THE ACCOUNT (Continued)
=The Balance of the Account.=—As stated in Chapter VIII, the account
is divided into two sections, a left and a right, for the purpose of
separating items relating to the same account which are dissimilar,
and thus affording a comparison between the totals of these dissimilar
groups. An account containing dissimilar items may have the same total
on both sides, in which case it is said to balance, i.e., the class of
items on one side exactly balances or cancels those on the opposite
side; or one side of the account may be larger than the other, in which
case the amount of the excess is called the “balance” in the account,
or of the account. An account takes its nature or classification from
the larger side, on which the balance appears. The account balances are
shown in summarized form on the balance sheet or the profit and loss
statement.
=The Account Title Indicative of Its Classification.=—The account
title or name should be so plain as easily to indicate its main
classification. The two main classes of accounts are, as stated above,
those relating to assets and liabilities, or property—things owned and
things owed; and those relating to proprietorship—those showing the
increases or decreases in net worth. The title of an account should
clearly indicate whether the account belongs to the asset or liability
class, or to the proprietorship class.
The accounts called Cash, Accounts Receivable, Mortgages Payable,
Accrued Wages, clearly show assets and liabilities; while those
entitled Sales, Rent Income, Wages, Expenses, indicate factors
affecting proprietorship.
=The Meaning of Account Balances.=—In the asset accounts the larger
side, and therefore the balance of the account, is normally on the
left, i.e., the balance of Cash, Land, Buildings, Furniture and
Fixtures, Notes Receivable, and the like are normally left-side
balances. It follows, therefore, that all entries showing the
acquisition or increase of assets are made on the left side of their
accounts, and all entries showing the disposal or decrease of assets
are made on the right side of the accounts. Very seldom are the
cancellations listed on the right side in excess of the assets listed
on the left.
In the liability accounts the balance is normally on the right side
because liabilities are subtraction items from the assets and should,
therefore, normally be on the opposite side of the account. Notes
Payable, Accounts Payable, Mortgages Payable, Interest Payable, Rent
Payable, and the like, have normally right-side balances. It follows,
therefore, that all entries showing the assumption of liabilities are
made to the right side of the account, and all entries showing the
cancellation of these liabilities are made on the left side. Rarely are
liability cancellations in excess of the liabilities owed.
As will be explained in Chapter XII, in the group of accounts
indicating decreases in proprietorship, the balance, or larger side, is
normally on the left; in the group showing increases in proprietorship
the balance is normally on the right. The balances of the accounts,
Wages, Salaries, Rent Expense, and all other expenses, are normally
left-side balances. It follows, therefore, that entries showing the
cost of such expenses to the business are made on the left side of
suitably named expense accounts, and entries showing a reduction in
the expenses are made on the right side. Items for wages, for example,
are shown on the left side of the Wages account, and any subtractions
because of overpayment or for other reasons, are shown on the right
side of the account.
The balances of the accounts Sales, Rent Income, Interest Income, and
other kinds of income, are normally right-side balances. From this it
follows that entries showing income are made on the right side of a
suitable account, and entries indicating a reduction or subtraction
from the income shown are made on the left side of the account. For
example, income from sales is shown on the right side of the Sales
account, while any reduction of that income, as when goods are returned
by customers, is shown on the left side.
Knowing, therefore, to what main class each account belongs—asset,
liability, expense, or income—one always knows on which side the
balance is normally, and also that the items on the opposite side are
subtraction items. Subtraction can be shown in the account only by thus
separating dissimilar items.
=Relation of the Account to the Financial Statements.=—The equation
of the balance sheet is the equation of the ledger. The fundamental
proprietorship equation is written in two ways:
(1) Assets - Liabilities = Proprietorship
(2) Assets = Liabilities + Proprietorship
The ledger (that is, the accounts in the ledger) is constructed in
accordance with the second form of the proprietorship equation. In
it are found all the accounts of the business, which are included
under the classes Assets, Liabilities, and Proprietorship. Under
Proprietorship are the subgroups: (a) Net Worth, or capital at the
beginning of the period, and (b) Current Profit or Loss. The Current
Profit or Loss is in turn shown by the two groups of accounts: (1)
Income, and (2) Expense. This classification of the accounts and their
relation to the balance sheet are illustrated graphically in the chart
shown in Form 2.
The asset accounts have net left-side balances, as previously
explained. Hence, if all the detailed accounts which record assets are
brought together, the sum total of the left-side balances of these
accounts will represent the total assets of the business. Liability
accounts have right-side balances, as also explained. Therefore, if all
the accounts that record the liabilities of the business are brought
together, the sum total of their right-side balances will represent
the total liabilities of the business. The proprietorship accounts
have right-side and left-side balances. The _net total_ of all the
proprietorship accounts will be a right-side balance, however, and will
show the present net worth of the business.
[Illustration: Form 2. Chart of Accounts]
Accordingly, when one views the accounts in the ledger in
their fundamental groupings—namely, assets, liabilities, and
proprietorship—it is seen that the equation of the balance sheet is
also the equation of the ledger. The account is thus seen to be an
integral part of the balance sheet. It is so arranged, however, as to
sort and handle additions and subtractions and to furnish a net result
for use in the balance sheet.
The asset portion of the proprietorship equation is in the ledger
broken up into the various kinds of assets, record of which is
desirable and necessary for purposes of adequate control of the
business. In keeping the record, all the transactions affecting—that
is, either adding to or subtracting from—a given asset are recorded
in the account kept with that asset. In this way each account brings
about a sorting of the transactions affecting it. It separates these
transactions into two kinds, those which add to and those which
subtract from its value, and by means of its net balance at any given
time it summarizes the numberless transactions which have affected it
during a period and gives a net result showing its present status.
In much the same way the liability item of the proprietorship equation
is broken up in the ledger for purposes of detailed information, into
a large number of individual liability accounts. The sum total of the
balance of these accounts is the liability item of the proprietorship
equation.
The proprietorship section of the equation is a little more complex
when split up, as it is in the ledger. In accordance with the chart
given in Form 2, it will be seen that proprietorship is classified
in the two main groups: (1) capital at the beginning of the period,
and (2) changes of capital during the period. It is this latter group
of accounts which, as they are carried in the ledger, have both
right-side and left-side balances. The income accounts, which tend
to increase capital and which, when merged with the capital accounts
at the beginning of the period, add to that capital, have right-side
balances. The accounts which tend to decrease capital, that is, the
expense accounts, because they are subtraction items, have left-side
balances. The net increase (or decrease) in capital for the period is
the excess (or deficit) of the total income accounts over the total
expense accounts. The summarized result therefore of current changes in
capital added to the capital at the beginning of the period, gives the
proprietorship of the business at any given time.
At the beginning of a business enterprise the accounts in the ledger
will be an opening balance sheet of the business. Day by day by day as
transactions take place, there will be a constant change in the values
of the assets, liabilities, and the proprietorship account which will
thus express the changing financial condition of the business. Some
assets will be increased while others will be decreased; liabilities
will also change; and with these changes there will be brought about
a change in proprietorship—an increase or a decrease. The ledger must
record these changing values as they take place, so that the condition
of the business can be determined practically at any time.
The ledger is thus seen to contain and comprise the balance sheet
of the business at all times. Certain groupings, summarizations,
and adjustments may be necessary before a balance sheet technically
correct as to form and content can be taken from the ledger, but the
fundamental balance sheet equation is always contained in the ledger.
This is pictured graphically in the chart shown in Form 2. A further
consideration of the relationships between assets, liabilities,
and proprietorship leads us to an explanation of the principles or
philosophy of debit and credit, a matter which will be taken up in the
next chapter.