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Title: Accounting theory and practice, Volume 1 (of 3)
a textbook for colleges and schools of business administration

Author: Roy B. Kester

Release date: March 24, 2023 [eBook #70367]

Language: English

Original publication: United States: Ronald Press, 1922

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*** START OF THE PROJECT GUTENBERG EBOOK ACCOUNTING
THEORY AND PRACTICE, VOLUME 1 (OF 3) ***

ACCOUNTING
THEORY AND PRACTICE

A TEXT-BOOK FOR COLLEGES AND
SCHOOLS OF BUSINESS ADMINISTRATION

BY

ROY B. KESTER, Ph.D.
CERTIFIED PUBLIC ACCOUNTANT; PROFESSOR OF ACCOUNTING,
SCHOOL OF BUSINESS,COLUMBIA UNIVERSITY

VOLUME I
(FIRST YEAR)
SECOND EDITION

Third Printing

NEW YORK
THE RONALD PRESS COMPANY
1922

Copyright, 1917, by
The Ronald Press Company
Copyright, 1922, by
The Ronald Press Company
All Rights Reserved

To My Father and Mother
An Appreciation of Their Steadfast
Interest in My Work

PREFACE
The basic soundness of the method of instruction in Accounting
developed in this book has received substantial demonstration throughout
five years of test. The Introduction to the first edition contained the
following statement regarding the development of the subject:
“The method of approach as given in this volume is perhaps not
orthodox but it has seemed that the student, given an understanding of the
purpose which the accounting records are to serve, will be able to make that
record with real intelligence instead of by rule-of-thumb. Accordingly, the
balance sheet and the profit and loss statement are presented first, as the
goal towards which all record-keeping looks. The student is taught to
analyze business facts and conditions from the very beginning. He is then
led, step by step, through the use of non-technical terms, into the ledger,
where he sees the way in which the data which he has been using are
summarized. The books of original entry are next explained, and the
method by which the information is classified as it is brought onto the
books. Finally, the business papers and documents which constitute the
source of all entries are described.”
To quote again from the original Introduction: “The subject is developed
in such a way that the student knowing something of bookkeeping has little
or no advantage over the one without such knowledge. This book has been
written for the use of students in our colleges and universities desiring a
first course in accounting. It gives the scope of the work in accounting
offered in the first year of the School of Business of Columbia University.”
The method then advocated and used in a few institutions has become
quite generally accepted. It has justified itself by the ease and extent to
which students without any previous training in accounting have grasped
the essentials of the subject. Experience with the book in the classroom,
however, and changing ideas with regard to manner of presentation and
sequence of material, have shown as desirable a rearrangement of some
parts and an addition of new material in places. Accordingly, a systematic
revision has been made.

The arrangement of the subject matter of the first portion of the book
has been altered but slightly. The use and function of the balance sheet and
profit and loss statement have been somewhat amplified. The working sheet
has been introduced earlier than in the first edition to afford an easy
summary of the period’s results. It should later on be made a part of the
regular work of summarization. The controlling account is also explained
earlier so as to afford more practice in its use. The accounting features of
the partnership and of the corporation are given continuous treatment. Here
a new chapter has been added, which discusses certain features of the
corporation not treated in the original book such as the issue and sale of
treasury stock and of bonds, bond interest as related to premium and
discount, sinking fund, sinking fund reserve, redemption of bonds, etc.
The material presented in the last quarter of the book deals with the
interrelations of accounting, financial management, buying, and marketing.
Thus the chapters dealing with the handling of cash, notes receivable and
payable, cash discounts, and balance sheet valuation, treat of the relations
between accounting and financial management. Several chapters at the end
treat of some special methods of accounting practice and of the basic
principles of single entry. In this portion of the book new chapters on
balance sheet valuation and on buying have been added.
Entirely new problem material has been furnished, carefully graded and
related so far as possible to the subject matter of the chapters of the text.
For the convenience of the student this material is separated from the text,
and grouped in three appendices. A few of the problems have been drawn
from the examinations of various state boards and the regents of the
University of the State of New York, and from other miscellaneous sources,
to all of which acknowledgment is due. The author is indebted to Mr.
George B. Kelley for assistance in building up a large part of the practice
material. It need hardly be said that a fundamentally sound knowledge of
accounting cannot be gained without ample practice work. Theory can
never be sure of itself until put to the test of practice.
The author desires to acknowledge again his debt to the many friends
whose counsel and aid counted so largely in the first writing of this book. In
the revision he finds himself still further indebted to many instructors in all
sections of the country for criticism and suggestion. He desires especially to
express his appreciation of the active co-operation of his associates on the

Columbia staff of instructors in First Year Accounting, in particular Miss
Nina Miller and Messrs. Ralph T. Bickell and E. Gaylord Davis. In the
actual work of revision Messrs. Eskholme Wade, John Jaffee, and Raymond
Gatchell have given valuable assistance.

Roy B. Kester
Columbia University,
New York City,
July 22, 1922

CONTENTS
CHAPTER PAGE
I Basic Relationships—Proprietorship 1
II Assets, Liabilities, and Capital 11
III The Balance Sheet 22
IV The Comparative Balance Sheet 32
V The Economic or Profit and Loss Elements of a Business 38
VI The Profit and Loss Summary 44
VII Interrelation Between the Economic and the Financial
Elements of a Business, and Some Inter-Ratios 57
VIII The Account 67
IX The Account (Continued) 72
X The Philosophy of Debit and Credit 78
XI Debit and Credit as Applied to Asset and Liability Accounts 85
XII Debit and Credit as Applied to Proprietorship Accounts 91
XIII Debit and Credit as Applied to Mixed Accounts 97
XIV Periodic Work on the Ledger 106
XV Periodic Adjustments and Summarization 115
XVI Sources of Data for the Ledger 132
XVII The Subdivision of the Journal 136
XVIII The Purchase and Sales Journals 139
XIX The Cash Journals 147
XX The Modern Journal 162
XXI Business Papers—Negotiable Instruments 173
XXII Business Papers—The Goods Invoice and Bill of Lading 185
XXIII Banks and Their Methods 192
XXIV Methods of Posting 199
XXV The Trial Balance and Methods of Locating Errors 204
XXVI The Classification of Accounts 213
XXVII The Work Sheet and Summary Statements 221
XXVIII Adjusting and Closing the Books 237
XXIX Types of Accounting Records and Their Development 251
XXX Controlling Accounts 264

XXXI Handling Controlling Accounts 272
XXXII Partnership from a Business Viewpoint 284
XXXIII Partnership from the Accounting Viewpoint 290
XXXIV Capitalization of the Partnership 297
XXXV Other Partnership Problems 305
XXXVI Partnership Profits 313
XXXVII Partnership Dissolution 321
XXXVIII The Corporation 330
XXXIX Opening the Corporation Books 338
XL Current and Closing Entries for the Corporation 351
XLI Handling the Cash 366
XLII Notes Receivable and Payable 376
XLIII Problems Encountered in Recording Notes Receivable and Payable 384
XLIV Discounts 392
XLV Balance Sheet Valuation 403
XLVI Buying and Stock Control 420
XLVII Sales 433
XLVIII Consignments 447
XLIX Adventure Sales 460
L Accounts Current 468
LI Balancing Methods 477
LII Some Application of Interest and Proportion 485
LIII Single or Simple Entry 495
LIV Illustration of Single Entry 504

Appendix A—Practice Work for Student—First Half-Year 513
B—Practice Work for Student—Second Half-year 553
C—Miscellaneous Problems for Supplementary Work 597

FORMS
FORM PAGE
1. Form of Ledger Accounts 70
2. Chart of Accounts 75
3. Accounts Balanced and Ruled 109
4. Transfer of Accounts to a New Page 112
5. Personal and Notes Payable Accounts 113
6. Standard Form of Journal 135
7. Purchase Journal 142
8. Modern Type of Purchase Journal 142
9. Departmental Purchase Journal 144
10. Cash Book (Cash Receipts Journal) 148
11. Cash Book (Disbursements Journal) 149
12. Columnar Cash Book—Debit Side 158
13. Columnar Cash Book—Credit Side 159
14. Divided Column Journal 164
15. Opening Entries on Books 166
16. A Promissory Note 175
17. A Draft 175
18. A Bank Draft 180
19. Forms of Checks 182
20. Monthly Statement of Account 191
21. Bank Deposit Ticket 193
22. Cross-indexing in Posting 202
23. Work Sheet 226-227
24. Balance Sheet—Report Form 232
25. Balance Sheet—Account Form 233
26. Statement of Profit and Loss—Report Form 234

27. Statement of Profit and Loss—Account Form 235
28. Profit and Loss Account in Ledger 249
29. Standard Ledger—Divided Column 258
30. Standard Ledger—Center Column 258
31. Balance Ledger Rulings 259
32. Balance Ledger Rulings 259
33. Boston Ledger Sometimes Used for Depositors 262
34. General Journal 279
35. Sales Journal Summary 279
36. General Journal Summary 281
37. Cash Book Summary Book—Receipts Side 282
38. Cash Books Summary Book—Disbursements Side 282
39. Petty Cash Book 369
40. Weekly Statement of Receipts and Disbursements 375
41. Notes Receivable Journal 380
42. Discount Columns Used for Cash Balance 400
43. Stock Control Card 430
44. Account Sales 451
45. Form of Adjusted Account Current 470
46. Account Marked for Analysis 478
47. Ledger Analysis Sheet 480

Accounting—Theory and Practice

CHAPTER I
BASIC RELATIONSHIPS—PROPRIETORSHIP
Records and Their Functions.—As far back as our knowledge
reaches, records of some sort have been kept and used and they have
frequently formed the basis on which our knowledge rests. In a broad sense
a record may be defined as a written memorial, a register or history of
events, a testimony. Even though the desire to make and hand on to the
future a record of achievement is a deep-seated characteristic, record-
making has seldom been an end in itself. Knowledge of what has been done
has always been a starting point and a guide for future achievement. The
longhand or narrative record is indispensable in some fields of knowledge;
the shorthand or statistical record is equally necessary in others. The
statistical method and accounting are, without question, most potent
agencies for the advancement of human knowledge and for the control of
human relationships. They provide the basis in fact on which judgments
must largely rest. This book, therefore, may begin by sketching the relation
of accounting to some of the larger fields of human endeavor—the
economic organization of society and the law—to point out its place in the
business unit and briefly state the basic function it performs therein.
The Business Unit.—To carry on its various activities, economic
society has organized itself into numberless separate units or business
organizations. These units are the means through which society operates,
their ultimate purpose being the easy and efficient satisfaction of human
economic wants. Individual business units, conducted as they are by
members of society, are under the broad general supervision of society as a
whole. This is evidenced everywhere by the laws, licenses, and regulations
by which society attempts to regulate the activities of the individual for the
larger interest of society as a whole. As business is conducted in most parts
of the world, it is highly individualized rather than communized. There is a
growing tendency, however, for society to exercise a larger control and
supervision over all types of individual activity, particularly with a view to

conserving the welfare of its members. The business unit is thus the
medium through which society works to satisfy its economic wants.
Internal Organization of the Business Unit.—Society early found that
only by means of a highly specialized division of its activities was it
possible to satisfy without waste its rapidly increasing economic wants.
Individual business units are thus organized for the purpose of carrying on
some one or more of these greatly subdivided activities. Within itself the
business unit is organized into departments or divisions for the efficient and
thrifty handling of its work. The two large divisions in any business
undertaking have to do with what the economist calls the production and
exchange of wealth, that is, commodities, services, and so forth. In carrying
on these activities of production and exchange it has usually been found
desirable to segregate into separate departments certain major functions
which are common both to production and to exchange. What the major
departments may be depends very largely upon the size of the business unit,
its relative complexity of organization, and to some extent on the individual
ideas of its managers. Throughout the business world one notes, however, a
quite general departmentization under the following heads:

1. Finance
2. Procurement or production
3. Marketing or distribution
4. Personnel
5. General administration

There are two main activities under the control of the finance division
of a business: (a) the problem of original investment, including that of
location and acquisition of a plant suitable for the conduct of a
contemplated business; and (b) the problem of operating finance, that is, of
providing the business with a fund of working capital for its efficient
operation. The financing of purchases, sales, credits, operating expenses,
and so forth, comprises a large part of the work of finance of an operating
or going concern.
In the second of the major departments, that of procurement or
production, one finds these activities: (a) the purchasing of the stock-in-
trade to be dealt in, if the concern is a trading business; or (b) the

manufacture of the stock-in-trade, if the concern is a manufacturing
business.
In the department of marketing or distribution, the following activities
center: (a) those having for their purpose the creation of a market or
demand for the commodity dealt in—the sales organization, the advertising
activities, and so forth; (b) the actual selling of the commodity; and (c) the
transportation and delivery of the product.
In the personnel department are included the human relations between
employer and employee. The hiring and training of the employee, his
classification and rating, his welfare and promotion, are the major activities
here.
The function of the department of general administration is in the main
that of supervision and management of the business as a whole. The general
manager must have a view of all of the activities of the business. He must
see that the various departments through which its activities are carried on
are properly correlated, that it is so organized that its departments function
smoothly and efficiently in the performance of their several duties. A
consideration of the means employed by the general manager for the proper
performance of his duty indicates the place of accounting in the business
unit.
Place of Accounting in Business.—In a small business where the
owner and manager is in close and intimate contact with these several
departments, or perhaps where he focuses all of them within himself, he has
no need of special means of keeping himself informed concerning the
activities of his assistants, nor does he require an elaborate system of
records to indicate the condition and state of the business at any time. In
large businesses, however, where the volume and complexity of the
commercial activities make it impossible for the executive, on whom rest
the responsibilities for the successful conduct of the business, to have an
intimate personal knowledge of all phases of the business, it is very
necessary that some means be employed for supplying him with this vital
information. Two types of information are necessary to him: (1) information
about the business unit itself, its activities and condition; and (2)
information about general economic conditions in the country, and
particularly about other businesses in the same line of activity as his own. It

is the function of accounting to supply information of the first type; it is the
chief purpose of statistics to supply information of the second type. The
accounting department, therefore, deals largely with the internal activities
of the business, while the statistical department provides knowledge of the
external relations of the business. A proper control and management of
business affairs cannot be exercised without the information supplied by
both departments. In the accomplishment of its function to supply the
internal information, the accounting department reaches out into all of the
main departments indicated above for data from which to make its record of
the various activities of the business unit.
Purpose of Accounts.—Accounts record the business history of a
concern. Their main purpose is to secure information concerning the results
of business activity and endeavor. The record required for this purpose can
be condensed and made very brief, although the full history of every
business comprises a multitude of transactions with a great mass of details.
The whole scheme and method of account-keeping is designed chiefly to
collect the detail and use it mainly for 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 radically. Stenography
abbreviates the writing of the spoken word with a view to its transcription
into longhand; accounting records business transactions in abbreviated form
with a view to summarizing them further so as to secure a bird’s-eye view
of the operations of the business as a whole and to use it in the formulation
of administrative judgments and policies.
In a large business there are executive duties within each of the five
main departments. Accounting must supply the information on which each
departmental executive will base his judgments and policies. The student
will see, therefore, that the accounting department brings together a record
of the activities of each of the main departments of a business. He will see,
too, how the final output or product of the accounting department must be a
summarization and interpretation of these departmental activities in order to
provide a basis for the various executives on which to formulate their
judgments and business policies. Accounting is, therefore, a handmaiden of
the executives in the conduct and management of the business. It is the

purpose of this volume to develop the technique of the bookkeeping and
accounting record and to indicate some of its uses in the management of
business.
Relation of Accountancy to Economics.—Economics is sometimes
defined as the science of wealth, by which is meant a body of classified
knowledge relating to wealth in the aggregate. Under the present-day
political and social system, the ownership of wealth is very largely private.
Furthermore, the division of labor, as industry is now organized, has been
carried to a very high degree. Because of these facts the present elaborate
organizations for producing wealth have given rise to an urgent need for
some effective means of keeping record of their activities.
The effort of every individual engaged in industry is to increase wealth.
He labors to extract the raw materials from nature, to shape and mould them
so as to supply the wants of his fellowmen. He then distributes them by
means of markets and exchanges so as to secure the greatest possible
returns for his effort. As competition becomes keener and the margin of
return per unit of product becomes smaller, he has to increase his volume of
business to secure the same amount of profit as when he did a lesser volume
of business.
To produce goods it is necessary to use the saved wealth of former
periods to pay the expenses of materials, labor, management, etc., of the
present period. One must consume wealth to produce wealth. After his
product is made, he must seek the best market for its exchange or sale. This
necessitates the use of a complex system of transportation and
communication. Finally, during the whole process of production and
exchange the estimated returns from the article must be distributed among
the several parties engaged in their creation. To make this distribution on
the basis of estimated returns, gives rise to the need—the absolute necessity
—of an accurate record of the costs of the activities and processes all along
the line. The record, then, of the value of the rights and properties of the
various parties to the production and distribution of wealth, as society is
now organized for its economic well being, is the special field assigned to
Accountancy as related to Economics.
Relation of Accountancy to Law.—The determination of the rights of
the several parties to the creation, exchange, and ultimate consumption of a

product is the field of Law, more particularly Business Law. The
determination by means of its records of the value and extent of these rights
is the province of Accountancy as related to Law. Accountancy is thus seen
to be the handmaiden of both Economics and Law. None of them can
progress far without the help of the other two. All being related to, and
arising out of manifold human endeavors, their progress and development is
dependent upon, and limited only by, the progress of these endeavors.
The Fundamental Problem of Accountancy.—The aim of all private
businesses being the increase of wealth, the first problem of accountancy is
to determine how much wealth is invested in a given enterprise and what
ownership or proprietorship exists at given periods, so that by comparison
the increases and decreases in the proprietorship may be known. When
accurate information is obtained, an intelligent plan of action can be
adopted to remedy such ills of the business as are shown and to increase
any profitable line of activity. Accordingly, proprietorship and its changing
values are the basic problems of accountancy as well as of business.
Definition of Terms.—Before proceeding to a definition or
determination of proprietorship, it is necessary to understand what is meant
by the terms “assets” and “liabilities.” The root idea of the word “assets” is
“sufficiency.” Specifically, assets are the “entire property of all sorts, of a
person, association, or corporation applicable or subject to the payment of
debts.” Similarly, the liabilities of a person, firm, or corporation are his or
its pecuniary obligations or debts. Proprietorship is the difference between
the value of the assets and the amount of the liabilities, and is defined and
measured by the equation:
Assets - Liabilities = Proprietorship
This proprietorship equation is a basic formula. It is also written:
Assets = Liabilities + Proprietorship
It will thus be seen that proprietorship represents the equity of the owners of
an enterprise in its assets. The assets are first applied in paying the claims of
creditors of the business, and whatever of them remains belongs to the
owners of the business.

Development of the Proprietorship Equation—The Balance Sheet.
—To indicate the basis of the standard form of the proprietorship equation,
several illustrations will be given. The equation is in its simplest form when
it indicates proprietorship in a new business immediately after the owner
has invested cash to provide the business with capital. For example, assume
that on January 1, 19—, James T. Runyon starts business by investing
$5,000 cash capital in the enterprise.
Here the proprietorship equation is:
Assets (cash $5,000) = Proprietorship ($5,000)
As yet there are no liabilities. However, in order to carry on his
business, Runyon must purchase a stock of merchandise and equipment for
his store. Accordingly, he purchases store furniture and fixtures from
Lowell Brothers for $500, of which he pays $250 in cash, and owes the
balance. He also buys a stock of groceries for $2,500 from Reid Murdock &
Co. on 10 days’ time. He now has more assets than the original $5,000 cash,
but he has become indebted for the additional amount, so that the amount of
his proprietorship has not changed—as is shown by the following equation,
somewhat more complex than the first:

Assets - Liabilities = Proprietorship
Cash $4,750 Lowell Bros.
Furniture 500 Claim $ 250
Merchandise 2,500 Reid Murdock
Claim 2,500
$7,750 - $2,750 = $5,000
Runyon now begins operations and after six months finds that his
activities have comprised the purchase of delivery equipment for $300 cash;
sale of goods amounting to $6,000; the payment of $1,000 cash for rent,
clerk hire, and advertising; and sundry purchases of stock-in-trade and other
items as needed. As a result he now has $1,000 cash on hand; customers
owe him $3,000; his stock of goods still on hand is worth $2,100; he owes
creditors $1,000 for goods bought and his clerks $50 for services rendered.
It is readily seen that as the number of assets and liabilities increases,
the method of showing them that was used above becomes awkward and

cumbersome; therefore, still using the equation, we make the following
vertical tabulation to determine and show proprietorship:
Assets
Cash $1,000.00
Customers 3,000.00
Merchandise 2,100.00
Furniture 500.00
Delivery Equipment 300.00
Total Assets $6,900.00
Liabilities
Creditors for Merchandise $1,000.00
Clerks for Services 50.00
Total Liabilities 1,050.00
Proprietorship
Capital $5,850.00
This method of expressing the proprietorship equation is called a
“Balance Sheet,” or “Financial Statement.”
Further analysis of the above information discloses the amount of
Runyon’s purchases and of his payments to creditors. Taking the
transactions involving cash, we find that he had $5,000 to start with and
received $3,000 from sales, or $8,000 in all. He bought furniture and
delivery equipment for $800, and paid expenses of $1,000, in all $1,800.
There is therefore a balance of $6,200 to be accounted for. $1,000 cash is
still on hand, so that he must have paid creditors $5,200. Since he still owes
creditors $1,000 for goods bought, his purchases must have been in all
$6,200.
The ability to make accounting statements and to analyze accounting
data for various purposes constitutes a very important part of the equipment
of the accountant.

CHAPTER II
ASSETS, LIABILITIES, AND CAPITAL
Before discussing the form and content of the balance sheet and some of
its major uses, the chief classes of assets, liabilities, and proprietorship or
capital will be explained so that the student will have an intelligent notion
of what is meant by each asset, liability, and capital item.
Kinds of Assets.—Accounting terms are not wholly standard. An
account title is often used in one business to include items not mentioned
under that title in another business. One finds also terms and titles peculiar
to particular businesses. However, there is a tendency towards a
standardization of the terms used in balance sheets. It is the purpose here to
present and explain those which are common to practically all businesses.
These include the asset titles Cash, Notes Receivable, Accounts Receivable,
Merchandise, Investments, Deferred Charges or Expense Assets, Furniture
and Fixtures, Delivery Equipment, Buildings, and Land.
Cash. Cash includes all kinds of money and usually whatever serves as
a medium of exchange, which is in the possession or control of the business
—deposits in banks, moneys in the safe and cash drawers, and sometimes
funds in the possession of agents. Checks received in the regular course of
business and not yet deposited in the bank are usually classified as cash.
Notes Receivable. The formal promises to pay, made by others for
debts owed the business, are classified under the general title Notes
Receivable. Time drafts drawn on the debtors of the business and accepted
by them may be included under this title, although they are sometimes
shown under a separate title, such as Acceptances Receivable. This is
particularly true when the acceptances are trade acceptances. It will be seen
later that the promissory note has a somewhat different legal status from the
open account claim against a debtor, and should therefore be classified
under such title as will indicate the exact nature of the item.
Accounts Receivable. These usually represent the claims of the
business against its trade customers for goods sold on open account and not

paid for. The term is, however, broader than this, being sometimes used—
although the practice is to be deplored—to include all claims against
debtors except those which are in the form of notes.
Merchandise. This asset represents the stock-in-trade in which the
business deals. It is of course a sort of revolving asset, that is, merchandise
is purchased and sold continuously, so that the stock-in-trade is constantly
being turned over. The rate of turnover is very important, as will later be
seen.
Investments. This asset represents the stocks and bonds of other
companies, municipalities, school districts, and so forth, owned by the
business. As a usual thing there are seasons of the year when the cash funds
of a business are built up and lie idle in the bank unless they are invested in
securities of some sort. These securities can be reconverted into cash when
the business requires a larger fund of cash.
Deferred Charges. Certain types of expenditure are necessary in every
business to secure operating supplies. Fuel must be purchased for heating
and power purposes; brooms, oil, waste, and other similar supplies are
needed for cleaning and maintaining the business plant; stationery, stamps,
wrapping paper, twine, cartons, packing materials, and so forth must always
be on hand; insurance policies giving protection against fire are usually
purchased for from one to three years and so are seldom completely used up
at any given date. All items of this sort, necessary for the operation of the
business but not dealt in as stock-in-trade, are called “expense assets.” The
portions of these assets on hand at a given time, the use of which will be
deferred to a later period, are classified as “deferred charges.”
Furniture and Fixtures. A business plant must be equipped with
furniture and fixtures suitable for the display of the stock-in-trade, for the
accommodation of customers, for the care and protection of the necessary
records of the business, for the efficient performance of duties by the
employees, and for other similar purposes. Assets of this type which are not
a permanent part of the business plant but are removable should the
business desire to change location, are listed under the title of Furniture and
Fixtures. This may be subdivided to suit conditions. Sometimes several
titles—Store Furniture and Fixtures, Office Furniture and Fixtures, Factory
Furniture and Fixtures, Machinery and Tools—are used.

Delivery Equipment. If a business delivers its commodities it will
usually have its own delivery equipment. This may comprise horses,
wagons, harness, automobile trucks, and so forth. The delivery equipment
may be used for both inbound and outbound deliveries.
Buildings. All buildings owned by the business, whether used for
business purposes or not, will usually be classified under the asset title
Buildings. Store, office, factory, warehouses, residences owned and rented
to employees—all assets of this type are to be listed here.
Land. This item represents land—city lots, plant sites, and so forth—
owned in fee simple or subject to mortgage. Sometimes when a plot of land
is leased for a term of years and a lump sum payment made at the beginning
of the lease, the asset may be included either under the title Land, or under
the broader title Land and Leaseholds.
Kinds of Liabilities.—Just as with assets, there is not entire uniformity
in terminology for the various classes of liabilities. The more common types
of items met with are: Notes Payable, Accounts Payable, Accrued Expenses,
Mortgages Payable, Bonds Payable, and so forth.
Notes Payable. These represent the formal promises to pay, signed by
the business or its owners. They represent the formal claims of others, that
is, creditors, against the business. Just as with notes receivable, it is
sometimes desirable to make a more distinct classification of notes payable.
In such cases the titles Acceptances Payable, Trade Acceptances Payable,
Long-Term Notes Payable, etc., are used.
Accounts Payable. Under this title are listed the liabilities to creditors
on open account, as distinguished from those formally acknowledged by a
written promise to pay. These include obligations to trade creditors for
merchandise, supplies, equipment, and property of almost any kind
purchased for use by the business. In a broad sense an account payable
includes any item for which the business is liable.
Accrued Expenses. Accrued Expenses represent usually the
accumulating but unpaid claims against the business for service rendered it,
as distinguished from the Accounts Payable, which usually represent
purchases of an asset of one kind or another. Thus the amounts due at a
given time to employees for work done since the last date of payment of

their wages, salaries, or commissions, to the landowner for the rent of
leased premises, to lenders for interest on moneys borrowed, are items
properly to be listed under this title.
Mortgages Payable. These represent the claims of creditors against
particular properties owned by the business but against which the creditors
have been given a lien or preferred claim as security for the borrowed or
unpaid amount. Mortgages are evidenced by a formal legal document and
are usually recorded in the county clerk’s office.
Bonds Payable. These are a type of long-term mortgage which is split
into lots of more or less standard amount and so made available to a larger
number of holders than is usually the case with the ordinary mortgage
payable. This type of liability is limited almost exclusively to corporations.
The student should realize that usually the owner or owners of a
business enterprise have both assets and liabilities other than those
employed in the business. These personal properties and obligations of the
owners are not to be taken into account when showing the proprietorship of
a business unit or enterprise. They are to be considered only in showing the
total proprietorship of any individual owner, when of course all of his
properties, both inside and outside of the business, must be listed.
Kinds of Proprietorship.—Proprietorship, called also Net Worth, is
shown under such titles as Capital, Investment, Capital Stock, Surplus,
Undivided Profits, Reserves, and so forth. The title used depends largely on
the type of organization under which the business is operated.
Capital. Under this title is shown the amount of the investment of each
owner in a single proprietorship or partnership business. To show each
owner’s share in the ownership the title Capital is preceded by his name.
Illustration of this is given on pages 19 and 20.
Investment. This title usually is synonymous with capital. Sometimes it
is used to indicate the amount of original investment in the business as
distinguished from the present investment.
Capital Stock. Under this title is indicated the sum total of the portions
of net worth owned by the shareholders as evidenced by stock certificates
and subject to their individual control. On page 20 is given an explanation
of the way in which the proprietorship or net worth of a corporation may be

composed of two (or more) parts: (1) the capital paid in by the owners; and
(2) the capital, representing profits made but not distributed to the owners.
While capital stock usually represents the capital contributed by the owners,
it sometimes arises from other sources, such as the distribution of a stock
dividend; but the portion of the net worth owned and controlled individually
by the owners is the capital stock.
Surplus. In a corporation this represents the second portion of the net
worth, as indicated in the preceding section. Surplus is sometimes defined
as the excess of the net worth over the capital stock. In other words, it is the
difference between the assets and the sum of the liabilities and the capital
stock.
Undivided Profits. This is a term used chiefly in financial institutions to
indicate the portion of the net profits concerning the disposal of which no
action has been taken.
Reserves. Under this title are included whatever portions of the surplus
are set aside or reserved for specific purposes.
Where Surplus, Undivided Profits, and Reserves appear as parts of Net
Worth, they together represent the difference between Net Worth and
Capital Stock. The reason for the careful segregation of these items from
the Capital Stock is given in the explanation of the corporate form of
organization, on page 20.
Types of Business Organization.—Before proceeding with a
discussion of proprietorship as it appears on the balance sheet, the three
general types of business organization will be treated briefly, because the
manner of indicating proprietorship is dependent to a certain extent on the
type of organization. These types are: (1) the single or sole proprietorship,
(2) the partnership, and (3) the corporation.
The Single Proprietorship.—The simplest form of business enterprise
is that conducted by a single proprietor. This form is well adapted to
businesses where the capital necessary for efficient production is small,
where the processes are simple and capable of being handled by the average
individual, and where the risks are slight. Very few legal obstacles are
placed in the way of the individual desiring to go into business for himself,
nor is a great deal required of him. In some cases registration and a license

are necessary. The observance of the general laws, concerning the payment
of taxes and of local regulations concerning disease and fire is all that is
usually expected. Subject to the general restrictions which ordinary
business acumen and foresight impose, one can enter practically any field
of enterprise, as a single proprietor, have entire freedom and privacy in the
conduct of his business, and share with none the results of his endeavor.
On the other hand, these conditions oftentimes prove to be decided
disadvantages. As industry is at present organized, many fields of activity
demanding large capital and many kinds of technical knowledge, are closed
to the single proprietor. Freedom of action carries with it sole responsibility,
and oftentimes the counsel and advice of others would prevent the disasters
which sometimes overtake the single owner of a business.
The Partnership.—A partnership is “a contract of two or more legally
competent persons to combine their money, property, skill, and labor, or
some or all of them, for the prosecution of some lawful business and to
divide the profits and bear the losses in certain proportions.” There are
different kinds of partnerships, as will later be shown, but the essence of
each from the point of view of a working organization is mutual agency,
each partner being the agent of the others, and, within the limitations of the
partnership agreement, capable of acting as a principal for the firm. The
partnership is subject to practically as few restrictions as the individual. In
some localities, to secure the right to sue and be sued in the firm name, it is
necessary to file in a public office a brief statement of the firm name and
the names of its members.
The chief advantages of the partnership are larger capital and therefore
access to fields closed to the individual; the combining of the business
wisdom, skill, and knowledge of several individuals; the subdivision of
duties and therefore the opportunity for specialization. While in the view of
the business community the partnership is an entity or a business unit, it is
not so in the sight of the law, each member of the firm being held liable to
creditors for the entire debts of the partnership as if it were his sole
business. If any one member has to pay the firm debts, he has a claim
against his copartners for contribution.
Some of the disadvantages of this type of organization are the
possibility of friction among the partners and consequent delay of action;

the extension to the firm of credit based not on the firm property but rather
on the total property of the members, and the consequent liability of each
partner and his entire private fortune for the debts of the firm.
It is important to note that the partnership agreement should be very
carefully drawn to cover in detail the relations of the partners, their duties
and their rights, particularly as to their shares in the profits or losses of the
firm.
The Corporation.—The corporate type of business organization is
distinguished from the other types discussed:
1. By the freedom of each owner from the personal
liability for the debts of the business to any greater
extent than his stock interest in the business,
though frequently in financial corporations, and in
a few states for all corporations, his liability is
double that stated.
2. By each share of ownership being evidenced by a
formal document called a certificate of stock.
3. By each owner being allowed a voice in the affairs
of the business only to the extent of his stock
ownership therein.
4. By the necessity of securing from the proper
authorities permission to do business.
5. By the necessity of complying strictly with the
terms of this permit and submitting to certain
requirements such as the filing of annual reports,
payment of special taxes, and the like.
The owners of a corporation, or its stockholders as they are called,
conduct the business through a board of directors which they elect for that
purpose and they review its management periodically, usually annually. In
this way they exercise indirect supervision over the business. This
remoteness of personal interest and supervision has been somewhat
overcome by electing to the board only those largely interested in the
business, and by retaining on the board those whose ability as managers has

been tried and proved. The board usually hires and delegates to others the
active management of affairs.
The advantages of the corporate form of organization are: (1) it limits
the liability of its owners; (2) it lends itself well to accumulation of the large
funds of capital necessary for the promotion of large-scale enterprises; and
(3) it secures through its board of directors a convenient and effective
means of centralized control and management.
Showing the Proprietorship of These Types.—The methods of
showing in the balance sheet the proprietorship for these three types of
organization differ somewhat. The title under which proprietorship is listed
is Capital. In a single proprietorship such title is preceded by the
proprietor’s name, as shown in the following illustration:
Assets
Cash $2,000.00
Accounts Receivable 5,000.00
Merchandise 3,000.00
Furniture and Fixtures 500.00
Total Assets $10,500.00
Liabilities
Accounts Payable $4,450.00
Due Clerk 50.00
Total Liabilities 4,500.00
Proprietorship
James Runyon, Capital $ 6,000.00
In a partnership the capital is not shown in one item, each partner’s
interest being stated separately, thus:
Assets
Cash $ 2,500.00
Accounts Receivable 10,250.00
Merchandise 8,750.00

Furniture and Fixtures 625.00
Total Assets $ 22,125.00
Liabilities
Notes Payable $ 1,660.00
Accounts Payable 5,465.00
Total Liabilities 7,125.00
Proprietorship
Represented by:
James Runyon, Capital $ 8,000.00
Philip Adams, Capital 7,000.00 $ 15,000.00
In a corporation, proprietorship is shown by the aggregate of the
outstanding shares of stock, which are valued at a fixed par, or cost, under
the single title Capital Stock, and if the proprietorship is greater than that
indicated under this title, the excess is listed separately under the title
Surplus or some of the other proprietorship titles already explained. This
method of showing proprietorship is prescribed by law and is an effort to
inform creditors, or those who may become creditors, that the corporation
has observed the legal requirement not to distribute to stockholders any of
its original capital. Hence, the capital stock of the corporation must be listed
separately from the other items of proprietorship. Any changes in
proprietorship during the life of the corporation are taken care of under
these other titles, somewhat as illustrated below.
Assets
Cash $ 1,850.48
Notes Receivable 1,645.65
Accounts Receivable 15,285.35
Merchandise 10,045.94
Supplies 1,145.37
Furniture and Fixtures 1,636.97
Delivery Equipment 1,427.50
Buildings 8,000.00

Land 2,000.00
Total Assets $ 43,037.26
Liabilities
Accounts Payable $ 5,762.26
Notes Payable 4,250.00
Salaries Due but Unpaid 25.00
Mortgage on Land and Buildings 3,000.00
Total Liabilities 13,037.26
Proprietorship
Represented by:
Capital Stock $ 25,000.00
Surplus 5,000.00 $ 30,000.00

CHAPTER III
THE BALANCE SHEET
Purpose and Use.—The balance sheet of a business is designed to show its
financial condition at a given time. As previously illustrated, it marshals the assets in
one list or schedule, and the liabilities in another. The difference between the totals of
the two schedules gives the present or net worth of the business. In compiling a
balance sheet it is not sufficient to give simply the figures of proprietorship or net
worth; schedules of assets and liabilities must be drawn up to show the items making
up that net worth. From the viewpoint of a prospective investor or purchaser, a banker
to whom the business has applied for a loan, or a concern considering the advisability
of extending it credit on a bill of goods, it makes all the difference in the world to
know that with a net value of $10,000 the business has assets of $15,000 and
liabilities of $5,000; or to know that its assets are $260,000 and its liabilities
$250,000.
The ratio of total assets to total liabilities is almost as important information to an
investor, purchaser, banker, or creditor as is the character of the assets and liabilities.
If the assets are in properties for which there is not a ready market and the liabilities
are claims which mature soon and will have to be met, the situation is unfavorable. If
there are large values invested in easily salable assets; if there is a large balance of
cash on hand after meeting current claims and providing for those which will soon
mature; if other liabilities are of a more permanent nature, such as mortgages or long-
time notes not requiring immediate attention—the situation may show evidence of too
large a capital, or of inefficient management as indicated by the failure to invest a part
of the surplus cash in properties from which some return might be secured.
Form and Content.—Questions of the kind raised above are not usually capable
of definite answer from the information contained on the balance sheet alone.
Oftentimes information as to the volume of business done, future plans for expansion
or contraction of business operations, and so forth, is needed in addition to that
supplied by the balance sheet. Of immediate interest to us, however, is the information
contained in the balance sheet. Here two main problems are met: that relating to the
form of the balance sheet, and that concerned with the content of the balance sheet.
By form of the balance sheet is meant its physical appearance—the arrangement
and classification of its items. The form is not standard. In this country there are few
legal regulations governing the way in which the records of a business are to be kept
or its reports are to be made. Some efforts have been made, however, to establish a
more or less standard form of balance sheet and to secure the use of standard titles in

the balance sheet so that wherever found those titles can be relied upon to mean one
and only one thing. Because balance sheets are not always drawn up for similar
purposes, such regulations should not be too inflexible. The form of any business
statement or report should always have regard to the purposes it is to serve.
Standardization of form is desirable within this limitation.
By content of the balance sheet is meant the items that are admitted to it and the
basis of their valuation.
These two problems of the balance sheet—form and content—are fundamental
and will be briefly considered here.
Titles—Main and Group.—Instead of “Balance Sheet,” other terms are used as
names for the statement itself, such as “Financial Statement,” “Statement of
Resources and Liabilities,” “Statement of Assets and Liabilities.” Within the
statement, Resources is an alternative title for Assets; and Net Worth, Present Worth,
and Net Assets, for Proprietorship. For the present, use of the terminology previously
employed will be continued, with the substitution, however, of the term Net Worth for
Proprietorship.
The title of a statement should be full; it should include the name of the business
enterprise and date, and should appear somewhat as follows:
Shongood & Goodwell
Balance Sheet
December 31, 19—
As stated, this should be followed by the schedules of Assets, Liabilities, and Net
Worth. Since the statement is a formal one, due regard should be had for its general
appearance, which should be neat and attractive. Further consideration will be given
to some of these features in Chapters XXVI and XXVII.
Classification and Arrangement.—As indicated above, the balance sheet is used
to picture the financial condition of a business at a given time. Some of the questions
which arise in determining the financial condition of a business have already been
mentioned. The chief use to which a balance sheet is put is the determination of the
solvency of the business for purposes of getting credit extensions. By solvency is
meant the ability of the business to pay its debts when due. Regardless of how great
the excess of assets over liabilities is, if it is tied up in assets which cannot be used for
the payment of debts, the creditors of the business will become impatient and may ask
a court to take the control of the business away from its owners and place it in the
hands of a representative of the court and the creditors, who will conduct the business
for the purpose of converting assets into cash to a sufficient extent to pay all debts.
A balance sheet should therefore be so arranged that the condition of the business,
viewed from the standpoint of its ability to pay its debts, will be clearly and easily

determinable. Cash is usually the only medium used for the payment of debts. In the
regular course of business, debts are incurred which come due at different dates.
Hence it is not necessary to have on hand at a given time cash sufficient to pay all of
the debts of the business. Certain classes of debts will not wait. The sums owed
employees for services must usually be paid when due. The debt to the government
for taxes, to the public service company for heat, light, and power, to the landlord for
rent, to the bank for money borrowed—all these debts must usually be paid
immediately as they come due.
The cycle of business operation includes the purchase of merchandise, the
payment of operating expenses, and the conversion of merchandise into cash through
sale, either directly, as when the sale is for cash, or indirectly as when credit is
extended a customer and cash is later collected from him. This cycle or turnover of
merchandise recurs constantly in the management of the financial affairs of a
business. It is necessary so to order the buying and selling of goods and the collection
of accounts from customers that there will be on hand at all times sufficient cash to
pay the expenses of operating the business and the debts contracted in the purchase of
merchandise. This is the vital and fundamental problem of the business executive. In
the solution of that problem it may sometimes be necessary to borrow funds from the
bank. Before lending money, the banker assures himself that the business will be in a
position to repay the borrowed money when due.
The balance sheet, accordingly, should be so arranged that the condition of the
business as related to its ability to pay its debts will be apparent. This requires a
classification or marshaling of the assets which are concerned in the trading cycle on
the one side, and the liabilities which must be assumed in conducting the business
during the trading cycle, on the other.
At the head of the list of assets is the item Cash, the most liquid of all, as it can be
used directly for the payment of debts. Following Cash come in order Notes
Receivable, which, with proper indorsement, can be sold to the banker and converted
into cash almost immediately; Accounts Receivable, which represent the claims
against customers for merchandise sold and which are collectible within the term of
credit extended to the customer; and finally, the Merchandise on Hand, which must be
sold either for cash or on credit and then converted into cash by the collection of the
outstanding accounts. Sometimes, also, there is included in this group the asset
Investments, representing stocks and bonds of other companies which can be
converted into cash by sale on a stock exchange. On such securities, and also on the
notes receivable, there is usually at the date of the balance sheet some interest which
has accrued and may not yet be collectible. It is customary to include the amount of
this interest receivable in the same group with the assets from which it arises.
This group of assets, comprising Cash, Notes and Accounts Receivable,
Merchandise, and so forth, is called the group of Current Assets. Asset items are

classified as current if conversion into cash is expected within three to six months.
These are the assets to which the current creditors of the business will have to look for
the payment of their claims.
The claims of current creditors are usually included under the titles Notes Payable,
Accounts Payable, and Accrued or Unpaid Expenses. The classification of a creditor
in the current liability group is usually determined on a time basis. Thus, all debts that
will have to be met within six months’ or one year’s time from the date of the balance
sheet are usually classed as Current Liabilities.
The excess of current assets over current liabilities is called the working capital of
the business; that is, an amount of the current assets equal to the current liabilities will
have to be used for the payment of these debts, leaving the excess or difference free
for use within the business. While it is not possible to determine, without considering
all the circumstances in a given case, how large this working capital should be, the
standard rule-of-thumb is that it should equal the amount of the current liabilities. It
will thus be seen that the standard ratio of current assets to current liabilities is two to
one. The solvency of a given business is always judged by a comparison of the current
asset group with the current liability group.
The next main group of assets is given the title Deferred Charges. The content of
this item was explained on page 12. Thus, if a management has paid some of its
expense bills in advance—rent for January paid during December, for example—
when showing its financial condition as at the end of December it is proper and
necessary, in order to make an accurate showing, that all such prepaid expenses be
listed as assets; for, had the payment not been made until the service which it
purchased had been used up, the asset cash would have been larger by the amount of
the prepaid expenses.
Similarly, with regard to the Accrued Expenses mentioned on page 14, whatever
expenses have been incurred that properly belong to the past period, such as wages
due but unpaid, are liabilities; for the cash would be smaller by the amount of such
postponed or accrued items had the claims been met during the period. The close
relationship of both deferred charges and accrued expenses to cash is thus apparent—
the one as an indirect addition to the cash, the other as an indirect deduction from or
claim against cash. Accordingly, deferred charges are shown on the balance sheet
immediately following the group of current assets, whereas accrued expenses are
listed with the current liabilities as noted above.
The next group of assets is called Fixed Assets. Under this title are listed those
assets which are used for carrying on the business but are not bought for the purpose
of being resold. A certain amount of capital must be invested in the physical business
plant. Furniture and fixtures, delivery equipment, buildings, land, machinery and
tools, and so forth, must be purchased before the business can commence operating. It
is assets of this type that comprise the class of fixed assets. There is a corresponding

group among the liabilities which are known as Fixed or Long-Term Liabilities. All
debts maturing a year or more after the date of the balance sheet are classed as fixed
liabilities. As examples of this class, we have long-term notes payable, mortgages
payable, bonds payable, and so forth.
The difference between the fixed assets and the fixed liabilities indicates the
amount of owner’s capital which has been invested in the business plant.
The final group of assets is called simply Other Assets, and includes all assets
which cannot be classified in any other groups, such as good-will, patents, trade-
marks, accounts and notes receivable having a credit term longer than six months, and
other similar items. If there are any liabilities not capable of classification in the two
groups of liabilities given above, they may be put in a group called Other Liabilities.
For the purpose of an easy showing of these various groups and their titles, it is
customary to list the amounts of the several detailed items of each group in an inner
money column, and to extend the total into the adjoining money column on the line of
the last item in the group. A similar arrangement is made of the groups of liabilities so
that not only the items in the various groups but the group totals as well are available.
The totals of the various groups give the grand totals for the assets and the liabilities
respectively.
The balance sheet as now classified and arranged provides first a formal title,
giving the name of the business and the date of the balance sheet; then the assets,
under which appear the groups Current Assets, Deferred Charges, Fixed Assets, and
Other Assets; under the liabilities appear the groups Current Liabilities, Fixed
Liabilities, and Other Liabilities. The showing of Proprietorship or Net Worth under
the three different kinds of ownership has already been set forth. The illustration on
page 31 shows a typical form of classified balance sheet. This should be studied
carefully, as it is the type which will be used hereafter.
The Problem of Content.—The form of the balance sheet serves the purpose of
making easily available the information contained in the balance sheet. Form is of
little value unless the content is accurate. What a balance sheet contains is, after all,
far more important than its form. The problem of content comprises a consideration of
two points: (1) the proper inclusion of all items, both assets and liabilities, belonging
in the balance sheet; and (2) the correct valuation of the items so included.
With regard to the first, it may be said briefly that care must be exercised to see
that all assets belonging to the business and having value, and that all claims against
the business of whatever nature, are included.
Assuming that a given balance sheet contains a list of all the assets and all the
liabilities, the further problem of the proper valuation of these items must be
considered. A balance sheet in which the title Cash includes counterfeit bills, N. G.
(that is, uncollectible) checks and other similar items, would not be considered a

reliable balance sheet. Similarly, the basis for the valuation of each of the asset items
must be investigated and determined correct before the balance sheet may be
considered to represent the true financial condition of the business. It is the experience
of every business that it cannot collect all of the credits extended to customers.
Regardless of how carefully credit is granted, it will be found that some customers do
not pay their debts. Accounts and notes receivable must, accordingly, be valued with a
proper consideration for the estimated amount of the uncollectible portion. The stock
of merchandise on hand must be valued according to the standard formula, at cost or
market, whichever is the lower. The deferred charges group of assets will show the
value of the unconsumed portions of the assets purchased, with due regard to the time
element. Thus, a three-year insurance policy purchased at the beginning of the year
will at the close of the year be valued at two-thirds of its original cost. The fixed asset
group will be valued at cost less depreciation, which represents the amount of the loss
in value of the assets due to wear and tear, lapse of time, and obsolescence.
In determining liabilities, providing they have all been included, there is not the
danger of an understatement, because their amount is subject to verification on the
basis of the creditors’ claims. For obvious reasons the liabilities are seldom
overstated.
General Principles Governing Form and Content.—In drawing up a balance
sheet, the form must be flexible enough to meet whatever requirements for
information may be placed upon it. Thus, a balance sheet to be presented to the banker
as the basis of a loan should be carefully classified so as to show clearly the financial
condition, and sufficient detail should be given to indicate the basis used in valuing
the various items. A balance sheet drawn up for publication may, on the other hand,
contain less detailed information and less attention need be given to its form. A
balance sheet drawn up for use within the business itself may well contain very full
information and its form should be such as will accurately portray the status of affairs.
A balance sheet which shows on its face that cognizance is taken of uncollectible
accounts and of the loss in fixed assets due to depreciation, is much more valuable as
a financial statement than one lacking that information, provided of course it is to be
used to indicate that consideration has been taken of those elements. Excepting for the
general remark that regard must always be had to the purpose for which the balance
sheet is drawn up, no hard-and-fast rule can be laid down in the matter of the relative
fullness of detail with which it should be made.
Illustration. To illustrate the features of the balance sheet discussed in this
chapter, the following statement showing the financial condition of the partnership of
Jackson & Edwards is given:

Jackson & Edwards
Balance Sheet June 30, 19—
Assets
Current Assets:
Cash $ 2,365.00
Accounts Receivable $8,500.00
Less—Reserve for Doubtful Accounts 170.00 8,330.00
Merchandise 10,425.00 $21,120.00
Deferred Charges:
License Fees Paid in Advance $ 175.00
Unexpired Insurance 75.00
Supplies 80.00 330.00
Fixed Assets:
Furniture and Fixtures $ 750.00
Less—Reserve for Depreciation 75.00 $ 675.00
Buildings $9,680.00
Less—Reserve for Depreciation 242.00 9,438.00
Land 2,500.00 12,613.00
Total Assets $34,063.00
Liabilities
Current Liabilities:
Notes Payable $2,500.00
Accounts Payable 6,750.00
Wages Accrued 250.00
Interest Accrued 75.00 $ 9,575.00
Fixed Liabilities:
Mortgage on Land and Buildings 2,500.00
Total Liabilities 12,075.00
Net Worth
Represented by:
S. J. Jackson, Capital $10,267.00
P. R. Edwards, Capital 11,721.00 $21,988.00

CHAPTER IV
THE COMPARATIVE BALANCE SHEET
Comparison of Net Worths.—The aim of every business enterprise is
to increase its net worth. If James Runyon at the beginning of the year is
worth $5,000 and at its close $7,500, it is evident that he has increased his
wealth by $2,500. Very little information is given him or anyone else as to
the manner in which the increase took place, except that it came about in
the ordinary course of business. No criterion is given by which to compare
effort with result. An increase of $2,500 may or may not be commensurate
with the labor expended in effecting it. However, since a business is not
likely to remain stationary, there is a degree of satisfaction in knowing
merely the extent of the change in its net worth. The taking of an inventory,
the appraising of the value of the assets from time to time, and the setting of
the liabilities for the same dates over against them, is the method of
determining the corresponding net worths. A comparison of these net
worths shows their increase or decrease during the period. A further
analysis of the individual items may be made. A comparison of each asset at
the beginning of the period with its value at the end of the period, shows the
increase or decrease in that item. A similar comparison of each liability item
brings out the increase or decrease during the period.
How a Gain or Loss May Be Evidenced.—During a period a gain or
increase in net worth may come about in one of four ways:
1. The assets may remain the same and the liabilities
may decrease.
2. The liabilities may remain the same and the assets
may increase.
3. The assets may decrease but the liabilities suffer a
greater decrease.
4. The assets may increase but the liabilities undergo a
smaller increase.

Provided no more money has been invested in the business, and none has
been withdrawn, there has been in all the above instances an increase in net
worth, that is, a profit has resulted. If the reverse of the above relationships
obtains, there has been a decrease in net worth, or a loss.
The following statements illustrate the points discussed above.

Aaron Conners
Balance Sheet,
June 30, 1921
Assets
Cash $ 1,000.00
Notes Receivable 250.00
Accounts Receivable 5,250.00
Merchandise 8,500.00
Store Fixtures 525.00
Total Assets $ 15,525.00
Liabilities
Accounts Payable $ 5,365.00
Notes Payable 1,250.00
Total Liabilities 6,615.00
Net Worth
Aaron Conners, Capital $ 8,910.00

One year later Conners’ financial condition is shown to be:

Aaron Conners
Balance Sheet,
June 30, 1922
Assets

Cash $ 850.00
Notes Receivable 100.00
Accounts Receivable 6,425.00
Merchandise 10,260.00
Store Fixtures 472.50
Delivery Equipment 350.00
Total Assets $ 18,457.50
Liabilities
Accounts Payable $ 6,192.75
Notes Payable 950.00
Accrued Salaries 50.50
Total Liabilities 7,193.25
Net Worth
Aaron Conners, Capital $ 11,264.25
The various types of information essential to judging the financial
condition as disclosed by the above balance sheets will now be discussed.
Comparison of Balance Sheets.—A comparison of balance sheets
gives more information than merely the amount of profit for the year. It
indicates trends in the business. Thus a comparison of the notes and
accounts receivable for the two years may give some indication of the vigor
with which collections are pressed. If the volume of business done, that is,
the amount of sales made, was about the same during the two years, and if
there are more uncollected accounts at the close of the second year than at
the close of the first, it would tend to show that collections were less
satisfactory during the second year. Investigation may show that this is due
to general conditions of business in the country rather than to failure to push
collections vigorously. If there is any marked change in the amount of the
stock of merchandise on hand it would invite inquiry. If the stock is much
larger at the end of the second year than at the end of the first, it might
indicate that the business man is speculating in merchandise, that he
considers the buyer’s market during the year particularly favorable and has
laid in an abnormally large stock. A banker with large experience in similar

businesses can formulate a fairly accurate judgment of how much working
capital a concern should have invested in merchandise. With that as a
criterion he can tell the normal amount of merchandise the business should
carry.
A comparison of current liabilities for the two periods will indicate the
extent to which borrowed working capital is being used. Thus, an unusual
increase in stock-in-trade may be offset by an equally large increase in
current liabilities, and so would indicate that the merchant has done his
buying on credit or has used borrowed working capital to increase his stock.
The danger of this is apparent in a fluctuating merchandise market,
particularly if the swing is generally downward. A comparison of the
working capital for the two periods gives useful information. A decrease in
the amount of working capital may indicate an investment of it in fixed
plant which, if continued, will lead to trouble with current creditors. An
increase in working capital may point to the advisability of greater sales
effort.
A comparison of fixed assets for the two periods will show the increase
or decrease in the plant investment. If this has been offset by a
corresponding increase or decrease in fixed liabilities, no additional capital
of the owners has become tied up in fixed plant, while the reverse is true if
there is not that correspondence between fixed assets and fixed liabilities.
Where the ratio between current liabilities and fixed liabilities has
increased, it may point to the desirability of funding some of the current
debt. Short-term liabilities have apparently been incurred for the purpose of
extending the fixed plant. It is usually desirable to convert, that is, fund
these current liabilities into long-term liabilities in order to conserve
working capital to pay current debts.
Thus it is seen that a proper understanding of the items in the two
balance sheets and of their various interrelationships will oftentimes give
very valuable information. Banks and business houses which are called
upon to extend credit, maintain regular files of credit information, including
periodic balance sheets, concerning their present and prospective
customers, so that they can judge fairly accurately the condition of the
businesses.

The Comparative Balance Sheet—Its Content and Form.—A
comparison of the above balance sheets shows an increase of net worth of
$2,354.25 during the year. It shows also that this profit is accounted for by
an increase of $2,932.50 in the assets, which is offset by an increase of
$578.25 in the liabilities, leaving a net increase of $2,354.25.
The two statements thus separated do not lend themselves easily to a
comparison of individual items. Accordingly, a method of showing the
comparison known as the “Comparative Balance Sheet” form is used. This
brings all the data into juxtaposition and so makes comparison easy. The
balance sheet for the current year is shown first, followed by that for the
preceding year. The increase and decrease column uses the current year as a
basis for comparison with the preceding year.

Aaron Conners
Comparative Balance Sheet,
June 30, 1922 and June 30, 1921
Increase
and
Assets 1922 1921 Decrease
Current Assets:
Cash $ 850.00 $ 1,000.00 - $ 150.00
Notes Receivable 100.00 250.00 - 150.00
Accounts Receivable 6,425.00 5,250.00 + 1,175.00
Merchandise 10,260.00 8,500.00 + 1,760.00
$17,635.00 $15,000.00 + $ 2,635.00
Fixed Assets:
Store Fixtures $ 472.50 $ 525.00 - $ 52.50
Delivery Equipment 350.00 + 350.00
$ 822.50 $ 525.00 + $ 297.50
Total Assets $18,457.50 $15,525.00 + $2,932.50

Liabilities
Current Liabilities:
Accounts Payable $ 6,192.75 $ 5,365.00 + $ 827.75
Notes Payable 950.00 1,250.00 - 300.00
Accrued Salaries 50.50 + 50.50
Total Liabilities $ 7,193.25 $ 6,615.00 + $ 578.25

Net Worth
Aaron Conners, Capital $ 11,264.25 $ 8,910.00 + $2,354.25

While it is true that a great deal of valuable information can be secured
from a comparative balance sheet, and that this form of balance sheet
locates definitely the changes in the asset and liability items, summarizes
those changes, and shows the net profit, it nevertheless fails to disclose the
forces within the business organization which have brought about the
changes—it sets forth effect or result but not cause. A supplementary or
rather a complementary statement is needed to show the reasons for the
changes. This is discussed in the following two chapters.

CHAPTER V
THE ECONOMIC OR PROFIT AND LOSS
ELEMENTS OF A BUSINESS
Fuller Information Needed.—As indicated in Chapter IV, in the summarization of the
business transacted during a given period, it is not usually sufficient to know how much net
worth has changed; nor is the whole story told when it is known exactly what items are
responsible for the change, that is, which of the properties are worth more and which are
worth less at the end than at the beginning of the period. Additional information is necessary
to account for the changes shown by the comparative balance sheet.
The proprietor who knows simply that his cash is $1,000 less now than it was at the
corresponding time in the last fiscal period, has not the kind of control over his business that
his competitor has who knows that the $1,000 was expended for an increased stock of goods,
or that an outstanding liability of that amount has been settled, or that his expenses for the
period have been larger by $1,000 than for the former period. His competitor may be worse
off but he at least has the advantage of knowing the reason for his being so. He has made a
correct diagnosis of the pulse beat of his business. If he cannot heal its ills or secure aid for
it, he can at least have the satisfaction of giving it a respectable burial, and the autopsy will
then disclose that he failed to take advantage of his information until it was too late.
However, the point should be clearly held in mind that the proprietor who knows exactly
what is happening in his business is in a position to exercise a definite and sure control over
it. Hence, the accounting department, to justify its existence, should aim to give full
information as to what is taking place within the business and what eventually will be the
result in its financial life. Only in this way can the department serve as a means of control.
Kinds of Records.—A business must have assets and usually must incur liabilities; a
plant must be used, stock-in-trade must be bought, and sold, and usually sufficient capital
must be provided for the extension of credit to customers. Capital for the payment of the
operating expenses of the business, the maintenance of the plant, the payment of salaries and
wages of employees, and so forth must at all times be provided. While it is true that the
balance sheet shows the financial condition of the business, it gives little information as to
the volume of business operations. It indicates the net worth and may even indicate the
increase or decrease in net worth if the comparative balance sheet is used. Yet as to how that
increase or decrease in net worth came about, little or no information is given. The balance
sheet, in other words, is static; it indicates a quiescent state. It is a snapshot, showing the
wheels of business momentarily stopped.
To give a full survey of the operations during a given period, a motion picture of the
events between the dates of the balance sheets must be shown. Such a picture is dynamic. It
gives a realization of the whirl and bustle of business being carried on. It pictures volume,
content, and extent, whereas the balance sheet indicates the state arrived at as of a given
moment. For purposes of management, which must control all the phases of business

activity, a balance sheet is insufficient. A review of the factors producing results up to a
given time must be had. Accordingly, the accounting department must supply not only
information as to the present state of the assets and liabilities, but also information which
indicates how the changes in assets and liabilities since the last fiscal period were brought
about—what volume of transactions occurred, what expenditures of assets and energy were
necessary to accomplish the results attained. This information, for purposes of internal
management, is more vital than that concerning simply the present status of assets and
liabilities. It is complementary to that obtained by a comparison of net worths and it is
therefore explanatory of the changes in net worth.
The Net Worth Section Expanded.—In its operation of buying and selling goods, a
business executes many different types of transactions. As was indicated in Chapter I, in the
development of the proprietorship equation, some types of transactions have no effect on
proprietorship, that is, they involve neither a profit nor a loss; while other types of
transaction—the really vital types, because it is for these that the business is carried on—
involve a change in proprietorship, either increasing or decreasing it. Goods are bought for
one price and sold at a price sufficiently higher to pay for all the expenses of operating the
business and leave a reasonable margin of profit. For example, goods may be bought for
$1,000 and sold for $1,800, bringing about an increase of $800 in the sum total of the assets.
This $800 may represent temporarily an increase in proprietorship but the increase must be
used first to meet the expenses of operating the business during the period in which the sale
is made, after which the net result represents the real or permanent increase in proprietorship.
The temporary increase of $800 is offset by a temporary decrease of, say, $600 for operating
expenses. It is vital to business management to have information not only concerning the net
increase in proprietorship but also concerning these temporary increases and decreases. To
give this information the net worth section of the balance sheet might be expanded as in the
illustration given below.

Edwin Markham
Balance Sheet, December 31, 19—
Assets
Cash $ 5,000.00
Accounts Receivable 75,000.00
Merchandise 20,000.00
Plant 50,000.00
Total Assets $150,000.00
Liabilities
Accounts Payable $30,000.00
Accrued Expenses 5,000.00
Mortgage on Plant 30,000.00
Total Liabilities 65,000.00

Net Worth
Edwin Markham:
Capital at the beginning of the year $70,000.00
Profits during the year:
Sales $200,000.00
Cost of Goods Sold 140,000.00
Temporary Increase in Proprietorship $ 60,000.00
Operating Expenses 45,000.00
Net Increase in Proprietorship 15,000.00
Capital at the end of the year $ 85,000.00

In the net worth section of this balance sheet, the capital with which the owner started
operations for the year is given first. To this is appended a summary of the operations for the
year resulting in a net increase in proprietorship which, added to the beginning capital, gives
the capital in the business at the end of the year. This method of setting up the information
concerning the operations of the business is not used to any extent because the information is
of such vital importance that it deserves more display. Accordingly, a separate statement,
known as the “Statement of Profit and Loss,” or “Statement of Business Operations,” is
drawn up to explain the balance sheet net worth item, Net Increase in Proprietorship for the
year, which shows just the amount of the net profit. The detail of this item is given in this
complementary statement. The above illustration is given merely for the purpose of pointing
out the relationship between the statement of operations and the balance sheet. From this it
will be seen that the statement of profit and loss is really a part of the net worth section of the
balance sheet.
Temporary Proprietorship Records.—The proprietorship records, indicating as they do
the sources of changes in net worth, are kept day by day as transactions take place, are
summarized at the close of the period, and the net result is determined. They are called
temporary because, as is seen, they do not at the time of record have regard for the final
change in proprietorship. At the end of the regular periods, to determine the total or final
change, the temporary proprietorship records are closed or transferred to the summarized
record called the “Profit and Loss Summary.”
Referring to the case of Aaron Conners discussed in Chapter IV, assume that the
accounting department furnishes the following additional information from its records:
During the year from July 1, 1921 to June 30, 1922, Conners bought
$22,362.50 worth of goods; his sales amounted to $28,465.20; he paid for
help $3,050.50; his other expenses were $2,405.45; and he estimated the
wear and tear on furniture at 10%, or $52.50. As shown in his statement
for 1922, he had $10,260 worth of merchandise on hand on June 30, 1922.
The analysis of this information explains the changes in his net worth
during the year. The goods he started with plus those purchased during the
year are the total goods to be accounted for, which amounted to

$30,862.50 ($8,500 + $22,362.50 = $30,862.50). These goods were
accounted for by his sales during the year and the amount on hand.
Knowing how much was on hand June 30, 1922, viz., $10,260, he
determined that the goods sold must have been the difference or
$20,602.50 ($30,862.50 - $10,260 = $20,602.50). The price which he
received for these goods sold was $28,465.20; hence, his profits from
sales were $7,862.70, the difference between selling price and cost.
We find, also, that the expenses he incurred in selling his goods and
conducting his business generally were $3,050.50 for clerk hire, office
help, delivery boys, etc.; and other expenses, such as rent, taxes, repairs,
delivery upkeep, supplies, heat, light, and the like, amounted to $2,405.45.
He estimated that his store fixtures depreciated in value $52.50. All these
items, representing costs of doing business, amounted to $5,508.45
($3,050.50 + $2,405.45 + $52.50 = $5,508.45), which subtracted from his
profits from sales, $7,862.70, gives him a net gain of $2,354.25
($7,862.70 - $5,508.45 = $2,354.25). This gain tallies with the increased
proprietorship of that amount shown by the balance sheet of June 30,
1922.
Without regard to a form which would be technically correct, the data of the preceding
paragraphs may be shown as follows:
Goods on hand at the beginning, July 1, 1921 $ 8,500.00
Goods bought during the year 22,362.50
Total goods to be accounted for $30,862.50
Goods accounted for, now on hand 10,260.00
Goods accounted for, by being sold $20,602.50

Selling price of goods sold $28,465.20
Cost price of goods sold, as above 20,602.50
Profit from sales $ 7,862.70
Expenses of doing business:
Clerk hire $3,050.50
Other expenses 2,405.45
Depreciation 52.50
Total expenses 5,508.45
Net profit, or increase in net worth $ 2,354.25
The technical form of the summary of the temporary proprietorship elements will be
presented in the next chapter.

CHAPTER VI
THE PROFIT AND LOSS SUMMARY
Type of Information Needed.—The need and purpose of the information to be furnished by
the temporary proprietorship records was pointed out in Chapter V. Without information of this
sort, proper control of business operations cannot be exercised. These records supply a
summarized picture of the activities of the business during a definite period, which have as their
goal the increase in proprietorship—the making of a profit. In attaining this goal, two main types
of activities or operations are entered into, usually classified under the heads of: (1) income or
earnings, by which is meant those activities which immediately and directly increase
proprietorship; and (2) expenses or outgo, comprising those activities which decrease
proprietorship. Expenses are the costs incurred in securing income, and are therefore deductions
from it. A fuller explanation of these terms will now be given.
Income.—Income is usually of two types: operating and non-operating. These terms are
always relative; that is, what is an operating income in one business may be a non-operating
income in another business. The term “operating income” is used to indicate the main sources of
income in a given business. It is always the duty of the accounting department to indicate the
sources of income. Thus in a trading or mercantile business, the selling of goods to customers is
the main source of income. In a professional business, the selling of services, often titled
“professional fees,” is the main source; in a brokerage or commission business, commissions
earned; in institutions, tuition and other fees; in a financial business, interest earnings; in a society,
membership fees. These are typical titles for indicating the main source of income in the several
kinds of undertakings mentioned.
While sales are the major source of income in a trading concern, there may be supplementary
sources. It may own stocks and bonds from which income may be derived. In a manufacturing or
mining enterprise the company may own dwelling houses and rent them to its employees.
Conditions of travel and communication may also force it to provide stores, places of amusement,
and so forth for its workers. From all these supplementary activities it will derive income. As it
was not organized primarily for these purposes, but chiefly to manufacture, or mine a commodity,
the income from these collateral activities is classed as non-operating income.
The distinction, then, between operating and non-operating income is, as mentioned above,
always a relative one and will be determined in any given instance on the basis of major activities
and supplementary or minor activities. Some of the titles under which income is recorded will now
be explained:
Sales. Under this title is recorded the amount of sales of the stock-in-trade in a merchandising
or manufacturing concern. The two elements included here, namely, the decrease of the asset
merchandise and the increase of proprietorship—the true income element—will be discussed later.
Sales Returns. This title does not represent income but, as its name indicates, shows the
amount of the goods sold which have been returned because of dissatisfaction with the quality or
condition of the goods or some error in sending the wrong kind.
Sales Allowances. These are similar to sales returns in that they indicate a deduction from the
sales income for the allowances made to the purchasers who for one reason or another have just

cause to be dissatisfied with the goods but agree to retain them providing an allowance from the
original selling price is made.
Interest Income. Under this title is recorded the income from money loaned or credit extended.
Notes receivable and bonds are the usual sources. Sometimes open accounts receivable also bring
interest.
Rental Income. Under this title is recorded income received from the lease of premises, lands,
or buildings.
Professional Fees. Under this title is recorded the income from charges made for professional
services.
Commissions Earned. Included under this title is the income received from services rendered in
the selling of commodities for a principal.
Purchase Discount. This represents the deduction allowed from the original charge for paying
a debt in advance of the date named in the purchase contract.
Expenses.—Expenses are also of two types: operating and non-operating. The same distinction
is made here as with income. Those expenses incurred in securing operating income are operating
expenses, while those incurred in securing non-operating income or for other purposes are called
non-operating expenses.
To secure control over the operating and non-operating types of activities, it is necessary to
compare operating income with operating expenses, and non-operating income with non-operating
expenses, in order to measure the return by the effort expended in securing that return. Some of the
more common titles under which the record of expenses is made are as follows:
Salaries (Wages). Under this title is included the cost of the services rendered by employees.
This may be classified in accordance with the department in which the service is rendered; for
example, factory wages, salesmen’s salaries, office salaries, and so forth.
Traveling Expenses. The costs of railroad fare, entertainment, and so forth, when traveling in
the interests of the business.
Advertising. The cost of publicity in making known the commodities offered for sale by the
business.
Buying Expense. The costs incurred in making purchases for the business. These may comprise
the salaries of buyers and all expenses in connection with maintaining a purchasing department.
Rent. The cost for the use of premises not owned.
Plant Maintenance. The cost of upkeep, repairs, and so forth, on the plant used by the
business. The cost, by purchase or manufacture, of light, heat, and power is included here.
Depreciation. The decrease in value of a fixed asset due to wear and tear, lapse of time,
obsolescence, etc.
Bad Debts. The amount of outstanding accounts receivable which have proven or are judged to
be uncollectible.
Sales Discounts. The cost incurred because of the financial policy of charging a customer a
smaller amount than the amount of the bill, provided he pays by a given date.
Telephone, Telegraph, Stationery, Postage, Interest Cost, Commissions Paid, and so forth.
These all indicate by their titles the nature of the expense or cost items.

The student should understand that expenses may be set up in very much greater detail than
that indicated by the above titles. Usually the title under which record of an expense is made will
indicate with sufficient clearness its character.
The Profit and Loss Summary.—As indicated in Chapter V, the profit and loss summary
shows the manner in which the net worth of the business has been changed as the result of
operations of the business, as distinguished from changes brought about through withdrawal or
investment of capital. Although it is really a part of the balance sheet, which shows financial
condition, because of its importance it is, however, set up as a separate statement. It amplifies and
fills out the record shown by the balance sheet. It is a supplementary record because it gives
additional information, and is complementary to the balance sheet because it rounds out and
completes the story of business life there recorded.
Just as with the balance sheet, the main problems of the profit and loss summary relate to: (1)
its form; and (2) its content. After an explanation of some of the terms used in connection with the
summary, these two problems will be discussed.
The Fiscal Period.—Because of the work involved and the frequent incompleteness of the
records at the close of each day, a daily statement of condition is very seldom made up. The
business experience of a particular enterprise determines the frequency of preparation of these
statements. Whatever the period may be between statements, be it a month, three months, a half-
year, or a year, it is called the fiscal period, i.e., it is the period at the end of which records are
summarized for the purpose of ascertaining the profit or loss for the period. For purposes of
comparison with preceding and following fiscal periods, under similar conditions, the fiscal period
should be, and usually is a period of regular length—a half-year or year being perhaps the most
common, though in many enterprises it is customary to draw up supplementary monthly
statements.
Need for the Physical Inventory.—Again, because of the work involved, especially where the
product dealt in is small in value and sales are numerous—as in stores dealing in clothing, food,
and the like—no record of the cost of each article is kept as it is sold, only the sale price being
recorded. It is not possible, therefore, to determine from the records as usually kept, the cost of the
goods on hand at a given time. The records are kept in this way, not because systems of accounting
cannot be devised to make both records, but because the results obtained by such systems are not
justified by their cost when other and less expensive means can be used with almost as satisfactory
results.
The customary method of finding the cost of goods sold was indicated in Chapter V.
Summarized, it requires that from the sum of goods on hand at the beginning and those purchased
since, there be subtracted the goods on hand and unsold at the close of the period. This last item,
the goods on hand and unsold, is secured by making an actual count and valuation of such goods at
the close of the fiscal period. The expedient of physical inventory-taking is therefore brought in as
an aid to the accounting records, but only in the interests of economy.
Form of Profit and Loss Summary
General Principles Governing Make-Up. The profit and loss statement, as the complement of
the balance sheet, is just as formal in character and the same general considerations govern as the
make-up of the balance sheet, viz.: (1) the general purpose it is to serve; (2) the likelihood of
obscuring essential facts through too great detail; and (3) the general appearance is to legibility,
clearness of form and expression, and arrangement on the page.

Title. The heading of the summary must show the name of the business, followed by the title
of the summary and the statement of the exact period covered by it. It was noted in Chapter V that
whereas the balance sheet is a statement of financial condition as at a given date, the profit and
loss summary is a statement of operations which have taken place during a given period. Hence, it
is not sufficient merely to state the date of the close of the period. If, as is usually the case, the
fiscal periods are of uniform length in a given business, the phraseology “For the Period Ending
...” will be sufficient for use within that business. It is better, however, for all statements of
operation to indicate the length of the period covered. A typical heading for the profit and loss
summary is indicated below:
James R. Robinson & Company
Statement of Profit and Loss For the Six Months’ Period Ending December 31, 19—
Arrangement. The arrangement of the summary has already been indicated. The income from
operations, that is, the operating income, is shown firsthand, and is followed by the operating
expense, and then by the amount of the difference or the net result of operation. Next is shown the
non-operating income, followed by the non-operating expense. The net result of this combined
with the net result from operations gives the net result for the period, which is the figure shown on
the balance sheet, the detail of which is explained by the profit and loss summary.
Content of Profit and Loss Summary.—The content of the profit and loss summary is
determined by the need of information for purposes of management. A profit and loss summary
which is sufficient for a small business, where the proprietor is in intimate contact with all phases
of the business, would not give sufficient information for the proper control of a large business,
where the managing executives are dependent for their information as to the various phases of
business activity on reports made to them. There is, however, a fairly standard outline or skeleton
in accordance with which this summary is usually drawn up. It is the purpose here to explain that
outline.
The first section of the statement has for its purpose the separation of the sales item into its two
elements, referred to above: (1) the Cost of Goods Sold, which indicates the amount by which the
asset merchandise has been decreased through sale of goods; and (2) the Gross Profit or the excess
of selling price ever cost, out of which must be met the costs of operating the business before the
net change in proprietorship can be determined. This section is usually spoken of as the “trading”
section of the statement. The set-up of this section shows, accordingly: (1) the Sales item, from
which is shown deducted the amounts of sales returns and sales rebates and allowances in order to
arrive at the figure of net sales; and (2) the Cost of Goods Sold, under which is listed the cost of
goods sold as explained in Chapter V. This cost requires the showing of the initial inventory, the
purchases for the period, the inward costs of laying down the merchandise at the place of business,
such as insurance on goods in transit, freight and cartage costs, and so forth. From the sum of these
items will be shown deducted the returned purchases and the amount of the final inventory, the
difference indicating the cost price of goods disposed of by sale. With the “inward” cost of goods
is sometimes included the sum total of all buying expenses. In other cases, particularly where a
complete purchasing department is maintained, a separate buying expense section is set up to
summarize these costs.
Following this trading section comes the formal statement of operating expenses which are
usually classified for purposes of information into the groups: Selling Expenses, General
Administrative Expenses, and Financial Management Expenses. Under each one of these groups
should be listed the detailed items. Thus, under the selling expense group should be shown such

items as salaries to salesmen; the traveling expenses incurred by them; the cost of publicity,
advertising, and so forth; the sales management expense; and the delivery expenses, although these
expenses are sometimes set up in a group by themselves.
The student will note that under the head of selling expenses are grouped all of the direct costs
incurred in making sales.
Under the general administrative expenses should be shown such items as office salaries,
stationery and supplies, postage, telephone and telegraph, light, heat, insurance, depreciation, and
all other items which cannot be charged to definite departments of the business but must be borne
by the business as a whole.
Under financial management expense should be listed the various items of expense which
represent the financial activity of the business as related to its major purposes and which are
operating financial expense items. Here will be shown such items as interest on money borrowed
for operating the business; sales discounts granted customers in order to secure cash payments
from them at an earlier date than the limit of the normal credit period allowed them; collection
costs, and so forth.
A final section of the operating portion of the profit and loss statement lists the items of
income arising out of the management of the working capital finances of the business. Interest
received on customers’ notes and on cash balances in the bank, and purchase discounts, are usually
the only items of income under this head.
The difference between gross profit on sales and the sum of these operating expenses minus the
financial income, is the operating profit of the business, sometimes called Net Operating Profit.
The section following this is devoted to the marshaling of the items of Non-operating Income
and Expense. Whichever of these two groups is the larger is set up first, and from its total is
deducted the total of the other group. The net amount is then shown extended under the item of net
operating profit, to which it is added if it is a net income item and from which it is subtracted if it
is a net expense item. The resulting figure is the Net Profit for the period.
Occasionally there are extraordinary items of profit or loss not to be classified under any of the
above heads, which have to be shown in additional sections of the profit and loss statement. These
are matters which will be taken up later.
It should be noted that the above paragraphs outline a simple statement of profit and loss for a
commercial or trading business as distinguished from an industrial or manufacturing enterprise, the
statement for which is somewhat more complex even in its general outlines.
Algebraic Content of the Profit and Loss Statement.—An algebraic presentation of the
profit and loss statement is oftentimes valuable. The cost-of-goods-sold portion becomes:

(1) Initial Inventory + Purchases
- Final Inventory = Cost of Goods Sold
(2) Sales - Cost of Goods Sold = Gross Trading Profit

The rest of the statement is covered by the following equation:

(3) Gross Trading Profit
- (Selling Expenses

+ General Administrative Expenses
+ Financial Management Expense
- Financial Management Income)
± (Non-operating Income - Non-operating Expense)

= Net Profit

The Disposition of the Net Profit.—The net profit for the period belongs to the proprietor and
constitutes an increase in his proprietorship or investment, unless he has already drawn out some
of these profits as they accrued. In this case, his drawings must be subtracted from the net profit
indicated before showing the increment to his net worth. Accordingly, a final section of the profit
and loss statement may give the disposition of the net profit and its appropriation or addition to the
previous net worth or proprietorship item. This section, when used, is known as the appropriation
section. If the business is a partnership, this section should show in detail the distribution of net
profit among the several partners according to the agreement among them as to the proportions in
which they are to share gains or losses. If a corporation, it should give the disposition made of the
net profit in the way of dividends to the stockholders, and any other appropriation made of these
profits, including transfer to surplus.
Two illustrations—one very simple, the other more complex—typical of profit and loss
summaries are given for the guidance of the student.

Illustration 1
Aaron Conners
Statement of Profit and Loss For the year ending June 30, 1922

Sales for the year $28,465.20
Goods on Hand July 1, 1921 $ 8,500.00
Purchases during the year 22,362.50 $30,862.50
Goods on Hand June 30, 1922 10,260.00
Cost of Goods Sold 20,602.50
Gross Trading Profit $ 7,862.70
Clerk Hire $3,050.50
General Expenses $2,405.45
Depreciation 52.50 2,457.95 5,508.45
Net Profit for the year $2,354.25

Illustration 2
Kimball and Morey
Statement of Profit and Loss For the Year Ending June 30, 19—

Sales $525,600.00
Less:
Sales Returns $ 5,000.00
Sales Rebates and Allowances 600.00 5,600.00
Net Sales $520,000.00
Cost of Goods Sold:
Inventory, July 1, 19— $ 96,670.00
Purchases during the year 350,000.00
Freight-In 1,000.00
Insurance (Goods in Transit) 750.00 $448,420.00
Less:
Purchase Returns $ 1,750.00
Final Inventory, June 30, 19— 105,000.00 106,750.00
Cost of Goods Sold 341,670.00
Gross Profit $178,330.00
Selling Expenses:
Salesmen’s Salaries $ 20,000.00
Advertising 25,000.00
Delivery Expense 5,000.00 $ 50,000.00
General Administrative Expenses:
Office Salaries $ 10,000.00
Stationery and Supplies 1,500.00
Postage 250.00
Telephone and Telegraph 750.00
Light and Heat 1,750.00
Insurance (Stock and Fixtures) 1,500.00
Depreciation:
Furniture and Fixtures $2,000.00
Buildings 1,500.00 3,500.00
Miscellaneous Expenses 750.00 20,000.00
Financial Management Expenses:
Interest Paid $ 250.00
Sales Discounts 5,000.00
Bad Debts 1,000.00
Collection Costs 250.00 6,500.00

Total Operating Expenses $ 76,500.00
Financial Management Income:
Interest Received $ 1,350.00
Purchase Discounts 3,500.00 4,850.00
Net Operating Expense 71,650.00
Net Operating Profit $106,680.00
Non-Operating Expense and Income:
Income—Interest on Liberty Bonds $ 2,000.00
Expense—Loss on Stocks Sold 900.00 1,100.00
Net Profit for the year $107,780.00

Appropriation of Net Profit:
J. H. S. Kimball, ⅖ share $ 43,112.00
H. F. C. Morey, ⅗ share 64,668.00 $107,780.00

The Two Methods of Determining Net Profit.—It is particularly important to note that the
profit shown by the profit and loss statement must be the same as that developed by the
comparative balance sheet, since both cover the same period and constitute merely two ways of
developing the same result. For this reason they are valuable in proving the correctness of results,
acting as checks against each other. The student must bear in mind, however, that the increase or
decrease in net worth as shown by the comparative balance sheet must always be adjusted by
taking account of additional investments or withdrawals of capital before the net profit for the
period can be determined, and therefore before this figure can be used as a check against the
amount of net profit shown by the statement of profit and loss.
The accounting department keeps both classes of records, viz., the asset and liability records
and the temporary proprietorship or income and expense records, not because both are needed to
develop the amount of net profit—either class would do this—but because both are needed for the
additional information which they give and which is valuable and necessary for the intelligent
management of the business.

CHAPTER VII
INTERRELATION BETWEEN THE ECONOMIC AND
THE FINANCIAL ELEMENTS OF A BUSINESS,
AND SOME INTER-RATIOS
Various Aspects of the Temporary Proprietorship Records.—The profit and loss statement
has been explained as a summary of the temporary proprietorship records kept for the purpose of
registering the changes in net worth as they occur from day-to-day, and also for the purpose of
noting the source or cause of many of the changes in assets and liabilities. The temporary
proprietorship records may be regarded as the chronicle or history of the economic life of the
business. The efforts of the business to produce income with the least possible outgo in the form of
costs or expenses, may be viewed as the work of forces or agencies striving towards that end. Every
effort is offset by the cost of that endeavor, and unless the result of the effort be more than its cost,
its aim, viz., the increase of net worth, is not accomplished.
Relation between Profit and Loss and Financial Elements.—These income-producing efforts
are the agencies that bring about the changes in the values of assets and liabilities. Expenses and
costs are incurred for the purpose of securing income. Every expense or cost that is settled causes a
diminution of business assets, usually of the asset cash. If not settled, it causes an increase in the
liabilities, usually the accounts payable, for the business becomes bound by or liable for it. Both of
these conditions result in a decrease in the net worth.
On the other hand, every item of income, as when a sale of goods is made, is reflected in an
increase of assets or a decrease of liabilities. The result of every sale is usually an increase in the
cash or in the claims against persons, the accounts receivable. The sale may sometimes result in a
lessening of liabilities through a cancellation of the claims of creditors by means of the claims
against customers arising out of the sale. This would be true when goods are bought from, and sold
to, the same person. Thus there is constantly a direct interrelation between the financial and the
profit and loss elements of every business.
Exchanges within the Asset and Liability Groups.—All changes in individual assets and
liabilities, however, are not always the result of business or economic forces. There may be an even
exchange of one asset for another asset, as when delivery equipment is purchased for cash. The
asset Delivery Equipment is increased by the same amount as the asset Cash is diminished. Or if a
bill of goods is purchased on credit, an increase of assets is exactly offset by an increase in
liabilities. These changes are illustrated in the second example in Chapter I, showing Runyon’s
proprietorship.
It is seen, therefore, that the changes in individual assets and liabilities are not so certain an
index of changes in proprietorship as those registered by the temporary proprietorship records. The
vital history of a business is its profit and loss record, the story of its economic life. As a means of
control this is of first importance because it chronicles the causes of most changes in financial
condition. The statement of financial condition may be looked upon as a picture of the framework,
the skeleton of the business personality, upon which is superimposed its economic structure. When
both the financial framework and the profit and loss summary are given, it is possible with
reasonable accuracy to tell the whole history of the business activities for the period covered.

Confusion between Profit and Loss and Balance Sheet Items.—The beginner frequently has
trouble in making a proper classification of income items and sometimes of expense items. Take
Interest Income as an example. The asset Cash Received is confused with the title Interest Income,
which denotes the source of the cash received. The accounting department maintains both types of
records. The receipt of cash arising out of interest income would be classified and recorded under
two heads: (1) the asset Cash, to indicate the increase in that asset; and (2) the temporary
proprietorship record Interest Income, to give the profit and loss information necessary for purposes
of management.
Similarly, the beginner oftentimes confuses the sales income record with the cash record of a
cash sale transaction. Also, when cash is disbursed for expense purposes, the decrease in the asset is
often confused with the expense record. When an expense is incurred it brings about either a
decrease in assets, usually cash if the transaction is settled at once; or an increase in liabilities,
usually an accrued expense item if the transaction is not immediately settled. Accordingly, in
making the record the accounting department must show the decrease in the asset or the increase in
the liability in the balance sheet group of records and the source of that decrease or increase under
some expense title in the profit and loss group of records. Familiarity with the titles appearing in
the profit and loss statement should prevent this confusion.
Illustration.—To show the interactions between the balance sheet and the profit and loss
groups of records, the following illustration is given. There is shown first a comparative balance
sheet, indicating the condition of a business at the beginning and the end of a period. This
comparative balance sheet, it will be noted, shows a net profit of $33,250. There is also given a
statement of profit and loss, showing the sources of the income and the expenses of the business.
The statement indicates a net profit of $33,250 for the period. By starting with the financial
condition as indicated by the balance sheet at the beginning of the period and working into it the
operations for the year as shown by the statement of profit and loss, and by using the balance sheet
at the end of the period as a goal, we can trace the probable interaction of the two types of records
for the period.

Jackson L. Gordon
Comparative Balance Sheet
December 31, 1922 and December 31, 1921
Increase
and
Assets 1922 1921 Decrease
Cash $ 10,000.00 $ 15,000.00 - $ 5,000.00
Accounts Receivable 100,000.00 119,000.00 - 19,000.00
Merchandise 70,000.00 65,000.00 + 5,000.00
Unexpired Insurance 1,000.00 250.00 + 750.00
Plant and Equipment 350,000.00 325,000.00 + 25,000.00
Total Assets $531,000.00 $524,250.00 + $ 6,750.00

Liabilities
Notes Payable $ 30,000.00 $ 35,000.00 - $ 5,000.00

Accounts Payable 50,000.00 40,000.00 + 10,000.00
Accrued Sales Salaries 2,500.00 1,500.00 + 1,000.00
Mortgage Payable 150,000.00 200,000.00 - 50,000.00
[1] 50,000.00 32,500.00 + 17,500.00
Depreciation Reserve Plant and Equipment
Total Liabilities $282,500.00 $309,000.00 - $26,500.00

Net Worth
Jackson L. Gordon, Capital $248,500.00 $215,250.00 + $33,250.00

Jackson L. Gordon
Statement of Profit and Loss For the Year Ending December 31, 1922
Sales $470,000.00
Sales Returns 20,000.00
Net Sales $450,000.00
Cost of Goods Sold:
Merchandise on Hand December 31, 1921 $ 65,000.00
Purchases 305,000.00
Inward Freight and Cartage 15,000.00 $385,000.00
Deduct—Merchandise on Hand
December 31, 1922 70,000.00
Cost of Goods Sold 315,000.00
Gross Profit $135,000.00
Selling Expenses:
Sales Salaries $ 20,000.00
Advertising 30,000.00
Sundry Sales Expense 10,000.00 $ 60,000.00
General Administrative Expenses:
Office Salaries $ 10,500.00
Insurance 3,000.00
Sundry Office Expense 2,000.00
Depreciation 17,500.00 33,000.00
Financial Management Expenses:
Interest Cost $ 10,000.00
Sales Discounts 7,000.00 17,000.00
Total Operating Expenses $110,000.00
Financial Management Income:

Interest Income $ 250.00
Purchase Discounts 8,000.00 8,250.00
Net Operating Expenses 101,750.00
Net Profit for the year $ 33,250.00
Interrelation Between Sales Income, Accounts Receivable, and Cash. In these two
statements, if to the outstanding accounts at the beginning of the period we add the net sales for the
period as shown in the profit and loss summary, and if from their sum we deduct the sales discounts
allowed customers and the accounts outstanding at the close of the period, as shown by the
comparative balance sheet, we arrive at the amount of cash received from customers during the
year. This is shown by the following statement:
Accounts Receivable, December 31, 1921 $119,000.00
Net Sales for the year 450,000.00 $569,000.00
Deduct:
Sales Discounts $ 7,000.00
Accounts Receivable, December 31, 1922 100,000.00 107,000.00
Cash Received from Customers during year $462,000.00

Interrelation Between Purchases, Accounts Payable, and Cash. The amount of cash paid for
merchandise during the year may be arrived at similarly, as indicated by the following statement:
Accounts Payable, December 31, 1921 $ 40,000.00
Purchases during the year 305,000.00 $ 345,000.00
Deduct:
Purchase Discounts $ 8,000.00
Accounts Payable, December 31, 1922 50,000.00 58,000.00
Cash Paid for Merchandise during year $287,000.00

Interrelation between Cash and Other Balance Sheet and Profit and Loss Items. If to the
amount of cash on hand at the beginning of the period we add the cash received from customers, as
determined above, and that received from interest income, as indicated by the profit and loss
statement, we arrive at the total cash available for use during the period.
Cash expenditures have been made for the following purposes:
1. Payments to creditors for merchandise of $287,000 as above.
2. Inward freight and cartage $15,000, as shown by the profit and loss
statement.
3. Sales salaries $19,000. (This amount is determined by considering
the expense of $20,000, as shown by the profit and loss statement,
in conjunction with the unpaid sales salaries, as shown by the
comparative balance sheet. Thus, if to the unpaid sales salaries
amounting to $1,500 at the beginning of the period, we add the

sales salary expense of $20,000 incurred during the period and from
their sum we subtract the amount of unpaid salaries, $2,500, at the
end of the period, we arrive at the amount of $19,000 spent for
salaries during the period.)
4. Advertising $30,000.
5. Sundry selling expense $10,000.
6. Office salaries $10,500.
7. Insurance $3,750. (This amount is also determined by considering
the amount of unexpired insurance as shown by the comparative
balance sheet in conjunction with the cost of insurance used during
the current period, as shown by the profit and loss statement. It will
be noted that $250 worth of insurance was in force at the beginning
of the period, that $3,000 worth of insurance was used during the
period—hence it must have been necessary to buy additional
insurance amounting to $2,750 during the period. When we find,
however, that there is unexpired insurance at the end of the period
amounting to $1,000, it will be seen that there must have been
purchased during the period $3,750 worth of insurance.)
8. Sundry office expense $2,000.
9. Interest cost $10,000.
10. Plant and equipment $25,000. (It will be noted from the
comparative balance sheet that there has been a net increase of only
$7,500 in plant and equipment. While $25,000 was added to the
plant and equipment asset during the year, there was a decrease in
value due to depreciation, amounting to $17,500, as shown by the
profit and loss statement. This depreciation expense is reflected as a
decrease in the value of the asset Plant and Equipment and does not
therefore decrease the asset Cash.)
11. Notes payable $5,000—the decrease being shown by the
comparative balance sheet.
12. Mortgage payable $50,000—also shown on the comparative
balance sheet.
If from the total cash available for use there is deducted the cash expended, as indicated above,
the difference should indicate the amount of cash on hand at the close of the period. This balance of
$10,000, as indicated by the tabulated statement below, is the amount shown by the comparative
balance sheet as being on hand.
Cash Receipts:
Balance on Hand December 31, 1921 $ 15,000.00
From Customers, as above 462,000.00
Interest Income 250.00
Total Cash available for use $477,250.00

Cash Expenditures:
For Purchases as above $ 287,000.00
Inward Freight and Cartage 15,000.00
Sales Salaries 19,000.00
Advertising 30,000.00
Sundry Selling Expense 10,000.00
Office Salaries 10,500.00
Insurance 3,750.00
Sundry Office Expense 2,000.00
Interest Cost 10,000.00
Plant and Equipment 25,000.00
Notes Payable 5,000.00
Mortgage Payable 50,000.00 467,250.00
Balance of Cash on Hand
$ 10,000.00
December 31, 1922, per Balance Sheet.
By a careful study of the interrelations between various items as explained above, the student
will see that the interactions between all of the transactions for the year as set forth in the
comparative balance sheet and the profit and loss statement, have been indicated and proved. The
proof is secured in the tie-up between the figure of cash as shown by the cash statement, and that
shown in the comparative balance sheet statement as cash on hand at the end of the period.
Inter-Ratios and Their Uses.—Before leaving the study of the balance sheet and profit and
loss statement and their interrelations, it is desirable to explain certain ratios between items found
on both statements. These are ratios which are watched very carefully in judging the financial
condition of a business. Their significance is apparent.
1. Merchandise Turnover. By merchandise turnover is meant the rate at which the merchandise
stock is moved or turned over by sale during the fiscal period. The ratio expressing the rate of
turnover is found by dividing the cost of goods sold, as shown in the profit and loss statement, by
the average inventory carried for the year. Where there are available only the figures of opening and
closing inventory, the amount of the average inventory is taken as one-half of the sum of these two
inventories. The rate of turnover varies in different businesses, ranging as high as 15 or 20 in some
and as low as 1 or 2 in others. The value of a rapid turnover is apparent. One dollar invested in
merchandise where the rate of turnover is 10 is equivalent to $10 invested where the rate is only 1.
The more work a dollar does, the greater the profit possibilities.
2. Working Capital Turnover. The amount of sales as indicated by the profit and loss
statement, divided by the working capital—the excess of current assets over current liabilities—as
determined from the balance sheet, is called the “working capital turnover.” This indicates the rate
at which the working capital is used in securing sales. Where the amount of working capital on
hand varies markedly at different periods of the year, the average should be used as the basis for
estimating the rate of turnover.
3. Accounts Receivable to Sales. The fraction represented by dividing the amount of
outstanding accounts at the end of the year by the volume of sales during the year, indicates the

portion of sales which has not yet been collected in cash. If this fraction is multiplied by the length
of the fiscal period, expressed in months, and the result compared with the normal credit term
allowed customers, it will indicate the trend of collections. For example, if the outstanding accounts
at the close of the period are $150,000, the sales for the year are $1,200,000, and the normal credit
period is 30 days, it will be seen that by the above ratios the $150,000 of outstanding accounts
represents on the average the sales for approximately 1½ months
150,000
———— × 12 months = 1½ months.
1,200,000
Since the credit term is only 30 days, the indication is that collections are slow and should be
pushed more vigorously. It must be understood that this ratio indicates merely a trend and must be
judged in the light of other significant facts in the business.
4. Profits to Net Worth. The net profit for the period divided by the net worth at the beginning
of the period is used to indicate the per cent of earnings on the capital invested.
Other Ratios.—For the purpose of watching the progress of business operations, it is
customary to develop the following ratios:

1. Cost of goods sold to net sales.
2. Gross profit to net sales.
3. Selling expenses to net sales.
4. General administrative expenses to net sales.
5. Net financial management expenses to net sales.
6. Net profit to net sales.

These ratios, set up each fiscal period and compared with similar ratios for previous periods,
indicate very definitely the trend of income and expenses and are useful in the determination of
business policies.

CHAPTER VIII
THE ACCOUNT
The Goal of Account-Keeping.—Throughout the preceding chapters
constant reference has been made to records or data of the business
furnished by the accounting department. Knowing the use made of these
data in the compilation of financial and profit and loss summaries, we shall
trace the process of gathering that information in exactly reverse order;
first, through the ledger, where it is grouped and summarized in accounts
and made ready for the preparation of statements; then into the books of
original entry, where the information is first sorted and classified for
posting to the proper ledger accounts, with a view always to fit it ultimately
into the final statements of financial and business condition; and finally, to
the business papers arising out of the transactions, which are the basis or
first source of all accounting records.
The Ledger and Its Content.—The ledger may be defined as the book
of accounts. In it are collected most of the data needed for the final
statements showing the financial condition of the business. By means of its
account titles, it makes an analytical record of all transactions, according to
the information desired, and through the mechanism of the account it
groups and summarizes all data affecting each particular account, thus
furnishing the proprietor with totals instead of items. In the ledger,
therefore, must be kept two main classes of accounts, viz., those used for
making up the balance sheet and those used for making up the profit and
loss statement. The one group shows assets and liabilities, and the other
temporary proprietorship increases and decreases brought about by the
receipt of income and the payment of expenses. The ultimate or net
proprietorship is determined by the summarization of all temporary
accounts in the way shown in preceding chapters.
The Ledger Account Defined.—An account may be defined as a record
of one or more items, either similar or dissimilar, relating to the same
person or thing, kept under an appropriate heading or title. The record is
kept in such a way as to make easy the addition of similar items and the

subtraction of dissimilar items. Accounts are kept both with persons, as the
accounts receivable and payable already mentioned, and with things, such
as land, buildings, machinery, merchandise, cash, and the like. Some asset
accounts and some accounts kept with persons are usually composed of
both similar and dissimilar items. For example, the cash account is
composed of both cash received and cash paid out items; the accounts
receivable record both the items for which the person is in debt to the
business and those which show the cancellation or settlement of the debt, in
part or in full; and the accounts payable record the items for which the
business is in debt to the person and those which show cancellation of the
debt or settlement by the business. Accounts which record income and
expenses usually comprise only similar items, as where all sales of
merchandise are recorded under one head or account and all purchases
under another.
The Account Title.—The title given to an account is important. It
should indicate clearly the content of the account. Accuracy is a basic
necessity in accounting. Correct titles are therefore essential. A title which
does not clearly and truthfully indicate the nature of the account, or one
which is so chosen that under it may be recorded items of various and
doubtful kinds, gives prima facie evidence of an imperfect knowledge of
accounting principles or of a desire to hide data which will not bear close
scrutiny. Therefore, care should be exercised in the selection of titles.
The Two Sections of the Account.—To separate similar from
dissimilar items, the account is divided into two sections, a left and a right
section, as we shall call them for the present, which are shown in the
standard form given in Form 1.
The account head or title is placed in the center over the division line.
At the extreme left of each section are the date columns—year, month, and
day. Note particularly where the “year” is shown. The space following is for
explanatory matter; the next column, left blank in the illustration, is a
reference column whose use will be explained later; and the last column in
each section is the money column, where the dollar subsection column is
further divided into columns for each digit of the amount. Care must be
exercised to observe such rulings when writing in the amounts. The account
with Cash in the illustration shows on the left a receipt of $150.25 from J.
B. Givens, and on the right, the payment of $5.50 for stationery. These two

items are entirely dissimilar. Another receipt of $72.69 on January 3 from
cash sales is shown on the same side of the account as the record of the
previous receipt and directly under it. Note that the name of the month is
not repeated.
The Mechanism of the Account.—Thus the mechanism of the account
is designed not only to give a brief history of each item entered therein, but
primarily to bring together all items of the same kind relating to that
account, so that they may be summarized. It should be thoroughly
understood that all items on each side of the account are similar items,
though the two sides themselves are of exactly opposite kinds. Where the
account has entries on both sides, i.e., is composed of dissimilar items, a
comparison of the totals of each group shows the condition of the account.
In the Cash account given, the total of the left side, $222.94, showing
receipts, compared with the total of the right, $5.50, showing
disbursements, indicates that there is $217.44 cash now on hand. It is
evident, therefore, that the account is a mathematical device for holding on
one side all items to be added and on the other all items to be subtracted.
Only in this way can addition and subtraction be performed within the
account.

Form 1. Form of Ledger Accounts

The Number of Accounts.—The number of accounts to be kept in the
ledger is determined by the minuteness of detail desired for the guidance of
the management of a business. The financial and profit and loss statements
usually lack detail and for this reason the items appearing thereon are
frequently subdivided in the ledger into numerous accounts.

CHAPTER IX
THE ACCOUNT
(Continued)
The Balance of the Account.—As stated in Chapter VIII, the account
is divided into two sections, a left and a right, for the purpose of separating
items relating to the same account which are dissimilar, and thus affording a
comparison between the totals of these dissimilar groups. An account
containing dissimilar items may have the same total on both sides, in which
case it is said to balance, i.e., the class of items on one side exactly balances
or cancels those on the opposite side; or one side of the account may be
larger than the other, in which case the amount of the excess is called the
“balance” in the account, or of the account. An account takes its nature or
classification from the larger side, on which the balance appears. The
account balances are shown in summarized form on the balance sheet or the
profit and loss statement.
The Account Title Indicative of Its Classification.—The account title
or name should be so plain as easily to indicate its main classification. The
two main classes of accounts are, as stated above, those relating to assets
and liabilities, or property—things owned and things owed; and those
relating to proprietorship—those showing the increases or decreases in net
worth. The title of an account should clearly indicate whether the account
belongs to the asset or liability class, or to the proprietorship class.
The accounts called Cash, Accounts Receivable, Mortgages Payable,
Accrued Wages, clearly show assets and liabilities; while those entitled
Sales, Rent Income, Wages, Expenses, indicate factors affecting
proprietorship.
The Meaning of Account Balances.—In the asset accounts the larger
side, and therefore the balance of the account, is normally on the left, i.e.,
the balance of Cash, Land, Buildings, Furniture and Fixtures, Notes
Receivable, and the like are normally left-side balances. It follows,
therefore, that all entries showing the acquisition or increase of assets are

made on the left side of their accounts, and all entries showing the disposal
or decrease of assets are made on the right side of the accounts. Very
seldom are the cancellations listed on the right side in excess of the assets
listed on the left.
In the liability accounts the balance is normally on the right side
because liabilities are subtraction items from the assets and should,
therefore, normally be on the opposite side of the account. Notes Payable,
Accounts Payable, Mortgages Payable, Interest Payable, Rent Payable, and
the like, have normally right-side balances. It follows, therefore, that all
entries showing the assumption of liabilities are made to the right side of
the account, and all entries showing the cancellation of these liabilities are
made on the left side. Rarely are liability cancellations in excess of the
liabilities owed.
As will be explained in Chapter XII, in the group of accounts indicating
decreases in proprietorship, the balance, or larger side, is normally on the
left; in the group showing increases in proprietorship the balance is
normally on the right. The balances of the accounts, Wages, Salaries, Rent
Expense, and all other expenses, are normally left-side balances. It follows,
therefore, that entries showing the cost of such expenses to the business are
made on the left side of suitably named expense accounts, and entries
showing a reduction in the expenses are made on the right side. Items for
wages, for example, are shown on the left side of the Wages account, and
any subtractions because of overpayment or for other reasons, are shown on
the right side of the account.
The balances of the accounts Sales, Rent Income, Interest Income, and
other kinds of income, are normally right-side balances. From this it follows
that entries showing income are made on the right side of a suitable
account, and entries indicating a reduction or subtraction from the income
shown are made on the left side of the account. For example, income from
sales is shown on the right side of the Sales account, while any reduction of
that income, as when goods are returned by customers, is shown on the left
side.
Knowing, therefore, to what main class each account belongs—asset,
liability, expense, or income—one always knows on which side the balance
is normally, and also that the items on the opposite side are subtraction

items. Subtraction can be shown in the account only by thus separating
dissimilar items.
Relation of the Account to the Financial Statements.—The equation
of the balance sheet is the equation of the ledger. The fundamental
proprietorship equation is written in two ways:

(1) Assets - Liabilities = Proprietorship
(2) Assets = Liabilities + Proprietorship

The ledger (that is, the accounts in the ledger) is constructed in accordance
with the second form of the proprietorship equation. In it are found all the
accounts of the business, which are included under the classes Assets,
Liabilities, and Proprietorship. Under Proprietorship are the subgroups: (a)
Net Worth, or capital at the beginning of the period, and (b) Current Profit
or Loss. The Current Profit or Loss is in turn shown by the two groups of
accounts: (1) Income, and (2) Expense. This classification of the accounts
and their relation to the balance sheet are illustrated graphically in the chart
shown in Form 2.
The asset accounts have net left-side balances, as previously explained.
Hence, if all the detailed accounts which record assets are brought together,
the sum total of the left-side balances of these accounts will represent the
total assets of the business. Liability accounts have right-side balances, as
also explained. Therefore, if all the accounts that record the liabilities of the
business are brought together, the sum total of their right-side balances will
represent the total liabilities of the business. The proprietorship accounts
have right-side and left-side balances. The net total of all the proprietorship
accounts will be a right-side balance, however, and will show the present
net worth of the business.

Form 2. Chart of Accounts
Accordingly, when one views the accounts in the ledger in their
fundamental groupings—namely, assets, liabilities, and proprietorship—it is
seen that the equation of the balance sheet is also the equation of the ledger.
The account is thus seen to be an integral part of the balance sheet. It is so

arranged, however, as to sort and handle additions and subtractions and to
furnish a net result for use in the balance sheet.
The asset portion of the proprietorship equation is in the ledger broken
up into the various kinds of assets, record of which is desirable and
necessary for purposes of adequate control of the business. In keeping the
record, all the transactions affecting—that is, either adding to or subtracting
from—a given asset are recorded in the account kept with that asset. In this
way each account brings about a sorting of the transactions affecting it. It
separates these transactions into two kinds, those which add to and those
which subtract from its value, and by means of its net balance at any given
time it summarizes the numberless transactions which have affected it
during a period and gives a net result showing its present status.
In much the same way the liability item of the proprietorship equation is
broken up in the ledger for purposes of detailed information, into a large
number of individual liability accounts. The sum total of the balance of
these accounts is the liability item of the proprietorship equation.
The proprietorship section of the equation is a little more complex when
split up, as it is in the ledger. In accordance with the chart given in Form 2,
it will be seen that proprietorship is classified in the two main groups: (1)
capital at the beginning of the period, and (2) changes of capital during the
period. It is this latter group of accounts which, as they are carried in the
ledger, have both right-side and left-side balances. The income accounts,
which tend to increase capital and which, when merged with the capital
accounts at the beginning of the period, add to that capital, have right-side
balances. The accounts which tend to decrease capital, that is, the expense
accounts, because they are subtraction items, have left-side balances. The
net increase (or decrease) in capital for the period is the excess (or deficit)
of the total income accounts over the total expense accounts. The
summarized result therefore of current changes in capital added to the
capital at the beginning of the period, gives the proprietorship of the
business at any given time.
At the beginning of a business enterprise the accounts in the ledger will
be an opening balance sheet of the business. Day by day by day as
transactions take place, there will be a constant change in the values of the
assets, liabilities, and the proprietorship account which will thus express the

changing financial condition of the business. Some assets will be increased
while others will be decreased; liabilities will also change; and with these
changes there will be brought about a change in proprietorship—an increase
or a decrease. The ledger must record these changing values as they take
place, so that the condition of the business can be determined practically at
any time.
The ledger is thus seen to contain and comprise the balance sheet of the
business at all times. Certain groupings, summarizations, and adjustments
may be necessary before a balance sheet technically correct as to form and
content can be taken from the ledger, but the fundamental balance sheet
equation is always contained in the ledger. This is pictured graphically in
the chart shown in Form 2. A further consideration of the relationships
between assets, liabilities, and proprietorship leads us to an explanation of
the principles or philosophy of debit and credit, a matter which will be
taken up in the next chapter.

CHAPTER X
THE PHILOSOPHY OF DEBIT AND CREDIT
Double-Entry Bookkeeping.—Several systems or methods of keeping
business records have at various times been in use. The method which at the
present time is used by all businesses, excepting those of the simplest sort,
is called “double-entry bookkeeping” and is the method which is being set
forth here. It is based on the proprietorship equation expressed in the form:
Assets = Liabilities + Proprietorship. It is possible to make a balance sheet
if only asset and liability records are kept, because proprietorship is always
the difference between them. Such a system of record-keeping would fail
completely in giving the information as to the current increases and
decreases in proprietorship and the causes of such changes. As was
indicated in an earlier chapter, such a system would have the disadvantages
which the comparative balance sheet has as a means of managing and
controlling a business enterprise. The information which is given by the
profit and loss records of the business would be entirely lacking.
Double-entry bookkeeping, accordingly, keeps a record not only of
assets and liabilities, but also of proprietorship and its constantly changing
value. The advantages of such a system were discussed when the need for
the information furnished by the profit and loss statement was pointed out
(see page 39). Not only does double-entry bookkeeping give this full and
complete information, but it ties this information into a system whose
mathematical accuracy and correctness can be proved. It is an invention or
device whose purpose is definitely to give the desired information and to
demonstrate the mathematical correctness of that information.
As already stated, the system of double-entry bookkeeping is based on
the proprietorship equation. An equation is an expressed equality. The
ledger kept by double-entry bookkeeping always maintains this equality.
The sum total of the entries on the left side of all the accounts must equal
the sum total of the entries on the right side of the accounts. The way in
which the ledger becomes an expanded or detailed balance sheet was
explained fully in the previous chapter. There it was shown that the sum of

the net balances of all asset accounts, as carried in the ledger as left-side
balances, at all times equals the sum of the net balances of the liability and
the proprietorship accounts carried in the ledger as right-side balances.
It is evident that, if in place of the net balances of each group of
accounts, the gross left- and right-side totals are substituted, the equation
would still be maintained, inasmuch as the net balance in each instance is
secured by subtracting the same amount, namely, the lesser total, from both
sides of the account.
Under double entry, therefore, the equality of the left side of the ledger,
that is, the total of the left-side amounts of all of the accounts, is constantly
maintained with the right side of the ledger, that is, the total of the right-side
amounts of all the accounts. The vertical division of the ledger separating
an account into its left and right sides, may with little stretch of the
imagination be considered an equality sign, which thus makes one big
equation out of all the accounts in the ledger. Under double-entry
bookkeeping, therefore, the principles of entry in the ledger are based on no
logic or philosophy other than that which attaches to the fundamental
proprietorship equation of the balance sheet. Double entry is an invention, a
device, and its use requires adherence to the principles of entry necessary to
maintain its equation. What these principles are will now be explained.
The Business Transaction Defined.—Reference has constantly been
made to business transactions. It may be well to show the idea at the bottom
of such transactions. We may define a business transaction as an exchange
of values. It may be between persons, as when a sale is made, or it may be
between accounts within the business itself, as when a transfer is made
between accounts, i.e., when an item is taken from one account and
transferred to another for the sake of more clearly showing its nature. Some
authors further analyze transactions as complete when the bargain is fully
consummated between the parties, as when delivery is made and the money
is paid in cash; or incomplete as where something still remains to be done
by either or both parties to the transaction. In this latter case, claims or
rights of action at law arise to protect the parties until the transaction is
consummated. But, since from the accounting standpoint a claim or right is
one kind of property or asset, there is little need of this finer analysis.

Analyzing the Transaction as to Its Accounting Record.—When a
transaction occurs in a business, it must first be classified before proper
record can be made of it under the account title which groups transactions
of a like nature. Its elements must be analyzed, its effect on assets and
liabilities, or on expenses and income, must be determined. Has the
transaction increased or decreased assets or liabilities, or has it increased or
decreased proprietorship, or has it resulted in simply a transfer between
accounts—these are the first questions to be determined. The basis of all
fundamental classifications is the effect of the transaction upon the balance
sheet and profit and loss statements. They are the goal towards which all
records look, but the principle which determines the subdivisions in the
main classes of accounts and the titles to be given to the accounts which are
to be carried in the records, is the amount and kind of information desired
by the management throughout the fiscal period. After the transaction has
been properly classified, it is merely a matter of recording it according to
the standards or forms of good accounting, which is merely a device for
abbreviating the work of recording, i.e., the transaction is translated into
correct accounting language.
The Use of Debit and Credit.—To show the side of the account
affected by a transaction, the words “debit” and “credit” are used, indicating
left and right respectively. The use of these words had its origin with
transactions between persons and the accounts kept with them. The person
owing was charged or debited, while the person to whom the business owed
a debt was credited. Through use the terms have come to have the meaning
stated first above, though still retaining their original connotation when
applied to persons.
Fundamental Principle of Debit and Credit.—As stated in Chapter V,
every transaction is recorded from two viewpoints, viz., its effect on the
assets and liabilities and its effect on the proprietorship or net worth.
Sometimes, however, the transaction may require merely a transfer entry,
i.e., a transfer of an amount from one account to another without affecting
the fundamental classes, as was shown above when defining the transaction
as an exchange of values. If it is remembered that from long-continued
custom asset accounts are debit accounts, i.e., normally have debit or left-
side balances, and liability accounts are credit accounts; that expense
accounts are debit and income accounts are credit, the fundamental

principles for determining the debit and credit involved in every transaction
become pretty well established in one’s mind.
Starting, therefore, with the original investment, whatever form it may
have, the transaction is reducible to the fundamental equation:
Assets = Liabilities + Proprietorship
in which “liabilities” may or may not be a “zero” quantity, depending on the
nature of the investment. All transactions thereafter must be viewed
according to their effects on the three terms of the equation above. We may
summarize the effects produced by the various transactions of the business
as:
Increase or decrease of assets
” ” ” ” liabilities
” ” ” ” proprietorship
with this qualification: that some transactions result in transfers only
without affecting the totals of any of the three groups above, as when an
asset is transferred from one account to another for purposes of more
accurate classification.
The Debit and Credit Schedule.—Bearing in mind the customary
distinction between debit and credit, and the fact that entry of a transaction
is always made from a double viewpoint—that of cause and effect—every
transaction may have its debit and credit determined by the following
schedule:

Debit: Credit:
(1) Increase of Assets (a) Decrease of Assets
(2) Decrease of Liabilities (b) Increase of Liabilities
(3) Decrease of Proprietorship (c) Increase of Proprietorship

Debit and Credit Determination Illustrated.—Examples illustrating
the various classes of transactions and the manner of determining their debit

and credit will now be given. The student should strive to understand the
double point of view necessary in determining debit and credit. It is perhaps
well to call attention to the fact that the illustrations are entirely unrelated,
i.e., do not constitute a sequence of events in any business. It should also be
kept in mind that transactions are recorded always from the standpoint of
the business whose records are being kept.
1. The purchase of merchandise for cash. The result is an increase of the
asset Merchandise caused by the decrease of the asset Cash. Accordingly,
the debit and credit of the entry for the transaction are shown by the above
schedule under (1) and (a), i.e., debit Merchandise and credit Cash. The
transaction is also an illustration of the transfer entry, in which there is no
increase or decrease of total assets, liabilities, or proprietorship.
2. The purchase of merchandise on account. This results in an increase
of assets caused by the increase of liabilities. The schedule above shows
under (1) and (b) a debit to Merchandise and a credit to the personal
account payable, indicated by the name of the creditor.
3. The receipt of cash for services performed, as when a broker receives
the amount of his commission in cash. The result here is an increase of the
asset Cash, caused by the increase of proprietorship, as the performance of
services is the chief source of the broker’s income. The schedule shows
under (1) and (c) a debit to Cash and a credit to some temporary
proprietorship account by name, as Commissions Earned.
4. The payment of a note payable in cash. This results in a decrease of
the liability, Notes Payable, caused by the decrease of the asset Cash.
Accordingly, debit Notes Payable and credit Cash, (2) and (a).
5. The settlement of a personal account payable by giving a note
payable. The effect here is simply a cancellation of one kind of liability
with another kind; it is a transfer entry. Debit the personal account payable;
credit Notes Payable, (2) and (b).
6. The rendering of a business service to a creditor, thereby canceling an
indebtedness to him; as when a physician renders medical aid to his creditor
from whom he has purchased supplies. The effect is a decrease in liabilities
and an increase in proprietorship. Debit the personal account payable, by

name, and credit some temporary proprietorship account, by name, as Fees
or Services, (2) and (c).
7. A workman is paid his wages in cash. The result is a decrease in
proprietorship and a decrease in the asset Cash. Wages are a cost of doing
business and therefore decrease Proprietorship. They are a service rendered
to the business instead of by it—an expense as distinguished from an
income. Debit the temporary proprietorship account, Wages, and credit
Cash, (3) and (a).
8. The account of a lawyer is credited for the amount of his fee. A
decrease of proprietorship, for the service rendered the business, and an
increase in liabilities. Debit Legal Expense and credit the personal account
payable, (3) and (b).
9. Transfer the net gain shown by the Profit and Loss account to the
Surplus account. The result is a simple transfer, causing a decrease in
proprietorship as shown in the Profit and Loss account and an increase in
proprietorship as shown in the Surplus account. Debit Profit and Loss and
credit Surplus, (3) and (c).
In a similar manner, all transactions may be analyzed and their entry in
the accounts determined.
Necessary Equilibrium of Debits and Credits.—Before passing to
more detailed rules for debit and credit, the necessary equality of debits and
credits should again be pointed out. Starting with the proprietorship
equation expressed in this form:
Assets = Liabilities + Proprietorship,
of which the left side is represented in the accounts by debits and the right
side by credits, the equality of the debit balances and the credit balances of
the accounts in the ledger is readily seen. If, now, for all succeeding
transactions an entry is made having an equal debit and credit, evidently the
equilibrium of the total debits and credits in the accounts is maintained and
the two sides of the ledger are in agreement. The making of an equal debit
and credit for every entry is fundamental and must be strictly observed.

CHAPTER XI
DEBIT AND CREDIT AS APPLIED TO
ASSET AND LIABILITY ACCOUNTS
Student’s Use of Working Rules.—In order to indicate the more usual types of transactions which
affect the asset, liability, and proprietorship accounts, a set-up of the various groups of accounts will be
given, under which will be shown transactions recorded as debits and those recorded as credits. Accounts
will be shown in the order in which they appear in the balance sheet. The accounts under each group
will, of course, bear their own individual titles and not the title of the group. Only such entries as are
more frequently met with will be given. Since in the group accounts given as guides only those entries
appear which affect these group accounts, it is deemed impracticable to attempt to show the contra, or
other side of each entry arising out of the transactions. However, the student should always supply
mentally the contra of each entry shown in the group reference account. For the sake of clarity, the
personal pronouns “we” and “us” will be used instead of the impersonal name.
Accounts with Cash and Notes Receivable.—Entries to the Cash and Notes Receivable accounts
are comparatively simple and are shown in the following schedule:
(Name of Account)
Debit: Credit:
(1) For all receipts or incoming items. (a) For all disbursements or outgoing items.
Transactions with cash are self-explanatory.
The accounts representing transactions with notes require some explanation. When, in the course of
business, we receive a note, Notes Receivable is debited and the person who gives it is credited, because
our asset Notes Receivable is increased and the claim against the open account of the person giving the
note is decreased. Similarly, when that note is disbursed by us, i.e., goes out of our possession, the asset
is diminished and therefore Notes Receivable is credited.
A note receivable can be disposed of in several ways:
1. Through its release on payment by the maker,
2. Through its transfer by us to another person in settlement of a claim
against us, or
3. Through its sale to the bank.
In all of these cases the credit goes to Notes Receivable. In cases 1 and 3, the asset increased, viz., Cash,
is debited; and in case 2 the liability canceled or decreased is debited. It may be stated, however, that in
cases 2 and 3, instead of making the credit direct to the asset account Notes Receivable, it is better
carried to a supplementary account, Notes Receivable Discounted, in order to show the liability arising
from the fact that, through our indorsement, we guarantee to pay the note at its maturity in case the
maker fails to do so. This is later explained in detail.
Accounts with Customers
(Name of Customer)
Debit: Credit:
(1) For amount he owes us at beginning. (a) For money he pays us on account.

(2) For goods we sell him on account. (b) For notes he gives us us on account.
(c) For goods he returns to us.
(d) For discounts we give him.
(e) For claims we allow him.

The balance owing us by a customer is an asset, and therefore a debit item.
Goods sold on account are charged to the customer because our claim against him constitutes an
asset; at the same time the income account, Sales, is credited.
When a customer pays us on account, his account is credited and Cash is debited, showing an
increase of the asset Cash and a decrease of the asset Accounts Receivable. Such an entry is simply a
transfer from one account to another, an increase of one asset offset by a decrease of another asset.
When a customer gives us his note, his account is credited and Notes Receivable is debited, usually,
with the face of the note.
When a customer returns goods to us, he is credited to decrease the original charge to his account and
Sales or Returned Sales is debited to reduce the income originally credited to Sales. It is not necessary to
make any other record of the returned goods, because, as was explained in Chapter VI, no day-to-day
record is kept to show the decrease of the asset Merchandise through Sales. So, when goods are returned
by a customer, the increase of the asset Merchandise will be shown at the end of the fiscal period when
the merchandise inventory is taken, and no other record than that indicated is necessary.
When a customer is allowed a discount for the early payment of his bill, he is credited to reduce the
original charge by the amount of the discount, and some temporary proprietorship account, as Discount
on Sales, is debited to show the decrease in proprietorship resulting from the allowance of the discount.
When a customer is allowed a claim for reduction in his bill on account of damaged goods or the
like, the entry is similar to the one next above—debit Claims and Allowances and credit the customer.
The Merchandise Account
(Merchandise)
Debit: Credit:
(1) For merchandise on hand at the beginning. (a) For sales of merchandise.
(2) For purchases of merchandise. (b) For returns of merchandise purchased.
(3) For all costs necessary to bring the
merchandise from its place of
purchase to its place of sale.
(4) For goods returned by customers.
Entries in the Merchandise account require no explanation excepting the debit entry (3). The value of
the asset Merchandise is not the price paid for it at the point where purchased, for it is of no value to the
business until it is placed on the shelves ready for sale. Accordingly, the value of the asset Merchandise
is not determined merely by the price paid the vendor, but by this price plus all of the costs necessary to
bring the merchandise to the store. Inasmuch as the merchandise is sold normally for more than it cost,
the credit entry in the Merchandise account includes two items: (1) the decrease of the asset, as indicated
by the cost price of the goods sold; and (2) the amount of profit on the sale, that is, the amount of the
increase in proprietorship.
The record of merchandise transactions is thus seen to be rather complex and will be explained fully
in Chapter XIII. The above schedule is simply an indication of the types of transactions recorded in the

Merchandise account and will be sufficient for the present. It will be seen that the sale of goods results in
a debit to the customer’s account and a credit to Merchandise.
Accounts with Fixed Assets.—Accounts with fixed assets are those with land, buildings, and
equipment of all sorts.
(Name of Account)
Debit: Credit:
(1) For full cost to the business (a) For sale or loss,
in position ready for use. at cost price.
The debit to this account is not for invoice or first cost only, but should include all expenditures
necessary to secure full title or to place the equipment in position for use by the business, such as
abstract of title costs, freight, drayage, and, in the case of machinery, setting-up and placement costs. The
corresponding credit is usually to Cash, or to Notes or Accounts Payable.
The account is credited for the sale of all or a portion of the asset at the same price at which it was
originally charged, so that the balance in the account shows the pro rata cost of the part left. A loss from
fire or otherwise is treated similarly. If the asset is sold at a profit (an unlikely occurrence), the account is
credited with its cost price, while the excess of the sale price over the cost price is credited to a
proprietorship account, such as Profit on Sale of Machinery. The debit corresponding to these two credits
is usually to Cash or some other asset received in payment. Where the asset is sold at a loss, the account
is credited with: (1) the sum received, and (2) the difference between this sum and the cost of the asset,
which difference represents a loss. The loss or deficiency is debited to a proprietorship account, such as
Loss on Sale of Machinery, and the additional debit is to Cash or some other asset received. This latter
debit amount plus the debit to Loss on Sale of Machinery must, of course, equal the two amounts
credited to the fixed asset account and representing the cost of the asset sold.
Fixed asset accounts are further considered in Chapter XIII, where the manner of recording loss
through depreciation is shown.
Accounts with Notes Payable.—When we issue our own note, the credit is to Notes Payable and the
debit is either to the liability account reduced or to the asset account increased. When we call the note in,
either by paying it or by canceling our claim against the person returning the note, Notes Payable is
debited and Cash or the person returning the note is credited.
Accounts Payable
(Name of Creditor)
Debit: Credit:
(1) For money we pay him on account. (a) For amount we owe him at beginning.
(2) For notes we give him on account. (b) For goods he sells us on account.
(3) For goods we return to him.
(4) For discounts he gives us.
(5) For claims he allows us.
As will be noted by reference to the customer’s account, the entries to the creditor’s account, being
viewed from the opposite standpoint, are exactly the reverse of the entries to the customer’s account.
Other Liability Accounts.—Accounts with other liabilities, such as Mortgages, Bonds, Expenses
Payable, and the like, follow in the main the general principles laid down (pages 81 to 83). Specific
treatment will be given them as they are met in the discussion. In the case of long-time notes payable

supported by mortgages, record should be made under the title “Mortgages Payable” rather than “Notes
Payable.”

CHAPTER XII
DEBIT AND CREDIT AS APPLIED
TO PROPRIETORSHIP ACCOUNTS
Proprietorship Accounts Defined.—Proprietorship accounts are the accounts
which record the effects, both temporary and ultimate, of business transactions upon
proprietorship. The study of the two preceding chapters has made clear the fact that
transactions which involve the receipt of income or the payment of expenses result
respectively in an increase or decrease of proprietorship, and that these increases or
decreases are temporarily recorded in suitable income and expense accounts until the
close of the fiscal period, at which time the accounts are summarized to determine the
net effect of all transactions upon proprietorship or the capital invested in the business.
Therefore, the proprietorship accounts are of two general kinds: temporary and vested.
Temporary proprietorship accounts make temporary and immediate record of the results
of the agencies or forces at work within the business to produce a profit. They set forth
the efforts to increase the net worth of the business. They record the costs of the effort
and its yield in earnings, the record being made under appropriate titles to show the kind
of cost and the source of the yield. Vested proprietorship accounts record the ultimate or
summarized results of business transactions. They therefore record the original
investment and its subsequent net increases and decreases.
Fundamental Consideration of Proprietorship Debits and Credits.—Income and
expenses comprise the temporary proprietorship items which, after being summarized,
show their ultimate effect upon vested proprietorship. In other words, they are
proprietorship items set up temporarily to furnish detailed information for aiding in
efficient management and control and are later transferred to the ultimate or vested
proprietorship records. Since, from the mathematical necessity of the proprietorship
equation, proprietorship items normally have credit balances, it is evident that all
income, or earnings, must be placed on the credit side of their appropriate accounts.
Cost of management and all expenses of operation are deductions from that income and
must therefore be recorded on the left or debit side of appropriately named accounts.
Income Debits and Credits.—With regard to their debits and credits, income
accounts follow this rule:
Income
(under appropriate titles)
Debit: Credit:
(1) For all deductions from the (a) For the yield.
yield shown contra.

Income accounts normally have entries only on the credit side. They are debited,
however, for the purpose of deducting from the yield shown on the credit side, (1)
because of overstatement of the amount of the yield in the first place; (2) because of
error in the original placing of the item of income, which is now transferred to its proper
account; and (3) for the purpose of summarizing when it becomes necessary to transfer
all income and expense items to one summary account. The entries made for the
purposes of transfer and summarization are sometimes called “adjusting” and “closing”
entries.
Expense Debits and Credits.—With regard to their debit and credit, expense
accounts follow this rule:
Expense
(under appropriate titles)
Debit: Credit:
(1) For the cost. (a) For all deductions from the cost,
shown contra.
Expense accounts normally have entries only on the debit side. Their credits are for
purposes similar to the debits to income accounts as stated just above.
Examples of temporary proprietorship items can be found in Chapters V, VI, and
VII, where the profit and loss summary is treated.
Vested Proprietorship Debits and Credits.—Two accounts should be kept on the
ledger with the proprietor, a capital and a personal account, i.e., “John Doe, Capital”
and “John Doe, Personal.” The capital account records the original investment or the
amount of capital now in the business as shown by the last financial statement. The
personal account shows all direct changes made in the capital during the fiscal period
either through withdrawal or the additional investment of funds or properties. The
capital account, therefore, shows no change until the close of the fiscal period, when the
increase or decrease in net worth is transferred to it.
An exception to this is sometimes made when there is evident intention to withdraw
during the period some of the invested capital, in which case such withdrawal is shown
in the capital account as a debit or subtraction item. Also, if there is evident intention to
increase the investment during the fiscal period, record of it is sometimes made in the
capital account. Practice in this regard is not uniform.
The ordinary transactions with the proprietor, such as more or less regular
withdrawals of cash or goods and other similar transactions, are recorded in his personal
account. This is his current account as distinguished from his more permanent capital
account. Both of these accounts may be termed vested proprietorship accounts. Their
debit and credit schedule appears as follows:
(Name of Account)

Debit: Credit:
(1) For amounts or values withdrawn. (a) For amounts or values invested.

The capital account usually shows only one item throughout the period until its
close; the personal account shows both debits and credits, made according to the above
schedule. The personal account ordinarily shows transactions of the following kind: on
the debit side, withdrawals in funds or goods, the payment or assumption by the
business of the personal debts of the proprietor, and his retention of any funds or
properties belonging to the business, such as collections from customers; on the credit
side, the investment in the business of any funds or properties, the retention by the
business of any funds or properties belonging to the proprietor, as where the business
collects and retains a debt due him personally, and the payment or assumption by him
personally of any debts of the business.
Further Consideration of Expense Items.—In explaining the debits to fixed asset
accounts it was pointed out that all costs necessary to place the asset in position for use
by the business constituted a part of the value of the asset and should be recorded in the
asset account. Similarly, it was explained that in the Merchandise account there was
included as a part of the value of the merchandise all the costs incident to putting the
merchandise in position for sale by the business. Costs of this kind are classed as
incoming costs and are almost without exception treated as additions to the value of the
asset. The costs incurred from this point on, in the course of business operations, are
classed as expenses or proprietorship decreases.
It might sometimes appear that all these operating costs—the kind shown in the
profit and loss statement—also add to the value of the assets of the business. Such is not
the case. In a mercantile concern, business is conducted for the purpose of selling
merchandise. Profit arises through the purchase of merchandise at one price and its sale
at a price sufficiently higher to pay for all operating expenses and leave a margin. The
cost of merchandise to the customer reimburses the proprietor for his original outlay in
merchandise and for a fair portion of the operating expenses incident to the maintenance
of the store. The customer is willing to pay this additional amount because it is cheaper
for him to pay the merchant a margin over the cost of the merchandise sufficient to
induce the merchant to conduct a market for merchandise, than to undergo the necessary
expenditures—of time, expense, and inconvenience—entailed in making the purchase
from the original vendor.
The economic organization of business is based on this hypothesis. In the
management of a business there is a very large element of risk. The sale price of
commodities at a given time is not always determined on the basis of the original cost of
the commodity plus the costs of maintaining a store for its sale. Competition sometimes
enters in to drive the price down below this amount. While every merchant expects in
the long run to receive from the sale of his merchandise not only what he himself has

paid for it but also the cost of conducting his store and a fair margin of profit, for a
given period and for a given item of merchandise he may not be so fortunate.
In recording business transactions, therefore, prudence demands that the costs of
operating the business be not recorded as increases in the value of the merchandise dealt
in, but rather that they be set up separately and charged against the income received
from the sale of the merchandise before the increase (or decrease) in the value of the
assets is determined and made a part of the asset record. As merchandise is converted
into cash the amount received is recorded as an increase in the asset cash. This cash
includes the original cost of the merchandise plus some of the costs of operating the
business. These are costs which must be incurred and they add value to the business as
indicated by the willingness of the customer to pay the merchant for them. Because the
added value is problematical at the time the costs are incurred, they are recorded as
expenditures which must be made good out of the sale of the merchandise at a
sufficiently enhanced price to cover them, i.e., they are expenses which are to be treated
as deductions from sales income.
The net difference between the income and the cost of securing the income, as
indicated by the expense accounts, will represent the value added to the assets of the
business, and will therefore be reflected tangibly in an increase in the value of the assets
by that amount. This increase will usually be reflected either in the cash holdings or in
claims against customers.
It may not be out of place at this point to call attention to the fact that, as the
bookkeeping record is usually handled, the only relationship between asset increases,
liability decreases, and expenses (proprietorship decreases) arises from the fact that all
of them are debits and are so placed because of the mathematics of the fundamental
equation on which double entry rests. Assets, liabilities, and proprietorship are three
distinct and separate groups of accounts related only by the logic of the proprietorship
equation. As the subject of accounting is developed the student will see the increasing
importance of drawing sharply the lines of division among these groups and he will see
also the difficulty at times of maintaining this distinction.

CHAPTER XIII
DEBIT AND CREDIT AS APPLIED
TO MIXED ACCOUNTS
Mixed Accounts Defined.—In the course of business operations certain accounts which at the beginning of
the period belong definitely to some one of the three groups, asset, liability, and proprietorship, with the progress
of the period take on a mixed character. That is, included under one account title there is a mixed record of asset
and expense, or other combination of two or more groups. For example, the machinery which belongs to the asset
group at the beginning of the period depreciates in value day by day, both through use and the lapse of time. This
daily decrease in value is of slight amount and in the management of the business it is not necessary that it be
shown on the books. While it is theoretically possible to record this daily loss, practically nothing would be gained
by so doing. Hence, the machinery account is allowed to carry both the asset value of the machinery at a given
time and the amount of its depreciation. Only periodically, usually at the close of each fiscal period, is the account
separated into its two parts, the one which shows the true asset value and the other which indicates the amount of
depreciation and which is therefore the expense or proprietorship-decrease portion of the account.
In the previous chapter the way in which the Merchandise account takes on a mixed character was briefly
explained. It was shown that the credit side reflected both a decrease of the asset and an increase of the
proprietorship by the amount of the gross profit on the goods sold. Thus, because of the way in which accounts are
kept practically, as distinguished from a theoretically correct method, which would maintain at all times a sharp
line of division between assets, liabilities, and proprietorship, certain accounts are allowed to become mixed. It is
the purpose of this chapter to discuss the proper handling of the more common mixed accounts.
Analysis of a Sale Transaction.—The impracticability of immediately separating each sale of goods into its
two elements of cost and profit and the taking of a physical inventory as a means to this end, was discussed in
Chapter VI. The necessity for this later separation may be made clear by analyzing a sale transaction.
Suppose an article costing $10 is sold for $12. At the time of its purchase a debit was made to Merchandise
account and a credit, say, to Cash. When the article is sold, it would seem that the credit should be to Merchandise
to show the decrease in that asset. However, in the sale price of $12 is included something more than the amount
by which the stock of merchandise is decreased. This additional amount is the profit of $2. Hence, a credit to
Merchandise of $12 would result in too large a subtraction from the asset Merchandise, if it is intended that the
Merchandise account shall always show by its balance the value of the unsold stock. Theoretically the best method
of entering this sale would be to debit Cash for $12, and to credit Merchandise with $10 and Profit with $2.
The Old Merchandise Account, Its Content and Significance.—It is impracticable, however, to compute
and record the cost of every unit sold. Using the above illustration, instead of crediting Merchandise with $10 and
Profit with $2, the entire $12 may be credited to the Merchandise account. There is a disadvantage in this
procedure, in that the Merchandise account then no longer represents the one asset Merchandise, but is a mixture
of an asset element, merchandise, and a proprietorship element, profit; two elements which must be separated at
the close of the period.
Originally, the Merchandise account was kept in this way; it was a mixed account and followed the rules of
debit and credit as shown below, the amounts being given for purposes of illustration:
(A)
Merchandise
Debit: Credit:
(1) For goods on hand at beginning. 10,000.00 (a) For sales. 25,00
(2) For purchases, sometimes including (b) For returned purchases. 2,000
freight-in, drayage-in, etc. 20,000.00
(3) For returned sales 1,000.00 (c) For purchases rebates and allowances. 10
(4) For sales rebates and allowances. 500.00

Where the account is kept in this manner it is usually burdened with the additional data listed under (3), (4),
(b), and (c). Sales being a credit item, it is plain that subtractions from sales (3) and (4), must appear on the debit
side, and, purchases being a debit item, subtractions from purchases (b) and (c) must appear on the credit side. If
these subtractions were actually performed instead of being indicated in the account, the debit side would show net
goods to be accounted for, viz., goods on hand at the beginning, $10,000, plus net purchases, $17,900, making a
total of $27,900; and the credit side would show net sales, $25,000 minus $1,500, or $23,500.
If, now, the cost value of the goods on hand at the close of the period (as determined by a physical inventory)
equals $8,000, it is evident that the cost price of the goods sold is equal to the cost value of the goods to be
accounted for, minus the cost value of the goods left on hand, that is, $27,900 minus $8,000, or $19,900. To secure
this subtraction within the account, it is necessary to enter on the credit side this $8,000, the cost value of the final
inventory. Accordingly, an additional credit item (d) is inserted, after which the account will show:
(B)
Merchandise
Debit: Credit:
(1) For goods on hand at beginning. 10,000.00 (a) For sales. 25,00
(2) For purchases, sometimes including (b) For returned purchases. 2,000
freight-in, drayage-in, etc. 20,000.00
(3) For returned sales 1,000.00 (c) For purchases rebates and allowances. 10
(4) For sales rebates and allowances. 500.;00 (d) For goods on hand at end. 8,00
The account is now a pure proprietorship account, the balance showing the gross profit on sales, amounting to
$3,600.
Modern Practice in Showing Merchandising Transactions.—Actual subtraction, however, within the
account is contrary to the method of showing subtractions in the account. Therefore, the mixed Merchandise
account cannot show the figures representing “net purchases,” “net sales,” “total goods to be accounted for,” and
“cost of goods sold”—information which is very essential to proper management. While containing all the data
necessary to give the final information, viz., the “gross profit,” the mixed account does not show the separate
factors leading up to it. Analysis of the mixed account is necessary to find the elements of which it is composed.
The best accounting practice provides for this analysis as the transaction takes place. The old Merchandise account
is no longer used; in its place separate accounts are set up to represent the various elements mentioned above. Each
account thus contains only one kind of item as indicated by its title. These accounts are:
(1)
Merchandise Inventory

(2)
Purchases

(3)
Inward Freight and Drayage

(4)

Returned Purchases

(5)
Purchases Rebates and Allowances

(6)
Sales

(7)
Returned Sales

(8)
Sales Rebates and Allowances

Accounts (1), (2), (3), (7), and (8) correspond to the four classes of debits shown above in the mixed
Merchandise account, and accounts (1), (4), (5), and (6) correspond to the credits. Explanation of the use of
account (1) for both the initial and final inventories is given in detail in Chapter XV.
The advantage of the use of these accounts instead of the one Merchandise account is in the availability of the
information they contain and in the saving of labor, because now there is no need to analyze the Merchandise
account for information relating to returns, allowances, and so forth. By later transferring the totals of the Returned
Sales and of the Sales Rebates and Allowances to the Sales account, the balance of this account will show the “net
sales.” A similar transfer of the Inward Freight and Drayage, the Returned Purchases, and the Purchases Rebates
and Allowances to the Purchases account, and a transfer to it of the initial and final inventories, make it show by its
balance the “cost of goods sold” which set over against “net sales” shows the figure of “gross profit.”
The student will understand that the use of these detailed accounts does not free the record of merchandise
transactions from the mixture of different elements, decrease of the asset and increase of the profits. It does,
however, make the record more valuable because of the information it makes available.
Accounts with Assets Subject to Depreciation.—Another kind of mixed account requiring explanation is that
of the fixed asset subject to depreciation. Due to ordinary wear and tear, and some other causes, most fixed assets
lose part of their value as time goes by. At the end of each fiscal period the amount of this loss and the present
value of the asset must be estimated, after an inventory has been taken, when necessary, of their number, weight, or
other units of measurement. Such an estimate is called an appraisal. The difference between the present appraised
value of the asset and its former cost or appraised value constitutes the loss from wear or other causes, and is
termed depreciation.
Since depreciation takes place day by day, but for practical reasons cannot be recorded daily, fixed asset
accounts, as they stand valued in the ledger, represent true asset values only for the date of their entry. Except on
that date, these accounts, then, include depreciation and hence are mixed accounts including both asset and

proprietorship elements. As with the Merchandise account, an adjustment is made periodically to separate the two
elements. Since the asset account is a debit account, entry of the amount of the depreciation to the credit side
would result in the account showing, by its balance, the appraised value of the asset at any given time. It is,
however, desirable to leave the account in its original condition, in order not to lose sight of the cost of the asset.
Therefore the usual practice is to enter this figure of depreciation to the credit side of a separate account called
Depreciation Reserve for the particular asset, using the word “reserve” in the sense of “estimate.”
If the latter method is followed, each asset has two accounts, one showing original cost and the other estimated
depreciation, and it is necessary for a true valuation of the asset to read the two accounts together; that is, from the
asset account showing original cost, the amount credited to the reserve account must be deducted to show the true
value of the asset. Because of this, the reserve account is often called a valuation account or an offset account, as it
gives the amount of the offset to the original asset account necessary to show its correct value. Similarly, when an
increment in the value of an asset is kept separate from its face or par value—as when the premium paid for stock
or bonds is shown separately from the par value of the stock or bonds—the account showing the increment is
called an adjunct account and must be read with the asset account to secure true valuation. The offset account,
then, is a subtraction item and the adjunct an addition item to the corresponding asset account. The showing of the
asset and its periodic valuation is made as follows:
Machinery
1921
Jan. 1 5,000.00

Depreciation Reserve Machinery
1921
Dec. 31 500.00
1922
Dec. 31 500.00
A reading of the two accounts taken together shows the original value of machinery as $5,000, the value after
one year’s use $4,500 and after two year’s use $4,000. The contra debit for the credit in the reserve account is
made to an account called Depreciation, which represents the expense of the depreciation for the period, that is, the
deduction from profit or proprietorship. Sometimes, this charge is made direct to Profit and Loss, as will be shown
in a later chapter.
Capital and Revenue Expenditures.—The fixed asset accounts usually show the investment of some of the
original capital and therefore are sometimes called capital asset accounts. A fundamental distinction must be made
between expenditures for the purchase and installation of the asset itself and expenditures for expenses in
connection with its repairs, maintenance, and upkeep. These two classes of expenditures are usually called “capital
expenditures” and “revenue expenditures” respectively.
The asset account itself is chargeable with all costs incurred up to the point of putting the asset in shape for use
in the business. It may be charged also with subsequent expenditures resulting in an increase in its value.
Expenditures, however, which are for the purpose of repairs or of keeping the property from too rapid depreciation
without adding anything to its original value, must be charged to a properly labeled expense account. These
revenue expenditures for expenses, such as repairs, maintenance, upkeep, together with depreciation, are
subtractions from profit and proprietorship, while asset expenditures usually constitute an exchange of the asset
cash for some other asset, which exchange has no effect on proprietorship.
Sometimes two items of expenditure are seemingly of the same nature, while in fact they belong to separate
groups, as the original painting cost of a building and the cost incurred later for repainting. In the first instance the
expenditure is an asset, a part of the original cost necessary to put the building in a finished condition; in the other
instance, it is an expense necessary to maintain the asset in something near its original condition. In order to secure
accuracy in the records, careful discrimination between capital and revenue expenditures is a matter of great
importance.

CHAPTER XIV
PERIODIC WORK ON THE LEDGER
The work preliminary to summarizing the record of transactions for a
period and preparing the balance sheet and profit and loss statement is
comprised under three heads: (1) the Trial Balance, (2) Adjusting Entries,
and (3) Closing Entries. These three steps will be discussed at this point
sufficiently for practice work in closing the ledger. Fuller treatment of the
subject is reserved for later chapters, after the nature of the transactions that
may complicate the closing of the ledger have been explained.
The Trial Balance.—When all transactions for the fiscal period have
been entered on the ledger, it is desirable to make sure that the ledger is in
equilibrium, i.e., to make sure that for every entry on the debit side there is
an equal credit entry, and that for every credit entry there is an equal debit
entry; in other words, that the ledger equation explained in Chapters IX and
X is maintained. This proof of the mathematical correctness of the ledger is
accomplished by means of a device called the “Trial Balance,” which
consists of a debit and credit list of either all account totals or of all account
balances. If the total debits equal the total credits, the mathematical
equilibrium is demonstrated. A trial balance is usually set up somewhat as
follows:

Trial Balance, June 30, 19—
Dr. Cr.
Cash $ 1,000.00
Notes Receivable 1,500.00
A. B. Casey 500.00
B. C. Darby 450.00
C. D. Ebbets 200.00
D. E. Field 300.00

E. F. Gall 150.00
F. G. Hiller 350.00
Merchandise Inventory 4,000.00
Store Equipment 500.00
Depreciation Reserve Store Equipment $ 75.00
Notes Payable 1,000.00
Hill & Innes 350.00
Jones & Kanter 175.00
Lunt & Mason 200.00
Noble & Oberly 150.00
P. I. Richards, Capital 5,000.00
P. I. Richards, Personal 1,000.00
Sales 20,000.00
Purchases 12,000.00
Salaries 2,500.00
Insurance 500.00
General Expenses 2,000.00
$26,950.00 $26,950.00

Work Preliminary to the Trial Balance.—Before taking a trial
balance, the accounts should be totaled on each side. These totals are shown
in small but legible pencil figures immediately beneath the last entry,
sufficient space being left for a regular entry on the line immediately below
the pencil footing. Reference to the illustration in Form 3 makes this
bookkeeping detail clear. The difference between the totals of the account
should now be shown in pencil in the explanation column on the side of the
larger amount. Taking the trial balance thus becomes merely a transcription
of pencil balances, debit or credit as the case may be, from the list of
accounts.
Balancing an Account.—Sometimes it is desirable, as in the Cash
account, to show on the face of the account the difference between the total

debits and credits, i.e., the balance of the account. This may be
accomplished by writing the balance on the side with the smaller total, and
by formally ruling up the account and entering in ink the totals on both
sides, which totals, of course, are now equal. It should be noted that the
total rules in the money columns are drawn on the same line on both sides
of the account, thus leaving several blank lines on the debit side. This is
done so that the entries in the new section of the account will start on the
same line for both debits and credits. On the next line below the double
ruling, the balance item is brought down to its proper side. The account is
now said to have been closed as to all items above the rulings and shows its
open balance in the one item beneath the rulings. The method of balancing
and ruling accounts is illustrated in the Cash account shown in Form 3.
It is important to bear in mind that the closing balance of the account is
on the side showing the smaller pencil total, whereas the opening balance
which appears beneath the ruling is on the opposite side. The only purpose
of the entry on the smaller side is to force an equality of the two sides, thus
formally closing all entries to that point and showing the “balance” as a
single item in the new portion of the account.
It should be noticed that this “balance” entry does not disturb the
equilibrium of the books, because it is entered on both the debit and credit
sides of the same account.
Use of Red Ink.—The total and closing rulings and the balancing entry
are sometimes made in red ink, but black ink is preferable. The use of red
ink is usually reserved for recording subtraction items in the same column
with those from which the subtraction is to be made. Where red ink is so
used, the total of the “red” is subtracted from the total of the “black”
amounts and the net result is shown in the total of the column. When there
are only a few “red” items, this method of recording obviates the use of a
separate column for them. Such red ink entries are not found in the standard
ledger, being confined to special ledgers and columnar statements of
various kinds.

Form 3. Account Balanced and Ruled
Rulings.—The single lines above the totals, indicating the addition,
extend only through the money columns and are on the same line on both
debit and credit sides. The closing rulings beneath the footings are double
and extend through the date columns, the money columns, and the posting
reference columns. The diagonal line on the debit side from the total line to
the date column for the last entry is for the purpose of filling all blank lines,
and preventing any further entries on them after the account is formally
closed, as such entries would have the effect of falsifying the totals shown.
Thus the diagonal line which may be on either debit or credit side serves as
a safeguard against fraud. Diagonal rulings, however, are not used so
extensively as formerly.
Transferring.—When for any reason it is desirable to transfer an
account from one page to another, the transfer is made by means of an entry
similar to the “balance” entry shown in the Cash account above. Instead of
the word “Balance,” the word “Transfer” or “Forward” is used, and in the
column between the explanation and money columns is entered the number
of the page to which the transfer is made. On that page the account name
appears, and the first entry is the amount transferred from the old account,
with a page reference to the old account in the reference column. In making

the transfer it is customary to close the portion of the account on the old
page in the manner explained above, and to transfer only the balance.
Sometimes an entry may be made in an account in error and for this or
some other reason may need to be transferred. Assuming, for the purpose of
illustration, that such an entry is a credit, its amount is first written as a
subtraction item on the debit side in the old account, with proper reference
to the page to which it goes. On the new page it appears on the credit side,
like the original item, and may be considered as the contra to its transfer
record in the old account. In the new account the old page number must be
entered. Great care should be exercised in all transfer entries to show
correct cross-indexing.
Sometimes it is desired to transfer not the balance but the total debits
and credits of an account. In this case the total debit amount may be entered
on the credit side of the old account and the total credit amount on the debit
side, with proper page and explanatory references. This forces the equality
of the two sides and the account may now be totaled and ruled off. The total
debit amount of the old account is then entered on the debit side and the
total credit amount on the credit side of the new account.
A much simpler and more workable method, however, is to treat the
new account as a continuation of the old. There is then no necessity of
formally balancing the old account. The transfer is effected by totaling both
sides of the old account and indicating the new page to which these totals
are transferred, taking care to enter the totals on the proper side of the new
account, with proper references to the old account page. This procedure is
illustrated in Form 4.
Rulings and Entries in Personal and Note Accounts.—Some
peculiarities met with in the entries and rulings of personal and note
accounts, both receivable and payable, will be discussed here.
In John Adams’ personal account (Form 5) notice that his address is
included in the heading, that the terms of credit extended to him on each
sale are shown in the explanation space on the debit side, and that his
payments are entered on the credit side according to the date on which they
are received. If a payment appears directly opposite the corresponding
charge, with no other credits intervening, lines are ruled underneath both
the debit and the credit items to show that down to that point the account

balances. The record of dealings with each customer should be as full as
possible in order to furnish an accurate basis for credit rating. If he is
prompt in his payments, taking advantage of the discounts offered him, the
account should show this.

Form 4. Transfer of Account to New Page

Form 5. Personal and Notes Payable Accounts
A convenient method of showing clearly the taking of discounts,
without the need of calculating the time between dates of charge and
payment, is to enter the discount in small ink figures above the net amount
received. When two partial payments are made, as on October 1 and 15, to
settle the charge of September 20, and there are no other credits intervening,
the two credits, with the total in small figures, may be ruled off against the
single charge. At the time the trial balance is taken—in the illustration on
August 31, September 30, and October 31—the balance of the account is
calculated and shown in pencil on its proper side, debit or credit, just to the
left of the reference column on the line of the last entry on that side.
Sometimes, when payments are made out of order or on account and it
is desired to show to what particular charges they apply, an index number or
letter showing the cross-reference is used, as shown in the Notes Payable
account. As notes are issued by the business, they may be numbered, and
when it pays a particular note, the entry should show the number of that
note.
These remarks apply also to notes receivable. If full payment is received
on each note as it comes due, the entry may be made on the same line on

which the note was first recorded. This may result in the entries to the
account appearing out of chronological order, but it assists in an easy
determination of the outstanding notes. Numbering, or preferably lettering,
the entries in an account may be applied with advantage also to the entries
in personal accounts, as it aids in locating unpaid items, especially where
payments cannot be recorded in the order in which the items to be settled
have been entered.
The method of ruling and thus canceling items as explained above, is
usually limited to notes and accounts receivable and payable, that is, to the
accounts on which particular payments are received or made and the
balance of which it is desirable to ascertain at frequent intervals. On the
other hand, it is advisable that the method of showing periodic balances, by
means of small pencil figures for use in the trial balance, be applied to all
accounts.

CHAPTER XV
PERIODIC ADJUSTMENTS AND
SUMMARIZATION
Why Current Records of the Ledger Need Adjustment.—At the end of the fiscal period the ledger does not
present a true record of financial condition. The fixed assets of the business are constantly depreciating in value;
merchandise tends to become out of date, shopworn, stale, or soiled; some merchandise has been sold, while some
is still on hand; some of the accounts receivable may prove uncollectible, and some of the notes receivable may be
dishonored. Also, at the end of the period liabilities such as taxes, salaries, rent, and the like may have been
incurred, but because there is no creditor’s invoice or other business paper as evidence of such liability they are not
usually entered on the books until payment is made.
Again, it may be that the services paid for during this period, as shown by the various expense accounts, have
not been entirely used, as where a supply of coal for heating purposes remains on hand, or when, as in the case of
insurance bought for a given period of time, a part of the protection period extends beyond the close of the current
fiscal period. In these and similar cases, the items must be separated into their two component elements, one part
belonging to the current period, and the other part to a later period. The part of the expense to be deferred and used
up in a later period represents an asset at the close of the current period and must therefore appear on the balance
sheet under the heading of “Deferred Charges.”
Similarly, income is sometimes received in advance to cover services which have not yet been rendered, or
rendered only in part, as when rent is received in advance to cover a given number of months, some of which
belong to the next fiscal period. Consequently, only a part of this income applies to the current period, the balance
being deferred to later periods.
For these reasons certain asset accounts need to be adjusted and certain liability accounts must be opened to
bring the ledger into accord with the actual condition of things and show the true financial status of the business.
The entries required for this purpose are called “adjustment entries” to distinguish them from the closing or
summarizing entries to be described later in this chapter.
First in importance among the adjusting entries are those required to show the correct value of the stock-in-
trade, the fixed assets, and the accounts receivable. Whether the merchandise items are kept in one or several
accounts, the value of the stock on hand is not shown at any given time during the fiscal period. Goods have been
purchased at one price and sold at another, and no record of the value of the merchandise inventory on hand is
available. Similarly, no current record has been made of the depreciation of buildings, furniture, fixtures, or other
equipment, nor has any provision been made for the accounts receivable that may prove uncollectible.
Basis of Adjustment Entries.—These items, then, merchandise, asset depreciation, bad debts, prepaid and
accrued expenses and income, are the occasion of the adjustment entries. An inventory is required to find the value
of the stock-in-trade; an appraisal is made of the depreciating assets to determine the amount of depreciation for
the current period; and proper consideration must be given to the prepaid and accrued income and expense items
for the period under review. The following illustrations are concerned with the several classes of adjustment
entries. The detail of the account is not shown in each case, but only the balance.
Adjusting and Closing the Merchandise Records.—Unlike the method shown in the debit and credit
schedule for merchandise in Chapter XIII, the modern practice is to keep the merchandise record by means of the
separate accounts used in the profit and loss statement, viz., Merchandise Inventory, Purchases, Inward Freight and
Cartage, Returned Purchases, Purchases Rebates and Allowances, Sales, Returned Sales, and Sales Rebates and
Allowances. It should be understood that this detailed record of merchandise transactions is preferable to the single
merchandise account only because it gives more information. The detailed record does not in any way maintain a
sharper separation of the asset and income elements of the merchandise transactions than does the single
merchandise account. It does, however, make immediately available information as to volume of business,
purchases, returns, and so forth—items which in any well-managed business are watched carefully. These detailed
accounts taken together comprise the merchandise record and are equivalent to the single merchandise account.

It is apparent from a consideration of the single merchandise account that at any given time it includes these
three items: (1) the net cost of the total goods to be accounted for; (2) the decrease in the asset merchandise
brought about by sale; and (3) the profit on the goods sold. In order to bring about the separation of the
merchandise records into the two elements (a) goods still on hand, that is, the asset element, and (b) the profit on
goods sold, that is, the income element, it is necessary to bring the detailed accounts together for the purpose of
summarization. This summarization is accomplished in much the same way as in the profit and loss statement. The
net amount of sales and the net cost of goods sold are determined and set up against each other in order to indicate
the gross profit. In arriving at the cost of goods sold it is necessary to bring together the opening inventory, the
purchases, the inward freight and cartage, and from their sum to subtract the purchase returns, the purchase rebates
and allowances, and the final inventory. How this is accomplished in the ledger is explained by an illustration, in
which the adjustments or transfers between accounts are traced by means of cross-index letters.
Assume the following facts: Goods on hand January 1, 19—, $10,125.67; purchases for six months
$47,897.42; inward freight and cartage $560.25; returned purchases $2,125.40; purchase rebates and allowances
$267.92; sales $65,283.21; returned sales $3,924.83; sales rebates and allowances $392.48; and goods on hand
June 30, 19—, $11,267.40. Each of these items appears as the first entry on the proper side of its account, and is
distinguished by not being marked with a bracketed letter. The items comprise the ledger record previous to
summarization at the close of the fiscal period.
Merchandise Inventory
19— 19—
Jan. 1 10,125.67 June 30 Purchases (B) 10,125.67
June 30 (E) 11,267.40

Purchases
19— 19—
June 30 (Total purchases) 47,897.42 June 30 Returned Purchases (C) 2,125.40
Inward Freight and Cartage (A) 560.25 Pur. Rebates & Allow (D) 267.92
Mdse. Inventory, Jan. 1 (B) 10,125.67 Inventory, June 30 (E) 11,267.40
Profit & Loss (F) 44,922.62
58,583.34 58,583.34

Inward Freight and Cartage
19— 19—
June 30 (Total) 560.25 June 30 Purchases (A) 560.25

Returned Purchases
19— 19—
June 30 Purchases (C) 2,125.40 June 30 (Total) 2,125.40

Purchases Rebates and Allowances
19— 19—
June 30 Purchases (D) 267.92 June 30 (Total) 267.92

Sales
19— 19—
June 30 Returned Sales (G) 3,924.83 June 30 (Total) 65,283.21
Sales Rebates & Allow (H) 392.48

Profit & Loss (I) 60,965.90
65,283.21 65,283.21

Returned Sales
19— 19—
June 30 (Total) 3,924.83 June 30 Sales (G) 3,924.83

Sales Rebates and Allowances
19— 19—
June 30 (Total) 392.48 June 30 Sales (H) 392.48

Profit and Loss
19— 19—
June 30 Purchases (F) 44,922.62 June 30 Sales (I) 60,965.90

To show the total cost of goods bought during the period, the freight-in of $560.25 is transferred or closed into
Purchases. To show the “gross cost of goods to be accounted for,” amounting to $58,583.34, the inventory of
January 1 of $10,125.67 is transferred to the debit side of Purchases account. To show the net cost of goods to be
accounted for, the returned purchases and allowances are deducted from this gross cost by being transferred to the
credit side of Purchases. The balance in Purchases account at this point, viz., $58,583.34 minus $2,393.32, or
$56,190.02, indicates the net cost of goods to be accounted for.
This item of $56,190.02 is not indicated in the account, however, but is given here simply to make the
discussion intelligible. Part of this $56,190.02 (net cost of goods to be accounted for), amounting to $11,267.40, is
the cost value of the unsold goods according to the inventory of June 30, and the balance of $44,922.62
($56,190.02 minus $11,267.40) constitutes therefore the cost of the goods sold. This final inventory is also shown
as an asset on the debit side of Merchandise Inventory in the new section of the account, i.e., the portion of the
account following the initial inventory section which has now been closed and ruled off as shown on page 118.
Put in a somewhat different form, we may say that the cost of goods sold is found by subtracting from the
gross cost of goods to be accounted for, $58,583.34, first the returns and the rebates, $2,393.32, and then the
amount of the closing inventory of June 30, $11,267.40. The balance left of $44,922.62 represents the cost of
goods sold. This balance is now transferred to the debit of Profit and Loss account.
All the transfer entries given above have their debits and credits determined as explained in Chapter XIV. The
student should note that the same additions and subtractions are thus brought about in the Purchases account as are
made arithmetically in the section of the profit and loss statement given over to cost of goods sold.
The Sales account is debited with the balances of the Returned, Sales and Sales Rebates and Allowances, thus
showing a balance of net income from sales which is transferred to the credit of Profit and Loss. The Profit and
Loss account then shows net income from sales on the credit side, and cost of goods sold on the debit side. The
difference between the two sides is gross profit on sales. All of the merchandise accounts, except the Inventory
account, are now balanced, and should be ruled off in the manner explained in Chapter XIV.
The second illustration covers the case where the stock-in-trade record is kept in one mixed account called
Merchandise. Using the same data as in the other illustration, the account appears as follows:
Merchandise
19— 19—
Jan. 1 Inventory 10,125.67 June 30 Sales 65,283.21
June 30 Purchases 47,897.42 Returned Purchases 2,125.40
Returned Sales 3,924.83
Sales Rebates and Allow 392.48 Purchases Rebates and Allow 267.92

Inward Freight and Cartage 560.25 Inventory, June 30 11,267.40
Profit and Loss 16,043.28
78,943.93 78,943.93
June 30 Inventory 11,267.40

When the merchandise record is kept under separate accounts the freight-in is transferred to the debit of the
Purchases account; but when a single mixed account is kept with merchandise, freight-in is usually entered directly
to the debit of that account. To adjust the account when kept in this manner, the new inventory is entered to the
credit of Merchandise. The balance of the Merchandise account now shows the gross profit on sales, $16,043.28.
This is transferred to the credit of Profit and Loss. (It will be noted that this transferred item is identical with the
balance of the Profit and Loss account of the first illustration.) The Merchandise account is now totaled and ruled
off. On the debit side, beneath the ruling, the new inventory is entered, being the contra to the credit entry of
$11,267.40 above the ruling. The equilibrium of debits and credits is thus maintained. In this open item of
$11,267.40 the account shows an asset, the goods on hand June 30.
The handling of merchandise transactions according to the second illustration is not considered good
accounting but is shown because it is frequently met with in bookkeeping practice.
Underlying Theory in the Adjustment of Merchandise Records.—Careful analysis and study of the
adjustment of the merchandise records should be made in order to see the way in which the logic of the trading
section of the profit and loss statement is worked out in the ledger. The record of the merchandise asset should be
kept, in strict theory, in the same way as that of every other asset, namely, the accounts should be charged with the
full cost of the asset and credited at cost price with the portion sold, the profit or loss on the sale being carried in a
separate account. The balance of the Merchandise account would then show the value of the asset merchandise on
hand at any time.
Theory, however, gives way to the practical difficulties of handling the account in this way. Therefore,
periodically the mixture of asset decreases and income increases brought about through this practical method of
handling merchandise records must be corrected, or “unmixed,” so that these elements will appear separately. The
Purchases account, after the opening inventory, the inward freight, and the purchase returns, rebates, and
allowances are transferred to it, gives the net total of the merchandise asset for the period. This net total represents
two things: (1) merchandise still on hand, and (2) merchandise sold. By way of adjusting the records, the goods on
hand, as shown by the physical inventory, are separated from the total and put into the Merchandise Inventory
account, which shows by its title that it is an asset. That leaves in the Purchases account the cost of goods sold. The
credits which should indicate the decrease in the asset, equal to the cost of goods sold, are found in the net
merchandise sales, as shown by the Sales account after transferring to it the sales returns, rebates, and allowances.
But these credits are here mixed with the gross profit. The portion of the net sales representing the cost of sales of
merchandise should now, in strict theory, be transferred from the Sales account to the Purchases account. This
transfer would effect the balancing of the Purchases account, indicating that there are no merchandise asset values
in that account, these having been transferred to the Merchandise Inventory account. The result of this theoretically
correct procedure would be to bring about a segregation of the merchandise records into their two elements, the
asset element as shown by the Merchandise Inventory account and the income element as shown by the remaining
balance in the Sales account.
Once again, however, strict theory gives place to the more practical need of requiring the accounts to give full
information for management purposes. Accordingly, instead of handling them in the way just indicated, the
adjustment procedure explained on pages 118 to 120 is followed.
Handling Depreciation of Fixed Assets.—As shown in Chapter XIII, the method of handling depreciation of
assets consists of nothing more than separating the expense element from the asset element, both of which are
carried currently under the title of the asset. For reasons explained in Chapter XIII, the credit to the asset which
effects the separation is not recorded in the asset account but in a supplementary account entitled “Depreciation
Reserve” for the particular asset. This reserve account is an integral part of the asset record and must always be
considered in connection with the asset account in determining the value of the asset. The credit entry in the
reserve account is a sort of suspended credit, recorded there temporarily for purposes of information. The
offsetting debit to this credit is made in the expense account Depreciation.

The adjustment entry thus effects a separation of the asset account into the two elements, (1) present value of
the asset as shown by the asset account and its depreciation reserve account, and (2) the expense element recorded
under the Depreciation expense account. The following illustration indicates the bookkeeping procedure:

Furniture and Fixtures
19—
Jan. 1 750.00

Depreciation Reserve Furniture and Fixtures
19—
June 30 (A) 75.00

Depreciation
19— 19—
June 30 (A) 75.00 June 30 Profit & Loss (B) 75.00

Profit and Loss
19—
June 30 Depreciation (B) 75.00

The asset Furniture and Fixtures, valued at $750 at the beginning of the year, is estimated by appraisal to have
depreciated 10%, or $75, during the half-year. This cost or expense is charged to an account called Depreciation,
and credited not to Furniture and Fixtures, but to the valuation account “Depreciation Reserve Furniture and
Fixtures.” The Furniture and Fixtures account and its valuation account, taken together, show the appraisal value
of $675. Thus the credit adjusting entry is made to record a decrease in asset values. The Depreciation account,
carrying the debit of $75, is an expense account and is closed into Profit and Loss, just as any other expense
account is closed.
The Estimate for Doubtful Accounts.—At the close of a fiscal period, when an accurate statement of the
financial condition of the business is to be drawn up, all assets must be very carefully valued. The bookkeeping
procedure necessary to show the correct value of fixed assets subject to depreciation has been explained. The
outstanding claims against customers also require evaluation. Every business man knows from past experience that
he will be unable to collect all of his outstanding accounts. He may not know which of the accounts will prove
uncollectible, but he does know that there will be a loss in the sum total of these claims against customers. The
amount of this estimate is based on past experience in each business.
A standard basis for the estimate is not possible because in some businesses credit is extended much more
carefully than in other businesses and in some collections are followed up more vigorously than in others. In
making the estimate two methods are used, one being a certain percentage of the outstanding accounts, the other
being a certain percentage of the sales made during the period. Where experience shows the necessity, the loss
from both outstanding accounts and notes receivable is provided for.
The same bookkeeping procedure is used here as with the estimate of depreciation. An expense account,
usually entitled “Bad Debts,” is debited, and an account called “Reserve for Doubtful Accounts” is credited for the
amount of the estimated loss. The effect of the entry is to separate the claims against customers into their two
elements, namely, the true asset element, represented by the difference between the asset account and its valuation
reserve account, and the expense element as indicated by the Bad Debts account.
The following illustration sets forth the method of handling bad debts on the books of account:
Accounts Receivable
19—

June 30 100,000.00

Reserve for Doubtful Accounts
19—
June 30 (A) 2,000.00

Bad Debts
19— 19—
June 30 (A) 2,000.00 June 30 Profit and Loss (B) 2,000.00

Profit and Loss
19—
June 30 Bad Debts (B) 2,000.00

It is known, from past experience, that the asset Accounts Receivable, $100,000 in this instance, will not be
collected in full. To bring this book value down to its real value, the estimated loss, which it is thought will be 2%
of the outstanding accounts, is reserved from their value, that is, credited to a reserve account, which is to be taken
in conjunction with the asset account. The offsetting debit is to Bad Debts, an expense account. It represents an
expense which the current period has to bear, and is closed into Profit and Loss with other expense accounts.
Handling Prepaid and Accrued Expenses and Income.—The method of handling the estimates or
inventories of prepaid and accrued expenses and income is very similar to that shown for handling the mixed
Merchandise account. Illustrations follow:
Insurance
19— 19—
Jan. 1 (Paid) 150.00 June 30 (Unexpired) 125.00
Profit and Loss 25.00
150.00 150.00
June 30 (Deferred) 125.00

Rent Income
19— 19—
June 30 (Unearned) 250.00 June 15 (Received) 300.00
Profit and Loss 50.00
300.00 300.00
June 30 (Deferred) 250.00

Wages
19— 19—
June 30 (Paid) 2,125.00 June 30 Profit and Loss 2,325.00
(Accrued, unpaid) 200.00 2,325.00
2,325.00
June 30 (Accrued) 200.00

Interest Income

19— 19—
June 30 Profit and Loss 145.00 June 30 (Received) 127.50
(Accrued, due us) 17.50
145.00 145.00
June 30 (Accrued) 17.50

The first account, Insurance, shows the method of handling a deferred or prepaid expense. At the close of the
period the account is a mixed account, the unexpired portion of the insurance representing an asset to be shown on
the balance sheet as a deferred charge, the expired or consumed portion representing an expense for the period to
be closed into Profit and Loss. Insurance has been paid, in this case for a three-year term; hence only one-sixth of
it is chargeable to the first half-year, the remainder being deferred to later periods. The amount of the inventory or
unexpired portion is entered to the credit of the account in order to effect subtraction of the amount, the balance of
$25 thereby showing the insurance cost for the current period. This balance is carried to Profit and Loss. After
closing the account, the inventory is entered to the debit side below the ruling, thus showing the so-called
“deferred asset” portion which will appear in the balance sheet.
The next account, Rent Income, is a mixed account with income and liability elements. It shows that rent has
been received for a period which extends beyond the current fiscal period. On June 15, rent for the period of, say,
June 15 to September 15 was received. Only one-sixth of this income applies to the term January 1 to June 30;
therefore the balance of $250 must be deferred or carried over to the next fiscal period. The adjustment is made by
an entry of $250 for unearned rent on the debit side to effect its subtraction from the earnings for the current
period, thus reducing them to $50. This income of $50 is transferred to the credit of the Profit and Loss account.
After the Rent account is ruled off, the deferred income is entered below the ruling on the credit side, forming a
part of the earnings of the next period. It is shown among the liabilities in the balance sheet for the current period,
usually under the caption of “Deferred Income.”
The third account, Wages, shows wages paid to June 30 of $2,125. At that date wages earned but not yet paid,
perhaps because the pay-day did not coincide with the date of closing the books, amounted to $200. This item is
obviously an expense of the current period incurred during the short interval between the last pay-day in June and
June 30. The adjustment is therefore made by entering $200 on the debit side of the Wages account, to effect the
addition of this sum to the expense already shown there. The total amount of the account is transferred to Profit
and Loss and the account is ruled off. The amount of unpaid wages, $200, is shown on the credit side beneath the
ruling. In the balance sheet it appears as a liability, usually under the caption of “Accrued Expense.”
Similarly with the fourth account, Interest Income. Income to date is $127.50; earned but not yet due on June
30, $17.50, showing full earnings of $145 for the current period. This total is transferred to Profit and Loss, the
account is ruled off, and the earned but not received portion is shown as a debit beneath the ruling, and as an asset
in the balance sheet.
Great care must be exercised in the adjustment of all inventories to maintain the equilibrium of the ledger by
the entry of each amount to both the debit and credit sides.
Besides the four illustrations given above, there are many other accounts requiring the same kind of adjustment
entries. In certain special cases it may be necessary to make adjustments on both sides, as for example in a general
expense account or in a mixed interest account showing both interest income and interest expense. For illustration
a mixed interest account is shown. The debit opening item of $100 in the new section of the account represents an
asset, an interest claim against outsiders, while the credit opening item of $50 represents the liability to others for
interest due them but not yet paid. For the sake of accuracy and clarity, however, the better bookkeeping practice is
to keep separate accounts for Interest Income and Interest Cost.
Interest
19— 19—
June 30 (Paid) 400.00 June 30 (Received) 500.00
(Unpaid) 50.00 (Accrued, due us) 100.00
Profit and Loss 150.00

600.00 600.00
June 30 (Accrued) 100.00 June 30 (Unpaid) 50.00

Summarizing the Ledger—The Profit and Loss Account.—After all the types of adjustments have been
made, the accounts in the ledger are restored to their fundamental classifications, namely, assets, liabilities, and
proprietorship. There is now no intermixture of these basic elements. The proprietorship group of accounts shows
both the vested proprietorship, that is, the capital at the beginning of the period, and the temporary proprietorship,
that is, the increases and decreases (as indicated by the income and expense accounts) which have taken place
during the current period.
At the close of the fiscal period, when the temporary proprietorship accounts have served their purpose by
showing the day-to-day changes in proprietorship and the results must be summed up, these accounts are closed
for the current period so as to keep the records separate from those of the next period. For the purpose of
summarizing the profit and loss group of accounts, an account called Profit and Loss is opened in the ledger and to
it the balances of all temporary proprietorship accounts are transferred.
The Profit and Loss account in the ledger must not be confused with the formal statement of profit and loss,
made up outside the ledger just as is the balance sheet. On the credit side of Profit and Loss will appear all credit
or income account balances, and on the debit side will appear all debit or expense account balances. Accordingly,
if the balance of the Profit and Loss account is a credit balance, it shows a net profit for the period; if a debit
balance, it shows a net loss for the period.
The net profit or net loss shown by the Profit and Loss account represents either an increase or decrease in
proprietorship, and as such is transferred to the proprietor’s personal account. As explained in Chapter XII, this
account usually shows his drawings during the period against these profits as they were assumed to be accruing.
The personal account thus indicates whether the amount which he has drawn out is larger or smaller than the net
profits as determined by the Profit and Loss account. If his profits are larger than his drawings, his capital has been
increased by the amount of the credit balance in his personal account and the transfer of this balance to the credit
side of his capital account will then show the total net worth of the business. If his drawings are larger than the
profits, there is a decrease in capital, as shown by the debit balance of his personal account, and the transfer of this
balance to the debit side of the capital account reduces the former capital amount.
The summarization of results at the close of a period is called “closing the ledger.” The procedure consists,
first, in a transfer, i.e., in a closing out, of all the temporary proprietorship accounts to the Profit and Loss account;
second, in the transfer of the balance of this account to the owner’s personal account; and third, in the transfer of
the balance of the personal account to the owner’s capital account. After all temporary proprietorship accounts, the
Profit and Loss account, and the owner’s personal account have been closed, the only accounts remaining open on
the ledger are those showing either assets, liabilities, or capital. A formal statement of the balances of these
accounts constitutes the balance sheet. The accounts through which the income and expense records of the
business are closed, summarized, and transferred to the vested proprietorship account, are shown below, with
typical entries:
Profit and Loss
19— 19—
June 30 Purchases (Cost of Goods Sold) 15,000.00 June 30 Sales (Net income from sales) 3
Sales Salaries 5,000.00
Delivery Expense 500.00
Office Salaries 2,400.00
Supplies, Postage, etc. 200.00
Insurance 150.00
Bad Debts 500.00
Interest 150.00
Depreciation 200.00
John Doe, Personal (Balance) 5,900.00

30,000.00 3

John Doe, Personal
19— 19—
Jan. 5 Cash 300.00 June 30 Profit and Loss
Feb. 10 ” 250.00 (Net profit)
Mar. 3 ” 150.00
Apr. 1 ” 200.00
May 10 ” 300.00
June 3 ” 250.00
30 John Doe, Capital
(Balance) 4,450.00
5,900.00

John Doe, Capital
19—
Jan. 1 7
June 30 John Doe Personal
(Net increase in proprietorship)

CHAPTER XVI
SOURCES OF DATA FOR THE LEDGER
Insufficiency of the Ledger Record.—In an earlier chapter a business transaction was
defined as an exchange of values, and the ledger as the book in which transactions are grouped
under predetermined titles or names. Thus, all transactions relating to machinery are grouped
under the title “Machinery”; those relating to cash under the title of “Cash”; those to purchases
under the name “Purchases”; etc. Even in a small business the ledger may contain a large
number of accounts, all necessary to give a clear-cut presentation of the volume and
significance of business transactions.
The ledger record presents an analysis of transactions into their component elements, each
transaction being classified and recorded, usually, in at least two ledger accounts, and
frequently in more. Consequently, in order to learn the nature of a given transaction, to see it
in its entirety, it may be necessary to refer to a number of separate ledger accounts. This
process, even if the ledger is small, is not always easy; and when the ledger contains a large
number of accounts, it becomes practically impossible. Accordingly, another kind of record is
needed.
The Book of First Record.—This other record shows in one place the transaction in its
entirety; it gives a complete statement of the conditions and all other data relating to the
transaction. It also shows the fundamental analysis of the transaction into its debit and credit
elements under appropriate titles. It is called the original or first record. Usually it is not the
very first record made of the transaction but it is the first record made in the books of account.
The book in which this record is kept is called the “Journal.” The record as kept in the ledger
is a secondary record based on the original or first record in the journal. Because of its
secondary nature, courts will not accept the ledger as evidence without verification.
Posting to the Ledger.—The act of transferring the original entry from the journal into the
ledger is called posting to the ledger. In order not to lose sight of the original record in the
journal it is important that the ledger entry show by letter and number the book and page
where the original entry can be found. This index is entered in what is called the reference
column of the ledger account, which is just to the left of the money column. In this manner
every entry in a ledger account has a reference to the original entry pertaining thereto.
The Journal.—A journal may be defined as a diary or log in which the happenings or
transactions of a business are recorded in chronological order; that is, consecutively day by
day as they arise. Formerly it was sometimes called a day-book or blotter. As usually operated,
however, the day-book or blotter contained a rough record giving all the essential data relating
to each transaction without regard to accounting terminology, i.e., without regard to the
formulation of the debit and credit of each transaction. The day-book entry was a sort of
memorandum from which a formal record was made in the journal. This day-book or blotter,
though still in use in some places, has very largely been discarded and only the formal journal
is used. This latter was originally a single book but in modern accounting practice it has
become separated into many special journals.

Characteristics of the Journal.—1. Being of the nature of a diary, the journal shows each
day’s transactions in consecutive order with little regard to grouping. The first characteristic,
therefore, of the journal is that it is a book of chronological entry, a record of each transaction
just as it took place, with the entries made according to the dates of the transactions.
2. Another characteristic of the journal entry is that it is an analytical and classifying
record. Before the entry is made, the transaction is analyzed into its two elements of debit and
credit, determined according to the effect the transaction has in increasing and decreasing
assets, liabilities, or proprietorship. The account titles used in the journal are the same as those
used in the ledger and are selected on the basis of a detailed subclassification of the three
fundamental groups of accounts. The degree of detail in classification depends on the desired
minuteness of the information required. The guiding principle in giving these titles is to use
such names as will tell truthfully and accurately what kind of information is recorded under
each head. A journal entry is therefore an analytical record as to debit and credit, which
classifies the different elements of the transaction under such titles as will later be used in the
ledger.
3. A final and a very essential characteristic of the journal is that every entry should carry
in addition to account titles, with their debit and credit amounts, a brief but complete summary
of all the conditions and data relating to the transaction, so that, if referred to in the future, the
journal record will call to mind the essentials of the entire transaction.
Because of these three characteristics, and particularly the last two, the journal record is of
prime importance.
Equilibrium of the Journal Entry; Compound Entries.—As explained in a preceding
chapter, the debit and credit elements of all transactions must be equal in amount. Since the
journal entry is an analysis of the transaction, it must obviously show equal amounts in the
debit and credit columns. In case the analysis and classification require an entry consisting of
more than one debit and one credit item, the total of the several debit items must equal the
total of the several credit items. Such an entry is called a compound journal entry.
Standard Form of Journal.—The standard form of journal provides spaces for the
following information: date, classification as to debit and credit, ledger index column, money
columns to show both the debit and credit amounts, and full record of the essentials of the
transaction. The following form illustrates a complete journal entry:

19—
Jan. 10 Notes Receivable 10 1,000.00
James Jackson 14 1,000.00
60-day note, payable at First National Bank,
Perryville, Maryland, with interest at
6% per annum. Due March 10, 19—

Form 6. Standard Form of Journal

The date is sometimes shown in the middle of the first blank line; but it is better to place it
at the extreme left. The account titles are placed on separate lines unencumbered with other
data, because they are of first importance in posting. The name of the debit account is shown
on the extreme left of the explanation column, with a uniform margin to the right for the credit
account. The debit and credit amounts are placed in the left and right money columns
respectively. Data giving full explanation of the entry are shown directly below the classified
debit and credit entry, slightly to the right of the margin of the credit account title, and a
uniform margin is maintained down the page. The column to the left of the money columns
shows the ledger pages to which the entry is posted. The entry is read thus: Notes Receivable,
debit; James Jackson, credit, $1,000.00.

CHAPTER XVII
THE SUBDIVISION OF THE JOURNAL
Inadequacy of the Old Journal.—As explained in the previous
chapter, every business transaction was formerly entered in the journal. This
necessitated the making of a formal debit and credit entry for every item,
many of which were of the same kind. As the object of every business is to
sell something, during any business day a large number of sales, in
consequence, had to be analyzed, classified, and entered separately. The
entry in each case was a credit to Sales, and either a debit to the customer if
the sale was “on time,” or a debit to Cash if the sale was for cash. It was
soon perceived that instead of making a separate entry for each sale, one
entry could be used for bringing into the books all the sales for a given day.
This was accomplished by carrying a memorandum of the individual
transactions until the close of the day when a formal summary or compound
entry was made in the journal. Such a summary or compound journal entry
is illustrated below:
A. Jackson 175.00
D. Hayes 25.00
J. M. Marshall 132.50
T. P. Pollard 79.40
I. M. Cranston 93.20
M. V. Johnson 17.15
Sales 522.25
To record the day’s sales.
The memorandum of each sale was made in a blotter to record the
quantities and kind of goods sold but such entry formed no part of the
double-entry record, being merely the source of information for the formal
summary entry.

The Special Journal a Labor-Saving Device.—This use of the journal
can also be made in connection with other transactions, with similar great
saving of labor. Throughout the day in every business there is a large
number of cash transactions—receipts and disbursements—which require a
debit and credit record. Also purchases of merchandise, although not
numerous for any particular day, comprise a large number of entries during
the course of a month or year. To save the labor of so many entries, the
original journal is divided into separate books known as special journals,
each containing the original entries for a particular group of similar
transactions, the number of books corresponding to the number of groups
into which the various transactions are divided.
For instance, where the policy of the business is to encourage the
settlement of outstanding customers’ accounts by notes, the use of a notes
receivable book or journal effects a very appreciable saving of labor.
Through the use of such a book, limited to a record of nothing but notes
receivable, it is unnecessary to write each time a note is received, a
complete journal entry as follows:

Notes Receivable 1,500.00
James Jackson 1,500.00

Instead, the entry of Jackson’s name in the notes receivable journal is in
itself evidence of a debit to Notes Receivable account. Thus only the credit
side of the entry need be shown, with appropriate explanation and detail,
the formal debit being suppressed. When, however, the books are closed at
the end of each regular period, the total of all these entries in the notes
receivable journal is formally labeled “Notes Receivable, Dr.” and posted to
the debit of the Notes Receivable account. This procedure brings on the
ledger one debit entry for the transactions of the entire month. The
corresponding credits have been posted in detail day by day from their
journal record.
So also, when it is the practice of the business to issue many of its own
notes either in payment of purchases or for discount purposes, a “Notes
Payable Journal” may be used. The method of handling this book is similar
to that of handling the notes receivable journal as described above. A
similar procedure is followed in the case of sales, purchase, and cash

transactions referred to above. The method of handling these four groups of
transactions will be explained in detail in the chapters which follow.
Basis of Subdivisions.—The basis for dividing the one general journal
into special journals is the relative frequency with which transactions of a
similar nature occur. It would evidently be of no utility to create a special
journal if the number of transactions to be recorded in it was small, as the
saving in the labor of making the entries would be more than offset by the
trouble of using an extra book.
Customary Subdivisions.—The special journals most frequently met
with are those for purchases, sales, and cash. The Purchase Journal contains
the original entry of purchases, the Sales Journal the original entry of sales,
and the Cash Journals the original entry of cash transactions. All other
original entries are made in the general journal. For the sake of brevity, the
general journal is usually designated by the single term “Journal.”
It should be thoroughly understood that no matter how many special
divisions of the journal may be in use, such books combined with the
general journal comprise the journal record of transactions. None of them is
merely a memorandum record to be summarized and to be formally
recorded later. The record made in each is formal, although abbreviated, and
each must be posted completely, both debit and credit, in order to secure in
the ledger a full record of all business transactions.
A brief explanation will be given in following chapters of the more
simple forms of special journals.

CHAPTER XVIII
THE PURCHASE AND THE SALES
JOURNALS
Types of Purchase Journal.—For recording purchases of stock-in-
trade, a separate special journal called “Purchase Journal” is used.
Sometimes this special journal takes the form of what is called an “Invoice
Book,” explanation of which is given in a later chapter. The purchase
journal is sometimes used to record all sorts of purchases, as for example,
purchases of store and office supplies, of advertising and printing, and even
of services such as labor, and of uses, such as the use of a building. Such
use of the journal is more commonly made by manufacturing concerns than
by mercantile houses and the journal is then known as a “Voucher” or
“Accounts Payable Register,” which is explained in Volume II. The present
discussion is limited to the purchase journal as a record of purchases of
stock-in-trade by a mercantile firm.
Analysis of the Purchase Transaction.—The debit and credit analysis
of a transaction covering a purchase of stock-in-trade may result in either
one of two groups of entries: (1) if the transaction is on credit, a debit to
Purchases and a credit to either a personal account payable or to Notes
Payable account; or (2) if the transaction is for cash, a debit to Purchases
and a credit to Cash. Whether the purchase is on open account, on a note, or
for cash, it is often desirable to keep the accounts in such a way as not only
to indicate the vendor in each instance, but also to show the volume of
business done with each creditor. This is accomplished when the purchase is
for cash or for a note, by opening an account with the creditor in much the
same way as when it is on open account.
Thus every purchase transaction is first recorded as follows:

(1) Purchases
Vendor

If the purchase is a cash purchase, the liability to the vendor is immediately
canceled by the entry:

(2) Vendor
Cash

The vendor’s account is canceled by being credited and then immediately
debited with the same amount. This leaves on the books as the net result of
these two entries a debit to Purchases and a credit to Cash. This record of
the transaction is seen therefore to agree with the analysis of the cash
purchase transaction as previously explained.
Instead of opening individual accounts with each vendor, in the case of
cash purchases, the same result is sometimes accomplished by the use of
one account called “Sundry Cash Creditors.” To it all such cash purchase
transactions are posted both from purchase journal and cash book. This
method records the combined liability to all vendors in one account. It does
not, however, show the volume of business done with each creditor.
If the purchase is on a note, the liability to the vendor as set up in entry
(1) is immediately canceled by the entry:

(3) Vendor
Notes Payable

The net result of these entries, (1) and (3), is seen to be a debit to Purchases
and a credit to Notes Payable—a record which corresponds with the
original analysis of the transaction.
Since a purchase on open account also results in a debit to Purchases
and a credit to Vendor, it is seen that all types of purchase transactions may
be recorded as a debit to Purchases and a credit to Vendor. Accordingly, in
making the current record in the purchase journal, the debit element may be
omitted, since it is always the same, and only the credit element, which
differs in each case, may be set up. Periodically, usually at the close of each
month, the debit element is formally set up for the total amount of
purchases for the period. (See Form 7, a typical purchase journal.) Thus the
one formal debit is made to offset the numerous credits set up during the

month. The purchase journal is thus seen to be as fully a debit and credit
journal as the general journal, even though in making its day-to-day record
the debit element is, for the sake of economy in labor, omitted.
Other methods of handling the cash and note purchase transaction are
explained on page 152.
Form and Method of Using the Purchase Journal.—The simplest
form of purchase journal is the same as that of the standard journal. It
provides space for date, classification, explanation, ledger index, and two
money columns. In the purchase journal the money columns do not have
“debit” and “credit” significance, but the first may be used for the detailed
extensions and the other column for the total of each purchase. Assume, for
the sake of illustration, that the following purchases have been made:
January 10, 19—, from S. C. Bontell, terms 2/10, n/30:
5 tons hay @ $12.00
100 bu. corn @ .90
1,000 bu. wheat @ 1.10
30 tons coal @ 4.50
January 18, 19—, from P. V. Stewart, terms 2/10, n/30:
50 tons hay @ $12.00
130 tons coal @ 5.00
January 22, 19—, from I. S. Van Doren, terms n/30:
100 tons coal @ $ 4.50
600 bu. wheat @ 1.00
January 28, 19—, from S. M. Sax, terms 2/10, n/60:
510 bu. wheat @ $ 1.10
The purchase journal record, using the simple form of the standard
journal, would be as follows:

Form 7. Purchase Journal
Usually, however, a form of purchase journal is used which is better
adapted to its purpose. In this, instead of giving the detailed explanation, the
file number of the original invoice is written as part of the explanatory
matter, which usually comprises only this file reference and the terms of the
purchase. This modern type of journal is illustrated below.

Form 8. Modern Type of Purchase Journal
Posting the Purchase Journal.—In posting the purchase journal, it is
customary to post daily the credits to the various vendor accounts as they
are entered from day-to-day in the journal. In this way the true status of the
amounts due these creditors may be known at any time by reference to their
ledger accounts. The offsetting debit to Purchases account is posted only at
the end of the month when the purchase journal is summarized. In the
meantime the ledger is out of equilibrium because only the credit side of all
purchase transactions has been entered in the ledger. This equilibrium is
restored, however, by the monthly posting of the debit to Purchases account
which must always be made before the trial balance is taken.
An essential part of posting is the cross-indexing of the two records, the
journal and the ledger. The cross-reference column in the ledger account
must show the initial and page of the journal from which each item is
posted. For example, “P. 10” in the ledger would refer to purchase journal,
page 10. Likewise the ledger folio (L.F. or Folio) column in the journal
must show the ledger page of the account to which the item has been
posted. Thus, in the illustration, Stewart’s account is on page 125 of the
ledger, where he is credited with $1,250. At the end of the month the
purchase journal is footed and the summary entry, “Purchases, Dr.,” is made
and posted to the debit of Purchases account on page 10 of the ledger. This
one debit item in the ledger brings about the equilibrium with the individual
credits posted to the various personal accounts payable. The purchase
journal is then ruled off and thus made ready for new entries for the next
month immediately below the rulings.

Departmental Analysis of Purchases.—When it is desirable to
separate various classes of purchases so as to determine the profit from each
class, particularly in a business which is departmentized, a purchase journal
similar to the one shown in Form 9, which has an additional money column
for each class of purchases, may be used. If there are three classes or
departments, at least four money columns are required. The entry in the first
column is for the total amount of the purchases; and the entries in the other
three columns, which are headed each with the name of a class or
department, are for the total purchases of the respective departments. It is
evident that the totals of these three columns, added together, must at all
times be equal to the total of the first column. This affords a check on the
accuracy of the distribution. At posting time a separate account is opened in
the ledger corresponding to each of these classes of purchases. The
summary entry in a purchase journal of this kind appears as follows:

Form 9. Departmental Purchase Journal
Purchases are classified under separate titles, usually because it is
desirable to make a corresponding classification of sales and so secure
departmental results of operation.
The Sales Journal—Analysis of the Sales Transaction and Method
of Record.—For recording sales of stock-in-trade, a record called the
“Sales Journal” is used, which is limited to sales of merchandise. A sales

journal practically identical in form with the purchase journal serves this
purpose. Its columns are ruled and current entries are made in it just as in
the purchase journal.
The analysis of a sales transaction shows a credit to Sales and a debit
either to Customer, Cash, or Notes Receivable, according as the sale is “on
time,” for cash, or against a note given by the customer. In handling cash
sales and sales against the customer’s note, the same procedure is followed
as with purchases, i.e., accounts with customers are opened for all sales,
and are immediately closed off if cash or a note is received at the time of
the sale.
The current entry in the sales journal shows only the debit item, i.e., the
charge to the customer’s account, the credit to Sales account being omitted.
At the end of the month, however, the total of all sales is indicated by the
summary entry and is posted to the credit side of the Sales account in the
ledger. In order to keep the customers’ accounts up to date, the current
entries in the sales book, giving the names of the customers and the
amounts, are transferred to the customers’ accounts in the ledger at the close
of each day.
Summarization of the Sales Journal.—At the end of the month or
other posting time, the sales journal is totaled and the summary entry is
made and posted, thus bringing the ledger into equilibrium by one credit to
Sales account for the sum of all the debits to customers accounts made day
by day. The closing rulings are then made. The treatment is exactly similar
to the work in the purchase journal, the only difference being in the
summary entry, where “Sales, Cr.” takes the place of “Purchases, Dr.” If it
is desired to keep the sales record by departments or classes of
commodities, analysis columns will effect the distribution. In this type of
sales record the closing summary indicates the various departmental or
other sales accounts to which postings are to be made, instead of the one
general account, Sales, precisely as the departmental purchase journal
(Form 9) indicates the departmental or other purchases accounts to which
purchase entries are to be posted.
Goods Sold to the Owner.—The treatment of goods sold to the owner
of the business requires brief consideration. The proprietor usually
withdraws goods at cost price. There is thus no element of profit in the

transaction as there is in other sales. A strict analysis of the transaction
shows that it brings about only a decrease of the asset unmixed with any
element of income. Theoretically, then, such transactions should not be
recorded with the regular sales, but should be shown as a credit to
Purchases account. In practice, however, entering them in the sales journal
is the easiest method of recording them, and since they are not usually large
in volume, this method does not vitiate the total sales figure as a basis for
estimating percentages of profit. This matter is discussed in detail on page
273.

CHAPTER XIX
THE CASH JOURNALS
The Cash Book.—For recording transactions involving cash, two
journals are used. One of these records receipts and the other disbursements
of cash. They are known respectively as the “Cash Receipts Journal” and
the “Cash Disbursements Journal.” Instead of being separate books,
however, they are usually bound together and comprise what is called the
“Cash Book.” When bound together their pages alternate throughout the
book. The cash receipts journal occupies the left-hand pages, i.e., the even
numbered pages—2, 4, 6, etc.—and the cash disbursements journal the
right-hand pages—3, 5, 7, etc.— page 1 not being used. This method sets
up the cash record, receipts and disbursements, on facing pages and the
movement of cash is thus under easy and constant review.
The Cash Receipts Journal—Analysis of a Cash Receipt.—If $100
cash is received on account from John Doe, a customer, an analysis of the
transaction shows “Cash” debit and “John Doe” credit.

Cash 100.00
John Doe 100.00

So with all receipts of cash; the “cash” element is a debit. The record of
cash receipts being made in a journal devoted exclusively to receipts of
cash, the “Cash, Dr.” element of the entry may be omitted and only the
“credit” element need be shown; the very fact that the entry is made in the
cash receipts journal is sufficient to indicate that “Cash” is a debit. The cash
receipts journal (Form 10)—the left or debit side of the cash book—is
operated, therefore very much like the purchase journal.

Form 10. Cash Book (left-hand page)
(Cash Receipts Journal)
The Cash Disbursements Journal—Analysis of a Cash
Disbursement.—If $10 is paid for expenses of some kind, the analysis
gives “Expense” debit and “Cash” credit.

Expense 10.00
Cash 10.00

So with all disbursements of cash. A separate journal being devoted
exclusively to cash disbursements, the “Cash, Cr.” element of the entry may
be omitted and only the debit shown. The cash disbursements journal is thus
seen to be operated in the same way as the sales journal.
Thus, all left-hand pages in the cash book show receipts and all right-
hand pages show disbursements. Because it is unnecessary to write the
debit element of cash received and the credit element of cash paid out, a
great saving of labor is effected. Nevertheless, it must be remembered that
the entry on either side of the cash book is essentially a journal entry, and
that the missing elements—cash debit on the left page and cash credit on
the right page—are supplied at the end of the period by the totals when the

two journals are summarized in preparation for posting to the Cash account
in the ledger.

Form 11. Cash Book (right-hand page)
(Cash Disbursements Journal)
Form of the Cash Journals.—In the cash journals, just as in all other
journals, provision is made for date, account classification, explanation,
ledger posting index, and money columns. In a simple form of cash book,
just as in the purchase and sales journals, two money columns are usually
provided, the one for detail—a day’s or week’s detail—and the other for
totals. Such a form is shown in Forms 10 and 11. The student should note
carefully how the cash receipts journal is summarized. The balance of cash
brought forward from the previous week is entered in the second or total
column so that the detail column shows only the current week’s receipts.
Inasmuch as the Cash account in the ledger already shows the balance of
cash at the beginning of the week, i.e., $5,000, this amount must not be
included in the summary entry for the current week. In summarizing the
cash receipts journal, therefore, the total only of the detail column, showing
the cash received since the last summary, is set up as a “Cash, Dr.” item. In
summarizing the cash disbursements journal, since there is normally no
balance carried over from the previous week, the total of the journal—
representing the cash disbursed since the last summary—is set up as a

“Cash, Cr.” item. This is shown as $365, the amount being posted to the
credit of the ledger Cash account on page 1.
Cash Book Taking the Place of the Cash Account.—Because the two
cash journals are set up on facing pages, the record contains essentially the
same information as a detailed Cash account in the ledger. The double page
record brings together both the receipts and the deductions from receipts—
cash being normally a debit account. For this reason the cash book record is
itself sometimes used as a ledger account and when it is so used its totals
are not posted to the ledger account. The balance of the cash book must,
however, be included in the trial balance of the ledger, because when so
used the cash book is not only a journal but a ledger account as well.
When, however, the totals of both cash receipts and disbursements are
posted to a Cash account in the ledger, the balance used in the trial balance
is taken from the ledger account and not from the cash book, although of
course the balances in both are the same.
Whichever of these two methods is used, it must always be remembered
that the cash book is essentially a journal and that therefore its
classifications of business transactions must be transferred to their proper
accounts in the ledger.
Best accounting practice, however, requires that a Cash account be
carried in the ledger so that the ledger will be a complete record of all
transactions and will be independent of all other records for proof of its
equilibrium.
Posting the Cash Book.—In posting the debit side of the cash book to
the ledger, it is important to remember that the debit element of the
transaction is merely indicated by the fact that the entry appears on the left-
hand page of the cash book. The account name written in the Account
Classification column is the credit element and must be posted to the credit
of the corresponding account in the ledger. Similarly, on the right-hand side
of the cash book, the cash credit element of the entry is suppressed and the
named account should be posted to the debit of the corresponding ledger
account.
After the posting of the individual items has been completed, the “Cash,
Dr.” and the “Cash, Cr.” as shown by the summary entries must be posted to

the ledger Cash account, as explained on page 143.
As stated above, each side of the cash book is, in reality, a journal in
itself—a cash receipts journal and a cash disbursements journal—and it is
only because these two journals are shown side by side that the cash book is
sometimes made to serve the purpose of a ledger Cash account.
Balancing and Ruling the Cash Book.—The cash book in its simple
form is balanced and ruled in the same manner as a ledger account. When
the balance is brought down to the new section it is usually entered in the
second or total column, thus reserving the first or detail column for the
daily or weekly cash receipts, and separating these items from the balance
brought down from the previous period. (See Forms 10 and 11.)
When the record is to be transferred to a new page, either the current
page (double page) is balanced and ruled and only the balance is carried
forward, or the current page is totaled and both debit and credit footings are
carried forward as shown in Chapter XIV for the ledger cash account. The
cash book is closed, ruled, and transferred as of the same date and on the
same line for both sides, although usually there is room for more entries on
one side or the other, which may be closed by diagonal ruling. This is done
in order to keep the record of the receipts of a given period and that of the
disbursements in nearly exact juxtaposition, and thereby facilitate a review
of the cash movements for that period.
The Cash Short and Over Account.—It sometimes happens that when
the cash book is balanced, the amount which ought to be on hand as shown
by this balance, does not agree with the amount of cash on hand as shown
by actual count. The discrepancy may be due to failure to enter some items
of receipts or disbursements in the cash book, or to errors in making
change; or it may be due to petty thieving by the cash clerk. If the error
cannot be rectified at the time, an entry is made in the cash book, on
whichever side necessary, in an amount sufficient to bring the book balance
into agreement with the actual cash balance. The account to be debited or
credited, as the case may be, is entitled “Cash Short and Over.” If the
correct charge or credit is afterwards determined, the item or items should
be transferred from Cash Short and Over to their proper accounts. Usually
the Cash Short and Over account is treated as an income or expense account
and closed into Profit and Loss at the close of the period. Sometimes it is

treated as an asset or liability account, depending upon the nature of its
contents, i.e., the amount of the discrepancy shown and its probable cause.
The Cash Purchase and Sales Transactions.—A standard method of
handling the cash purchase transaction when it is desired to keep a record of
the volume of business done with each vendor, was explained on page 140,
where the purchase was shown to be “washed” or cleared through the
vendor’s account. A more direct method is sometimes used.
When purchases are made for cash, a complete record of the
transactions is made by the entry:

Purchases
Cash

Here there is evidently a conflict of places of original record. The
transaction being a purchase, record should be made in the purchase
journal; and since it is also a cash transaction, record should also be made in
the cash book. However, if an independent record were made in both places,
a duplication of the transaction would result, since entry in either journal is
a complete debit and credit record. The transaction would be entered twice
in full, causing an inflation of the purchases and cash disbursements. In the
purchase journal, the credit to Cash would be set up at the time of the
transaction and at the time of summarization the debit to Purchases would
be included in the total of the Purchases, thus completing the ledger record.
In the cash book the debit to Purchases would be set up at the time of the
transaction, and when the summary was made the credit to Cash would be
in the Cash total. Entry in both journals would, when posted to the ledger,
bring about two debits and two credits for the same transaction.
To overcome this difficulty the following methods are commonly
employed:
1. The record is made complete in both journals, but the credit to Cash
from the purchase journal record is not posted, because that credit will be
posted from its record in the cash book. Similarly, when posting the cash
disbursements journal, the debit to Purchases is not posted, because that
will be posted from the purchase journal. In this way original record may be
made in both journals and each journal will then show by its total what it is

intended to show, viz., total purchases and total cash disbursed,
respectively. In the secondary record, the ledger, only half of each journal
entry is set up, the debit to Purchases from the purchase journal and the
credit to Cash from the cash book. This prevents the inflation mentioned
above and does not destroy the equilibrium of the ledger because there is
omitted, when posting from the cash book, a debit equal in amount to the
credit omitted when posting the purchase journal.
2. The method explained on page 140 is used with this variation: The
record in each journal shows the individual vendor’s account, but at posting
time no vendor account is set up in the ledger, neither the credit to the
vendor’s account shown in the purchase journal nor its offsetting debit
shown in the cash disbursements journal being posted.
It is necessary, when making the original entries in the journals, to
indicate all postings which are to be omitted, by entering a check mark, ✔,
or a cross, ❌, in the ledger folio column of the journal.
The purchase on a note payable, one method of recording which was
explained on page 140, may also be handled more directly by either of the
methods explained above for a cash purchase. In the case of the note,
however, the journals used are the purchase and general journals.
Similar methods are employed, also, for handling the cash sale and the
sale against a customer’s note.
Columnar Analysis of Cash Receipts and Disbursements.—As
illustrated in the chapters on purchase and sales journals, additional money
columns are often used for the purpose of analyzing the purchases and sales
by departments or classes of commodities. A similar analysis of both the
cash receipts and cash disbursements may aid in segregating certain classes
of cash items and thus save labor in posting. Of cash receipts, two classes
are usually more active than all others combined. More cash is received
from cash sales and from customers on account than from any other source.
Accordingly, two additional columns may be used with these headings. All
cash receipts must be entered in the Total, Bank, or Net Cash column, as it
is variously termed, and then distributed into any special columns provided.
Thus all “Cash Sales” would be extended, both in the Net Cash and in the
Sales column, and all receipts from customers would be entered in the Net
Cash and in the Accounts Receivable column.

In the case of cash disbursements, the number of columns depends upon
the degree of analysis desired. At least two additional columns are
frequently found, one for creditors and one for expenses. Where cash
purchases are numerous they may be segregated, or where any particular
class of expense is of frequent occurrence it may be shown in a separate
column. Where one ledger is used for customers, creditors, and general
accounts, there is little gain in segregating customers and creditors by
special columns in the cash book, except as a slight aid in posting. Where
separate ledgers are used, it is important to have separate customers and
creditors columns in the cash book, as will be shown later in connection
with the subject of controlling accounts. Illustration and explanation of the
columnar cash book are given on pages 158 and 159.
Cash Discounts Analyzed.—Sales and purchase discounts are another
class of transactions best handled through the cash book, although, strictly
speaking, they are not cash transactions. When a customer buys goods on
account, he is usually offered two bases of settlement, depending on the
length of the credit term allowed. Thus, 2% off is frequently allowed if
payment is made within 10 days; otherwise the full amount of the invoice
must be paid. Because the vendor does not know, at the time of entry on his
books, on which basis settlement will be made, he makes the charge at the
full invoiced amount. If the customer takes advantage of the discount
offered, he pays less than the amount at which his account stands debited,
yet the vendor must credit his account for the full amount of the original
charge, in order to cancel his entire claim against the customer. To illustrate,
a customer buys $100 worth of merchandise, with 2% off if paid within 10
days. On the 10th day he pays $98. The sale entry would be:

(1) Customer 100.00
Sales 100.00

The cash entry would be:

(2) Cash 98.00
Customer 98.00

But this does not cancel in full the $100 claim against the customer. The $2
discount, an allowance for early payment, is an expense to the business and
must be charged to an expense account called “Sales Discount,” and the
customer must be given $2 additional credit, the entry being:

(3) Sales Discount 2.00
Customer 2.00

Entries (2) and (3) are usually combined in one as follows:

(4) Cash 98.00
Sales Discount 2.00
Customer 100.00

Entry (4) is known as a compound entry. If entry (2), which is the part
involving cash, is made in the cash book, then the additional entry (3) will
have to be made in the general journal because there is no cash element in it
and theoretically nothing but cash should be recorded in the cash book.
Handling Discounts in the Cash Book.—This recording in two
separate places of what is really one transaction has led to the introduction
into the cash book of a non-cash column in order to bring the whole
transaction together. The customer’s payment being a receipt of cash, the
record must be made on the debit side of the cash book. Reference to entry
(4) shows that Sales Discount is also a “debit.” Where the cash book is
limited strictly to cash transactions, the cash debit record shows only the
“credit” element of the entry. The use of a Sales Discount column on the
debit side of the cash book for the sake of making a complete record in one
place thus introduces an extraneous element, one out of harmony with the
other entries made there. In posting, great care must be exercised not to
transfer Sales Discount to the credit side of its ledger account but to the
debit side.
Alternative Treatment for Cash Discounts.—Sometimes another
treatment of sales and purchase discounts in the cash book is met with. This
treatment for sales discount is based on the fiction that the full amount of
the original charge is received from the customer and that an immediate

return is made to him of the amount of the discount. To use the example
cited on page 155, the entries would be:

Cash 100.00
Customer 100.00

showing receipt of the full invoice price and therefore full credit to the
customer; and

Sales Discount 2.00
Cash 2.00

representing the fictitious payment in cash of a discount on sales of $2. In
the cash book these two entries would appear as follows:
Dr. Cash Cash Cr.
Customer 100.00 Sales Discount 2.00

This method of entering discount on sales would have the same ultimate
result in the ledger as the columnar method, but the objection to it is that it
makes the cash book show more money received and paid out than has
actually been the case, thus making it difficult to check the cash against the
bank record of deposits and checks. Another objection is that by this
method the cash book does not show in one place a full record of the
transaction, since the two items are shown on opposite sides of the cash
book. Moreover, these items are seldom on contiguous lines because one
side of the cash book is often considerably “ahead” of the other. Cash
discount on purchases is sometimes handled by a similar unsatisfactory
method.
The first method shown, requiring special discount and net columns on
either side of the cash book, is the approved method.
Illustration and Explanation of the Analytic Cash Receipts Journal.
—An example of a columnar cash book debit side is given (Form 12) for
the purpose of illustrating some points in the discussion. It should be
understood that there is little uniformity in the columnization of cash books.

The needs of the business govern the ruling suitable in any given case. The
illustration shown is therefore not presented as a standard form but is given
only for the purpose of illustrating the method of analysis of cash receipts.

†This balance is taken from the credit side
of the cash record appearing on page 159.

Form 12. Columnar Cash Book—Debit Side

Form 13. Columnar Cash Book—Credit Side
As shown in the illustration, all actual cash receipts are entered in the
Net Cash column, which in connection with the Sales Discount column
comprises the total corresponding to the Total column of the other
subsidiary journals when an analytic record is made. All items received
from customers are entered in the Accounts Receivable column; but it is
important to note that the amount entered in that column is not the actual
cash receipt but the full amount of the original charge to the customer. Sales
discount, if any, is entered in the Sales Discount column, and the net
amount, the actual cash received from the customer, is the amount
appearing in the Net Cash column. Cash sales are entered in the Cash Sales
column and also in the Net Cash column. All other kinds of receipts are
extended to the Sundry column.
In the ledger folio column, checks are placed for the individual cash
sales entries, the posting usually being made from the summary in the sales
journal, as explained a little later, or from the total of the Cash Sales column
in the cash book if the other method is not employed. In the summary entry
of the illustration, it is assumed that a Cash account is kept in the ledger.
Hence “Cash, Dr.” is shown posted to ledger Cash account on page 4; and
the total Sales Discount, also debit, on page 20. The student should note the

method of showing the amount of cash received during the current week,
this amount comprising the “Cash, Dr.” posting to the ledger Cash account.
Of course, the itemized credits, except the cash sales, are posted to their
respective accounts, as indicated in the ledger folio column.
The use of the Sundry column for extension of the miscellaneous items
makes proof of the distribution possible. The sum of “Net Cash” and “Sales
Discounts”—both debit items—must equal the sum of all the other
columns.
Handling Columnar Analysis of Cash Sales.—If all sales, both cash
and “on time,” are entered in the sales journal, the totals of these two
classes of sales are posted to the ledger Sales account from the summary in
the sales journal. In this case there is no need of a separate Cash Sales
column in the cash book, because such a column would simply duplicate
the Cash Sales entry in the sales journal. Needless to say, cash sales always
appear in the Net Cash column of the cash book, because they are cash
receipts, but the “Ledger Folio” must be checked.
Sometimes two sales accounts are kept in the ledger, one for cash and
the other for “time” sales. Here, also, if there is a Cash Sales column in the
sales journal, no posting of cash sales from the cash book is necessary. On
the other hand, if cash sales are omitted from the sales journal, then the cash
book should provide for a Cash Sales column and the posting must be made
from the total of this column in the cash book.
Illustration and Explanation of the Analytic Cash Disbursements
Journal.—The cash disbursements columnar record corresponding to the
cash receipts shown above, would appear as in Form 13. As with cash
receipts, the illustration is not presented as a standardized form but merely
for the purpose of showing the method of analysis. Postings are made or
omitted, and the same considerations govern the making and posting of the
summary entry, as in cash receipts. Being few in number, cash purchases
are not shown in a separate column. The treatment of discounts received on
purchases is exactly parallel to that of sales discount.
Since all net cash appears in Net Cash column on either side of the cash
book, the cash balance is found by taking the difference between these two
columns. The two sides must be ruled up and closed on corresponding lines
and as of the same date.

CHAPTER XX
THE MODERN JOURNAL
Matter Left for Record in the Journal.—By the use of a cash receipts, a cash
disbursements, a purchase, and a sales journal, four principal classes of transactions are
taken out of the old-time journal and entered in separate books of record. If transactions of
any other class are numerous enough to justify the use of a separate book of record, such a
record should be set up. Although the number of subsidiary journals, each recording one
kind of transaction, may become very large, nevertheless in practically all cases it is
necessary to retain the general journal (often referred to simply as “the Journal”), in order
to take care of such miscellaneous items as are not recorded in any of the special journals.
The standard form of journal was illustrated in Chapter XVI, where it was stated that a
journal must provide space for date of entry, account classification, ledger folio index, debit
and credit money columns, and explanation. As an explanation of the form, method of use,
proper observance of margins, etc., was made there, it need not be repeated here.
Kinds of Transactions Recorded in the Journal.—When the number of subsidiary
journals used is limited to the cash receipts, cash disbursements, purchase, and sales
journals, as is frequently the case, all items not affecting these four books should be entered
in “the Journal”; i.e., transactions involving notes receivable and notes payable;
adjustments with customers and creditors resulting from return of goods or claims and
allowances thereon; and all formal opening, adjusting, and closing entries. Furthermore,
there is usually a number of other transactions, which because of their special and unusual
nature cannot be grouped with the items of the special journals and must therefore be
entered in the general journal.
Journal Explanations.—When these various classes of transactions are entered in the
Journal, a very complete explanation should be given the entry. In fact, all entries covering
settlements and adjustments with outsiders and within the business itself are of primary
importance and the explanation should be so carefully worded as to make the intent of the
entry plain and intelligible.
Closing and Posting the Journal.—No particular formality attaches to the closing and
posting of the ordinary standard form of journal. There is no summary entry, no totaling,
and there are no rulings to be made. Ordinary care must be exercised to see that the debits
and credits are correctly posted. Since the entry in the Journal is given in its complete form
and no debits or credits are suppressed, as is the case in the special journals, posting is not
difficult.
The Analytic Journal with Divided Columns.—One form of the journal has its debit
and credit columns separated, the debit money column appearing at the extreme left of the
page, followed in order across the page by columns for date, account classification, ledger
folio, and credit money amount. This kind of journal is called a divided or split-column

journal and is ordinarily used to collect the totals to be posted to controlling accounts and
thus to secure control over subsidiary ledgers. This matter will be fully discussed in later
chapters. When the journal is so used it is provided with additional debit and credit analysis
columns on each side according to the subsidiary ledgers employed. A divided-column
journal with three debit and three credit columns is shown in Form 14. There is always a
general money column on each side, the other columns depending on the kind of analysis
required by the business.

Form 14. Divided Column Journal
In the illustration referred to, an Accounts Receivable and an Accounts Payable column
are provided. It is obvious that the Accounts Receivable column should usually appear on
the credit side and the Accounts Payable column on the debit side; although in some cases
provision is also made for an Accounts Receivable column on the debit and an Accounts
Payable column on the credit side. The account of S. J. White, a customer, which is paid by
his note, should be credited for the amount of $510.20 and consequently the item is
extended to the Accounts Receivable column.
Illustrations—Opening Entries.—Illustration will be given of a few typical
transactions requiring journal entry. The standard two-column journal will be used.
For the purpose of illustrating opening entries, assume the following data:
On September 30, 19—, Jack Gibson started in business, with the
following assets and liabilities: Cash $3,500; Notes Receivable $800;
Merchandise $4,000; Furniture and Fixtures $450; Accounts Receivable
$2,100; Accounts Payable $1,500; and Notes Payable $1,200.
An analysis of this transaction shows that no part of it belongs to either the purchase or
sales journals. The part relating to cash is entered in the cash receipts journal. However, in
order to show the complete investment in one place, the entire transaction including the
cash part, is entered in the Journal and posted from there, with the exception of the cash

item. The reason for this exception is that the cash investment is also entered in the cash
book and will find its way to the ledger Cash account through the total cash debits at the
end of the period. Because of this the cash item in the Journal should be checked and not
posted to the Cash account in the ledger.
Likewise, the investment item in the cash book, showing a credit of $3,500 to Jack
Gibson, Capital account, should be checked and not posted to the credit of his account in
the ledger because this item forms a part of the total investment of $8,150 posted to his
credit from the Journal entry.
If the student has difficulty in determining the debits and credits of entries of this kind,
it may be helpful to set up the data informally first, in the form of a balance sheet. Using
this as a guide, he should then make his journal entry, debiting the asset items and crediting
the liability and net worth items.

Form 15. Opening Entries on Books

The above entries bring the transaction completely on the books of original entry and
show the ledger folios to which the various items are posted. Notice the check in the L. F.
column in the Journal opposite “Cash” and in the cash book opposite “Jack Gibson,
Capital,” which is inserted to prevent posting the same item twice.
For opening entries full explanation and details, where necessary, should be given in the
Journal, covering lease agreements and contracts entered into when commencing business,
and other similar data. It should be noted that with opening entries it is customary for the
explanation to precede the formal showing of debits and credits, rather than to follow it as
in the case of all other journal entries.
Adjusting and Closing Entries.—Other typical entries to be illustrated are those made
at the close of a fiscal period: (1) to adjust the books in accordance with certain data that
were not obtainable before; (2) to transfer all temporary proprietorship accounts to the
summary account, Profit and Loss; and (3) to transfer the net profit, i.e., the balance of the
Profit and Loss account, to the proprietor’s personal account, and the balance of this latter
account to the proprietor’s capital account.
The debits and credits of the entries necessary to effect the record of the data and
transfers mentioned, can be determined as in the operations with ledger accounts previously
shown.
The following data relate to Jack Gibson’s business and are given to illustrate the three
classes of entries mentioned above:
During the year, sales amounted to $33,000; purchases to $25,000;
selling expenses to $3,500; and general administrative expenses to
$2,025. It is estimated that of outstanding accounts $350 are
uncollectible; that furniture and fixtures have depreciated in value $45.
Merchandise inventory shows $5,000 on hand. Gibson drew $1,000
during the year.
The first thing necessary is to make the adjustments on account of depreciation, bad
debts estimate, and present inventory. These adjustment entries are made in the Journal as
follows:
19—
Sept. 30 Depreciation 20 45.00
Depreciation Reserve Furniture and Fixtures 6 45.00
To bring on the books the expense
due to estimated depreciation and
to effect the proper valuation of
Furniture and Fixtures.
Bad Debts 21 350.00
Reserve for Doubtful Accounts 3 350.00
To bring on the books the expense
due to estimated loss from

uncollectible accounts.
Purchases 16 4,000.00
Merchandise Inventory 4 4,000.00
To transfer the goods on hand at
the beginning of the year to
Purchases.
Merchandise Inventory 4 5,000.00
Purchases 16 5,000.00
To transfer the inventory of
merchandise now on hand to
Merchandise Inventory account.

The first two entries, when posted, will bring on the book valuation accounts for
furniture and fixtures and accounts receivable, and will set up the expense accounts,
Depreciation and Bad Debts. The third Journal entry, when posted, will transfer the goods
on hand at the beginning of the year so that they can be added to the Purchases made during
the year. In this connection it will be remembered that the sum of these two items, old
inventory plus purchases during the year, constitutes the primary factor of “cost of goods to
be accounted for.” The fourth entry shows the asset Merchandise now on hand and, by its
credit to Purchases, effects a subtraction from Purchases, so that the balance of Purchases,
$24,000, shows the “cost of goods sold.”
The books are now adjusted and ready for summarization by means of the Profit and
Loss account. The following Journal entries, transferring all temporary proprietorship items
to the Profit and Loss account, will effect the closing operation:
19—
Sept. 30 Sales 15 33,000.00
Profit and Loss 14 33,000.00
To close.
Profit and Loss 14 29,920.00
Purchases 16 24,000.00
Selling Expense 18 3,500.00
General Administrative Expense 19 2,025.00
Bad Debts 21 350.00
Depreciation 20 45.00
To close. 29,920.00
Profit and Loss 14 3,080.00
Jack Gibson, Personal 11 3,080.00

To transfer net profit for the year.
Jack Gibson, Personal 11 2,080.00
Jack Gibson, Capital 10 2,080.00
To transfer the portion of the year’s
net gain left in the business.
The first entry transfers the sales income to the credit of Profit and Loss. The second
entry charges the Profit and Loss account with the cost of goods sold and all other expenses
for the fiscal year. When the posting has been completed up to this point, the balance of the
Profit and Loss account shows a net gain of $3,080, which, belonging to the proprietor, is
transferred to the credit of his personal account, as shown by the third entry. He has drawn
against prospective profits to the extent of $1,000, leaving $2,080 of profit remaining in the
business as an addition to his permanent investment. Hence, this balance is transferred to
Gibson’s capital account by the fourth entry.
Objection to the Direct Ledger Method of Adjusting and Closing the Books.—
These adjustment and closing transactions are sometimes recorded directly in the ledger
without first entering them in the Journal. Usually this is not satisfactory because it does not
show in one place a complete record of all the adjustment and closing summaries necessary
at the close of a fiscal period. These summaries are matters of sufficient concern to the
business to warrant their entry in the Journal where full and complete explanations can be
given. The more complex entries often needed to adjust and close the books of a business
where numerous income and expense accounts are kept, follow the same general principles
as those discussed above. Adjusting and closing entries are given fuller treatment in
Chapters XXVII and XXVIII.
The two illustrations given above cover certain types of Journal entries which are of a
more difficult character than the customary purchases, sales, and cash entries. A keen
analysis is often required to formulate the debits and credits of these entries, and the
explanatory matter should be worded with sufficient care to render them intelligible even
after the immediate interest in them has been lost and their recording ink has become
“cold.”
Entries Affecting Several Journals.—Transactions sometimes require entry in two or
more journals. A basic principle of bookkeeping is that there should be no duplication of
entry in the various journals. A transaction that can be completely entered in one journal
should not be entered in any other journal. The one exception to this principle is made in
the case of an investment transaction, as explained on page 171. Sometimes, however, there
may be a conflict of places of entry, as in the case of cash purchases and sales, already
explained, where entry is made in both journals in order to allow each journal to perform its
proper function. Two examples will illustrate the proper method of handling such
transactions.
Problem 1. Assume that a customer, James Robbins, buys $1,000
worth of goods, paying $300 cash, giving a note for $500 and leaving the
balance on open account.

The following entries should be made:
(a) James Robbins 1,000.00
Sales 1,000.00
(b) Cash 300.00
James Robbins 300.00
(c) Notes Receivable 500.00
James Robbins 500.00
It will be noted that three journals are involved. Entry (a) is recorded in the sales journal;
entry (b) in the cash receipts journal; and entry (c) in the general journal. The net effect of
the three entries is:
James Robbins 200.00
Cash 300.00
Notes Receivable 500.00
Sales 1,000.00
Because special journals are used, however, the transaction must be split up as indicated
above.
Problem 2. Assume that the business purchases from the Investment
Trust Co. a building site valued at $5,000, paying for it $2,000 cash and a
note for the balance supported by a mortgage.
Two methods are used to record this transaction, neither having any special advantage
over the other.
First Method:
(a) Land 2,000.00
Cash 2,000.00
(b) Land 3,000.00
Mortgage Notes Payable 3,000.00
Entry (a) is made in the cash disbursements journal, and entry (b) in the general journal.
This method of entry requires the splitting of the land value into two parts and breaks up
what is really a unit transaction by recording it in two places. Because of this, the general
journal portion of the entry should be followed by a very full explanation of the entire
transaction, in which reference to the partial cash payment should be made. In the cash
disbursements journal the only explanation needed will be a reference to the general journal
entry.
Second Method.—To bring about a complete record of the land item in one place, the
following method is often used:

(a) Land 5,000.00
Investment Trust Co. 5,000.00
(b) Investment Trust Co. 2,000.00
Cash 2,000.00
(c) Investment Trust Co. 3,000.00
Mortgage Notes Payable 3,000.00
Entry (a) in the general journal sets up an account with the vendor, the Investment Trust Co.
Entry (b) in the cash disbursements journal and entry (c) in the general journal show the
cancellation of the liability to the vendor through the payment of cash in the one case and
the giving of a mortgage in the other. The net effect of the entries is:
Land 5,000.00
Cash 2,000.00
Mortgage Notes Payable 3,000.00
It will be noted that this method sets up a formal account with the vendor—a desirable
thing—but that it requires one more entry than the first method.
The other entries recorded in the Journal ought not to give the student any particular
difficulty.

CHAPTER XXI
BUSINESS PAPERS—NEGOTIABLE
INSTRUMENTS
The books of original entry, i.e., the journals, having been explained, the
attention of the student will be directed next to the sources of information
on which the entries in the various journals depend. Accordingly, some of
the important papers and methods used in business will be discussed, after
which further accounting principles and methods will be given adequate
treatment.
Use of the Note Receivable.—The purpose of sales is the ultimate
conversion of stock-in-trade into cash to provide for the payment of
services and for the purchase of commodities for future sale. This
conversion of stock-in-trade into money may be immediate, as when goods
are sold for cash, or deferred, as when goods are sold on account. In the
latter case the conversion is indirect, because the charge against the
customer must be collected before conversion is complete.
Frequently the “note receivable” acts as an intermediate step in the
process of converting stock-in-trade into cash. It is an instrument in which
the customer formally promises to pay his debt at a fixed time in the future.
The kind of claim represented by a note receivable is, legally, different from
the open account claim; generally speaking, a note is considered a better
claim than an open account. This is because the note implies a prima facie
acknowledgment of the correctness of the original charge, and in event of
suit relieves the holder from proving the original items of the claim.
Accordingly, when a promissory note is received from a customer, the
open account claim against him ceases to exist and a different kind of claim
evidenced by his promissory note is acquired. Therefore the open account is
credited to show cancellation of the original charge, and Notes Receivable
is debited to show the new claim. It may be well to remark here that the
same instrument which is a note receivable to the vendor is a note payable
to the customer.

In some businesses, it is the policy to encourage customers to give
notes. In such cases it is often advantageous, particularly for the credit
information shown, to set up the note transactions with each customer under
individual names, e.g., “John Doe, Notes Receivable.” Such a title plainly
indicates the nature of the items listed under it; viz., claims against John
Doe, witnessed by his promissory notes. As a general rule, however, the
notes received from any one customer or all customers are usually relatively
small in number and for this reason they are for the most part brought
together under one class title, Notes Receivable.
Negotiable Instruments—Their Use and Requisites.—Notes
receivable belong to a class of business papers termed negotiable
instruments, the distinctive feature of which is that in many ways and for
many purposes they take the place of money. The negotiable instrument,
usually of small size but often representing a large sum of money, is used in
the commerce of the world as a medium of exchange, in place of heavy and
bulky coin or valuable bank notes which when lost or stolen can be passed
as currency.
From a legal standpoint a negotiable instrument is one which gives a
bona fide holder an absolute right to it, whether the preceding holder had
acquired it lawfully or not. It is in this respect distinguished from other
objects of value, as a horse, for example, the present possessor of which is
the legal owner only if he acquired it in good faith from one who in turn
had acquired it lawfully.
To be negotiable, an instrument must have the following requisites:
1. It must be in writing and signed by the maker or
drawer.
2. It must contain an unconditional promise or order to
pay a fixed sum of money—and the payment must
be made in legal tender.
3. It must be payable on demand or at a time which is
either fixed or can be determined.
4. It must be payable to bearer or to order.
Negotiable Instruments—Kinds and Definitions.—Any formal or
informal written promise to pay possessing these essentials is a negotiable

instrument. Examples are: promissory notes—notes receivable and notes
payable—drafts, checks, money orders and, with certain restrictions,
warehouse receipts.
A promissory note may be defined as an unconditional promise to pay a
specified sum of money at a certain time. It usually has a form similar to the
following:

Form 16. Promissory Note
The Draft.—A draft is a written order by one party on a second party to
pay to a third party the amount of money named. To be negotiable, it must
be so drawn as to meet the requirements of negotiability named above. A
draft may have a form similar to the following:

Form 17. A Draft
It will be noticed that there are three parties to a draft—the drawer, the
drawee, and the payee. The drawer is the person who draws the draft and
whose signature appears at the lower right-hand corner of the draft. The
drawee is the person on whom the draft is drawn, George S. Perkins, above.
He is sometimes called the payer. The payee is the person who is to receive
the payment ordered, James Stanley Jackson & Co.

To understand the use of the draft as an instrument of business, suppose
the following relations exist between the three parties named above:
1. George S. Perkins bought goods from Bert V. Robbins
on account for $175.
2. Robbins bought goods from James Stanley Jackson &
Co. to the amount of $125.75 on account.
The problem will be discussed from the standpoint of Bert V. Robbins.
From the above data it is clear that Robbins has a claim against Perkins for
$175 and owes $125.75 to Jackson & Co. Instead of collecting the claim
against the former and paying his debt to the latter, he writes out a draft for
$125.75 on Perkins, with Jackson & Co. as payee, thereby requesting (or
ordering) Perkins to pay $125.75 to Jackson & Co. This draft he sends to
Jackson & Co. and they present it through their bankers to Perkins. Under
ordinary circumstances Perkins acknowledges the correctness of the draft
and writes his acceptance on the face of it, thereby promising to pay the
amount when due. Acceptances are usually worded in the following
manner:
Accepted, Oct. 6, 19—
Payable at First National Bank
of Providence
George S. Perkins
It should be said that the three-party draft is not usually made use of
without the consent of the drawee previously obtained, as in the case of a
bank check, which is a draft on the bank drawn by the depositor. Very often
in ordinary drafts, particularly when drawn against an export of goods, the
drawer makes out the draft in favor of himself and indorses it in blank, thus
making it transferable to bearer.
The Accepted Draft.—When accepted, the draft becomes, to all intents
and purposes, an ordinary promissory note—Perkins’ promise to pay
Jackson & Co. $125.75. Until the draft is accepted by Perkins, it simply
constitutes a request from Robbins to Perkins to pay the amount named and
the draft as such does not bind Perkins in any way. Hence, no entry is made
on the books of account of any of the three parties until acceptance. Of
course, a memorandum is kept of all drafts drawn.

Illustrative Entries.—Upon acceptance by Perkins, the following
entries are made:
1. On the books of Jackson & Co., the payee:
Notes Receivable 125.75
Bert V. Robbins 125.75
Robbins’ draft on G. S. Perkins,
accepted by Perkins, payable December 5.

Perkins’ acceptance, in possession of Jackson & Co., constitutes a claim
against Perkins, and Jackson & Co. therefore debit Notes Receivable. They
credit Robbins because this draft was sent to them by Robbins in payment
of Jackson’s open claim against Robbins for $125.75.
2. On the books of Perkins, the drawee:
Bert V. Robbins 125.75
Notes Payable 125.75
Accepted Robbins’ draft at 60 days’ sight,
favor of J. S. Jackson & Co.

This entry cancels Perkins’ liability on open account to Robbins, and shows
as a substitution therefor the amount of his acceptance in favor of Jackson
& Co. at Robbins’ request.
3. On the books of Robbins, the drawer:
James Stanley Jackson & Co. 125.75
George S. Perkins 125.75
To record the cancellation of our liability
to Jackson & Co. on open account, and to
credit Perkins with his acceptance of our
draft on him at 60 days’ sight.

From the point of view of Bert V. Robbins, the acceptance by Perkins
means two things: (1) the cancellation of a part of Robbins’ claim against
Perkins, and for this reason Robbins credits Perkins with $125.75; (2) the
cancellation of Robbins’ debt to Jackson & Co., hence Jackson & Co. is
debited on Robbins’ books for $125.75.
It is important to note here that in case Perkins fails to pay the note at
maturity, Robbins becomes liable to Jackson & Co. Robbins may therefore

be considered the first indorser of the accepted draft. The discussion of the
manner of booking Robbins’ liability contingent upon Perkins’ failure to
pay is deferred to Chapter XLIII.
Entries After Payment of the Draft.—Upon payment by Perkins, the
following entries are made:
1. On Perkins’ books, a debit to Notes Payable and a
credit to Cash.
2. On Jackson & Co.’s books, a debit to Cash and a
credit to Notes Receivable.
Draft and Cash Compared as Instruments of Payment.—The
following two diagrams may further illustrate the utility of the draft as an
instrument of trade.
1. Showing the settlement of the several claims in cash—in case
Robbins had collected $125.75 from Perkins and had paid $125.75 to
Jackson & Co., the payments being made independently in each case:

2. Showing a settlement by draft—a clearing house method:

The commercial, three-party draft is little used now. With the larger
function of banks in the conduct of modern business, other kinds of drafts
as discussed below have come into use. The three-party relationship is the
basis of all draft transactions, however, and must therefore be thoroughly
understood.
Classification of Drafts.—There are several kinds of drafts, which may
be either sight or time instruments. A draft drawn “at sight” is a request on
the drawee to pay at sight, i.e., immediately upon presentation to him. The
use of the sight draft in making collections is quite common. A delinquent
customer is drawn on at sight and collection is attempted through the bank.
The method is oftentimes effective because refusal to pay may reflect on the
drawee’s credit with his own bank. Usually no formal book entry is made of
such drafts until paid. A draft drawn, say, “at 60 days’ (or 30 days’) sight” is
a request to pay 60 (or 30) days after presentation. Hence, the dating of the
acceptance of such a draft is of prime importance. Such a draft is, of course,
a time draft.
A draft drawn “60 (or other number) days after date” is called a date
draft and is payable 60 days from the date of the instrument—not, as in the
first case, 60 days after presentation or acceptance. It also is a time draft. It
is not necessary, although customary, to present time drafts for acceptance.
Drafts may be “commercial” or “bank” according as the drawee is a
merchant or a bank, respectively. B. V. Robbins’ draft on Perkins shown
above is a merchant’s draft. A bank draft is a request by one bank on a
correspondent bank to pay a given amount of money to a named payee. A
customary method of remitting money is by the purchase and remittance of

a bank draft, for the issuing of which banks usually charge a fraction of a
per cent. To illustrate its use, take the following situation:
L. W. Roberts of Denver owes Field & Co. of Chicago $210 on account.
Roberts goes to his Denver banker and buys a bank draft which may read as
follows:

Form 18. A Bank Draft
Before sending this draft to Field & Co., Roberts indorses it in favor of
Field & Co., who upon its receipt deposit it with their own bank and
through it secure its collection from the Second National Bank. Roberts
pays his bank for the draft $210 plus exchange.
Drafts may be foreign or domestic. They are domestic when they are
drawn and payable within the same state or country; otherwise they are
foreign. According to the present usage, the term “draft” is used whenever
the parties concerned live within the United States, although they may
reside in different states, and the term “bill of exchange” is applied to all
such instruments where some of the parties live abroad.
The Trade Acceptance.—The Federal Reserve Board defines a trade
acceptance as “a bill of exchange drawn by the seller on the purchaser of
goods sold and accepted by such purchaser.” The chief characteristic of this
document as contrasted with the ordinary draft is the showing on its face of
the origin of the transaction giving rise to the draft, usually by means of the
following statement: “The obligation of the acceptor hereof arises out of the
purchase of goods from the drawer.” The following requirements to make a
trade acceptance eligible for rediscount by the federal reserve banks have
been laid down by the Federal Reserve Board:
1. It must have arisen out of an actual commercial
transaction, usually the purchase and sale of
commodities.

2. It must have been drawn under a credit opened for
the purpose of conducting or settling accounts
resulting from business transactions involving the
shipment or storage of goods.
3. At the time of presentation to a federal reserve bank
for discount or as collateral for the loan of money,
it must have a maturity of not more than three
months exclusive of days of grace.
Trade acceptances are promissory notes just as are any other accepted
drafts. Because they comprise a very liquid asset, it is not unusual to record
them in an account, Trade Acceptances, and so distinguish them from other
notes and drafts. If they are few in number, they are more usually recorded
as Notes Receivable.
Checks.—A check is a draft on a depositary bank. It is an individual’s
order to his bank of deposit to pay a named or designated payee a certain
sum of money. Two illustrations are given below, somewhat different in
form but identical in nature. In the first, likeness of the check to a draft is
very evident.

Form 19. Forms of Checks
The certified check is usually an individual’s or firm’s check bearing the
certification of the bank’s cashier that the check is good. This certification

is evidenced by writing across the face of the check these or similar words:
Good
when properly indorsed
First National Bank
F. G. Moffitt, Cashier
Such a certification makes the bank responsible for its payment.
A cashier’s check is a bank’s own check drawn on itself in favor of a
third party and signed by its cashier. As a medium of exchange it ranks
higher than the check of a private person, due to the superior credit of the
bank and to the fact that the bank is usually more generally known in a
community.
Other Negotiable Instruments.—Express and postal money orders are
drafts payable at sight, drawn respectively by one express agent on another
and by one postmaster on another.
A warehouse receipt is a receipt from a warehouse, elevator, or other
storage concern acknowledging the receipt of goods or property. Such a
receipt usually contains the contract agreements entered into by the parties,
covering the conditions according to which the goods are accepted for
storage. The warehouse receipt is usually negotiable, or partially so, in that
title to the property may pass with its transfer.
Principles Governing the Writing of Commercial Paper.—Ordinary
prudence requires commercial paper to be drawn in a way that will make
forgery difficult if not impossible. To this end the following two rules
should be observed:
1. Leave no blank spaces, particularly where the
amount is written. This is not so important when
the amount is perforated, with a perforated star at
each side.
2. Write the indorsement at the top margin. Unless this
is done, some statement might be inserted which
would change materially the effect of the
signature; e.g., the payer might later write above
the signature that the check is accepted in full
payment for a definite bill.

Kinds of Indorsement.—An indorsement is usually for the purpose of
transferring title. There are several kinds of indorsement, as follows:
1. A blank indorsement, which consists only of the
payee’s signature; this renders the instrument
payable to bearer.
2. A full indorsement, which reads as follows: “Pay to
the order of . . . . . . . . .,” giving the name of the
indorsee, i.e., the person to whom the instrument is
transferred, and followed by the signature of the
indorser, who before his indorsement was the
payee.
3. A qualified indorsement, which is either a blank or
full indorsement with the words “without
recourse” added to it. This kind of indorsement
transfers title with no liability attaching to the
transferor in case of non-payment by the maker at
maturity.
4. A restrictive indorsement, giving the name of the
party to whom the check is transferred, the words
“for collection” or “for collection and deposit”
being added and followed by the signature. This
indorsement does not transfer title but merely
appoints the person or bank named as agent for the
purpose of collection.

CHAPTER XXII
BUSINESS PAPERS—THE GOODS INVOICE
AND BILL OF LADING
Definition.—When a business transaction takes place, a record or
memorandum of its amount and nature is usually made out. Thus, the
amount of cash received for a sale may be rung up on the cash register or a
sales clerk may make out a duplicate sales ticket and turn over the carbon
copy as a sales memorandum to the bookkeeper; for cash disbursed a
receipt, to be the basis for formal entry on the books, may be demanded
from the person to whom the payment is made.
These memoranda of business transactions are called “business papers.”
They comprise all of the more or less formal and informal documents which
constitute the firsthand evidence of most transactions. Among the most
common business papers may be mentioned: the goods invoice for
purchases or sales; negotiable paper, including the check, note, draft, money
order, and warehouse receipt; the statement and account sales; the shipping
order and bill of lading; the bill of sale; the lease agreement; and contracts
of all sorts. A few of the business papers most frequently used will be
explained.
The Invoice.—When a merchant sells goods to a customer he writes
out an itemized “bill” which is sent along with the goods. This bill, loosely
called an “invoice,” is from the seller’s viewpoint more accurately
described as a sales invoice, and from the customer’s or buyer’s viewpoint
as a purchase invoice. It is an itemized statement of goods bought or sold,
and should state the names of vendor and vendee, the address of the vendor
and the date of sale, the quantities, kinds, and prices of the goods, the terms
of sale, and additional information as to method of shipment, etc.
Handling the Purchase Invoice.—When goods are bought the
purchase invoice should be verified or audited. The method of audit
depends upon the organization of the business. In a small business, if the
invoice is received before arrival of the goods, it is usually held till their

arrival and then checked against them as to quantities, quality, and price.
The extensions and total are verified and entry made in the purchase
journal, using the audited invoice as a basis. The invoice should then be
placed in a temporary file till paid, after which it is usually filed under the
vendor’s name for future reference. The check in payment of the invoice,
when returned canceled by the bank, is frequently attached to the invoice
for which it was issued as evidence of its settlement. At any rate the paid
invoice should bear on its face a notation to show the payment.
In a large business where the clerical work is divided among
departments, several copies of the original purchase order sent to the vendor
are usually made out—one copy, for instance, for the purchasing
department, one for the receiving room, one for the auditing department and
so on. The procedure of auditing is then more complex. The copy furnished
the receiving room is usually left blank as to quantities, and sometimes the
description of the goods ordered is also omitted. When the goods are
received, quantities and kinds are filled in by the receiving department, and
the copy is sent to the auditing department where it is checked against the
auditor’s copy of the original order and the purchase invoice from the
vendor. If found correct as to quantity, kinds of goods, extensions, and
additions, the invoice becomes the basis for entry in the purchase record—
journal or voucher register as the case may be—after which it follows the
customary routine as to filing. The invoice remains in a temporary file as
long as it is unpaid. Upon payment it is placed in a permanent file, either
under the name of the vendor, by invoice number, or according to whatever
system may be in use.
Handling the Sales Invoice.—Practically all systems of handling sales
require that at the time of the sale some record or memo of the transaction
be made. In retail establishments the use by each salesman of a book of
sales tickets with provision for duplicate or triplicate impression is very
general, whether the sale be cash or charge. The cash and charge tickets are
usually put up in separate books and a different color of paper is used for
each. At the close of the day the total cash tickets are checked against the
cash received from cash sales, and the total charge tickets give a controlling
figure for charges to customers. The total of the cash tickets plus that of the
charge tickets gives the total credit to Sales.

These sales tickets are usually entered on a daily sales sheet provided
with distributive columns for analysis according to departments or kinds of
commodities. A recapitulation giving the totals of each of these columns is
made and posted to the ledger, while the customers ledger accounts may
receive their charges direct from the sales ticket. This recapitulation really
constitutes the sales journal record, as is explained in Chapter XLVII.
Where the number of charge accounts is not large, a folder system is
sometimes used. Each charge sales ticket is placed in the folder which takes
the place of that customer’s account, thus avoiding the necessity of making
a formal entry on the ledger. When the customer pays this bill, the sales
ticket is so marked and is either left in the folder or transferred to a
permanent file. The successful operation of the folder system presupposes
that the customer will pay the exact amount of his bills shortly after the date
of the ticket, no provision being made to care for overlapping credits.
Whatever the system, the sales ticket is the original record of the transaction
and therefore valuable as evidence in case of dispute. These tickets should
be filed away and kept until all danger of dispute is past.
Credits and Returned Goods Invoices.—If for any reason goods
purchased prove unsatisfactory and are returned, record of their return
should be kept by the shipping clerk and used as a basis for securing proper
credit from the vendor. The vendor usually sends a returned goods invoice,
which, though similar in form to the purchase invoice, constitutes a credit to
the purchaser instead of a charge. These credit memos, as they are termed,
are always of some distinctive color, frequently red, in order to distinguish
them readily from the regular invoice.
Similarly, when dissatisfied customers return goods, or when the
business makes them an allowance on goods sold, a credit invoice or credit
memo is sent them and the duplicate copy of this memo retained in the
office becomes the basis for entering the transaction on the books.
Shipping Goods—The Bill of Lading.—The purchase and sale of
goods usually involve dealings with railroads. It is not the purpose of this
chapter to give an extensive system or method of handling shipments, but
merely to explain the purpose of the railroad documents and their use as
business papers.

A shipment of goods is evidenced always by a “bill of lading,” a
contract under which the railroad accepts freight for carriage, defines its
liabilities as a transportation company or warehouseman, and states its
duties and those of the shipper. Its standard content is prescribed by the
Interstate Commerce Commission, although any additions to it not in
conflict with the standard content are not forbidden. If the shipper so
desires, he may have bills of lading printed to conform in size with his own
files, instead of using those furnished by the railroad. There are two
standard forms, the straight bill of lading which is not negotiable and the
order bill of lading which is negotiable.
The bill of lading is always made out in triplicate, the original and the
two copies being identical except as to titles and signatures. The original is
signed by the shipper and the railway agent, and constitutes the shipper’s
receipt for the goods delivered to the railroad. The second copy called the
“shipping order,” is signed by the shipper only. It is his order to the railroad
to ship the goods, and is held by the railroad as evidence of its authority.
The third copy or memo is an exact duplicate of the original. Like the first
copy, it is signed by the shipper and the agent, and is held by the shipper as
a duplicate receipt. Sometimes it is forwarded with the invoice to the
customer, but otherwise should be filed by the shipper with the original bill
of lading. In case of claim against the railroad for loss or damage to goods
in transit, the original bill of lading is required as evidence and should
therefore always be kept in the shipper’s possession.
Freight Notice and Expense Bill.—A notice, called “freight notice,” is
sent by the railroad to the consignee upon arrival of the goods. A more or
less formal order is given by the consignee to the teamster or drayage
company to call for the freight. This order authorizes the railroad to deliver
it to the teamster or drayage company. Upon its delivery, an “expense” or
freight bill is sent to the consignee itemizing the freight charges due on the
shipment. The freight notice and the freight bill are usually made at one
impression, the heading on the one being a notice of the arrival of freight,
while on the other the heading is that of an ordinary invoice or bill showing
the freight charges on the designated goods. Some railroads make three
copies at one impression, consisting of (1) the freight notice, (2) the
delivery receipt, and (3) the freight bill. Copy (2) is a receipt surrendered by
the consignee upon delivery of the goods.

C. O. D. Shipments.—C. O. D. shipments are handled through the
agency of an express company, the post-office, or a bank. Express
companies accept for shipment freight which is to be paid for upon delivery,
agreeing to collect and remit the amount of the invoice to the consignor less
collection and remittance charges. This method of shipping sometimes
gives the consignee the privilege of examination before acceptance. It is
used with customers who are unknown to the shipper or with those whose
credit is doubtful.
When the parcels post service is used for shipping goods C. O. D., the
post-office makes the collection for the shipper. The shipper must, of
course, always prepay the postage, although this may by agreement become
a charge against the customer.
When a bank is made the shipper’s agent to collect on delivery, a draft
is drawn on the consignee and sent to the bank along with a special C. O. D.
bill of lading, the order bill referred to above. This original C. O. D. bill
together with the attached draft is sent by the bank to its correspondent
located in the same city as the consignee. The correspondent bank presents
the draft to the consignee for acceptance or payment, as the case may be,
and thereupon delivers the special bill of lading to him. The shipper’s order
to the railroad provides that the goods are to be delivered only upon
presentation by the consignee of this special bill of lading. In the use of the
order bill of lading, it is customary for the original copy to show the goods
consigned to the order of the shipper himself. This copy, indorsed by the
shipper, and the attached draft are the documents used by the bank in
making the collection.
Duties of the Traffic Department.—In a large business a special
department known as the traffic department is authorized to handle all
shipments. Briefly, its duties are to look after all incoming freight, its
receipt in good condition and its proper distribution to the several
departments; to handle all outgoing freight, its proper routing so as to
secure lowest tariffs and speedy delivery; and to secure the adjustment of
claims for damage or loss of goods in transit.
The Statement of Account.—When goods are sold, an invoice or bill
showing terms of sale, quantities, items, prices, and total amount of sale is
sent to the customer. Periodically, frequently the last of the month, a

statement is rendered each customer whose account shows a debit balance.
Frequently the date of sending the statement is recorded in the explanation
column of the ledger account, which, from a credit point of view, is a
desirable practice.
The statement of account is a transcript, sometimes a summary, of the
customer’s ledger account, i.e., it contains all charges and all credits for the
period covered. If there is a balance outstanding at the beginning of the
month, the current statement opens with the balance item and is followed by
lists of all charges, payments, and other credits for the current period; the
total credits are subtracted from the total charges and the balance constitutes
the amount now due and owing. Sometimes a statement of account is made
out in detail, giving a copy of the original invoices which evidence the
several sales transactions. Statements of account are issued in many
different forms, but the following illustration shows all the essentials:

Form 20. Monthly Statement of Account

CHAPTER XXIII
BANKS AND THEIR METHODS
Service of the Bank to the Community.—Practically all business houses at the
present time take advantage of the banking facilities to be found in every community
where there is enough business transacted to justify the establishment of a bank. A
bank is sometimes defined as an institution which deals in money and credit. One of
its chief functions and the one on which its main income is based is that of acting as
a place for the deposit of moneys, these deposits forming the basis for its loans and
discounts. Among its other important functions and services are to collect drafts and
checks drawn on other banks; to issue and sell its own drafts on other banks, thereby
enabling its customers to make payments to out-of-town creditors; to discount
commercial paper, i.e., to loan money to its patrons on approved security; and to
issue paper currency.
Opening an Account with the Bank.—Because so much of the bank’s business
is based on the honor and integrity of its customers, a prospective depositor is
usually required to present a card of introduction signed by a customer of the bank
or someone else known to it. A depositor who wishes to open a checking account is
asked to file a “signature” card bearing the signatures which he will use in signing
checks. As considerable expense attaches to handling depositors’ accounts, some
banks require that the balance of the account shall never fall below a fixed
minimum.
The Deposit Ticket.—When an account is opened, the depositor is provided
with a pass-book and check book. All deposits are made by means of deposit tickets,
discount memoranda, or collection notices. The deposit ticket is in form similar to
the following:

Form 21. Bank Deposit Ticket
All moneys and checks deposited are listed on this ticket under the indicated
classifications. The deposit is handed to the receiving teller of the bank, who, after
verifying the ticket, makes an entry of the amount in the depositor’s pass-book.
Duplicate deposit tickets are usually kept by the depositor. It is important to note
that checks must be indorsed before they are deposited, so as to make them
collectible by the bank.
The Pass-Book.—The pass-book is the record of the depositor’s dealings with
his bank and, although written up by the bank teller, it is usually kept from the
depositor’s viewpoint, i.e., the bank is debited with all deposits and credited with all
checks presented for payment. At stated intervals, say monthly, the book is left with
the bank for balancing, at which time the total amount of checks paid by the bank is
entered in the pass-book and the canceled checks are returned to the depositor.
Sometimes the pass-book is kept in account form, the left page indicating deposits,

and the right page payments by the bank. More frequently, however, the pages of the
pass-book do not have debit and credit significance but constitute a continuous
record. In this case, at the end of the period, the deposits are footed and the total of
the checks is subtracted from the total deposits, thus showing the balance due the
depositor.
A method coming into quite general use among banks is to send a monthly
statement of account just as trading concerns do. This statement is a transcript of the
bank’s ledger account kept with each depositor, showing deposits and withdrawals.
When this is done, withdrawals are not entered on the pass-book, which thus serves
only as a memo or receipt of the moneys deposited.
The Check Book.—The check book is provided either with a stub, counterfoil,
or interleaf, for making a duplicate record of the check drawn. Provision is usually
made in the check book for the entry of the deposits. Sometimes each check is
subtracted from the previous balance and the amount of the new balance shown;
more often, total checks and total deposits are shown separately and in this way,
while it is an easy matter to find the balance by subtracting the total checks from the
total deposits, the actual figure does not appear and hence is not available to curious
eyes.
The balance shown in the monthly statement or by the periodic balance of the
pass-book is seldom the same as that shown in the depositor’s check book, due to
the fact that certain checks issued by the depositor have not yet been presented for
payment to the bank. The method of reconciling the pass-book with the bank
balance is treated in Chapter L, “Accounts Current.”
Securing a Loan through the Discount of a Note.—A common practice of
business men in borrowing money is to discount or sell to their bank or to a broker
their own promissory notes and those received from customers. When merchants
discount their own notes at a bank, the notes bear only one signature, that of the
merchant, and for this reason they are called “one-name” paper. If a merchant
receives a note from a customer, indorses it, and then discounts it at the bank, two
signatures appear on it—that of the original maker and that of the indorser. Notes of
this kind are called “two-name” paper. Banks usually prefer two-name paper
because, if the maker fails to pay the note at maturity, the indorser can be held liable
for its payment, while in the case of one-name paper the bank has recourse to no one
except the maker.
When a merchant makes out a promissory note of, say, $1,000 due 90 days after
date, and discounts it at his bank, the bank usually deducts interest at, say, 6%, from
the face of the note; i.e., the merchant is credited not for the full $1,000 but only for
$985, and when the note matures he either pays the amount, $1,000, or his account
is debited with it. The $15 is called “discount” because it is “subtracted” from the

face of the note; but since this item is paid for the use of the amount loaned by the
bank, it is of the same nature as interest. There is no reason, therefore, for keeping
two separate ledger accounts, one for discount and one for interest paid, the two
usually being combined under one title, “Interest and Discount” or “Interest.”
Principles to be Observed in the Calculation of Interest.—In connection with
interest computations it is important to observe the following points, the principles
involved in each case being best explained by making use of suitable illustrations.
1. In commercial practice, when the interest period is expressed in months, the
interest for each month is one-twelfth of the annual interest, i.e., a note for $1,000
dated April 11, 19—, due “three months from date,” matures July 11 and the interest
at 6% is 6% of $1,000 divided by 12 multiplied by 3, or
$1,000 × .06 × 3
————— = $15
12
2. Were the same note worded “ninety days from date,” it would mature July 10
instead of July 11, the number of intervening days being 19 in April, 31 in May, 30
in June, and 10 in July; total 90 days. The interest would amount to
$1,000 × .06 × 90
————— = $15
360
3. If a note is dated March 6, 19—, and matures, say, on April 30, the interest
period is 55 days (25 in March and 30 in April). Usually, in computing the number
of days in the interest period the opening date is omitted but the closing date is
included. In some instances the practice is to include both days.
It is important to note that it is almost a universal custom to use 360 as a
denominator in all these cases, although the theoretically correct number is 365. This
is done for the reason that the use of 360 greatly facilitates the computation. The
government of the United States makes an exception to this rule and counts the year
as 365 days, and disregards the month as a unit base; i.e., instead of counting the
month of January as ¹/₁₂ of a year, its computation requires the use of the fraction ³¹/
₃₆₅ as the multiplier. Interest on $1,000 for, say, 12 days, by this method, amounts to
$1,000 × .06 × 12
————— = $1.97
365
instead of

$1,000 × .06 × 12
————— = $2
360
The incorrectness resulting from the commercial method (using 360 days as
denominator) usually is negligible and is fully justified by the economy of time in
computation. It may be noted that under this practice the amount of annual interest is
¹/₇₂ more than under the method used by the government.
4. When paper is discounted by a bank, even though its term be given in months,
the bank invariably counts the exact number of days in estimating the amount of the
discount. Take a note dated June 25 with a term of 3 months and due therefore on
September 25, but discounted at the bank on July 25. The term of discount, instead
of being 2 months, would be for 62 days, a gain to the bank of 2 days on a 360-day
basis.
Short Methods of Interest Computation.—In calculating interest or discount,
the so-called 12% or 6% method seems the easiest of application. Its base is taken as
$1. In the 12% method the interest for a year is therefore 12 cents, for a month 1
cent, and for a day ⅓ mill. In the 6% method, the interest for a year is 6 cents, for a
month ½ cent, and for a day ⅙ mill. Using these fractions with the years, months,
and days as multipliers, the result is the interest on $1 for the given period. This
result multiplied by the face of the note gives the required interest, assuming that the
interest rate is 12% or 6%.
A variation of the above gives the following rule, somewhat easier to apply.
Reduce the time to days—using a 360-day year, 30-day month basis; multiply the
time by the face, point off three places (i.e., treat the product as mills), and divide by
3 or 6 according as the calculation is on a 12% or 6% basis. If the basis used is 6%,
but the actual rate is different, add or subtract whatever aliquot part the given rate is
more or less than 6%; i.e., if the rate is 8%, add ²/₆ or ⅓; if 5%, subtract ⅙; etc. The
following example will illustrate:
A note for $1,000 dated June 10, 19—, for 4 months, with
interest at 7%, was discounted July 30 at 8%. Find the net
proceeds. The note when due will be worth $1,000 plus 4 months’
interest at 7%. That becomes the basis for the discount calculation.
Applying the 6% method:
4 months = 120 days
Multiplied by 1,000 (face of note)
120,000

Marking off 3 points 120
Take ¹/₆ (index for 1 day) ¹/₆
20 = interest @ 6%
Add ¹/₆ 3.33
23.33 = interest @ 7%
Add 1,000
Value of note on October 10 1,023.33
This amount (1,023.33) is the basis on
which the discount is to be figured.
Multiply by the term of discount (72 days[2]) 1,023.33
72
2,046.66
71,633.1
73,679.76
Marking off 3 points 73.68
Take ¹/₆ (day index) ¹/₆
12.28 = discount @ 6%
Add ²/₆ or ⅓ 4.09
16.37 = discount @ 8%
Value of note on October 10 1,023.33
Less discount 16.37
Net proceeds on July 30 1,006.96

CHAPTER XXIV
METHODS OF POSTING
The Journal and Ledger Records Differentiated—Posting.—When a
correct and complete record of business transactions has been made in the
various journals, practically all the current information needed by the
business has been secured. However, because this information is recorded
in chronological order, it is not available for use. It requires sorting,
grouping, and indexing. To meet this requirement the original chronological
record must be transferred to other records which provide for the desired
grouping. The separation of the general journal into journals for different
classes of transactions such as sales, purchases, and cash, results in making
certain kinds of information somewhat more available, but more than this is
required for business management. The original records must be grouped
and summarized under proper account titles, so that the total results for the
period may be had under review at one time. The book containing these
account titles is called the ledger, and the transfer of the original record to
the ledger is called posting.
Time of Posting.—Where subsidiary journals are used, it is not
customary to post all entries at the same time. The entries affecting personal
accounts, i.e., those of customers and creditors, should be posted daily.
Inquiries from customers as to their balances are received every day, and in
order that this information may be given promptly and correctly, customers
ledger accounts should be kept up to date in every respect. This is a matter
of great importance because, if the information desired by the customer is
not given promptly, or if an error is made in giving it, thus calling for
correction at a later date, the customer’s good-will may be lost and his trade
transferred to others. For this reason personal accounts, especially those
with customers, should be posted daily, and great care should be exercised
in doing the work.
All other accounts may have their postings made periodically—once a
week or once a month—the frequency depending upon the need of the
business for the information furnished by the accounts. The flow of cash—

always of importance—is shown daily by the cash book record; the volume
of sales each day can be had from the sales journal; but information as to
expenses can usually be had only from the ledger after completing the
weekly or monthly postings.
Methods of Posting.—Knowing that errors in posting are easily made
and that when made they may cause great confusion, it is important for the
bookkeeper to know what kinds of errors occur most frequently, and to
study means of avoiding them. Certain methods of posting have been found
to produce a minimum of error. Some points in connection therewith will be
considered here.
One of the chief errors in posting is to make entry on the wrong side of
the account, i.e., to post a debit as a credit, or vice versa. The use of
subsidiary journals has done away with a large part of errors of this kind,
yet it is advisable to keep the following points constantly in mind when
posting:
1. The sales journal is a “charge” journal, i.e., the individual items
represent debits and must therefore be posted to the debit side of the proper
ledger accounts. The sales summaries, however, are credits and must be
posted as such.
2. The purchase journal is a “credit” record and all postings, except
summaries, are made to the credit side of the respective accounts.
3. In the cash receipts journal, each individual item represents a credit,
as explained in a previous chapter, and each individual item in the cash
disbursements journal represents a debit. Hence, postings of the individual
items on the debit side of the cash book must be made to the credit side of
the ledger account, and postings of items on the credit side of the cash book
must be made to the debit side of the ledger accounts. The posting of the
summary entries of the cash book follows the debit and credit designation
made at the time of summarization. The principles here involved were fully
discussed in Chapter XIX.
4. In the Journal the debits and credits of each entry are fully expressed,
i.e., neither element is suppressed. In posting from this record it is best to
transfer all the debits consecutively and then all the credits. The possibility
of posting a debit item as a credit is thereby greatly reduced.

Cross-Indexing the Entries.—An essential part of posting, in addition
to recording the date and the amount, is to cross-index every entry, i.e., to
index it both in the book of original entry and in the ledger. The “folio”
column in each book is used for this purpose. The index in the ledger
consists of the first letter of the book of original entry followed by the page
number, and the index in the book of original entry shows the number of the
ledger page to which the item is posted. (See Form 22.)
In this way, when the indexing in both books is completed it is possible
without loss of time to trace the entry from the journal to the ledger, and
vice versa. Usually the ledger folio is entered in the book of original entry
immediately after each item is posted. When this is done the absence of a
reference number in the journal indicates that the item has been omitted in
posting. This check is frequently helpful in tracing errors. Some
bookkeepers, however, before doing any posting, go through the book of
original entry and from the account index of the ledger enter in the ledger
folio column of that particular journal the ledger page numbers. By this
method, much time is saved in finding the account in the ledger, but a check
mark should be placed after each item as soon as it is posted, to indicate the
fact. Then the absence of the check mark indicates an unposted item.

Form 22. Cross-Indexing in Posting

Explanatory Matter in the Ledger.—In posting personal accounts it is
customary to show the terms of credit in the explanation column of the
account. In this way the face of the account shows whether the customer
pays promptly or not, and affords a basis for his credit rating.
Notes Payable and Notes Receivable accounts in the ledger should show
essential data, such as due date, interest rate, etc. However, when a separate
note or bill book is used, these data are given therein and may be omitted
from the account in the ledger.
With all other accounts, except sometimes the Profit and Loss account,
little or no explanatory matter is carried. However, when a posting is made
that is at all unusual, it is well to enter explanatory matter in the ledger.
From the business man’s point of view, the ledger is the most important
book of account, and if its record can be so made as to require a minimum
of reference to original books, it serves its purpose so much the better.
Where possible, the Profit and Loss account should carry the names of the
accounts closed into it; in fact all transfers, whether made on the face of the
ledger or by journal entry, should carry the account title and the ledger folio
to which and from which the item is transferred. It is a fundamental
principle that every entry must be indexed in such a way as to render
reference to it easy at any time.

CHAPTER XXV
THE TRIAL BALANCE AND
METHODS OF LOCATING ERRORS
The Trial Balance.—In Chapter XIV the trial balance was defined as a
list of account totals, debit and credit, or account balances, debit or credit,
for all the open accounts in the ledger. This list is set up in two columns,
debit and credit, and if the original entries in the journals and the postings to
the ledger have been done correctly, the totals of these two columns should
be the same.
Neither method of showing the trial balance has any inherent advantage
over the other. Some concerns desire the account totals to be shown in the
trial balance, as that indicates to some extent the volume of business. This
would be true of all accounts which had been opened during the current
period. As to those carried over from a previous period little current
information would be given. As a general thing, however, the status of
customers’ accounts is better indicated when both total charges and total
credits are shown. Where only the balance is shown, it does not provide any
basis for determining whether that balance is normal for that particular
account. In judging a request for a further extension of credit there is a
rather close relationship between the volume of trade with a customer and
the amount of his unsettled balance.
Sometimes, even the totals of accounts that balance are shown in the
trial balance, thus giving the status of all accounts appearing in the ledger.
Again, concerns desirous of knowing the net amount owing on customers’
accounts and the net amount owed on creditors’ claims, require balances of
all personal accounts and cash, but debit and credit totals of all other
accounts. No unalterable rule can be given. The manner of showing the
accounts in the trial balance is governed by the way in which the trial
balance is to be used and the purpose it is to serve. Manifestly, however, the
trial balance cannot give information of every kind desired by a manager.
As personal accounts are usually handled by canceling offsetting credits

against corresponding debits and carrying only balances forward, the trial
balance cannot well show at the same time both total transactions and
outstanding balances. Only in small concerns could the trial balance give
the information which in larger concerns would be gathered statistically and
furnished in addition to the trial balance.
The tendency in modern accounting is to make the ledger record so
detailed that all accounts are currently “uniphase,” i.e., have entries on but
one side, and in connection with such accounts the two methods of entering
them in the trial balance are identical, because the total of the one side of
the account is at the same time the balance of the account. It must be
observed that as a matter of course this modern tendency does not apply to
personal accounts nor to adjustment and closing accounts.
Errors in the Trial Balance.—The manner of entering the small pencil
footings of both sides of each account and also the account balances
previous to taking the trial balance, was explained in an earlier chapter. This
preliminary work should be done carefully so as to reduce errors to a
minimum.
It is not purposed here to discuss all the kinds of errors that find their
way into the accounting records. Errors are frequently made in the original
analysis and classification of the transaction, which, as previously stated,
result in an entirely incorrect showing of financial condition. Such errors do
not affect the balance of the books and are not detected by the trial balance.
Their detection is one phase of the professional auditor’s work. This
discussion has been qualified by saying that if the work of original and
secondary entry has been done correctly, then the ledger should prove.
Some points in connection with errors which often occur in posting will be
treated here.
The equality of the two totals of the trial balance proves that for every
debit entry on the books there has been made an equal credit, or at any rate
that the sum of all debit entries equals the sum of all credit entries; i.e., it
proves only the mathematical correctness of the work.
It might happen that an item, though posted to the correct side of the
ledger, has been entered in the wrong account. The trial balance would not
detect an error of this kind. For example, John Doe’s account might be
debited with a charge belonging to Richard Roe, both being customers. This

of course would make the books show wrong balances in those particular
accounts, but would not cause an incorrect showing in the total assets.
However, more serious results may come from an error caused by posting to
the wrong account.
According to the schedules shown earlier, all transactions bring about
increases and decreases in the three main groups of accounts, viz., assets,
liabilities, and proprietorship. A transaction resulting in an increase of assets
may have its credit in any of the three classes—decrease of assets, increase
of liabilities, or increase of proprietorship. A credit entry in any one of these
would result in an exact offset to the debit and would therefore so far as that
transaction was concerned, result in equal debits and credits in the trial
balance; but were entry made to the wrong group of accounts, it would
bring about absolutely false results. This would be the case if a
proprietorship account were credited, resulting in an increased profit, when
the credit should have been to the liability group with a resulting increase of
the liabilities—two divergent results.
Thus, while the trial balance does not detect errors in posting to the
wrong account, it has great value in that its equality is considered as good
evidence of the correctness of the books. This is so because errors of the
kind just referred to are not of so frequent occurrence as those involving
only the mathematics of the work.
Suggestions for Locating Errors.—Where trial balance totals do not
agree, it is certain that one or more errors have been made somewhere. The
following suggestions may be useful in locating them:
1. If there is a difference of 1 in any column, i.e., .01, .10, 1.00, 10.00,
etc., the error very likely results from wrong addition. Check additions of
the trial balance and if the error is not located there, those of the ledger
accounts must be checked as well.
2. If the difference between the two trial balance totals is an even
number, divide this difference by two and look through the trial balance for
an item of that amount but entered as a debit instead of a credit or vice
versa. The amount of the error must be divided by two because the placing
of a given item in the wrong column would result in a difference of twice
this amount in the totals of the trial balance. If the error is not located in the

trial balance, it may be necessary to look through the ledger accounts
because the wrong placing may have occurred there.
In checking through the ledger for an error of this kind, some aid is
afforded by the fact that all postings from even pages in the cash book (i.e.,
the cash receipts) appear on the credit side of the ledger accounts, and all
postings from the odd pages in the cash book appear on the debit side of the
ledger accounts. If, therefore, in any of the credit reference columns in the
ledger is seen a reference like “C 13” or “C 29,” or in any of the debit
reference columns an index like “C 40” or “C 58,” it is probable that the
error is due to posting to the wrong side.
3. If the mistake has not been found in this way, the trial balance should
be checked against the ledger to be sure that no open accounts have been
omitted. Examine all closed accounts to see that they balance.
4. Examine the posting index column of all books of original entry to
see that no items have been omitted in posting.
5. When the totals of the trial balance are unequal, the error may lie
either in the debit total or in the credit total, or both may be wrong. Even
when the trial balance “proves,” both totals may contain the same error. In
order to determine what is the correct footing, the following method may
sometimes be applied: Take the total of the previous trial balance, add to it
the current totals from the several journals, and deduct the total of all
accounts closed during the period. The result shows the correct footing for
the present trial balance. Where the number of accounts closed during the
period is large, the work entailed by this method may be prohibitive. The
method is of easy application only when the trial balance is taken by means
of debit and credit totals.
It may be left to the student to prove why this is a correct method for
determining the present trial balance total. Suffice it to say that it is based
on the fundamental fact that for every credit item in any of the journals
there is of necessity a debit or group of debits the total of which
corresponds with the credit item. Duplicating entries in two or more
journals must be eliminated from the journal total.
The following table will serve to illustrate the above method:

Previous trial balance total $12,967.30

Sales journal total for current period 8,429.60
Purchase ” ” ” ” ” 5,627.40
General ” ” ” ” ” 564.90
Cash receipts ” ” ” ” 2,572.60
Cash disbursements ” ” ” 1,962.75
$32,124.55
Closed accounts total 1,211.41
Correct trial balance total $30,913.14

6. If the difference between trial balance totals is divisible by 9, the
error may be due to a transposition of figures or to a transplacement,
sometimes called a slide. A transposition is an interchange of figures, as 96
for 69, 215 for 512, 6,274 for 4,276, etc. The first is called a simple or one-
column transposition, the second a two-column, and the last a three-column
transposition. One-column transpositions may also occur in numbers of
three or more figures, as 172 for 712, or 3,129 for 1,329.
Transpositions.—The following rules will be of help in locating errors
of transposition. To determine divisibility by 9, the easiest way is to “cast
out” the 9’s.
(a) If the difference between the trial balance totals is divisible by 9 and
consists of less than three figures, i.e., 9, 18, 27, 36, a one-column
transposition may be the cause of the error. Divide this difference by 9. If
the quotient is 1, the difference between the two transposed figures is 1. If
the quotient is 2 or 3 or 4, the difference between the transposed figures is 2
or 3 or 4, etc. For instance:
Correct Transposed
Difference
Number Number
54 45 9 divided by 9 = 1
87 78 9 ” ” 9=1

75 57 18 ” ” 9=2

Correct Transposed
Difference
Number Number
97 79 18 ” ” 9=2

30 03 27 ” ” 9=3
85 58 27 ” ” 9=3

Thus the figures in the last column indicate the difference between the
figures of the original item.
(b) If the difference is divisible by 9 and consists of two significant
figures followed by one or more naughts, the error may be caused by a one-
column transposition between columns of a higher order. For instance:
The correct amount being 6,394
and the transposed amount 3,694
the difference is 2,700
which divided by 9 gives 300. This indicates a transposition between
figures in the “100” and “1,000” columns, the difference between these
figures being 3. Reference to the example given will show this to be the
case.
(c) When the difference between the trial balance totals is divisible by 9
and lies between 99 and 1,000, the error may be due to a two-column
transposition. Here the middle figure of the error is always a 9, e.g., an error
of 297 resulting from writing 512 as 215. Dividing the number (27) formed
by the two outside figures of the difference by 9, the quotient (3) is the
difference between the two transposed figures, i.e., the 5 and the 2. For
instance:
Correct Transposed
Difference
Number Number
514 415 99 9 divided by 9 = 1
735 537 198 18 ” ” 9=2
981 189 792 72 ” ” 9=8

Correct Transposed
Difference
Number Number

Thus, the figures in the last column (1, 2, 8) indicate the difference
between the two transposed figures in the correct item. Instead of dropping
the middle figure of the difference and dividing by 9 as above, the entire
difference figure may be divided by 99 with the same result.
(d) Similarly, when the difference is 999 or a four-figure amount with
two 9’s in the middle, a three-column transposition may be indicated
thereby. For instance:
Correct Transposed
Difference
Number Number
5,174 4,175 0,999 09 divided by 9 = 1
6,392 2,396 3,996 36 ” ” 9=4
7,081 1,087 5,994 54 ” ” 9=6

the figures in the last column (1, 4, 6) again indicating the difference
between the transposed figures in the original.
Instead of dividing the number formed by the outside digits (9, 36, 54)
by 9, we might divide the full amount of the difference (999, 3,996, 5,994)
by 999; this would give the same result.
The reason for the divisibility of this difference by 999 in an error of
this kind is apparent when a number is given algebraic notation instead of
Arabic. The Arabic number 2,197 expressed algebraically would be 2,000 +
100 + 90 + 7. Generalizing, we may formulate any number of four figures
by 1,000a + 100b + 10c + d, in which a, b, c, and d may have values from 0
to 9 inclusive. A transposition between the thousands and units digits, the
“a” and the “d,” would result in the following number: 1,000d + 100b + 10c
+ a. The error would therefore be:
Original number 1,000a + 100b + 10c + d
Transposed number a + 100b + 10c + 1,000d

Difference 999a - 999d
This error is plainly divisible by 999, and the resulting quotient (a-d) is the
difference between the two transposed digits.
It may be shown similarly why 99 is a divisor of the error cited under
case (c) above.
Transplacements.—A transplacement or slide occurs when some or all
of the digits of a number are moved one or more places to the right or left
without change in the order of the figures; for instance, 736 written as
73.60, as 7.36, or as 700.36. The first is called a one-column slide, the
second and third two-column slides. The error caused by a one-column slide
is always divisible by 9, a two-column by 99, a three-column by 999, etc.
The division by 9, 99, 999, etc., disregarding decimals, always gives the
figures whose transplacement has caused the error. Thus the error caused by
writing 736 as 73.60 is 662.40, which divided by 9 is 736; or 736 written as
7.36 produces an error of 728.64, which divided by 99 gives 736; or 736
written as 700.36 causes an error of 35.64, which divided by 99 gives 36,
the part transplaced. The reason is similar to that given above for the
transposition.
When a whole number of dollars is written as cents, the resulting error
is divisible by 9 and moreover the cents added to the dollars gives 99 in
each case. For instance in writing:
.73 instead of 73.00, the resulting error is 72.27
.58 ” ” 58.00, ” ” ” ” 57.42
.16 ” ” 16.00, ” ” ” ” 15.84

When the error in the trial balance is of this kind, the amount
transplaced may be found by subtracting the cents of the error from 100. In
the above examples this difference would be 100-27, 100 -42, 100-84, or
73, 58, and 16 respectively, which are in each case the figures of the
transplaced amount as seen in the example. Having determined this, the trial
balance and ledger accounts should be gone over to look for a slide of the
given number.

Checking the Postings.—From the above discussion, the impossibility
of determining in all cases the nature of the error is quite evident—
particularly as to whether it is one caused by a transposition or a slide.
Unless the kind of error is readily discernible, it is usually advisable to
employ the method of checking, i.e., going over all the work of posting to
determine its correctness—or other methods to be discussed in Chapter LI.
After all, careful work in making the record with legible figures and in
proving additions and subtractions, wherever possible, more than pays for
itself in the time saved hunting for errors caused by slovenly and inaccurate
work.

CHAPTER XXVI
THE CLASSIFICATION OF ACCOUNTS
Accounting Routine Related to Account Classification.—The basic
relationships between the accounts and the statements of financial condition
were explained in Chapter IX, where a chart of accounts was given to
illustrate the fundamental equation of the ledger. The complete record-making
routine, comprising the use of business papers for memorandum entry, the use
of the journals for the first formal record of transactions, and the use of the
ledger for the classified entry, has now been explained. There remain,
however, two classes of entries, the adjusting and closing, whose relationship
to the journal-ledger routine has not yet been fully discussed although their
relationship to each record has been separately considered. Since the closing
of the books contemplates the drawing up of financial statements and since all
record-keeping must have in view from the very beginning a proper
classification of accounts giving the desired information to be reflected finally
in the statements, it seems best at this point to consider some phases of
account classification before proceeding with a detailed explanation of the
method used in adjusting and closing the books.
The Need for Classification.—As explained in preceding chapters,
accounts may be broadly classified into the three main divisions of assets,
liabilities, and proprietorship. This threefold division, however, is inadequate
for the purpose of presenting detailed information as to the kinds of assets
owned by the proprietor, the nature of his liabilities, and the causes that have
produced increases or decreases of proprietorship. Subdivisions of the three
main groups must, therefore, be made, the minuteness of subdivision being
determined by the amount of detailed information desired.
One of the main purposes of account-keeping is to summarize results on
the financial statements. The items which appear on these statements represent
the balances of one or more groups of accounts. Items, for instance, such as
“Land” and “Buildings,” may each represent a single ledger account recording
the value of the land, the factory, and the office buildings respectively;
whereas the item “Accounts Receivable” represents the group of customers’
accounts, the number of which may run into the hundreds and even thousands

and which may be kept in a ledger devoted exclusively to the recording of
their detail. The reasons for grouping assets and liabilities on the basis of
degree of liquidity, and the advantages resulting from such grouping when
drawing up the summary statements of the period, were discussed and
illustrated in Chapter III.
It is evident from the above that the classification or grouping of the
ledger accounts is reflected in the items on the financial statements; and that,
conversely, the kind of information which it is desirable to present on the
statements will to a large extent govern the groupings in the ledger. This
dependence of the account titles and groupings in the ledger upon the end and
aim in view makes it necessary to draw up the original classification with
great care. To aid in securing a record correct in the first instance, certain
fundamental groupings or classification of accounts must always be made.
Basic Classification.—While other groupings of accounts have been
made, the classification used here has been from the beginning a three-phase
one, consisting of an asset, liability, and proprietorship nomenclature. The
third group of accounts, proprietorship, is further divided into the two
subclasses, temporary and vested, as explained in Chapter XII. At the end of
the fiscal period, after the ledger has been closed, there appear only asset,
liability, and vested proprietorship accounts; but during the fiscal period, the
temporary proprietorship accounts come into being and certain asset and
liability accounts take on a mixed character resulting from the method in
which the record is kept. This method is dictated not by a pure accounting
theory, but by a theory designed to accommodate itself to the practical
requirements of the average business. It is because the practical method of
making the record falls short of the theoretically exact method, that
adjustments must be made before summarizing.
For this reason, a record is not made daily of the portion of assets which
has been consumed each day, but the asset accounts are adjusted at the close
of each fiscal period to separate their asset and proprietorship elements. Also,
when a note is discounted at the bank, its entire face value is set up as a
liability. From the standpoint of accurate accounting, however, the face value
of the note overstates the liability for the current fiscal period, if the note falls
due in the following period, by the amount of the prepaid interest charge
belonging to that next period. Only on the due date of the note does the record
show the true condition of the liability. Thus, a “practical” method of keeping
the record necessitates the use of certain “mixed” accounts. Fundamentally,

however, the three-group classification given answers every necessary
purpose.
Fundamentals of a Good Classification.—In judging the fitness of a
particular classification, the end and purpose for which it is made must always
be the criterion. Any classification of accounts must, therefore, 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 data necessary for the summaries of
these statements. Classifications may be made from many different viewpoints
and for many different purposes, but a classification which is logical and
carries titles clearly indicating the purpose for which the accounts are
intended, and which therefore needs little or no explanation, is a satisfactory
classification. The three-group classification—assets, liabilities, and
proprietorship—meets these requirements.
A two-group classification—real and nominal—is frequently used. Under
this classification, asset and liability accounts are grouped as real, and
proprietorship accounts comprise the nominal class. This is the standard
classification. The student should be familiar with it, although the meaning of
the groups is not so apparent as in the case of the three-group classification,
referred to above.
Classifying Business Transactions.—When making the record of
business transactions on the books of account, it is necessary, first, to
determine the main account group or groups affected by the transaction. After
this is done, it is usually easy to determine which particular account in the
group is affected. Great care must be used in the determination of the main
groups, since a wrong classification results in an incorrect showing in the
summary statements at the close of the fiscal period.
To illustrate, in Chapter XIII reference was made to the fundamental
distinction between capital and revenue expenditures. When making the
original entry of some transactions this difference is frequently lost sight of
and what should be charged to an asset account is charged to some expense
account or vice versa. This charging to an asset account, of items which are
rightly expense items and therefore cut down the proprietorship element of the
business, is one of the easiest ways of inflating the profits for a period and so
of making a better showing than would be the case if the facts were recorded
correctly.

Correct classification of transactions is a matter of vital importance. An
accurate analysis of every transaction must therefore be made before bringing
it on the books. After determining the main group of accounts in which record
is to be made, further analysis as indicated above is necessary in order to fit a
particular transaction into its place under a suitable account title belonging to
the main group.
Detailed Classification.—In dealing with account classification, the more
detailed groupings must also be considered. Such consideration deals, (1) with
account titles in detail and even with the kinds and classes of transactions to
be recorded under particular titles, and (2) with the arrangement and use of
these detailed accounts in the various sections of the summary statements at
the close of the fiscal period. Certain broad principles have already been laid
down which are to be followed in the selection of the account title, and the
objection to the inclusion of unlike items under the same title, and the care to
be exercised against a more detailed analysis than is required by the needs of
the business, have also been explained. That system of accounts which groups
only one kind of data under each particular account title is better than a
system which mixes its records by grouping dissimilar data under a single
head. Yet, caution is always to be exercised against too great detail and an
unnecessary multiplication of accounts. Oftentimes essential facts and forces
of business activity are lost sight of in a maze of detail.
Below is given a somewhat detailed classification of accounts in
accordance with the two considerations stated above. No attempt is made at
completeness; only the more usual titles are presented. This classification will
be used throughout the rest of the volume.

Chart of Accounts
Asset Accounts
Current
Cash
Petty Cash
Notes Receivable
Accounts Receivable
Reserve for Doubtful Accounts[3]

Merchandise Inventory
Stocks and Bonds (for current investment)
Accrued Income

Deferred Charges to Operation
Shipping Supplies
Insurance
Interest
Office Supplies
Etc.

Fixed
Furniture and Fixtures
Depreciation Reserve Furniture and Fixtures
Delivery Equipment
Depreciation Reserve Delivery Equipment
Buildings
Depreciation Reserve Buildings
Good-Will
Etc.

Liability Accounts
Current
Notes Payable
Accounts Payable
Dividends Payable
Accrued Expenses

Deferred Income
Rentals
Interest
Subscriptions

Etc.

Fixed
Mortgages Payable
Long-Time Notes Payable
Bonds Payable
Debentures
Etc.

Proprietorship Accounts
Vested
Proprietors, Capital
Proprietors, Personal
Capital Stock
Surplus (Profit and Loss)
Reserves of Profit (not valuation items)

Temporary
Income, Operating
Sales
Sales Returns and Allowances

Cost of Sales:
Initial Inventory
Purchases
Inward Freight and Cartage
Purchases Returns and Allowances
Final Inventory

Expenses, Operating
Selling Expenses
Salesmen’s Salaries and Commissions

Salesmen’s Traveling and Entertainment Expenses
Delivery Expense (wrapping, shipping room, horse
and motor expenses, delivery salaries, etc.)
Outward Freight
Sales Management Salaries and Expense
Advertising
Depreciation on Salesroom Equipment,
Delivery Equipment, etc.
Sundry Selling Expenses

General Administrative
Officers’ Salaries
General Salaries
Stationery and Printing
Legal Expense
Postage
Telephone and Telegraph
Sundry Office Expense and Supplies
Depreciation on Office Building, Equipment, etc.
Light, Heat, and Power[4]
Taxes
Insurance[5]

Financial Management Expense and Income
Interest Expense
Rent[6]
Bad Debts
Sales Discount
Collection Expenses
Interest Income
Purchase Discount
Non-Operating Expense
Non-Operating Income

Method of Arranging Accounts in the Ledger.—As to the order of
arrangement of accounts in the ledger, one principle governs: Arrange all
accounts in such a manner as to facilitate the drawing up of the final
statements. Thus, assets should come first, arranged in the degree of their
liquidity or availability, and each valuation account following its particular
asset. Liabilities, coming as they do after the asset accounts, should be
arranged in a similar order. Next should come the proprietor’s accounts, the
summary Profit and Loss account, and the income and expense accounts in the
order in which they are to be used in the statement of profit and loss. Where
only one ledger is kept, the personal accounts receivable and payable are
usually recorded in distinct groups, after all the other accounts, towards the
back part of the ledger rather than in the position required by the principle just
stated.
A trial balance taken from a ledger in which the order of arrangement of
the accounts is strictly in accordance with this principle, is called a “classified
trial balance.”

CHAPTER XXVII
THE WORK SHEET AND
SUMMARY STATEMENTS
Procedure Preliminary to Adjusting and Closing.—Before tracing the detail of the
adjusting and closing entries through the books, explanation will be given of the usual method of
insuring the accuracy of this periodic work preliminary to the formal closing of the books. This
preliminary work comprises the technical procedure employed in drawing up the balance sheet
and profit and loss statement before the books are closed. It thus brings about a summarization of
the period’s results made outside the books instead of in them. Therefore, a proof of the accuracy
and correctness of the work of adjusting and closing can be secured before the summarization
entries are made in the books. After proof of accuracy has thus been secured, the statements are
used as a guide in making the formal adjusting and closing entries.
The information for the balance sheet and profit and loss statements comes mostly from the
regular monthly trial balance taken at the end of the period just before the adjusting entries are
made. This trial balance must of course be modified in order to include the effect of the
adjustments. For the purpose of incorporating the adjustments in the trial balance and then
separating the accounts into the two groups, namely, those which are to be summarized in the
profit and loss statement and those which are to be used for the balance sheet, a regular form is
used known as the accountant’s “work sheet.” This form and the method of its use will now be
explained.
The Work Sheet.—For the work sheet “analysis” paper is used, which is ruled in its simple
form as shown in the illustration on pages 226 and 227, space being provided for:

1. Account titles
2. Trial balance items
3. Adjustment items
4. Profit and loss items
5. Balance sheet items

For the purpose of illustration, a trial balance and a list of adjustments are given below, followed
by the work sheet and the necessary explanatory detail.
The student must understand that the work sheet is no part of the formal accounting record,
nor is the procedure employed by it a part of the formal work of closing the books. It is only a
means by which a rough summarization of the period’s results may be made outside the regular
accounting records and all the data needed for the formal statements be brought together. Its
purpose is to secure and prove the accuracy of results before the formal adjusting and closing
work is entered on the books. Where many or complicated adjustments are to be made, with a
resulting probability of error and difficulty in an orderly arrangement of the adjusting entries, the
method of the work sheet is almost indispensable. The formal adjusting entries are then made up
from the adjustment columns of the work sheet.

Illustration
Trial Balance, December 31, 19—
1 New York National Bank $ 17,600.00
2 Petty Cash 100.00
3 Notes Receivable 15,000.00
4 Trade Customers 35,000.00
5 Reserve for Doubtful Accounts $ 875.00
6 Liberty Bonds 3,000.00
7 Merchandise Inventory 30,000.00
9 Office Furniture and Fixtures 2,800.00
10 Depreciation Reserve Office Furniture and Fixtures 700.00
11 Store Furniture and Fixtures 12,000.00
12 Depreciation Reserve Store Furniture and Fixtures 3,000.00
13 Delivery Equipment 4,500.00
14 Depreciation Reserve Delivery Equipment 2,250.00
15 Buildings 35,000.00
16 Depreciation Reserve Buildings 7,000.00
17 Land 15,000.00
18 Notes Payable 12,000.00
19 Trade Creditors 25,000.00
20 Mortgages Payable 17,500.00
21 U. R. Smart, Capital 90,000.00
22 U. R. Smart, Personal 10,500.00
24 Sales 195,000.00
25 Sales Returns and Allowances 1,850.00
26 Purchases 135,000.00
27 Purchases Returns and Allowances 5,400.00
28 In-Freight and Cartage 1,350.00
29 Salesmen’s Salaries 13,500.00
30 Selling Supplies and Expense 1,600.00
31 Advertising 4,800.00
32 Out-Freight 400.00
33 Delivery Expense 3,300.00
34 Office Salaries 5,000.00
35 General Expense 2,000.00
36 Office Expense 4,500.00

37 Printing and Stationery 750.00
38 Taxes 2,840.00
39 Insurance 1,750.00
40 Interest Cost 900.00
41 Collection and Exchange 85.00
42 Sales Discount 850.00
43 Interest Income 1,500.00
44 Purchase Discount 1,300.00
45 Sub-Rentals Income 650.00
46 Special Police on Strike Duty 1,200.00
Total $362,175.00 $362,175.00

Adjustment Data, December 31, 19—
Inventory of Merchandise $26,500.00
Estimated Depreciation:
Office Furniture and Fixtures, 10% of original cost
Store Furniture and Fixtures, 10% of original cost
Delivery Equipment, 16⅔% of original cost
Buildings, 4% of original cost
Doubtful Accounts, ¼% of Net Sales
Accrued Income:
Interest Accrued on Notes Receivable 150.00
Deferred Expenses:
Insurance Unexpired 250.00
Advertising Paid in Advance 300.00
Printing and Stationery Supplies on hand 150.00
Selling Supplies and Expense 200.00
Accrued Expenses:
Taxes 340.00
Salesmen’s Salaries 175.00
Interest on Notes Payable 50.00
Special Police on Strike Duty 150.00
Office Salaries 100.00
Deferred Income:
Sub-Rentals Paid in Advance 50.00

The initial step in the use of the work sheet is to enter the trial balance in the first two
columns, as shown on pages 226, 227. The accounts in the trial balance should be arranged in
classified form before being entered on the work sheet, as this aids greatly in drawing up the
statements. The various adjustment entries, debit and credit, which are almost the same as in the
ledger, are then entered in the adjustment columns. The work sheet may be looked upon
somewhat as a ledger, entries in whose accounts are to be made horizontally instead of vertically.
The analogy to the ledger cannot be carried too far, however. It should be noted that when it is
necessary to adjust any account in the trial balance by increasing its debit, this is accomplished
by entering the item in the debit adjustment column on the same line with the account to be
adjusted. On the other hand, if a subtraction is to be made from a debit amount shown in the trial
balance, the amount to be deducted is entered in the credit adjustment column. A complete debit
and credit entry must be made in the adjustment columns for each adjustment.
There is given below a debit and credit list of these entries as they are to appear on the work
sheet. The manner of making and cross-indexing these adjustment entries is indicated by the
cross-reference letters used. It will be noted that, while in most instances these entries are exactly
the same as the formal adjusting journal entries, there is a difference in the case of the
merchandise inventories.
The student should understand that the list of adjustment entries given below does not appear
anywhere in the formal accounting records. It is shown here in journal form only to indicate the
debits and credits of the entries to the work sheet. Entries of the adjustment transactions are
always made direct to the work sheet, never being set up in journal form. Each of these entries
should be traced into the adjustment columns of the work sheet. The figures in parentheses just
preceding the debit and credit amounts are, of course, not ledger folios but refer to the similarly
numbered items on the work sheet so that the student will have no difficulty in tracing them.
(a) Merchandise Inventory—Final ( 8) 26,500.00
(a) Merchandise Inventory—Final ( 8) 26,500.00
(b) Depreciation Office Furniture and Fixtures (51) 280.00
(b) Depreciation Reserve Office Furniture and Fixtures (10) 280.00
(c) Depreciation Store Furniture and Fixtures (51) 1,200.00
(c) Depreciation Reserve Store Furniture and Fixtures (12) 1,200.00
(d) Depreciation Delivery Equipment (51) 750.00
(d) Depreciation Reserve Delivery Equipment (14) 750.00
(e) Depreciation Buildings (51) 1,400.00
(e) Depreciation Reserve Buildings (16) 1,400.00
(f) Bad Debts (50) 482.88
(f) Reserve for Doubtful Accounts ( 5) 482.88
(g) Interest Income (Accrued) (52) 150.00
(g) Interest Income (43) 150.00
(h) Insurance (Deferred) (53) 250.00
(h) Insurance (39) 250.00
(i) Advertising (Deferred) (53) 300.00

(i) Advertising (31) 300.00
(j) Printing and Stationery (Deferred) (53) 150.00
(j) Printing and Stationery (37) 150.00
(k) Selling Supplies and Expense (Deferred) (53) 200.00
(k) Selling Supplies and Expense (30) 200.00
(l) Taxes (38) 340.00
(l) Taxes (Accrued) (54) 340.00
(m) Salesmen’s Salaries (29) 175.00
(m) Salesmen’s Salaries (Accrued) (54) 175.00
(n) Interest Cost (40) 50.00
(n) Interest Cost (Accrued) (54) 50.00
(o) Special Police on Strike Duty (46) 150.00
(o) Special Police on Strike Duty (Accrued) (54) 150.00
(p) Office Salaries (34) 100.00
(p) Office Salaries (Accrued) (54) 100.00
(q) Sub-Rentals Income (45) 50.00
(q) Sub-Rentals Income (Deferred) (55) 50.00

Form 23. Work Sheet

In order to set up some of these adjusting entries, it becomes necessary to add some new
accounts on the work sheet. The student will note these appended at the end of the regular trial
balance shown on the work sheet. They are, first, Bad Debts and Depreciation, under the latter of
which the detail of the fixed assets subject to depreciation is given, and then follow in order the
balance sheet classifications of Accrued Income, Deferred Charges to Operation, Accrued
Expenses, and Deferred Income, provision being made to show under each of these titles the
detail of the accounts involved.
It will be noted that some of the adjusting entries are not set up in the adjustment columns in
exact accord with the way in which the same items are entered on the ledger, but rather in accord
with the use to be made of the particular items in drawing up the periodic statements. The
purpose of the columns is not to make the adjustments and summarization in a formal manner as
is done in the books, but to gather together all the adjusting data so that a correct separation of
the balance sheet and profit and loss items can be made for use in the formal summary entries
and in the statements. Thus, instead of transferring the initial inventory to the Purchases account,
it is allowed to remain under its own title, because it will be needed as a separate item in drawing
up the cost-of-goods-sold section of the profit and loss statement. Similarly, the final inventory is
not shown deducted from Purchases, but is set up, debit and credit, in the adjustment columns,
opposite the title “Merchandise Inventory—Final,” which is inserted immediately following the
account “Merchandise Inventory—Initial.” At the time of summarizing, the debit item goes into
the balance sheet, while the credit item goes into profit and loss. This method of handling
provides in the profit and loss columns the detailed information needed for the cost-of-goods-
sold section of the statement, comprising Initial Inventory, Purchases, In-Freight, Purchases
Returns and Allowances, and Final Inventory.
The bad debts adjustment is entered in the adjustment columns as a debit to Bad Debts and a
credit to Reserve for Doubtful Accounts. Similarly, the depreciation entry is shown as a debit to
Depreciation in detail, the credits going to the various depreciation reserve accounts.

The adjustments covering deferred charges are shown as debits to the “Deferred Charges to
Operation” classification in detail, the offsetting credits being to the various expense accounts as
shown in the trial balance. These credits in the adjustment column will, when combined with the
corresponding debit in the trial balance column, indicate the net amount of the charge to profit
and loss. The other classes of adjustment entries follow the same procedure.
After all adjustments have been made, a complete distribution of the items in the trial balance
and adjustment columns is made either to the profit and loss or the balance sheet columns. The
difference between the profit and loss columns will thus show the net profit or loss for the period
and must be transferred to the balance sheet as a vested proprietorship item. Instead of being
shown as a definite addition to the proprietor’s capital, the transfer is indicated as the final item
on the work sheet, being a debit in the profit and loss columns to balance them, and a credit in
the balance sheet columns. This difference, $14,747.12 in our illustration, constitutes the net
profit for the period, and when added to the credit side of the balance sheet columns should give
a total equal to the total of the debit balance sheet column. This transfer of net profit effects a
proof of the accuracy of the work.
When this proof has been secured, the formal profit and loss statement should be drawn up,
all of the material for which will be found in the profit and loss columns of the work sheet, where
it is arranged in almost the exact order needed for the formal statement. The information for the
balance sheet is found similarly in the balance sheet columns, all of the detail being properly
grouped but a rearrangement of the order of some items being necessary. Thus, while the detail
of the deferred charges to operation has been gathered together in one place in the work sheet, in
the formal balance sheet this group of items must appear immediately after the current asset
section. See page 234 for the profit and loss statement and page 232 for the balance sheet.
It is thus seen that the work sheet provides a convenient method of passing through the trial
balance the adjustments necessary to a summarization of the results of the period and of effecting
a rough summarization of these results. The work sheet becomes the source of information for
the formal statements and a preliminary stage to the adjustment and closing of the books.
The purpose of the formal adjusting entries and the manner of framing them are fully
explained in Chapter XXVIII. After the information on which they are based is brought together
and entered on the work sheet and after the work of summarization has been proven, the
adjustment columns of the work sheet are made the source for these entries. The formal adjusting
entries as they appear in the journal are given on page 245. They should be compared with the
debit and credit list for the work sheet as given above and the differences noted.
Need for the Summary Statements.—Before setting up the formal journal entries necessary
to adjust and close the books, the balance sheet and statement of profit and loss will be shown.
These two periodic statements 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 often lacks sufficient knowledge of accounting to
interpret correctly the information shown by the journal and ledger. The periodic statements are
intended to show the results of the year in a concise, non-technical form, so that a proprietor,
even though not versed in the science of accounts, can readily understand them.
The Two Forms of Balance Sheet.—The balance sheet may be arranged in either of two
forms. The first form (illustrated on page 232) follows the principles already laid down in
Chapter III. This is called the “report form” and is based on the proprietorship equation when
written

Assets - Liabilities = Proprietorship
Being non-technical, it is perhaps more favored by executives not versed in technical account-
keeping.
The second form (illustrated on page 233) follows the proprietorship equation when written
Assets = Liabilities + Proprietorship
This form shows financial condition by means of the account form, the subtraction of the
liabilities from the assets being indicated by their respective debit and credit 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 the valuation
reserves which are subtracted from the respective assets to which they apply. This is done in
order to render the statement more intelligible. The same principles govern the arrangement of
the items and groups of items as in the first form, viz., degree of liquidity for the assets and a
similar arrangement for the liabilities. The account form is used almost always when the
statement is submitted for publication.
Two Forms for the Profit and Loss Statement.—The statement of profit and loss is also
made up in either of two forms, called the report form 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 V and VI. The account form (illustrated on page 235) is very
nearly a transcript of the ledger Profit and Loss account. It differs chiefly in that the information
concerning “sales” which is summarized in the Sales account on the ledger is here set up in an
inner column and shown summarized on the face of the statement. The information as to cost of
goods sold is similarly summarized.

Form 24. Balance Sheet—Report Form

Form 25. Balance Sheet—Account Form

Form 26. Statement of Profit and Loss—Report Form

Form 27. Statement of Profit and Loss—Account Form

Interim Statements.—In many businesses, where the fiscal period is six months or a year, it
is often desirable and important that at least approximate results be secured at interim periods.
This can be accomplished by means of the work sheet without entailing the burdensome work
involved in a formal closing of the books. At the time of the taking of any trial balance, the work
sheet can be used as a means of making the necessary adjustments before securing results as to
financial and operating condition. Accurate results would of course require as careful work as at
the end of the regular fiscal period. The purpose of interim summaries is to indicate trends rather
than to show accurate and definite results. At such times, therefore, the inventory is usually
estimated, oftentimes the same amount being used as at the beginning of the period. Accruals and
deferred items are not so carefully estimated nor in so great detail. Bad debts and depreciation
must be taken into account. In this way approximate results for any period—frequently every
month—may be secured without interfering with those for the regular fiscal period.

CHAPTER XXVIII
ADJUSTING AND CLOSING
THE BOOKS
Adjustment Entries—Kinds and Place of Record.—In Chapter XV it was
shown that the records as they are usually kept do not reflect the true condition of the
business at any time during the fiscal period. For this reason before summarizing the
book record for the current period it is necessary to bring onto the books a number of
entries the purpose of which is to “adjust” the mixed accounts and thus make the
ledger reflect the true condition. These adjustments may be effected by entry made
directly on the face of the ledger, but it is better to run them through the journal, thus
making it possible to give ample explanation. A further advantage of first recording the
adjustment entries in the journal is that in this way all such entries appear in one place
in the books of account. The ledger should always be kept as a book of secondary
entry, with supporting data in some book of original entry.
Seven types of adjustment entries are needed for the ledger of a mercantile
concern. They are:

1. Merchandise Inventory
2. Depreciation
3. Bad Debts
4. Accrued Income
5. Deferred Expenses
6. Accrued Expenses
7. Deferred Income

All such items must be given consideration and entered upon the books before the final
results for the period can be correctly shown. It is oftentimes necessary to make
correcting entries for items the improper entry or the omission of which are not
detected until the close of the fiscal period. These errors, whenever discovered, should
of course be corrected at once. Because entries of this kind are in the nature of
adjusting entries, consideration of them is included in this chapter.
It may be observed here that if a business manager has an intelligent insight into
the development of his enterprise, and carefully watches the volume of sales,
purchases, and expenses, he may be able to forecast with some degree of accuracy the
approximate results for a given period; but only by making the actual count of stock

now on hand and by carefully estimating the classes of items just mentioned, can
accurate and dependable results be assured.
All these types of adjustment entries are not always found in every such business,
however. Each type will be discussed in turn.
Inventory of Stock-in-Trade.—One of the most important adjustment entries is
that by which the inventory of stock-in-trade is set up separately on the books. By
reference to Chapter XIII it will be seen that none of the accounts connected with
merchandise, viz., purchases, sales, returns, etc., contain any definite and up-to-date
information as to the value of merchandise on hand. To determine the gross profit on
sales this value must be known, and until the gross profit is determined the net profit
cannot be ascertained. The balance sheet, the statement of profit and loss, and the
Profit and Loss account, call for this information. Therefore, before these statements
are made, and before the books can be closed, the value of goods on hand must be
determined. The process by which this is done is called “inventory-taking.”
Without discussing the detail of a system of inventory-taking, three fundamental
principles can be stated relative thereto:
1. Make sure that all goods belonging to the firm on the date
of the inventory are included.
2. Make equally sure that there is no duplication of count, i.e.,
that no goods are counted twice.
3. See that the condition of the goods, viewed from the
standpoint of salability, is indicated.
Two factors of importance enter into the determination of the inventory, viz., the
quantity of the goods on hand and their value per unit. Inaccuracy in either factor may
lead to a gross error in the final amount. By falsifying the count of the goods the
inventory can, of course, be inflated. A usual and more elusive method, often resorted
to, consists in raising the price per unit, since the addition of even a fraction of a cent
per unit may have the effect of converting an actual loss into an apparent profit.
Without further indication of the reason for such valuation, it is now generally required
that the inventory be valued on the basis of cost, or market if market is lower than cost.
The term “cost” should include all costs, incurred up to the point of placing the goods
in condition ready for sale, not only the purchase price, but also duties, freight,
drayage, insurance during transit, etc.
After the amount of the inventory has been determined, it is placed on the books.
However, before this is done it is necessary that the Merchandise Inventory account be
cleared of the goods on hand at the beginning of the period by transferring the amount
to Purchases. The following journal entry effects the transfer:

Purchases

Merchandise Inventory
To transfer the opening inventory
to Purchases.

The posting of this entry automatically clears the Inventory account and, by its
addition to Purchases, causes that account to show the “total goods to be accounted
for.” Purchases, as it now stands, contains both the cost of goods which have been sold
during the current period and those which are still on hand as shown by the inventory
just taken. Accordingly, to separate the two items, the following journal entry is
necessary:

Merchandise Inventory
Purchases
To set up the inventory of
goods now on hand.

This entry when posted shows in the Merchandise Inventory account the asset
element, and leaves in the Purchases account the cost of the merchandise sold. The
effect of these two entries, then, is to adjust the books to true conditions so far as the
merchandise is concerned.
Depreciation, and Loss on Doubtful Accounts.—As indicated in Chapter XV, the
amount of depreciation of particular assets and the losses due to bad and doubtful
accounts are carefully estimated at the close of the fiscal period. The individual
depreciation items are all summarized in a single depreciation account—an expense
account—whose total debit is closed out to Profit and Loss. The depreciation reserves,
however, which are credit items, are handled under separate account titles, and
constitute the valuation account of the corresponding assets. The journal entry
covering depreciation reads as follows:

Depreciation
Depreciation Reserve Buildings
Depreciation Reserve Furniture and Fixtures
Depreciation Reserve Delivery Equipment
Depreciation Reserve Machinery

The Reserve for Doubtful Accounts is the valuation account of Accounts and Notes
Receivable. Assume, for instance, that the debit balances of the latter two accounts are
$15,900, and the credit balance of their valuation account is $600. The difference
between these two accounts, viz., $15,300, represents the present estimated value of

Accounts and Notes Receivable. The journal entry made periodically to record the
estimated loss from uncollectible items is:

Bad Debts
Reserve for Doubtful Accounts

When the two entries above, for estimated depreciation and bad debts, are posted,
the present appraised values of those particular assets are brought on the ledger; i.e.,
from the values, as shown by the respective asset accounts, are taken the portions
estimated to have been used up, lost through depreciation, or uncollectible. These lost
portions are set up as expense items, leaving in the adjusted asset accounts true asset
values as existing at the close of the period.
Accrued Income.—As to the asset portion of items of this kind, it is indicated in
the account in a manner similar to deferred expenses, as explained on page 242. Take
the case of interest income earned but not due. The entry for adjusting it is:

Interest Income (Accrued)
Interest Income

The credit part is posted immediately, thereby showing an addition to the income
already recorded as earned during the current period. The debit part is posted after the
current account is adjusted and allowance made for the closing transfer entry to Profit
and Loss. The debit part of the adjusting entry is then entered on the debit side of the
new portion of the account. Assume this debit item to be $50, and the interest received
during the next period to be $170. The new account will indicate a credit balance of
$120, which is the amount actually earned during that period, since the previous period
took credit for the $50 accrued or earned during that period.
Deferred Expenses.—When a part of the expense paid during the current period
applies to the next period, the prepaid portion must be taken out of the current
expenses and held over—deferred—as a charge to the expenses of the next period.
Taking insurance as an example, the following journal entry effects the required
adjustment:

Insurance (Deferred)
Insurance

In posting this entry, the credit part is posted first in order to take out of the
excessive cost shown chargeable to this period the portion equitably belonging to the
next period. When this is done, the debit balance of the Insurance account indicates the
amount to be charged to the current period and is the correct charge against the Profit
and Loss for the period. After making allowance for the space needed for closing the

account, the debit side of the above entry is posted, this debit becoming the first charge
in the account for the next period. Note that the use of the bracketed “Deferred” is as a
guide in posting. It indicates that that portion of the entry is not to be posted until
provision has been made for closing the account. After posting is completed, the
Insurance account appears as follows:
Insurance
Jan. 2 125.00 Dec. 31 200.00
Apr. 10 250.00
Aug. 15 300.00
675.00
Jan. 1 200.00
There remains, of course, the transfer to Profit and Loss of the current balance before
the account is closed. This closing work is treated later in the chapter.
Accrued Expense Items.—These items cover expenses which the business has
incurred but has not yet paid, and which are properly chargeable to this period but have
not yet been charged on the books. For instance, salaries earned up to the close of the
period but not paid at its close constitute an additional charge to the period’s operations
which must be entered on the books before they will show true conditions. This
amount also constitutes a liability of the business. Accordingly, the journal entry is:

Salaries
Salaries (Accrued)

thus charging the Salaries account with the amount due but not paid, and bringing this
amount down as a credit balance to the new account for the next period. Assuming this
unpaid amount to be $72, the account after closing will show this $72 as a liability on
the closing date. Its effect, however, during the next period will be to reduce the
amount charged to salaries during that period, because this $72, although paid during
that period, has already been charged to the previous period.
The credit to Salaries, therefore, serves two purposes, viz., that of showing the
outstanding liability at the close of the current period, and that of effecting a reduction
of what would be, without this credit, an overcharge to next period’s salaries. For
example, if the total salary paid during the next period is $600, the balance of $528 is
the amount applicable to that period, although the amount actually paid is $600.
Deferred Income.—Income received by the business during the present period
which, however, belongs to the subsequent period is called “deferred income,” as for
instance, rent received in advance from a tenant. As to the liability portion of items of

this kind, it is indicated in a manner similar to the accrued expense items. In this case
the journal entry is:

Rent Income
Rent Income (Deferred)

the effect being to decrease the amount of rent income for the current period and to
show the portion belonging to the next period deferred to that period’s account.
Corrections.—When an error has been made in any entry on the books, it should
not be erased or scratched out, because by so doing suspicion may be raised as to what
was expunged. The wrong item should be ruled out and the correct item written above
it or wherever it belongs. This applies particularly to books of original entry whose use
as evidence has often been destroyed because many erasures appeared in them.
Another way of making a correction, when an amount has been posted to a wrong
account, is first to cancel the wrong posting through a similar entry on the other side of
the same account, and then to post it to the correct account. Cross-reference to the two
accounts must be made.
When an amount has been posted to the wrong side of the correct account, e.g.,
$100 to the credit side of John Doe’s account, when it should have been posted to the
debit side, the incorrect credit may be canceled by a debit of $100, and after this the
original $100 should be entered on the debit side; or the cancellation and correction
may be combined by entering $200 on the debit side. Better still, the incorrect posting
may be ruled out and a correct posting made of the original entry whose wrong posting
caused the error. Adequate cross-reference should be given so as to make the tracing of
the items easy and to indicate exactly what was done.
As these entries are of a somewhat unusual nature, their exact purpose should be
plainly indicated in the explanation columns. According to the methods mentioned
above, the various correcting entries are made directly on the face of the ledger. It is
often preferable, however, first to make the required correction entries in the journal
with full explanation, and then to post them to the ledger.
Adjusting Entries Illustrated.—In order to indicate clearly the routine and
method to be followed in summarizing the books at the close of the fiscal period, the
formal adjusting and closing journal entries needed for the books of U. R. Smart will
now be set up, the illustrative data being the same as were used for the work sheet in
Chapter XXVII to which reference should be made. In connection with the work sheet
it was stated that the adjustment columns of the work sheet are used as a guide to
making the adjusting entries. As to sequence in the journal, these follow immediately,
without break, the last current entry for the month. The adjusting entries for U. R.
Smart are:

Purchases 30,000.00
Merchandise Inventory 30,000.00
Merchandise Inventory 26,500.00
Purchases 26,500.00
Depreciation 3,630.00
Depreciation Reserve Office Furniture and Fixtures 280.00
Depreciation Reserve Store Furniture and Fixtures 1,200.00
Depreciation Reserve Delivery Equipment 750.00
Depreciation Reserve Buildings 1,400.00
Bad Debts 482.88
Reserve for Doubtful Accounts 482.88
Interest Income (Accrued) 150.00
Interest Income 150.00
Insurance (Deferred) 250.00
Insurance 250.00
Advertising (Deferred) 300.00
Advertising 300.00
Printing and Stationery (Deferred) 150.00
Printing and Stationery 150.00
Selling Supplies and Expense (Deferred) 200.00
Selling Supplies and Expense 200.00
Taxes 340.00
Taxes (Accrued) 340.00
Salesmen’s Salaries 175.00
Salesmen’s Salaries (Accrued) 175.00
Interest Cost 50.00
Interest Cost (Accrued) 50.00
Special Police on Strike Duty 150.00
Special Police on Strike Duty (Accrued) 150.00
Office Salaries 100.00
Office Salaries (Accrued) 100.00
Sub-Rentals Income 50.00
Sub-Rentals Income (Deferred) 50.00

Purpose of Summarizing.—After the adjusting entries are posted, the ledger
reflects the true financial condition as of the date of these entries. However, at this
stage the information contained in the ledger is usually scattered over a large number
of accounts. To obtain a concise view of the results of the business, it is necessary to
summarize this information. The Profit and Loss account is the means by which the
temporary proprietorship accounts are summarized and the net results as to profits or
losses are indicated.
In this connection it will be remembered that the adjusting entries have already
effected a separation of the elements of the mixed accounts, so that the temporary
proprietorship items—expenses and income—applicable to the current period are now
separately shown. The transfer of these temporary proprietorship items to the vested
proprietorship accounts constitutes the work of closing. The use of the Profit and Loss
account as a place of summary—a clearing house—through which the net result can be
passed on or transferred to the vested proprietorship accounts, constitutes a part of the
method or technique of closing.
The Closing Entries.—The student is already familiar with the principles of debit
and credit involved in making the closing entries. As indicated above, these are
transfer entries and merely effect a transfer of all temporary proprietorship items to the
Profit and Loss account for summary there and for the transfer of the net result to some
vested proprietorship account or accounts. Like all other entries, these are made first in
the journal and are posted from there to the ledger. The current sections of the various
expense and income accounts are then ruled off and the ledger is said to be “closed.”
Method of Closing the Books.—As explained on page 129, the Profit and Loss
account in the ledger is used for summarizing the temporary proprietorship accounts
before transferring them, i.e., their net result, to the vested proprietorship accounts.
The use of Purchases and Sales accounts for a partial summarization of the various
merchandise accounts has also been explained. After this partial summarization has
been made, the debit balance of the Purchases account, showing cost of goods sold, is
transferred to the Profit and Loss account; and similarly, the credit balance of the Sales
account, representing net sales, is transferred to the Profit and Loss account. Profit and
Loss then shows on the credit side net sales and on the debit cost of goods sold, the
difference being the income portion, i.e., the gross profit of the merchandising
activities for the period. If it is desired to show on the face of the account the actual
figure of gross profit, the Profit and Loss account may be balanced at this stage,
though this is not usually done. The rest of the work of summarization is accomplished
directly through the Profit and Loss account.
Closing Entries Illustrated.—The formal journal entries necessary to effect this
summarization in the ledger are given below, being based on the illustration used for
the work sheet and being made up directly from the various sections of the formal
profit and loss statement shown on page 234. The way in which this is done should be

carefully noted. As to their sequence in the journal, these closing entries will, of
course, immediately follow the formal adjusting entries illustrated above.
Purchases 1,350.00
In-Freight and Cartage 1,350.00
Purchase Returns and Allowance 5,400.00
Purchases 5,400.00
Profit and Loss 134,450.00
Purchases 134,450.00
Sales 1,850.00
Sales Returns and Allowances 1,850.00
Sales 193,150.00
Profit and Loss 193,150.00
Profit and Loss 25,225.00
Salesmen’s Salaries 13,675.00
Selling Supplies and Expense 1,400.00
Advertising 4,500.00
Out-Freight 400.00
Delivery Expense 3,300.00
Depreciation 1,950.00
Store Furniture and Fixtures 1,200.00
Delivery Equipment 750.00
Profit and Loss 18,560.00
Office Salaries 5,100.00
Office Expense 4,500.00
General Expense 2,000.00
Printing and Stationery 600.00
Taxes 3,180.00
Insurance 1,500.00
Depreciation 1,680.00
Office Furniture and Fixtures 280.00
Building 1,400.00
Profit and Loss 2,367.88
Interest Cost 950.00
Sales Discount 850.00

Bad Debts 482.88
Collection and Exchange 85.00
Interest Income 1,650.00
Purchase Discount 1,300.00
Profit and Loss 2,950.00
Profit and Loss 1,350.00
Special Police on Strike Duty 1,350.00
Sub-Rentals Income 600.00
Profit and Loss 600.00
Profit and Loss 14,747.12
U. R. Smart, Personal 14,747.12
U. R. Smart, Personal 4,247.12
U. R. Smart, Capital 4,247.12

It will be noted that after the net sales and cost of goods sold are transferred to the
Profit and Loss account, all expenses directly connected with sales, such as Salesmen’s
Salaries, Advertising, Delivery Expense, Depreciation of Delivery Equipment, of Store
Furniture and Fixtures, and similar items, are closed into the Profit and Loss account.
The groups of accounts closed next are those covering General Administrative
Expenses, Financial Management Expenses, Financial Management Income, Non-
Operating Expense, and Non-Operating Income. It will be noticed that the order of
closing follows the order in which the same items appear in the profit and loss
statement.
The Profit and Loss account now shows on the credit side the items of income and
on the debit side the 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 accrues, the proprietor may have drawn against
it for personal use, as shown in his Personal account. 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 the amount of undrawn or
overdrawn 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.
The Profit and Loss Account.—In posting the closing journal entries to the Profit
and Loss account in the ledger, usually only the group totals as indicated by the entry
will appear. In small concerns where expenses and income are not classified in much

detail, the individual items composing the group total are often shown. These items
are, of course, the same as appear in the part of the journal entry which is contra to the
group total charged or credited to Profit and Loss. The ledger Profit and Loss account
for the illustration will appear as follows when completely posted:

Form 28. Profit and Loss Account in Ledger

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 or device by which the
transactions for the year are summarized and the net result determined. This net result,
whether a profit or a loss, belongs 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 means by which
the temporary proprietorship accounts are summarized and the medium through which
the net result is cleared into some vested proprietorship account or accounts.
Effect of Closing the Ledger.—The transfer of net profit to a vested
proprietorship account completes the work of closing the ledger, all temporary
proprietorship accounts for the current period being closed out. All open balances now
shown on the ledger constitute either assets, liabilities, or vested proprietorship. A
post-closing trial balance contains only the accounts shown on the corresponding
balance sheet. The income and expense accounts, having been cleared of their current
record, are prepared to receive the record of the next period. The business cycle for
this particular business has been completed and its correct history recorded.

CHAPTER XXIX
TYPES OF ACCOUNTING RECORDS AND
THEIR DEVELOPMENT
Evolution of Analytical Journals.—Though the only books absolutely
necessary for an accounting record under the double-entry method are the
journal and the ledger, even the small business finds some subdivision of
the journals advantageous, and so makes use of sales, purchases, and cash
receipts and cash disbursements journals. As a business grows and its
transactions increase in volume and complexity, further subdivision is
needed. When the scope of its organization becomes too great for a personal
oversight, a method or system must be devised for keeping the proprietor or
manager in close touch with the various departments and lines of business
endeavor. This is accomplished by means of reports from the accounting
department, which exists largely for the purpose of furnishing this kind of
information.
Principle to be Followed in Securing Analysis.—In an earlier chapter
it was laid down as a fundamental principle that the information desired by
the management should be furnished from analytical records made at the
time of original entry, rather than by analyzing a composite record at the
time the information is wanted. Such analytical records make possible a
quicker and more up-to-date report to the management, and they save labor
in securing the information by making the analysis at the time of record
when all the facts related to it are readily available.
Types of Sales Journals and Methods of Handling.—The first step in
the analysis of business transactions is the subdivision of the general journal
into separate journals, and this analysis is carried still further by the use of
columnar journal records. Reference has already been made, in Chapter
XVIII, to the use of additional columns in the sales and purchase journals.
Here a brief sketch will be given of the methods of recording sales in
various kinds of sales journals.

1. The earliest type of sales journal, not often used today, consisted of a
letter impression book containing the press copy of invoices sent to
customers, with columns for the extension of the amounts and sometimes
with additional columns for purposes of analysis. Such a journal has the
advantage that the original entry is an exact copy of the invoice.
Oftentimes, however, the impression is poor and nearly or quite illegible; it
takes much room; the detail shown is not often used; and it increases the
work of making and handling the record.
2. Another method makes use of a perforated invoice book with a
columnized interleaf solid-bound between the perforated invoice sheets.
The sales invoice is written on one of the perforated sheets and a carbon
underneath gives a duplicate on the interleaf, the latter constituting the
formal sales record. The advantages and objections are practically the same
as for the impression book method.
3. Another method is to make a separate carbon copy of each invoice
and use the duplicate as the source of entry in the sales journal. The journal
entry gives only the file number of the duplicate invoice so that in case of
need the duplicate can easily be referred to. Such a sales journal may, of
course, contain analytical columns with any desired heads.
4. Still another method uses the duplicate invoice for posting to the
customer’s account, after which it is filed in binders. The latter are usually
provided with recapitulation sheets which show the totals and analysis for
each day, week, or month as the case may be. Just as above, the invoice file
provides the detail in support of the ledger account and the recapitulation
sheets constitute the journal from which credits to the various sales
accounts are made. Either one of these last two methods eliminates most of
the objections and embraces most of the advantages of the other methods
mentioned above.
Where several sales ledgers are used, the sales journal is sometimes
subdivided on the same basis as an aid in posting and for the purpose of
securing controlling figures as explained in following chapters.
The Sales Returns and Allowances Journal.—The use of any special
form of sales journal, particularly if it provides for an analysis of the sales,
requires a similar record of sales returns and allowances. Either a separate
book, similar in form to the sales journal, may be employed for recording

these items or the pages in the back of the sales journal may be used
instead.
Development of the Purchase Journal.—The development of the
purchase records from the old-time scrapbook for invoices to the modern
analytic voucher record resembles the development of the sales journal. The
old-fashioned invoice book was usually a big, loose-bound, coarse paper
volume in which were pasted the invoices for goods bought. An extension
column was provided for the amount of the invoice, and the total of this
gave the purchases for a given period. The use of columns for various
classes of purchases provided the required analysis, but, as it was a
cumbersome, nondescript record, it was bound to give place to something
better—the formal purchase journal or register of today.
The purchase journal or register consists of a bound or a loose-leaf book
ruled to suit individual needs and purposes. Where sales are analyzed by
classes, an exactly similar analysis of purchases must be made in order to
secure a gross profit figure for each class. Therefore its form follows very
closely that of the sales journal. Entries are made in the purchase journal of
the name of the creditor, the amount of his invoice, and the number of the
file where the invoice can be found in case of need.
Where a separate purchasing department is maintained, the duplicate
purchase orders, corrected if necessary to correspond with the purchase
invoice received, may be used as the basis of the purchase journal. In this
case recapitulation sheets are inserted just as with the sales journal. The
handling of purchases is simplified by the fact that as a rule they are much
smaller in number than sales. The same general considerations apply to the
handling of returned purchases as to returned sales.
Handling Expenses through the Purchase Journal.—It is the practice
of some concerns to treat expenses such as labor, rent, salaries, supplies,
etc., as purchase transactions. Under this method, instead of postponing the
entry until the item is paid, it is made at the time of securing the service or
supplies. The basis for the entry may be either: (1) the bill or purchase
invoice; (2) a formal purchase memo or voucher made out for each
transaction; or (3) the fact that the expense has been incurred may suffice
for the entry on the books with no formal paper to vouch for it. The use of
such formal papers as the basis for entry is known as the voucher record

system. The details of this system are fully explained in the second volume.
Discussion is here limited to a brief outline of the method and of the
advantages of its use.
When expense invoices are entered and analyzed in the voucher record
form of purchase journal, their posting requires debits to the various
expense accounts and credits to the individual creditors’ accounts in the
ledger. If the ledger contains only a controlling account, this account must
be credited with the total of the expense and other purchases, while the
individual accounts in the creditors subsidiary ledger must be credited with
the details which make up the total. When the bill is paid, entry in the cash
book will not be, as usual, to the debit of the expense account in the general
ledger, but to the debit of the creditor’s account in the subsidiary ledger.
The reason for this procedure will be made clear in the discussion of
controlling accounts to follow.
The entry of expense invoices in the above manner secures an
immediate record of all liabilities as incurred and therefore makes the books
show at all times the true state of affairs as regards liabilities. The method,
however, necessitates a little more work in making the record, and for this
reason many concerns do not enter expenses until paid, making the debit to
them through the cash book. In this latter case all unpaid expense bills
should be kept in an expense file for reference when information as to the
unrecorded liabilities is desired.
Note Journals.—As explained previously, note journals are sometimes
used instead of the general journal for the record of note transactions, where
these are sufficiently numerous. Provision is sometimes made for securing a
proper analysis in order to distinguish between notes from customers and
notes from other sources. It will be seen later that such an analysis is
necessary when controlling accounts are operated.
Analysis in the Cash Book.—The cash journals may be ruled to
furnish any desired analysis, showing on the debit side (i.e., the cash
receipts journal) the sources of receipts, and on the credit side the objects of
expenditure. As the sources of cash receipts are usually more limited than
the objects of expenditures, they do not require so much analysis. The
analysis may be very detailed, the only limit to the number of columns
being the width of the page. A minute analysis of expenditures, however, is

usually made, not in the cash journal, but in the purchase or voucher record,
which thus relieves the cash book of a mass of detail.
The chief advantage of using additional columns in books of original
entry lies in the fact that time and labor are saved in posting. The column
total is posted in one item, whereas each of the numerous items composing
it would have to be posted separately to the account named in the column
heading if no analytical column were provided. Hence it would be a waste
of space to provide separate columns for items which recur so infrequently
as to make their summarization unnecessary. Care should be taken to avoid
needless columnization.
It is customary to have the following columns on the debit side of the
cash book: General or Sundry, Accounts Receivable, Sales Discount, and
Net Cash or Bank; on the credit side: General or Sundry, Accounts Payable,
Purchases Discount, and Net Cash or Bank. (See page 282 for illustration.)
The proof of the distribution is secured by checking the sum of the net cash
and discount columns against the sum of the totals of the other columns. In
both receipts and disbursements journals every item must appear in the
respective Net Cash columns, and from these distribution is made to the
other columns. For example, in the cash receipts journal, receipts from
customers are distributed into the Accounts Receivable column for the gross
amount of each item, and into Sales Discount for the discount, if any is
taken. All other items are carried into the General or Sundry column. Where
several sales ledgers are kept, additional columns may be provided so that
instead of having one accounts receivable column, there are columns for
each ledger. Similar treatment is given to the disbursements.
Analysis in the General Journal.—Where the general journal is used
for returned goods, allowances, and other adjustments with customers and
creditors, use is made of analytic columns with these captions for both the
debit and credit: Accounts Receivable, Accounts Payable, and General.
Here, however, there is no column in which to enter all items for
distribution to the other columns. If a customer’s or a creditor’s account is
affected, entry is made in that column in the first place. All other entries are
in the General column. (See page 281 for illustration.)
With regard to analysis columns in the general journal, some
accountants maintain, with good reason, that if the number of transactions

of a particular kind is sufficiently large to justify their segregation in a
separate column, this in itself would be ample justification for the use of a
separate journal to record these items. Whenever the analysis of recurring
transactions in the general journal is facilitated by the use of separate
columns, the advisability of opening a new journal for the record of such
items as appear in the general journal most frequently should be considered.
Subdivision of the Ledgers.—The next step in the subdivision of the
records is made in the ledgers. The general or impersonal accounts of the
business are of a more permanent character than the accounts with persons
—customers and creditors. Consequently, when once it is determined under
what account titles information is desired and those accounts are set up,
there is usually little need to change their titles. Personal accounts, however,
are constantly changing as some customers are lost and new ones are added,
and also because creditors change with purchases in new markets. Hence,
when a business outgrows its small beginnings, it is customary to keep
these changing accounts in separate books. The basis for the first
subdivision of the ledgers, therefore, is the separation of the accounts into
personal and impersonal. The accounts with customers are carried in a
separate ledger called variously the sales, customers, or accounts receivable
ledger, and those with creditors in a ledger called purchase, creditors, or
accounts payable ledger. All other accounts are kept in the main ledger
known as the general ledger. One advantage of this subdivision is that
several bookkeepers can work on the various ledgers at the same time.
A further subdivision of the customers ledger is frequently made into
“city” and “country,” the former containing the accounts with customers
located within the city where the business is situated, and the latter the out-
of-the-city accounts. Other subdivisions may be made on an alphabetical
basis, i.e., customers ledger No. 1, containing all accounts from A to G;
customers ledger No. 2, H to M, etc. Sometimes the concern’s sales
territory is divided into arbitrary districts and the ledgers are subdivided to
correspond with such districts.

Form 29. Standard Ledger—Divided Column

Form 30. Standard Ledger—Center Column

Form 31. Balance Ledger Rulings

Form 32. Balance Ledger Rulings

Kinds of Ledgers.—There are several kinds of ledgers, which may be
classified (1) as to their rulings, and (2) as to their bindings.
1. Rulings. As to their rulings, ledgers are either standard, balance, or
progressive. The standard ruling has two duplicate parts, a debit and a
credit, and is usually divided in the center of the page, one money column
appearing at the extreme right of each part, although sometimes the
arrangement is symmetrical with both debit and credit money columns at
the center, and the date columns at either side of the page. (See Forms 29
and 30.)
The balance ruling is a three or four-column ledger with the money
columns either at the center or at the right-hand margin, or at both the
center and the right-hand margin. The extra columns are for the account
balances. If the balance is usually either a debit or a credit, only one balance
column would be necessary; where it is apt to be a debit at one time and a
credit at another, a debit balance column and a credit balance column are
advantageous. The balance ruling is used particularly with personal
accounts where there is need for an up-to-date balance. Where this kind of

ledger is used, entry of new debits or credits should always be on the next
blank line as shown in the balance column, so as to allow the extension of
the new balance opposite the last entry even though this should leave blank
several of the preceding lines on the debit and credit sides. Typical forms of
some of these are shown in Forms 31 and 32.
The Boston, progressive, or tabular ledger, as it is variously called,
makes provision for a horizontal progress of the account as to sequence of
time; the title of the account is written at the left-hand margin, and one or
more lines are allowed to each account according to the degree of its
activity. The account title is written once at the left margin of the master or
main sheet, and is sometimes repeated at the right margin if the sheet is
very wide. The page is divided into columns for each day of the period. To
effect this, short-margin insert sheets must be bound in to give the desired
room for accommodating a whole period’s record. This style of ruling was
formerly much used in banks where a daily balance for each depositor’s
account was necessary. It is capable of adaptation to other uses, however.
One form is shown, Form 33.

Form 33. Boston Ledger Sometimes Used for Depositors

2. Bindings. Ledgers may be classified also as solid-bound, loose-leaf,
and card, the titles being self-explanatory. One of the great advantages of
the loose-leaf and card ledgers over the solid-bound ledger is their
flexibility. They lend themselves easily to any desired grouping of the
accounts; they may be numerically arranged where accounts are numbered
instead of named; they may be arranged as to classes and each class made
self-indexing; or a geographical grouping may be made. Another great
advantage of this form of ledger is the ability to discard or file away in
other binders all “dead” accounts, thus making for ease and facility in the
use of the “live” ledger. Also it is possible for several clerks to work
simultaneously, since the leaves or cards are removable and may be
distributed among any number of clerks. There is always the danger,
however, of failure to return a leaf or card, or of placing it out of regular
order when returning it, or of destroying it, if it were desired fraudulently to
do away with any particular account. The use of loose-leaf and card ledgers
for personal accounts is pretty thoroughly established, notwithstanding the
disadvantages just mentioned.

CHAPTER XXX
CONTROLLING ACCOUNTS
Introductory.—Reference to controlling accounts has been made
several times in preceding chapters. It is purposed now to define them and
explain their use. The separation of the various journals on the basis of an
analysis of transactions frees the general journal of a vast mass of detail it
formerly carried. This separation, however, in no way affects the underlying
debit and credit scheme of the whole system. Each journal is an integral
part of the whole; every entry therein has its equal debit and credit which
are in due course posted to its proper account, thus maintaining the
equilibrium of the ledger. The separation of the ledger into three or more
special ledgers in the interest of economy of effort and ease of use has also
been mentioned. Still, each of these special ledgers is an integral part of the
whole ledger and the accounts in the special ledgers must be entered in the
trial balance to secure proof of equilibrium.
The customers ledger is usually the most active of the various ledgers,
i.e., more postings are made in it because the majority of business
transactions involve dealings of various sorts with customers, and more
accounts are required to keep the records with customers. It is usually,
therefore, the largest part of the whole ledger, but its accounts are all of the
same kind, viz., accounts receivable. When taking a trial balance, the total
of the balances of the customers ledger accounts is usually set up under the
title “Accounts Receivable,” leaving the details to a supplementary list or
schedule.
Advantage of a Controlling Account.—The advantage of thus
condensing the trial balance is apparent and suggests the desirability of
obtaining the “accounts receivable” balance independently of the customers
ledger. If this is done the bookkeeper in charge of the general ledger can not
only draw up his trial balance without reference to the customers ledger, but
has also the correct figure for the total of the account balances in the
customers ledger. In other words, he has a figure which controls the
customers ledger and which therefore furnishes him with a check on the

accuracy of the ledger clerk or bookkeeper who keeps that ledger. The most
convenient method of recording the accounts receivable figure is evidently
by means of a formal account on the general ledger. When such an account
is kept, the effect is to make it a summary account whose detail is carried in
the customers ledger.
Controlling Account Necessitates Changed Idea of Ledger
Equilibrium.—By having a customers controlling account (or “Accounts
Receivable” as it is commonly called, though other terms are also used) in
the general ledger, the customers ledger is no longer used as an integral part
of the whole ledger and becomes a “subsidiary” ledger; that is, its function
is reduced to that of a supporting schedule or list of detail for the summary
controlling account. The equilibrium of the general ledger is now
maintained by summary posting to the controlling accounts. Though the
customers ledger has ceased to be a “ledger” in the proper sense of the term,
it is still a vital part of the system, carrying as it does the detail of the
summary controlling account. Moreover, it is linked up to the system by
being provable against its summary account. Yet it should be borne in mind
that its scheme of debit and credit is now an independent one and is not
linked up to the debit and credit equilibrium of the general ledger; that is,
the postings in the subsidiary ledger are merely memorandum entries of the
detail posted in summary form to the general ledger. Thus the mathematical
basis of the controlling account is simply that the whole is exactly equal to
all its parts, the balance of the summary account being equal to the total of
the balances of all the customers’ accounts of which it is the summary. To
illustrate, if we have customers’ accounts whose balances are $1,000,
$2,000, $3,000, $4,000, and $5,000 respectively, then the summary account
must have a balance of $15,000.
Debits to the Controlling Account.—The principle and the purpose of
the controlling account having now been explained, the next problem to
consider is how best to gather the summary figures for its debits and credits.
If every debit to a customer’s account must be posted also to the controlling
account and every credit to a customer’s account must be shown as a credit
in the controlling account the work involved would be almost doubled and
little would be gained by thus duplicating the postings in another ledger.
Therefore it is important to secure the figures for entry in the controlling
accounts with the least effort, i.e., in the form of debit and credit

summaries. Hence, to determine the sources of these debits and credits of
the controlling account, analysis must be made of the sources of the debits
and credits to the customers’ accounts.
Most of the debits to customers’ accounts are from the sales journal.
Additional debits may be from the cash disbursements journal when cash
payments are made as a rebate or a refund for overpayment or some other
similar transactions; still others from the general journal for adjustments of
various kinds. The debits to customers, however, for cash paid them are
very few in number, because such adjustments usually are not made by
means of cash payments. The sales journal, as usually operated, carries a
column for credit sales, whose total represents in one amount the total of all
detailed debits to customers’ accounts. The total of the credit sales column,
therefore, controls the total debits to all customers on account of charge
sales to them. In summarizing the sales journal the summary entry should
show that this total is to be posted not only to the credit side of the Sales
account but also to the debit of the controlling account in the ledger. This is
so because the customers ledger has ceased to be an integral part of the
general ledger, the controlling account having taken its place. Accordingly,
the general ledger contains no record of either the debits or credits of the
entire group of sales transactions until the end of the month, when this
group must therefore be brought into the general ledger in summary form,
both debit and credit.
Where the total sales in the sales journal include an analysis of sales
into cash sales and credit sales, the following summary entry should be
made:

Accounts Receivable
Cash
Sales

The cash debit is set up only to show the equilibrium of the summary
entry and is not posted, because it is entered also in the cash book and is
posted from there. This debit posting to “Accounts Receivable” in the
general ledger secures in one posting a debit amount equal to all individual
debit postings to the customers ledger from this source. The controlling

account in the general ledger is variously termed “Sales Ledger,” “Accounts
Receivable,” “Trade Debtors,” “Customers,” etc.
The two other sources of debit posting to customers’ accounts are the
general journal and the cash book. The debit side of the journal is provided
with an Accounts Receivable analysis column in which, as explained in the
previous chapter, debits to customers’ accounts are entered. At posting time
the total of this Accounts Receivable column will therefore give in one
figure a debit posting item to the general ledger Accounts Receivable
account equal to all individual debit postings from the general journal to
customers’ accounts in the customers ledger.
Usually it is not necessary to provide an Accounts Receivable column
on the credit side of the cash book, since debit postings from there to
customers’ accounts are very infrequent. Hence no total or controlling
figure for entry in the Accounts Receivable account can be obtained. Every
item which is posted from this source to the debit of a customer’s account
must be also posted—item by item—to the debit of Accounts Receivable in
the general ledger. This is of course a double debit posting, but one of these
debits is to a subsidiary ledger which is no longer a part of the equilibrium
scheme and therefore does not throw the general ledger out of balance.
Great care must be exercised to make sure that each of these items is posted
both to a customer’s account and also to the Accounts Receivable account.
Credits to the Controlling Account.—An analysis of the credits to
customers’ accounts shows four main sources:
1. The cash receipts journal for payments made by
customers.
2. The sales returns journal, if one is kept, for goods
returned by customers.
3. The note journal for notes received in payment.
4. The general journal for various adjustments and
also for the purpose of recording notes and
returned sales where special journals are not kept
for these transactions.
Accordingly, analytic columns for accounts receivable are provided in
the cash receipts journal and the general journal. The totals of their columns

are posted to the credit of Accounts Receivable, and the detailed amounts to
the credit of the various customers’ accounts. The credit postings from these
sources to the customers ledger accounts and to the general ledger Accounts
Receivable account are therefore the same so far as totals are concerned.
The sales returns journal is summarized at posting time by means of an
entry similar to that in the sales journal, as follows:

Sales Returns
Accounts Receivable

In this case the credit posting to the Accounts Receivable account is equal
to the detailed credits to customers’ accounts.
Similarly, a summary entry for the notes receivable journal secures a
controlling figure for Accounts Receivable. If the notes are all received
from customers to apply on their accounts, the summary entry is:

Notes Receivable
Accounts Receivable

the amount being the total of that journal.
In this way the total of all debits and of all credits to the individual
customers’ accounts is represented by the summary items entered in the
general ledger controlling account, Accounts Receivable. Consequently, the
balance of this single account is equal to the balance of the customers
ledger. For the trial balance, therefore, one account takes the place of
hundreds or even thousands of customers’ individual accounts. As a result
of this, much time is saved and the possibility of error on the general ledger
is greatly reduced.
Proving the Customers Ledger.—The use of a controlling account in
the general ledger, however, does not eliminate the necessity of proving the
accuracy of the customers ledger. It merely makes it possible to take a trial
balance without bringing the numerous customers’ accounts into it. It is just
as much a part of the proof of the work to make a list of customers’
accounts balances and check it against the balance of the Accounts
Receivable general ledger account, as it is to prove the general ledger by

means of a trial balance. If there is a discrepancy between the subsidiary
ledger and its controlling account on the general ledger that discrepancy
does not necessarily prevent a trial balance of the general ledger, but it does
show error in the work which must be searched out and corrected.
Accounts Payable Account.—A similar arrangement will make
possible a controlling account on the general ledger for the creditors or
purchases ledger. This account is variously termed Accounts Payable,
Purchase Ledger, Creditors, or Trade Creditors account. Its mechanism is
the same as for Accounts Receivable. Analysis of credit postings to
creditors’ accounts shows the purchase journal as their main source. Other
credits come through the general journal and a very few through the cash
receipts journal. The summary entry for the purchase journal is:

Purchases
Accounts Payable
Cash

This shows a debit to the Purchases account for the total amount of the
purchases, a credit to Accounts Payable for the liability to creditors, and to
Cash for the amount paid on cash purchases. The cash item is not posted.
The Accounts Payable column total on the credit side of the journal, and the
separate items from the cash receipts journal, furnish the other credits to the
Accounts Payable account in the general ledger.
The debits come from the Accounts Payable columns in the cash
disbursements journal and in the general journal, and the summaries for the
notes payable and purchases returns journals.
Basic Principle as to Postings to Controlling Accounts.—In the
handling of controlling accounts, the one fundamental requirement is to
make sure that every entry in books of original entry which affects any
account in the subsidiary ledger is reflected in the postings to the
controlling account in the general ledger. This principle resolves itself into
the mathematical axiom stated above that a whole is equal to all—not just
some—of its parts. Only thus can a true control be established.
Making the Subsidiary Ledger Self-Balancing.—Through the use of
the two controlling accounts explained above, the trial balance is relieved of

a large number of accounts, and the general ledger is made independent of
the subsidiary ledgers. On the other hand, the subsidiary ledgers are
dependent for their proof on the controlling account balances in the general
ledger. In an effort to make every ledger “self-balancing,” a further
refinement of the controlling account idea is frequently incorporated in each
subsidiary ledger. It is accomplished in the following manner: An exact
duplicate of the controlling account on the general ledger is set up in the
subsidiary ledger, with this difference, that the sides of the account are
reversed so that the subsidiary ledger account has for its debits the credits of
the general ledger account, and for its credits the debits of the general
ledger account.
Take the Accounts Receivable controlling account for illustration. On
the general ledger its balance is of course a debit balance representing the
total outstanding accounts due from customers. Similarly, the schedule or
list of customers’ accounts taken from the sales ledger will represent debit
balances whose total is the same as the controlling account balance. If, then,
the controlling account itself is placed on the customers ledger as an
additional account, the sides being reversed, the balance of this one account
will be a credit equal to the total debit balance of all the other accounts in
the customers ledger. Therefore, if the customers ledger is correct, its own
balance will be offset exactly by the credit balance of the one additional
account, and the ledger then is said to be self-balancing. There is no theory
or principle of debit and credit involved in this; the device is simply
introduced in order that the ledger may provide an internal proof of its
correctness. The title of the balancing account on the subsidiary ledger is
“Adjustment” or “Balance” and has no significance other than that
mentioned. In a similar manner any subsidiary ledger may be made self-
balancing.

CHAPTER XXXI
HANDLING CONTROLLING ACCOUNTS
Chapter XXX concerned itself with the statement and explanation of the
principles on which the controlling account rests, the manner of its
construction, its advantages, and with the changed application of the
fundamental scheme of debit and credit under a system of records operating
controlling accounts. The present chapter will be devoted to a consideration
of the problems met with in the practical operation of these accounts.
Introduction of the Controlling Account.—Upon the installation of a
new system or set of books, the controlling account feature may be
incorporated from the start. The new system must provide for the separation
from the general ledger, of the ledgers over which control is to be
established. The method of securing controlling totals for posting to the
general ledger controlling accounts was indicated in the preceding chapter.
Where it is desired to introduce controlling accounts into a system
which has not formerly used them, certain adjustments must be made, i.e.,
the accounts to be controlled must be segregated and controlling account
columns must be provided for in the books of original entry. With the
transfer of these accounts to a separate ledger, together with the
introduction of the controlling accounts into the general ledger, the
equilibrium of that ledger is maintained. The opening entry in the newly
established controlling account is of course the sum of the balances of the
transferred accounts.
If it is desired to establish the new controlling account by journal entry,
that entry would appear somewhat as shown on page 279, Form 34, with
suitable explanation added. All these items should be posted to the general
ledger as shown by the entry, and in addition the detailed items should be
posted as debits to the accounts in the customers ledger. The effect of these
postings would be, first, to close the individual customers’ accounts
formerly carried in the general ledger and open up in their stead the
controlling account; and second, to set up on the subsidiary ledger the detail
of the customers’ accounts.

Recording Withdrawals of Stock-in-Trade.—The original basis for
separating the main journal into its subsidiary parts was the analysis of
transactions by kinds, such as sales, purchases, cash, etc. The sales journal
was presumed to contain only sales of stock-in-trade. Departure from this
principle was advisable in the case of goods drawn at cost, for use in the
business or by the proprietor or for other purposes. This is done because
withdrawals of stock-in-trade, at whatever price and for whatever purpose,
can be recorded more conveniently in the sales journal than elsewhere.
It is theoretically incorrect, however, to enter such items in the Sales
account because withdrawals at cost do not represent actual sales, and for
this reason they should be regarded as deductions from purchases or from
inventory. The only proper place for their record, under this view, is the
general journal, entry in which would have to be by detailed debit and
credit for each item. However, because this requires much more work than
entry in the sales journal, this last method is more commonly employed.
Usually the volume of such transactions is not large and would not seriously
vitiate the use of the Sales account as the basis for estimating percentages of
cost of goods sold, gross profit, selling expenses, etc. Moreover, as the total
amount of these withdrawals is often fairly constant as between periods
their record in the sales journal is countenanced.
The Problem of the Sales Journal Summary.—When withdrawals
from stock at cost price are recorded in the sales journal, a new problem
arises in summarizing the sales journal when operating under a controlling
account system. The customers or sales ledger is usually limited absolutely
to customers’ accounts. Accounts with the proprietors, and with all other
titles under which withdrawals for other purposes may be recorded, are
almost invariably carried in the general ledger. Therefore, while most of the
items entered in the sales journal are posted to the customers ledger, these
withdrawal items must be posted in detail to the general ledger. Thus the
total of the sales journal does not represent the correct debit to accounts
receivable in the general ledger. Evidently an analysis of the content of the
sales journal must be made in order to obtain the correct controlling figure.
Such analysis may be made in several ways. Where possible, three
columns in addition to the departmental columns should be used. The
column titles would be “Sales Ledger,” “Cash,” and “Sundry.” The sum of
these three would give the total to check against the total of the other

distributive columns, but only the “Sales Ledger” total would be posted to
Accounts Receivable, and the individual items in that column would be
posted to the customers’ accounts in the sales ledger. The items in Sundry
column would be posted to their named accounts in the general ledger. This
method secures an automatic separation of the controlling account total
from other items, and should be used where possible.
If the number of these extraneous items is too small to warrant the use
of a separate column, they may be recorded in the Sales Ledger column and
indicated by means of an “❌” or some other mark. At summary time, the
sales journal must be looked over and these items picked out. Subtraction of
their sum from the Sales Ledger column total would give the correct
controlling account posting.
Still another method requires a correcting general journal entry at the
time the sales journal entry is made. Under this method these special items
are included in the Sales Ledger column, thereby causing an overcharge to
Accounts Receivable. The correcting general journal entry must therefore
credit Accounts Receivable by the amount of the overcharge for each item.
For instance, if stock has been drawn by the proprietor, the general journal
entry at the time the sales journal entry is made would be:

Proprietor, Personal
Accounts Receivable

the debit to proprietor being checked here and posted from the sales journal,
or vice versa. This method, however, results in a duplication of work. It
would be preferable not to enter these items in the sales journal and to make
the record only in the general journal, and so leave the Sales Ledger column
total in the sales journal the correct controlling figure.
In a complicated controlling account system, where for current entry a
simple bookkeeping routine must be established and all items of whatever
kind be handled in the same way, the withdrawals by proprietors are
recorded in accounts opened with them in the sales ledger just as with
customers. At the end of the period, before closing the books, these
proprietors’ accounts are transferred by general journal entry to the general

ledger, requiring one entry—like the one last shown above—for the
drawings of the period.
Cash sales may also be handled without the use of a separate column in
the sales journal. Two methods are used for this. Under the one, cash sales
are included in the Accounts Receivable debit total of the sales journal,
although the individual items are not posted to the subsidiary ledger, and
they are also included in the Accounts Receivable credit total of the cash
receipts journal. The inflated debit in the general ledger controlling account
is thus offset by an equally inflated credit, the balance therefore being the
correct amount to control the sales ledger.
Under the other method the postings to the general ledger controlling
account are the same as in the first method. The two methods differ,
however, in that under the second method an account is opened in the
subsidiary ledger entitled “Cash Customers” or “Cash Sales,” to the debit of
which are posted in detail the cash sales items from the sales journal and to
the credit of which are posted in detail the cash sales items from the cash
receipts journal. The account is thus only a “wash” or clearing account. This
method, however, prevents the inflated debits and credits in the controlling
account.
The methods last described for handling proprietors’ withdrawals and
cash sales are the ones most frequently used in large businesses where
simplicity of routine for current entry must be secured.
The Problem of the Purchase Journal Summary.—The practice of
recording extraneous transactions in the purchase journal brings about at
summary time a situation similar to that of the sales journal, when a
controlling Accounts Payable account is maintained. The purchase journal
is, and should be, the place of record for purchases made for the business. If
the proprietor (or other person), for his personal account and use, purchases
through the business merchandise which never goes into stock, accurate
accounting requires such transactions to be charged direct to the proprietor
and not to the Purchases account of the business. Inasmuch as the liability is
assumed by the business and the creditor’s account will appear in the
purchase ledger, the use of the purchase journal total for credit to the
Accounts Payable controlling account gives the correct figure. The trouble
comes in because this same figure cannot be used as the debit to Purchases.

Subtraction of these extraneous items must be made to determine the proper
amount chargeable to the Purchases account, thus necessitating an analysis
at summary time.
Accounts Both Receivable and Payable.—It frequently happens that
purchases from, and sales to, the same party are made, i.e., goods are
sometimes bought from and sold to a customer. If the account of this
debtor-creditor is normally a purchase account, it is set up in the purchase
ledger. If a sale is made to this debtor-creditor and charged to his purchase
ledger account, such transaction should not be included in the Accounts
Receivable controlling figure from the sales journal unless an adjusting
entry is made through the general journal. Such entry would affect only the
controlling accounts and would be:

Accounts Payable
Accounts Receivable

Or the item might be omitted from the sales journal controlling figure and
stated separately in the summary entry for the sales journal.
A more satisfactory method is to set up two accounts with such parties
—one as a creditor, the other as a customer. Then no adjustment need be
made at the time of summarizing the journals, because the two accounts are
treated as entirely independent of each other. The settlement of these two
accounts may be handled separately or by a payment of the balance
between the two. If settled by balance, an adjusting journal entry should be
made to show on the books the two separate elements involved. This would
of course affect both the controlling accounts and the two individual
accounts.
The Problem of the Note Journals Summaries.—Of notes receivable
the large majority are usually received from customers. The summary entry
for such is:

Notes Receivable
Accounts Receivable

Where notes are received from other sources, as from officers, partners, or
from outside parties to whom loans have been made, it is evident that these
must not be included in the credit to Accounts Receivable, and it may be
advisable also to eliminate them from Notes Receivable unless they are
short-term, current items, as only such should be carried under Notes
Receivable. These special notes may be carried in a “Notes Receivable
Special” account.
If, as sometimes happens, interest is included in the face of a note, this
must be adjusted by the summary entry, as follows:

Notes Receivable
Accounts Receivable
Interest Income

The considerations stated above as applicable to the notes receivable
journal, are of equal importance in handling the notes payable journal. A
very careful analysis of the note journals should be made at a summary
time, which analysis should be shown by the summary entry.
Summary Entries for Columnar Books.—Illustration will now be
given of some standard forms for summarizing the columnar journals.
Sometimes the summary entries for the various subsidiary journals are
made in the general journal. This seems to accomplish no good purpose and
is not usually recommended. Theoretically it is desirable to show a formal
debit and credit summary for each journal footing posted to the ledger. If,
however, the number of columns is small and it is readily seen that the
debits and credits are equal, the formal summary is often dispensed with. So
also, if there are many distributive columns of the same effect, i.e., debit or
credit, as in the large departmental sales journal or the voucher register
referred to on page 144, formal summary is not shown, the posting being
made from the column totals as illustrated for Petty Cash on page 369.
The Sales Journal Summary.—An illustration of the sales journal
summary is given in Form 35. The Sundry items should be posted in detail
from their column and their total checked in the summary entry. Where a
Sundry column is not used and the Sundry items are included in the Sales

Ledger column, they must be separated before the summary entry can be
made.

Form 34. General Journal

Form 35. Sales Journal Summary

Where, also, a Cash column is not carried, as is so often the case, there
being just one column for Sales Ledger, Cash, and Sundry items, from
which distribution is made, the separation of the Cash items need not be
shown in the summary entry, provided those items are entered also in the
Sales Ledger column of the cash book. Where, due to the large number of
distributive columns, the sales journal can ill afford the room for a Cash
column, the above method offers the best solution of the problem.
The purchase journal summary is similar to that of the sales journal, and
therefore no separate illustration need be given here.

The General Journal Summary.—As shown by the illustration in
Form 36, in summarizing the general journal the Accounts Receivable and
Accounts Payable columns are formally totaled, ruled off, and their totals
brought into the General columns on both debit and credit sides and these
columns are totaled and ruled off, thus showing the equilibrium of the
journal. This summary entry is posted to the proper accounts in the general
ledger. There is no particular advantage, however, in this formal summary
entry because the postings could easily be made directly from the column
totals.
The Cash Book Summaries.—As illustrated in Forms 37 and 38, the
formal summary for each side of the cash book shows the equality of the
Bank and Discount columns total against the General and Accounts
Receivable and Payable columns. To show the correct debit to the bank for
the present month, the balance brought forward from last month and entered
in both the General and Bank columns on December 1, must now be
subtracted from both.
On the disbursements side no explanation of the summary entry is
necessary. It will be noted that, to show the balance of the bank account, a
restatement of the Bank column total is necessary.

Form 36. General Journal Summary

Form 37. Cash Summary Book—Receipts Side

Form 38. Cash Summary Book—Disbursements Side

Other Controlling Accounts.—It is frequently desirable to keep some
accounts of the business private, such as those showing partners’
investments, drawings, ratios of sharing profits, the adjusting and closing
entries, the profit and loss, etc. This can be accomplished through the use of
a private ledger supported by a private journal and sometimes a private cash
book. For their operation a controlling account of the private ledger is set
up in the general ledger, and similarly a controlling account of the general
ledger appears in the private ledger. The use of private books is explained in
Volume II of this work.

Sometimes subsidiary expense ledgers are used to carry a minute
division of each expense group, with corresponding controlling accounts,
such as Selling Expense, Office Expense, General Expense, Factory
Expense. Similarly, if the consignment sales of a business are large enough
to justify a separate record in a consignments ledger, a controlling account
is set up in the general ledger. In a manufacturing business, Raw Materials,
Goods in Process, and Finished Goods accounts are often controlling
accounts for the stores, jobs, and finished stock ledgers. In a corporation the
Capital Stock account (or accounts) is a controlling account over the stock
ledger.
Principle Governing Content of Subsidiary Ledgers.—Before
closing this chapter, it should be stated as a fundamental principle that no
accounts should be carried in a subsidiary ledger except such as are of the
same general kind and can without misrepresentation be carried under the
group title of the controlling account.

CHAPTER XXXII
PARTNERSHIP FROM THE
BUSINESS VIEWPOINT
Partnership Defined.—In Chapter II, reference was made to some of
the features of a partnership—the purpose of its formation, advantages,
disadvantages, etc. The laws of the state of New York define a partnership
as follows: “A partnership, as between the members thereof, is the
association, not incorporated, of two or more persons who have agreed to
combine their labor, property and skill or some of them for the purpose of
engaging in any lawful trade or business, and sharing the profits and losses
as such between them.”
This definition brings out in a general way the reasons for the formation
of the partnership and its essential features. Under this type of organization,
where several persons combine their capitals, it is possible to secure a larger
fund of capital than under the sole proprietorship. This opens to the
partnership avenues of business usually closed to the sole proprietor. The
bringing together of the man with a special aptitude or skill, or of a man
with a following in the community on account of social standing and
acquaintanceship, with another who has money or a plant for the operation
of a business, often makes successful an otherwise unpromising
undertaking.
Operating Feature and Working Organization.—Mutual agency is
the essential operating feature of the partnership. By this is meant that any
one of the partners can act for the others, and in the eyes of the law all are
equally responsible for the management of the business. Except in the case
of a limited partnership, to be explained later, each partner has an equal
voice in the management and control of affairs. Unlike the corporation
where for management purposes the owners’ powers are delegated to a
controlling board, the essential character of the partnership is that each
partner has, regardless of the amount of his investment, an equal right in the
direction of its business. As between themselves, for purposes of division of

duties and specialization of effort, definite power to exercise control over
certain features of the business may be delegated to individual partners. But
such delegation means nothing more than a method of dividing the work
and is simply the working organization of the firm which may be changed
at any time the majority of the partners see fit. Thus, while a partner may be
limited in his actions for the firm by agreement among the partners, so that
he is not a general agent for the firm, still as to outsiders who know nothing
of this internal arrangement, he has power to bind the partnership by his
acts, because an outsider has a right to expect that any partner has power to
act as an agent for the firm. This is so because such power is of the essence
of the partnership form.
Essential Characteristics of the Partnership.—Limited life is an
essential characteristic of the partnership. The partnership relation is a very
personal one. It can be terminated in a number of ways, but the death or
retirement of any member automatically works a dissolution of the firm,
even though another man takes his place. The legal theory is that the old
partnership is dead and a new one, even though bearing the same firm
name, has come into existence. Thus a partnership cannot be perpetual. The
relationship between the partners is so intimate that the success of the
undertaking depends fundamentally on the good faith and honor exercised
by each partner towards the others, and therefore any addition to the
personnel of a partnership can be made only with the consent of all
members of the existing firm.
The partnership being the outgrowth of the sole proprietorship, certain
of the aspects of its earlier form still cling to it. For suit at law it is looked
upon as a collection of single owners, and action on contract must usually
be taken against the individual members of the firm. Suit by or against the
partnership cannot as a rule be brought in the firm name. Some states,
however, allow this under recent enactments. Title to personalty can be held
and transferred under the firm name, but realty must be in the name of the
individual members or in the name of one member acting as trustee for the
firm. Thus, while in the view of the business community the copartnership
is a business entity under a firm name, in the sight of the law it is not an
entity but merely a collection of single owners. This legal view accounts
also for the full debt liability of every partner—except in a limited

partnership. In case the firm assets are insufficient to meet the claims of
creditors, any or all the partners’ private resources may be levied upon.
Co-ownership of the profits of a business is another feature essential to
the copartnership. No sharing in the profits on any other basis than that of
co-ownership will constitute a partnership. When the question comes before
the courts, the intention of the parties governs, and evidence showing that
each acted as principal for himself and as agent for the others, and has
shared profits as profits, would be sufficient to constitute the relationship.
The Partnership Contract.—A partnership being a contract
relationship, all the requirements governing legality of contracts, such as
agreement, consideration, lawful object, competency of contracting parties,
etc., apply to the copartnership. The contract may be oral or in writing. In
case of dispute an oral contract, on account of the difficulty of proof, is of
little force in regulating the relations of the partners, and the general law of
partnership would usually govern. Inasmuch as there is so great an
opportunity for disputes in a relationship of this sort, it is imperative, if
efficient working relations are to be maintained, that very carefully drawn
articles of copartnership be agreed upon before active business is begun.
These articles should contain, at least, the following:
1. The name of the firm and of the partners.
2. The kind and place of business.
3. The duration of the partnership.
4. The method of terminating it.
5. A detailed statement of the relations between the
partners, such as duties and powers, capital
contributions, withdrawals of capital, salaries,
division of profits and losses, interest on capital,
and the time of closing the books to secure a
definite determination of the partners’ interests.
Even when the utmost care is exercised in drafting the articles of
partnership, it almost always happens that some portion is not understood
alike by all or that some contingency arises not specifically provided for.
Nevertheless, it is the only way in which a comparative avoidance of
misunderstanding and dispute can be obtained.

Partnerships Classified.—As to the scope of their business operations,
partnerships are usually classified into general and special. The general
class embraces those for the conduct of some general or ordinary lines of
business. The special class comprises those formed to undertake a definite
task or some particular line of business. Joint ventures would come under
this latter class.
As to the liability of their members, partnerships may be classified as
general and limited. The general partner has the full liability, referred to
above; the limited partner’s liability never exceeds the amount of his
investment. In a limited partnership one or more, but not all, members may
limit their liability. This class of partnership can be formed only under
direct authority of statute law. A limited partner is not active in the
management of the business, being more in the nature of a lender of money
to the firm, who gets his return in profits instead of interest. Should he
become active in the firm’s management, he will constitute himself an
ordinary partner with full liability. The New York statute governing the
formation of the limited partnership is as follows:
Two or more persons may form a limited partnership
which shall consist of one or more persons of full age, called
general partners, and also of one or more persons of full age
who contribute in actual cash payments, a special sum as
capital, to the common stock—or fund—called special
partners, for the transaction within this state of any lawful
business, except banking and insurance by making, severally
signing and acknowledging and causing to be filed and
recorded in the clerk’s office in the county where the
principal place of business of such partnership is located, a
certificate in which is stated:
1. The name or firm under which such partnership is
to be conducted and the county wherein the
principal place of business is to be located.
2. The general nature of the business intended to be
transacted.
3. The names, and whether of full age, of all general
and special partners therein, distinguishing which

are general and which are special partners, and
their places of residence.
4. The amount of capital which each special partner
has contributed to the common stock—or fund.
5. The time at which the partnership is to begin and
end.
Affidavit of the payment of capital must be made and a notice of the
formation of the partnership published in a paper of general circulation. The
limited partnership is thus hedged about with safeguards for creditors,
bankers, and other interested parties, particularly by the rule that a limited
partnership cannot exist unless there are one or more general partners with
full liability.
The Joint-Stock Company.—The joint-stock company is a partnership
or association in which ownership, voice in the management, and profit-
sharing ratio are evidenced by transferable shares of stock. Control and
management are exercised through a board of directors chosen by the
stockholders. If the company becomes bankrupt and the firm assets are
insufficient to satisfy creditors, the members are personally liable to the full
extent of their private property in the same way as in a general partnership.
The mining partnership is a form of joint-stock company which operates
in mining communities. Usually the mining property itself is beyond the
scope of such a partnership, only the development of this property by means
of a lease being contemplated. Unlike the ordinary partnership, the
members of a mining partnership may assign their shares of ownership.
Upon their death or bankruptcy, their interests pass to others who take their
place in the partnership without the consent of the remaining partners. Thus,
the confidential relationship based on the right of selection of its members,
characteristic of the ordinary partnership, is largely lacking in the mining
partnership.
Partners Classified.—Finally, brief mention may be made of the
following terms applied to partners to indicate varying degrees of activity
within the ordinary partnership:
1. Ostensible partners—those who hold themselves
out and are known to be partners.

2. Nominal—those who are known as partners but
who have no real interest in the firm.
3. Dormant or silent—those who are not known to
outsiders as partners and who take no active part in
the management of the firm’s affairs.
4. Secret partners—those who are not known as
partners to outsiders but who have an interest and
take active part in managing the firm.
For more detailed information as to a partner’s rights, duties, and
responsibilities to his copartners and to outsiders, a standard legal text on
partnerships or business law should be consulted. The student should also
read Chapter II in connection with this chapter and the next.

CHAPTER XXXIII
PARTNERSHIP FROM THE
ACCOUNTING VIEWPOINT
From the fact that the law looks upon the partnership as a combination
or collection of sole owners, some of the accounting problems arising out of
the partnership form of organization are unique, and a partial or full
treatment of some of these problems will be given in this chapter.
Profit-Sharing in the Partnership.—Of these problems perhaps the
one occurring most frequently is that concerning the division of profits.
Attention was called in Chapter XXXII to the need of explicit statement on
this point in the articles of copartnership under the head of the
intrapartnership relations. Since men combine their capitals for the purpose
of realizing profits, it would naturally be supposed that all partnership
agreements would be specific on that point. Yet it very often happens that
many contingencies relating to the matter of profit-sharing have not been
foreseen and as a result disputes arise.
The fundamental principles governing profit distribution may be stated
as follows:
1. Where the agreement is silent, the law provides that profits shall be
divided equally among the partners regardless of the amounts of their
respective investments of capital. Some partners may have made no
investments of money or property, setting up their particular skill and
aptitude or standing in the community as their share and contribution to the
profit-earning capacity of the organization. Unless it is specifically agreed
otherwise, these will share equally in any profits.
2. Where profits are to be shared in the same ratio as capital, the
agreement should specify whether the basis of division is to be the original
investments or the capitals as shown at the beginning of each period, which
would be the original investments plus profits left in the business. This
latter interpretation would usually result in a changing ratio for succeeding

periods, whereas under the former interpretation the ratio of profit-sharing
would be always the same.
3. Provision should be made, either in the original articles or at a
subsequent time, for a change in the profit-sharing ratio in the event of a
partner’s withdrawing some portion of his original investment if such
withdrawal is allowed. It may be stated here that an agreement between the
partners as to any ratio for division of profits can be made at any time and
will govern such ratio, but must be on a determinable basis.
4. Where the articles are silent as to the division of losses, the profit-
sharing ratio governs. Where a different ratio is desired, specific statement
of it must be made. Of course, upon the inception of an undertaking losses
are not contemplated, but the experience of others should cause provision to
be made for apportionment of losses in order to avoid possible difficulties
or disputes.
5. Unless the articles—or subsequent agreements—provide for the
payment of salaries to any or all of the partners, none are allowed.
6. The conditions governing the partners’ drawings should be explicit as
to the amount to be drawn during a given period. It should be stated
explicitly whether excess drawings shall be regarded as a charge against
capital, or as the basis for an interest charge, or simply as an excess drawing
standing in the partner’s current account without penalty other than a
disallowance of future drawings until lapse of time brings the total amount
drawn within the agreed limitations.
7. The manner of handling undrawn profits should be made definite. Are
they to be transferred to the capital account and so be made a part of capital,
resulting in changing capital ratios; or are they to be carried as open
balances in the drawing accounts and thus take on the nature of temporary
loans subject to withdrawal at any time?
Average Investment as a Basis for Profit-Sharing.—Attention should
be called to a basis for profit-sharing sometimes employed for special
partnerships, entered into for the performance of a specific contract or for
doing any special work. In these cases the capital needed may not be known
at the start, or if known may not all be required then but is to be furnished
by whichever partner may have available funds at the time of need. In such

cases the basis of profit-sharing may be made the amount of capital
furnished by each partner and the length of time of its use in the enterprise.
Two methods of determining the ratio may be employed.
First Method. Each investment may be multiplied by the number of
days occurring between the date on which the investment was made and the
date of profit determination, giving a result which may be called “day-
dollars” of investment in a sense similar to the term foot-pound in physics.
From the total day-dollars of investment must be subtracted the day-dollars
of withdrawals, arrived at similarly, thus showing net investment in terms of
day-dollars. The sum of all the investments in day-dollars becomes the basis
on which to prorate profits, each partner’s share being the part which his
individual net investments bear to this total net investment.
Second Method. The original investment of each partner may be
multiplied by the time it remains unchanged, i.e., until it is added to or
some portion is withdrawn. Similarly, this changed capital is multiplied by
the time it remains fixed, and so for every change. The total of these items
constitutes each partner’s net investment, from which the profit-sharing
ratio is determinable as above. In the problem given below, for purposes of
illustration the dates are so taken that the calculation can be made on a
month-dollar instead of a day-dollar basis, thus shortening the operation.
The capital accounts of the partners, showing investments and withdrawals,
are as follows:
A. B. Card
19— 19—
Jan. 15 2,500.00 Jan. 1 10,000.00
Apr. 1 4,500.00 Mar. 15 7,500.00
June 15 1,500.00 June 1 5,000.00

D. E. Folwell
19— 19—
Feb. 1 3,000.00 Jan. 1 5,000.00
May 15 2,000.00 15 5,000.00
Apr. 1 5,000.00

June 15 2,500.00
Profits as on July 1, 19—, were $5,000. Determine each share.

Solution
(Using the second method)
Amount Months Month-Dollars
A. B. Card:
$10,000 × ½ $ 5,000
7,500 × 2 15,000
15,000 × ½ 7,500
10,500 × 2 21,000
15,500 × ½ 7,750
14,000 × ½ 7,000
6 $63,250

D. E. Folwell:
$ 5,000 × ½ $ 2,500
10,000 × ½ 5,000
7,000 × 2 14,000
12,000 × 1½ 18,000
10,000 × 1 10,000
12,500 × ½ 6,250
6 55,750
Total investment in month-dollars $119,000

63,250
Card’s share of the profit: ——— of $5,000 = $2,657.56
119,000