The case against the inclusion of treasury stock in temporary investments is not quite so apparent, but equally convincing upon examination. Treasury stock differs from unissued stock only in that it has once been issued but has, through various channels, found its way back into the possession and control of the company. While outstanding in the hands of stockholders and under their individual control, the increased stock proprietorship is reflected in increased assets. If the stock comes back into the treasury through donation, the decrease in proprietorship stockholdings is compensated by a new proprietorship element under donated surplus. Thus, while there are not so many shares outstanding, the value of each is enhanced by a combined or common proprietorship in donated surplus, which reflects exactly the status of the treasury stock. Whereas formerly there was individual control over the stock, now that it is in the treasury, control is common or combined. Stock proprietorship has been diminished and the balance sheet should show it by treating Treasury Stock as an offset account and not as a part of current assets under Temporary Investments.
As to the valuation of treasury stock at some other figure than par, the same argument holds as in the case of unissued stock. If the treasury stock has been acquired by purchase on the open market, its price may be a good and sufficient basis for valuation; but even here individual ownership and control has been exchanged for common and combined ownership. The individual stockholdings are decreased, and the decrease is reflected on the assets by the amount paid for the stock. It would seem, therefore, that a showing more in accord with the facts would require treasury stock to be treated as a deduction from the capital stock authorized. Thus the best practice eliminates a company’s own stocks from the list of its assets. Where such holdings are small and insignificant, they may without any serious impropriety be included among the assets and even under the caption “Temporary Investment” so long as substantial accuracy obtains.
Summary of Valuation Formula
To sum up, then, the valuation formula for current investments requires their showing at cost or market, whichever is the lower. The most satisfactory method of applying the formula is by means of the Reserve for Investment Fluctuations which makes possible the incorporation of market value whether lower or higher than cost, with the differences between market and cost carried in the reserve account. Thus the conservatism of the valuation formula is made effective and at the same time information is given as to the present market values of the investment.
Accrued and Deferred Items
Nature of Accrued Income
Income derived from many different sources is never fully received at the close of the fiscal period. For instance, of the sales made many will still be outstanding as charges to various customers; interest will have accrued on notes receivable and on investments held; rental income is earned day by day but is received only periodically; royalties based on the use of some machine or process are accumulating where the device or process is being used but settlement is made only periodically; and dividends on stocks or other investments may have been declared during the current period but are not payable and therefore will not be received until the next period.
Inadequacy of Cash Method of Handling Accruals
All these accrued items give rise to claims which must find expression in the accounts either currently or ultimately. In the case of sales of merchandise the customary practice is to set up the claim on the books when the sale is made. In the case of the other items usually no record is made until the income is actually received. Under this method—called the cash method—it is evident that the true income cannot be shown in the period in which it is earned and that the period in which it is received secures the credit for it. This means not only that the current period may at its beginning receive credit for items of income mostly earned during an earlier period, but at its end it will be deprived of similar earnings accruing from day to day up to its close but not credited because their time of payment overlaps into the next period. This method is defended as being substantially correct on the principle of averages, i.e., those earnings which do not entirely belong to the current period but for which credit is taken will in the long run just about offset the earnings accrued at the end of the period which are not taken account of.
The statement may be true and, if so, can be easily tested; but, whether true or not, modern practice requires the accurate accounting of all claims. It is therefore required that these accrued earnings be brought onto the books if reliable results are desired.