Building Expenses and Income
Allocation of Building Expense
It is purposed here to draw attention to two problems in connection with the bookkeeping records of buildings owned by the business. The one problem has to do with the proper allocation of the various building expenses as between the different departments of a business such as manufacturing, selling, general administration, etc., and even the subdepartments within these general classifications. It frequently happens that the same building is used partially for manufacturing and partially as a warehouse and sales room, while it may also contain the administrative offices. Within each of these groups there may be various subdepartments. A large store may be departmentalized and it may be desirable to show the results of operation by departments. If cost accounting by departments is determined upon, it becomes necessary to carry the departmental analysis beyond the gross profit stage, in which case building expense must be taken account of and spread equitably over the various departments. Likewise, within the factory it may be desirable to allocate the item of building expense over the various departments of storeskeeping, costing, and production proper, and even a further analysis may be necessary depending somewhat on the detailed information desired. Where building expense has to be spread over these various departments and subdepartments, an equitable basis of distribution must be found. A common basis is the amount of floor space used by the various departments. This method is not always fair inasmuch as some portions of the building are subject to heavier wear and tear, and therefore to heavier maintenance and depreciation charges, than other portions. Consideration must be taken of all the physical factors involved in order to secure an equitable distribution of the expense.
Ownership versus Renting
The second problem has to do with the gathering of information as to the relative advantages of owning or renting a building. The chief elements of expense which must be met in connection with the ownership of buildings are maintenance, depreciation, taxes, and insurance. In determining the relative advantages of ownership or leasing, the item of interest on investment in buildings must also be taken into consideration. It is doubtful, however, whether this last item should be brought onto the books as a cost of ownership. As in the case of a manufactured product, the item of interest is best handled by means of a statistical record rather than as an entry upon the financial records of the business.
Methods of Bookkeeping
Two methods of presenting the information on the books are met with. In the one case, an account is kept with Building Expense and Income to which are charged all expenses in connection with the building and to which are credited any items of income, as from subleasing, etc. Instead of having the one account, separate accounts may be kept and cleared at the end of the fiscal period through Building Expense and Income account before transfer to Profit and Loss. The difference between the net cost of building ownership, as indicated by Building Expense and Income account, and the market rental value of similar space and accommodations elsewhere will represent the net advantage or disadvantage of ownership as compared with leasing. At this point, before making the comparison, it will be necessary to take into consideration the item of interest on the money invested.
The second method is simply a variation of the first so far as securing the information desired is concerned. Under it the Building Maintenance account is charged with all expenses as above and credited with a fair rental value as determined by market conditions for similar space elsewhere. The difference between the charges and credits to the Building Maintenance account will be an indication of the profit or loss on the policy of the ownership. A theoretical objection to this last method is that the crediting of a fair rental to the account makes necessary a charge to a rent account, which will have to be shown as a charge to some department or phase of business activity, such as the factory, sales department, etc. As in the case of interest, the best authority inclines towards treating rent as an item of financial management rather than as a burden to the other departments of the business. Practically, however, where the expense of rent is actually incurred through the use of a building belonging to outside parties, the prevailing practice at the present time is to charge rent expense to the departments using the accommodations. Consistency seems to demand that both interest and rent be treated in the same way, and handled as financial management items.
Workmen’s Dwellings and Social Betterment Work
To maintain a fairly constant supply of labor, a corporation frequently finds it necessary to provide housing accommodations for its employees. This may be because the concern is located far from a settled community and outside capital cannot be induced to provide the needed accommodations. Accordingly, corporations oftentimes spend large sums in so-called social betterment work, and it is customary for the corporation to charge a fair rental on workmen’s dwellings. The expense in connection with such work is to be treated rather as an item of extraordinary expense just as the income from the corporation’s investment in workmen’s dwellings must be treated as income outside the regular operations of the business. The problem here is simply the determination of the proper place to show the items of expense and income in the profit and loss summary for the period.
CHAPTER XXXIV
THE CONSOLIDATED BALANCE SHEET
AND PROFIT AND LOSS SUMMARY
Purpose and Function
The consolidated balance sheet is a form of statement distinctively American. As indicated in previous chapters, its use has arisen as a result of the corporation laws of some of the states which allow the formation of the holding company. This, if strictly a financing company, has a very simple operating organization. Its chief assets are usually the securities, capital stock and bonds, of the subsidiary companies which it owns in part or in full. Accordingly, its balance sheet is comparatively simple; in fact this very simplicity results in giving little information as to its real financial condition or that of the subsidiaries which it owns. If, however, the holding company is at the same time both an operating and a financing corporation, all the complexities encountered in the balance sheet of a manufacturing company will be found on that of the holding company. However, the financial statement of an operating holding company is not any more intelligible because of its complexity than that of a purely financing corporation.
The items on the balance sheet of either type of corporation which are evidence of the activities peculiar to a holding company are, as stated above, the securities of the subsidiary concerns held by the holding company and whatever advances have been made on open account to the various subsidiaries in order to provide funds for making extensions or for recouping losses incurred by the subsidiaries. The principles governing the valuation of the securities of the holding company have already been stated and explained in Chapter XV. In that chapter were stated the different applications of the principles of valuation to the three conditions met; namely, (1) the condition in which the holding company owns the entire capital stock of the subsidiary; (2) the condition in which a controlling but partial interest only is held; and (3) the condition in which the holding company is a minority stockholder of the subsidiary. In making up the balance sheet of the holding company the application of these principles to the valuation of the holdings of the corporation must be carefully handled. Aside from this problem of valuation, the balance sheet of the holding company presents no new problems. Such a balance sheet, however, gives very little information as to the actual financial condition of the corporation because its finances are tied up so completely with the financial condition of the various subsidiaries. In order, therefore, to present a statement which will intelligently show the real condition of the holding company, it becomes necessary to combine or consolidate the statements of financial condition of all its subsidiaries.
Problem of Partial Ownership
Where the ownership of the subsidiaries is complete, the consolidated balance sheet in which are brought together all the various assets and liabilities of the subsidiaries, presents a true, full, and intelligent statement of the financial condition of the holding company. Where, however, ownership is not complete, in which case there may be majority or minority holdings, the problem of drawing up a statement which will present the actual condition of the holding company is more difficult and much more complex. Manifestly, a consolidated balance sheet under either of these latter conditions as to partial ownership cannot be applicable alone to the holding company, inasmuch as in such a statement there must be included interests over which the holding company has no direct control or authority.
Because of this difficulty, three different ways of attempting to show the holding company’s condition are met with. One method makes no attempt to overcome the difficulty but limits itself to showing simply the balance sheet of the holding company as explained in the early part of this chapter. A second method consists in showing the balance sheet of the holding company supported by the separate balance sheets of all of the subsidiary companies. The third method is the method of the consolidated balance sheet which has just been briefly explained. This last is, perhaps, the most satisfactory method of the three. The insufficiency of the first method and the objection to it have been referred to already. The second method gives all essential information but presents it in such form that it is practically impossible for anyone but a trained student of finance and accounting to correlate the various parts and arrive at an intelligent understanding of actual conditions. The stockholder or the outsider is usually completely at a loss to know the meaning of all the figures and statements presented. Under the third method the data as to the condition of the various companies are brought together and presented in logical form on the consolidated balance sheet so that the combined statement shows as clearly as is possible the condition of the holding company.
Conditions under which Used
It should be clearly understood that the consolidated balance sheet is not a balance sheet of the holding company except and only when the holding company owns the entire capital stock of all the subsidiaries. A consolidated balance sheet, therefore, is a statement which presents the condition of all of the subsidiary companies. If it reflects the condition of the holding company better than the latter’s balance sheet, then, and then only, should a consolidated balance sheet be used. A fine distinction must sometimes be drawn to determine when it is more desirable, in the interests of an accurate showing of condition, to present a consolidated balance sheet rather than the balance sheet of the holding company, and a delicate appreciation is needed of the various financial problems involved. When the holding company is not the complete owner but nevertheless has a controlling interest in all the subsidiaries, the method of the consolidated balance sheet is usually the better way of showing its financial condition. Where the holding company, however, holds only minority interests, it is oftentimes open to question as to whether the consolidated balance sheet gives a true presentation of the facts of financial condition, especially in view of the fact that the holding company cannot always control the policies of its subsidiaries.
The Setting Up of the Consolidated Balance Sheet
With this explanation of purpose and function of the consolidated balance sheet, it is purposed now to draw attention to some of the problems met in drawing up such a statement. The first essential condition to facilitate the consolidation of the balance sheets of the various subsidiaries with that of the holding company is that standardized methods of accounting resulting in a similar classification of accounts and presentation of results be used by all the subsidiaries. The consolidated statement is then merely a combination of the values of similar items in all the balance sheets to determine the valuation at which the consolidated items shall appear.
On the balance sheets of the various companies certain accounts will appear which represent intercompany relationships. Thus, on that of the holding company appear the securities which are represented on the statements of the subsidiaries by their net assets. In other words, the securities of the holding company are assets represented by the proprietorship items of the various subsidiaries. Sometimes on the consolidated balance sheet both items are shown. This results, of course, in an almost exact duplication of items inasmuch as the holding company’s securities are a statement of the net asset values of the subsidiaries. The better method of presentation, however, seems to be the elimination of the securities of the holding company against the proprietorship items of the subsidiaries. It may frequently happen that the values of these two items to be eliminated are not the same. This will always be the case if the holding company values its securities either above or below the par of the capital stocks of the subsidiaries, plus any surplus belonging to the subsidiary at date of purchase by the holding company.
It is to be presumed that the values at which the securities are held on the books of the holding company represent the latter’s estimate of the value of its interests in the various subsidiaries. If this value is more than the net worth of the subsidiary as shown by its capital stock outstanding and surplus at the time of purchase by the holding company, the difference between the value at which the securities are carried by the holding company and the net worth of the subsidiary must represent the value placed by the holding company on the good-will of the subsidiary. This good-will does not appear, of course, on the books of the subsidiary. Hence, in consolidating the balance sheet of the subsidiary with that of the holding company, it is necessary to set up the asset good-will and thus increase the net worth of the subsidiary to the point where it can be exactly canceled against the value of the securities on the balance sheet of the holding company. If, however, the value of the securities on the holding company’s books is less than the net worth of the subsidiary, that condition indicates that in the opinion of the holding company the assets of the subsidiary as carried on the subsidiary’s books are overvalued. In this case it becomes necessary, upon consolidation, to set up a depreciation reserve under suitable title.
The effect of this, so far as the eliminations on the consolidated balance sheet are concerned, is merely to set up under the title Depreciation Reserve the portion of the subsidiary’s capital stock—or capital stock and surplus—not canceled by the amount at which the holding company carries on its books the value of its interest in the subsidiary. Instead of carrying this difference in values under the title Depreciation Reserve, it is sometimes shown as Capital Surplus. This is merely another way of saying that the portion of the subsidiary’s capital stock not canceled by the holding company’s investment in the subsidiary is simply carried on the consolidated balance sheet under another name. Another method of handling this uncanceled amount is to carry it into the consolidated balance sheet as a credit to Good-Will account, and so secure a reduction in the value at which this intangible asset is shown in the balance sheet of the allied companies. This may sometimes result in reducing the value of good-will to a negligible figure, or in writing it off the books entirely, or even in showing it with a credit balance. There is little to choose between the methods; the author prefers the use of the depreciation reserve. The balance sheets of all of the subsidiaries are in this way consolidated with the balance sheet of the holding company.
On the consolidated balance sheet as at the date of the purchase of the various subsidiaries, there will not therefore be shown any item of surplus, inasmuch as the items of surplus on the balance sheets of the various subsidiaries have been eliminated together with their capital stock items against the securities on the balance sheet of the holding company. This is as it should be. Surplus account properly used should represent only profits reserved from operation. The holding company cannot, therefore, previous to its operation, show any item of surplus even though the subsidiary companies have accumulated profits which they, of course, are entirely right in showing under the title Surplus.
A distinction must be made here between what is termed “contributed” surplus and “operating” surplus. Any corporation, the holding company included, may at the time of its organization have some portion of its capital represented by contributed or capital surplus. It has been pointed out that this may arise either through subscription to its stock at a premium, or by a later donation of stock by its stockholders which, when sold, may be recorded as working capital surplus or contributed surplus. It is not possible, however, for any corporation, previous to its operation, to show as a balance sheet item an operating surplus from which it might be possible to declare dividends.
Showing of Intercompany Accounts
At the time of consolidation, intercompany accounts of various sorts will also appear. The holding company may have made advances of cash to some of the subsidiaries. These will be shown on the books of the holding company as open account claims against the subsidiaries, while on the books of the subsidiaries they appear as increases among the assets—usually cash or other current items—offset by open liability claims in favor of the holding company. The account receivable on the holding company’s books should be eliminated against the account payable on the books of the subsidiary. Similarly, there may be numerous inter-subsidiary accounts which may be eliminated, the ones against the others. The need for a very careful classification of accounts receivable in order to separate the claims against trade debtors from those against allied companies should be emphasized when it is desirable to consolidate balance sheets on which these various classes of accounts receivable appear.
Showing of Notes Discounted
One kind of intercompany item needs further consideration. A corporation may, as the holder of the notes of an allied company, have had those notes discounted. On the maker’s books the notes appear as a liability. On the holder’s books, after discount, the notes will be shown as a contingent asset offset by a contingent liability of equal amount. Upon consolidation of all the balance sheets, neither the contingent asset nor liability will appear, being canceled against each other, but the full liability as maker of the notes must be shown; for now that the notes have passed into possession of an outsider, the bank, the liability is no longer an intercompany liability but one for which the consolidated interests are fully liable.
Reconcilement of Current Accounts
Previous to the consolidation of the balance sheets, it is possible that some of the intercompany accounts may need reconciliation just as any other current accounts. For instance, Company A may have shipped goods to Company B and have charged B’s account, but A’s account on B’s records may not yet have been credited because the goods have not yet been received. All items in transit will require reconciliation. These are all intercompany transactions which will be eliminated upon consolidation; but to make exact cancellation possible, the intercompany current accounts on the books of the various companies must be reconciled.
Valuation of Inventory
The problem of the valuation of the stock-in-trade inventory on the consolidated balance sheet is perhaps the most troublesome. The situation with regard to inventories of stock-in-trade is often complicated by the fact that the same raw material or partly finished material may pass through the hands of several companies each doing certain processes upon it. The process of manufacture may not be completed until the goods are turned over ultimately to the holding company for sale and final distribution to the consumer. This—or other possible variations of the procedure—is usually the situation so far as stock-in-trade is concerned. Inasmuch as the various subsidiaries are independent corporate organizations, the price at which they transfer their product to the allied subsidiaries is not cost price but a sale price determined, perhaps not by market conditions, but rather by some fixed policy set by the holding company; although it frequently happens that market price is the price at which the partially completed product is turned over to allied subsidiaries. However determined, the price includes an element of profit which from the standpoint of the holding company is not a realized profit until the goods are finally disposed of to the outside consumer. Were the manufacture carried out by a single corporate organization, the product, as it passed through its various stages of manufacture, would be charged into each succeeding stage at the costs accumulated during preceding stages, and the element of profit would not need to be considered until the product was ultimately sold by the holding company.
Thus, the valuation at which the inventory of stock-in-trade is carried on the books of the various subsidiaries is often inflated by the profit in each case, so that by the time the product reaches the holding company it may carry a very large element of unrealized profit. While from the standpoint of each subsidiary company the act of transfer has been legally a sale and therefore the seller is entitled to a profit on the sale, without which there would be no element of profit appearing in the operations of each subsidiary company at any time, from the standpoint of the holding company such transactions are in no sense sales, but are simple transfers from one process or stage of manufacture to another.
In order to show the true condition as to the value of the inventory of stock-in-trade on the consolidated balance sheet, it becomes necessary to eliminate these intercompany items of profit loaded onto the goods at the time of transfer between companies. The figure at which the value of the consolidated inventories will appear in the consolidated balance sheet should represent the actual cost figure, as if the entire process of manufacture were carried on under one corporate organization. The corresponding offset to this reduction in value of the consolidated inventories will appear as a reduction in the surplus as shown on the consolidated balance sheet.
This principle of inventory valuation should always be applied to the full in the case where the holding company is the complete owner of all its subsidiaries. It cannot, however, be too rigorously lived up to under conditions where the holding company may not have absolute control over the policies of the subsidiary companies. It may sometimes even be modified by the fact that the product as turned over by one company to another is in such stage of completion that there is a ready market for it outside that of the allied subsidiaries. The accountant is, however, treading on somewhat uncertain ground when he attempts to incorporate any element of profit in the consolidated inventory. Conservative management as adopted by some of our largest corporations eliminates all elements of profit, and that should be the standard practice. Only under unusual circumstances and after a very careful consideration of all the conditions should the consolidated inventory be carried at any other valuation than that of full manufacturing cost.
Reserve for Intercompany Profits
In eliminating intercompany profits from the valuation of the inventory, use is sometimes made of a Reserve for Intercompany Profits account. The reserve is created by a charge against Surplus. The inflated valuation of the inventory is allowed to stand but it is offset by this reserve in sufficient amount to reduce its value to a cost basis.
Valuation of Inventory—Minority Interests
An interesting problem arises in handling the consolidated inventories and other similar items when there are minority interests to be taken into account. To write down the inventory to a cost basis for the consolidated companies involves a valuation below cost for the subsidiary companies which purchased the commodities from their allied companies. This is hardly equitable to the minority interests in those companies, for they are concerned not with what is the proper basis for valuation on the consolidated balance sheet but rather on their own balance sheet. Their company as a distinct legal organization has the right to show all the profits arising out of a valuation of its inventory on its own purchase-cost basis. Recognizing this right, some accountants advocate carrying the portion of the inventory represented by the ratio of the minority interests to the whole interests, at the cost price to the subsidiary and writing down the rest of it to a true cost basis for the consolidated companies. The effect of this is to leave undisturbed the portion of the subsidiary’s surplus belonging to, or, more strictly, representing the minority interests. Such a method results in the valuation of the inventory on two different bases for the consolidated balance sheet—a practice which is objectionable. The more conservative policy is to write down the whole inventory to a consolidated cost basis, charging the amount written off against the consolidated company’s surplus. This will leave the minority interest surplus unaffected by the changed basis of valuation—a desirable thing from the standpoint of equity to the minority.
Valuation of Liabilities
So far as the liabilities of the corporation are concerned, the values at which these will be carried on the consolidated balance sheet will be the combined values of all the liabilities of the subsidiaries, aside from the intercompany accounts payable and other similar items which have been canceled against the accounts receivable of the subsidiaries and holding company.
Showing of Capital Stock
The showing of the capital stock item on the consolidated balance sheet will depend somewhat on the degree of ownership of the holding company. If the ownership is partial, in addition to the capital stock of the holding company a statement must appear of the consolidated minority interests of the various subsidiaries. This should, of course, be shown separately from the capital stock of the holding company. This becomes necessary because of the fact that items which do not belong in full to the holding company have been incorporated with the assets on the consolidated balance sheet. It is seldom if ever feasible to attempt a separation of the various asset items on the basis of the degree of ownership of the holding company; hence, the only offset to the inclusion of asset values not belonging to the holding company is by showing the outside interest in those assets by means of the minority holdings of capital stock.
Showing of Surplus
The other element of net worth, i.e., the surplus, will also have to be adjusted in order to give the best showing of the interest of the various parties therein. This is, of course, the operating surplus referred to above. The portion of the surplus belonging to the holding company as indicated by its proportion of ownership in the allied companies will be shown separately from the portion of surplus belonging to the minority interests. Sometimes when this is relatively insignificant it is shown as a liability rather than as an item of net worth, on the ground that the minority has a claim on that surplus and will very probably, in the near future, receive it by way of dividends. It would seem to be, however, a truer index of the exact status of affairs at the time of the consolidation, to show the item separately as a portion of surplus in the net worth section of the balance sheet.
Showing of Deficit
When it becomes necessary to incorporate a deficit rather than a surplus, conservative practice usually demands that the entire deficit be shown as belonging to the holding company rather than merely its proportionate share as indicated by its share of ownership in the subsidiary. This is advisable because an initial deficit is often an indication of the inability of the company to be operated profitably, in which case the holding company may have to stand practically the entire deficit.
Showing of Profit and Loss Summary
The consolidated balance sheet should be supported by a consolidated profit and loss summary. Just as with the balance sheet, a distinction is made between the profit and loss statement of the holding company and the consolidated profit and loss statement in which are brought together the summaries of all of the allied companies. If the holding company is primarily a financing company, its chief source of earnings will be from dividends on the stocks of the subsidiary companies held by it. The profit and loss summary of the holding company may be a true reflection of its earning condition for the current year if proper provision has been made for the losses of the subsidiary companies which have been operated unprofitably. The information which the holding company’s profit and loss summary gives, however, is not adequate or sufficient on which to base an intelligent judgment as to whether it is a correct statement of current operations. Much the same difficulties are met in connection with it as in connection with the balance sheet of the holding company referred to above. For instance, if, during a given period, some of the subsidiary companies were operated at a loss or on a narrow margin of profit but dividends were declared out of surplus earnings accumulated from other periods, there would be no indication on the profit and loss summary of the holding company as to the actual conditions under which the earnings of the holding company had been secured. In other words, there would appear on the profit and loss summary of the holding company as earnings for the current period items representing accumulated earnings from previous periods.
Thus, the profit and loss summary of the holding company would not give a true reflection of the earnings for the current period, and furthermore would give no information whereby it would be possible for an interested party to form any judgment as to the current operations of the holding company and its subsidiaries. Inasmuch as the holding company usually owns a majority interest in all the subsidiaries and therefore can dictate their policies, the management of the holding company is always in possession of the true status of affairs, but the stockholder or other interested party can form no judgment whatever as to the actual condition. On the profit and loss statement of the holding company there will be no data as to gross earnings, operating expenses, fixed charges, or miscellaneous income and expense items reflecting the operating conditions of the various subsidiaries. Furthermore, if a subsidiary company has been operating at a loss and has declared no dividend, the absence of that item of earnings from the profit and loss summary of the holding company would not be necessarily a proper reflection of the condition of the subsidiary on the holding company’s summary. It might be necessary, in order properly to show the true condition of affairs, to make provision by way of a reserve for the loss of the subsidiary.
Again, it becomes very easy, if control of the holding company is in the hands of an unscrupulous clique, to understate the profits of the holding company by refusal to declare such a dividend on the part of each subsidiary as will reflect the true earnings of the subsidiary for the current period. Such a policy may be used for the purpose of manipulating the stocks of the various companies.
The Consolidated Profit and Loss Summary
For these reasons and others of the same kind as those mentioned in connection with the balance sheet of the holding company, it is best, in order to give an intelligent showing of condition, to set up a consolidated profit and loss account. The comment made on the consolidated balance sheet is here pertinent also. It is not a profit and loss account of the holding company for it includes also items representing other interests. In some respects it is an unwieldy instrument, but it seems to be the best way in which to show the actual condition of the holding company’s operations. On the consolidated profit and loss summary the earnings from dividends which appear as the chief source of the holding company’s earnings on its profit and loss summary will be eliminated and in their stead will appear the combined earnings of the allied companies. This might seem to be an inflation of earnings inasmuch as the goods which were sold by one company and are recorded by it as earnings will be resold by another company on whose books they will appear also as earnings. The sale of the same goods may thus appear as earnings in many of the subsidiaries. However, such a showing of combined results does provide a true basis on which to judge earnings in comparison with the values invested by the various companies from the use of which values the earnings have been derived. Similarly, on the consolidated profit and loss statement will appear all the operating expenses and other items belonging to the individual profit and loss summaries of the subsidiaries. As it is necessary on the consolidated balance sheet to make some adjustments in the surplus on account of the unrealized elements of profits in the values at which the combined inventories were taken over, so this same adjustment will perhaps be best handled as an appropriation of profits in the last section of the consolidated profit and loss summary.
If the holding company owns all of the stock of the subsidiaries, a true profit and loss summary with no inflated values should be drawn up. In this there will appear only the sales to outside consumers; no intercompany sales should be shown. The cost of goods sold will be determined on the same basis, viz., the basis of cost from the standpoint of the consolidated companies as a unit organization, all intercompany profits being eliminated. All the expenses of the subsidiaries are loaded onto, and therefore absorbed in, the cost of the goods sold by the holding company. Usually only the holding company’s expenses—selling, general administrative, etc.—will appear as such on the consolidated profit and loss summary. Where, however, there are minority interests to be taken into account, the method of combining all the elements is doubtless the most satisfactory.
Illustration of Consolidated Balance Sheet
Problem. Company X, the holding company, owns all of the capital stock of Company Z and 60% of the stock of Company Y. Company X is chiefly the financing company, Company Y is the selling company, while Company Z manufactures the commodities and turns them over to Company Y at a price slightly under the market. The following balance sheets of the several companies show their condition at the close of the fiscal period. Company Z records show that the cost of the merchandise carried on the balance sheet of Company Y at $75,000 is $60,000. It is required to draw up a consolidated balance sheet of the affiliated companies.
| Company X—Balance Sheet | |||
| Cash | $ 50,000.00 | Notes Payable | $ 100,000.00 |
| Notes Receivable Y | 100,000.00 | Bonds | 500,000.00 |
| Advances to Z | 250,000.00 | Capital Stock | 1,000,000.00 |
| Stock Y | 300,000.00 | Surplus | 250,000.00 |
| Stock Z | 550,000.00 | ||
| Patents | 500,000.00 | ||
| Other Property | 100,000.00 | ||
| $1,850,000.00 | $1,850,000.00 | ||
| Company Y—Balance Sheet | |||
| Cash | $ 25,000.00 | Notes Payable X | $100,000.00 |
| Accounts Receivable | 125,000.00 | Accounts Payable | 25,000.00 |
| Notes Receivable | 100,000.00 | Bonds | 75,000.00 |
| Notes Receivable Z | 50,000.00 | Capital Stock | 500,000.00 |
| Z (open account) | 50,000.00 | Surplus | 25,000.00 |
| Merchandise | 75,000.00 | ||
| Plant | 300,000.00 | ||
| $725,000.00 | $725,000.00 | ||
| Company Z—Balance Sheet | |||
| Cash | $ 40,000.00 | Company X | |
| Accounts Receivable | 180,000.00 | (open account) | $250,000.00 |
| Notes Receivable | 230,000.00 | Notes Payable Y | 50,000.00 |
| Merchandise | 150,000.00 | Company Y | |
| Plant | 350,000.00 | (open account) | 50,000.00 |
| Capital Stock | 450,000.00 | ||
| Surplus | 150,000.00 | ||
| $950,000.00 | $950,000.00 | ||
Solution
| Working Sheet | |||
|---|---|---|---|
| Assets | Co. X | Co. Y | Co. Z |
| Cash | $ 50,000.00 | $ 25,000.00 | $ 40,000.00 |
| Notes Receivable | 100,000.00 | 230,000.00 | |
| Notes Receivable Y | 100,000.00 | ||
| Notes Receivable Z | 50,000.00 | ||
| Accounts Receivable | 125,000.00 | 180,000.00 | |
| Advances to Z | 250,000.00 | ||
| Co. Z (open account) | 50,000.00 | ||
| Stock Y | 300,000.00 | ||
| Stock Z | 550,000.00 | 550,000.00 | |
| Merchandise | 75,000.00 | 150,000.00 | |
| Patents | 500,000.00 | ||
| Other Property | 100,000.00 | ||
| Plant | 300,000.00 | 350,000.00 | |
| Good-Will | |||
| $1,850,000.00 | $725,000.00 | $950,000.00 | |
| Liabilities and Capital | |||
| Notes Payable | $ 100,000.00 | $ . . . . . . . . . | $ . . . . . . . . . |
| Notes Payable X | 100,000.00 | ||
| Notes Payable Y | 50,000.00 | ||
| Accounts Payable | 25,000.00 | ||
| Co. X (open account) | 250,000.00 | ||
| Co. Y (open account) | 50,000.00 | ||
| Bonds | 500,000.00 | 75,000.00 | |
| Capital Stock | 1,000,000.00 | 500,000.00 | 450,000.00 |
| Surplus | 250,000.00 | 25,000.00 | 150,000.00 |
| $1,850,000.00 | $725,000.00 | $950,000.00 | |
| Assets | Combined | Elimination | Consolidated |
|---|---|---|---|
| Cash | $ 115,000.00 | $ 115,000.00 | |
| Notes Receivable | 330,000.00 | 330,000.00 | |
| Notes Receivable Y | 100,000.00 | (a) 100,000.00 | |
| Notes Receivable Z | 50,000.00 | (b) 50,000.00 | |
| Accounts Receivable | 305,000.00 | 305,000.00 | |
| Advances to Z | 250,000.00 | (c) 250,000.00 | |
| Co. Z (open account) | 50,000.00 | (d) 50,000.00 | |
| Stock Y | 300,000.00 | (e) 300,000.00 | |
| Stock Z | (f) 550,000.00 | ||
| Merchandise | 225,000.00 | (g)[73] 15,000.00 | 210,000.00 |
| Patents | 500,000.00 | 500,000.00 | |
| Other Property | 100,000.00 | 100,000.00 | |
| Plant | 650,000.00 | 650,000.00 | |
| Good-Will | (f)[74] 100,000.00 | 100,000.00 | |
| $3,525,000.00 | $1,215,000.00 | $2,310,000.00 | |
| Liabilities and Capital | |||
| Notes Payable | $ 100,000.00 | $ . . . . . . . . . | $ 100,000.00 |
| Notes Payable X | 100,000.00 | (a) 100,000.00 | |
| Notes Payable Y | 50,000.00 | (b) 50,000.00 | |
| Accounts Payable | 25,000.00 | 25,000.00 | |
| Co. X (open account) | 250,000.00 | (c) 250,000.00 | |
| Co. Y (open account) | 50,000.00 | (d) 50,000.00 | |
| Bonds | 575,000.00 | 575,000.00 | |
| Capital Stock | 1,950,000.00 | (e) 300,000.00 | 1,000,000.00 |
| (f) 450,000.00 | 200,000.00 | ||
| Surplus | 425,000.00 | (g) 15,000.00 | 410,000.00 |
| $3,525,000.00 | $1,215,000.00 | $2,310,000.00 | |
| Company X and its Subsidiaries Consolidated Balance Sheet | |||
| Assets | Liabilities and Capital | ||
| Cash | $ 115,000.00 | Notes Payable | $ 100,000.00 |
| Notes Receivable | 330,000.00 | Accounts Payable | 25,000.00 |
| Accounts Receivable | 305,000.00 | Bonds | 575,000.00 |
| Merchandise | 210,000.00 | Total Liabilities. | $700,000.00 |
| Other Property | 100,000.00 | ||
| Plant | 650,000.00 | Capital Stock of Co. X | 1,000,000.00 |
| Patents | 500,000.00 | Capital Stock of Subsidiaries | |
| Good-Will | 100,000.00 | not owned by Co. X | 200,000.00 |
| Surplus of Affiliated Companies. | 400,000.00 | ||
| Surplus of Minority Interests. | 10,000.00 | ||
| $2,310,000.00 | $2,310,000.00 | ||
Comments on Problem. There is little in the solution to which attention need be directed. In the handling of the capital stock items, it will be noted that only $300,000 of Company Y’s stock is eliminated, the remainder of $200,000 being shown on the consolidated balance sheet as a minority interest. In eliminating Company Z’s capital stock, it becomes necessary to bring a good-will item of $100,000 onto the consolidated balance sheet. This is shown on the working sheet by means of the three “f” items in the “Elimination” column. On the consolidated balance sheet it will be noted that the minority interest in Surplus (40% of $25,000, Y’s surplus) is not shown affected by the reduction of Y’s inventory to a cost basis. The solution assumes that all the surplus items on the balance sheets of the various companies represent operating surplus accumulated since the purchase of the subsidiaries by the holding company.
This problem calls attention to some of the questions encountered in handling the consolidated balance sheet, although in practice much more complicated situations arise. All that can be hoped for here is to impress upon the student some fundamental principles to be observed and to point out some of the methods used in order best to express the relations of the various interests in the business. The idea of the consolidated balance sheet is simple in concept but usually difficult of full realization.
CHAPTER XXXV
ACCOUNTS AND REPORTS OF
RECEIVERS AND TRUSTEES
Appointment of Assignee or Receiver
A condition of bankruptcy does not necessarily exist in order to secure the appointment of an officer of the court or a representative of a business for the purpose of taking possession and disposing of the property and applying the proceeds to the liquidation of some or all of the debts. The titles given to the various capacities of the representative of the business or the court are assignee, receiver, and trustee. An assignee is a party to whom the owner of a business makes a general assignment of his business, usually for the benefit of his creditors. The owner is usually bankrupt or verging on bankruptcy at such a time. The assignee becomes a representative of the owner, appointed by him, and to that extent the owner is able to regulate the distribution of his estate. As a usual thing the creditors must consent to the appointment of the assignee if the estate is to be liquidated and distributed under his control. If such consent is not given or if the appointment of the assignee and his conduct of the liquidation prove unsatisfactory, it is possible for certain creditors to bring bankruptcy proceedings against the owner and secure the settlement of the estate under bankruptcy procedure. It is usually held, however, that no creditor who has given active approval of the liquidation under assignment can become a party to an application in bankruptcy. The procedure of the assignee in winding up the affairs of the owner does not differ in any essential respect, so far as the accounting is concerned, from that of the receiver or trustee. The accounting features, therefore, will be treated under the later heads of “Receiver” and “Trustee.”
If everything is satisfactory to both parties, a complete settlement of the estate will be effected by the assignee and the affairs of the owner will thus be wound up. In case of dissatisfaction, or in the absence of a general assignment in favor of creditors, proceedings in bankruptcy may be brought against the owner. As was pointed out in Chapter XXVIII, a receiver as an agent of the court may act in two capacities, he may be either a receiver in bankruptcy or a receiver in equity.
The receiver in bankruptcy takes possession of all the property of the bankrupt with the expectation of its ultimate disposal and the application of the amounts realized therefrom to the liquidation of the debts of the bankrupt. The receiver in equity, however, usually comes into possession of only a part of the property, which he is to use in whatever way seems best for the liquidation of the more pressing current claims of creditors. In this latter case a condition of insolvency cannot be said to exist because usually the assets exceed the liabilities. Simply because the management has allowed the current assets to become tied up in a more or less unrealizable form which is inapplicable to payment of liabilities, the business finds itself in difficulty. It becomes necessary temporarily to turn the property over to a representative of the owner and his creditors in order to satisfy their claims and at the same time to preserve the property from needless dissipation until such time as a satisfactory settlement with creditors can be made and the business placed on a sound footing once again. In case, however, a condition of insolvency exists, i.e., a condition in which the liabilities exceed the assets, a receiver in bankruptcy may be appointed by the court upon application of the creditors or at the request of the owner.
Appointment of Trustee
If the owner makes a voluntary application for settlement in bankruptcy there is usually no need to appoint a receiver. The creditors may come together almost immediately and elect a trustee who takes charge of the property and applies it to settlement with the creditors. If the bankruptcy is involuntary, it is frequently necessary for the court to appoint a receiver to whom the property of the proposed bankrupt is turned over for safe-keeping until the exact status of the owner can be determined and a trustee appointed. The primary duty of the receiver and the purpose of his appointment is to prevent the dissipation of the owner’s property and to maintain its integrity, thus insuring its full application to the claims of creditors. Hence, whether the procedure is one in voluntary or in involuntary bankruptcy, the receiver may be appointed if the court deems that the conditions so warrant. A receiver will almost always be appointed in case any of the properties of the proposed bankrupt are of a perishable nature and must be disposed of immediately to secure any return from them. In the absence of a receiver, sometimes the marshal in bankruptcy is called upon to take possession of the property and preserve it.
The receiver holds the property until the first meeting of the creditors which must be called by the court within 30 days after the owner has been adjudged a bankrupt by the court. Creditors are entitled to 10 days’ notice of the meeting in order to make their plans to attend. The chief business of this first meeting of creditors is the appointment of a trustee who takes over the property from the receiver in case one has been appointed, or from the bankrupt in the absence of the intermediary receiver. It is the duty of the trustee to take charge of the entire property, to turn it into cash as quickly and advantageously as possible, and to apply the proceeds to the liquidation of all claims against it.
It is purposed now to discuss some of the accounting phases of the receiver’s and trustee’s activities and to present also some more or less academic theories with regard to such accounting.
Accounts and Reports of a Receiver in Equity
When a receiver in equity is appointed by the court, he is entrusted with property for a specific purpose and must render a full accounting of his stewardship. It becomes necessary, therefore, for him to keep full record of all his activities. In simple situations where his activities are not complex, the keeping of a record of cash receipts and disbursements is sometimes deemed all that is required. Usually, however, it is much better for the receiver to keep a complete set of books showing the detail of his operation of the business, thus enabling him to furnish any desired information. The receiver generally acts under the somewhat specific orders of the court and must be careful to follow out those instructions in all matters. The opening up of the accounts of the receiver will depend somewhat on the court’s order specifying the property to be taken over.
It frequently happens that only a portion of the property passes into the possession and control of the receiver. As a usual thing he does not take onto his records the liabilities of the corporation incurred prior to his appointment, although he may be ordered by the court to pay those liabilities or some portion of them. His books will show, however, the liabilities incurred by him in his conduct of the business. Sometimes this requires a nice distinction and care must be exercised in making it—as in the case of goods ordered prior to the appointment of the receiver but not received until after his appointment. At the time the receiver takes over the properties, an account is opened with him on the books of the corporation, in which he is charged with all properties turned over to him and credited with all valuation reserves applicable to those properties. But, as stated above, no credit for liabilities is entered. The offsetting entries to the receiver’s account are credits and debits respectively to the accounts of the assets taken over and the valuation reserve accounts. On the books of the receiver these entries are reversed, i.e., the various asset accounts will be charged and their valuation reserves credited and a credit will be made to the corporation in receivership for the net values taken over. In case he is required by the order of the court to pay any of the prior liabilities of the corporation, the entry for such becomes a debit to an account called Debts Paid for the Corporation, or other similar title, and a credit to his cash.
In keeping account of the regular operations of the receiver, nothing new in principle is met. The receiver must at all times be careful to keep distinct all payments on his own account from those for the corporation. Similarly, he must keep separate the expenses which are incurred by him and those which belong to the corporation but which he pays. It is held, for instance, that the interest charges on the corporation’s obligations are not an operating expense of the receiver although he may be ordered by the court to pay them. Some of his duties will more than likely be to realize partly or fully on some of the assets turned over to him, in addition to the regular trading assets with which he conducts most of the business. These are accounted for on his books just as they would be on the books of the corporation. In a similar way any liabilities liquidated, record of which appears on his books, will be shown canceled in the usual way. As mentioned above, care must be exercised to keep his liabilities separate from those of the corporation. In the payment of liabilities the question of priority often arises. He must be careful in passing on their priority and he may have to secure the instructions of the court before settling the matter. This will be true particularly with regard to receiver’s certificates, the court usually determining at the time of their issue their relative priority as compared with the other liabilities. On the books of the receiver certain expenses will appear which are peculiar to the receivership. These include such items as lawyers’ and accountants’ fees, bonding company costs, etc., and are, of course, to be treated as his expenses. He should close his books periodically, and so far as possible the period of closing should correspond with the regular fiscal period of the corporation for the sake of preserving the continuity of the records for purposes of comparison.
Reports to the Court
The receiver must make periodic reports to the court—the first report to be made shortly after the assumption of his duties. In it he presents schedules or inventories of the properties taken over. If some of these are mortgaged or have other liens on them, the facts should be indicated. At the same time schedules of the corporation’s creditors should be drawn up, grouped under the heads of preferential, secured, unsecured, and contingent. In the preferential group appear those claims against the corporation which are given preference by law, such as taxes due the state, wages due workmen, mechanics’ liens, etc. In the secured group appear the claims of creditors who hold property as partial or full security for their claims. In the unsecured group appear all claims not secured; while in the contingent group appear the usual items of contingent liability such as were discussed in [Chapter XIX].
Subsequent reports will be made to the court at its will or at least once yearly. No standardized form is followed in the submission of these reports, the attorney’s wishes usually governing. The report is designed for the purpose of apprising the court of the progress of the receiver’s administration and should cover such items as the assets realized during the period since the last report, the liabilities liquidated, and the results of the operation of the properties held by the receiver. A convenient form for the showing of this report is that known as the “charge and discharge” form. Under it the receiver is shown charged with certain items of property and income received, and discharged with liabilities paid and other similar items. Whatever variations from this form are needed to meet particular conditions, these should be incorporated. The report may follow somewhat the order of the items shown below.
“The receiver charges himself with:
1. The assets at the date of the receivership (or at the date of the last report), exclusive of permanent or fixed assets.
2. Additions to such assets since discovered.
3. Increments upon realization of such assets.
4. Amounts realized from the sale of permanent or fixed assets.
5. Amounts realized from the sale of receiver’s certificates.
6. Increases in the amount of receiver’s liabilities.
7. Gross income from the operation of the property.
“The receiver credits himself with:
1. Preferred or other liabilities of the company paid.
2. Decreases in the assets stated as taken over at the date of the receivership.
3. Losses on realization of such assets.
4. Expenditures on permanent or fixed assets.
5. Receiver’s certificates repaid.
6. Decreases in the amount of receiver’s liabilities.
7. Interest charges paid.
8. Expenses of operation of the property.
9. Receivership expenses.
10. The assets at the close of the period covered by the report, exclusive of permanent or fixed assets.”[75]
This report may well be supported by a comparative balance sheet showing the condition at the time of the previous report and now. A profit and loss account to show the operations of the receiver is also helpful. A summary of all cash transactions may be included.
In a final report to the court a summary should be presented of all the operations since the beginning of the receiver’s control. This will, of course, show whatever property is turned back to the corporation. Upon the close of the receivership the receiver’s books may be closed up by crediting the accounts of the various assets which are turned back to the corporation, charging the corporation’s account which was originally set up at the time the property was taken over by the receiver and through which adjustments of the values of the assets have been made at the time of sale or otherwise. An important thing to keep in mind in connection with all accounts and reports of the receiver is the necessity for making full and adequate explanations of all entries, giving the authority for them and their source.
Accounts and Reports in
Bankruptcy Proceedings
Initial Statements Presented to the Court
In the case of a voluntary bankrupt, as was stated in [Chapter XXVIII], at the time of the petition to the court a schedule must be presented of all the property owned by the bankrupt and a list of his creditors giving the address, if known, the amount of the claim, the consideration, and the security held, if any. If the bankrupt makes any claim for exemption of any properties, that claim should be presented at this time. These schedules must follow the forms prescribed by the court. In the case of an involuntary bankrupt, these various schedules will, of course, not be available at the time the petition is made, inasmuch as the condition of the proposed bankrupt is undetermined; the amounts of his assets and of his liabilities are unknown. It becomes necessary, therefore, to examine him in the presence of the court for the purpose of securing a statement of all property owned and of all claims against it. This information, as elicited by court examination, becomes the basis for the receiver’s and trustee’s records. If a receiver is appointed by the court and remains in possession of the property for any length of time, it will be necessary for him to present periodic reports to show the condition of the property at various times and a statement of his operations. The reports which he will make will be similar to those which a trustee would make had he been appointed immediately; therefore, the matter of reports and accounts for both the receiver and the trustee can be treated together.
Reports and Accounts of Receiver or Trustee
The law provides that the trustee must keep regular accounts showing all amounts received and the sources from which received, and all amounts expended and on what account such expenditures were made. This would seem to imply merely the keeping of a record of the cash received and expended. The trustee, however, is looked upon both as the representative of the bankrupt, as custodian of his property, and as the representative of the creditors for the purpose of liquidating their claims. Immediately upon assuming office he must make, or cause to be made, a complete inventory of all property coming into his possession. In valuing this inventory all real and personal property belonging to the bankrupt’s estate must be appraised by three disinterested appraisers appointed by the court. The trustee must make a written report to the court of the condition of the estate, as to the amount of money on hand and any other details demanded by the court, within the first month after his appointment, and bimonthly thereafter unless otherwise ordered by the court. His final report must be made 15 days before the final meeting of the creditors is called by the court.
In disposing of the property of the bankrupt, provision is made that without court order the trustee cannot sell any of the property for less than 75% of the value at which it was appraised by the court’s appraisers. The right of set-off is allowed, i.e., if the bankrupt has a claim against any of his creditors, the amount of the claim is canceled dollar for dollar against the creditor’s claim and only the balance of the claim is to be prorated on the same basis as the other creditors.
The trustee must keep a careful record of all properties disposed of by him and of all liabilities liquidated. What constitutes a careful record will depend largely on the circumstances in each case. Sometimes merely a record of cash received and disbursed will fulfill all requirements. In other cases it may be necessary to keep a full set of books in order properly to secure the information needed in the accounting to the court and the creditors. All reports made should be narrative in form rather than consisting only of formal schedules and accounts. A straightforward statement of all the activities of the trustee, supported by schedules in order to show summarized results, is the desideratum.
Liquidating Dividends
Whenever the cash in the hands of the trustee is sufficient to pay the claims of preference creditors and a 5% dividend to the unsecured creditors, a dividend must be declared. The declaration of the dividend is placed in the hands of the referee in bankruptcy who is a direct representative of the court in most bankruptcy matters. The trustee must pay the dividend within 10 days after its declaration by the referee who prepares and delivers to the trustee dividend sheets showing the dividend declared and the parties to whom payable. All dividend checks drawn by the trustee must be countersigned by the referee.
Relative Standing of the Creditors
In connection with the creditors of a receiver in equity a statement was made above of the various classes of creditors whose claims are to be satisfied. These consist of preference creditors, secured creditors, and unsecured creditors. The trustee in making his liquidating dividends will pay first those creditors who are given preference by law. Within the preference class the order of priority of claims is as follows:
1. Taxes due the government, the state, or the municipality.
2. The actual costs incurred by the trustee or receiver in the preservation of the estate subsequent to time of filing the petition in bankruptcy.
3. The filing fees paid by creditors in the case of a petition in involuntary bankruptcy.
4. The costs of administration by the trustee.
5. The wages due workmen, clerks, servants, etc., earned within three months prior to the date of commencement of proceedings—not exceeding $300 to each claimant.
6. Debts owing to any person who, by federal or state law, is entitled to priority. In the State of Pennsylvania claims on account of rent are frequently entitled to this kind of priority.
Creditors who are fully secured rest their claims against the security held by them and not against the trustee. Any surplus realized on the property held must be turned over to the trustee for the benefit of unsecured creditors. The general rule in the case of a lien is that the remedy against the property must be exhausted first before any creditor may share with the unsecured creditors. When all the property has been realized upon and all the cash which has come into the hands of the trustee has been disbursed in satisfaction of the claims of the various creditors, the trustee’s duties are at an end and his records may be closed up.
Statement of Affairs
While having no legal status in this country, the statement of affairs, as it is called, is used to serve certain purposes in connection with matters in insolvency proceedings. Under the English bankruptcy laws such a statement is required of every insolvent debtor. Its complementary schedule, known as the deficiency account, is also required. In this country the chief significance of these two forms of statement is found in the examinations set by the various state boards of certified public accountants. They may, however, serve some additional purposes, chief of which are the following:
1. To show whether a receiver in equity should be appointed to manage the affairs of the business.
2. To show whether the creditors should advance funds in order to allow the business to continue, and perhaps in this way be able to meet its debts in full.
3. To show whether bankruptcy should be forced.
4. It may prove a valuable method of showing the exact condition of affairs to an incoming partner or investor.
The statement of affairs presents lists of all assets at their book values and also at the values which they might fairly be expected to realize upon a forced sale. Against this showing of the assets, an analysis is set up of all the claims against the business by its outside creditors on the basis of the various classes of creditors referred to above, namely, preference creditors, fully secured creditors, partially secured creditors, and unsecured creditors. Such a statement gives information in such form that it can be used for the purposes enumerated above. There are two forms of presenting this information. In the one the liabilities are shown on the left-hand side and the assets on the right-hand side, as is the case with the English form of balance sheet. The reason sometimes given for this is either that it is analogous to the English form of balance sheet or that in such a case the liabilities may be expected to exceed the assets and are therefore of prime importance. In the other form the assets are shown on the left and the liabilities on the right, as in the usual form of balance sheet. This latter form is the one shown here. The statement of affairs thus ties together the values shown on the balance sheet as taken from the books, with a fair estimate of the values which may be realized, and so indicates the shrinkage in value expected by forced realization of the assets.
Basis of Valuations in Statement of Affairs
The basis for the estimate of valuations is the same as in the case of bankruptcy proceedings where appraisers are appointed to determine the value of properties. Here, however, the matter is not under court control and the best appraisal possible must be made by the parties concerned, although if proceedings have progressed to the point where the appraisers’ report is available, these values may be incorporated. The order of marshalling the assets and liabilities in the statement is not standardized although it would seem best to follow the customary balance sheet order for the assets, running perhaps from the most liquid to the fixed. With the liabilities, those entirely unsecured may be shown first, followed by the partly secured, the fully secured, and the preferred creditors. A comparison of the total values expected to be realized from the sale of the assets with the total of the unsecured creditors gives some indication of the share which each creditor in the unsecured class may expect to receive. The student is referred to the type solution and form shown on pages 635-638.
Statement of Affairs
| Book Values | Assets | Items | Expected to Realize | Expect’d Loss on Realizat’n |
|---|---|---|---|---|
| Cash | ||||
| Notes Receivable (see Schedule 1) | ||||
| Accounts Receivable (see Schedule 2) | ||||
| Good | $..... | |||
| Doubtful | ..... | |||
| Bad | ..... | |||
| Merchandise | ||||
| Securities on Hand (see Schedule 3) | ||||
| Securities Pledged with Creditors: | ||||
| Partly Secured | $..... | |||
| Fully Secured | ..... | |||
| Deducted contra | ||||
| Excess of Pledged Securities over | ||||
| Claims of Creditors Fully | ||||
| Secured (see contra) | ||||
| Other Properties (see Schedule 4) | ||||
| Total Unpledged Assets | $ . . . . . . | |||
| Less Preferential Claims (see contra) | . . . . . . | |||
| Net Free Assets for Unsecured Claims | $ . . . . . . | |||
| Deficiency (see Deficiency Account) | ||||
| Book Values | Liabilities | Items | Expected to Rank |
|---|---|---|---|
| Creditors Unsecured (see Schedule 5) | $. . . . . . | ||
| Creditors Partly Secured (see Schedule 6) | $. . . . . . | ||
| Less Securities Held (see contra) | . . . . . . | ||
| Portion Unsecured | . . . . . . | ||
| Creditors Fully Secured (see Schedule 7) | $. . . . . . | ||
| Less Securities Held | . . . . . . | ||
| Excess Carried contra | $. . . . . . | ||
| Contingent Liabilities (see Schedule 8) | |||
| Preferential Creditors (see Schedule 9): | |||
| Deducted contra | . . . . . . | ||
| Capital | |||
| Surplus | |||
Deficiency Account
It is customary to support the statement of affairs by a deficiency account, which bears somewhat the same relation to the statement of affairs that the profit and loss account does to the balance sheet, i.e., it is a statement of the expected losses incurred upon realization of the assets and must prove against the losses or deficiency as shown by the statement of affairs. Sometimes on the asset side of the statement of affairs a third column is shown in which is indicated in detail the expected loss on realization for each asset. Where this is done the information which makes up the deficiency account is readily available. On the debit side of the deficiency account appears such items as losses on trading, shrinkages in value of the assets, and, if a partnership, withdrawals of capital. On the credit side appear the capital as shown by the books. The difference between the two sides is the amount of deficiency as shown by the statement of affairs. It may sometimes happen that the assets will realize more than enough to meet the claims of all creditors, leaving a remainder to be distributed among the owners. Where such is the case the deficiency account, instead of being technically described as such, is sometimes called an impairment of capital account—carrying, however, essentially the same information. The balance of the account is on the opposite side and indicates the present capital as impaired by the losses incurred. The skeleton form on page 633 and that given below show the way in which the various items may be presented.
Deficiency Account
| Detailed Shrinkage in | Appreciation in Values as | ||
| Values as per Statement | per Statement of Affairs | ||
| of Affairs | Capital | ||
| (Net Impairment of Capital) | Surplus | ||
| Net Deficiency as per | |||
| Statement of Affairs | |||
Illustration of Statement of Affairs and Deficiency Account
Problem. The following balance sheet shows the condition of the A B C Company as on December 31, 1918.
A B C Company
Balance Sheet, December 31, 1918
| Cash | $ 3,000.00 | Notes Payable | $ 25,000.00 | |
| Notes Receivable | 55,000.00 | Accounts Payable | 310,000.00; | |
| Accts. Rec. | $255,000 | Accrued Expenses | 10,000.00 | |
| Res. for Bad Debts | 5,000 | 250,000.00 | Bonds Payable | 175,000.00 |
| Merchandise | 77,000.00 | Total Liabilities | $520,000.00 | |
| X Y Co. Stock | 30,000.00 | |||
| Mach. & Equip | $ 95,000 | Capital Stock | 250,000.00 | |
| Depr. Res | 25,000 | 70,000.00 | Surplus | 25,000.00 |
| Buildings | $ 88,000 | |||
| Depr. Res | 13,000 | 75,000.00 | ||
| Land | 110,000.00 | |||
| Good-Will | 125,000.00 | |||
| $795,000.00 | $795,000.00 | |||
The company has had difficulty in meeting its current claims. Interest to the amount of $5,000 on its bonds is past due. On January 10, 1919, it would become liable for $30,000 on accommodation paper to that amount, because of the bankruptcy of the makers. It is estimated that the creditors will receive 50% of their claims. At a meeting of its creditors, where this condition of affairs was disclosed, it was decided to have a statement prepared to show the condition of the company on a liquidating basis, any action respecting a petition in bankruptcy to be deferred until after receipt of such statement. An appraisal committee made the following report, to be used as the basis for the statement.
In the cash are found I O U memos, not collectible, $500. The notes receivable, all estimated good, are pledged with creditors on open account to secure claims of $61,000. Of the accounts receivable, $100,000 are good, $80,000 doubtful, estimated at 50% of their value, and the remainder bad. The merchandise is estimated to bring in $50,000, the machinery $20,000, and the land $125,000. The land and buildings are expected to yield no surplus above the claims of bondholders. The X Y Co. stock is pledged with the holders of notes payable and should produce a surplus of $10,000. The accrued expenses comprise taxes $1,500, unpaid pay-roll $3,500, and bond interest $5,000.
Solution
A B C Company
Statement of Affairs
| Book Values | Assets | Items | Expected to Realize | Shrinkages |
|---|---|---|---|---|
| $ 3,000.00 | Cash | $ 2,500.00 | $ 500.00 | |
| 250,000.00 | Accounts Receivable: | |||
| Good | $100,000.00 | 100,000.00 | ||
| Doubtful—worth 50% | 80,000.00 | 40,000.00 | 40,000.00 | |
| Bad $75,000.00 | ||||
| Less Reserve 5,000.00 | 70,000.00 | 70,000.00 | ||
| $250,000.00 | ||||
| 30,000.00 | Claim Against Accommodated Party | |||
| (Estimated to yield 50%) | 15,000.00 | 15,000.00 | ||
| 77,000.00 | Merchandise | 50,000.00 | 27,000.00 | |
| 70,000.00 | Machinery | 20,000.00 | 50,000.00 | |
| Securities Pledged with Creditors: | ||||
| Partly Secured: | ||||
| 55,000.00 | Notes Receivable (Deducted contra) | $ 55.000 00 | ||
| Fully Secured: | ||||
| 75,000.00 | Buildings | $ 55,000.00 | 20,000.00 | |
| 110,000.00 | Land (at market) | 125,000.00 | [76]15,000.00 | |
| Deducted contra | $ 180,000.00 | |||
| 30,000.00 | X Y Co. Stock (at market) | 35,000.00 | [77] 5,000.00 | |
| Deducted contra | ||||
| Excess over Claims against it | 10,000.00 | |||
| 125,000.00 | Good-Will. | 125,000.00 | ||
| Total Unpledged Assets | $237,500.00 | |||
| Less Preferential Creditors | ||||
| (see contra) | 5,000.00 | |||
| Net Free Assets for Unsecured Claims | $232,500.00 | |||
| Deficiency | ||||
| see Deficiency Account) | 52,500.00 | |||
| $825,000.00 | $285,000.00 | $327,500.00 | ||
A B C Company
Statement of Affairs
(Continued)
| Book Values | Liabilities | Items | Expected to Rank | |
|---|---|---|---|---|
| Unsecured Creditors: | ||||
| $249,000.00 | Accounts Payable | $310,000.00 | ||
| Less Partly Secured | 61,000.00 | $249,000.00 | ||
| Partly Secured Creditors: | ||||
| 61,000.00 | Accounts Payable | $61,000.00 | ||
| Less Notes Receivable Held as Security | 55,000.00 | 6,000.00 | ||
| Fully Secured Creditors: | ||||
| 25,000.00 | Notes Payable | $25,000.00 | ||
| X Y Co. Stock Held as Security | 35,000.00 | |||
| Excess of Security Carried contra | $10,000.00 | |||
| Bonds Payable. | $175,000.00 | |||
| Accrued Interest on Bonds | 5,000.00 | $180,000.00 | ||
| Land & Buildings Held as Security | 180,000.00 | |||
| Contingent Liabilities: | ||||
| 30,000.00 | Accommodation Notes. | |||
| Maker, now bankrupt, will pay 50% | 30,000.00 | |||
| Preferential Creditors: | ||||
| 1,500.00 | Taxes | $1,500.00 | ||
| 3,500.00 | Wages | 3,500.00 | ||
| Deducted contra | $5,000.00 | |||
| 250,000.00 | Capital Stock | |||
| 25,000.00 | Surplus | |||
| $825,000.00 | $285,000.00 | |||
ABC Co. will be able to pay, on the basis of the above showing, 81.6 cents on the dollar of all unsecured claims.
| A B C Company Deficiency Account, December 31, 1918 | |||
| Estimated Shrinkages in Value: | Estimated Increments in Value: | ||
| Cash | $ 500.00 | Land | $ 15,000.00 |
| Accounts Receivable. | 110,000.00 | X Y Co. Stock | 5,000.00 |
| Claim against Accommodated Party | 15,000.00 | Capital Sunk: | |
| Capital Stock | 250,000.00 | ||
| Merchandise | 27,000.00 | Surplus | 25,000.00 |
| Machinery | 50,000.00 | Net Deficiency to be | |
| Buildings | 20,000.00 | borne by Creditors | |
| Good-Will | 125,000.00 | (see Statement of Affairs) | 52,500.00 |
| $347,500.00 | $347,500.00 | ||
Comments on Problem. From the above solution it will be noted that the order of showing the assets is not quite the same as would be ordinarily followed on a balance sheet. A separate group is made to indicate the securities pledged with creditors, shown under the two heads “Partly Secured,” and “Fully Secured.” It is to be further noted that the securities in the hands of partly secured creditors have no realizable value applicable to general unsecured creditors; hence, they are always shown deducted on the liability side of the statement from the claims of partly secured creditors, the difference giving the amount of such claims which must rank with other unsecured creditors. In the case of fully secured creditors, if the value of the security held is estimated to exceed the claims against it, this excess will be shown on the asset side of the statement as property to which the unsecured creditors may look for the satisfaction of their claims.
It should be noted that the amount of net worth is included in the Book Values column of the liabilities, chiefly for the purpose of showing a complete balance sheet. This makes possible an easy estimate of the deficiency figure, as shown on the face of the statement. The estimate is made by subtracting the figure of net worth from the total of the Shrinkages column. This is, of course, the same figure as shown in the Deficiency account and is arrived at in practically the same way. In the solution given, the two items indicated by asterisk in the Shrinkages column represent increments in value, and in arriving at the total of that column these are, of course, subtracted from the total shrinkages.
Inasmuch as the accommodation notes were not previously carried on the books of the bankrupt, they must here be inserted in the balance sheet columns both as an asset and a liability.
It is to be noted that the amount due the preferential creditors must be shown deducted from the total unpledged assets because the creditors have no claim against any specific asset although a first claim against all unpledged assets. After deducting the amount from the total unpledged assets, the figure of net free assets which can be applied to the claims of unsecured creditors is arrived at. A comparison of this figure of net free assets with the total amount due unsecured creditors gives the percentage which the creditors may expect on their claims. It is to be understood that the expenses of winding up the business will also be a charge against the net assets before the creditors can receive anything. It therefore usually happens that the estimate of this percentage is higher than is actually realized at the time of final settlement.