DEBIT AND CREDIT AS APPLIED TO MIXED ACCOUNTS
=Mixed Accounts Defined.=—In the course of business operations certain
accounts which at the beginning of the period belong definitely to
some one of the three groups, asset, liability, and proprietorship,
with the progress of the period take on a mixed character. That is,
included under one account title there is a mixed record of asset and
expense, or other combination of two or more groups. For example, the
machinery which belongs to the asset group at the beginning of the
period depreciates in value day by day, both through use and the lapse
of time. This daily decrease in value is of slight amount and in the
management of the business it is not necessary that it be shown on the
books. While it is theoretically possible to record this daily loss,
practically nothing would be gained by so doing. Hence, the machinery
account is allowed to carry both the asset value of the machinery at
a given time and the amount of its depreciation. Only periodically,
usually at the close of each fiscal period, is the account separated
into its two parts, the one which shows the true asset value and the
other which indicates the amount of depreciation and which is therefore
the expense or proprietorship-decrease portion of the account.
In the previous chapter the way in which the Merchandise account takes
on a mixed character was briefly explained. It was shown that the
credit side reflected both a decrease of the asset and an increase of
the proprietorship by the amount of the gross profit on the goods sold.
Thus, because of the way in which accounts are kept practically, as
distinguished from a theoretically correct method, which would maintain
at all times a sharp line of division between assets, liabilities, and
proprietorship, certain accounts are allowed to become mixed. It is
the purpose of this chapter to discuss the proper handling of the more
common mixed accounts.
=Analysis of a Sale Transaction.=—The impracticability of immediately
separating each sale of goods into its two elements of cost and profit
and the taking of a physical inventory as a means to this end, was
discussed in Chapter VI. The necessity for this later separation may be
made clear by analyzing a sale transaction.
Suppose an article costing $10 is sold for $12. At the time of its
purchase a debit was made to Merchandise account and a credit, say, to
Cash. When the article is sold, it would seem that the credit should be
to Merchandise to show the decrease in that asset. However, in the sale
price of $12 is included something more than the amount by which the
stock of merchandise is decreased. This additional amount is the profit
of $2. Hence, a credit to Merchandise of $12 would result in too large
a subtraction from the asset Merchandise, if it is intended that the
Merchandise account shall always show by its balance the value of the
unsold stock. Theoretically the best method of entering this sale would
be to debit Cash for $12, and to credit Merchandise with $10 and Profit
with $2.
=The Old Merchandise Account, Its Content and Significance.=—It is
impracticable, however, to compute and record the cost of every unit
sold. Using the above illustration, instead of crediting Merchandise
with $10 and Profit with $2, the entire $12 may be credited to the
Merchandise account. There is a disadvantage in this procedure, in
that the Merchandise account then no longer represents the one asset
Merchandise, but is a mixture of an asset element, merchandise, and a
proprietorship element, profit; two elements which must be separated at
the close of the period.
Originally, the Merchandise account was kept in this way; it was a
_mixed_ account and followed the rules of debit and credit as shown
below, the amounts being given for purposes of illustration:
(A) MERCHANDISE
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_Debit_: | _Credit_:
(1) For goods on hand | (a) For sales 25,000.00
at beginning 10,000.00 | (b) For returned
(2) For purchases, | purchases 2,000.00
sometimes including | (c) For purchases
freight-in, | rebates and
drayage-in, | allowances 100.00
etc. 20,000.00 |
(3) For returned sales 1,000.00 |
(4) For sales rebates |
and allowances 500.00 |
Where the account is kept in this manner it is usually burdened with
the additional data listed under (3), (4), (b), and (c). Sales being
a credit item, it is plain that subtractions from sales (3) and (4),
must appear on the debit side, and, purchases being a debit item,
subtractions from purchases (b) and (c) must appear on the credit
side. If these subtractions were actually performed instead of being
indicated in the account, the debit side would show net goods to be
accounted for, viz., goods on hand at the beginning, $10,000, plus
_net_ purchases, $17,900, making a total of $27,900; and the credit
side would show _net_ sales, $25,000 minus $1,500, or $23,500.
If, now, the cost value of the goods on hand at the close of the
period (as determined by a physical inventory) equals $8,000, it is
evident that the cost price of the goods sold is equal to the cost
value of the goods to be accounted for, minus the cost value of the
goods left on hand, that is, $27,900 minus $8,000, or $19,900. To
secure this subtraction within the account, it is necessary to enter
on the credit side this $8,000, the cost value of the final inventory.
Accordingly, an additional credit item (d) is inserted, after which the
account will show:
(B) MERCHANDISE
==================================================================
_Debit_: | _Credit_:
(1) For goods on hand | (a) For sales 25,000.00
at beginning 10,000.00 | (b) For returned
(2) For purchases, | purchases 2,000.00
sometimes including | (c) For purchases
freight-in, | rebates and
drayage-in, | allowances 100.00
etc. 20,000.00 | (d) For goods on hand
(3) For returned sales 1,000.00 | at end 8,000.00
(4) For sales rebates |
and allowances 500.00 |
The account is now a pure proprietorship account, the balance showing
the gross profit on sales, amounting to $3,600.
=Modern Practice in Showing Merchandising Transactions.=—Actual
subtraction, however, within the account is contrary to the method of
showing subtractions in the account. Therefore, the mixed Merchandise
account cannot show the figures representing “net purchases,” “net
sales,” “total goods to be accounted for,” and “cost of goods
sold”—information which is very essential to proper management. While
containing all the data necessary to give the final information, viz.,
the “gross profit,” the mixed account does not show the separate
factors leading up to it. Analysis of the mixed account is necessary to
find the elements of which it is composed. The best accounting practice
provides for this analysis as the transaction takes place. The old
Merchandise account is no longer used; in its place separate accounts
are set up to represent the various elements mentioned above. Each
account thus contains only one kind of item as indicated by its title.
These accounts are:
(1) MERCHANDISE INVENTORY
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(2) PURCHASES
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(3) INWARD FREIGHT AND DRAYAGE
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(4) RETURNED PURCHASES
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(5) PURCHASES REBATES AND ALLOWANCES
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(6) SALES
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(7) RETURNED SALES
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(8) SALES REBATES AND ALLOWANCES
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Accounts (1), (2), (3), (7), and (8) correspond to the four classes of
debits shown above in the mixed Merchandise account, and accounts (1),
(4), (5), and (6) correspond to the credits. Explanation of the use
of account (1) for both the initial and final inventories is given in
detail in Chapter XV.
The advantage of the use of these accounts instead of the one
Merchandise account is in the availability of the information they
contain and in the saving of labor, because now there is no need to
analyze the Merchandise account for information relating to returns,
allowances, and so forth. By later transferring the totals of the
Returned Sales and of the Sales Rebates and Allowances to the Sales
account, the balance of this account will show the “net sales.” A
similar transfer of the Inward Freight and Drayage, the Returned
Purchases, and the Purchases Rebates and Allowances to the Purchases
account, and a transfer to it of the initial and final inventories,
make it show by its balance the “cost of goods sold” which set over
against “net sales” shows the figure of “gross profit.”
The student will understand that the use of these detailed accounts
does not free the record of merchandise transactions from the mixture
of different elements, decrease of the asset and increase of the
profits. It does, however, make the record more valuable because of the
information it makes available.
=Accounts with Assets Subject to Depreciation.=—Another kind of mixed
account requiring explanation is that of the fixed asset subject to
depreciation. Due to ordinary wear and tear, and some other causes,
most fixed assets lose part of their value as time goes by. At the end
of each fiscal period the amount of this loss and the present value of
the asset must be estimated, after an inventory has been taken, when
necessary, of their number, weight, or other units of measurement.
Such an estimate is called an appraisal. The difference between the
present appraised value of the asset and its former cost or appraised
value constitutes the loss from wear or other causes, and is termed
depreciation.
Since depreciation takes place day by day, but for practical reasons
cannot be recorded daily, fixed asset accounts, as they stand valued
in the ledger, represent true asset values only for the date of their
entry. Except on that date, these accounts, then, include depreciation
and hence are mixed accounts including both asset and proprietorship
elements. As with the Merchandise account, an adjustment is made
periodically to separate the two elements. Since the asset account is
a debit account, entry of the amount of the depreciation to the credit
side would result in the account showing, by its balance, the appraised
value of the asset at any given time. It is, however, desirable to
leave the account in its original condition, in order not to lose sight
of the cost of the asset. Therefore the usual practice is to enter this
figure of depreciation to the credit side of a separate account called
Depreciation Reserve for the particular asset, using the word “reserve”
in the sense of “estimate.”
If the latter method is followed, each asset has two accounts, one
showing original cost and the other estimated depreciation, and it is
necessary for a true valuation of the asset to read the two accounts
together; that is, from the asset account showing original cost, the
amount credited to the reserve account must be deducted to show the
true value of the asset. Because of this, the reserve account is often
called a valuation account or an offset account, as it gives the amount
of the offset to the original asset account necessary to show its
correct value. Similarly, when an increment in the value of an asset is
kept separate from its face or par value—as when the premium paid for
stock or bonds is shown separately from the par value of the stock or
bonds—the account showing the increment is called an adjunct account
and must be read with the asset account to secure true valuation. The
offset account, then, is a subtraction item and the adjunct an addition
item to the corresponding asset account. The showing of the asset and
its periodic valuation is made as follows:
MACHINERY
=================================================================
1921 |
Jan. 1 5,000.00 |
DEPRECIATION RESERVE MACHINERY
=================================================================
| 1921
| Dec. 31 500.00
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| 1922
| Dec. 31 500.00
A reading of the two accounts taken together shows the original value
of machinery as $5,000, the value after one year’s use $4,500 and after
two year’s use $4,000. The contra debit for the credit in the reserve
account is made to an account called Depreciation, which represents
the expense of the depreciation for the period, that is, the deduction
from profit or proprietorship. Sometimes, this charge is made direct to
Profit and Loss, as will be shown in a later chapter.
=Capital and Revenue Expenditures.=—The fixed asset accounts usually
show the investment of some of the original capital and therefore are
sometimes called capital asset accounts. A fundamental distinction
must be made between expenditures for the purchase and installation of
the asset itself and expenditures for expenses in connection with its
repairs, maintenance, and upkeep. These two classes of expenditures
are usually called “capital expenditures” and “revenue expenditures”
respectively.
The asset account itself is chargeable with all costs incurred up to
the point of putting the asset in shape for use in the business. It may
be charged also with subsequent expenditures resulting in an increase
in its value. Expenditures, however, which are for the purpose of
repairs or of keeping the property from too rapid depreciation without
adding anything to its original value, must be charged to a properly
labeled _expense_ account. These revenue expenditures for expenses,
such as repairs, maintenance, upkeep, together with depreciation, are
subtractions from profit and proprietorship, while asset expenditures
usually constitute an exchange of the asset cash for some other asset,
which exchange has no effect on proprietorship.
Sometimes two items of expenditure are seemingly of the same nature,
while in fact they belong to separate groups, as the original painting
cost of a building and the cost incurred later for repainting. In the
first instance the expenditure is an asset, a part of the original
cost necessary to put the building in a finished condition; in the
other instance, it is an expense necessary to maintain the asset in
something near its original condition. In order to secure accuracy
in the records, careful discrimination between capital and revenue
expenditures is a matter of great importance.