A. THEORY QUESTIONS

1. Name five classes of bonds, describing briefly each class with regard to issue, purpose, redemption, etc.

C. P. A. Mich.

2. Do unsold bonds of a railroad company constitute a liability? If they do, under what account would they appear in the ledger? C. P. A. Mich.

3. An issue of Mortgage Bonds of the par value of $100,000.00 and running for five years has been sold at 90, the money to be used in the erection of new buildings. How should the transaction be recorded and why? C. P. A. Mich.

4. If a bond reads at 4%, but the amount which will be received is 1.05 of the nominal par, what is the actual percentage✓ of cost income? C. P. A. Mich.

5. If a company sells its own bonds at a premium, is the premium received a legitimate profit of the company?

I.

C. P. A. Ohio.

B. ACCOUNTING PROBLEMS

1. (a) A corporation issued First Mortgage Bonds bearing interest at 5%, dated January 1, 1917, to subscribers at $125.00 for each bond, par value $100.00. The bonds are to be paid for in three installments: $25.00 on February 1; $50.00 on March 1; and $50.00 on April 1. The February I and March I installments have been paid and the proper entries made on the cash book. You are called in to formulate the journal entries on the two installments. How would you make them? There were issued and sold $100,000.00 par value.

(b) A corporation borrows $120,000.00 for a period of ten years to pay off an existing loan at a higher rate of interest, paying therefore in brokerage and costs $2,750.00. How would you treat this item on the books? C. P. A. Ind.

2. The Smith and Jones Manufacturing Company issued $200,000.00 of first mortgage 50-year, 5% sinking fund bonds which were marketed at 9812, 1% commission, and expended the entire proceeds in the erection of their plant. The discount and commission were charged to the Unamortized Debt Discount and Expense accounts, to be subsequently charged to Profit and Loss, proportionately, during the life of the bonds. Five years later, the company was enabled, owing to a disturbance in the financial market, to purchase $50,000.00 of said bonds for Sinking Fund account at 95.

Prepare the necessary journal entries to record correctly the above transactions of the company. C. P. A. N. Y.

(Note. You may assume that the bonds were placed in the hands of a firm of bankers for sale. The bonds purchased for sinking fund account were cancelled by the company.}

3. The Standard Trust Company is appointed by the Peninsular Mining Company as Trustee of a Bond Issue, aggregating $1,000,000.00, all Bonds of $1,000.00 denomination, rate 5% and bearing date January 1, 1914. Bonds mature in ten equal annual installments, beginning January 1, 1917, unless previously converted or retired.

The issue is not purchased by the Trustee, but is sold through Emory Davis & Company, Brokers, the Company realizing 90% and accrued interest less the cost of appraisal of property, printing, trustees' expenses, etc., amounting to $9,310.80.

The entire issue was taken over, and paid for by the brokers on January 20, 1914.

Among other things the trust deed provides:

Bonds convertible on any interest date for 6% preferred stock at 90%, at option of holder.

Bonds may be retired out of surplus on any interest date at 103, at option of company.

Sinking fund for payment of principal only to be based on production of ore at ten cents per ton. Trustee to charge 4% of principal on issue, and 4%

on coupons.

Interest payable January I and July 1.

The company's production for three years is assumed to be, for the purpose of this problem, 1,000,000 tons per year. January 1, 1916-$100,000.00 are converted to preferred stock.

of:

January 1, 1917-$200,000.00 are redeemed at 103. Formulate all necessary entries in journal form for books

(a) Standard Trust Company,

(b) Peninsular Mining Company,

(c) Emory Davis & Company,

which may be occasioned by the above transactions up to and including January 1, 1917.

C. P. A. Mich.

(Note. It would be well to review the discussion of securities and the accounting for sinking fund investments before preparing a solution to the above problem. See pages 70-76, Chapter Five.)

(Note.

PRACTICE DATA

The following transactions are a part of special practice data designed as a test of your knowledge of the principles of accounting and auditing, and of your ability to apply the knowledge in actual practice. If you have properly learned all of the principles of accounting and auditing

taken up in this text, you should experience no difficulty in recording the following transactions in proper form and in preparing the necessary financial statements. Use ordinary journal and ledger paper. If you desire, you may use analysis paper for special statements such as the Working Sheet. As this practice data is continued in the next chapter, you should carefully preserve your working papers until you are ready to continue the work. You may now proceed by recording the following transactions in journal form.)

Transaction No. 1. The General Manufacturing Company was incorporated under the laws of the state of Ohio with an authorized capital stock of $4,000,000.00, consisting of 10,000 shares of 7% cumulative preferred stock of the par value of $100 each, and 30,000 shares of common stock of the par value of $100 each.

Transaction No. 2. Subscriptions to the capital stock were made as follows:

R. V. Williams-5,000 Shares Common and 5,000 Shares Preferred Stock.

A. B. Opfer-2,000 Shares Common and 1,000 Shares Preferred Stock.

H. W. Henry-1,000 Shares Preferred Stock.

C. H. Bowser-5,000 Shares Common Stock.

Maude E. Barnes-1,500 Shares Common and 1,500 Shares Preferred Stock.

Ruth E. Forry-2,000 Shares Common and 1,500 Shares Preferred Stock.

R. O. Wiggins-5,000 Shares Common Stock.

E. W. Atkinson-5,500 Shares Common Stock.

All of the stock was subscribed for at par, payment to be made upon demand.

To further the purposes of the new corporation, it is intended to take over the business owned and conducted by R. V. Williams under the name of the Williams Manufacturing Company. The newly organized company is to acquire all the assets, excepting cash, and to assume all the existing liabilities of the Williams Manufacturing Company. Mr. Williams is to be allowed a price equal to his present investment with no allowance for good will or other intangible assets. Therefore, Williams' subscription to the capital stock of the General Manufacturing Company is based upon this agreement.

Chapter Thirteen

NET WORTH

Business Organization. An auditor must be familiar with the different classes of business organization. A business may be conducted by an individual, an association of individuals known as a copartnership, or by an artificial body created by law and known as a corporation.

1. ACCOUNTING THEORY

The Sole Proprietorship. A business conducted by an individual is known as a sole proprietorship. The individual contributes the capital, is entitled to the profits and must stand the losses. The Balance Sheet must show the investment or capital and any increase or decrease in the investment. By reference to the formal Balance Sheet exhibited on page 41 of Chapter Three, it will be seen that the net worth of an individual should be shown thus:

(a) Capital. . . ..

XXXXX.XX

(b) Undistributed profits or deficit.... xxxxx. XX

Naturally, if the business shows a profit which has not been distributed, it constitutes an addition to the investment, but in the case of a deficit or net loss, there is a deduction from the investment.

The Copartnership. An association of individuals in business is known as a copartnership. In this class of business organization the capital may or may not be contributed equally and the profits and losses may or may not be shared equally. Hence, before the auditor can prepare the Balance Sheet he must ascertain the conditions of the copartnership agreement. It is needless to say he must also be familiar with Partnership Law. A special section of this course will be devoted to partnership accounting, therefore, we will confine this Unit to showing the classifications of partnership accounts in the Balance Sheet. This is not shown clearly in the formal Balance Sheet in Chapter Three. The following is a suggested classification of all partnership accounts for Balance Sheet purposes: (Assuming two partners and a net profit for the fiscal period.)

It must be remembered that this discussion is confined to a Balance Sheet prepared for credit purposes. Note that it is not necessary to show the distribution of the profits or losses although this may be shown if desired. One peculiarity of the Federal Reserve Board's requirements is that a partner's personal or drawing account, when a debit balance is shown, should be classified among the secured current assets, (see item 29, formal Balance Sheet, page 40, Chapter Three), and when a credit balance is shown, should be classified among the unsecured current liabilities. (See item 18, page 41, Chapter Three.) When the account constitutes an asset, it is classified as a current asset but not as a quick asset. This distinction is due to the fact that an account receivable from a partner may be slower and more difficult to realize upon than an account due from a

customer.

The Corporation. Due to the fact that the first fifteen Units of this course constitute instructions for a Balance Sheet audit of the Blank Manufacturing Company, which is a corporation organized under the laws of Indiana, we must give more space in this Unit to corporate organization than to either the individual or copartnership form of organization. No stress will be placed upon corporate law at this time, however.

Share Capital. In Chapter Twelve it was shown that there are two classes of capital, share capital and loan capital. Any capital borrowed, by means of mortgages and bonds, for a long period of time may be looked upon as loan capital, but capital contributed by the stockholders of a corporation is considered share capital. When a corporation is organized there is authorized a certain issue of capital stock. The capital stock is divided into shares and ownership of these shares is represented by stock certificates. Reference to the Chart on page 198 will show that, generally speaking, there are three classes of corporations— municipal, stock and non-stock corporations. We are concerned at this time with stock corporations.

Stock Corporations. Stock corporations may be classed as financial, business and public service. It will be seen that practically every corporation organized for profit can be classed as a stock corporation. By this is meant that the original capital for financing the business is raised principally by selling shares