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

CHAPTER XIII

1185 words  |  Chapter 86

MERCHANDISE STOCK-IN-TRADE Definition and Scope of Term Stock-in-trade, as the term is usually understood, comprises all commodities purchased for resale. Thus, assets, which in one concern belong to the fixed asset group, may be the stock-in-trade of other concerns. In stating the principles of valuation for these assets, it is definitely to be understood that they apply only to such as are used as stock-in-trade, and not to the same items when used as fixed assets. Oftentimes the process of manufacture intervenes between the purchase of a commodity and its sale. In such a case the commodity, at the time of valuation, may be in different stages of completion. It is then usually so listed on the balance sheet under suitable titles, such as Raw Material, Goods in Process, and Finished Goods, all of which are treated as current assets. Included in the problem of valuation of stock-in-trade is the treatment of goods out on consignment, goods of others held for sale on a commission basis, and scrap material. Finally, some points to be observed in taking the physical inventory will be considered. Valuation at Market or Cost Price Inasmuch as stock-in-trade is purchased solely for resale or ultimate conversion into cash, it is desirable for the balance sheet to reflect the proper value of what remains on hand unsold. Such goods may have a realizable value higher or lower than cost value, from the standpoint of the market in which they were purchased, and will usually have a higher value in the market where they are to be sold. The value of all current assets to be shown on balance sheet is usually stated at the present realizable value. As applied to stock-in-trade, that must not be understood to mean sale or retail value. To value the stock-in-trade on such a basis would result in taking into the current period the profits on sales not effected until the next period; furthermore, these profits would not even be offset by the costs of making the sale. It may be laid down as a principle of business practice based on sound reason, that the period in which the sale is made should be given credit for it. Stock-in-trade must therefore be valued on the basis of its purchase or wholesale market price and according to well-established practice, either at cost or market, whichever is the lower. This principle has the support of conservative practice throughout the world. Objections to Valuation at Less than Cost The effect of valuing the stock-in-trade at a lower market than cost is to bring into the period’s results a loss which may never be realized, either because the change in the purchase market may not be reflected in the sale market, or because, if so reflected, the market may swing back before actual sale of the stock is made. If valuation is to be at the market when that is lower than cost, consistency would seem to demand that, when the market is higher than cost at the time of preparing the balance sheet, market value should be used and the profit occasioned thereby be credited to the current period. The answer to this argument is that operation would thus be placed on a speculative basis. Again, it is sometimes argued that good buying is just as essential to profit-making as good selling. Accordingly, the purchasing department, with the foresight to buy in a favorable market, should receive the credit for it; if conditions are reversed, it should bear the blame, i.e., the loss. In other words, the period in which the purchase effort is expended should be credited or charged with the gain or the loss brought about by a favorable or unfavorable condition of the current market as compared with its condition at the time the purchase was made. Anticipation of Profits or Losses Undesirable In answer to these various contentions, it may be stated that though good buying is an essential factor in profit-making, no refinement of logic can obscure the obvious fact that goods are bought to be sold and that no profit arises until the sale takes place. All effort before the sale, whether directed towards good buying, careful storing and display, the placing of advertising, or the selection of a sales force, will come to naught unless sales are made. It would seem, therefore, that potential profit or loss on any or all effort preliminary to the actual sale has no place in the current record. From the standpoint of the profit and loss statement, this conclusion as to the policy of valuation of stock-in-trade at cost can be stated without fear of contradiction. In support of this is a direction of the Treasury Department in connection with the federal income tax returns. This reads, as revised in October, 1916: “In case the annual gain or loss is determined by inventory, merchandise must be inventoried at the cost price, as any loss in salable value will ultimately be reflected in the sales during the year when the goods are disposed of.” From the viewpoint of the balance sheet, objection is sometimes raised—and supported by conservative practice and legal requirement as indicated above—that a balance sheet showing stock-in-trade at cost may thus very obviously under-or over-value the item, a situation not at all desirable. In this discussion, the whole problem of valuation is being treated from the point of view always of a going concern and not of one facing dissolution and the forced sale of its properties. Under these circumstances, such a balance sheet must frequently be used as the basis for asking credit, and credit extended on inflated values of current assets is not properly extended. Method of Treatment and Summary To meet this situation, particularly in the case of large fluctuations in the market, the true status of affairs is disclosed by appending to the balance sheet a footnote in which is stated the present market value of the inventory. Without this information, oftentimes, when the market is showing steadily rising values, as much harm and financial ruin may result through the extension of insufficient credit, as under other conditions might arise from an ill-advised inflation of credit. Sometimes the present market value is indicated by setting up a reserve out of _profits_, called “Reserve for Market Fluctuations in Merchandise”—or other similar title—when the market is lower than cost. This method retains the inventory on the books at cost value and so does not burden the current profit and loss, although it does lessen the amount of profits available for dividend distribution. Without doubt the policy is good in cases of extreme and somewhat permanent changes in the market. To sum up, therefore, the valuation formula of cost or market, whichever is the lower, while based on conservatism may unnecessarily and improperly burden the current income account. Valuation at cost, on the other hand, while placing the profit or the loss in the period when realized may cause the balance sheet to present an entirely inadequate and even misleading story as the basis for credit. To remedy this, three courses are open, viz.:
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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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