The accounts will then appear as follows:
| Accounts Receivable | |||
| Dec. 31 | 75,000.00 | Feb. 28 | 500.00 |
| Reserve for Doubtful Accounts | |||
| Feb. 28 | 500.00 | Dec. 31 | 5,000.00 |
It will thus be seen that the decrease in value of the accounts receivable as estimated by the amount in the Reserve for Doubtful Accounts can never be applied to the asset until it is definitely determined what particular customer’s account included in the Accounts Receivable account is bad and must therefore be written off the books. Inasmuch as the Bad Debts account set up at the close of each fiscal period to indicate the loss or expense due to uncollectible accounts, has been charged as an expense of operating for that period, it would manifestly be duplicating the expense charge if a debt that proved bad were charged to the Bad Debts account rather than to the Reserve for Doubtful Accounts. Only during the first period of operation of a business are debts, if determined bad during that period, charged to the Bad Debts account. Even here, if it is expected at the close of the first period to base the estimate of uncollectible accounts on the sales for the period rather than on the amount of outstanding accounts at the end of the period, it would be necessary to charge the debts becoming bad during the period against the Reserve for Doubtful Accounts account—even though at the time of the charge it contained no credit entries—and not to the Bad Debts account. The desirability of establishing a standard routine for the handling of all items should be kept in mind. Best practice, therefore, demands that all debts shall be charged against the Reserve for Doubtful Accounts whenever they are determined to be bad, regardless of the amount held in reserve in that account. If such practice creates a debit balance in the Reserve for Doubtful Accounts, it is an indication that the estimate of uncollectible accounts made in previous periods has not, as a matter of fact, been sufficient and a larger estimate must be made for future periods.
Merchandise. Merchandise is purchased for the purpose of resale at a profit. Sale price is dependent, in a free market, on the force of demand and supply and not at any given time on cost. Until the goods are sold no profit, as a matter of fact, has been secured. Conservatism, therefore, demands that sale price should not ordinarily be used as the basis for the inventory valuation. Unless there has been a decided change in prices, it is the confident expectation of the management that at least the cost price of the merchandise will be realized when the goods are sold. Ordinarily, therefore, merchandise will be priced in the balance sheet at cost. When, however, there has been a change in price levels, particularly when the indication is that there is a generally declining market and not simply a temporary fluctuation in prices, it is the part of conservatism to value the merchandise at its replacement cost, or even at a lower figure, if stocks are large and market conditions are such that customers are withholding their purchases until price levels have dropped still further. The basic principle for valuing all current assets requires that they be valued as nearly as possible at the realization figure. Therefore, the amount expected to be realized governs or influences the valuation basis. The valuation formula or rule-of-thumb method, in accordance with which merchandise inventory is usually valued, is expressed as cost or market, whichever is the lower. As indicated above, there are times when exception is taken to this basis.
Investments. Stocks and bonds representing the investment of temporary surpluses of cash are valued on a realization basis. Inasmuch as the tying up of cash in these securities is only temporary and it is expected that they will be converted again into cash as needed, the amount which can be realized from their sale on the date of the balance sheet is the amount to be considered when judging the financial condition on that date. A large amount of discretion must be used in valuing these securities, because of the violent fluctuations to which quotations on the various stock exchanges are subject. Here also conservatism does not usually authorize value at the market if the market is higher than the cost. Accordingly, the valuation formula is cost or market, whichever is the lower.
Accrued Income. The income accrued on the date of the balance sheet is determined on the basis of a fair distribution between the periods during which the income accrues. Thus, the income from money loaned during the current period but not due until a succeeding period must be distributed over two or more periods. Where the income is dependent on time, the portion applicable to the current period is determined on a time basis. Where the income is dependent on some other basis, such as sales or units of work done, the portion applicable to the current period is determined by the ratio of the whole to the amount completed during the present period. Thus, in the case of a contract entered into to sell goods on a commission basis, the commission income accrued during the current period will usually be based on the amount of sales made during that period.
Deferred Charges. The valuation principle for deferred charges has been stated above in connection with the principles of valuation to be applied to the various groups of accounts on the balance sheet.
Fixed Assets. Fixed assets may usually be divided into two classes: (1) assets not subject to depreciation, and (2) assets subject to depreciation. The usual example of assets not subject to depreciation is the land on which a building stands. Land used for growing crops may easily be subject to depreciation. Land subject to the exploitation of the natural resources under its surface is similarly subject to depreciation. To distinguish the decrease in value of such natural resources because of the fact that they enter into and become a part of the commodity dealt in, the term “depletion” is used. Thus, a coal mine or oil well decreases in value with every unit of product taken therefrom. It is not purposed hero to discuss the principles of valuation applicable in such cases, the assets under discussion being limited in meaning to those of a mercantile business. (See Volume II, page 312, for a discussion of depletion.)
The valuation formula for assets not subject to depreciation is cost. Increase in value due to changed market conditions is not usually to be taken account of.
The second group of assets, those subject to depreciation, are to be valued on the basis of original cost less the amount of depreciation accrued to the date of the balance sheet. The valuation of such assets, therefore, requires the determination of the amount of depreciation.