Read Ebook: Accounting theory and practice Volume 1 (of 3) by Kester Roy B Roy Bernard

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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."

During the year from July 1, 1921 to June 30, 1922, Conners bought ,362.50 worth of goods; his sales amounted to ,465.20; he paid for help ,050.50; his other expenses were ,405.45; and he estimated the wear and tear on furniture at 10%, or .50. As shown in his statement for 1922, he had ,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 ,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., ,260, he determined that the goods sold must have been the difference or ,602.50 . The price which he received for these goods sold was ,465.20; hence, his profits from sales were ,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 ,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 ,405.45. He estimated that his store fixtures depreciated in value .50. All these items, representing costs of doing business, amounted to ,508.45 , which subtracted from his profits from sales, ,862.70, gives him a net gain of ,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:

The technical form of the summary of the temporary proprietorship elements will be presented in the next chapter.

THE PROFIT AND LOSS SUMMARY

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.

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 . 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.

Just as with the balance sheet, the main problems of the profit and loss summary relate to: its form; and its content. After an explanation of some of the terms used in connection with the summary, these two problems will be discussed.

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.: the general purpose it is to serve; the likelihood of obscuring essential facts through too great detail; and the general appearance is to legibility, clearness of form and expression, and arrangement on the page.

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.

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.

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.

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

Gross Trading Profit - ?

AARON CONNERS STATEMENT OF PROFIT AND LOSS For the year ending June 30, 1922

KIMBALL AND MOREY STATEMENT OF PROFIT AND LOSS For the Year Ending June 30, 19--

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.

INTERRELATION BETWEEN THE ECONOMIC AND THE FINANCIAL ELEMENTS OF A BUSINESS, AND SOME INTER-RATIOS

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.

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