Cash basis accounting

“ Putting to one side the point that many of the cases relied on involved cash basis taxpayers, [18] these decisions no more pertain to deferred reporting of totally unearned receipts than do the claim of right decisions. These cases, like the claim of right cases, start from the premise that the income in question has been fully earned. [19] The underlying premise of the annual accounting requirement is that otherwise reportable income derived from a transaction cannot be excluded from gross income in order to let the taxpayer wait to see in a later year how the over-all transaction turns out. ”

“ Stocks and bonds representing the investment of temporary surpluses of cash are valued on a realization basis. Inasmuch as the tying up of cash in these securities is only temporary and it is expected that they will be converted again into cash as needed, the amount which can be realized from their sale on the date of the balance sheet is the amount to be considered when judging the financial condition on that date. A large amount of discretion must be used in valuing these securities, because of the violent fluctuations to which quotations on the various stock exchanges are subject. ”

“ Should the value of the net assets comprising plant, equipment, etc., or the earnings for a number of years serve as a basis in arriving at the ratio of exchange in cash or stock? What relative weight should be given to the various items? A concern with large assets when not running its plant to full capacity would be averse to having the apportionments based on earnings. The corporation with relatively small assets but with large earnings on the capital invested would not want the value computed on net assets. ”

“ Sales as the Basis. Inasmuch as there cannot be any loss from bad debts in the cash sales, theoretically the credit sales provide the proper base for making the estimate. Practically, total sales, either gross or net, furnish the base most frequently employed because the total is always available without the necessity for analysis. So long as the ratio of the two kinds of sales remains fairly constant, the loss from bad debts does bear a direct relation to total sales. ”

“ In recording business transactions, therefore, prudence demands that the costs of operating the business be not recorded as increases in the value of the merchandise dealt in, but rather that they be set up separately and charged against the income received from the sale of the merchandise before the increase (or decrease) in the value of the assets is determined and made a part of the asset record. As merchandise is converted into cash the amount received is recorded as an increase in the asset cash. ”

“ Confusion between Profit and Loss and Balance Sheet Items.—The beginner frequently has trouble in making a proper classification of [Pg 59] income items and sometimes of expense items. Take Interest Income as an example. The asset Cash Received is confused with the title Interest Income, which denotes the source of the cash received. The accounting department maintains both types of records. The receipt of cash arising out of interest income would be classified and recorded under two heads: (1) the asset Cash, to indicate the increase in that asset ”

“ Similarly, the beginner oftentimes confuses the sales income record with the cash record of a cash sale transaction. Also, when cash is disbursed for expense purposes, the decrease in the asset is often confused with the expense record. When an expense is incurred it brings about either a decrease in assets, usually cash if the transaction is settled at once; or an increase in liabilities, usually an accrued expense item if the transaction is not immediately settled. ”

“ If a careful accounting is made of the profit or loss at the time of the sale of each piece of property and these profits and losses together with the dissolution expenses are summarized and distributed to the partners’ capital accounts, those accounts will of course show the claims of the various partners on the net assets of the business after all assets have been converted into cash and all liabilities paid. ”

“ Accounts are kept both with persons, as the accounts receivable and payable already mentioned, and with things, such as land, buildings, machinery, merchandise, cash, and the like. Some asset accounts and some accounts kept with persons are usually composed of both similar and dissimilar items. For example, the cash account is composed of both cash received and cash paid out items; the accounts receivable record both the items for which the person is in debt to the business and those which show the cancellation or settlement of the debt, in part or in full ”

“ In the ultimate analysis the best safeguard is the integrity of the employee; still the employer should not tempt the employee by making the abstraction of his cash an easy performance.
Principle of the Double Record.—A fundamental principle in the handling of cash is to secure a double—not a duplicate—record of its receipt and disbursement. The practice of depositing in a bank all cash receipts and making disbursements only by check should be followed invariably, because it secures this double record—the bank’s record and the cashier’s record. ”

“ Accounts with Customers
The balance owing us by a customer is an asset, and therefore a debit item.
Goods sold on account are charged to the customer because our claim against him constitutes an asset; at the same time the income account, Sales, is credited.
When a customer pays us on account, his account is credited and Cash is [Pg 87] debited, showing an increase of the asset Cash and a decrease of the asset Accounts Receivable. Such an entry is simply a transfer from one account to another, an increase of one asset offset by a decrease of another asset. ”

“ 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. ”

“ With the exception of the items transferred to the analysis sheet from the Cash account—where a Cash account is carried in the ledger—all items in the cash debit column of the analysis sheet represent, in the cash book, credits to certain accounts, and those in its credit column represent debits to certain accounts. The entries to the cash analysis column from the ledger Cash account, showing on its debit cash receipts and on its credit cash disbursements, must bring about the equilibrium. ”

“ The general and long-standing rule for all taxpayers, whether they use the cash or accrual method of accounting, is that costs incurred in the acquisition, production, or development of capital assets, inventory, and other property used in the trade or business may not be currently deducted, but must be deferred until the year of sale, when the accumulated costs may be set off against the proceeds of the sale. ”

“ The only advantage of this method is to bring all summary debit postings on one side of the cash book and all credits on the other. Where the cash book is operated according to method 2, the closing summaries are made as shown in Form 42, using columns on the debit side for Customers, Sales Discount, and Sundry; and on the credit side for Creditors, Purchases Discount, and Sundry. As there is no net cash column, the totals for Customers and Creditors are not all cash. ”

“ An account title is often used in one business to include items not mentioned under that title in another business. One finds also terms and titles peculiar to particular businesses. However, there is a tendency towards a standardization of the terms used in balance sheets. It is the purpose here to present and explain those which are common to practically all businesses. These include the asset titles Cash, Notes Receivable, Accounts Receivable, Merchandise, Investments, Deferred Charges or Expense Assets, Furniture and Fixtures, Delivery Equipment, Buildings, and Land. ”

“ Cash sales may also be handled without the use of a separate column in the sales journal. Two methods are used for this. Under the one, cash sales are included in the Accounts Receivable debit total of the sales journal, although the individual items are not posted to the subsidiary ledger, and they are also included in the Accounts Receivable credit total of the cash receipts journal. The inflated debit in the general ledger controlling account is thus offset by an equally inflated credit, the balance therefore being the correct amount to control the sales ledger. ”

“ Yet it should be borne in mind that its scheme of debit and credit is now an independent one and is not linked up to the debit and credit equilibrium of the general ledger; that is, the postings in the subsidiary ledger are merely memorandum entries of the detail posted in summary form to the general ledger. Thus the mathematical basis of the controlling account is simply that the whole is exactly equal to all its parts, the balance of [Pg 266] the summary account being equal to the total of the balances of all the customers’ accounts of which it is the summary. ”

“ If the proprietor begins business with an investment of cash only and without any obligations, an entry in the cash book of the amount invested as a credit to the proprietor’s capital account is all that is necessary. If the investment consists of a variety of properties and liabilities to creditors, and obligations on leases, salaries, etc., are assumed, a very careful and complete record should be made in the journal, showing the kinds and values of the properties invested, and the kinds and amounts of the liabilities assumed. ”

“ Columnar Analysis of Cash Receipts and Disbursements.—As illustrated in the chapters on purchase and sales journals, additional money columns are often used for the purpose of analyzing the purchases and sales by departments or classes of commodities. A similar analysis of both the cash receipts and cash disbursements may aid in segregating certain classes of cash items and thus save labor in posting. Of cash receipts, two classes are usually more active than all others combined. More cash is received from cash sales and from customers on account than from any other source. ”

“ For instance, a corporation keeping its books and filing its income tax return under sections 41, 42, and 43 on the cash receipts and disbursements basis may not use the accrual basis in determining earnings and profits; a corporation computing income on the installment basis as provided in section 44 shall, with respect to the installment transactions, compute earnings and profits on such basis ”

“ In concerns where both regular and instalment sales take place, a separation of the customers’ balances on the basis of the sales contract gives the necessary information for balance sheet purposes. The accounts of instalment trade debtors normally require a much more liberal valuation reserve than those of regular credit customers. ”

“ The time during which an asset continues in use is the customary basis for a classification of its cost as between expenses and fixed assets. Thus, an asset acquired for purposes of business operation which, however, will be used up completely during the current period is charged immediately to some expense account, whereas an asset which will continue in use over several periods is charged to an asset account. Fixed asset purchases are never for purposes of resale. ”

“ The record in each journal shows the individual vendor’s account, but at posting time no vendor account is set up in the ledger, neither the credit to the vendor’s account shown in the purchase journal nor its offsetting debit shown in the cash disbursements journal being posted. ”

“ In determining the amount of earnings or profits (whether of the taxable year, or accumulated prior to March 1, 1913) due consideration must be given to the facts, and, while mere bookkeeping entries increasing or decreasing surplus will not be conclusive, the amount of the earnings or profits in any case will be dependent upon the method of accounting properly employed in computing net income. ”

“ After all assets have been converted into cash and all liabilities liquidated, only the cash and net worth accounts will remain on the books of the corporation. If the net result of the liquidation has been to encroach upon the original capital, the net worth accounts will consist of a deficit account and one or more capital stock accounts. If, however, a profit has resulted or if the resulting deficit is not sufficient to wipe out any previously accumulated surplus, the net worth accounts will consist of a surplus account and the various capital stock accounts. ”

“ Entry (a) in the general journal sets up an account with the vendor, the Investment Trust Co. Entry (b) in the cash disbursements journal and entry (c) in the general journal show the cancellation of the liability to the vendor through the payment of cash in the one case and the giving of a mortgage in the other. The net effect of the entries is:
It will be noted that this method sets up a formal account with the vendor—a desirable thing—but that it requires one more entry than the first method. ”