Chapter Xii. At the End of the Fiscal Period, After the Ledger Has Been

closed, there appear only asset, liability, and vested proprietorship accounts; but during the fiscal period, the temporary proprietorship accounts come into being and certain asset and liability accounts take on a mixed character resulting from the method in which the record is kept. This method is dictated not by a pure accounting theory, but by a theory designed to accommodate itself to the practical requirements of the average business. It is because the practical method of making the record falls short of the theoretically exact method, that adjustments must be made before summarizing.

For this reason, a record is not made daily of the portion of assets which has been consumed each day, but the asset accounts are adjusted at the close of each fiscal period to separate their asset and proprietorship elements. Also, when a note is discounted at the bank, its entire face value is set up as a liability. From the standpoint of accurate accounting, however, the face value of the note overstates the liability for the current fiscal period, if the note falls due in the following period, by the amount of the prepaid interest charge belonging to that next period. Only on the due date of the note does the record show the true condition of the liability. Thus, a “practical” method of keeping the record necessitates the use of certain “mixed” accounts. Fundamentally, however, the three-group classification given answers every necessary purpose.

=Fundamentals of a Good Classification.=—In judging the fitness of a particular classification, the end and purpose for which it is made must always be the criterion. Any classification of accounts must, therefore, have in view the fact that all accounts lead up to the balance sheet and profit and loss statement, and that they must provide the data necessary for the summaries of these statements. Classifications may be made from many different viewpoints and for many different purposes, but a classification which is logical and carries titles clearly indicating the purpose for which the accounts are intended, and which therefore needs little or no explanation, is a satisfactory classification. The three-group classification—assets, liabilities, and proprietorship—meets these requirements.

A two-group classification—real and nominal—is frequently used. Under this classification, asset and liability accounts are grouped as real, and proprietorship accounts comprise the nominal class. This is the standard classification. The student should be familiar with it, although the meaning of the groups is not so apparent as in the case of the three-group classification, referred to above.

=Classifying Business Transactions.=—When making the record of business transactions on the books of account, it is necessary, first, to determine the main account group or groups affected by the transaction. After this is done, it is usually easy to determine which particular account in the group is affected. Great care must be used in the determination of the main groups, since a wrong classification results in an incorrect showing in the summary statements at the close of the fiscal period.

To illustrate, in Chapter XIII reference was made to the fundamental distinction between capital and revenue expenditures. When making the original entry of some transactions this difference is frequently lost sight of and what should be charged to an asset account is charged to some expense account or vice versa. This charging to an asset account, of items which are rightly expense items and therefore cut down the proprietorship element of the business, is one of the easiest ways of inflating the profits for a period and so of making a better showing than would be the case if the facts were recorded correctly.

Correct classification of transactions is a matter of vital importance. An accurate analysis of every transaction must therefore be made before bringing it on the books. After determining the main group of accounts in which record is to be made, further analysis as indicated above is necessary in order to fit a particular transaction into its place under a suitable account title belonging to the main group.

=Detailed Classification.=—In dealing with account classification, the more detailed groupings must also be considered. Such consideration deals, (1) with account titles in detail and even with the kinds and classes of transactions to be recorded under particular titles, and (2) with the arrangement and use of these detailed accounts in the various sections of the summary statements at the close of the fiscal period. Certain broad principles have already been laid down which are to be followed in the selection of the account title, and the objection to the inclusion of unlike items under the same title, and the care to be exercised against a more detailed analysis than is required by the needs of the business, have also been explained. That system of accounts which groups only one kind of data under each particular account title is better than a system which mixes its records by grouping dissimilar data under a single head. Yet, caution is always to be exercised against too great detail and an unnecessary multiplication of accounts. Oftentimes essential facts and forces of business activity are lost sight of in a maze of detail.

Below is given a somewhat detailed classification of accounts in accordance with the two considerations stated above. No attempt is made at completeness; only the more usual titles are presented. This classification will be used throughout the rest of the volume.

CHART OF ACCOUNTS Asset Accounts

CURRENT Cash Petty Cash Notes Receivable Accounts Receivable Reserve for Doubtful Accounts Merchandise Inventory Stocks and Bonds (for current investment) Accrued Income DEFERRED CHARGES TO OPERATION Shipping Supplies Insurance Interest Office Supplies Etc.

FIXED Furniture and Fixtures Depreciation Reserve Furniture and Fixtures Delivery Equipment Depreciation Reserve Delivery Equipment Buildings Depreciation Reserve Buildings Good-Will Etc.

Liability Accounts

CURRENT Notes Payable Accounts Payable Dividends Payable Accrued Expenses

DEFERRED INCOME Rentals Interest Subscriptions Etc.

FIXED Mortgages Payable Long-Time Notes Payable Bonds Payable Debentures Etc.

Proprietorship Accounts

VESTED Proprietors, Capital Proprietors, Personal Capital Stock Surplus (Profit and Loss) Reserves of Profit (not valuation items)

TEMPORARY Income, Operating Sales Sales Returns and Allowances

Cost of Sales: Initial Inventory Purchases Inward Freight and Cartage Purchases Returns and Allowances Final Inventory

Expenses, Operating Selling Expenses Salesmen’s Salaries and Commissions Salesmen’s Traveling and Entertainment Expenses Delivery Expense (wrapping, shipping room, horse and motor expenses, delivery salaries, etc.) Outward Freight Sales Management Salaries and Expense Advertising Depreciation on Salesroom Equipment, Delivery Equipment, etc. Sundry Selling Expenses

General Administrative Officers’ Salaries General Salaries Stationery and Printing Legal Expense Postage Telephone and Telegraph Sundry Office Expense and Supplies Depreciation on Office Building, Equipment, etc. Light, Heat, and Power Taxes Insurance Financial Management Expense and Income Interest Expense Rent Bad Debts Sales Discount Collection Expenses Interest Income Purchase Discount Non-Operating Expense Non-Operating Income

The items in italics in this chart are to be handled as subtraction items from the account below which they are placed or from the group in which they appear.

Light, heat, and power expense should in strict theory be distributed over the departments using it; the selling department to be charged with its share and the general administrative with its share. Where such procedure is difficult or undesirable, the expense is best classified as above.

These items are sometimes distributed partly to Selling and partly to General Administrative where an equitable basis for distribution can be determined.

These items are sometimes distributed partly to Selling and partly to General Administrative where an equitable basis for distribution can be determined.

=Method of Arranging Accounts in the Ledger.=—As to the order of arrangement of accounts in the ledger, one principle governs: Arrange all accounts in such a manner as to facilitate the drawing up of the final statements. Thus, assets should come first, arranged in the degree of their liquidity or availability, and each valuation account following its particular asset. Liabilities, coming as they do after the asset accounts, should be arranged in a similar order. Next should come the proprietor’s accounts, the summary Profit and Loss account, and the income and expense accounts in the order in which they are to be used in the statement of profit and loss. Where only one ledger is kept, the personal accounts receivable and payable are usually recorded in distinct groups, after all the other accounts, towards the back part of the ledger rather than in the position required by the principle just stated.

A trial balance taken from a ledger in which the order of arrangement of the accounts is strictly in accordance with this principle, is called a “classified trial balance.”