Accounting theory and practice, Volume 2 (of 3) : a textbook for colleges and…

3. COMPOUND INTEREST METHODS

814 words | Chapter 64

General Considerations In a discussion of compound interest methods the basic feature, that of the compound interest principle, requires consideration. The thought of progression on a compound interest basis is fascinating to many. It is a powerful instrument of accumulation and its charm seems to lie in the fact that through its instrumentality small sums can be made to grow into large sums. Whether the principle is applied to the creation of a fund or simply as a method of _calculating_ periodic amounts, the remarks of P. D. Leake,[36] an English authority, are equally appropriate. He says: “May I impress upon you that these devices are dangerous expedients in any but the most skillful hands.... It (the sinking fund) is apt to give a sense of false security, because its whole virtue depends upon its obligations being faithfully carried out over the whole period, and this condition is not always fulfilled.... It is probable that in many cases the use of a sinking fund is an altogether unwarrantable draft upon the future, because there is no reasonable certainty that the fund, whether it be state, municipal or commercial, will not be raided before it attains its object.” [36] In “Depreciation and Wasting Assets.” Over short periods the difference between the periodic amounts under this method and the straight line method is slight, as will be apparent from a comparison of the two charts on pages 153 and 162, giving graphic illustration of the two methods. There the period is for five years. When the period is extended to, say, twenty or fifty years, the difference in burden, due to interest accumulations, between the early years and the later years is very marked. “Thus, a 10-year unit having no salvage value, loses half its value in 5 years under the straight line theory, regardless of the rate of interest, and at 5% under the compound interest theory it loses nearly as much—about 44% of its value in the same time; ... but a 50-year unit, losing half its value in 25 years, under the straight line theory, loses only 22.8% of its value, at 5%, under the compound interest theory.” (a) Sinking Fund Method The sinking fund method as an orderly scheme for estimating the periodic depreciation charge _will_ make the estimate, and, if adhered to faithfully, the entire depreciation will be written off by the end of the service life of the asset. In this respect it is to be preferred to any arbitrary or haphazard method. That it secures an equitable distribution of depreciation costs over the product of the various periods, or that it effects a correct valuation of the asset at intermediate periods of its life is open to serious questioning. The periodic charge under the sinking fund method perhaps bears no relation to the fact of depreciation. The method is, at the best, simply a mathematical device for an orderly calculation of periodic amounts. In the valuation work of public service companies or in regulation work where, as in California, actual funds must be set aside to accumulate at compound interest, there is no serious objection to the method. Although it rests on false or doubtful assumptions of fact and results in an inequitable burden on the product as viewed from the standpoint of individual assets, these are minor considerations; for the method does by the end of its service life take care of the loss in value. Judged from the standpoint of its relation to up-keep costs, the method lays an increasingly heavy burden on the later years of the life of the asset. (b) Annuity Method All that has been said with regard to the sinking fund method applies with equal point to the annuity method. As previously indicated, in the explanation of its essential features, this method automatically secures a charge for interest on the investment as a part of the depreciation charge. Not only is the charging of interest of doubtful propriety in itself, but certainly its inclusion under the title of depreciation is misleading and indefensible. The courage of one’s convictions with regard to interest as a part of cost should not allow interest to shelter itself under the cloak of “depreciation.” By referring to the appraisal schedule and chart, it is seen that the real depreciation charge is exactly the same under the annuity as under the sinking fund method. (c) Unit Cost Method The unit cost method represents an attempt to secure an equal burdening of each unit of product with interest, depreciation, and operating costs. In the language of its proponents, “this theory is probably the soundest theory of depreciation, and when applied with intelligence, probably furnishes the truest measure of accrued depreciation.” While the end sought by the unit cost method is commendable, it is a compound interest method and it mixes interest, up-keep, and depreciation under the one title “depreciation.”

Chapters

1. Chapter 1 2. Introduction of System 3. 1. PROPORTIONAL METHODS 4. 2. VARIABLE PERCENTAGE METHODS 5. 3. COMPOUND INTEREST METHODS 6. 4. MISCELLANEOUS METHODS 7. 1. PROPORTIONAL METHODS 8. 2. VARIABLE PERCENTAGE METHODS 9. 3. COMPOUND INTEREST METHODS 10. 4. MISCELLANEOUS METHODS 11. Introduction 12. Introduction 13. CHAPTER I 14. 5. Debenture 15. CHAPTER II 16. Introduction of System 17. Chapter XXXVI, a cash discount is usually treated as a financial 18. 6. Indexing vouchers. 19. 4. It localizes responsibility by showing authority for 20. 5. It secures a receipted bill for all disbursements of cash. 21. 1. Clumsy provision for returns and allowances, partial 22. 3. The giving out of information about the business 23. CHAPTER III 24. CHAPTER IV 25. 2. Deferred Charges to | 2. Deferred Income 26. 5. Fixed Assets | 27. 4. For publication or report to regulating or 28. 6. For advertising purposes to float new issues 29. CHAPTER V 30. 12. Liquidation or forced-sale value, etc. 31. 1. For the current assets, the principle of valuation may be stated 32. 2. The principle of valuation involved in deferred charges to operation 33. 3. For the fixed assets, the principle of valuation generally 34. CHAPTER VI 35. 2. The managerial policy as to repairs, maintenance, 36. 3. The past performance and expected future performance 37. 4. All other factors locally present which may affect 38. Chapter XIII.) 39. CHAPTER VII 40. 5. Crystallization[25] 41. CHAPTER VIII 42. 2. Rates of depreciation and their relation to repairs, 43. 5. Financing depreciation and some related problems. 44. Chapter IX. 45. 4. Normal climatic conditions. 46. 5. Probable misuse and neglect brought about by the 47. 6. Probable change in ownership and consequent 48. 7. Probable change in the requirements of the market, 49. 2. Installed operating and generating machinery 50. 3. Fixed equipment including boilers and piping 51. Chapter X of the effect of the various methods used for calculating 52. CHAPTER IX 53. 4. Miscellaneous Methods 54. 4. Under some methods, an arbitrary interest rate 55. 1. PROPORTIONAL METHODS 56. 2. VARIABLE PERCENTAGE METHODS 57. 3. COMPOUND INTEREST METHODS 58. 4. MISCELLANEOUS METHODS 59. CHAPTER X 60. 2. Inadequacy, which is lack of capacity to do the 61. 3. Obsolescence, which represents the inability to 62. 1. PROPORTIONAL METHODS 63. 2. VARIABLE PERCENTAGE METHODS 64. 3. COMPOUND INTEREST METHODS 65. 4. MISCELLANEOUS METHODS 66. Chapter XI. 67. CHAPTER XI 68. 2. Estimate of life in periods, working hours, service 69. 5. Periodic appraisal value. 70. 3. Profits of the past may be reserved in the business 71. CHAPTER XII 72. Introduction 73. 4. Bank 74. 1. Cash deposited to cover breakage or damage to 75. 2. Moneys advanced to subsidiaries, salesmen, and other 76. 3. Claims against creditors for returned or damaged 77. 4. Prepayments on purchase or expense contracts, as 78. 5. Unpaid calls or instalments on stock subscription 79. 6. Claims against absconding officers for property 80. 1. In the case of a new concern where there is no past 81. 2. In the case of an outsider—a professional auditor 82. 3. Periodically, in any business, as a check on the 83. 1. The amount of outstanding trade debt at the time 84. 2. The amount of sales on credit made during the 85. 3. The total sales, both cash and credit, for the present 86. CHAPTER XIII 87. 1. Carry the market valuation, whether more or less 88. 2. In case market value is less than cost, set up a reserve 89. 3. Carry in an inner column in the body of the balance 90. Chapter XXVI of this book, where a full presentation of the case for 91. CHAPTER XIV 92. CHAPTER XV 93. 1. By practically full ownership of the subsidiary 94. 3. Through the agency of advances, particularly when, 95. CHAPTER XVI 96. Chapter IX, is the one most widely employed. It is to be preferred to 97. CHAPTER XVII 98. 1. If the building is purchased outright for cash, whatever costs 99. 2. If the building is bought by the issue of stocks or bonds, the 100. 3. When buildings are put up by the concern itself, full cost may 101. Chapter XVI, any increase or decrease in the value of the land cannot 102. CHAPTER XVIII 103. 1. _Time Lapse._ There is no such thing as wear and tear on a patent 104. 2. _Supersession._ If no other causes than time lapse were operative, 105. 3. _Obsolescence._ Akin to the element of supersession is that of 106. 1. Lump sum payments to the state or some division 107. 2. The full purchase price paid another company for 108. 3. Legal and other fees in connection with securing 109. 4. Any other legitimate expenses, such as the cost of 110. CHAPTER XIX 111. 6. Merchandise Inventory 112. Chapter XX, in the discussion of the liability, bonds. 113. CHAPTER XX 114. 1. The character of the issuing corporation under 115. 2. The security of the bonds under which come: 116. 3. The purpose of the issue, as: 117. 4. The conditions incident upon payment of principal 118. 4. A bond sold at par to be redeemed at a premium on maturity. 119. CHAPTER XXI 120. CHAPTER XXII 121. 2. Profits realized on sales of fixed assets should be first applied 122. 3. A sufficient surplus should be accumulated (in addition to the 123. CHAPTER XXIII 124. Chapter XXII, have their proper place of record direct into some margin 125. Chapter XXV on sinking funds for a full discussion of the merits and 126. 2. Reserves created to provide an additional capital 127. 3. Reserves created to provide for equalizing dividends 128. 1. Valuation Reserves 129. 5. Market Fluctuations Reserves, etc. 130. 2. Proprietorship Reserves 131. 3. Reserves for Working Capital, etc. 132. CHAPTER XXIV 133. Introduction 134. CHAPTER XXV 135. 1. The sinking fund, then, under suitable title, may appear only among 136. 2. The balance sheet may record the sinking fund status among the 137. 3. There may appear on the balance sheet as the only evidence of a 138. 4. There may be no record of the sinking fund transactions shown on 139. 1. Those dealing with the original and subsequent 140. 2. Those required to book the trustee’s periodic 141. 3. Those to show the redemption of the debt and the final 142. CHAPTER XXVI 143. 1. The difficulty of determining the rate at which 144. 2. Inasmuch as the amount of investment in current 145. 3. If interest is to be charged, how shall the offsetting 146. 4. The introduction in production costs of a more or 147. 5. As the business world is accustomed to consider 148. CHAPTER XXVII 149. Chapter XXIII on “Reserves and Surplus.” There the illegitimate use of 150. CHAPTER XXVIII 151. 1. To convey, transfer, conceal, or remove, or to permit 152. 2. To transfer while insolvent any portion of the property 153. 3. To make a general assignment for the benefit of 154. 4. For the debtor to admit in writing his inability to 155. 5. To suffer or permit, while insolvent, any creditor to 156. 1898. The courts of the Federal Government have jurisdiction in these 157. CHAPTER XXIX 158. 1. Agreement by the directors of the various companies 159. 2. Assent of the stockholders of each company to the 160. 3. Filing of certified copies of the agreement, with the 161. 4. The exchange and issuance of new stock for the 162. 1. A uniform accounting system for all the companies 163. 2. The reserves for depreciation should be based on 164. 3. Costs should be determined in the same way if the 165. 4. The apportionment of labor, factory expense, and 166. 5. Only real items of cost should be included under the 167. 6. The same methods of inventory-taking, both of 168. 7. The amount of orders on hand should be considered. 169. CHAPTER XXX 170. 2. A proper rate of turnover on the merchandise 171. 3. Economical management. 172. 3. Facilities for centralizing and comparing such

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