Origin of English Form of Balance Sheet
In the development of record-keeping a stage was passed through in which every account on the ledger was closed. Not only were the temporary proprietorship accounts cleared through the Profit and Loss account, but all the remaining asset, liability, and vested proprietorship accounts were in like manner closed into a Balance account opened on the ledger for this purpose. The Balance account, after transfer of the various accounts into it, became virtually a balance sheet and so was itself in balance. In this way the whole ledger was closed. The Balance account at this stage, so the controversialists maintain, represents, and was later adopted as, the Continental form of balance sheet. The ledger could not, of course, remain closed; it had to be reopened for the record-keeping of the next fiscal period. This was accomplished by credit entries to transfer the assets, and by debit entries to take out the liabilities and vested proprietorship. These reopening entries as appearing in the Balance account represent the English form of balance sheet.
This explanation of the origin of the two forms is ingenious and even plausible, although not synchronizing historically with the lapse of use of the Balance account. Others have attempted an explanation on purely logical grounds. These hold to the theory of the personality of accounts, which looks upon the business always as an entity distinct from its owners. Here, the English form of balance sheet is said to be the statement of account rendered by the business to its owners, whereas the Continental is the account given by the owners to the business. A. Lowes Dickinson,[5] in discussing the two forms, says: “The balance of argument would seem to favor the latter (English) on the theory that a balance sheet is intended to set forth the position of the owner of the property, who should therefore be credited with what he possesses and charged with what he owes.”
Quite opposed to this view is the position taken by an English authority, George Lisle,[6] He says: “Why ... the assets which are on the debit side (of the ledger)[7] and the liabilities which are on the credit side, as according to the principles of accounting they ought to be, should change places (in the balance sheet),[8] it is impossible to justify. The custom seems to have arisen through the influence of the forms given in Acts of Parliament, chiefly The Companies Act, 1862, which must have been prepared by those unacquainted with the theory of accounts. The Profit and Loss account is taken from the ledger, and the sides are not transposed, and there is no logical reason why the sides in the balance sheet should be reversed.... The form of balance sheet in which the assets appear upon the left side is both theoretically the correct form and in practice is the most convenient form to use.... Prior to about the passing of The Companies Act, 1862, it was the form chiefly adopted in England, but is so no longer.”
R. H. Montgomery[9] proposes a psychological explanation. He says: “The only sound reason the author can think of for the custom is that a conservative Englishman looks for his liabilities first and then looks to see if he has enough assets to discharge, them ... that the average American looks for his assets first and subsequently glances at his liabilities in order to assure himself that his excess of assets is as much as he believes it to be.” Regardless of the origin of the two types and their respective merits, a balance sheet is everywhere used to show assets, liabilities, and net worth, and less and less regard is being paid to debit and credit or left and right sides, technical form giving place to an elasticity in the method of showing adapted to accomplish definite purposes.
Variation of English Form
A variation of the English form of balance sheet is seen in the make-up of the balance sheet for British public service companies. These companies are authorized by special act of Parliament to raise money for designated purposes. The act, therefore, requires as a part of the statement of financial condition the rendering of an accounting of the receipts from sale of stock and bonds. Accompanying the financial statement, or rather as a part of it, is the statement, “Receipts and Expenditures on Capital Account,” comprising the fixed asset and liability sections of the ordinary balance sheet. Illogical as it may appear in view of the usual English practice, this account is credited with the capital stock and bonds issued to establish the undertaking, and is debited with the fixed assets in which the capital funds have been invested, the intent of the law being that the capital funds raised should be applied to purchase of fixed equipment with which to earn revenue and that all other expenditures should be made from revenue. If the fixed assets exceed at any time the fixed liabilities and capital, it means that the excess has been supplied out of revenue. If the reverse is true, it means that capital receipts are being used as working capital. Any balance is carried down to the second part of the financial statement known as “General Balance Sheet,” in which arrangement of the two sides is made according to English custom. The act authorizing this double-account form of balance sheet allows the valuation of the fixed assets always at cost, on the theory that their maintenance in a state of constant good repair and efficient working condition constitutes a charge against revenue and hence that depreciation need not be considered.
It has been suggested that the double-account form of balance sheet, or rather the law on which it rests, has been responsible for the decisions in the cases of Lee v. Neuchatel Asphalte Co. and Verner v. The General and Commercial Investment Trust, Ltd., reference to which is made later in [Chapter XXII], “Profits,” and [Chapter XXIV], “Dividends.” Here the decisions rested on the distinction between fixed and circulating assets and declared in favor of the maintenance of the capital funds invested in circulating assets but not necessarily of those invested in fixed assets. The following illustrates the double-account form:
| The East and West Railway Company Receipts and Expenditures on Capital Account | |||
| Railroads, Franchises and | Capital Stock: | ||
| Other Properties | $410,000.00 | Common | $200,000.00 |
| Preferred | 75,000.00 | ||
| Current Expenditures for | Debenture | 50,000.00 | |
| Construction and | Funded Debt: | ||
| Equipment | 65,000.00 | General Mortgage Bonds | 150,000.00 |
| Investments in Other Companies | 50,000.00 | Equipment Trust Bonds | 100,000.00 |
| Securities in Hands of Trustee | 15,000.00 | ||
| Balance carried to | |||
| General Balance Sheet | 35,000.00 | ||
| $575,000.00 | $575,000.00 | ||
| General Balance Sheet, December 31, 1918 | |||
| Capital Account, | Securities | $50,000.00 | |
| credit balance | $35,000.00 | Prepaid Expenses | 750.00 |
| Special Betterment Fund | 15,000.00 | Accrued Income | 1,250.00 |
| Accrued Expenses | 1,500.00 | Accounts Receivable | 25,000.00 |
| Dividends Payable | 17,500.00 | Materials and Supplies | 10,000.00 |
| Accounts Payable | 25,000.00 | Cash | 7,000.00 |
| $94,000.00 | $94,000.00 | ||