the agreement is entered into, the name of the contracting parties,
the name by which the partnership is to be known, and the address of
the place of business. Following should be a statement of the nature
of the business, the amount and form of investment of each partner,
the duration of the partnership, the basis of division of profits,
provisions for the dissolution of the partnership, definition of
the duties of active partners, and a provision for the division of
the assets in the event of dissolution or at the termination of the
partnership.
=31. Kinds of Partners.= Partners are of different kinds, depending
on the nature of the partnership agreement and the extent of their
liability, expressed or implied, as between themselves or in respect
to third persons. The usual classification of partners is as follows:
_ostensible_, _secret_, _nominal_, _silent_, and _dormant_.
Ostensible partners are those whose names are disclosed to the public
as actual partners.
Secret partners are those whose names are not disclosed to the public,
though participating in the profits.
Nominal partners are those who allow their names to be used as
partners, though they may have no actual interest in the business.
The fact of their being known as partners makes them liable to third
parties.
Silent partners are those who, while sharing in the profits, take no
active part in the management of the business. Their names may or may
not be known. Silent partners may also be secret partners,
Dormant partners are those, who are both silent and secret partners.
They are usually included in a general term like _Company_, _Sons_, or
_Brothers_.
=32. Participation in Profits.= The most simple partnership from an
accounting standpoint is one in which the investments of the several
partners are equal, and profits are to be divided equally.
This condition does not exist in all partnerships. The members of the
partnership may invest unequal amounts and share in the profits on the
basis of their investment. The investment may be equal, but one partner
may receive an extra share of the profits in return for work performed
in lieu of a salary. The investment may be unequal, but the one with
the smaller investment may share equally in the profits in return for
work performed. It is not unusual for a silent partner to furnish all
of the capital and share equally in the profits with an ostensible
partner who assumes full responsibility for the management of the
business.
=33. Interest on Investment.= When the investment of the partners is
unequal, it is customary to allow interest on the capital invested and
to charge interest on all withdrawals. The interest on capital must
be credited, and the interest on withdrawals must be charged, before
profits can be distributed.
=34. Capital and Personal Accounts.= In a partnership a special
account should be opened in the name of each partner to represent his
investment (for example, John Smith, Capital). To this account is
credited his net investment. When the books are closed, the account
is credited with his share of the profits, and debited with his
withdrawals.
A personal account should be opened in the name of each partner, to
which is debited all withdrawals, either of money or goods. Even when
the capital invested is equal, some partnership agreements provide
that interest shall be charged on all withdrawals, particularly when
the business is of such a nature that goods traded in are likely to be
withdrawn by the partners, or when, for any reason, withdrawals are
likely to be unequal. The balance of the partner's personal account
is closed into his capital account when the books are closed. Before
closing this account, it should be credited with interest on capital
account and charged with the interest provided on withdrawals.
=35. Opening the Books.= When the books of a partnership are opened,
the essential features of the partnership agreement should be written
at the top of the first page of the journal. Next following the
partnership agreement, are the entries showing the nature and amount of
the investment of each partner, the amounts being posted to the credit
of partners' capital accounts.
=36. Closing the Books.= When the books of a partnership are to be
closed, the revenue accounts are closed into trading and profit and
loss, the same as in any other form of business organization. The net
profit is then apportioned according to agreement, the share of each
partner being credited to his capital account. The balance of his
personal account is then carried to his capital account; the balance of
that account will then show his net investment.
=Illustration of Closing Entries.= A, B, and C form a partnership, each
investing $1,000.00, profits to be shared equally. When the books are
closed, the net profits are found to be $909.60. A's personal account
shows a debit balance of $46.50; B's personal account shows a credit
balance of $100.00; C's personal account shows a credit balance of
$52.00. The entries are as follows:
Profit and Loss $909.60
To A, Capital _a/c_ $303.20
" B, " " 303.20
" C, " " 303.20
A, Capital _a/c_ 46.50
A, Personal _a/c_ 46.50
B, Personal _a/c_ 100.00
B, Capital _a/c_ 100.00
C, Personal _a/c_ 52.00
C, Capital _a/c_ 52.00
The capital accounts after closing are:
A, CAPITAL _a/c_
Dec. 31, Bal. personal _a/c_ $46.50 $1,000.00 Jan. 1
Balance 1,256.70 303.20 (1/3 profits) Dec. 31
-------- --------
$1,303.20 $1,303.20
========= =========
$1,256.70 net invest. Dec. 31
B, CAPITAL _a/c_
Dec. 31, Balance $1,403.20 $1,000.00 Jan. 1
303.20 (1/3 profits) Dec. 31
100.00 pers. _a/c_ Dec. 31
-------- --------
$1,403.20 $1,403.20
========= =========
$1,403.20 net invest. Dec. 31
C, CAPITAL _a/c_
Dec. 31, Balance $1,355.20 $1,000.00 Jan. 1
303.20 (1/3 profits) Dec. 31
52.00 pers. _a/c_ Dec. 31
-------- --------
$1,355.20 $1,355.20
========= =========
$1,355.20 net invest. Dec. 31
SAMPLE TRANSACTION
=37.= The first business taken up for consideration under the head of
partnerships is a retail shoe business. The stock is kept in three
classes: men's, women's, and children's shoes. Purchase and sales
books, ruled to segregate transactions of each class, are used. The
bank account is kept in the cash book, which is also provided with two
columns for discount. All sales, whether for cash or on account, are
recorded on sales tickets.
James Benton, Horace Douglas, and Henry Kemp form a partnership under
the firm name of Benton, Douglas & Kemp, for the purpose of conducting
a retail shoe business in Buffalo, N. Y. The date of the agreement,
which is to continue for ten years, is March 1, 1908. James Benton
invests $1,000.00 in cash and a stock of shoes inventorying $2,000.00
as follows: men's, $800.00; women's, $700.00; children's, $500.00.
Horace Douglas and Henry Kemp each invest $3,000.00 in cash. The three
partners are to share equally in the profits and each is to receive a
salary of $100.00 per month. The books are to be closed and net profits
divided at the end of each three months' period counting from January
1, which brings the first distribution on March 31.
The following transactions are recorded during the month of March:
--March 1--
Deposited in Second National Bank $7,000.00
--March 1--
Bought from National Fixture Co.
Store fixtures 2,000.00
Invoice #1
--March 1--
Bought from John C. Morrison, Buffalo
Men's shoes 135.00
Invoice #2
--March 1--
Bought from Hoyt & Co., Rochester, N. Y.
Women's shoes 127.50
Children's shoes 84.00
------
211.50
Net 60; 2% 10.
Invoice #3
--March 2--
Sold to R. H. Wallace, 842 Delaware Av.
1 pr. men's shoes 6.00
1 pr. men's slippers 2.50
------
8.50
--March 2--
Sold to D. H. Lyon, 416 Niagara St.
1 pr. women's 3.50
1 pr. women's 4.00
1 pr. children's 2.00
------
9.50
--March 2--
Sold to Henry Norris, 297 Madison Av.
1 pr. men's 5.00
1 pr. children's 1.25
1 pr. children's 1.50
------
7.75
--March 2--
Sold to R. H. Homans, 427 Lafayette Av.
1 pr. women's 5.00
--March 2--
Sold for cash
Men's 44.00
Women's 37.50
Children's 22.00
------
103.50
--March 3--
Sold to H. J. Watson, 197 Locust St.
2 pr. men's 15.00
1 pr. women's 5.50
------
20.50
--March 3--
Sold to H. J. Meyer, 82 Bennett St.
1 pr. children's 1.50
1 pr. children's 2.00
1 pr. women's 3.50
------
7.00
--March 3--
Paid Hoyt & Co. bill by check
Less cash discount.
--March 3--
Deposited in Second National Bank 75.00
--March 3--
Paid freight on shoes in cash 2.60
--March 3--
Sold for cash
Men's 30.00
Women's 24.00
Children's 15.00
------
69.00
--March 4--
Bought from Lee & Co., Rochester
Women's shoes 140.00
Net 30.
Invoice #4
--March 4--
Sold to D. Andrews, 84 Peck St.
1 pr. men's 3.50
1 pr. men's 5.00
1 pr. women's 4.00
------
12.50
--March 4--
Sold to Jas. Hayes, 519 Washington St.
1 pr. women's 3.50
1 pr. children's 2.00
1 pr. children's 1.25
------
6.75
--March 4--
Sold for cash
Men's 27.00
Women's 32.00
Children's 12.50
------
71.50
--March 5--
Sold to R. D. Nelson, 842 Niagara St.
1 pr. men's 6.00
1 pr. women's 5.00
------
11.00
--March 5--
Sold to D. Needham, 47 Ames St.
1 pr. men's 3.50
1 pr. women's 2.50
1 pr. children's 1.50
------
7.50
--March 5--
Sold for cash
Men's 31.50
Women's 26.00
Children's 11.00
------
68.50
--March 6--
Deposited in Second National Bank 200.00
--March 6--
Sold to D. B. Wright, 47 Andrews St.
1 pr. men's 5.00
--March 6--
Sold to H. N. Hoyt, 821 Delaware Av.
1 pr. women's 5.00
1 pr. children's 2.50
------
7.50
--March 6--
Sold to Amos Wiggins, 92 Prospect St.
1 pr. men's 5.00
1 pr. women's 3.50
------
8.50
--March 6--
Sold for cash
Men's 52.00
Women's 36.50
Children's 18.25
------
106.75
--March 6--
Paid clerk hire, cash 9.00
--March 6--
Gave checks as follows:
Horace Douglas 20.00
Henry Kemp 25.00
--March 8--
Sold to D. Altman, 127 Wright St.
1 pr. men's 6.00
Gave him check 44.00
Credited his account for 1 mo.'s rent 50.00
--March 8--
Sold to R. H. Homans, 427 Lafayette Av.
1 pr. men's 6.00
--March 8--
R. H. Wallace paid his account in full.
--March 8--
Paid account of John C. Morrison by check
--March 8--
Sold for cash
Men's 25.00
Women's 18.00
Children's 10.50
------
53.50
--March 9--
Sold to Walter Jenks, 87 South Av.
1 pr. men's 6.00
1 pr. women's 4.00
1 pr. children's 2.00
------
12.00
--March 9--
Sold to D. W. Mantel, 419 Delaware Av.
1 pr. women's 5.00
1 pr. children's 2.50
------
7.50
--March 9--
Sold to D. C. White, 1160 Main St.
1 pr. men's 5.00
1 pr. men's 3.50
------
8.50
--March 9--
Sold to A. R. Crows, 40 Shaw St.
1 pr. women's 3.50
--March 9--
Sold for cash
Men's 54.00
Women's 41.50
Children's 20.50
------
116.00
--March 9--
Deposited in Second National Bank 275.00
--March 10--
Sold to Henry Brown, 87 Douglas St.
1 pr. men's 6.00
1 pr. women's 4.00
------
10.00
--March 10--
Sold to D. L. Benedict, 80 Adams St.
1 pr. women's 3.50
1 pr. children's 2.00
1 pr. children's 1.50
------
7.00
--March 10--
Sold for cash
Men's 48.50
Women's 39.00
Children's 16.50
------
104.00
--March 11--
Sold to D. H. Lyon, 416 Niagara St.
1 pr. men's 6.00
--March 11--
Received from Henry Norris, cash 7.75
--March 11--
Sold to D. B. Wright, 47 Andrews St.
1 pr. women's 3.50
1 pr. children's 2.00
------
5.50
--March 11--
Sold to H. J. Meyer, 82 Bennett St.
1 pr. men's 3.50
--March 11--
Sold for cash
Men's 42.00
Women's 39.50
Children's 11.00
------
92.50
--March 12--
Deposited in Second National Bank 195.00
--March 12--
Sold to D. L. Benedict, 80 Adams St.
1 pr. men's 5.00
--March 12--
Sold to H. A. Fisher, 42 Lyons St.
1 pr. women's 4.00
1 pr. children's 1.50
------
5.50
--March 12--
Sold to Andrew Winters, 476 Delaware Av.
1 pr. men's 6.00
1 pr. children's 2.50
------
8.50
--March 12--
Sold for cash
Men's 51.50
Women's 43.00
Children's 17.75
------
112.25
--March 13--
Bought from Rochester Shoe Co., Rochester
Men's shoes 265.00
Women's " 220.00
Children's " 98.50
------
583.50
Net 30; 2% 10.
--March 13--
Sold to D. Altman, 127 Wright St.
1 pr. women's 4.00
1 pr. children's 2.50
1 pr. children's 2.00
------
8.50
--March 13--
Sold to D. Alton, 46 Eastern Av.
1 pr. men's 5.00
1 pr. women's 3.50
------
8.50
--March 13--
Sold for cash
Men's 67.00
Women's 52.00
Children's 29.00
------
148.00
--March 13--
Paid clerk hire 9.00
Henry Kemp wishes to retire from the business. His partners, Benton and
Douglas, agree to pay him cash for his interest. To close the books,
each partner is credited with one-half a month's salary, and the amount
is charged to expense. The inventory shows the stock to be:
INVENTORY
Men's shoes $759.75
Women's 835.75
Children's 519.00
--------
$2,114.50
[Illustration: Journal Showing Opening Entries for a Partnership]
[Illustration: Cash Book with Center Column for Particulars]
[Illustration: Departmental Sales Book]
[Illustration: Departmental Sales and Purchase Books]
[Illustration: Classified Ledger Accounts]
[Illustration: Classified Ledger Accounts]
[Illustration: Classified Ledger Accounts]
[Illustration: Classified Ledger Accounts]
[Illustration: Classified Ledger Accounts]
[Illustration: Classified Ledger Accounts]
[Illustration: Classified Ledger Accounts]
[Illustration: Classified Ledger Accounts]
[Illustration: Classified Ledger Accounts]
EXERCISE
=38.= 1. Submit a trading and a profit and loss account as shown by the
books at the close of business March 13.
2. What errors do you find in these books?
3. Submit a balance sheet.
4. Submit the journal entries to be used in apportioning the profits,
and in closing partner's personal account. Show partners' capital
accounts after final closing.
5. Submit proper entries when Kemp's interest is purchased, assuming
that he is paid by check from the funds in hand.
6. Submit trial balance of ledger of Benton & Douglas as the accounts
appear after the purchase of Kemp's interest. Remember that no
additional capital is invested.
=39. Sale of Partnership.= When the business of a partnership is
sold, the net assets must be divided among the partners according to
agreement, unless the partnership is to continue for the transaction of
the same or some other class of business. As a rule, the liabilities
are paid (if possible), from the cash funds on hand, leaving the net
assets for division.
In the division of assets, one partner will frequently agree to accept
a certain class of assets in lieu of cash, but at a discount. To
illustrate, one partner might accept fixtures, which cost $1,000.00, at
10% discount. Deducting 10% from the cost price of the fixtures reduces
the assets just that amount, and it is necessary to debit profit and
loss and to credit fixture account, with the loss.
If any class of assets, other than the goods in which the firm is
trading, bring a price above cost, it is necessary to debit the
purchaser and credit profit and loss with the profit. If the stock
regularly traded in is sold at a profit, no special entry is required;
the sale is recorded in the regular way and credited to sales account,
from which it finds its way into profit and loss in the final closing
of the books.
This class of transactions involves but one of the many kinds of
adjusting entries, all of which necessitate careful study on the part
of the bookkeeper. In making adjusting entries, full explanations
should be given that their meaning or intent may not be misunderstood
by one who later refers to them. It is better to err on the side of
what may appear as too detailed explanation, than to leave anything to
be taken for granted.
Following is an illustration of the entry involving the sale of
fixtures at 10% discount:
Profit and Loss $100.00
Fixture Account $100.00
10% discount allowed on fixtures taken
by A in part payment of his share of
assets
A's Capital _a/c_ $900.00
Fixture Account $900.00
Fixtures taken at 10% discount in part
payment of his share of assets.
=40.= Benton and Douglas agree to continue the business and to share
profits equally. At the close of business, Dec. 31, their balance sheet
showed the following:
BALANCE SHEET, DEC. 31
_Assets_
Cash
In office $144.60
In bank 1,287.20 $1,431.80
--------
Accounts Receivable 810.00
Inventory, Merchandise 3,769.50 4,579.50
--------
Inventory, Fixtures 2,000.00 2,000.00
--------
Total Assets $8,011.30
_Liabilities_
Accounts Payable 925.20
--------
Present Worth $7,086.10
Benton's present worth $3,543.05
Douglas's present worth 3,543.05
They accept an opportunity to sell for cash the stock and fixtures, the
buyer agreeing to pay 15% above cost price for the merchandise, and
cost price for the fixtures. The money received from this transaction,
and the money in the office at time of sale, are deposited in the
bank. Checks are drawn to settle all accounts payable, $7.22 discount
being earned. In liquidating the business of the firm, Benton agrees
to accept the accounts receivable in part payment of his share, on
condition that 10% be first charged off to cover uncollectable accounts.
EXERCISE
1. Show all entries required to complete the liquidation of this
business.
2. At the final settlement, how much cash does each partner receive?
=41. Division of Profits.= When the investment of the several partners
is unequal, the partnership agreement usually provides for the
crediting of interest on capital, and the charging of interest on
withdrawals.
A and B form a partnership, and commence business Oct. 1. A invests
$7,000.00, and B invests $3,000.00. The agreement provides that
interest at 6% shall be credited on capital and charged on withdrawals
at the time of closing the books, profits to be shared on the basis of
their investments.
The books were closed Oct. 31, with the following results:
[Illustration]
[Illustration]
The adjustment is made as follows:
A's investment, $7,000.00 Interest for 30 days (1 month) $35.00
A's withdrawals 200.00 Interest for 15 days .50
--------
Net interest to be credited to A $34.50
B's investment, $3,000.00 Interest for 30 days $15.00
B's withdrawals, 100.00 Interest for 10 days .17
--------
Net interest to be credited to B $14.83
The journal entry is:
Interest $49.33
A's personal _a/c_ $34.50
B's personal _a/c_ 14.83
Net interest credited on capital accounts.
After posting the entry, our interest account shows the following:
Interest on capital $49.33
This account is, of course, closed into profit and loss, leaving net
profits to be divided, $954.67, of which A receives 70%, and B 30%.
For the final closing of the books, we would close the personal
accounts of A and B into their capital accounts, and close profit
and loss account into their capital accounts. In actual practice the
interest on withdrawals and investment would be entered and charged
to profit and loss through interest account, before the net profit
is brought down. In our illustration we have first brought down what
appears to be the net profit, for the purpose of emphasizing the fact
that the interest must be considered before profits are divided.
EXERCISE
=42.= C, D, and E formed a partnership Nov. 1. C invested $9,000.00
cash; D invested $7,000.00 cash; E invested $4,000.00 cash. The
partnership agreement provided that profits should be shared on the
basis of the capital invested by each; interest at 6% to be credited on
capital and charged on withdrawals.
At the close of business the following statistics are gathered from the
books:
C's Capital _a/c_ Cr. $9,000.00
D's Capital _a/c_ Cr. 7,000.00
E's Capital _a/c_ Cr. 4,000.00
Purchases Dr. 15,000.00
Sales Cr. 12,000.00
Expense Dr. 160.00
Rent Dr. 150.00
Salaries Dr. 700.00
Bank Dr. 7,250.00
Bills Receivable Dr. 6,000.00
Accounts Receivable Dr. 7,220.00
Bills Payable Cr. 3,000.00
Accounts Payable Cr. 2,820.00
C's personal _a/c_ Dr. Nov. 15 $300.00
D's personal _a/c_ Dr. Dec. 1 200.00
E's personal _a/c_ Dr. Nov. 20 100.00
Inventory Dec. 31 7,000.00
Make trading account, profit and loss account, and journal entries to
adjust interest.
Make balance sheet, and show partners' capital accounts after final
closing of the books.
[Illustration: A VIEW OF THE NEW YORK GENERAL OFFICES OF THE WESTERN
ELECTRIC COMPANY]
CORPORATION ACCOUNTS
CORPORATIONS
=1.= A corporation is an artificial body created by statute law
and vested with power to act in many respects as an individual--in
particular to acquire, hold, and dispose of property, real or personal;
to make contracts; to sue and be sued, and the like.
It is a legal entity apart from its members. It may sue without joining
its members, and may be sued by others without the necessity of joining
its members. It may transfer property and transact all business, not
inconsistent with the rights granted by its charter, in its own name.
In the transaction of business it is regarded as an individual.
CLASSIFICATION OF CORPORATIONS
=2.= Corporations may be divided into two general classes--public and
private. A _public_ corporation is a political entity organized for
the purposes of government--as a city, county, or village. A _private_
corporation is one organized to further the interests of its members.
These may be divided into two classes--stock corporations and non-stock
corporations.
A _stock_ corporation is one organized for the pecuniary gain of its
members.
A _non-stock_ corporation is one organized to further a particular
object--as clubs, charitable associations, societies for scientific
research, etc.
Stock or business corporations are the ones with which we are chiefly
concerned. Such corporations are organized to enable several persons
to unite their capital to conduct a legitimate business enterprise and
such organization accomplishes two important results; the rights of the
members to transfer their interest without affecting the standing of
the business, and exemption from personal liability for contracts or
acts of the corporation.
In a partnership, each individual partner is liable for the debts of
the partnership, and any partner can make contracts in the name of
the partnership, such contracts becoming obligations of net only the
partnership but of each individual partner.
A member or stock holder in a corporation is, as a rule, liable
only for the amount of his subscription to the capital stock of the
corporation. The exception to this is the organization of certain
classes of corporations in which it is provided that a stockholder
shall be liable for twice the amount of his stock subscription.
National Banks are examples of this class. No stockholder, as such, has
the right to make contracts in the name of the corporation, and any
contracts he may make are not binding on the corporation. Contracts
made in the name of the corporation, to be binding, must be executed by
an officer duly authorized to make such contracts.
=3. Joint Stock Companies.= _How distinguished from corporations._
A joint stock company is a large partnership in which the capital
is divided into shares which are distributed among the partners in
proportion to their interests. Joint stock companies differ from
corporations and are like partnerships in the following respects:
Each member is liable for the debts of the company, and if he sells his
shares he is still liable for the debts which were contracted while he
was a shareholder.
Except when otherwise provided by statute, all members must join in any
action at law by the company, and if another brings an action against
the company he must join as many shareholders as he wishes to hold.
In some states the law provides that an action against a joint stock
company may be brought in the name of its president or other designated
officer representing all the members.
=4. Joint Stock Companies.= _How like Corporations._ A joint stock
company is like a corporation and differs from a partnership in the
following respects:
The shares may be transferred. If a member dies his shares pass to his
estate; if bankrupt they pass to his assignee; if he sells his shares
they pass to the purchaser. Partners may withdraw and new partners may
be admitted without the dissolution of the company. A partnership is
dissolved by the withdrawal by death or otherwise of a single partner.
The shareholders do not manage the affairs of the company but elect
directors or other officers in whom the management of the business is
vested. Members, as such, have no authority to bind the company.
CREATION OF CORPORATIONS
=5.= A corporation is created by legislative act. Formerly each
corporation received a special charter from the legislature of the
state, but as the advantages of corporations began to receive universal
recognition it was seen that the delays incident to the granting of
special charters were bound to work a hardship on those desiring to
incorporate. Partly to overcome this, but more particularly to insure
uniformity in the rights and privileges of corporations, and to prevent
the conferring of special privileges through special charters, the
legislature of most states has enacted uniform corporation laws.
These statutes prescribe uniform regulations for the organization of
corporations. State constitutions now very generally prohibit the
granting of special charters to private corporations.
=6. Requirements.= While every state has its own corporation laws, the
requirements of corporations are in many respects uniform. The law
usually provides that a certificate of incorporation shall be filed
with the secretary of state, or some other designated officer. This
certificate must as a rule state:
The name of the corporation;
The place of business, where its principal office is located;
The objects of the corporation, including a statement of the business
in which it is to engage;
The amount of the capital stock, and the number and par value of the
shares into which it is to be divided;
The period for which the corporation is organized;
The number of its directors and the names of those who are to serve
at the outset;
The names and addresses of the original incorporators with the number
of shares of the capital stock subscribed for by each.
The form of the certificate required in the state of Illinois is shown
in the illustration, p. 4.
STOCKHOLDERS
=7.= The members of a business corporation are known as stockholders
or shareholders. At the time of organization the members subscribe for
the shares of the capital stock agreeing to take and pay for them when
issued. When the stock has been delivered and paid for, the stockholder
is under no further obligation, unless the stock is by statute or
contract subject to assessment.
[Illustration]
=8. Stock Certificate.= When a stockholder has paid for his shares
a certificate, known as a stock certificate, is issued to him. This
certificate is the written evidence issued by the corporation that the
person whose name appears therein is registered on the company's books
as the owner of shares of the number and par value named.
The owner of a stock certificate can transfer it, and the one to
whom it is transferred becomes a stockholder. Such transfers are not
complete, however, until registered on the books of the company. A
stock certificate is not, strictly speaking, a negotiable instrument,
but it is the custom among business men to indorse stock certificates
in blank and transfer them from hand to hand as negotiable instruments,
until some one inserts his own name and has the transfer registered on
the books of the company.
Such indorsement does not make a stock certificate a negotiable
instrument, and the purchaser can acquire no better title than is
possessed by the seller. Courts have held that the fact that a
certificate of stock is not payable to bearer makes it non-negotiable.
CAPITALIZATION
=9.= This is the term commonly used to designate the amount of
stock which the company is authorized to issue. It may have little
reference to the amount subscribed or paid in, for most states
authorize corporations to begin business as soon as a certain number
of shares have been subscribed for, or even when only a small part
of the subscriptions have been paid. For instance, a company with an
authorized capitalization of $100,000 may be permitted to commence
business as soon as $10,000 has been subscribed and $1,000 is actually
paid in.
=10. Capital and Capital Stock.= The _capital_ of a corporation is
usually understood to mean its assets, and is a general term covering
all of its property of every nature. It has no connection with the
capital stock authorized or the number of shares subscribed.
_Capital Stock_ is a term used in many ways each of which implies a
different meaning. It may mean the amount which must be paid in before
it can transact business as a corporation; it may mean the capital
which the corporation is authorized to issue; it may mean the amount
subscribed regardless of the amount actually paid in; or it may mean
the amount actually paid in regardless of the amount subscribed.
=11. Kinds of Stock.= As a rule the capital stock of a corporation is
of two classes--common and preferred--though not all corporations issue
both classes.
_Common Stock_ is the stock of a corporation issued to all stockholders
under the same conditions, and which is to share equally in the
dividends.
_Preferred Stock_ is stock which gives its owner certain preferences
over the owners of common stock. This preference usually consists of a
provision for the payment of certain dividends out of the net earnings
of the business before any dividends can be paid on common stock. The
officers of a corporation have no power to issue preferred stock unless
it is provided for in the charter. Preferred stock may, however, be
issued with the consent of all common stockholders. Preferred stock
falls into subdivisions depending upon its provisions as follows:
_Cumulative_ preferred stock is stock on which the payment of dividends
is not dependent upon the earnings of one year. If a dividend is
passed in one year or if not paid in full, it must be paid from future
earnings before common stock can draw dividends.
_Non-cumulative_ preferred stock is stock which carries a dividend
preference only in respect to the earnings of the current year. While
dividends are payable prior to dividends on common stock, no liability
attaches to the corporation if earnings in any year are insufficient to
pay dividends.
_Guaranteed Stock_ is another name for cumulative or non-cumulative
preferred stock--any stock on which the payment of dividends is
guaranteed.
A corporation may issue more than one series of preferred stock,
as _first preferred_, _second preferred_, etc. These issues take
preference in the payment of dividends in the order of their priority.
Dividends must be paid on _first preferred_ before any surplus is
available for the payment of dividends on _second preferred_.
=12. Treasury Stock.= This is stock subscribed for and issued which
has been acquired by the corporation either by purchase or donation.
The term is often erroneously applied to that part of the authorized
capital stock which has never been issued, and the error has even
been made of referring to it as unsubscribed stock. Treasury stock is
an asset and should be so treated on the books of the corporation.
Unsubscribed or unissued stock is in no sense an asset; or as one
writer puts it, no more an asset than the power of a person to issue
notes is an asset.
=13. Watered Stock.= Any stock which is not represented by actual
assets is called watered stock. It is usually represented by fictitious
assets--as patents, copyrights, franchises, promotion expense,
goodwill, etc.
STOCK SUBSCRIPTIONS
=14.= It is customary for the first board of directors to state
by resolution in what manner the stock is to be disposed of; if
subscriptions are to be received; if subscriptions are to be paid
immediately or in installments. When the certificate of incorporation
has been filed the subscription list is opened. This may be in book
form, or a written or printed list. The following is a common form of
stock subscription:--
We, the undersigned, do hereby subscribe to the capital stock of the
--------company, organized under the laws of the state of
--------in the amount set forth below, and severally agree to pay
the amount of such subscription as follows:
When the board of directors shall, through its secretary or
treasurer, certify that there has been subscribed----% of the
authorized capital of $--------, then we severally agree to pay----%
of said subscriptions, and to pay a further----% on the----day of
each month thereafter, until the full amount of such subscriptions
shall have been paid.
[Illustration]
MANAGEMENT OF CORPORATIONS
=15.= The affairs of a corporation are managed by its directors
who are elected by the stockholders. A director has no authority
individually to bind the company. He can only act in conjunction
with other directors in regular meeting as provided by the by-laws.
The acts of the board are effected by orders or resolutions passed
at such meetings. The number of directors constituting the board and
the number required to form a quorum is specified in the by-laws.
Directors must attend meetings in person to be entitled to vote. They
cannot be represented by proxy. Since it is not practicable for the
directors to attend to all of the details, they usually delegate to
their officers authority to transact all of the every day business of
the company. In larger corporations the directors organize themselves
into subcommittees as executive committee, finance committee, etc. In
small corporations these committees are unnecessary, their acts being
performed by the board of directors.
=16. Powers of Directors and Officers.= The powers of the directors are
extensive and are prescribed by the charter and by-laws. The directors
have the power to bind the corporation in all its dealings with other
persons or corporations. The powers of the stockholders are limited
to the election of the directors; but as the directors are elected by
a majority of the stockholders, the power to control the corporation
through the election of a board of directors who will respect their
wishes is thus conveyed to a majority of the stockholders.
Being representatives of the stockholders as a body, the directors must
at all times be governed by what they honestly consider the wishes
of the majority. Directors have the power to make contracts with the
corporation only when they are manifestly fair contracts. For example,
when not otherwise provided for, they may fix a fair compensation for
their services and for the services of their officers. Except in cases
of actual fraud, it is for the majority of stockholders to complain of
such contracts, and they have the power to remove offending directors.
Officers of a corporation are its agents and have limited powers,
usually prescribed by the by-laws. When not so specified, they are
prescribed by the directors. It is not always necessary that all of the
powers of an officer be specified in detail. If an officer has been
accustomed to perform certain acts with the knowledge and consent of
the directors, his acts become binding on the corporation. The title of
an office does not necessarily convey any special powers. For example,
while it is customary for the directors to confer special powers on
the president, his title does not make him, in the corporation's
dealings with the public, an agent of higher grade than the secretary,
treasurer, or any other officer.
[Illustration: THE SUPERINTENDENT'S OFFICE, DOBIE FOUNDRY & MACHINE
CO., NIAGARA FALLS, N. Y.]
=17. Powers of Corporations.= As such, a corporation possesses certain
necessary powers, and such other special powers as may be conferred by
its charter.
To have a corporate name which can only be changed by law.
To sue and be sued.
To possess a corporate seal.
To appoint the necessary officers for the conduct of its business.
To enact by-laws necessary for the management of its business, for
transferring of its stock, for calling of meetings, etc.
To acquire and dispose of such property as may be necessary for the
conduct of the business for which it is organized.
To make contracts necessary for the carrying out of its purposes.
In general a corporation can engage in no other business than that
specified in its charter, but it is granted certain incidental powers
necessary to carry out its original purpose.
=18. Stockholder's Rights.= Each stockholder has the right to
have a certificate of stock issued to him; to vote at meetings of
stockholders; to inspect the books of the company; to participate in
dividends; to invoke the aid of the courts in restraining the directors
from committing a breach of trust.
DIVIDENDS
=19.= Every business corporation is conducted with a view to earning
profits. When such profits are distributed to its stockholders they are
called dividends, but stockholders cannot participate in the profits
until a dividend has been declared by the directors. The law specifies
that dividends must be paid out of the net surplus of the company, and
provides a penalty for their payment out of capital. Therefore, before
declaring a dividend, the directors must be provided with a balance
sheet and use every care to determine that a surplus actually exists.
For dividend purposes, surplus is usually considered that part of the
profits remaining after paying expenses and providing the necessary
reserve to cover depreciation of machinery and buildings and losses
from uncollectable accounts. Sometimes a further provision is made in
the by-laws for the creation of a sinking fund for the payment of bonds.
The times for the payment of dividends are fixed in the certificate of
incorporation or the by-laws. Provision is usually made for the payment
of dividends either quarterly, semi-annually, or annually.
Directors have full discretion in the declaration of dividends and,
so long as they are acting in good faith, may add profits to capital
instead of declaring a dividend. When the directors have, by proper
resolution, stated that the surplus, or a part of the surplus, shall
be distributed to the stockholders, a dividend is said to have been
declared. When declared, a dividend becomes a debt of the corporation
to its stockholders. It is not necessary that the directors declare
dividends of all the surplus or net profits. Frequently the by-laws
provide that a certain amount be reserved as working capital, and under
any circumstances the questions of the advisability of declaring a
dividend rests with the directors. They cannot be compelled to declare
a dividend unless it can be shown that, in declining to do so, they are
acting in bad faith.
=20. Stock Dividends.= At their discretion, the directors may, instead
of paying a dividend in cash, declare what is known as a stock
dividend. When there remains certain unsubscribed stock, or when
the corporation is in possession of treasury stock, this stock may
be issued to stockholders in payment of dividends. A stock dividend
cannot, however, be declared when it would not be proper to declare
a cash dividend. The assets must exceed all liabilities, and in
determining the existence of a surplus available for dividends, all
capital stock that has been issued must be considered as a liability.
CLOSING TRANSFER BOOKS
=21.= In large companies it is customary for the board of directors
to close the stock transfer books a certain number of days prior to
the date of payment of a dividend, for the purpose of obtaining the
names and addresses of all stockholders. Notices are then sent to all
stockholders that a dividend will be paid on a certain date and that
the transfer books will be closed for a stated period. Transfer books
are also frequently closed for a certain period prior to the annual
meeting of the stockholders. The laws of some states provide that only
those stockholders whose names have appeared as stockholders on the
books of the company for at least thirty days prior to the date of the
annual meeting, shall be entitled to vote at said meeting.
STOCKHOLDERS' MEETINGS
=22.= Meetings of stockholders are, as a rule, held annually, and the
date of such meeting is usually specified in the charter. At the annual
meeting the board of directors presents, through its president or
other officer, a report of the business for the year, accompanied by a
financial statement. At this meeting the stockholders elect directors
to take the place of those whose terms of office have expired. A
stockholder may vote at stockholders' meetings either in person or by
proxy, and is entitled to one vote for each share of stock registered
in his name at the time of the meeting. Notice of a stockholders'
meeting must in all cases be mailed to each stockholder at his last
known address, a certain number of days prior to the date of the
meeting. This notice is mailed by the secretary of the company.
SALE OF STOCK BELOW PAR
=23.= Many corporations formed to carry on business of a speculative
nature find it difficult to sell stock at par. This is especially true
when the assets consist largely of patents, an undeveloped mine, or
property of a similar nature. It has become the custom for corporations
to take over such properties, issuing in payment for the same full
paid stock greatly in excess of its value. The original owners of the
property will in turn donate a certain portion of the stock to the
corporation to be sold to provide working capital. This stock then
becomes treasury stock and is offered for sale at a liberal discount.
The selling of property to a corporation at an inflated value is called
the process of watering the stock. It can only be justified when an
uncertainty exists as to the actual value of the property acquired. In
the purchase of a going business, the real value of the goodwill is
largely a matter of opinion, and the judgment of the board of directors
of a corporation making such a purchase must be considered as final.
CORPORATION BOOKKEEPING
=24.= Bookkeeping for a corporation as a record of its business
transactions with the public is not different than bookkeeping for a
single proprietorship or a partnership. There are, however, certain
necessary records peculiar to a corporation, including accounts of
a financial nature between the corporation and its stockholders.
It is with these records and accounts that we are concerned in this
discussion of corporation bookkeeping.
=25. Books Required.= The books required for corporation records are,
_Stock Certificate Book_, _Stock Transfer Book_, _Stock Ledger_,
_Minute Book_, (and in certain cases, _Installment Book_, _Stock
Register_, and _Dividend Book_). These are auxiliary books and are
known as _stock_ books.
_Stock Certificate Book._ This is a book of stock certificates, with
stubs giving full particulars of each certificate issued. When a stock
register is used, the record is posted to it from the stub, otherwise
posting is made direct from the stub to the stock ledger.
_Stock Transfer Book._ This is a book in which is kept a record of
all transfers of stock. Each entry is practically a copy of the form
of assignment found on the back of the stock certificate. It is
supposed that each transfer will be signed by the one transferring the
stock, but frequently when certificates are presented with the proper
endorsement, the transfer is signed by the one making the transfer as
_attorney in fact_. The transfer book is made with two, and sometimes
three, transfers to a page. Transfers are posted to the stock register,
when used, or direct to the stock ledger.
[Illustration: Transfer Book]
_Stock Ledger._ This is the book in which an account is kept with each
stockholder showing the number of shares held by him. Sometimes the
amount is included. When a stockholder receives a certificate of stock
it is posted to the credit side of his account in the stock ledger.
When he transfers a certificate it is posted to the debit side of his
account. A trial balance of the stock ledger should be taken at stated
periods, for the stock standing to the credit of the stockholders
should equal the total stock outstanding. The stock ledger is supposed
to show only the stock issued and the names of its holders. For
example, if the authorized stock of a corporation is 1,000 shares and
there remains 300 shares unsubscribed, the stock ledger will show 700
shares--the total issued--to the credit of individual stockholders.
An account should be opened in the stock ledger with _Capital Stock_,
which account will be debited with all stock issued. This is in effect
a representative account since it represents the total stock that
should stand to the credit of other accounts in the stock ledger.
[Illustration: Stock Ledger]
_Minute Book._ This is a record book in which the secretary keeps
records or minutes of the proceedings of all stockholders' and
directors' meetings. This is an official record of the acts of the
corporation, and is frequently called for to be introduced in court as
evidence. The secretary is custodian of the minute book and should see
that it is carefully preserved.
_Installment Book._ When stock subscriptions are payable in
installments, a form of receipt called a scrip or installment
certificate is issued. As payments are made they are endorsed on
the back of this certificate, and when all payments have been made
the scrip is exchanged for a regular stock certificate. These scrip
certificates are bound in book form similar to stock certificates.
Sometimes the scrip certificate takes the form of an installment
receipt for the amount paid, all receipts being surrendered to the
company when payments have been completed.
[Illustration: INSTALLMENT CERTIFICATE]
_Stock Register._ Some large corporations keep, in addition to
the stock ledger and transfer books, a stock register which is a
complete register of all stock issued. This book is kept by the
_registrar_--usually a trust company or bank. All certificates are
entered in the register in numerical order and full particulars of each
are given. When a transfer is made both the old and new certificates
must be taken to the registrar, who cancels the old and places his
indorsement on the new, certifying that it has been registered.
One purpose of having a registrar is to prevent an over-issue of stock.
The number of shares shown on the register must not exceed the number
of shares which the corporation is authorized to issue.
[Illustration: Stock Register]
_Dividend Book._ When the directors declare a dividend it is necessary
to make a list of stockholders entitled to receive a dividend. Large
corporations use a special form similar to the one illustrated. It is
made either in a book or on loose sheets which are placed in a binder.
[Illustration: Dividend Book]
Some stockholders issue written orders to pay all dividends to some
other person, which makes it necessary to record on this list the name
of the person to whom this dividend is payable, as well as the name of
the stockholder.
OPENING ENTRIES
=26.= In opening the books of a corporation it is necessary to first
get the capital entered. In a proprietorship, the capital is credited
to the owner; in a partnership it is credited to the individual
partners. On the books of a corporation an account called capital stock
is opened, to which capital is credited. This account is opened in the
general ledger and original entries are made in the journal. The manner
of making the opening entries depends upon the method of disposing of
the capital stock.
_If stock is sold for cash only_ and the entire amount is subscribed
and paid for, the entry is simply
Cash $100,000
To capital Stock $100,000
Stock subscribed and paid
for by the following:
John Doe $50,000
Richard Roe 25,000
Henry Snow 25,000
as per subscription
list dated--------190----.
_If only a part of the authorized stock is subscribed_, there are two
methods of entering the transaction.
First: Debit cash and credit capital stock as above, only as fast as
stock is subscribed and paid for.
Second: Debit cash and credit capital stock for the amount actually
subscribed and paid for. Debit a new account called _unsubscribed
stock_ and credit capital stock for the balance of the total
authorized issue of stock.
Illustrating the above, we will suppose that the National Manufacturing
Co. is organized with a capitalization of $100,000, of which $50,000 is
subscribed and paid for in cash. The entries would be:--
Cash $50,000
To capital stock $50,000
Stock subscribed and paid
for by the following:
John Doe $25,000
Richard Roe 15,000
Henry Snow 10,000
--------
Unsubscribed stock 50,000
To capital stock 50,000
_If stock is not paid for when subscribed_ or if it is payable in
installments the entry is:
John Doe 25,000
Richard Roe 15,000
Henry Snow 10,000
To capital stock 50,000
For subscription to stock
as per subscription list.
Or if it is not desired to enter the names of the subscribers an
account is opened in the name of _subscriptions_, and the entry is:
Subscriptions 50,000
To capital stock 50,000
The above entries at once place the entire authorized capital stock on
the books. When further subscriptions are made, subscription account
is debited and unsubscribed stock is credited. When subscriptions are
paid, cash is debited and subscriptions credited.
When subscriptions are payable in regular installments, payments may
be credited to subscriptions. The plan is sometimes followed, however,
of opening an account for each installment, as Installment No. 1, to
which payments are credited. When the installment is fully paid this
account would be closed into subscription account.
Or still another formula--when stock has been sold _subject to
assessments to be made by the board of directors_, and an assessment
has been called the entry is:
Assessment No. 1. $10,000
To subscriptions $10,000
An assessment of 20%
as per resolution of
the board of directors
John Doe 5,000
Richard Roe 3,000
Henry Snow 2,000
When paid, cash is debited and assessment No. 1 is credited. When the
next assessment is called an account is opened with assessment No. 2.
=27. When a Part of the Stock is Paid for in Property and the Balance
in Money.= A corporation known as The National Manufacturing Company
is formed to take over a manufacturing business owned by John Doe. The
capital stock is $100,000 of which Mr. Doe is to receive $50,000 for
the assets and goodwill of his business, the company agreeing to assume
his liabilities. His statement of affairs shows the following:
_Assets_
Cash in bank $2,264.00
Accounts receivable 4,650.50
Machinery 9,000.00
Manufactured goods 2,100.00
Material and supplies 3,780.00
Furniture and fixtures 700.00 $22,494.50
--------
_Liabilities_
Accounts payable 864.20 864.20
-------- --------
21,630.30
Since the net assets are $21,630.30, and the stock to be issued to John
Doe is $50,000 the difference, or $28,369.70, represents the amount
paid for the goodwill of the business.
The transaction is entered as follows:--
Property and Goodwill of
the business of John Doe,
transferred to this company as
per resolution of the board
of directors, Dec. 21st, 1908.
Goodwill $28,369.70
Cash 2,264.00
Accounts receivable 4,650.50
Machinery 9,000.00
Manufactured goods 2,100.00
Material and supplies 3,780.00
Furniture and fixtures 700.00
Accounts payable $864.20
Capital stock 50,000.00
One half of the capital stock is thus accounted for. The balance is to
be subscribed, and when subscribed the entries will be as explained in
Art. 26, depending upon whether subscriptions are paid in full or in
installments.
=28. When Stock is Issued in Payment of Property and a Part of the
Stock is to be Donated to the Company.= John Doe owns a valuable patent
on an automobile attachment and desires to secure capital to carry on
its manufacture. He interests Richard Roe and Henry Snow, who agree to
assist him to form the National Manufacturing Company to take over his
patent and manufacture the attachment. The company is incorporated with
an authorized capitalization of $150,000. Roe and Snow agree that Doe
shall receive $100,000 full paid stock for his patent, and to subscribe
$25,000 each, payable in cash to be used for the purchase of the
necessary machinery. John Doe, in turn, agrees to donate $50,000 of his
stock to provide working capital. The entries are:
Patents $100,000
Capital stock $100,000
Full paid stock issued to
John Doe to pay for
patents transferred to the
Company by bill of sale dated
Dec. 2, 1908.
Subscriptions $50,000
Capital stock $50,000
Subscriptions to capital
stock as follows:--
Richard Roe $25,000
Henry Snow 25,000
--------
Treasury stock 50,000
Working capital 50,000
Full paid stock donated
by John Doe to provide
working capital.
When subscriptions are paid:--
Cash 50,000
Subscriptions 50,000
It is decided to sell $30,000 of the treasury stock at 50% of its face
value, and subscriptions are received for this amount.
Subscription to treasury stock 30,000
Treasury stock 30,000
Subscription account is debited and treasury stock credited for the
full amount since this is the amount of full paid stock to be issued,
regardless of the price at which it is sold.
When this stock is paid for, the entry in the cash book on the debit
side is:
Subscriptions to treasury stock 15,000
This leaves a debit balance of $15,000 in the account _subscriptions to
treasury stock_, which represents a discount on the stock sold.
The manner of disposing of this discount depends upon the provisions
made by the directors in respect to the creating of working capital.
If their resolution provides that the fund maintained for working
capital shall be only such an amount as may be realized from the sale
of treasury stock, the discount is disposed of by the following entry:
Working capital 15,000
Subscriptions to treasury stock 15,000
Discount on 30,000 treasury
stock sold.
Suppose, however, that the directors have provided by resolution for
the maintaining of a working capital of $50,000. In that case the
liability for the full $50,000 must remain on the books until such time
as other provision is made. The entry would then be:
Bonus $15,000
Subscriptions to treasury stock $15,000
The discount is, to all intents, a bonus given to the purchasers, and
if, as frequently happens, purchasers are promised a bonus of a share
of stock for every share purchased, it would be proper to make the
following entry in the first place.
Subscriptions to treasury stock 15,000
Bonus 15,000
Treasury stock 30,000
Sold 30,000 treasury stock at 50%
of face value.
In any dividend distribution the purchasers are entitled to draw
dividends on the face value of their stock, since it was issued to them
as full paid. It would be manifestly unfair to charge the discount
or bonus against profits for the current year, and it is customary
to spread it over a period of several years, charging off a certain
per cent each year. The bonus account is, in the meantime, carried on
the books as an asset, and belongs in the class known as _fictitious_
assets.
Treasury stock is an asset, its real value being the market value of
the stock represented. In the event of liquidation of the company,
treasury stock would off-set the liability on account of capital stock.
When all of the treasury stock is sold the account closes itself; or
if it is issued to stockholders in the form of stock dividends, it is
closed into profit and loss.
Working capital is a liability, which may be termed an _assumed_ or
_nominal_ liability. Like capital stock it is a liability only as
between the company and its stockholders. It off-sets whatever form of
asset--cash or otherwise--that represents proceeds from the sale of
treasury stock. The real position of working capital in the balance
sheet is that of a capital liability which must be considered before
any surplus available for dividends can be said to exist. Power is
usually given the directors to reserve a certain amount for working
capital, and even though an actual surplus may exist they have the
right to off-set this with a working capital liability instead of
declaring a dividend.
=29. Premium on Stock.= The stocks of many well-managed enterprises
sell at a premium. In all such cases the amount received above the par
or face value is credited to an account called _premium on stock_. At
the end of the year this account is closed into surplus account. If
any such items are standing on the books it can be used to off-set
bonus account or organization expenses. It is not proper to close
premium account into the current profit and loss account, for while it
represents a profit, it is not earned in the regular operations of the
business.
=30. Reduction of Working Capital.= As before stated, so long as
working capital remains on the books it must be treated as a liability.
Having the right to create working capital, the directors also have the
right to reduce it whenever, in their judgment, the necessities of the
business no longer require its maintenance in the original amount.
A reduction of working capital has the effect of increasing surplus,
since surplus is increased by an increase of assets or a decrease of
liabilities. To reduce working capital, the account is closed into
surplus. It is perhaps necessary to say that the account should not
be closed into profit and loss, since it does not represent current
profits.
Suppose that in the case of the National Manufacturing Co., it is
desired to reduce working capital from $50,000 to $25,000; the entry
would be:
Working capital $25,000
Surplus $25,000
Working capital reduced by
resolution of the board of
directors, January 15th, 1909.
ENTRIES IN STOCK BOOKS
=31.= The entries in the stock books are very simple and are just the
opposite of stock entries in the general or financial books of the
company. When certificates of stock are issued, an account is opened
in the stock ledger with each stockholder, to which is credited the
stock issued to him. At the same time an account is opened in this
ledger with capital stock which is debited with all stock issued, thus
preserving the balance of the stock ledger. Taking the example in Art.
26, when stock is issued--
We debit--
Capital stock $150,000
We credit--
John Doe $100,000
Richard Roe 25,000
Henry Snow 25,000
When the $50,000 stock is donated to the treasury to provide working
capital--
We debit
John Doe 50,000
We credit
Treasury stock 50,000
and open an account with treasury stock in the stock ledger.
When treasury stock is sold--
We debit
Treasury stock 30,000
We credit
Subscribers 30,000
When a stockholder sells a part or all of his shares to another it has
no effect on capital stock or treasury stock accounts in the stock
ledger. The only change takes place in the accounts of the individual
stockholders involved. The stock transferred is debited to the account
of the _transferor_, and credited to the account of the _transferee_.
Supposing that $30,000 treasury stock was purchased by Henry Benson,
George Dennis, and Richard Carpenter, each purchasing $10,000, the
stock ledger and stock register--if one is used--would appear as shown
in the illustration. Footing the two sides of the stock register we
find a balance of 1,300 shares which is the actual amount outstanding,
the balance of 200 shares remaining in the treasury. A trial balance
also shows that the stock ledger balances with a credit of $20,000
treasury stock.
[Illustration: Stock Ledger]
[Illustration: Stock Ledger]
[Illustration: AIR-LINE CASH-CARRYING SYSTEM FOR LARGE RETAIL DRUG
STORE Applicable to a Moderate-Sized General Store. Lamson Consolidated
Store Service Co.]
[Illustration: Stock Register]
EXERCISES
1. A corporation is organized with a capital of $50,000.00, divided
into 500 shares of $100.00 each. The corporation begins business when
250 shares have been subscribed for. Of this amount _A_ subscribes for
100 shares, _B_ for 100 shares, and _C_ for 50 shares. These shares are
paid for in cash within 30 days after the date of subscriptions.
Six months later the balance of the stock is subscribed for,
subscriptions being received from _A_ for 50 shares, _B_, 50 shares,
_D_, 100 shares, and _E_, 50 shares. _C_ sells 50 shares to _B_. These
new shares are paid for in cash.
Make all entries in general books.
Make all entries in stock books.
2. _A_, _B_, and _C_ organize a corporation with an authorized
capitalization of $100,000.00, divided into 1,000 shares of $100.00
each. _A_ subscribes for 400 shares, _B_, 300 shares, and _C_,
200 shares. The corporation buys from _D_ land and buildings for
$20,000.00, paying him $10,000.00 in cash and issuing to him 100 shares
of stock.
Subscriptions are paid as follows: _A_ pays $20,000.00 cash and gives
his note due in 60 days for $20,000.00; _B_ pays $20,000.00 cash and
gives his note for $10,000.00 payable in 30 days; _C_ pays $10,000.00
cash and gives his note for $10,000.00 payable in 10 days.
Make all entries in journal and cash book and post to ledger.
NOTE.--Land and buildings are grouped under the head of real estate.
3. John Davis and Daniel Greene own the La Belle mine, and to secure
capital for its development they decide to organize a mining company
and to sell shares. A corporation is organized with a capitalization of
$1,000,000.00 in shares of $1.00 each. Of this stock 999,000 shares are
issued to Davis and Greene, each receiving an equal number, and they,
in turn, deed the La Belle mine to the company. The remaining 1,000
shares are subscribed and paid for by Martin Otis. Davis and Greene
donate to the treasury 49,800 shares to be sold for the purpose of
securing working capital. The directors, by proper resolution, decide
to sell 200,000 shares: 50,000 shares to be sold at 20 cents on the
dollar, 50,000 shares at 25 cents, and 100,000 shares at 35 cents. The
resolution also provides that the corporation's liability for working
capital shall be no more than the amount realized from the sale of
treasury stock. Subscriptions are received for the 200,000 shares and
payments are made at the prices specified.
Make all necessary entries to get these transactions properly recorded
on both the general and stock books.
STOCK ISSUED FOR PROMOTION
=32.= Frequently when a corporation is organized, stock is issued to
a promoter as payment for his services. An enterprise may have great
latent possibilities provided sufficient capital can be secured for
its development, but until the possibilities for making a profit can
be clearly shown, it is difficult to interest the investing public.
To interest investors in an enterprise yet to be developed requires a
special talent not possessed by the average owner of a patent, mine, or
process. There are men who possess this special talent and who make a
business of promoting companies.
In many cases--probably most cases--the owner of the thing to be
promoted has no money with which to pay the promoter. Consequently, the
promoter first satisfies himself that the enterprise actually holds
possibilities of profit and then agrees to accept all or a part of
his fees in the stock of the company. The portion of his fee that he
is willing to accept in stock, and the number of shares demanded, is
governed largely by his own faith in the enterprise. His fee may be
a certain per cent on the stock sold, or it may be an arbitrary sum
represented by a certain number of shares. When he accepts his entire
fee in stock, it may represent from 25 per cent to 50 per cent of the
entire capitalization, and while the fee may appear exorbitant when
represented by the par value of the stock, its actual value to him is
represented by the _real_ value of the stock, or the price at which he
could sell it.
Volumes might be written on the subject of promotion, but our special
concern is the proper treatment of promotion fees on the books of the
company. Strictly speaking, promotion fees are as much an expense as
the cost of printing the company's prospectus, but to immediately
charge it to expense would, in many cases, cause the accounts to show
an impairment of capital at the outset. Suppose, for example, that a
corporation is organized with a capital of $100,000.00 all paid in
cash. The promoter is paid a fee of $15,000.00. Profits earned--trading
profits--in the first year are $8,000.00, but we have a charge of
$15,000.00 for promotion in the expense account. The books show that
the company is insolvent, the liabilities being $7,000.00 in excess of
the assets, while the business actually is in a healthy condition.
Expenses paid in the regular course of business are expected to be
off-set by earnings. When we pay rent for a store or office we expect
that, by reason of our occupancy of that store or office as a place of
business, our earnings will be increased in an amount greater than that
paid for rent. Promotion expense cannot, in itself, produce earnings.
The cash, or other form of asset, received from the sale of stock--the
direct result of promotion expense--is off-set by the stock liability
created. Earnings to off-set promotion expense must come from future
operations of the business.
It has become quite the general custom, therefore, to allow the expense
incident to the organization of the company to stand on the books as
a fictitious asset, under some such caption as _promotion expense_,
_promotion fund_, or _organization expense_. The amount is gradually
reduced by charging a stated per cent to profit and loss each year.
There is another special reason why it would be manifestly unfair
to immediately charge promotion fees to expense. Suppose a promoter
receives 20% of the stock for his services, while the holders of the
remaining 80% have paid cash for their shares. Since the 80 per cent
paid in cash must earn dividends on the entire 100 per cent of stock,
it would be unjust to the holders of the 80 per cent to withhold
dividends until the par value of the 20 per cent of stock shall have
been added to the assets of the company from profits earned.
=The Entry.= A patent is owned by Geo. Davis, who secures the services
of Wm. Lane to promote a company to undertake its manufacture. The
corporation is capitalized at $500,000.00. Davis sells the patent to
the company receiving $250,000.00 stock in payment, and Lane receives
$25,000.00 stock for promotion, when he has secured subscriptions for
the remaining $225,000.00 at par. The entries to record the issue of
stock to Lane for promotion are:
Subscriptions $25,000.00
Capital stock $25,000.00
Subscription of
Wm. Lane
Promotion expense 25,000.00
Wm. Lane 25,000.00
Fee due Wm. Lane for
promotion of company
and sale of stock.
--------
Wm. Lane 25,000.00
Subscriptions 25,000.00
Amount due to Lane credited
to subscriptions to pay for
stock subscribed by him.
The entries for the shares issued to Davis and those sold are the same
as previously explained and illustrated.
SURPLUS AND DIVIDENDS
=33.= The directors are under no obligation to distribute in dividends
the profits earned in any one year. Instead, the by-laws usually
provide that the decision as to when a dividend shall be declared is
to be left entirely to the directors. They have it in their power
to retain of the profits such an amount as, in their judgment, is
advisable or necessary to safeguard the interests of the company. At
the close of the fiscal year it is customary to close profit and loss
account, and in a corporation it is closed into surplus.
=34. Surplus Sub-divided.= Sometimes the term surplus is used to
designate a part of the profits set aside for a special purpose, as the
creation of a fund to meet an obligation falling due at some future
date. When surplus is treated as a special fund, or when it has been
provided by resolution of the directors "_that a certain sum, or a
certain per cent of the profits shall be set aside as a surplus fund_,"
and remaining profits not distributed as dividends may be placed to
the credit of an account called _Undivided Profits_ or _Undistributed
Profits_.
In reality undivided profits is surplus, and the division of the
account merely serves to show that the amount credited to surplus
is for some reason reserved, while the amount credited to undivided
profits is available for dividends whenever the directors may so elect.
Whether or not the surplus should be shown in the balance sheet under
these various headings, or all under the general head of surplus, with
explanatory notes, is a question which need not concern us at this
point.
=35. Declaring a Cash Dividend.= When a dividend is declared an account
should be opened under the caption _Dividends Payable_ or _Dividend No.
1._, etc. We will suppose that a dividend has been declared out of the
profits of the business for the current year. The entry is:--
Profit and Loss
Dividends payable
Dividend of----% declared
by the board of directors
--------1909, payable--------1909.
When the dividend is paid the entry will be--
Dividends payable
Cash
To pay dividend payable
--------1909.
=36. Declaring a Stock Dividend.= Not all dividends are paid or payable
in cash. Sometimes the directors declare a dividend payable in stock
and this is known as a stock dividend. There may be treasury stock in
possession of the treasurer, and if the books show a surplus, which
would make it proper to declare a cash dividend, a dividend may be
declared payable in treasury stock. When such a dividend is declared
the entry is--
Profit and Loss
Stock dividend
A dividend of----% declared
by the board of directors
--------1909 payable--------1909,
payment to be made in
treasury stock
Stock dividend
Treasury stock
To pay stock dividend
declared--------1909.
The shares are then transferred on the stock books debiting treasury
stock and crediting stockholders.
It is not absolutely necessary that a company possess treasury stock
to declare a stock dividend. When current profits are large or a
surplus, larger than the requirements of the business demand, has been
accumulated, a stock dividend may be declared by issuing additional
shares, provided the original stock has not all been subscribed for.
If a large surplus has been accumulated and a part of the stock is
unsubscribed, a stock dividend would require the following entries:
Surplus
Stock dividend
A stock dividend of----%
declared by the directors--------1909
payable in the unissued
stock of this company.
--------
Subscriptions
Capital stock
Additional stock subscriptions
received from the following.
--------
Stock dividends
Subscriptions
Stock dividend due stockholders
used to off-set subscriptions.
The stock dividend is a device frequently used to conceal actual
profits, or to cover up the fact that dividends are being declared in
excess of a fixed rate. This is especially true of such public service
corporations as lighting companies or street railways. In many cases
a company will go through the necessary formalities to increase its
capital stock for the purpose of absorbing surplus by means of a stock
dividend.
=37. Treatment of a Loss.= If, during any year, the business has
sustained a loss, it will, of course, appear as a balance on the debit
side of profit and loss account. This will then be transferred to the
debit of undivided profits or surplus, if any, remaining from previous
years. For illustration, suppose the books show a surplus of $5,000.00,
undivided profits $500.00, loss for the current year $2,500.00, the
entry will be:--
Undivided profits $500.00
Surplus 2,000.00
Profit and loss $2,500.00
Loss for the year.
If there is no surplus remaining from former years, the business is
insolvent, in which case the capital is said to be impaired. This can
be taken care of in either of two ways. First--by the stockholders
subscribing to a fund to cover the deficiency. Second--by a reduction
of the capital stock.
EXERCISES
1. David Francis and Henry Harmon own a large tract of timber land in
Mexico. In connection with F. B. Walker--a promoter--they organize a
corporation to build railways and mills for the purpose of developing
the property and to market the timber. The company is capitalized for
$1,000,000.00. The land is sold to the corporation for $1,000,000.00,
stock for that amount being issued to Francis, Harmon, and Walker.
Francis and Harmon each received $400,000.00 and Walker, $200,000.00.
This $200,000.00 stock is issued to Walker as his fee for promoting the
company. Francis and Harmon each donate 250 shares, of the par value of
$100.00 each, to the treasury to be sold to produce working capital.
Make all necessary entries in general books.
2. The profits of a manufacturing company with a paid up capital of
$100,000.00, are $9,765.00. The directors, by proper resolution,
declare a cash dividend of 6 per cent, set aside a surplus of
$3,000.00, and transfer the balance to undivided profits.
Make all necessary entries in general books, showing ledger accounts
after payment of dividends.
3. The following year's business of the above company showed a loss of
$2,160.00. How is this loss disposed of? Make entries.
4. A company capitalized at $250,000.00 has sold $100,000.00 of its
stock, the balance being unsubscribed. Its accumulated surplus is
$90,000.00, and the directors declare a stock dividend of 50 per cent
to all stockholders. Make all entries.
5. A manufacturing company has a capital stock of $100,000.00. One item
in its assets is machinery $26,750.00. The profits for the year are
$11,640.00. The directors provide for a reserve for depreciation of
machinery of 10% and declare a dividend of 5%.
Make all entries.
CHANGING BOOKS FROM A PARTNERSHIP TO A CORPORATION
=38.= Wilson, Brackett, and Nixon have been conducting a retail
clothing business under a partnership agreement. Appreciating the
advantages of a corporate form of organization, they decide to
incorporate under the name of the Continental Clothing Company.
The first step necessary to prepare for the incorporation of a
partnership is to ascertain the net capital of the business as it
stands. Accordingly, an inventory is taken, the books are closed, and a
balance sheet prepared with the following results:
_Balance Sheet of Wilson, Brackett, and Nixon_
_Assets_
Cash $1,650.72
Bills receivable $1,725.00
Accounts receivable 3,264.18 4,989.18
--------
Merchandise inventory 10,450.00
Furniture and fixtures 4,000.00 14,450.00 $21,089.90
-------- --------
_Liabilities_
Bills payable 3,000.00
Accounts payable 2,089.00 5,089.90
--------
Wilson, capital account 7,000.00
Brackett, capital account 5,000.00
Nixon, capital account 4,000.00 16,000.00 21,089.90
-------- --------
From this balance sheet it is seen that the net capital is $16,000.00,
of which Wilson owns $7,000.00, Brackett, $5,000.00, and Nixon,
$4,000.00. On this showing, it is decided to form the company with
a capital stock of $20,000.00, all of which is to be issued as full
paid stock to the partners in proportion to their interests in the
partnership.
New books are opened for the corporation and the next step is to
transfer the accounts of the partnership to the corporation. An account
is opened in the partnership ledger with the Continental Clothing
Company and the following entry is made:
Continental Clothing Co. $21,089.90
Cash $1,650.72
Bills receivable 1,725.00
Accounts receivable 3,264.18
Merchandise inventory 10,450.00
Furniture and fixtures 4,000.00
The above entry closes all of the asset accounts and shows that they
have been transferred to the new company.
The next entry is:
Bills payable $3,000.00
Accounts payable 2,089.90
Wilson 7,000.00
Brackett 5,000.00
Nixon 4,000.00
Continental Clothing Co. $21,089.90
The above entry closes the liability and partners' accounts showing
that they have been transferred to the new company and also closes the
account of the Continental Clothing Co.
=39. Entries on the Corporation Books.= We are now ready to open
the books of the new company. Subscription books are opened and the
following subscriptions are received:
Wilson 8,750.00
Brackett 6,250.00
Nixon 5,000.00
The net assets of the partnership are $4,000.00 less than the capital
stock of the new company. No money is to be invested to cover this
discrepancy, so it will be necessary to account for it on the books by
opening a fictitious asset account under some such name as _goodwill_.
Having made this provision, the books of the new company are opened by
the following entries:
Subscriptions 20,000.00
Capital stock 20,000.00
Subscriptions received
as per subscription books.
--------
Cash 1,650.72
Bills receivable 1,725.00
Accounts receivable 3,264.18
Merchandise inventory 10,450,00
Furniture and fixtures 4,000.00
Goodwill 4,000.00
Bills payable 3,000.00
Accounts payable 2,089.90
Subscriptions 20,000.00
The business and goodwill of the
firm of Wilson, Brackett, and
Nixon transferred to this company
in payment of subscriptions
to capital stock.
These entries serve to get the capital stock, also the assets and
liabilities of the partnership properly recorded on the books of the
new company.
STOCK DONATED TO EMPLOYES
=40.= A partnership composed of Benson, Black, and Mabley is conducting
a retail hardware business. They desire to give their bookkeeper
(Parker) an interest in the business. The firm has the following assets
and liabilities:
_Assets_
Cash $3,000.00
Accounts receivable 2,000.00
Merchandise 15,000.00
Total assets $20,000.00
_Liabilities_
Accounts payable 2,000.00
Benson capital 6,000.00
Black capital 6,000.00
Mabley capital 6,000.00
Total liabilities 20,000.00
They incorporate the Benson Company with a capitalization of $40,000.00
divided into 400 shares of $100.00 each. Benson, Black, and Mabley
each subscribe for 100 shares, and 20 shares are presented to Parker.
The balance of the stock is to remain unsubscribed until such time
as it is decided to accept further subscriptions. The business of
the partnership is to be accepted by the company in payment of
subscriptions which have been made, and which are for 320 shares
or $32,000.00. The net assets of the partnership being $18,000.00,
goodwill must represent the balance of $14,000.00. The entries on the
books of the partnership follow--
The Benson Co. $20,000.00
Cash $ 3,000.00
Accounts receivable 2,000.00
Merchandise inv. 15,000.00
--------
Accounts payable 2,000.00
Benson 6,000.00
Black 6,000.00
Mabley 6,000.00
The Benson Co. 20,000.00
=41. On Books of the Benson Co.= The entries on the books of the new
company are the same as in previous illustrations, the stock donated to
Parker having been a gift from the partnership and the amount included
in the goodwill.
Subscriptions 32,000.00
Capital stock 32,000.00
--------
Cash 3,000.00
Accounts receivable 2,000.00
Merchandise inventory 15,000.00
Goodwill 14,000.00
Accounts payable 2,000.00
Subscriptions 32,000.00
=42. When the Gift is Made by an Existing Corporation.= We will suppose
that the Benson Co. wishes to donate 10 shares of stock to each of
three employes, _A_, _B_, and _C_. Having 80 shares unsubscribed, the
donation will be made from that stock. Supposing that the company has
accumulated a surplus, the transaction will be entered on the "books"
as follows:
Subscriptions 3,000.00
Capital stock 3,000.00
Subscriptions of _A_, _B_, & _C_
per subscription book.
--------
Surplus 3,000.00
Subscription 3,000.00
Surplus appropriated to subscriptions
per resolution of the
board of directors
Jan. 25th, 1909.
The above would be a rather unusual proceeding as the stock is fully
paid, though such gifts are sometimes made. The tendency of the present
times is toward profit sharing for the employes of corporations. The
plan of profit sharing takes many forms, and there are some notable
examples among very large corporations which have given employes stock
in the corporation, or afforded them an opportunity to acquire stock on
very favorable terms.
Among smaller corporations it is quite common to enable employes to
acquire its stock subject to certain special conditions. Frequently
employes are permitted to subscribe for stock with an agreement that
they are to pay no money, but that dividends declared are to be applied
to the payment of subscriptions. In this way the stock is made to pay
for itself out of its own earnings. Sometimes provision is made for the
payment of small annual installments on the subscriptions in addition
to applying the dividends. When stock is issued to employes under these
conditions, the contract sometimes specifies that in the event of the
subscriber leaving its employ before the subscription is paid in full,
the ownership of the stock shall revert to the company, and in such
cases the stock, until it becomes full paid, is usually placed in the
hands of a trustee. The principal object in issuing stock to an employe
and surrounding the transaction with these restrictions is, of course,
to insure his continuous service by making it an object to him to
remain in the employ of the company.
When stock is so issued, the entry is--
Subscriptions
Capital stock
Subscriptions to stock
by employes, said stock
to be issued subject to the
conditions named in the resolution
authorizing its issue,
passed by the board of
directors January 25th, 1909.
The subscription account is left open until such time as it is closed
by the payments credited. When a dividend is declared the entries are--
Surplus
Dividends payable
Being a dividend of----%
declared by the board of
directors on--------1909
payable--------1909.
--------
Dividends payable
Subscriptions
Dividend applied to the
payment of subscriptions.
Another provision sometimes met with in the issue of stock to an
employe is that in lieu of an increase in salary he shall receive, at
the end of the year, a certain amount in stock. He is then permitted to
subscribe for a stated amount of stock and to apply the bonus, or added
salary, as a payment. The bonus is usually a stated per cent of sales
or of net profits. When such a contingency arises the entry is--
Salaries
John Jones
----% of sales as
per agreement.
John Jones
Subscriptions
Amt. due applied in
payment of stock subscription.
If he has no account, on the books the transaction may be recorded by
one entry--
Salaries $1,500.00
Subscriptions $1,500.00
------------
WHEN STOCK SUBSCRIPTIONS ARE NEVER FULLY PAID
=43.= Corporations are sometimes organized with all capital stock
subscribed but only paid for in part, and the balance of subscriptions
never called for. T. C. Harris, John Alfred, and M. B. Hatch organize
a company to conduct the business of buying, selling, and renting
automobiles with a capital stock of $15,000.00, each subscribing for
$5,000.00. A cash payment of 25% is made on the stock and the balance
is to be paid in when called for. The entries stand on the books as
follows--
Subscriptions $15,000.00
Capital stock $15,000.00
Cash 3,750.00
Subscriptions 3,750.00
The business prospers to such an extent that the profits provide
sufficient money and it is not likely that the stockholders will be
called upon for further payments. It is decided to reduce the stock to
$5,000.00 and to declare a dividend to make this stock full paid. The
entries for these transactions follow:
Capital stock 10,000.00
Subscriptions 10,000.00
Capital stock reduced in accordance
with resolution of board of directors
passed Jan. 27, 1909.
--------
Surplus 1,250.00
Dividends payable 1,250.00
Dividend declared by board
of directors Jan. 27, 1909,
payable immediately.
--------
Dividends payable 1,250.00
Subscriptions 1,250.00
Dividends applied to the
payment of stock subscriptions.
The original stock certificates are now surrendered and new ones issued
in their place. In the stock ledger the stockholders are debited and
capital stock credited for the shares surrendered. Then, capital stock
is debited and stockholders credited for the new shares issued.
It might happen that a corporation wishes to reduce the capital stock
held by stockholders without having it appear that capital stock has
been reduced. This has been done by purchasing its stock and placing it
in the treasury. Payment for the stock may be made in cash or notes, or
it may be taken from surplus. The entries would be--
Treasury stock 10,000.00
Cash 10,000.00
or
Treasury stock 10,000.00
Bills payable 10,000.00
or
Treasury stock 10,000.00
Surplus 10,000.00
If the capital stock is to be reduced on the books, capital stock will
take the place of treasury stock in these entries as--
Capital stock 10,000.00
Cash 10,000.00
EXERCISES
1. Parsons, Young, and Searles are partners and decide to form a
corporation with capital stock of $40,000.00, which is to be issued as
full paid stock in exchange for their present business. Each partner is
to receive stock in proportion to his interest in the present business.
The balance sheet of the partnership is as follows:
_Assets_
Cash 3,500.00
Bills receivable 6,000.00
Accounts receivable 6,500.00
Merchandise 14,000.00
--------
Total 30,000.00
_Liabilities_
Bills payable 4,000.00
Accounts payable 2,000.00
Parsons 10,000.00
Young 8,000.00
Searles 6,000.00
--------
Total 30,000.00
Make entries on books of the partnership.
Make entries on books of the corporation.
[Illustration: A CORNER IN ONE OF THE SHOPS OF BROWNE & SHARPE
MANUFACTURING CO., PROVIDENCE, R. I.]
2. Hoadley and Stockton are partners and desire to incorporate a
company with a capital of $10,000.00 to take over their business. It
being necessary to have three incorporators they agree to give Hopper,
an employee, 10 shares--$1,000.00--of the stock of the new company.
The stock is to be divided equally between Hoadley and Stockton after
giving Hopper $1,000.00. The balance sheet of the partnership is as
follows:
_Assets_
Cash $960.00
Accounts receivable 1,570.00
Merchandise 720.00
--------
Total $3,250.00
_Liabilities_
Accounts payable 460.00
Bills payable 500.00
Hoadley 1,145.00
Stockton 1,145.00
--------
Total 3,250.00
Make all necessary entries on the books of the partnership.
Make open entries on the books of the new company.
3. The National Manufacturing Co., has an authorized capital of
$100,000.00 of which $60,000.00 is paid up and $40,000.00 unsubscribed.
It is decided to permit employes to subscribe for $10,000.00 of the
stock by paying 10 per cent in cash, all dividends declared to be
applied to the payment of subscriptions.
What entries are made when this stock is subscribed for?
A 10 per cent dividend being declared at the end of the first year what
entry is required?
4. The Atlas Novelty Co. has a capital stock of $50,000.00. All of the
stock has been subscribed for, but only 40 per cent has been paid. A
surplus of $10,000,00 has been accumulated. It is desired to reduce the
stock to $25,000.00 full paid. What is the necessary proceeding, and
what entries are required?
5. A company has a capital stock of $50,000.00 full paid, and a surplus
of $11,172.00. A stockholder who owns $7,000.00 stock in the company
wishes to dispose of his stock and, to secure cash, offers to sell it
to the company at par. His offer is accepted and the stock purchased,
but the company does not wish to reduce its capitalization. What is the
entry?
RESERVES AND THEIR TREATMENT
=44.= A reserve is an amount retained from current earnings to meet a
future contingency. According to a prominent authority whose recent
discussions of this subject have attracted attention, _a reserve is an
expression of the judgment of the accountant as to what amount will
be necessary to meet a contingency_. Reserves are created for many
purposes, among which the following are good examples.
_Reserves for bad debts._ An amount--usually a stated per cent
of accounts receivable--annually set aside to cover losses from
uncollectable accounts.
_Reserves for depreciation._ The plant--buildings and machinery--will
wear out, no matter how substantially built. A charge is made against
current earnings to create a reserve which will provide for a renewal
of the plant, or any part of it, when worn out. Separate reserves are
usually maintained for buildings and machinery.
_Reserves for Patents, Franchise, Goodwill_ and similar fictitious
assets. An annual charge of an amount sufficient to extinguish the
value at which the fictitious asset has been placed on the books.
_Reserves for permanent improvements on leased property._ Permanent
buildings, title to which will revert to the lessor at the expiration
of the lease, are sometimes erected on leased property. A reserve is
created to absorb the cost of such improvements during the life of the
lease.
_Reserves for buildings in hazardous undertakings._ In certain lines
of business, manufacturing plants are erected with the expectation of
having a permanent supply of raw material. If the supply gives out, the
plant may be valueless for other purposes. Examples are oil wells and
mines. A reserve is created to absorb the cost.
The reserve is coming into more general use every year, especially
by corporations, whose managers see the necessity of providing for
these contingencies. When a machine wears out it must be replaced. If
no reserve has been created, the money for its replacement must come
from current earnings, or be provided by borrowing money or increasing
capital. The better plan is to make provision in advance by creating a
reserve.
The amount of the reserve should be the value of the asset, and the
sum set aside annually should be sufficient to equal the value of the
asset at the end of its estimated life. To illustrate, if a machine is
estimated to last 10 years, the annual reserve for depreciation should
be 10% of its cost. The reserve is carried on the books as a liability
and is an off-set to the asset which it is to replace. If we were to
prepare a statement of the value of machinery as shown by the books we
would state it in this form--
Machinery $20,000
Less reserve for depreciation 2,000
--------
$18,000
This shows the exact amount at which this asset is valued. Taking the
illustration referred to--at the end of 10 years the liability _reserve
for depreciation_ will equal the asset _machinery_, and the funds
which have been reserved from profits during the past 10 years will be
available for the purchase of new machinery.
=45. Reserve Funds.= A term frequently used to designate a reserve
created for a certain purpose is reserve fund. This term is somewhat
confusing for when we speak of a _fund_ we are more likely to think
of it as an asset than as a liability. When the principle underlying
reserves is thoroughly understood, however, it is readily seen that
the use of the term _reserve fund_ is merely a question of the use of
English and does not affect the principle. A reserve or _reserve fund_
is a nominal liability artificially created to off-set a decrease in
value of an asset. On the principle that an increase of liabilities
represents a loss, the amount reserved each year represents a loss, but
since the liability created is not a real but a nominal liability it
does not affect the real assets of the business.
=46. Sinking Funds.= A sinking fund is an amount set aside out of
profits to meet an anticipated liability, or an obligation which is
to fall due at some future date. Sinking funds are set aside for such
purposes as the payment of bonds at maturity, mortgages, etc. The
sinking fund is the amount which, invested at compound interest, will
produce the desired amount at the end of the period.
A sinking fund is an asset and may or may not be withdrawn from the
business. Frequently a sinking fund is invested in securities, such
as government bonds, which are placed in the hands of a trustee, thus
insuring against the withdrawal of the funds from actual use in the
business.
Unlike a reserve, a sinking fund has no effect on the apparent profits
of the period in which it is created. It does, however, tie up or
render unavailable for dividends a certain part of those profits.
Whether or not it is carried on the books in a separate account, a
sinking fund is a part of the surplus of a business.
=47. Computing Sinking Funds.= The amount necessary to set aside at the
end of the year to provide a given sum in a stipulated number of years
at a stated rate of interest, compounded annually, may be found as
follows:
Divide the interest for one year upon the sum to be accumulated by the
compound interest upon $1.00 for the stipulated time. The result will
be the amount necessary to invest at the end of each year.
If the amount is to be invested at the beginning of the year, divide
the result obtained as above by the amount of $1.00 for one year.
_Example._ To provide for payment of $50,000.00 at the end of 15
years, what amount must be put into a sinking fund at the end of each
year, if the fund is invested to earn 3% compound interest? Interest
on $50,000.00 for 1 year at 3% is $1,500.00. Compound interest on
$1.00 for 15 years at 3% is .55797. Dividing $1,500.00 by .55797 gives
$2,688.32, the amount necessary to put into the fund annually. If this
amount is to be invested at the beginning of each year, divide the
above result ($2,688.32) by $1.03 (the amount of $1.00 for one year at
3%) and we obtain $2,610.02 the amount needed.
BONDS
=48.= In the sense here used a _bond_ is the written obligation of a
corporation to pay a certain amount at a specified future date. Bonds
are usually secured by a mortgage on all or a part of the property of
the corporation.