CHAPTER XXII

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. As is proverbially true of the prescriptions of different physicians for the same malady, so no two accountants would arrive at the same figure of profit for any given concern. Economic Definition It may be of some advantage at this point to attempt a definition of profits although to compress the meaning of the word within defined limits is hardly possible and for this reason the formulation of a working definition is very difficult. Etymologically, “profit” comes from the Latin word _proficere_, meaning to make progress, and a better definition than this would be difficult to find. At the best the term is an elusive one, being used with slightly different connotations in different schools of thought. Thus, we find the word used and defined in economics, law, and accountancy, and some of the definitions are twisted almost to the point of absurdity. Alfred Marshall,[52] the English economist, says: “If a person is engaged in business, he is sure to have to incur certain outgoings for raw material, the hire of labour, etc. And, in that case, his true or net income is found by deducting from his gross income ‘the outgoings that belong to its production.’” Charles S. Devas[53] says: “The income from production combining both labor and capital is profits.” He defines gross income as “the total wealth added to the property of a given person in a given time from _whatever_ source ... and net income as gross income minus the following items: (a) Destruction, damage, or loss by fire or other accident, by violence, by thieves, by bad debtors. (b) Using up of materials in production, and wear and tear of machinery and industrial buildings such as factories or shops. (c) All sums spent on purchases of goods that are to serve the purchaser not as subjects of enjoyment, but as means of getting an income. (d) All sums spent on hire of goods that in like manner are to serve as means of getting an income. (e) All payments for labor that in like manner are to serve as means of getting an income.” One wonders if Marshall’s idea of incomings and outgoings is limited to a cash basis or if he recognizes accruals. On the other hand, from the point of view of accounting, Devas includes too much, as will be pointed out later. E. R. A. Seligman[54] says: “Profits are the income from business enterprise.... Profits are always a surplus. They are the difference between the cost of production or acquisition and the selling price.” He summarizes expenses of production as including cost of raw materials, wages, rent, interest on capital borrowed or _invested_, taxes, and miscellaneous outlays such as insurance, advertisements, and transportation expense. Again, he says:[55] “Income is that which comes in to an individual above all necessary expenses of acquisition and which is available for his own consumption.” He recognizes depreciation as a necessary expense. [52] In “Principles of Economics.” [53] In “Political Economy.” [54] In “Principles of Economics.” [55] In “Income Tax.” All of this attests the statement made above that the formulation of a satisfactory working rule for the determination of net profits, from the business standpoint, is extremely difficult. It should be said, of course, that in some respects the idea of net profit as used in economics differs from that used in business; the chief difference being that interest on invested capital is in economics looked upon as an expense deduction before the determination of profits. Legal Definition The efforts of the law, as evidenced by court decisions, to mark out definitely the meaning of net profits have resulted in many odd twists of terms and meaning. In an English case[56] decided as recently as 1902, this language is used: “If it is a mere question what were the profits made in a particular year, it seems to me that the duty is to ascertain what cash has been received and what cash has been expended, and, if that is fairly done, you know the profits of the year. 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. In cheering contrast is a legal opinion quoted by R. H. Montgomery,[57] in the following: “I should think that no commercial man would doubt that this is the right course—that he must not calculate _net profits_ until he has provided for all the ordinary repairs and wear and tear occasioned by his business. That being so, it appears to me you can have no net profits unless this sum has been set aside.... If you had done what you ought to have done, that is, set aside every year the sum necessary to make good the wear and tear in that year, then in the following years you would have a sum sufficient to meet the extra cost.” Even here confusion is apparent between a valuation reserve and a reserve which has been funded and the emphasis is rather on the point of providing funds necessary for the purpose—a financial problem as distinguished from an effort to define net profits. [56] Badham v. Williams. [57] In “Auditing, Theory and Practice.” Between these extremes of legal opinion and phraseology one finds all shades and degrees of understanding and misunderstanding. In recent years there is evident in the decisions of our higher courts and of our many excellent governmental commissions and bureaus a real appreciation of some of the technical points involved in profits determination. It is believed that a body of authoritative decisions will in time and perhaps soon reflect the best opinion of the business men of the country. Accounting Definition The purpose of this chapter is to discuss some of the points at issue in this vexed problem, but before entering upon this discussion it will be of advantage to quote from leading authorities on the attitude of accountants towards the determination of profits. A. Lowes Dickinson[58] says: “In the widest possible view, profits may be stated as the realized increment in value of the whole amount invested in an undertaking; and, conversely, loss is the realized decrement. Inasmuch, however, as the ultimate realization of the original investment is from the nature of things deferred for a long period of years, during which partial realizations are continually taking place, it becomes necessary to fall back on estimates of value at certain definite periods, and to consider as profit and loss the estimated increase or decrease between any two such periods.” It is in the making of these estimates that the most difficult problems of profits determination are met. [58] In “Accounting Practice and Procedure.” Mr. Montgomery in his dictum, “The net profit of a business is the surplus remaining from the earnings after providing for all costs, expenses, and reserves for accrued or probable losses,” offers the best available working definition, although a caution is needed against the danger of relying exclusively upon any one definition. Methods of Determining Profits Systems of bookkeeping, in the main, provide two distinct methods for the determination of profits, namely, by means of single entry and double entry. The student is referred to the author’s first volume for the detailed working out of profits by single entry. Here it is sufficient to say that the determination of profits rests upon a comparison of assets and liabilities as at the beginning of a fiscal period, with those as at the end of the period. Then the increase or decrease in net worth as so determined, after making due allowances for any withdrawals or investments of capital during the period, constitutes the figure of net profit or loss for the period. The disadvantages and inaccuracies inherent in this method have already been pointed out. The method of determining profits by means of double entry provides an entirely distinct set of accounts known as temporary proprietorship or profit and loss accounts. These record the daily changes in net worth and must be summarized through the Profit and Loss account at the close of the fiscal period, at which time they must prove against the profits as determined by the balance sheet, the method of which is essentially the single-entry method. In addition to this control secured by checking the results obtained by one group of accounts against those of another group, is the important advantage of presenting in the record a mass of statistical information for guidance in the conduct of a business, without which the present-day enterprise with its many complexities of organization and working could not hope for any certain measure of success. The Problem a Question of Valuation Inasmuch as every profit made must be reflected in a corresponding increase of some asset or the decrease of a liability, and, conversely, every expense incurred is reflected as a decrease of assets or increase of liabilities, it is apparent that profits determination is largely a question of the valuation of assets and liabilities and therefore rests upon the principles already established. Thus the amount of _gross_ profit is not determinable until the value of the stock of merchandise on hand is known. Gross profit rests on inventory valuation, whether that be accomplished by the perpetual inventory method or that of periodic stock-taking. While under the double-entry system the charges for expense are more or less fixed and certain and not so dependent on inventory, it has been seen in Chapters XIV and XIX that before accuracy can be secured, here too there must be an inventory or appraisal to determine the prepaid and accrued expense items. The basis for valuing these was indicated in the chapters referred to. Estimates of depreciation, bad debts, and other similar items must also be made to secure a proper appraisal of the corresponding asset items. Similarly, in the determination of other income, accruals and prepayments must be taken into account. In the making of the record of temporary proprietorship data, the fundamental distinction between capital and revenue charges is vital and must be kept constantly in view. Thus the problem of profits is seen to be in its broader aspects the same problem of valuation to which attention has already been directed. It is purposed here to point out the application of the valuation problem to the periodic determination of profits and to re-examine some phases of the problem from the standpoint of profits as distinguished from that of assets. Effect of Asset Losses on Future Profits The first question for discussion may be stated as follows: In the determination of _periodic_ profits must all the data which have affected proprietorship during that period be summarized in order to make a proper showing of profits for the period? An illustration will better present the issue. A manufacturing concern with plants in many places suffers a heavy loss from fire. Must this loss be considered (1) as an expense applicable to the current period and to be taken account of before the determination of profits for the period; or (2) may it be treated as a deferred expense to be shared by several succeeding periods; or (3) may it be charged directly against capital? Three somewhat different solutions are thus presented. The first treats the loss as a _temporary_ proprietorship charge; the second as a deferred charge to operation and so includes the portion deferred among the assets and to this extent does not reflect the loss as a diminution of net worth; and the third treats the loss as a charge against _vested_ proprietorship. Any adequate treatment of the question requires a consideration of (1) the type of business organization, i.e., single proprietorship, partnership, or corporation; (2) the appropriation of profits, whether they are to be withdrawn or reinvested in the business; and (3) the nature of the loss, as to whether fixed or current assets were affected. The practical aspect of the problem is the adoption of a policy not in contravention with the law, and in the determination of this phase of the subject there are some court decisions none of which, however, seem entirely trustworthy. It must be borne in mind that in the types of organization known as single proprietorship and partnership, there is little legal restriction in their formation and operation. The law presumes that the full liability of the owner or owners offers sufficient protection to creditors. Hence the withdrawal of profits or capital is not safeguarded in any way in the interest of creditors. With the corporation, however, provision is specific that nothing shall be returned to the stockholder except profits so long as the business continues in operation. Exception here is usually made for those concerns operating assets which are subject to depletion, in which case it has been held that dividends may include a return of the depleted portion. The theory of the law is that, except as just indicated, the capital of a corporation is an _indication_ to creditors of the amount by which the assets may suffer shrinkage and their claims still be protected in full. Hence, the return of capital in the form of dividends is not allowed, as that would impair the margin of safety for creditors. From the practical standpoint, therefore, the problem concerns only the corporate form of organization and that only in its relation to dividend payments. So long as the profits are reinvested in the business, neither creditors nor owners have any cause for action, except in case of fraud. Legal Decisions as to Asset Losses In decisions relating to this question of asset losses, the courts have seen fit to make a distinction between what they term fixed and circulating capital, corresponding in the main to the fixed and current classification of assets for the balance sheet. In the leading English case,[59] it was held that a trust company holding stock, which during the last business year paid 50 per cent dividend but which before the end of the year became utterly worthless, may include the 50 per cent in its yearly profit, without deducting a penny for the depreciation of the property from which this profit was derived. In the language of the court Lord Justice Lindley said: “Fixed capital may be sunk and lost and yet the excess of current receipts over current payments may be divided. But floating or circulating capital must be kept up, as otherwise it will enter into and form part of such excess (seeing that circulating capital, with the particulars of its purchase and sale, must appear in revenue account), in which case to divide such excess without deducting the capital which forms part of it will be contrary to law.” [59] Verner v. General and Commercial Investment Trust, Limited, 2 Ch. 239 (1894). The stock held by the trust company was for permanent investment and therefore in the nature of a fixed asset. The language of the court is quite specific and there would seem to be no _need_ for including all or any portion of the loss in the current statement of profit and loss. Other later decisions have somewhat extended the doctrine so that it has been held that the current profits may be determined without making any provision for a loss, even of circulating capital, occurring in a _previous_ year. Thus it would seem that so far as the _legality_ of profits determination is concerned, each fiscal period may be counted as entirely free from liability for the happenings in other periods—a unit of business history distinct from all other units. These decisions are English cases and have not always been followed in this country. For a statement of the prevailing opinion in this country, see page 443 of Chapter XXIV, “Dividends.” The danger of the position is apparent. In the hands of unscrupulous managers the profit and loss might be so manipulated that alternate years would always show profits in spite of the fact that the company’s capital was constantly being depleted. Loss Charged against Current Profits In stating the question on page 393, three alternatives were presented by way of solution. The first of these suggested that the entire loss be treated as a charge against the profits of the current period. It has been seen that there is no support in law for this method of handling the loss, nor is there any need or justification for it from the standpoint of correct accounting theory. Only such losses as occur more or less regularly and which within the experience of the business can be fairly accurately estimated, are proper charges to the current period. It is not the function of the periodic profit and loss statement to reflect charges covering contingencies which with almost equal certainty may or may not materialize. Loss Treated as Deferred Expense Charge The second solution suggested, viz., that the loss be treated as a deferred expense to be shared by several succeeding periods, has much to commend it and little to condemn it, except a possible lack of business foresight as will be evident when the third solution is examined. It may be argued, and with a good show of reason, that such losses are so infrequent, occurring perhaps only once or twice in the life of any business, as to make it unfair as between periods to burden some with a charge of this sort and not all. For comparative purposes, the spreading of the loss over several periods will tend to obscure the true state of operations for those periods, although that is largely a matter of the way in which results are presented. The situation is relentless, however. If it is desired to recoup the loss in order not to show an impairment of capital, the loss must be charged in its entirety or piecemeal against profits. If there are no accumulated profits against which it can be charged in its entirety, it must be charged piecemeal against current profits. Loss Charged to Capital The third solution suggested that the charge be made directly against capital. Without the limitation as to the policy of recouping the loss mentioned above, this solution may take two somewhat different directions. If a surplus has been accumulated out of previous profits, such surplus constitutes a part of the capital and provides the logical place for setting up the charge. If no surplus is available, the loss must be charged against the capital stock, thus constituting an impairment of it. In either case, the results of the current period’s operation are not affected, except in so far as a diminution of the assets may have made necessary a curtailment of operation. Of course, the charge against the capital stock, whether made direct to the account or carried in a separate account, does not automatically bring about a reduction of the capital stock; that can be accomplished only by legal process and is often shunned because of the difficulties incident thereto and also because of a possible reflection on the concern’s credit occasioned thereby. The charge does indicate a reduction in the value of the shares outstanding. Since there is no compulsion in law and there may be no need from a business standpoint that the loss be recouped, undoubtedly this third method offers the best solution both practically and theoretically. That this is so is brought out clearly by H. R. Hatfield’s almost classic illustration:[60] “An individual’s entire income is derived from ten houses each worth $10,000 and each yielding 10 per cent net income. If two of these houses burn down, uninsured, the common sense view is that the proprietor’s income is thereby cut down from $10,000 to $8,000 per annum, and that coincidentally, there is a loss of capital of $20,000. It never occurs to him that he must consider his income as entirely cut off for two years until the principal can be restored. Similarly it might be an act of cruelty to dependent stockholders to stop dividends entirely until an exceptional loss is reimbursed. The main difficulty is that in a corporation such an occurrence really calls for a reduction of the nominal capital, a cancellation of part of the capital stock.... The criticism properly to be made is not so much that dividends are paid before restoring the capital ... but rather that the capital stock has not been reduced to correspond with the amount of remaining assets, before the dividend is paid.” [60] In “Modern Accounting.” It should be stated that this criticism is of little real weight if the balance sheet shows the true condition of the business. 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. The carrying value of the asset destroyed must, of course, be reduced to accord with the facts of present value, and, if there is no surplus available, the amount of the loss should be shown as a deduction from the capital stock outstanding, short-extended, with the present capital full-extended, somewhat as follows: Capital Stock Outstanding $1,000,000.00 Fire and Earthquake Loss resulting in impairment $250,000.00 ------------- Net Capital available for the business $750,000.00 Profit on Work in Progress A second problem to be solved in the determination of profits is concerned with the allowance or non-allowance of profit on work in progress but not completed. Most manufacturing and contracting concerns have at all times a more or less constant volume of work in various stages of completion. At the close of the fiscal period when results are summarized, the proper treatment of this uncompleted work is an important matter. The general principles governing the valuation of this work were discussed in Chapter XIII where it was pointed out that in the main conservative business policy demands that work in progress be included in the inventory at full cost, which is to include both prime cost and an equitable share of burden accrued to date. Manifestly this principle precludes the taking of any profit, the theory being that there is no profit until goods are sold. A full discussion of the subject requires separate consideration of work which is being done on order or contract and work for the concern’s own stock-in-trade, due weight being given always as to whether the unit of work is large or small. Goods Made for Stock but not Sold The general principle mentioned above must usually be applied to the valuation of the concern’s own stock-in-trade in process of manufacture. Here sales are being made constantly from finished stock and manufacture replenishes the stock. But the essential step before profits can be claimed, viz., making the sale, usually comes after the process of manufacture and not before. It may sometimes happen that stock is sold out ahead of its manufacture, because the factory is not able to keep up with sales. It is not intended here to include the case in which it is the custom of the trade to sell goods in advance of their manufacture and regulate the operation of the factory to turning out the advance orders booked. This will be considered later. The discussion here concerns those firms which usually keep their finished stock well ahead of sales but because of the exigencies of the market find themselves behind their sales. Such a situation is sometimes called a sellers’ market. If purchasers contract for goods with full knowledge of factory conditions, such sales are in the nature of work on contract and might in unusual instances be so treated. Usually, however, conservative management requires that no profits be taken under such circumstances. Goods Made to Order Where the factory works only on order, conditions as to profit-taking are somewhat changed. Here, the sale has already been made for delivery of the product at some future time, named or left indefinite. While, of course, cancellation of the order is always possible before date of delivery and acceptance, inasmuch as here we have under consideration a special product made to individual specifications and not a stock or standardized article, cancellation of the contract is not probable without incurrence of damages or even being held to specific performance. Under these circumstances it is apparent that, within reasonable limits, a portion of the profit may be taken up in the current period, which has, of course, done a portion of the work and therefore earned a portion of the profit, if there is one. This last contingency is, of course, the crux of the whole problem. If a portion of the profit is taken, this necessitates a predetermination of profit on the whole contract, an estimate of the portion of the contract completed, and adequate provision for unforeseen difficulties in completing the work. Where conditions are such that these things can be done with any degree of certainty, there is not only no objection to taking up a portion of the profit for the current period, but it is the only way in which profits may be allocated to the period earning them and so stabilized somewhat as between periods. As has been said already a number of times, the summary of results at the close of regular periods is in many cases based on _estimate_, which in the final analysis is merely the expression of an opinion. If the estimates are made with due care, in the light of all available information and probable contingencies, and without intent to deceive or defraud, more than that cannot be asked of any concern. The practical application of this principle requires consideration. In some few cases the volume of product passing through the factory will be fairly constant as between periods. Where this is so—and frequent tests should be made to establish it—it would be a useless expenditure of effort to make the estimates necessary for determining profits on uncompleted work. The same situation is met with also in concerns where the unit of work is small. Here the effort, entailed in making the estimate is more than offset by any advantage gained thereby. If the product is somewhat standardized, it may be possible as a result of past experience to make a rough estimate on the basis of the _volume_ of work in progress instead of by means of an examination of the conditions of each contract. Such a policy is fraught with many pitfalls and, as a usual thing, does not commend itself to conservative management; speculative conditions are too many. Profits on Long-Term Contracts Where the unit of work is large, conditions are somewhat different, however. The necessary estimates are not based on so many uncertainties, and, oftentimes, financial considerations and an equitable treatment of stockholders demand the determination of profits on work in progress. Thus, one contract extending over a number of years may occupy the entire attention and facilities of a concern. To withhold profits if earned, until the completion of the contract might work a real injustice. Such contracts are usually financed by means of periodic payments on account, based on a careful estimate by the supervising engineer or architect of the portion completed on such dates. As these estimates are sufficiently accurate on which to base payment of contract price, they can be allowed to serve as the basis for a determination of profits after liberal reserves for contingencies are made. The nature and terms of the contract itself will usually indicate the method of estimating the profit. If the price agreed upon is for the contract as a whole, then extraordinary care must be exercised in estimating the portion completed and almost a seer’s prevision of the requirements to complete is needed. If, on the other hand, the contract is broken into smaller units on which price is based and there is no guarantee as to the number of units in the contract, profit may be taken on the number of units completed. Thus, a contract calling for excavation of earth or other material may be taken at a named price per cubic yard. The building of a canal, the driving of a tunnel, the construction of a dam and reservoir, are frequently handled on this or a similar basis. So, also, the use of a concern’s equipment and organization on a per diem basis. Under these conditions each fiscal period can safely take its profits or losses with little regard for the uncompleted portion of the work. Contracts taken on a so-called “cost plus” basis, i.e., at cost plus a definitely agreed upon per cent of profit, may have their profits determined without consideration of the uncompleted portion. Profit on Goods Awaiting Delivery Similar to the problem of profits on work in progress is that of profits on goods awaiting delivery. The goods have been sold, are completed, and may even be prepared for shipment. All that remains is delivery and that cannot be effected until the date agreed upon. In some lines of trade this method of sale is a time-honored and even necessary custom. The practice is found in some kinds of clothing industries, woolen manufactures, farm implements, etc. Here because the product is a standard product, cancellations take place and are usually allowed right up to, and in some instances beyond, the date of shipment. Because of this trade practice, profits should never be taken until delivery has been effected. To a similar or even greater extent than with work in progress, costs and expenses are under this principle incurred and charged in one period and the profit is taken in another period which is not thus charged with the cost of getting the income. Two methods of handling the difficulty are met. The one operates on the expectation that the volume of such orders awaiting delivery is fairly constant as between periods; hence, the income from goods of this sort delivered during the current period is charged with the costs and expenses of goods to be delivered in future periods. This is the rule-of-thumb method to be used where accurate allocation of costs is neither necessary nor justified by results. The other and more accurate method consists of deferring the costs and expenses properly applicable to the deferred income. But the difficulty of determining just what expenses are so applicable often causes this method to break down, giving less accurate and dependable results than the first. The roseate optimism of the average proprietor or manager as to his own business almost always results in a too liberal estimate of the portion of expense to be applied against the deferred income. In treating this problem of profits in connection with contracts and the length of the cost period (Chapter XIII), the principle was stated that such goods should be included in the inventory at cost. This results in deferring the main item of cost, but omitting the further costs of selling and administration which belong to all sales effort made and to the progress of the order up to the point of delivery. While theoretically these should be deferred, practically the estimate of the amount to be deferred should lean on the side of too little rather than too much. Where, as stated above, the volume of this kind of trade is fairly constant, the rule-of-thumb method first stated gives more satisfactory and safer results. Interdepartment Profits The problem of interdepartment profits was stated and discussed briefly in Chapter XIII, page 233, and will later be treated in another connection (see page 607 following). Here, it may be repeated that while such profits are not to be allowed because they are not yet realized, they may, under exceptional circumstances, be estimated and shown if offset by reserves of an exactly equal amount. Profits Due to Appreciation of Assets The problem of profits due to appreciation of assets, both fixed and current, has also been handled in the chapters on valuing the various assets. All that need be said here is that such profits are not realized until the asset is 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. Capital Profits There remains a final problem, viz., that of capital profits, which is more a question of their disposition than determination. When any of the fixed assets are sold, the profits, if any, are classed as capital profits. These are as legitimate as those arising from sale of stock-in-trade or other source, and belong to the owners. The question of their disposition hinges mostly on practical considerations. If the sale is for cash, funds are available for distribution without encroaching upon the working capital. If not for cash, payment of dividends based on such profits might seriously diminish working capital. The question as to whether capital profits should ever be distributed is, of course, a mooted one. Many well-known cases of such distribution—the so-called cutting of juicy melons—are on record. Conditions seem to justify their payment at times, and under other equally impelling conditions distribution of them should not be made. As a general policy it is always safe to set aside such profits in a special reserve to be used to care for capital losses. If the company is well provided with such reserves beyond any reasonable doubt, it is oftentimes unwise and unjust to withhold their distribution. Of a similar nature and to be handled under like considerations are the profits arising from sale of capital stock at a premium, the reissue of forfeited stock, etc. In concluding this subject no better summarization of the accounting principles and practical considerations to govern in the determination of profits can be given than the following from A. Lowes Dickinson:[61] [61] In “Accounting Practice and Procedure.” “1. All waste, both of fixed and circulating assets, incident to the process of earning profits by the conversion of circulating assets must be made good out of the profits earned.