3. Make a trial balance of the ledger accounts.

[Illustration] [Illustration] TREATMENT OF CASH DISCOUNTS =73.= _Cash discounts_ are discounts allowed for prepayment of bills. They are frequently confused with bank discounts (or interest collected in advance when notes are discounted), but are of an entirely different character. When the price is made, the profits are calculated with the idea that the customer may take advantage of the cash discount; that is, the price after the discount is deducted includes a legitimate profit. We cannot debit the customer with the amount of the bill less the discount, for we do not know that he will take advantage of the discount; and so, the charge to the customer and credit to sales account is an amount which may never be received. If the bill is paid less the discount, the amount deducted reduces our profit on the sale. It is not an allowance for the use of capital, for we can probably borrow money at 6 per cent, while the discount may be 5 per cent or more for anticipating payment 30 days or less. = 74. Discounts Allowed.= Cash discounts allowed must eventually come out of the profits arising from the sale of the commodities in which we are trading. There are two methods of charging cash discounts, either of which is considered correct: (1) Open an account called _Discounts on Sales_, and charge to it all discounts allowed for the prepayment of bills. When the books are closed, the total will be charged against trading profits. This method is coming into general use, and may be considered standard. (2) Charge to _Sales Account_ directly all discounts allowed, treating them as allowances. The balance of the sales account will then represent net sales after returns, rebates, and cash discounts have been deducted. One feature to recommend this plan is that sales account does not show a fictitious volume of sales. =75. Entering Cash Discounts in Cash Book.= When we receive payment from a customer who has deducted the cash discount, the discount must be taken account of in entering the payment, as the customer is to receive credit for the full amount. We might enter the cash payment in the cash book, and make a journal entry of the cash discount, but this would necessitate two postings from separate books. A better method, and one which has become standard, is to provide a _cash discount column_ in the cash book. When a column has not been provided for this purpose, a narrow column can be ruled in on the cash received or debit side of the cash book. This is carried as a memorandum until the end of the month, when the total is posted to the debit of discount on sales. Two ways of making the entry are shown (p. 84). In Example No. 1, the cash discount is entered in the discount column, and the net cash received is entered in the cash column. When the payment is posted, two entries are made in the ledger. One advantage in this is that reference to the account of R. L. Brown & Co. shows at a glance whether they are taking advantage of cash discounts. In Example No. 2, the cash discount is entered in the proper column, but the gross amount is entered in the cash column. The payment is then posted in one item, and reference to the ledger account does not show whether the payment of $100.00 is all cash or part discount. It is necessary, also, to deduct the footing of the discount column from the footing of the cash column to ascertain the amount of cash received. For these reasons the method shown in Example No. 1 is recommended. =76. Cash Discounts Earned.= When we take advantage of the discount offered for the prepayment of bills, the discount earned can be considered a legitimate source of profit. Our own selling prices for goods purchased to be resold are based on the prices at which they are billed to us, without considering a possible saving by discounting our bills. Whether or not we discount our bills is largely a question of capital, and such earnings are legitimate profits entirely outside of regular trading profits. Discounts earned should be treated as interest earned and credited to interest account, from which they will find their way into profit and loss account. [Illustration] PROFIT AND LOSS =77.= The _profit and loss account_ is a summary account made up of the balances of all income and expenditure (revenue) accounts in the ledger, the balance of this account representing the _net loss_ or _net gain_ of the business. It is advisable to show the net profits for each year; and to accomplish this, it is customary to transfer the balance of profit and loss account at the end of the year. In single proprietorships and partnerships, the net gain is transferred to proprietor's or partner's investment accounts, while in a corporation it is usually transferred to a surplus account. A loss is transferred to a deficiency account. =78. Trading Account.= This is a subdivision of profit and loss account intended to exhibit the gross profit derived from the manufacture or purchase and sale of goods in which the business is organized to trade. These profits are known as _trading profits_. Just what items of income and expenditure enter into trading profits or losses is an important question in the science of accounts. A safe rule to follow is to debit trading account with the cost of goods sold, including cost of preparing them for sale. In a manufacturing business the cost represents cost of raw materials and cost of manufacture. Credit the account with net income from sales, arrived at by deducting from gross sales all returns, allowances, rebates, and cash discounts. All expenses incurred in selling the goods, and all expense of administration of the business, should be charged to profit and loss account proper. All profits arising from other transactions than trading should be credited to profit and loss. These include interest received on past due accounts, on notes, or for money loaned; discount earned by the prepayment of bills; profits from the sale of real estate or any property other than that in which the business is trading. =Trading Account, How Constructed.= The trading account is made up by charging total inventory at the beginning of the year and purchases during the year; crediting net sales and inventory at the close of the year, the balance representing the gross profit. [Illustration] =Turnover.= It is desirable to know the cost of goods sold. This is known as the _turnover_, on which percentages of profit are based. The turnover may be found by deducting the present inventory from the debit side of the trading account. [Illustration] =79. Manufacturing Account.= In a manufacturing business it is very desirable to know the cost to produce the goods; and for this purpose a subdivision of profit and loss, called _manufacturing account_, is used. The manufacturing account is debited with inventory of materials at the beginning of the year; purchases of material; labor or wages in factory, and all other expenses of manufacture; and credited with inventory of materials at the close of the year. The balance represents cost of manufactured goods to the trading division. The principal value of these subdivisions of profit and loss lies in the fact that they reveal not only the _amount_ but the _sources_ of profits and losses, which is one of the important functions of accounting. [Illustration] The profit and loss account of a professional or other non-trading concern need not be subdivided as explained for a trading concern. In a non-trading business, all accounts representing revenue receipts or revenue expenditures are transferred direct to profit and loss account. =80. Transfer of Gross Profit.= The gross profit from trading is now transferred to the credit of profit and loss account, and this account is debited with the balances of all revenue expenditure accounts. Continuing the illustration from Article 78, we have: [Illustration] =81. Transfer of Net Profit.= The net gain is transferred to the credit of proprietor's account in a single proprietorship. [Illustration] MERCHANDISE INVENTORY ACCOUNT =82.= The accounts now open in the ledger, other than proprietor's account, exhibit all assets and liabilities of the business with the exception of the present inventory, which is included in the trading account. The amount of the inventory is transferred to the debit of a merchandise inventory account. [Illustration] The books are now said to be _closed_, there being no open accounts except those representing assets or liabilities of the business. BALANCE SHEET =83.= A statement of the assets and liabilities of a business is called a _balance sheet_. If the assets exceed the liabilities, the difference is the _present worth_. If the liabilities exceed the assets, the business is _insolvent_, and the difference or balance shows the amount of insolvency. The balance sheet is prepared from the ledger balances after the books have been closed. In arranging the accounts on a balance sheet, the assets should be listed first, followed by the liabilities. The balance will agree with the balance shown in the proprietor's or investment account. For the business of a single proprietor, it is customary to list the accounts in the following general order: _First_--Cash in bank and office. _Second_--Open accounts and bills receivable. _Third_--Merchandise per inventory, store fixtures, etc. _Fourth_--Real estate. The first two classes are termed _active_ or _quick_ assets, as they can be most readily converted into cash. The liabilities represented by credit balances, are listed in the order of their urgency: _First_--Open accounts due others. _Second_--Bills payable. _Third_--Mortgages or bonds payable. The third class represents secured liabilities, while the first two represent unsecured liabilities. Continuing the previous illustration, we find the balance sheet of our imaginary ledger to be as follows: [Illustration] SAMPLE TRANSACTIONS =84.= At the end of the first year, the trial balance of a single proprietorship was as follows: DEBIT BALANCES Bank Account $ 764.20 Sundry Open Accounts Receivable 1,127.30 Bills Receivable 475.00 Furniture and Fixtures 325.00 Cash in Office 68.50 Purchases 9,571.40 Expense 675.00 Discount on Sales 96.75 Interest 72.10 -------- 13,175.25 CREDIT BALANCES Proprietor (Investment) 2,500.00 Bills Payable 2,000.00 Sundry Accounts Payable 1,761.60 Sales 6,913.65 -------- $13,175.25 The inventory at the end of the year was $4,962.30; at the beginning of the year, there was no merchandise in stock. The books are to be closed into trading and profit and loss, and a balance sheet prepared. When closing the books, all entries necessary to adjust the balances of ledger accounts should be made through the journal. When an audit is made, it is difficult to trace the entries unless they are plainly stated in one group, which is provided when they are made in the journal. The making of entries in the ledger directly, also increases the opportunity for fraudulent entries. _Never make original entries in the ledger._ EXAMPLE FOR PRACTICE From the following trial balance prepare trading account; profit and loss account; and balance sheet. TRIAL BALANCE Proprietor (Investment) $7,600.00 Bills Payable 4,000.00 Accounts Payable 1,470.00 Bank $1,262.84 Accounts Receivable 2,693.11 Bills Receivable 4,360.00 Merchandise Inventory 6,277.76 Furniture and Fixtures 750.00 Purchases 7,105.78 Expense 1,416.30 Discount on Sales 112.65 Interest 44.20 Sales 10,985.70 Cash 121.46 ---------- ---------- $24,099.90 $24,099.90 Inventory at end of year $6,493.06. [Illustration] [Illustration] [Illustration] [Illustration] [Illustration: CASHIER TERMINAL, LAMSON MOTOR-DRIVEN CABLE CASH CARRYING SYSTEM FOR DRY GOODS, GENERAL, OR DEPARTMENT STORES Lamson Consolidated Store Service Co.] JOURNALIZING NOTES =85.= When a note is received by us or we give our note to another, it is necessary to make a journal entry in order that there may be a proper record of the transaction on our books. Careful study is sometimes necessary to determine just how the entry should be made, and the following illustrations will serve as a guide. =86. When Received.= When we receive a note, we debit bills receivable and credit the maker--that is, the person who gives us the note. We receive a note from Samuel Smart for $100.00 payable in 30 days. The journal entry is: Bills Receivable $100.00 Samuel Smart $100.00 30-day note dated Sept. 10 =87. When Paid.= When this note is paid, we debit cash and credit bills receivable. The entry is made in the cash book on the debit side which debits cash and credits bills receivable. Bills Receivable Samuel Smart's note $100.00 due Oct. 10th =88. When Collected by Bank.= Perhaps the note was collected through our bank; in that case, the bank, instead of sending us the cash, will credit the amount to our account. The bank may, also, charge a small fee for collecting the money; consequently the amount placed to our credit will be the sum collected, less their fee. The entry in the journal would then be: Bank $99.85 Interest and Discount .15 Bills Receivable $100.00 Smart's note due Oct. 10th Collected by bank. =89. When Discounted.= At the time we received Samuel Smart's note, we may have needed the money for immediate use in our business. We would then take the note to the bank, endorse it payable to the bank, when they would discount it, giving us credit for the net proceeds. Since the money is advanced to us, the bank would charge us interest for its use, which amount would be deducted from the whole amount, leaving the net proceeds. This amount would then be available for immediate use. The note is then the property of the bank; it has gone out of our possession and we have received the cash. The note is not paid, and in discounting it we have created a liability to the bank. Remembering that one of the functions of bookkeeping is to exhibit the true nature of our assets and liabilities, we open a _Bills Discounted_ account in the ledger. The entry is: Bank $99.50 Interest .50 Bills Discounted $100.00 Discounted Smart's note due Oct. 10th. =90. When a Note Drawing Interest is Discounted.= The above transaction presupposes that the note is given _without_ interest; but if it were given _with_ interest, the bank would simply add the interest to the principal and deduct the discount from the total. In the case the sum of the principal and interest ($100.00 + .50 = $100.50) is $100.50, and the discount $.50, which would leave $100.00 as the net proceeds. If the amount of the note were larger or the interest was figured for a longer time, it would make a difference. Suppose the amount of the note to be $2,000.00, time 30 days, interest 6% per annum. Principal $2,000.00 Interest 30 days 10.00 Total $2,010.00 Less interest on $2,010.00 for 30 days 10.05 ---------- $1,999.95 Since the net amount realized is less than the face of the note, we need not consider the interest earned, but the entry would be: Bank $1,999.95 Interest and Discount .05 Bills Discounted $2,000.00 =91. When a Note Drawing Interest is Paid.= But suppose Samuel Smart's note is $100.00 for 30 days, with 6% interest, and that the note is kept by us and the money is paid directly to us when due. We shall then receive the interest, in addition to the face of the note, making a total of $100.50. The entry would then be made in the cash book on the debit side, and would be: Bills Receivable $100.00 Interest and Discount .50 Samuel Smart's note due Oct. 10, paid to-day. =92. When a Discounted Note is Not Paid.= When we discounted Samuel Smart's note of $100.00 for 30 days without interest at the bank, we were obliged to endorse it, which had the effect of a guarantee of payment. If not paid when due, the amount would be charged to our account at the bank. The note would again come into our possession, and the amount must be debited to some account, the credit being to the bank. We have previously credited the amount to bills discounted, and our entry is: Bills Discounted $100.00 Bank $100.00 Samuel Smart's note not paid at maturity. But suppose the transaction to have been the one described in Article