The Net Worth Section Expanded.—In its operation of buying and selling goods, a business executes many different types of transactions. As was indicated in [Chapter I], in the development of the proprietorship equation, some types of transactions have no effect on proprietorship, that is, they involve neither a profit nor a loss; while other types of transaction—the really vital types, because it is for these that the business is carried on—involve a change in proprietorship, either increasing or decreasing it. Goods are bought for one price and sold at a price sufficiently higher to pay for all the expenses of operating the business and leave a reasonable margin of profit. For example, goods may be bought for $1,000 and sold for $1,800, bringing about an increase of $800 in the sum total of the assets. This $800 may represent temporarily an increase in proprietorship but the increase must be used first to meet the expenses of operating the business during the period in which the sale is made, after which the net result represents the real or permanent increase in proprietorship. The temporary increase of $800 is offset by a temporary decrease of, say, $600 for operating expenses. It is vital to business management to have information not only concerning the net increase in proprietorship but also concerning these temporary increases and decreases. To give this information the net worth section of the balance sheet might be expanded as in the illustration given below.
Edwin Markham
Balance Sheet, December 31, 19—
| Assets | |||
| Cash | $ 5,000.00 | ||
| Accounts Receivable | 75,000.00 | ||
| Merchandise | 20,000.00 | ||
| Plant | 50,000.00 | ||
| Total Assets | $150,000.00 | ||
| Liabilities | |||
| Accounts Payable | $30,000.00 | ||
| Accrued Expenses | 5,000.00 | ||
| Mortgage on Plant | 30,000.00 | ||
| Total Liabilities | 65,000.00 | ||
| Net Worth | |||
| Edwin Markham: | |||
| Capital at the beginning of the year | $70,000.00 | ||
| Profits during the year: | |||
| Sales | $200,000.00 | ||
| Cost of Goods Sold | 140,000.00 | ||
| Temporary Increase in Proprietorship | $ 60,000.00 | ||
| Operating Expenses | 45,000.00 | ||
| Net Increase in Proprietorship | 15,000.00 | ||
| Capital at the end of the year | $ 85,000.00 | ||
In the net worth section of this balance sheet, the capital with which the owner started operations for the year is given first. To this is appended a summary of the operations for the year resulting in a net increase in proprietorship which, added to the beginning capital, gives the capital in the business at the end of the year. This method of setting up the information concerning the operations of the business is not used to any extent because the information is of such vital importance that it deserves more display. Accordingly, a separate statement, known as the “Statement of Profit and Loss,” or “Statement of Business Operations,” is drawn up to explain the balance sheet net worth item, Net Increase in Proprietorship for the year, which shows just the amount of the net profit. The detail of this item is given in this complementary statement. The above illustration is given merely for the purpose of pointing out the relationship between the statement of operations and the balance sheet. From this it will be seen that the statement of profit and loss is really a part of the net worth section of the balance sheet.
Temporary Proprietorship Records.—The proprietorship records, indicating as they do the sources of changes in net worth, are kept day by day as transactions take place, are summarized at the close of the period, and the net result is determined. They are called temporary because, as is seen, they do not at the time of record have regard for the final change in proprietorship. At the end of the regular periods, to determine the total or final change, the temporary proprietorship records are closed or transferred to the summarized record called the “Profit and Loss Summary.”
Referring to the case of Aaron Conners discussed in [Chapter IV], assume that the accounting department furnishes the following additional information from its records:
During the year from July 1, 1921 to June 30, 1922, Conners bought $22,362.50 worth of goods; his sales amounted to $28,465.20; he paid for help $3,050.50; his other expenses were $2,405.45; and he estimated the wear and tear on furniture at 10%, or $52.50. As shown in his statement for 1922, he had $10,260 worth of merchandise on hand on June 30, 1922.
The analysis of this information explains the changes in his net worth during the year. The goods he started with plus those purchased during the year are the total goods to be accounted for, which amounted to $30,862.50 ($8,500 + $22,362.50 = $30,862.50). These goods were accounted for by his sales during the year and the amount on hand. Knowing how much was on hand June 30, 1922, viz., $10,260, he determined that the goods sold must have been the difference or $20,602.50 ($30,862.50 - $10,260 = $20,602.50). The price which he received for these goods sold was $28,465.20; hence, his profits from sales were $7,862.70, the difference between selling price and cost.
We find, also, that the expenses he incurred in selling his goods and conducting his business generally were $3,050.50 for clerk hire, office help, delivery boys, etc.; and other expenses, such as rent, taxes, repairs, delivery upkeep, supplies, heat, light, and the like, amounted to $2,405.45. He estimated that his store fixtures depreciated in value $52.50. All these items, representing costs of doing business, amounted to $5,508.45 ($3,050.50 + $2,405.45 + $52.50 = $5,508.45), which subtracted from his profits from sales, $7,862.70, gives him a net gain of $2,354.25 ($7,862.70 - $5,508.45 = $2,354.25). This gain tallies with the increased proprietorship of that amount shown by the balance sheet of June 30, 1922.
Without regard to a form which would be technically correct, the data of the preceding paragraphs may be shown as follows: