PART II
CLASSES OF ACCOUNTS
39. In double entry bookkeeping, the accounts used may be divided into the two general classes of personal and impersonal. For the purpose of more complete classification, the second class is further subdivided into real, representative, and nominal accounts.
40. Personal Accounts. A personal account is a record of transactions with a particular person or persons.
Examples—
A record of transactions with persons who buy goods from us.
A record of transactions with persons from whom we buy goods.
41. Real Account. A real account is a record of transactions with respect to a particular property. Properties which we possess are termed resources or assets; therefore all real accounts are also asset accounts.
Examples—
Real estate (land and buildings), Machinery, Furniture, Merchandise, etc.
42. Representative Account. A representative account is a summary of all debit or credit transactions of a particular class with respect to several personal accounts. The debit or credit to this account completes the double entry, and illustrates the rule that in double entry there must be a credit for every debit.
Example—
We sell goods to a number of customers, and the amounts of these sales are debited to their several accounts. To complete the double entry, we credit the total amount of these sales to an account called sales account. The total credits to this account during any given period represent the sales to all customers for the same period, and the sales account is a representative account.
The total debits to all customers' accounts for goods purchased in one month amount to $1,423.62. This amount is credited to the sales account. Likewise the purchases for the same period amount to $947.20, and the several amounts are credited to the personal accounts of those from whom the purchases were made, while a like amount is debited to a representative account known as a purchase account.
43. Nominal Account. A nominal account is a record of transactions having to do with profit and loss; a record of a particular class of expenditures from which no direct returns are expected; any impersonal account which does not come under the classification of real or representative accounts.
Example—
We buy coal to be used in heating our building. The coal is not to be resold, but its use is necessary; it is one of the expenses of conducting the business, and we charge the amount to an expense account. Expense is a nominal account kept for the purpose of showing the total expenses of the business.
44. Merchandise Account. The merchandise account is a real account formerly much used, but discarded by modern accountants. When used, this account is debited with all purchases of merchandise and credited with all sales. The account is also charged with all goods returned by our customers, and credited with all goods which we return to those from whom we have purchased them. Goods returned by our customers are charged at the prices at which they were purchased by the customers; consequently the debit side of the merchandise account does not furnish a true exhibit of our purchases; neither is the credit side a true exhibit of our sales. Since the merchandise account furnished no valuable information, other accounts which exhibit more vital statistics have been substituted.
45. Purchase account is one of the accounts substituted for the merchandise account. This account is charged with all purchases as represented by the footings of the purchase book or purchase journal. This completes the double entry, the separate purchases having been credited to the personal accounts of those from whom the goods were purchased. All returns or other similar deductions allowed on purchase invoices are charged to those from whom the purchases were made and credited to purchase account. The balance of the purchase account then shows the total net purchases.
46. Sales account takes the place of the credit side of the merchandise account. All sales as shown by the footings of the sales book are credited to the sales account, completing the double entry. All returns and allowances are likewise charged to the sales account. The balance of the sales account shows total net sales.
SAMPLE TRANSACTIONS
47. The following transactions, properly recorded in journal sales book, purchase book, and ledger, demonstrate the uses of the merchandise, purchase, and sales accounts explained in the preceding paragraphs:
In the first demonstration, the footings of the sales and purchase books, as well as the returns entered in the journal, are posted to a merchandise account. It will be noted that the debit side of the merchandise account does not represent the actual purchases, and the credit side does not represent the sales.
In the second demonstration, the purchase and sales accounts are used. Total sales are credited to sales account from purchase book, and returns credited from the journal. The balances of these accounts show actual net purchases and sales.
CLASSES OF ASSETS
48. Asset accounts are accounts representing resources or assets of the business. Assets are classified as Fixed; Active or Floating; Passive or Speculative; Fictitious.
Fixed assets are those permanent forms of property which are a necessary part of the equipment used for conducting the business—such as real estate, buildings, machinery, etc.
Active or floating assets are those forms of property of which the quantity in our possession varies from day to day—as merchandise, accounts, cash, etc.
Passive or speculative assets are those (a) whose values are not readily determined, or (b) whose values are subject to market fluctuations—as, for example, (a) franchises, copyrights, patents; (b) stocks, bonds, or other speculative securities.
Fictitious assets are those which are not represented by tangible property, or which are of value to a going business but would have no market value if the business were closed out or liquidated. These assets are frequently represented by an expense account on the books. The initial advertising expense necessary to launch the business successfully is frequently carried on the books as an asset. The amount of such advertising expense is spread over a stated period, a certain proportion being charged into the regular expense accounts each year until the entire amount is used.
49. Examples of Fixed Assets. The assets of an ordinary mercantile business are of the first two classes only—fixed and floating. The most common forms of fixed assets of such a business are:
Real Estate—generally understood to include land and buildings owned and used in the business.
Furniture and Fixtures—represented by office and store furniture, shelving, counters, stoves, furnaces or other heating appliances, lighting fixtures.
Horses and Wagons or Trucks—including all horses, wagons, trucks, harness, or motor-cars used for hauling goods.
If the business is one in which these classes of property are dealt in, they become active assets. Land, for example, would be one of the active assets of a business organized to buy and sell real estate.
50. Examples of Floating Assets. The active or floating assets of a mercantile business are:
Merchandise—meaning the stock in trade or goods dealt in.
Accounts—the open accounts of customers who owe for goods purchased.
Notes or Bills Receivable—all outstanding notes payable to the firm.
Cash—the amount of cash on hand and in the bank.
51. Examples of Passive Assets. Passive or speculative assets are more frequently found on the books of a manufacturing business, a corporation, or a business a part or whole of which has been sold by the original owners. Examples of these assets are:
Patents—A manufacturer owns a patent the value of which depends upon future profits resulting from the manufacture and sale of the article which it covers. It is customary to place a value on the patent, and to consider it an asset of the business.
Good-Will—A man has established a business which has become extremely profitable, and in selling the business he places a certain value on the reputation or goodwill which he has built up.
Speculative—A firm having a surplus not required in the business sometimes invests it outside of the business with the expectation of realizing a profit by selling at an advanced price. They buy grain or provisions, mining or railway stocks, etc. Or an investment may be made in the stock of some manufacturing business to be established in the town, because such an enterprise, if successful, will naturally result in an increase in their own business.
52. Examples of Fictitious Assets. Fictitious assets are seldom found on the books of other than corporations where a large initial promotion expense is involved. A good example of a fictitious asset is:
Advertising—A business house may decide on an average annual expenditure for advertising; but to be effective, the expenditures for the first two or three years may necessarily exceed this amount. The excess is considered as an investment since it is expected that as the business becomes firmly established the annual expenditure can be reduced to an amount even less than that estimated, gradually reducing the amount carried on the books as an asset. To illustrate:
REVENUE ACCOUNTS
53. The term revenue (synonymous with income) is used to designate those items which, when brought together in an account, exhibit the profit or loss of the business.
Revenue receipts are the receipts which originate exclusively from the sale or exchange of the commodities or things of value for the handling of which the business has been organized.
Revenue expenditures are those expenditures connected with the expense of operation or administration of a business, including such items of expense as postage, printing, salaries, rent, etc.
Revenue accounts is a term used to designate those accounts that represent revenue receipts or revenue expenditures.
54. Revenue Receipts. The account representing revenue receipts in all lines of business (though it may sometimes be known by another name) is the sales account—a representative account showing net sales. Net sales, less cost of goods sold, represent gross profits. Gross profits, less cost of conducting the business (revenue expenditures) represent net profits.
55. Expense. The broad term expense account represents all revenue expenditures; but in modern bookkeeping the amounts of the different classes of expense are kept separate as far as possible.
Some of the most commonly used divisions of expense are: Rent; Insurance; Taxes, Interest and Discount; Out Freight and Express; Heat and Lights; Labor; Salaries, etc. It is customary to open one account in the name of General Expense, to care for expenditures not included in special accounts.
56. Insurance—A nominal account to which is charged all sums paid to insurance companies (called premiums), in consideration of which our property is insured against loss by fire, cyclones, or other disaster.
57. Rent—A nominal account to which is charged all sums paid for use of property which we rent or lease from others for the benefit of our business—usually the buildings in which our business is transacted or in which our goods are stored.
58. Taxes—A nominal account to which are charged all taxes and license fees paid on account of property owned or business transacted.
59. Interest—This is a nominal account which should include only interest charges paid or interest earned on account of capital. When we borrow money or discount a note, we do it because we need cash capital, and the interest paid is a capital expense or a direct source of loss. Exchange charged for the collection of notes and drafts belongs in the same class. All interest paid for the use of money, and exchange paid for the collection of notes, drafts, and checks, should be debited to interest account. When we save the discount by prepayment of bills, the discount is earned by the use of capital. All such earnings are a direct source of profit and should be credited to interest account. Discount paid on notes is interest paid in advance, and should not be confused with discounts allowed to customers for the prompt payment of bills; the latter is a reduction in the price received for our goods, and reduces trading profits. This question is discussed under the head of Cash Discounts.
60. Out Freight and Express—A nominal account which is debited with all transportation charges paid on goods that we ship, whether sales are made at delivered prices or freight is paid as an accommodation to the customer. When goods are sold at f. o. b. prices, and the freight is paid by us as an accommodation to the customer, out freight should be credited and the customer debited.
This should not be confused with in freight, or freight paid on goods received, as such charges add to the cost of the goods and should be charged to the account representing that particular class of goods.
61. Heat and Light—This account is debited with all sums paid for fuel, heating bills, lighting bills, and lighting supplies.
62. Labor—A nominal account which is debited with all sums paid as wages to mechanics or laborers employed by the business.
63. Salaries—A nominal account which is debited with all salaries paid to managers, salesmen, clerks, and others employed in the administration of the business.
RULES FOR JOURNALIZING
64. Journalizing is one of the most important operations in bookkeeping, since journalizing a transaction involves the selection of the proper accounts to be debited and credited completing the double entry. With the use of separate sales and purchase records, the journal itself is used principally for those entries involving a transfer of values from one account to another. These are frequently referred to as cross entries. The number of possible entries of this class is practically unlimited, and they require careful study on the part of the bookkeeper.
Rules for journalizing are frequently referred to in bookkeeping textbooks; but, since the custom of journalizing every transaction is now obsolete, the term is no longer sufficiently descriptive. A better term to use would be rules for debit and credit, for it is the rules of debit and credit that must be followed when a journal entry is to be made.
65. Three-Column Journal. A three-column journal suitable for a small business is shown above. The third column is used for sales only, while the first two columns are used for regular journal entries. The use of the column for sales answers the same purpose as a sales book, and total sales are posted to the credit of sales account at the end of the month.
SAMPLE TRANSACTIONS
66. For the purpose of demonstrating the principles of debit and credit as exemplified in the journal, the following transactions except those involving cash are journalized in a three-column journal. The third column is used for sales, and it is to be understood that a cash account is kept in a separate cash book.
EXAMPLES FOR PRACTICE
1. After you become familiar with each entry and the nature of the accounts to be debited or credited, journalize the transactions given in Article 66, then compare with the model journal, and see if your work is correct.
2. Journalize the following transactions:
| —April 10— | ||
| Bought from David Cole & Son on account | ||
| 100 bbls. flour at | $4.60 | $460.00 |
| —10— | ||
| Sold to L. H. Stebbins on account | ||
| 20 bbls. flour at | 5.10 | 102.00 |
| —10— | ||
| Sold to Henry Waterbury on account | ||
| 30 bu. beans | 2.00 | 60.00 |
| 20 " oats | .37 | 7.40 |
| —11— | ||
| Paid to David Cole & Son | ||
| Cash on account | 160.00 | |
| Gave them my note for 30 days | 300.00 | |
| —11— | ||
| Received note from L. H. Stebbins | ||
| for 30 days to balance account | 102.00 | |
| —12— | ||
| Paid cash for harness oil | .35 | |
| —12— | ||
| Henry Waterbury paid cash on account | 40.00 | |
RULES FOR POSTING
67. The act of transferring all items from the journal, sales book, purchase book, cash book, or other books to the ledger is called posting. All items relating to one account are posted to that account in the ledger; thus all sales are posted to the sales account, and all transactions with a person are posted to the account of that person. Every debit must be posted to the debit side of the corresponding account in the ledger.
68. Routine. The first operation in posting is to open an account in the ledger by writing the name of the account on the line at the head of the ledger page. The month and day are then written in the date column; the page of the book from which the item is posted is written in the folio column, and the amount is placed in the money column. The final operation is to place the number of the ledger page in the folio column of the book from which the item was transferred, directly opposite the item posted.
Posting from Journal. In posting from the journal, all items in the left or debit columns are posted to the debit side of the corresponding ledger accounts, while all items in the credit column are posted to the credit side of the ledger accounts.
The first item in the journal in the preceding section is a debit to Hiram Watson, amount $1.15. It is necessary to open an account in the ledger, which is done by writing Hiram Watson's name at the head of the page, above the date column on the left side of the page; in the date column we write the date, April 2; in the folio column we write the journal page, 1: and in the money column we write the amount, $1.15. The number of the ledger page is now written in the folio column in the journal, directly opposite the name of Hiram Watson.
The second transaction recorded in the journal is a purchase which makes it necessary to open a purchase account in the ledger, to which is debited the amount of the purchase $18.75. The first transaction recorded in the journal is a sale, therefore the credit is to the sales account. Since we are placing all sales in a special column, the amount will not be posted until the end of the month, when the total sales will be posted to the credit of the sales account as one item. In the second transaction, the credit is to a personal account, and we open an account in the ledger with Eureka Milling Co., following the same routine in posting as with debit items, except that the item is posted to the credit side of the account.
Posting from Cash Book. When posting from the cash book, it must be remembered that all items on the left-hand page (which debit cash) must be posted to the credit of some other account; and that all items on the right-hand page (which credit cash) must be posted to the debit of an account in the ledger.
Why cash received is entered on the left-hand page of the cash book, and cash paid out on the right-hand page, is a point not always clear to the bookkeeper. To obtain a clear view of this point, it should be remembered that the cash book is nothing more or less than a ledger account with cash, and cash received is entered on the left-hand page (or debit side) for the reason that any account is debited for what is received or is added to it.
We sell merchandise, for example, and the person is debited because he receives it. We buy real estate; the real estate account is debited because our real estate possessions are added to. Broadly speaking, we (the business) receive the real estate; but, instead of charging the amount to ourselves (the person), we charge it to Real Estate, that we may know the amount of our real estate investment.
A customer pays us cash; cash is debited because our cash possessions are added to. We might charge the amount to our account; but we prefer to charge it to a cash account that we may know how much cash we have on hand. We pay out cash; cash is credited because cash has gone out of our possession. The main point of difference is that we post to other ledger accounts direct from the cash book, which is itself a ledger account, instead of journalizing cash transactions.
If cash transactions were journalized—
Cash
To Person
Person
To Cash
the amounts would be posted to the debit or credits of the cash account in the ledger; but for convenience we keep the cash accounts in a separate book. Journalizing a few of the transactions given will clearly demonstrate the point.
TRIAL BALANCE
69. A trial balance is a list of the balances of all accounts remaining open in the ledger, together with the balance shown by the cash account. On journal paper, all open accounts are listed by name; the debit balances are placed in the debit column, and credit balances are placed in the credit column; the pages of the ledger are placed in the folio column, opposite the names of the account. Both debit and credit columns are footed, and the footings of the two columns should agree.
A trial balance is taken for the purpose of testing the accuracy of the postings to the ledger; to find out if the ledger is in balance. The trial balance can be taken without considering the balances, by taking the total debit and credit items posted to all open accounts.
While the trial balance shows that for every debit posted to the ledger a corresponding credit has also been posted (double entry principle), it does not absolutely prove the accuracy of the work. If a debit item of $100.00 were posted to the debit of the wrong account, it would not affect the balance of the ledger; but if the item were posted to the credit instead of to the debit of the account, the ledger would be out of balance and the amount that it was outwould be shown by the trial balance.
CLASSIFICATION OF ACCOUNTS
70. The arrangement of the accounts in the ledger is of considerable importance. Since one of the objects of bookkeeping is to exhibit the standing or condition of the business, the accounts should be classified in a manner that will make easiest the assembling of important statistics.
The accounts in the ledger represent either Assets (resources), Liabilities, Profits (gains), or Losses. Every account having a debit balance represents either (a) an asset or (b) a loss. (a) A personal account having a debit balance represents an asset; (b) any expense account having a debit balance represents a loss, as it reduces the chance for profit.
Every account having a credit balance represents either (c) a liability or (d) a profit. (c) A personal account having a credit balance represents a liability—that is, something we owe; (d) a sales account having a credit balance represents a profit because it increases our chance of gain.
OFFICE OF THE REGISTRAR, AMERICAN SCHOOL OF CORRESPONDENCE
71. Arrangement in Ledger. The foregoing classifications should be kept in mind in arranging the accounts in the ledger. First provide space for the asset and liability accounts; then follow with the profit and loss (or revenue) accounts. As far as possible, keep all asset accounts together, following the same plan with liability and profit and loss accounts.
The accounts are arranged in the trial balance in exactly the same order as they appear in the ledger; and if correctly classified they will show at a glance the assets (except inventories of merchandise) and liabilities of the business. Likewise the profit and loss accounts (also known as revenue accounts—see Article 53) will show total sales, purchases, and expense of conducting the business.
SAMPLE LEDGER ACCOUNTS
72. The ledger accounts shown on pages 80-81, representing the transactions given in the preceding set of sample transactions, demonstrate the proper arrangement of accounts, manner of posting, and the trial balance.
EXAMPLES FOR PRACTICE
1. From the copy of the journal (Article 66) which you have made, post the transactions to the ledger.
2. Post the transactions from the journal you have made (Exercise 2, preceding section) to the ledger.
3. Make a trial balance of the ledger accounts.
TREATMENT OF CASH DISCOUNTS
73. Cash discounts are discounts allowed for prepayment of bills. They are frequently confused with bank discounts (or interest collected in advance when notes are discounted), but are of an entirely different character.
When the price is made, the profits are calculated with the idea that the customer may take advantage of the cash discount; that is, the price after the discount is deducted includes a legitimate profit. We cannot debit the customer with the amount of the bill less the discount, for we do not know that he will take advantage of the discount; and so, the charge to the customer and credit to sales account is an amount which may never be received.
If the bill is paid less the discount, the amount deducted reduces our profit on the sale. It is not an allowance for the use of capital, for we can probably borrow money at 6 per cent, while the discount may be 5 per cent or more for anticipating payment 30 days or less. 74. Discounts Allowed. Cash discounts allowed must eventually come out of the profits arising from the sale of the commodities in which we are trading. There are two methods of charging cash discounts, either of which is considered correct:
(1) Open an account called Discounts on Sales, and charge to it all discounts allowed for the prepayment of bills. When the books are closed, the total will be charged against trading profits. This method is coming into general use, and may be considered standard.
(2) Charge to Sales Account directly all discounts allowed, treating them as allowances. The balance of the sales account will then represent net sales after returns, rebates, and cash discounts have been deducted. One feature to recommend this plan is that sales account does not show a fictitious volume of sales.
75. Entering Cash Discounts in Cash Book. When we receive payment from a customer who has deducted the cash discount, the discount must be taken account of in entering the payment, as the customer is to receive credit for the full amount. We might enter the cash payment in the cash book, and make a journal entry of the cash discount, but this would necessitate two postings from separate books.
A better method, and one which has become standard, is to provide a cash discount column in the cash book. When a column has not been provided for this purpose, a narrow column can be ruled in on the cash received or debit side of the cash book. This is carried as a memorandum until the end of the month, when the total is posted to the debit of discount on sales. Two ways of making the entry are shown (p. 84).
In Example No. 1, the cash discount is entered in the discount column, and the net cash received is entered in the cash column. When the payment is posted, two entries are made in the ledger. One advantage in this is that reference to the account of R. L. Brown & Co. shows at a glance whether they are taking advantage of cash discounts.
In Example No. 2, the cash discount is entered in the proper column, but the gross amount is entered in the cash column. The payment is then posted in one item, and reference to the ledger account does not show whether the payment of $100.00 is all cash or part discount. It is necessary, also, to deduct the footing of the discount column from the footing of the cash column to ascertain the amount of cash received. For these reasons the method shown in Example No. 1 is recommended.
76. Cash Discounts Earned. When we take advantage of the discount offered for the prepayment of bills, the discount earned can be considered a legitimate source of profit. Our own selling prices for goods purchased to be resold are based on the prices at which they are billed to us, without considering a possible saving by discounting our bills. Whether or not we discount our bills is largely a question of capital, and such earnings are legitimate profits entirely outside of regular trading profits. Discounts earned should be treated as interest earned and credited to interest account, from which they will find their way into profit and loss account.
PROFIT AND LOSS
77. The profit and loss account is a summary account made up of the balances of all income and expenditure (revenue) accounts in the ledger, the balance of this account representing the net loss or net gain of the business.
It is advisable to show the net profits for each year; and to accomplish this, it is customary to transfer the balance of profit and loss account at the end of the year. In single proprietorships and partnerships, the net gain is transferred to proprietor's or partner's investment accounts, while in a corporation it is usually transferred to a surplus account. A loss is transferred to a deficiency account.
78. Trading Account. This is a subdivision of profit and loss account intended to exhibit the gross profit derived from the manufacture or purchase and sale of goods in which the business is organized to trade. These profits are known as trading profits. Just what items of income and expenditure enter into trading profits or losses is an important question in the science of accounts. A safe rule to follow is to debit trading account with the cost of goods sold, including cost of preparing them for sale. In a manufacturing business the cost represents cost of raw materials and cost of manufacture. Credit the account with net income from sales, arrived at by deducting from gross sales all returns, allowances, rebates, and cash discounts.
All expenses incurred in selling the goods, and all expense of administration of the business, should be charged to profit and loss account proper. All profits arising from other transactions than trading should be credited to profit and loss. These include interest received on past due accounts, on notes, or for money loaned; discount earned by the prepayment of bills; profits from the sale of real estate or any property other than that in which the business is trading.
Trading Account, How Constructed. The trading account is made up by charging total inventory at the beginning of the year and purchases during the year; crediting net sales and inventory at the close of the year, the balance representing the gross profit.
Turnover. It is desirable to know the cost of goods sold. This is known as the turnover, on which percentages of profit are based. The turnover may be found by deducting the present inventory from the debit side of the trading account.
79. Manufacturing Account. In a manufacturing business it is very desirable to know the cost to produce the goods; and for this purpose a subdivision of profit and loss, called manufacturing account, is used. The manufacturing account is debited with inventory of materials at the beginning of the year; purchases of material; labor or wages in factory, and all other expenses of manufacture; and credited with inventory of materials at the close of the year. The balance represents cost of manufactured goods to the trading division.
The principal value of these subdivisions of profit and loss lies in the fact that they reveal not only the amount but the sources of profits and losses, which is one of the important functions of accounting.
The profit and loss account of a professional or other non-trading concern need not be subdivided as explained for a trading concern. In a non-trading business, all accounts representing revenue receipts or revenue expenditures are transferred direct to profit and loss account.
80. Transfer of Gross Profit. The gross profit from trading is now transferred to the credit of profit and loss account, and this account is debited with the balances of all revenue expenditure accounts. Continuing the illustration from Article 78, we have:
81. Transfer of Net Profit. The net gain is transferred to the credit of proprietor's account in a single proprietorship.
MERCHANDISE INVENTORY ACCOUNT
82. The accounts now open in the ledger, other than proprietor's account, exhibit all assets and liabilities of the business with the exception of the present inventory, which is included in the trading account. The amount of the inventory is transferred to the debit of a merchandise inventory account.
The books are now said to be closed, there being no open accounts except those representing assets or liabilities of the business.
BALANCE SHEET
83. A statement of the assets and liabilities of a business is called a balance sheet. If the assets exceed the liabilities, the difference is the present worth. If the liabilities exceed the assets, the business is insolvent, and the difference or balance shows the amount of insolvency.
The balance sheet is prepared from the ledger balances after the books have been closed. In arranging the accounts on a balance sheet, the assets should be listed first, followed by the liabilities. The balance will agree with the balance shown in the proprietor's or investment account.
For the business of a single proprietor, it is customary to list the accounts in the following general order:
First—Cash in bank and office.
Second—Open accounts and bills receivable.
Third—Merchandise per inventory, store fixtures, etc.
Fourth—Real estate.
The first two classes are termed active or quick assets, as they can be most readily converted into cash.
The liabilities represented by credit balances, are listed in the order of their urgency:
First—Open accounts due others.
Second—Bills payable.
Third—Mortgages or bonds payable.
The third class represents secured liabilities, while the first two represent unsecured liabilities.
Continuing the previous illustration, we find the balance sheet of our imaginary ledger to be as follows:
SAMPLE TRANSACTIONS
84. At the end of the first year, the trial balance of a single proprietorship was as follows:
The inventory at the end of the year was $4,962.30; at the beginning of the year, there was no merchandise in stock. The books are to be closed into trading and profit and loss, and a balance sheet prepared.
When closing the books, all entries necessary to adjust the balances of ledger accounts should be made through the journal. When an audit is made, it is difficult to trace the entries unless they are plainly stated in one group, which is provided when they are made in the journal. The making of entries in the ledger directly, also increases the opportunity for fraudulent entries. Never make original entries in the ledger.
EXAMPLE FOR PRACTICE
From the following trial balance prepare trading account; profit and loss account; and balance sheet.
| Trial Balance | ||||
| Proprietor (Investment) | $ | 7,600.00 | ||
| Bills Payable | 4,000.00 | |||
| Accounts Payable | 1,470.00 | |||
| Bank | $ | 1,262.84 | ||
| Accounts Receivable | 2,693.11 | |||
| Bills Receivable | 4,360.00 | |||
| Merchandise Inventory | 6,277.76 | |||
| Furniture and Fixtures | 750.00 | |||
| Purchases | 7,105.78 | |||
| Expense | 1,416.30 | |||
| Discount on Sales | 112.65 | |||
| Interest | 44.20 | |||
| Sales | 10,985.70 | |||
| Cash | 121.46 | |||
| ————— | ————— | |||
| $24,099.90 | $24,099.90 | |||
| Inventory at end of year $6,493.06. | ||||
CASHIER TERMINAL, LAMSON MOTOR-DRIVEN CABLE CASH CARRYING SYSTEM FOR DRY GOODS, GENERAL, OR DEPARTMENT STORES
Lamson Consolidated Store Service Co.
JOURNALIZING NOTES
85. When a note is received by us or we give our note to another, it is necessary to make a journal entry in order that there may be a proper record of the transaction on our books. Careful study is sometimes necessary to determine just how the entry should be made, and the following illustrations will serve as a guide.
86. When Received. When we receive a note, we debit bills receivable and credit the maker—that is, the person who gives us the note.
We receive a note from Samuel Smart for $100.00 payable in 30 days. The journal entry is:
| Bills Receivable | $100.00 | |
| Samuel Smart | $100.00 | |
| 30-day note dated Sept. 10 |
87. When Paid. When this note is paid, we debit cash and credit bills receivable. The entry is made in the cash book on the debit side which debits cash and credits bills receivable.
| Bills Receivable | Samuel Smart's note | $100.00 |
| due Oct. 10th |
88. When Collected by Bank. Perhaps the note was collected through our bank; in that case, the bank, instead of sending us the cash, will credit the amount to our account. The bank may, also, charge a small fee for collecting the money; consequently the amount placed to our credit will be the sum collected, less their fee. The entry in the journal would then be:
| Bank | $99.85 | |
| Interest and Discount | .15 | |
| Bills Receivable | $100.00 | |
| Smart's note due Oct. 10th | ||
| Collected by bank. |
89. When Discounted. At the time we received Samuel Smart's note, we may have needed the money for immediate use in our business. We would then take the note to the bank, endorse it payable to the bank, when they would discount it, giving us credit for the net proceeds. Since the money is advanced to us, the bank would charge us interest for its use, which amount would be deducted from the whole amount, leaving the net proceeds. This amount would then be available for immediate use. The note is then the property of the bank; it has gone out of our possession and we have received the cash. The note is not paid, and in discounting it we have created a liability to the bank. Remembering that one of the functions of bookkeeping is to exhibit the true nature of our assets and liabilities, we open a Bills Discounted account in the ledger. The entry is:
| Bank | $99.50 | |
| Interest | .50 | |
| Bills Discounted | $100.00 | |
| Discounted Smart's note due Oct. 10th. |
90. When a Note Drawing Interest is Discounted. The above transaction presupposes that the note is given without interest; but if it were given with interest, the bank would simply add the interest to the principal and deduct the discount from the total. In the case the sum of the principal and interest ($100.00 + .50 = $100.50) is $100.50, and the discount $.50, which would leave $100.00 as the net proceeds. If the amount of the note were larger or the interest was figured for a longer time, it would make a difference. Suppose the amount of the note to be $2,000.00, time 30 days, interest 6% per annum.
| Principal | $2,000.00 |
| Interest 30 days | 10.00 |
| Total | $2,010.00 |
| Less interest on $2,010.00 for 30 days | 10.05 |
| ————— | |
| $1,999.95 |
Since the net amount realized is less than the face of the note, we need not consider the interest earned, but the entry would be:
| Bank | $1,999.95 | |
| Interest and Discount | .05 | |
| Bills Discounted | $2,000.00 |
91. When a Note Drawing Interest is Paid. But suppose Samuel Smart's note is $100.00 for 30 days, with 6% interest, and that the note is kept by us and the money is paid directly to us when due. We shall then receive the interest, in addition to the face of the note, making a total of $100.50. The entry would then be made in the cash book on the debit side, and would be:
| Bills Receivable | $100.00 |
| Interest and Discount | .50 |
| Samuel Smart's note due Oct. 10, paid to-day. | |
92. When a Discounted Note is Not Paid. When we discounted Samuel Smart's note of $100.00 for 30 days without interest at the bank, we were obliged to endorse it, which had the effect of a guarantee of payment. If not paid when due, the amount would be charged to our account at the bank. The note would again come into our possession, and the amount must be debited to some account, the credit being to the bank.
We have previously credited the amount to bills discounted, and our entry is:
| Bills Discounted | $100.00 | |
| Bank | $100.00 | |
| Samuel Smart's note not paid at maturity. | ||
But suppose the transaction to have been the one described in Article 90. The note returned to us is $2,010.00, that being the amount of principal and interest. Our bills receivable and bills discounted accounts show the item as $2,000.00 only. Therefore we must include the $10.00 in our adjusting entries which will be:
| Bills Receivable | $10.00 | |
| Interest added to Smart's note not paid when due | ||
| Bills Discounted | $2,000.00 | |
| Bank | $2,010.00 | |
| Smart's note not paid at maturity. | ||
93. When a Note is Past Due. The above entries leave this unpaid item in the bills receivable account. If the business is one in which a large number of bills are discounted, it will be advantageous to show past due bills receivable by themselves, leaving bills receivable account to represent only paper not due. The entry for a bill unpaid at maturity would be:
| Bills Receivable Past Due | $2,010.00 | |
| Bills Receivable | $2,010.00 | |
| Smart's note past due. | ||
94. When a Note is Renewed. We shall now suppose that Samuel Smart finds that he will be unable to pay his note when due. He comes to us and offers a new note for 30 days, which we accept. He prefers to add the interest due on the original note to the principal, and makes his note for $100.50. We then return the original note and the entry is:
| Bills Receivable | $100.50 | |
| Interest and Discount | .50 | |
| Bills Receivable | $100.00 | |
| New note given by Samuel Smart to cover note due Oct. 10, with interest. | ||
The effect of this transaction is that we have received a new note for $100.50, and we debit bills receivable. This new note pays an older one which goes out of our possession, so we credit bills receivable. The amount of the new note includes the interest on the old, and we credit interest.
We might have gone about this in a roundabout way by making these entries:
| To cancel the old note: | ||
| Samuel Smart | $100.50 | |
| Bills Receivable | $100.00 | |
| Interest, and Discount | .50 | |
| Note due Oct. 10th. | ||
| To enter the new note: | ||
| Bills Receivable | $100.50 | |
| Samuel Smart | $100.50 | |
| New note 30 days to take up note due Oct. 10th. | ||
These entries would leave the accounts in exactly the same condition as our first entry, and would serve no useful purpose. This is given as an illustration of how several entries may be made when the transaction could be as clearly explained in one.
95. When Renewed Note Has Been Discounted. If the note which Samuel Smart has renewed has been discounted at the bank, we must reimburse the bank in some manner before we can obtain possession of the original note. The most simple way to handle this transaction will be to give the bank our check to pay the note. The entry is:
| Bills Discounted | $100.00 | |
| Interest and Discount | .50 | |
| To Bank | $100.50 | |
| Gave check to take up Samuel Smart's note. | ||
We shall then treat the new note as previously explained. If, after getting it recorded on the books, we wish to discount this note, the entries will be exactly the same as when we discounted the original note.
96. When We Give or Pay a Note. When we give our note, the effect of the transaction is just the opposite of the receipt of a note. Instead of adding to one class of our resources we are increasing one class of our liabilities, in return for which we either receive something of value or reduce our liabilities of another class. When we give our note in payment of a loan, we receive cash; if we buy goods and give a note in payment, we receive merchandise; if we give a note in payment of an account, we simply reduce our liabilities of one class and add to those of another.
The entries necessary to properly record transactions involving notes given or bills payable, are not so complex as is the case with transactions involving bills receivable. The following illustrations cover transactions likely to arise in the average business:
We give our note for $100.00 payable in 30 days, without interest, to Western Grocer Co. in settlement of an account. The entry is:
| Western Grocer Co. | $100.00 | |
| Bills Payable | $100.00 | |
| Note 30 days without interest | ||
When we pay the note the entry is:
| Bills Payable | $100.00 | |
| Bank | $100.00 | |
| Check to Western Grocer Co. to pay note due Oct. 10. | ||
97. When Our Note Has Been Discounted. The Western Grocer Co. has either discounted the note or placed it in the bank for collection, and it is presented for payment by the Merchants Bank. We give them a check in payment, and the entry is:
| Bills Payable | $100.00 | |
| Bank | $100.00 | |
| Check to Merchants Bank to pay our note to Western Grocer Co.,due Oct. 10. | ||
The entry in this case is the same as in the previous illustration, with the exception of the explanation.
98. When We Pay Our Note With Interest. We give our note to Western Grocer Co. for $100.00 payable in 30 days, with interest at 6%. We pay the note by check, and the entry is:
| Bills Payable | $100.00 | |
| Interest and Discount | .50 | |
| Bank | $100.50 | |
| Paid Western Grocer Co. note due Oct. 10, by check No. 10. | ||
99. When We Discount Our Note. We wish to borrow $100.00 from the bank, and give our note for the amount, payable in 30 days. The bank discounts the note, placing the proceeds to our credit. The rate of interest charged is 6%. Our entry is:
| Bank | $99.50 | |
| Interest and Discount | .50 | |
| Bills Payable | $100.00 | |
| Note for $100.00, 30 days discounted at bank. | ||
100. When We Pay for Goods With Our Note. We buy goods from Michigan Milling Co. to the amount of $100.00, and tender our note at 30 days with interest, in payment. This makes it unnecessary for us to open an account with Michigan Milling Co. and the entry is:
| Purchases | $100.00 | |
| Bills Payable | $100.00 | |
| Invoice #16 from Michigan Milling Co. Gave note for 30 days with interest at 6%. | ||
101. When We Renew a Note. When this note is due, we find it inconvenient to pay, and give a new note for 30 days, adding the interest now due to the face of the original note. The amount of the new note is $100.50, and the entry is:
| Interest and Discount | $ | .50 | |
| Bills Payable | 100.00 | ||
| Bills Payable | $100.50 | ||
| New note given Michigan Grocer Co. to renew note due Oct. 10, $100.00, interest $.50, 30 days, with interest. | |||
102. When We Renew Our Discounted Note. When our note given to the bank is due, we find it inconvenient to pay the entire amount. We give the bank a check for $50.00, and a new note at 30 days for the balance. The bank always collects interest in advance, so we shall be obliged to give them our note for $50.00 plus the interest, or $50.25. In effect, the bank discounts our note for $50.25, the proceeds, $50.00, paying the balance of our note now due. The entry is:
| Bills Payable | $100.00 | |
| Interest and Discount | .25 | |
| Bank | $50.00 | |
| Bills Payable | 50.25 | |
| Gave check for $50.00 to apply on note due at bank to day. | ||
| Discounted new note for $50.25, payable in 30 days. | ||
JOURNALIZING DRAFTS
103. When a draft has been accepted, it should be treated the same as any other form of bill receivable or bill payable. If we make a draft on a customer, which he accepts, it becomes a bill receivable. If we accept a draft drawn on us, it becomes a bill payable.
Sight drafts are frequently made use of as a convenient means of collecting an account. Such drafts are taken to our bank for collection, but they do not give us credit for the amount until the draft is paid. Drafts of this kind, which are placed with the bank for collection only, are not treated as bills receivable, as we do not credit the account of the one on whom it is drawn until payment is received.
104. When Our Sight Draft is Paid. We draw on Samuel Smart at sight for $50.00 through our bank. When paid, we receive credit at the bank for the amount, less collection charges. The entry in our journal is:
| Bank | $49.90 | |
| Interest and Discount | .10 | |
| Samuel Smart | $50.00 | |
| Paid sight draft | ||
105. When Discounting Time Draft. Samuel Smart owes us $100.00, and while the amount is not due for 30 days, we have reason to believe that he will accept a draft payable in 30 days. We accordingly draw on him through our bank. Our reason for doing this is that his acceptance will be a promise to pay, and our bank will then discount the draft. The draft is accepted, and our bank notifies us that the proceeds have been placed to our credit, the draft being discounted at 6%. The entries are:
| Bills Receivable | $100.00 | |
| Samuel Smart | $100.00 | |
| Samuel Smart accepted our 30-day draft | ||
| Bank | 99.50 | |
| Interest and Discount | .50 | |
| Bills Discounted | $100.00 | |
| Discounted Samuel Smart's 30-day acceptance. | ||
106. When We Accept. When we accept a draft payable at a future date, it immediately becomes a bill payable and should be so treated.
We accept the 30-day draft of the Western Grocer Co. for $200.00. Our journal entry is:
| Western Grocer Co. | $200.00 | |
| Bills Payable | $200.00 | |
| Accepted 30-day draft. | ||
107. When We Pay an Acceptance. When this draft is due, we pay it, giving our check to the bank. The entry is:
| Bills Payable | $200.00 | |
| Bank | $200.00 | |
| Gave check to pay draft of Western Grocer Co. | ||
108. When We Pay a Sight Draft. Instead of accepting a time draft, we pay a sight draft of Western Grocer Co. for $200.00. In this case it has not become a bill payable, and our entry is:
| Western Grocer Co. | $200.00 | |
| Bank | $200.00 | |
| Check to Merchants Bank to pay sight draft. | ||
EXAMPLES FOR PRACTICE
The following examples are to be journalized by the student after he has become thoroughly familiar with the transactions previously explained:
—Nov. 6—
Received from Jackson & Co. their note for $214.00 without interest, payable in 30 days, in full settlement of account.
—Nov. 6—
Received from David Newman his note for $650.00 with interest at 6%, payable in 30 days, in settlement of account. We discounted this note at First National Bank.
—Nov. 7—
Paid our note given Oct. 6, to National Spice Co., amount $150.00 with interest at 6%. This note was paid by check #11 to Mechanics Bank.
—Nov. 8—
Bought from Valley Mills on our note for 30 days with interest at 6%, 100 bbls. flour at $5.25 per bbl.
—Nov. 9—
Discounted our note for $1,000.00, 30 days, at First National Bank.
—Dec. 6—
Jackson & Co., paid their note due to-day, $214.00.
—Dec. 6—
David Newman paid $300.00 on his note due to-day. Gave new note for balance due, payable in 30 days with interest at 6%.
—Dec. 8—
Paid our note to Valley Mills by check #11.
—Dec. 9—
Paid $500.00 on our note to First National Bank by check #12. Gave new note for $500 payable in 30 days, interest at 6%.
—Dec. 9—
Andrew White paid sight draft, $42.60, through First National Bank, exchange $.10.
—Dec. 9—
J. D. Jenks accepted our 30-day draft for $140.00, which we discounted at First National Bank at 6%.
—Dec. 10—
Accepted a 30-day draft for $75.00 drawn by Eastern Woodenware Co.
—Dec. 11—
Gave First National Bank our check for $90.00 to pay 60-day draft of Farwell & Graves accepted by us Oct. 11.
—Dec. 12—
Gave First National Bank our check for $41.00 to pay sight draft of Dun & Co.
ACCOUNTING DEPARTMENT, SWIFT & COMPANY, CHICAGO