The Balance Sheet and the Determination of Profit.—The balance sheet, listing all assets and all liabilities, makes a determination of proprietorship or net worth possible. Under the inventory and appraisal method it must be taken periodically. A comparison of the net worths as shown by successive statements develops the gain or loss for the period, provided no other elements affecting net worth have become involved. The additional element to be taken into consideration is the relation of the proprietor to the funds of the business. He may have withdrawn some of the assets or he may have made additional investments, so that the condition of the assets as shown at the end of the period is not entirely the result of business activities and transactions.
Profits determination by this method, therefore, must take cognizance of the two factors: (1) comparative net worths, and (2) proprietor’s interim drawings and investments. A withdrawal of cash during the period equal in amount to the profits for that period would result in the same net worth at the close as at the opening of the period. Drawings in excess of profits would cause a net worth less at the end than at the beginning; and withdrawals less than profits would cause an increased net worth. But under none of the three cases stated would a comparison of the two net worths show the actual profits.
Similarly, additional investments have an opposite effect, bringing about an increase in closing net worth in the exact amount of the additional investment and so obscuring the true amount of profit or loss for the period. Accordingly, the increase or decrease of net worth as shown by the comparative statements of financial condition must be adjusted in accordance with the proprietor’s withdrawals and additional investments to make a correct determination of profits. To determine the profits for the year, to the change in net worth—treated algebraically, i.e., positive if an increase and negative if a decrease—must be added the withdrawals, and from this sum the additional investments must be subtracted.
Single and Double Entry Compared.—From the foregoing discussion and from the illustrations in the next chapter it will be seen that single entry can be worked through to a conclusion as to profit and loss. It tells nothing, however, of the sources of that profit or loss, nor does it give any control over expenses. It is true that a comparative statement of assets and liabilities as shown in Chapter IV, presenting increases and decreases of the various assets and liabilities, will give additional information, but even that does not show the reasons for the change and so affords no basis for control. For such purposes the statistical totals of the sales and purchase records, and of the cash book, where analytical columns are used, furnish the only information available under single entry. Its only advantage, then, is brevity, the saving of labor in making the record. No difficult analysis is met with in the original record and posting is a less heavy task than in double entry. But brevity and labor-saving are secured at the expense of the very information which the business man needs.
The advantages of double entry may be summarized as follows:
1. The ledger shows a classified record of every transaction.
2. Expenditures for capital purposes, i.e., for new assets or additions and betterments to existing assets, are recorded as such, so that there is no danger of losing sight of them.
3. A gross profit figure is obtainable and percentages of profits and expenses, making possible an estimate of merchandise inventory at any time. This is particularly valuable in case of fire loss.
4. The double-entry method provides a proof of the mathematical accuracy of the ledger.
5. A full statement of sources of profits and causes of expenses can be obtained in double entry.