Accounting theory and practice, Volume 1 (of 3)

by Roy B. Kester

Capital Stock. Under this title is indicated the sum total of the portions of net worth owned by the shareholders as evidenced by stock certificates and subject to their individual control. On [page 20] is given an explanation of the way in which the proprietorship or net worth of a corporation may be composed of two (or more) parts: (1) the capital paid in by the owners; and (2) the capital, representing profits made but not distributed to the owners. While capital stock usually represents the capital contributed by the owners, it sometimes arises from other sources, such as the distribution of a stock dividend; but the portion of the net worth owned and controlled individually by the owners is the capital stock.

Surplus. In a corporation this represents the second portion of the net worth, as indicated in the preceding section. Surplus is sometimes defined as the excess of the net worth over the capital stock. In other words, it is the difference between the assets and the sum of the liabilities and the capital stock.

Undivided Profits. This is a term used chiefly in financial institutions to indicate the portion of the net profits concerning the disposal of which no action has been taken.

Reserves. Under this title are included whatever portions of the surplus are set aside or reserved for specific purposes.

Where Surplus, Undivided Profits, and Reserves appear as parts of Net Worth, they together represent the difference between Net Worth and Capital Stock. The reason for the careful segregation of these items from the Capital Stock is given in the explanation of the corporate form of organization, on [page 20].

Types of Business Organization.—Before proceeding with a discussion of proprietorship as it appears on the balance sheet, the three general types of business organization will be treated briefly, because the manner of indicating proprietorship is dependent to a certain extent on the type of organization. These types are: (1) the single or sole proprietorship, (2) the partnership, and (3) the corporation.

The Single Proprietorship.—The simplest form of business enterprise is that conducted by a single proprietor. This form is well adapted to businesses where the capital necessary for efficient production is small, where the processes are simple and capable of being handled by the average individual, and where the risks are slight. Very few legal obstacles are placed in the way of the individual desiring to go into business for himself, nor is a great deal required of him. In some cases registration and a license are necessary. The observance of the general laws, concerning the payment of taxes and of local regulations concerning disease and fire is all that is usually expected. Subject to the general restrictions which ordinary business acumen and foresight impose, one can enter practically any field of enterprise, as a single proprietor, have entire freedom and privacy in the conduct of his business, and share with none the results of his endeavor.

On the other hand, these conditions oftentimes prove to be decided disadvantages. As industry is at present organized, many fields of activity demanding large capital and many kinds of technical knowledge, are closed to the single proprietor. Freedom of action carries with it sole responsibility, and oftentimes the counsel and advice of others would prevent the disasters which sometimes overtake the single owner of a business.

The Partnership.—A partnership is “a contract of two or more legally competent persons to combine their money, property, skill, and labor, or some or all of them, for the prosecution of some lawful business and to divide the profits and bear the losses in certain proportions.” There are different kinds of partnerships, as will later be shown, but the essence of each from the point of view of a working organization is mutual agency, each partner being the agent of the others, and, within the limitations of the partnership agreement, capable of acting as a principal for the firm. The partnership is subject to practically as few restrictions as the individual. In some localities, to secure the right to sue and be sued in the firm name, it is necessary to file in a public office a brief statement of the firm name and the names of its members.

The chief advantages of the partnership are larger capital and therefore access to fields closed to the individual; the combining of the business wisdom, skill, and knowledge of several individuals; the subdivision of duties and therefore the opportunity for specialization. While in the view of the business community the partnership is an entity or a business unit, it is not so in the sight of the law, each member of the firm being held liable to creditors for the entire debts of the partnership as if it were his sole business. If any one member has to pay the firm debts, he has a claim against his copartners for contribution.