The Theory of the Machinery Account. The object of this account is to show the cost of machinery on hand and in use in the factory. Separate accounts may be kept with different classes of machinery. For instance, one account might be kept with Universal machines and another with Special machines. By Universal machines is meant standard or stock machines that may be purchased from manufacturers whose business it is to manufacture such machines. They are built and carried in stock for sale. By Special machines is meant those specially designed and built either by the concern itself or by another under contract according to specifications. The usual practice, however, is to maintain but one account with Machinery. It is frequently combined with tools, implements, and other items, but this is poor practice and is not to be encouraged.

The account with Machinery should show on the debit side; (a) the cost of machinery on hand at the beginning of the business; (If the machinery is part of a plant that has been purchased or otherwise acquired, for a purchase price covering the entire plant, it may be necessary to estimate the value of each part of the plant subdivided into accounts. Furthermore, the book value set up may not be the actual inventory or appraisal value, but the difference between the asset account and the reserve for depreciation account, applicable thereto, should represent the actual value, provided sufficient reserve for depreciation has been set up.) (b) the cost of machinery and equipment purchased or manufactured by the concern itself after operations have begun; (c) the cost of additions or alterations which actually increase the value and efficiency of the machinery already in use; (This must not be construed to include alterations made necessary by a mere change in product, nor to include the cost of moving and reinstalling machines to permit of more economical operation. In such cases, if the cost is large, it may be advisable to treat it as a deferred expense and to be charged off over a period of years or during the years to be benefited by the changes made.) and (d) the cost of new parts purchased.

With regard to the last item, a great deal will depend on the policy of the firm concerning the method used in arriving at the proper amount of depreciation to be charged off. If the cost of all new parts which are to replace old parts is charged to operating expense, the rate of depreciation will be lower, otherwise, the rate should be higher. If the cost of new parts is charged to the Machinery account, then the cost of the worn parts being replaced should be credited to the Machinery account and at the same time charged to reserve account, because the rate of depreciation charged off to operating expense has been sufficiently high to include the wear of such parts. After a part has been replaced with a new part no further reserve for depreciation on that particular part is necessary, hence it should be charged to the reserve account. Another argument in favor

of charging new parts to the Machinery account is their cost may be higher or lower than the original parts, and if the cost of the old parts being replaced is credited to the account and the new parts charged to the account, the Machinery account will at all times represent the actual cost of machinery in operation.

Any machines or machine parts exchanged, discarded, destroyed, or otherwise disposed of, should be credited to the Machinery account and charged to the reserve account at cost price.

In the case of machinery built or manufactured by the concern itself, the cost should include the cost of material and labor, plus the freight and cartage inward and a proper proportion of overhead expenses. It is customary to add, also, the cost of the experiments, which were made before a desirable type was obtained, plus the cost of the designs and patterns.

The cost of installing new machinery, such as the building of foundations, connecting it with the transmission, moving it into place, etc., is a part of the cost of the machinery and should be charged to the Machinery account. In other words, the Machinery account should show the actual cost of machinery when it is ready for operation.

Montgomery says:

"The cost of installation, including freight, labor, and other items is as much a part of the cost as the price of the machinery itself."

Cox* says:

"The entire cost of installing new machines constitutes an addition and should be capitalized."

Walton says:

"The purchase price, the freight, the cost of moving an old machine to make way for a new one and the cost of installing a new machine are proper charges to the Machinery account.'

It is not considered good accounting practice to add interest on borrowed money used to purchase or construct machinery or in the installation process. If this were done the firm who borrowed money with which to construct machinery or to pay the cost of installation, would show the asset at a higher value than the firm who did not need to borrow the money.

The Theory of the Tools and Implements Account. The object of this account is to show the value of small tools on hand. There are several different methods for recording the value of tools. It is always best, if the value of tools on hand is to be considered a fixed asset, to take a physical inventory at the end of the period under audit before preparing the statements. Tools are so often lost, misplaced, or stolen and they are used up so rapidly that it is difficult to determine their actual value in any other manner.

*"Classified C. P. A. Problems and Solutions."

One method is to charge the Tools and Implements account with the cost of all tools purchased and at the end of the year to take a physical inventory and make an adjusting entry crediting the asset account with the cost value of all tools used up or missing and charging the proper operating expense account. If this is done, no reserve for depreciation need be set up.

Another method is to charge the account with tools as above, but to issue all tools to the workmen and at certain times require them to submit all tools for inspection. At this time all tools worn out, broken, or worthless are charged to expense and new tools issued to the workmen. Any tools missing or otherwise unaccounted for are charged to the workmen and deducted from their wages. In either case the account with tools would be credited with the cost price of the tools worn out, broken, worthless, or missing and the balance of the account would show the cost of tools on hand and in use. No reserve for depreciation is necessary, but it is necessary to require the workmen to submit all tools for inspection before preparing the statements. At this time the account would be adjusted.

A third method is to charge all tools and implements to operating expense at the time of their purchase, and if there are any new tools on hand at the end of the fiscal period, their value at cost price is treated as a deferred expense. This method simply necessitates an inventory of new tools on hand undistributed.

Montgomery says:

"As a rule, the practice of depreciating small tools by way of a percentage cannot be followed satisfactorily. So many small tools are used up, or lost, or stolen, that an inventory should be made periodically and all tools on hand revalued. If this plan is followed for several years and a dependable rate of depreciation is secured, it may be feasible to omit the revaluation for a year or two, applying the rate previously ascertained." The Tax Commissioner of one of the states has adopted rates varying from 25 to 50 per cent, or as an alternative the entire cost of replacements.

Esquerre' says:

"The tools contained in this account are sometimes referred to as 'small equipment.' They comprise, saws, files, hammers, screwdrivers, etc., which on account of their fragility, their size, the manifold uses to which they are placed, and the facility with which they can be passed from hand to hand and from bench to bench, cannot be readily or accurately inventoried. They are generally kept under the custody of a storekeeper and charged to cost of manufacture when issued to the factory."

Greendlinger* says:

"Tools which are fixed and which in reality enter into the same category as machinery, should be valued in the same man

*Author of "Accountancy Problems with Solutions."

ner. Small tools, however, unless the aggregate is large, should be considered expenses. Where there are a great many it would be better to consider them as supplies and so list them in the inventory."

The Theory of the Account with Horses, Wagons and Harness. This account is rapidly being replaced with accounts with Auto Trucks or motorized delivery equipment. However, the theory of the account is the same. The items charged to it represent delivery equipment. The only difference is the amount of depreciation to be charged off or set up.

Some firms charge the account with the original cost and then charge all replacements and additions to expense. This is hardly to be commended because it does not show true facts at the end of the period. If the original value is increased or decreased by a conservative inventory or appraisement before preparing the statements, the difficulty may be overcome to some

extent.

A better practice would be to charge the account with the cost of all delivery equipment and then set up a reserve for depreciation that is estimated to be equal to the reduction in the value of the property. Under this plan, if losses occur by reason of accidents or other causes, the account is credited with the original cost. If the account had been credited direct with the amount of the estimated depreciation, then only the depreciated value would be credited to the account at the time of loss. It is advisable to set up special reserve accounts for each property account subject to depreciation. (Depreciation will be taken up in the Tenth Chapter and will be discussed in detail.)

The Federal Trade Commission, in a bulletin issued July 15, 1916, entitled "A System of Accounts for Retail Merchants,,' says, "Charge the account with Delivery Equipment with the cost of automobiles, wagons, horses, and harness. This account must not be charged with repairs to automobiles and wagons, horseshoeing or anything of this nature. A fair amount should be written off periodically for depreciation."

The Theory of the Office Furniture Account. In practice different methods will be found to exist in recording the value of office furniture or equipment. It will depend upon the policy of the concern. In many instances the account will include fixtures, partitions, etc. What was said with reference to the account with delivery equipment is applicable here. The important thing is to be conservative. If the account is charged with the cost of all office furniture purchased and a reserve account is set up crediting it with the estimated amount of the depreciation each year, it will represent sound accounting practice.

The Federal Trade Commission says in regard to the account with Office Furniture, "Charge this account with office furniture, desks, safe, and other office appliances. It should not be charged with the cost of typewriter supplies, account books, etc., as these are clearly items of expense. A fair amount should be written off periodically for depreciation."

AUDITING THEORY

Quoting from Federal Reserve Bulletin:

Schedules. "In preparing the leading schedules for the accounts grouped under this heading, such as real estate, buildings, plant, machinery, etc., the balances at the beginning of the period, the additions to or deductions from the accounts during the year, and the balances at the end of the period must be shown.

"The total of the balances at the beginning of the period must agree with the cost of property figures given in the Balance Sheet at that date, and the balances at the end of the period with the amount shown in the Balance Sheet that is being audited. The charges entering into the additions must be verified in detail, and in this connection the following notes are of value:

Authorizations for Expenditures. (1) "Authorizations for the expenditures made during the year should be examined, and where the costs of the additions have overrun the sums authorized, inquiries should be made in regard thereto. The authorizations should show the accounts to which the expenditures are chargeable, the amounts thereof, the approvals of the comptroller and manager, and descriptions of the jobs. When the authorizations are not specific as to the work done, the actual additions should, if possible, be inspected.

Additions. (2) "The auditor should satisfy himself before approving additions that they were made with the object of increasing the earning capacity of the plant, and that they are not of the nature of either renewals or improvements, and in this connection changes in the production and capacity of the plant should receive consideration.

Pay Roll and Store and Supply Charges. (3) "To verify the pay roll and store and supply charges to jobs, one or two pay roll distribution reports should be examined in detail, and also one or two storehouse reports. In cases where large purchases have been made from outside parties for capital construction work, the vouchers therefor should be examined and the usual precautions taken to see that they are properly approved for the the receipt of materials, prices, etc.