Accounting Principles – Structure of Accounts

Books are kept for the purpose of recording financial transactions. Accounts are kept in order that transactions may be classified.

In their construction, or the manner in which the transactions are arranged within them, accounts are of three distinct kinds, embraced in two classes:
(1) Those which contain transactions of the same nature, reflecting one kind of information, concerning some simple subject, which subject is indicated by the title of the account.
(2) Those which contain transactions of opposite natures, reflecting two kinds of information concerning the simple subject of the account.
(3) Those which contain transactions of opposing natures, reflecting two kinds of information, concerning various topics of the complex subject indicated by the title of the account.
From the foregoing it will be observed that, with regard to their construction, all accounts are either simple or mixed, whether or not the title of the account so indicates. The accounts in the second and third groups differ from those in the first, in that they are mixed instead of simple, while as between themselves they differ only as to the degree of mixture.

Financial transactions consist in the doing or performing of financial acts. It is, of course, intended that the record thereof shall be complete and accurate. This, however, frequently does not take place for various reasons. The transaction may involve the purchase of goods where a certain number of units are purchased at a certain price. The computation of units at the specified price establishes the money value representing the transaction. A clerical error in not stating correctly the number of units or the price will be followed by an erroneous result. A transaction of this kind is usually recorded first, upon an invoice, and if there be a number of similar transactions they may all be recorded on the same invoice. An error in footing the items on the invoice will result in a total which is incorrect. Thus it will be seen that there are many ways in which errors in recording transactions may occur and that a corresponding number of correcting entries may be necessary.

The recording of the financial transactions should be distinguished from a subsequent entry which may be made for the purpose of adjusting or correcting the amount involved in the transaction; the latter operation being regarded as in the light of doing something right ultimately which should have been done right originally.

An exhaustive analysis of the different financial transactions would result in an ideal classification of accounts. Such a classification would not permit in any one account, of items other than those of precisely the same nature. The nature of the item should not be confused with the bookkeeping tendency of the transactions. By bookkeeping tendency is meant, that tendency which is expressed by the words debit and credit to denote items which are positive or negative in their character. In any one account items representing transactions of the same nature might be either all of the same or opposing tendencies. In such a case the items of a positive tendency might represent adjustments or corrections of errors in recording the transactions. As an illustration of this, may be cited the account for “purchases.” In its simplest form the purchase account would consist of a series of items on the debit side where the items are all of the same nature and same tendency. An error in any of the amounts might require an off-setting credit for the purpose of correction. In such a case, the nature of the transaction would be the same, but the respective entries of opposite tendencies. However, such entries would not in any way conflict with the principle of simplicity upon which the account is founded.

If there were to be introduced into the purchase account on the credit side an entry representing the return of certain goods purchased, it is apparent that the account would then contain transactions different in their nature as well as transactions of opposing tendencies. Professor Sprague in his treatise on the philosophy of accounts closes his definition of an account with the statement that it ” leads to a conclusion.” The conclusion to be drawn from the hypothetical purchase account is that the balance shows the purchase for the period covered by the account. Such an account appears offhand to have fulfilled the purpose for which it was constructed, namely, to lead to a conclusion. That the conclusion is a correct one should be disputed, for the reason that the account contains entries representing transactions which differ in their nature. Such transactions consist of two kinds; one representing purchases, the other representing returns. For this reason the account loses its simplicity and becomes a mixed account. There is a conclusion but the conclusion is a false one. In order to reflect the true condition, the balance must be analyzed and the different elements set forth.

The simple account should contain nothing except elements intimately characteristic of the account, and attention should again be directed to distinguishing between entries representing transactions which are characteristic of the account, and those which merely adjust or correct such entries as have been improperly or incorrectly made.

Mixed accounts are those which contain either entries which are contrary in their character to those strictly indicated by the title of the account, or a series of transactions of opposing natures, intentionally so arranged for the purpose of producing a certain result.

The most striking example of a mixed account is the merchandise account. While it is to be observed that the use of the merchandise account is no longer permitted by good practice, for very good reasons, the principle involved is frequently met with in other accounts where the transactions are not so numerous and the account not so involved. The use of the merchandise account might be excused if it existed in an ideal state. By an ideal state is meant, one item representing each of the elements found in the merchandise account. In such an event the work of analysis would be a matter of a few moments. When increased by the great number of items not only of opposing tendencies, but opposing natures which occur even in the short period of a month, the work of analysis becomes extremely laborious and a loss of time results. In the merchandise account, as it exists in practice, there are found either on the one side or the other, sales, sales returns, purchases, purchase returns, trade discount allowed on sales, trade discount received on purchases, cash discount on both sales and purchases, freight and cartage inward, and freight and cartage outward, to say nothing of off-setting items to the above arising in connection with the corrections of errors and adjustments. In addition it is to be noted that the account contains an element of profit as well as the items of, income from sales, and cost of sales, and is closed by the introduction into the account, on the credit side, of the inventory at the end of the period. The effect of the inventory is two-fold. One effect is, that of off-setting the cost of the goods purchased, while the amount of the inventory brought down, serves to provide an asset which remains on the books after they are closed.
There is a decided movement to-day in the direction of simple accounts. Accounts which will represent transactions of a similar nature and nothing else; accounts which will give comprehensive and unqualified information on the subject indicated by their titles without being confused in any way through the introduction of elements differing in their nature.

Mixed accounts before they are closed merely show balances. Without analysis of the opposing items from which the balance results, the conclusion has little meaning. After being closed, the account will usually show a profit or a loss, as the case may be, but without analysis it gives no hint as to the economic transactions from which the profit or loss resulted. It serves in no way to provide information as to how the profit or loss came about. It helps no one to take advantage of such information in providing against a loss or increasing the profits in the future. It has no value as an index to operations or to efficiency. It gives no hint to the proprietor as to possible defects in his organization or the work of his employees. Its uses while permissible in certain cases where the items are few is to be avoided wherever possible, especially in cases similar in character to those in which the merchandise account is used, for the reason that the elements comprising a mixed account may as well be classified first as last and the information so greatly to be desired by the proprietor secured without unnecessary effort.