Roy B. Kester

“ 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. ”

“ 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. ”

“ 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. ”

“ 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. ”

“ 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. ”

“ Just as it is a misfortune to be born under some conditions, so here it would be a misfortune to a commodity to be produced during the latter years of the service life of an asset. The life-period of an asset must be viewed as a whole and its total depreciation should be distributed evenly over its output, if equity is to be secured—other conditions, of course, remaining the same. ”

“ 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. ”

“ 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. ”

“ 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. ”

“ 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.” ”

“ The nature of a corporation is such, however, that many acts and privileges which are per se rights of the stockholders must in their exercise be delegated to others. Thus, while the right of ownership and control of the profits of a corporation is inherent in its proprietorship, the control is indirect—through the medium of a board of directors subject to periodic review and election by the owners. ”

“ After all, this magic rule of averages which is invoked to cover up many troublesome and embarrassing situations is obnoxious to scientific accounting; it is a makeshift which carries with it a shiftless trust in the happy outcome of things—a trust which has been so often betrayed as to carry little weight. ”

“ 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. ”

“ 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. ”

“ 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. ”

“ 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. ”

“ 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. ”

“ While for purposes of credit it may be wise and proper to show the true valuation of the assets, for the purpose of profits, particularly profits available for dividends, such appreciation in values must not be taken into account. It should be remembered that appreciating the value of fixed assets frequently results in the necessity of meeting higher depreciation charges and is thus not an unalloyed gain. The payment of dividends based on such profits would, without taking profits from other sources into consideration, always result in the diminution of the fund of working capital. ”

“ The service output method bases the depreciation cost not on years of [Pg 178] life nor on life in terms of working hours of service. Here an attempt is made to predetermine the output of the asset in terms of units of product, and so burden every unit with its fair share of depreciation. To secure full equality of charges, up-keep costs must be reckoned on the same basis, rather than on a time basis of service hours or length of life. If conditions are uniform and normal, this method, where applicable, secures perhaps the most satisfactory of all allocations of depreciation costs. ”

“ The corporate form of business lends itself to exploitations of many kinds. The public is usually victimized, but sometimes the stockholders suffer through a breach of trust on the part of officers—as for example, the granting of contracts or the payment of exorbitant salaries to the detriment of the large body of stockholders. Another form of exploitation is the diversion of profitable business to some other corporation controlled by the untrustworthy officers. Then again the officers may buy up unprofitable ventures and sell them to the corporation at a large profit. ”

“ Although it may be foreseen with reasonable certitude that a power plant generating a thousand horse-power will be entirely inadequate in ten years, yet it may be the better business economy to scrap it at the end of ten years rather than incur the up-keep and depreciation charges on a larger plant which would give longer service. Whichever policy, according to best engineering economy, results in the lowest unit cost of product is usually the determining factor. ”

“ Inasmuch as dividends can be declared only out of profits, a company cannot guarantee its own stock—or rather a guarantee on the company’s own issue must always be dependent or contingent upon the earning of profits sufficient for that purpose. Stock issued by one company and guaranteed by another may with strict propriety be called guaranteed stock. Thus, a large company may enter into a contract of lease with a smaller concern whereby the compensation shall be, let us say, an 8% dividend guaranteed to all holders of the stock of the smaller concern. ”

“ 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. ”

“ It cannot be denied, however, that all the other elements of good-will may have been acquired and built up by the old company and that without them the new concern would be unable to bring good-will into evidence simply by a change of management. It is true that the merger may be able to build up quickly a good-will of its own through the elimination of competition, and through the full utilization of all the advantages of the different units—such as access to supplies of raw material, favorable trade agreements of various sorts, and the like. ”

“ A prevalent feeling is that the appearance on a balance sheet of such an item as discount on stock is a serious reflection on the standing of the corporation and is to be avoided in any way possible. Discount on stock is not an attractive item on a balance sheet, but there is little justification for such sentiment in those states where the sale of stock at a discount is a perfectly legitimate transaction. The balance sheet ought to represent facts as they are until they change ”

“ In factory accounting, labor is divided into two classes, direct and indirect. These are sometimes called productive and non-productive, terms doubtless carried over from the old economics which looked upon some labor as productive and some non-productive—necessary, it is true, but rather of the nature of a necessary evil. Direct labor is a direct cost as explained above. That is, it is the labor of the workmen who apply themselves directly to the manufactured product as distinguished from the labor of those employees [Pg 54] who plan, lay out, and supervise the work of others. ”

“ Yet even today it is sometimes difficult to convince the proprietor of a small business of the necessity, from the standpoint of accurate accounting, of taking cognizance of accrued and deferred expense items. Instances may sometimes, though rarely, arise in which all income has been received in cash at the end of the fiscal period and all expenses applicable to that period have been met in cash and that no deferred items need to be taken into account. Where such is the case, a statement of cash receipts and disbursements might give a fair indication of the profit and loss for the period. ”

“ Any theory for ascertaining existing depreciation in the plant of a public utility which confines such depreciation solely to the actual, visible, physical, demonstrable deterioration which can be seen by the human eye and measured by the human hand, must of necessity ignore that other species of deterioration which the experience of the past has demonstrated beyond peradventure exists in the property of every telephone company, although it cannot always be seen by the human eye or measured by the human hand. ”

“ A favorite method of charging the discount on stock to organization expense is not approved, not because it is a misnomer, for discount may well be looked upon as one of the expenses of organization, but because it is an item of sufficient importance and interest to require separate record. Charging the discount to some asset account, when payment of stock is made by property instead of by cash, is to be severely condemned. Inflation of asset values to cover up such an item cannot be justified. ”