Such transactions are incidental and are not contemplated in the scheme of business for the realization of profit. That there are profits in connection with such sales, as well as losses, may not be ignored. They are irregular and intermittent and may not be depended upon to produce income. Only such items should be considered as income as recur regularly. Such is the distinction to be made between profits and income. The assets above enumerated are normally held for the purposes of the business. If sold at a figure either above or below their cost a profit or loss results. Such profits should be classified as miscellaneous. This group should also include, providing such items are considered as profits, appreciation of land and appreciation of securities. With regard to such treatment of these items, it may be said that the best practice does not countenance appreciation as being considered a profit. Profits, strictly speaking, do not arise until a sale has taken place. If it is desired to show such assets as land, securities or materials and supplies at their market price, it would be very much better to credit the increase to a reserve instead of considering such increase as a profit. The practice of so treating a theoretical increase in value is responsible for the well-known expression “anticipating profits.” Such practice has nothing in its favor and everything to condemn it. The items are merely mentioned here on account of the tendency of many concerns to anticipate profits and, while contrary to good practice, place the items in a definite class in case they are so treated.
For the purpose of general classification there has been included among miscellaneous profits amounts previously written off—now collected. This is satisfactory so far as general classification is concerned, but if the refinements are to be entered into, the item should be distinguished from the other items in this group and preferably treated as an addition to surplus rather than a miscellaneous profit. This item illustrates very well the distinguishing line between profits and surplus. Profits should cover only items having to do with the present period. The recovery of an item previously written off takes us naturally to surplus, since it must mean that the writing off had taken place in a previous period and the surplus, therefore, correspondingly decreased. If such a loss has been charged to a previous period and the loss is now wholly or partially recovered, credit for same should not be given to the present period but to the previous period. Since the nominal accounts for the previous period have been closed, there remains only surplus. Surplus should, therefore, be credited.
It sometimes happens that where an accounting period is a lengthy one, possibly a year, there will have been written off during the early part of the year certain bad or doubtful accounts. It may subsequently happen that within the same year a collection will be made on some of the supposedly bad accounts. In case of such occurrence the credit for the recovery should be made to profit and loss, or to the account for bad and doubtful accounts written off, instead of to surplus.
In closing the books the procedure will depend entirely upon whether separate accounts have been opened for the respective miscellaneous profits or whether such items have been carried direct to profit and loss. The latter is probably the most usual method of treatment. If separate accounts have been raised, however, they should be closed out to miscellaneous profits, which accounts would correspond to the seventh section of the statement of income and profit and loss, namely: profit and loss credits. What usually happens with these items is that either at the time the sales took place or when the books are closed the credits were made direct to the profit and loss account. In preparing the statement it, therefore, becomes necessary to analyze the credit side of the profit and loss account in order that comprehensive details may be set forth in the statement.
Miscellaneous losses comprise not only the complementary side of transactions enumerated above, such as sales of land, buildings, etc., but also provision for doubtful accounts, depreciation of buildings and miscellaneous items, such as amortization of patents, trademarks or good-will and organization expense written off.
With regard to doubtful accounts, some distinction should be made between the provision for doubtful accounts and doubtful or bad accounts written off. Provision for doubtful accounts anticipates a loss through such causes and provides for it in advance. In making such provision it is customary to base it on a sales charge concurrent with the charges to accounts receivable. Varying rates, ranging from 2 to 5 per cent. or even higher, depending upon the experience of the organization in past years, are used. The charge to profit and loss is offset by a credit to a reserve for doubtful acounts. This has the effect of providing within a given period for losses which may occur on accounts receivable raised in connection with sales made during the same period. Good practice advocates the making of this charge monthly as sales are made. If losses are subsequently sustained they are charged to the reserve and not to profit and loss, for the reason that provision for them has already been made through a preceding charge. If ultimately there remains in the reserve an amount corresponding to the provision that was not required, this amount may be closed out to surplus and not to profit and loss.
It will thus be seen that there is a considerable difference between providing for doubtful accounts and writing off accounts which ultimately prove bad. Where the latter method is used care should be exercised to determine whether the loss is on sales which have taken place during the current or during a preceding period. For losses on sales during the current period, profit and loss may be charged. For losses on sales in prior periods surplus should be charged. The reason in the latter case is that the profits of the preceding period and, consequently, surplus receive credit for a sale which in a succeeding period proved to be bad and resulted in a loss. Concerning amortization of patents, trademarks or good-will, organization expense written off, it may be said that there are two methods of treatment available for use. The assets may thus be written down, in which case profit and loss will be charged and the assets credited, or their value may be reduced by the creation of a reserve. In the latter case profit and loss will be charged and the reserve credited.
The remarks with regard to the closing of the profit accounts apply with equal force to miscellaneous losses. It is not probable that separate accounts for the respective losses will be raised. If they are raised, they should be closed out to an account for miscellaneous losses or to profit and loss. It will usually happen, however, that these losses will have been charged direct to profit and loss and that it will be necessary in preparing the statement of income and profit and loss to analyze this side of the profit and loss account in order that the details of losses may be set forth in the section of the statement of income called profit and loss charges.
It will no doubt have been observed that dividends payable have not been included in the classification presented. While they may be appropriately discussed at this point, they are not to be looked upon as an item of expense. They are rather to be considered as a distribution of profits. Profits or losses in the case of a sole proprietor or copartnership will be disclosed by the profit and loss account and will be closed out to proprietorship; in accordance with the division agreed upon in the contract. in the case of copartnership. In corporations profits may be distributed by vote of the directors from the surplus arising from the business. Technically profits are closed into the surplus account and the surplus distributed as dividends. After the action of the directors in declaring a dividend the proper entry consists in debiting “dividends declared” or surplus and crediting “dividends payable.” If the account “dividends declared” has first been charged, it will be closed out to surplus. Dividends declared becomes the nominal account while the liability is taken up in the dividends payable account. When the liability is liquidated by the payment of cash, dividends payable is charged and cash credited. Some concerns do not raise the account for dividends payable, waiting until the payment is made before charging the nominal account. This is not thought to be the best practice, since it fails to show the history of the dividend transactions and may result in neglecting to show a liability for dividends declared at closing time, which neglect has the effect not only of failing to show this important point but to show an augmented surplus.
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