Accounting Principles – Various Types of Capital

Proprietorship implies ownership. When used in connection with business organization it signifies ownership of the assets. If there are liabilities the ownership is restricted to an equity in the assets.

Few organizations are free from liabilities so that it might be said that proprietorship is that equity in the financial status of a business organization which is represented by the excess of assets over liabilities. This means in a sense that the proprietor shares with the creditors, whose claims are represented by certain accounts, the ownership of the assets.

Proprietorship is synonymous with capital. Creditors may be looked upon as having loaned capital to the business. Thus it would appear that in the discussion of capital, two classes of persons must be considered, namely, proprietors and creditors. Capital might be classified as owned and borrowed.
Owned capital appears either as capital contributed to the business by the proprietor or as an accumulation of profits; borrowed capital as having been obtained from creditors. With reference to owned capital it may be interesting to inquire into the different names which the accounts take under the various legal types of organization and with regard to borrowed capital whether same is secured or unsecured and the instruments whereby the capital is obtained.

Owned Capital
The sole proprietor’s capital at the start is represented by his investment, or capital account. Subsequently it may be represented by his eapital account plus his salary and drawing account and accounts for reserves. The accounts for salary and drawings while perhaps not so essential in the case of a sole proprietor, since they will usually be closed into the capital account at the end of the accounting period, are in keeping with the modern practice of analysis and make statistical calculations, such as the determination of return on the investment, easy. Keeping the investment account separate is advisable, in order that additions and withdrawals of invested capital may be shown without involving the other accounts. Reserves are to be considered at all times as capital, either invested or accumulated out of profits, based as a rule on an estimate and set aside for certain purposes which will be discussed later. At the present it will suffice if the fact is borne in mind that reserves are always an adjunct of the capital account.
In copartnership, which may be either general or limited, the accounts do not differ materially, except that individual capital accounts for partners, together with those for individual salary, drawings and general reserve accounts are supplemented by individual interest accounts for partners.

Joint ventures differ from copartnerships largely in the extent to which the business is conducted. A copartnership transacts any and all business incident to the line of business in which it is engaged. It may continue until terminated by any one of a number of causes, such as the lapse of the period specified in the contract of copartnership, mutual consent, or the death of a partner, etc. On the other hand, a joint venture is created for the accomplishment of a specified purpose and ends usually when the purpose has been accomplished. In so far as the capital accounts are concerned, it will be seen that they be identical with those of a co-partnership.

Associations or societies (non-corporate) derive their capital from contributions or dues of members. As evidence of membership or evidence of contribution they may issue certificates of membership or indebtedness. They may also create out of capital, reserves for the control of certain funds. Accordingly the capital accounts of associations or societies may take the names of membership account, certificates of indebtedness, etc.

Joint stock associations as they are legally called, or joint stock companies as they are commonly known, obtain their capital through the disposal of capital stock. They may also set aside reserves and have undivided profits or unappropriated surplus. Thus the capital accounts, if occasion dictates, will take the names corresponding to the above.

Corporations are of two kinds, stock and non-stock. Stock corporations will have accounts for capital stock, reserves, undivided profits and unappropriated surplus. Capital stock may be of several kinds, namely, preferred, common, voting, nonvoting, etc. The preferred stock may be preferred as to assets or as to dividends, or both; it may also be first, second or third preferred, etc. The dividends may be cumulative or non-cumulative. The capital stock accounts will take such names as are appropriate under the existing facts. An account should invariably be kept for each class of stock.

Non-stock corporations obviously will require no accounts for capital stock. Their capital is obtained as a rule by gift, bequest (left by will), or legacy (bequests of property). It may also be obtained by contribution of members. The capital account is usually known as surplus. There may also be reserve accounts representing a part of the surplus created for the purpose of controlling certain funds.
The capital accounts of trusts or holding companies are the
same as those of stock corporations. There is given below, a chart summarizing the accounts as explained in the preceding

Borrowed Capital
Familiarity with the different forms which borrowed capital may take is essential to the accountant for two reasons: first, under normal conditions he should have a knowledge of the accounts representing same, and more especially the instruments whereby certain parts of such capital is obtained on account of the legal and financial relations which arise between a business organization and its creditors. Second, in the case of bankruptcy or insolvency it becomes necessary to distinguish among creditors as to whether their claims are secured or unsecured.

Neither the accounts nor the instruments appear to be affected by types of organization. Borrowing on bonds is probably more common with corporations than with sole proprietors or copartners. This may be due to the fact that corporations, owing to the peculiarities of their organization, are enabled to amass enormous quantities of property and thus amply secure their borrowings. However, given equal financial strength and integrity there would seem to be no reason why a sole proprietor could not issue bonds as well as a corporation. John Wanamaker, for instance, if he happened to be a sole proprietor, might borrow on an equipment trust obligation as well as the Pennsylvania Railroad.

It is to be presumed that students are familiar with the details of the various forms of financial instruments so that mere mention of the principal accounts and instruments involved in borrowed capital with regard to whether they are usually secured or unsecured, will be indulged in at this time. One thing, however, cannot be too firmly impressed upon the mind of the prospective accountant; whenever it becomes necessary to make any record of a financial instrument, a great deal of time and worry will be avoided subsequently if the record is exact, and, above all, complete. By this is meant giving the maker, description of the instrument, the date, date of maturity, rate of interest and how and when payable. For example, Louisville and Nashville R. R. Co., 1st Mortgage Sinking Fund Gold Bond; dated July I, 1911; payable July 1, 1931; interest 5%; payable semi-annually, January 1 and July 1. A chart, showing the accounts and instruments most commonly found, follows:

Borrowed capital.
Bonds secured by mortgage,
Real estate,
General mortgage,
Blanket mortgage,
Consolidated mortgage,
Divisional (railroads),
Collateral trust,

Equipment trust,
Car trust (railroads).
Collateral notes.
Collateral trust certificates.
Accounts payable,

Promissory notes, drafts, foreign bills,
Income bonds.

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