The advantage of the use of these accounts instead of the one Merchandise account is in the availability of the information they contain and in the saving of labor, because now there is no need to analyze the Merchandise account for information relating to returns, allowances, and so forth. By later transferring the totals of the Returned Sales and of the Sales Rebates and Allowances to the Sales account, the balance of this account will show the “net sales.” A similar transfer of the Inward Freight and Drayage, the Returned Purchases, and the Purchases Rebates and Allowances to the Purchases account, and a transfer to it of the initial and final inventories, make it show by its balance the “cost of goods sold” which set over against “net sales” shows the figure of “gross profit.”

The student will understand that the use of these detailed accounts does not free the record of merchandise transactions from the mixture of different elements, decrease of the asset and increase of the profits. It does, however, make the record more valuable because of the information it makes available.

Accounts with Assets Subject to Depreciation.—Another kind of mixed account requiring explanation is that of the fixed asset subject to depreciation. Due to ordinary wear and tear, and some other causes, most fixed assets lose part of their value as time goes by. At the end of each fiscal period the amount of this loss and the present value of the asset must be estimated, after an inventory has been taken, when necessary, of their number, weight, or other units of measurement. Such an estimate is called an appraisal. The difference between the present appraised value of the asset and its former cost or appraised value constitutes the loss from wear or other causes, and is termed depreciation.

Since depreciation takes place day by day, but for practical reasons cannot be recorded daily, fixed asset accounts, as they stand valued in the ledger, represent true asset values only for the date of their entry. Except on that date, these accounts, then, include depreciation and hence are mixed accounts including both asset and proprietorship elements. As with the Merchandise account, an adjustment is made periodically to separate the two elements. Since the asset account is a debit account, entry of the amount of the depreciation to the credit side would result in the account showing, by its balance, the appraised value of the asset at any given time. It is, however, desirable to leave the account in its original condition, in order not to lose sight of the cost of the asset. Therefore the usual practice is to enter this figure of depreciation to the credit side of a separate account called Depreciation Reserve for the particular asset, using the word “reserve” in the sense of “estimate.”

If the latter method is followed, each asset has two accounts, one showing original cost and the other estimated depreciation, and it is necessary for a true valuation of the asset to read the two accounts together; that is, from the asset account showing original cost, the amount credited to the reserve account must be deducted to show the true value of the asset. Because of this, the reserve account is often called a valuation account or an offset account, as it gives the amount of the offset to the original asset account necessary to show its correct value. Similarly, when an increment in the value of an asset is kept separate from its face or par value—as when the premium paid for stock or bonds is shown separately from the par value of the stock or bonds—the account showing the increment is called an adjunct account and must be read with the asset account to secure true valuation. The offset account, then, is a subtraction item and the adjunct an addition item to the corresponding asset account. The showing of the asset and its periodic valuation is made as follows:

Machinery
1921
Jan. 1 5,000.00
Depreciation Reserve Machinery
1921
 Dec. 31500.00
1922
 Dec. 31500.00

A reading of the two accounts taken together shows the original value of machinery as $5,000, the value after one year’s use $4,500 and after two year’s use $4,000. The contra debit for the credit in the reserve account is made to an account called Depreciation, which represents the expense of the depreciation for the period, that is, the deduction from profit or proprietorship. Sometimes, this charge is made direct to Profit and Loss, as will be shown in a later chapter.

Capital and Revenue Expenditures.—The fixed asset accounts usually show the investment of some of the original capital and therefore are sometimes called capital asset accounts. A fundamental distinction must be made between expenditures for the purchase and installation of the asset itself and expenditures for expenses in connection with its repairs, maintenance, and upkeep. These two classes of expenditures are usually called “capital expenditures” and “revenue expenditures” respectively.

The asset account itself is chargeable with all costs incurred up to the point of putting the asset in shape for use in the business. It may be charged also with subsequent expenditures resulting in an increase in its value. Expenditures, however, which are for the purpose of repairs or of keeping the property from too rapid depreciation without adding anything to its original value, must be charged to a properly labeled expense account. These revenue expenditures for expenses, such as repairs, maintenance, upkeep, together with depreciation, are subtractions from profit and proprietorship, while asset expenditures usually constitute an exchange of the asset cash for some other asset, which exchange has no effect on proprietorship.

Sometimes two items of expenditure are seemingly of the same nature, while in fact they belong to separate groups, as the original painting cost of a building and the cost incurred later for repainting. In the first instance the expenditure is an asset, a part of the original cost necessary to put the building in a finished condition; in the other instance, it is an expense necessary to maintain the asset in something near its original condition. In order to secure accuracy in the records, careful discrimination between capital and revenue expenditures is a matter of great importance.