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A. THEORY QUESTIONS I. In auditing the accounts of a corporation, for the first year of its existence, what records and documents should be examined in addition to the books of account and the vouchers?

Inst. Ex. 1917. 2. In making an audit, should the auditor require to see the corporate minute book, and such other purely corporate records of a company? Give reasons for your answer.

C. P. A. Ind. 3. What do you understand by the following terms and give illustrations of each: Fixed Assets, Quick Assets, Fixed Liabilities, Current Liabilities, Fixed Charges, Real Accounts, Nominal Accounts, Account Stated, Internal Check?

C. P. A. Mich. 4. A company used its own material and laborers' services in the erection of an addition to its own plant. These additions to Capital account were charged at market prices, the profit on the transaction being absorbed in current trading profits. Do you consider this method correct? Explain fully the principles involved.

C. P. A. Nebr. 5. A concern needs an addition to its plant. Not having enough ready capital, they borrowed money and when the interest was paid it was charged to the "Plant” account on the theory that it was not an expense in the ordinary conduct of the business and should, therefore, not be charged to the regular Interest and Discount account but might with propriety be charged as a part of the cost of the addition. Is the theory sound?

C. P. A. Mich. 6. A company purchased land and on this land was a building which the company had to pull down in order to make the required use of the land. During the demolishing of the building, a workman was killed. To what account should the compensation in respect of this accident be charged and why?

C. P. A. Pa.


1. You are employed to prepare a statement for credit purposes from figures submitted to you in a letter from the Western Manufacturing Company. Their letter submits figures and data as follows:

Their plants stand at cost price, $90,600.00. They have set up a reserve for depreciation of $15,300.00. There is a mortgage of $30,000.00 on the plant and interest on the mortgage is at 6% and is paid to within three months of date of your proposed statement. They hold $15,000.00 of notes receivable and have discounted at bank $37,500.00. Accounts receivable they consider good, amount $27,000.00, including $4,500.00 due from employee on personal account. Accounts with trade customers are subject to 5% discount if paid at due date, and $15,000.00 is now past due. Suspense accounts amount to $6,000.00, 50% of which are believed to be good. A new machine has been ordered but not yet delivered, which cost $9,000.00. They have endorsed a note for $9,000.00 for Smith and Co., but say it will be paid when due. Accounts payable amount to $63,000.00, insurance amounts to $600 a year and has six months to run. They owe a note at bank for $7,500.00, interest paid to date. They own 50 shares of stock in a company from whom they buy raw materials. They cost $4,200.00, and are presumed to be worthless. Inventory was taken at a selling price of 10% more than cost. This amounts to $26,400.00.

You are not asked to accept any responsibility for the figures in the statement but simply to prepare the statement in the best form you can from their letter.

C. P. A. Ind. 2. A company is formed under the laws of Mexico, to take over and work certain mining properties. At the end of one year the company is found to possess: Mining lands..

$ 484,675.48 Buildings and Improvements.

20,409.76 Machinery...

25,612.88 Cash on hand and in bank.

24,612.50 Silver Bullion...

85,209.50 Ore in dump..

13,680.00 Merchandise.

5,420.80 Fuel, oil, etc.

679.20 The company owes: On open accounts....

3,890.12 On account of pay-rolls..

400.00 Note due in six months with int. 6%.. 25,000.00 Capital Stock (Fully paid) is....

500,000.00 Set up Balance Sheet.

C. P. A. Mich.


You own two houses, in one of which you live. The other is leased to a tenant at a fixed monthly rental. You paid during 1918 real estate taxes to the state, county, city or township on both properties. You also paid for the repairs on both.

(a) Does the present federal income tax law make any distinction between the two properties as to these two classes of expenses? (b) If so, explain the reason, if any, for the distinction.

Inst. Ex. 1919.

Chapter Nine

FIXED ASSETS (Continued)

Capital and Revenue Expenditures. Buildings are also subject, after construction or purchase, to improvement, betterment, repair, renewal, replacement, alteration, depreciation, assessment, and destruction. All subsequent charges, after the cost has been recorded, raise the question of the proper separation of capital expenditures and revenue expenditures.

Briefly, capital expenditures might be defined as, all sums expended for addition to, or improvement of properties. The American Encyclopedia defines revenue expenditures as, "expenditures made in connection with the running expenses of the legitimate business of the firm or corporation concer ed.

Capital expenditures may be charged to the asset accounts affected while revenue expenditures should be charged to the proper expense account. Lawrence R. Dicksee* says, “If an expenditure has only had the effect of putting the earning power of the undertaking upon the same footing as that which had previously obtained, it must be charged to revenue.

In summing up, the auditor should analyze the accounts with fixed assets, and if he finds any items that he is in doubt about they should be noted and carefully investigated. Improvements that increase the earning capacity of the plant and that are not of the nature of either renewals or improvements, may be

capitalized. All other expenditures in the nature of upkeep and repairs should be charged to an expense account. Some bookkeepers, when in doubt as to whether an expenditure constitutes an actual improvement, charge it to the asset account anyway. Their reason for so doing is that if it is later found that the item should have been charged to expense, it may be adjusted without much difficulty, while on the other hand, an item charged to expense, but which should have been charged to the asset account, is always difficult to adjust because it is usually necessary to make explanations and secure authority for the adjustment. It is more conservative, however, to overcharge the revenue expenditures than to overcharge the capital expenditures. So far as possible, adjustments should be avoided except when absolutely necessary.

*Of the firm of Price & Dicksee.

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 fuither 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."

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