Accounts: Their Construction and Interpretation for Business Men and Students of Affairs

By William Morse Cole | Go to book overview

necessary. Let us see how these three forms will appear in accounting.

The first, allowing the property to wear out without provision for replacement, can be good business policy under only one condition, namely, if the business, or that department of it, is to be abandoned. In such a case policy requires full benefit to be got from the plant without large cost for renewal and repairs. The property must be exhausted as thoroughly as possible. An easy method of treating depreciation under such a condition would be to distribute to stockholders all net receipts. If that is done, stockholders get all they are entitled to, and when the business is exhausted the profits stop and the capital is gone. If the capital was originally wisely invested and has been properly employed, the stockholders will ultimately receive back their original investment in the final winding-up of affairs; for if the business could have replaced the worn-out plant -- as it could if prosperous--it can pay the stockholders as much as replacement would have cost, which is, of course, practically the original capital.1 The thing works automatically; but since, as a matter of fact, the stockholders are getting their capital handed back to them piecemeal, they must be informed that the dividend is not all profit, or they may be sadly deceived and led to consequent extravagance and ultimate loss. Careful accounting should show that a part of each dividend of this sort is not earnings, but is simply capital returned because the business has no further use for it. The method will be then as follows: first, debit Profit and Loss for the depreciation of property, and credit Real Estate and Plant. The loss, going upon the income sheet as one of the expenses, causes the net income to appear so much less than otherwise; and the credit to Real Estate and Plant reduces the resources on the balance sheet by the same amount. As soon as certain parts of the real estate and plant have worn out, since they have not been replaced or extensively repaired the property other than real estate and plant in the hands of the business is greater in amount or value than it

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1
Of course fluctuations may occur in costs between the time of original investment and the time of exhaustion, and in any particular case the capital may not be restored; but the price of commodities cannot ordinarily and permanently fall so low as to fail to supply replacement funds for goods manufactured under proper conditions; or else manufacturing would not pay.

-80-

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