Accounting theory and practice, Volume 2 (of 3)

by Roy B. Kester

Valuation Accounts

Nothing has been said thus far concerning the showing of valuation accounts on the balance sheet. Two different practices are met with. Sometimes such accounts are listed with the liabilities, and there is a sense in which they may be regarded as liabilities. Rather, however, they should be looked upon as credits to asset accounts, held temporarily in suspense until they can be definitely allocated to their assets. They are offsets to show the appraised values of the various properties. As such, therefore, they are best shown as deductions from their corresponding assets with the appraised value full-extended. This applies to both the debit and the credit valuation accounts. A full discussion of these and other reserves is given in [Chapter XXIII].

Statutory Requirements as to Frequency of Balance Sheets

Excepting in the case of corporations, there are few, if any, compulsory regulations governing the frequency of balance sheets. Some of our tax laws have brought about an increasing regularity with regard to the issuance of formal statements, both balance sheet and profit and loss. England, France, and Germany require a formal statement from corporations once a year. In this country, most states require some form of statement but oftentimes the requirement is so indefinite or so inadequately or half-heartedly enforced that the statement submitted is of little value. On the other hand, some classes of financial and public service corporations are required to present full and adequate reports periodically, at least once a year. In the case of national banks five reports are asked for; in the case of savings banks in some states two reports are required.

Condensation of Information in the Balance Sheet

The relation of the formal balance sheet to the post-closing trial balance needs further consideration. It has been stated that a post-closing trial balance is essentially a balance sheet. As the purpose of the latter is to present a bird’s-eye view of financial conditions, much of the detailed information shown in the post-closing trial balance must be condensed and consolidated with similar items, so that only totals are shown on the balance sheet. Just as the purpose of the ledger is by a process of analysis to secure detailed information for use in the current control of the business, so the balance sheet by losing sight of the detail and by setting forth the fundamental currents of business life and health, provides the data for the larger aspects of control. How far this process of condensation should be carried depends largely upon the use to which the balance sheet is to be put. A statement of financial condition to be issued to the public—stockholders and outsiders—can well omit data which would be required for internal use. Care must always be taken in condensed statements to avoid consolidation of detail in such a way as to render the statement misleading. The English Companies Act of 1862 provided that the “auditors’ report should state whether in their opinion the balance sheet was a ‘full and fair balance sheet’ containing the particulars required by the company’s Articles and ‘properly drawn up so as to exhibit a true and correct view of the company’s affairs.’” This represents the proper attitude for every accountant to assume in the making of statements. This is not meant to require the publication of information which is the private property of the business. The phrase, “full and fair,” must be interpreted to mean sufficiently full, and only so much so that it will be fair to both parties. The company is entitled to withhold legitimate information the publication of which would be detrimental to it, and not to do so would be unfaithful to the proper guardianship and protection of its interests, and this in turn would bring about dissatisfaction with the management and oftentimes ill-feeling among the owners.

Use of Supporting Schedules

By means of supporting schedules, as illustrated and discussed briefly on pages 411 and 412 of Volume I, it is possible to carry condensation to almost any desired degree and still have available all necessary detail in the accompanying schedules. What items in the balance sheet should be supported by schedules and what should not, must be determined by the conditions peculiar to each case. Here again, the determination rests largely upon the use the statement is to serve. The informational content is therefore largely dependent upon the purpose for which the statement is drawn.

Balance sheets may serve any one of the following purposes:

1. Internal use by proprietor or manager.