Roy B. Kester

“ It is argued that the plant unit ‘deteriorates’ year by year and that this ‘deterioration’ is the true measure of the ‘depreciation’ in the value of the unit during the intermediate years of its life, and, being a physical condition of the plant, can in no way be measured by the purely financial considerations upon which the reserves for depreciation necessarily must be based. Such a line of reasoning is absolutely faulty. Any attempt to reconcile ‘deterioration’ with ‘depreciation’ at any intermediate period in the life of the plant of an undertaking, is not only unnecessary but futile. ”

“ If the cost to make is less than the market, to bring the machine on the books at market would necessitate the taking of a profit of the difference between cost and market. No profit has been made, only a saving in capital investment. ”

“ In compiling a balance sheet it is not sufficient to give simply the figures of proprietorship or net worth; schedules of assets and liabilities must be drawn up to show the items making up that net worth. From the viewpoint of a prospective investor or purchaser, a banker to whom the business has applied for a loan, or a concern considering the advisability of extending it credit on a bill of goods, it makes all the difference in the world to know that with a net value of $10,000 the business has assets of $15,000 and liabilities of $5,000 ”

“ PROFITS Difficulty of Determining Profits
What constitutes a profit is oftentimes a perplexing question and at all times its determination is more an estimate than an absolute fact. This arises from the nature of accounting itself in that so many items of expense are known to exist and must accordingly be provided for but the amount of such expenses cannot be exactly determined. This is seen to be true in the case of the provision which must be made for bad and doubtful accounts and for depreciation of fixed assets and is, of course, inherent in all problems of valuation. ”

“ BASIC RELATIONSHIPS—PROPRIETORSHIP
Records and Their Functions.—As far back as our knowledge reaches, records of some sort have been kept and used and they have frequently formed the basis on which our knowledge rests. In a broad sense a record may be defined as a written memorial, a register or history of events, a testimony. Even though the desire to make and hand on to the future a record of achievement is a deep-seated characteristic, record-making has seldom been an end in itself. Knowledge of what has been done has always been a starting point and a guide for future achievement. ”

“ If there is a large outstanding liability which cannot be settled, the partners will estimate that, and it will not be considered as part of the profits. If there is a large outstanding possible loss, and there is a large sum due to a client, then you would provide for that. But in ascertaining what is really actually divisible for the year fairly, you would take the cash account as it stands.” In the light of such mental obtuseness and obliquity, one cannot wonder at the occasional reluctance of business to entrust the determination of important matters to the courts. ”

“ Buying must always have regard to the sales activities. To buy without reference to the ability to sell is suicidal. Both overbuying—buying more than can be disposed of at a profit—and underbuying—buying less than is needed to meet the sales demand—are conditions to be avoided. Underbuying means a loss of sales. Unless their needs are met promptly in accordance with their orders, customers will go elsewhere. Overbuying means the unnecessary tying up of capital in a stock of goods which increases the possibilities of loss resulting from changes in fashions and the level of prices. ”

“ Regardless of the actual progress of depreciation, the theoretically ideal method of distributing the charge, from the standpoint of a going concern, is so that each unit of output shall bear its just proportion of the burden. Any other attitude is inconsistent. Thus, assuming that actual depreciation does not progress uniformly, that, as some maintain, the rate of depreciation is heaviest towards the end of the service life of an asset, it would not be equitable to charge the product of those years with a much higher burden than that of the earlier years. ”

“ For instance, although the net profits of a single proprietorship and of a partnership are usually determined in the same manner, there is nevertheless variation in the treatment of some items such as salaries, drawings, interest on capital invested, etc. The partnership form, like the single proprietorship, contemplates an investment on the part of the owners not only of capital but also of time and effort. This is one of the differences in working organization between these forms of business and the corporation. Investment in the corporation is of capital only. ”

“ Creating a demand for a product by means of extensive advertising is one of the quickest ways of building up good-will. The difference between the cost of the advertising necessary to retain a given volume of trade—which we may call the normal advertising expenditure—and the cost of the publicity required to secure that trade may be treated, in theory at least, as an expenditure on account of good-will and be so shown on the books. ”

“ A balance sheet which shows on its face that cognizance is taken of uncollectible accounts and of the loss in fixed assets due to depreciation, is much more valuable as a financial statement than one lacking that information, provided of course it is to be used to indicate that consideration has been taken of those elements. Excepting for the general remark that regard must always be had to the purpose for which the balance sheet is drawn up, no hard-and-fast rule can be laid down in the matter of the relative fullness of detail with which it should be made. ”

“ It is not the purpose here to go into the question of original cost versus cost of reproduction new, either as a basis for valuation of public utility properties or from the viewpoint as to where the incidence of the burden of replacement properly should rest—whether on the users of the service given by the asset to be replaced or on those using the new asset. In the private enterprise where the rights of the public are not so apparent, under present-day tenets of political and economic philosophy, only internal policies and purposes to be accomplished need be considered. ”

“ Allowance of Salaries.—The allowance of salaries to partners is not so much for the purpose of measuring the excess of the profits of the partnership over what the individual owners might have earned by working for others, as it is for the purpose of equalizing or adjusting their interests on an equitable basis. When, on the one hand, men invest their abilities and services in addition to their capitals, and on the other hand, the profit and loss-sharing ratio is determined on the basis of capitals invested, the greater ability of a given partner may be recognized and compensated by a salary. ”

“ And again, if a company is formed “to acquire and work a property of a wasting nature, for example, a mine, a quarry, or a patent, the capital expended in acquiring the property may be regarded as sunk and gone, and if the company retains assets sufficient to pay its debts, it appears to me that there is nothing whatever in the Act to prevent any excess of money obtained by working the property over the cost of working it from being divided amongst the shareholders.” ”

“ We may define a business transaction as an exchange of values. It may be between persons, as when a sale is made, or it may be between accounts within the business itself, as when a transfer is made between accounts, i.e., when an item is taken from one account and transferred to another for the sake of more clearly showing its nature. Some authors further analyze transactions as complete when the bargain is fully consummated between the parties, as when delivery is made and the money is paid in cash ”

“ The one school bases its main contention on the economic theory of profits; namely, that profits represent the balance remaining after deducting the cost of land, capital, and labor. The function of the entrepreneur, it is contended, does not in itself involve the owning of capital. Profit is the reward for combining the other factors of production and assuming the risk involved. Interest is a cost for the use of capital and it does not matter who owns the capital. ”

“ Other conditions being equal, a firm which enjoys a good reputation is worth more than a new venture. Such a reputation is known as “good-will” and constitutes an exceedingly valuable though an intangible asset. The essence of good-will is the ability to produce more than normal profits, i.e., profits above the average in that line. Consequently, whenever the members of a firm consider the admission of a new partner, good-will is regarded as one of the assets of the existing enterprise, thereby increasing its net worth. ”

“ The price of the product may be set without regard to true costs, and losses pile up with or without the knowledge of the management. Competitive conditions may have to be met and efficiency of management be an absolute requisite if profits are to be made. An organization is of slow growth and the price paid for experience may eat up all the profits. Poor workmanship, duplication of effort, poor planning in the factory, resulting in a high unit cost—these are all factors which may bring disaster if not detected and remedied in time. ”

“ The incorporation of a single individual is not legally possible in this country.
The corporation, because of its peculiar advantages over other forms of business organization, has become the accepted form for most large enterprises. The gathering together of large capital funds, the ease and efficiency of management and control, continuous life, the facility of transfer of ownership, and the limited liability of the stockholders, make the corporate form attractive to the investor and absolutely necessary to the large businesses carried on today. ”

“ As competition becomes keener and the margin of return per unit of product becomes smaller, he has to increase his volume of business to secure the same amount of profit as when he did a lesser volume of business.
To produce goods it is necessary to use the saved wealth of former periods to pay the expenses of materials, labor, management, etc., of the present period. One must consume wealth to produce wealth. After his product is made, he must seek the best market for its exchange or sale. ”

“ It is apparent that an under-estimate effects an inflation of profits due to an overvaluation of the assets. Equally apparent is it that an over-estimate brings about an understatement of profits due to an undervaluation of the assets. The effect of this is to make the valuation reserve account a mixed account. Instead of its content being solely a suspended credit to an asset, it includes also a true reserve of profits. If at any time the facts indicate a too liberal or too parsimonious estimate in the past, adjustment should be made to accord with the newly determined facts of experience. ”

“ Before coming to the question of profits at all the company is entitled to earn a sufficient sum annually to provide not only for current repairs, but for making good the depreciation and replacing the parts of the property when they come to the end of their life. The company is not bound to see its property gradually waste, without making provision out of earnings for its replacement. It is entitled to see that from earnings the value of the property invested is kept unimpaired, so that, at the end of any given term of years, the original investment remains as it was at the beginning. ”

“ Appreciation in value due to so-called unearned increment is entirely a matter of market value. By this is not meant that the monetary value of this kind of appreciation fluctuates with the market; it accrues from day to day and is just as real as depreciation. Although very real, it does not become realized until the property is disposed of, a thing which is determined by business policy and does not rest on any principles of accountancy. It is not good practice to bring such unrealized values on the books. ”

“ Carrying the loss as a part of the assets, particularly if clothed with a title the meaning of which even a code expert could but lamely guess at, is to be condemned. If, however, the title clearly indicates the nature of the item, the situation is not so bad, although it does reflect the slavery to form which compels some very well-meaning individuals to show impairment of capital on the asset side of the balance sheet for the sake of making it balance. The best practice compels the showing of impairment items as direct deductions from capital. ”

“ Stock-in-trade, as the term is usually understood, comprises all commodities purchased for resale. Thus, assets, which in one concern belong to the fixed asset group, may be the stock-in-trade of other concerns. In stating the principles of valuation for these assets, it is definitely to be understood that they apply only to such as are used as stock-in-trade, and not to the same items when used as fixed assets. Oftentimes the process of manufacture intervenes between the purchase of a commodity and its sale. ”

“ Almost invariably some finished stock is on hand and goods are in process of manufacture. Where interest is added, the result is to inflate the value at which the goods must be carried on the inventory—a very undesirable procedure from an accounting and financial viewpoint. By such means it is conceivable that a factory might be made to show a handsome profit even before any of the product had been sold. ”