUITY WHICH A PRINCIPAL WILL PURCHASE . 374

THE APPORTIONMENT OF ANNUITY PAYMENTS . . . 376

THE VALUATION OF BONDS . 378

ACCUMULATION AND AMORTIZATION 381

DETERMINING THE INTEREST RATE 383



CONTENTS XV
XVII

PAGE

INTEREST TRANSACTIONS EQUITY ACCOUNTS .... 387-411

LONG-TERM NON-INTEREST BEARING NOTES .... 387

ANNUITIES 391

BONDS ISSUED AT PAR 395

BONDS ISSUED AT A DISCOUNT 4OI

BONDS ISSUED AT A PREMIUM 405

THE REFUNDING OF SECURITIES 409

XVIII

INTEREST TRANSACTIONS ASSET ACCOUNTS .... 412-429

INVESTMENTS IN SECURITIES . . . . . 412

INTEREST IN FIDUCIARY ACCOUNTING 421

SINKING FUNDS . . . . 425



PART FOUR
THE VALUATION OF ASSETS

XIX

ORGANIZATION AND CONSTRUCTION 433-450

ORGANIZATION COSTS 433

DEPRECIATION DURING CONSTRUCTION . . . " . 436
INTEREST, DIVIDEND AND TAX ACCRUALS DURING CON-
STRUCTION 438

THE CONSTRUCTION PERIOD ILLEGITIMATE COSTS . . 446

DISCOUNTS ON SECURITIES 448

XX

THE BASIS FOR REVALUATION 451-469 ,

THE GENERAL SIGNIFICANCE OF VALUE CHANGES ' . . 451

VALUATION AND MANAGEMENT 455

THE MEASUREMENT OF INVESTMENT OR SACRIFICE . . 461
SPECIAL OBJECTIONS TO THE RECOGNITION OF APPRECI-
ATION 463

XXI

THE VALUATION OF SPECIAL ASSETS 470-481

CASH AND RECEIVABLES 47



xvi CONTENTS

PACK

MERCHANDISE AND GOODS IN PROCESS 474

MACHINERY, BUILDINGS AND LAND 477

XXII

THE DEPRECIATION ACCOUNTS 482-505

THE DEPRECIATION PROBLEM 482

REPAIRS AND RENEWALS 485

THE REPLACEMENT POLICY 488

FORMAL DEPRECIATION ACCOUNTS 49 1

THE DEPRECIATION FUND 496

DEPRECIATION FUND RETURNED TO INVESTORS ... 500

THE POLICY OF REINVESTING THE FUND IN THE BUSINESS 503

XXIII

METHODS OF MEASURING DEPRECIATION 506-527

THE BASIS FOR MEASUREMENT 506

STRAIGHT LINE METHOD 511

THE SINKING FUND METHOD 515

THE COMPOUND INTEREST METHOD 517

PRESENT VALUE OF FUTURE REVENUE METHOD . . . 520

MISCELLANEOUS METHODS 524

XXIV

THE INTANGIBLE ASSETS . . . . . . . . 528-541

THE NATURE OF GOODWILL 528

THE VALUATION OF GOODWILL 530

GOING VALUE 535

MISCELLANEOUS INTANGIBLES 538



PART FIVE

THE CONSTRUCTION AND ANALYSIS OF FINANCIAL
STATEMENTS

XXV

THE INCOME SHEET 545-571

PURPOSES OF INCOME SHEETS 546

SUMMARY INCOME SHEETS 549



CONTENTS



xvii



THE COMPARATIVE INCOME SHEET
SOME SPECIAL FORMS OF INCOME SHEETS
FURTHER CLASSIFICATION OF OPERATING ACCOUNTS
THE CONSOLIDATED INCOME SHEET

XXVI

THE GENERAL BALANCE SHEET ....
GENERAL BALANCE SHEET CAPTIONS .
ILLUSTRATIVE BALANCE SHEETS ....
CLASSIFICATION OF ASSET ACCOUNTS .

XXVII

COMPARATIVE AND CONSOLIDATED BALANCE SHEETS
THE COMPARATIVE BALANCE SHEET
THE CONSOLIDATED BALANCE SHEET



555
558
563
567



572-586
572
576

584



587-598
587
592



STATEMENTS OF INSOLVENCY
STATEMENT OF AFFAIRS
DEFICIENCY STATEMENT .



XXVIII



599-605

599
603



PART SIX
SPECIAL FIELDS OF ACCOUNTING

XXIX

COST ACCOUNTING

THE PROBLEMS OF MANAGEMENT

THE CLASSIFICATION AND DISTRIBUTION OF EXPENSE .



609-619
609
615



XXX



MUNICIPAL ACCOUNTING

THE MUNICIPAL BALANCE SHEET
THE MUNICIPAL INCOME SHEET
THE MUNICIPAL BUDGET



620-628
621
623
626



xviii CONTENTS

XXXI

PAGE

RAILROAD ACCOUNTING 620-641

THE I. C. C. CLASSIFICATIONS 629

RATE REGULATION AND ACCOUNTING 638

XXXII

AUDITING 642-649

THE PURPOSES OF AUDITS 642

THE ESSENTIALS OF AUDITING 646



APPENDICES

A

THE TREATMENT OF CASH DISCOUNTS 653-656

B
INTEREST TABLES 657-667

C

RAILWAY STATEMENTS . . . . * . . . . 668-674

D

SELECTED BIBLIOGRAPHY 675-676

INDEX 677-685



INTRODUCTION



PRINCIPLES OF ACCOUNTING



THE NATURE AND SCOPE OF ACCOUNTING

ACCOUNTING, in a broad sense, is the science which attempts to
present and classify the statistics of the properties and property
rights in the business enterprise. All valuable considerations
coming into the possession of a business concern should be ac-
counted for, and the rights which various individuals and
interests have in the business must be protected. To accomplish
this, more or less elaborate statistical records are usually neces-
sary.

Since accounting has to do primarily with the private business
enterprise, the gaining of a general conception of the enterprise as
the accounting unit of organization is an essential preliminary
step in the study of this subject. In the following section the
nature of the business enterprise will accordingly be briefly
discussed.

THE BUSINESS ENTERPRISE

A business enterprise involves the investment of capital
funds, often by more than one individual, in some commercial
project. Such a venture, supposedly, contemplates the pro-
duction of some commodity or service which commands a price
on the market. The owners of the capital invested in any case
naturally expect to realize a gross income from the sales of the
product which will not only maintain the original investment
but will yield a net income as well. It is the function of account-

3



4 PRINCIPLES OF ACCOUNTING

ing to follow the investment, as it takes shape in various com-
modities and services, and to inform the investor as to the
amount and rate of net income and the subsidiary facts which
will enable him to make a rational disposition of his resources.

The familiar types of business organization in the United
States are the single-proprietorship, the partnership, and the
corporation. The joint stock company, a kind of halfway
house between the partnership and the corporation, is no longer
common in this country, having been almost entirely superseded
by the corporation. A brief statement of the nature of these
three common types of business units will be given at this point.

The single-proprietorship is a business enterprise conducted
by a single individual. Actual ownership of the property used
commonly resides largely in the hands of the proprietor, so-
called. The proprietor is usually the active manager of the
business and may furnish a considerable part of the ordinary
labor services required.

In a strict sense any capitalist, however humble, who is utilizing
his resources in an independent commercial venture, is a pro-
prietor, and his business is a single-proprietorship. The majority
of retail stores are of this type, many wholesale and manufactur-
ing businesses are single-proprietorships, and farm establish-
ments are almost always in this class. Such enterprises range in
importance from the fruit stand on the corner to the private
banking house or other large business having an investment of
many thousands of dollars. Very large aggregates of capital,
however, are seldom brought together under the single-proprie-
torship form.

Although the single-proprietorship is legally only a kind of
personal enterprise, and no formal steps of organization are
usually required for its initiation, still it is useful for the
accountant to conceive of such a business as a commercial unit
of organization. The personification of the business enterprise,
a figure so much deplored by some writers, is one of the funda-
mental ideas of accounting, and it may well be applied to all
kinds of businesses, the simple as well as the complex. In gen-
eral this view conforms to commercial and legal practice and no
apologies need be made for such a conception. The most im-
portant financial statement, the balance sheet, can always be



NATURE AND SCOPE 5

conveniently conceived as representing the financial condition
of a distinct business entity.

Probably the great majority of single-proprietors make but
an imperfect use of accounts ; but something in the way of
statistical records is essential in nearly all such cases, and
efficiency in the management of even the small concern would
generally be much advanced by an extension of the use of
systematic accounting methods. Certainly the accountant
should be familiar with the general nature of the single-pro-
prietorship and the accounting problems arising in such cases.

The partnership is an association of two or more persons by
contractual agreement in a business undertaking. Partnerships
are usually composed of but two, three, or four members, but
there may be any number of partners. The partnership associa-
tion is usually based upon a written agreement called the articles
of copartnership. This agreement commonly contains stipula-
tions in regard to investments, withdrawals of principal or in-
come, management, division of income, dissolution, etc.

It is fairly evident that careful accounting is much more im-
portant in the case of the partnership than in the case of the
single-proprietorship. Where more than one individual or interest
is involved in an enterprise questions of equity commonly arise.
The failure to keep a careful record of all business transactions
in such a case may result in the exploitation of one equity to the
advantage of another ; and at any rate if the business is of con-
siderable size and complexity the partners will be very much in



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