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1. In the machinery account of a company under audit, you find the following among other items:



Sale of old machine,
type A (less cost
of removal and
freight)..... $1,264.00.
Sale of old machine,


type B....

Purchase of two machines, type A, including freight.. ..

$8,000.00 Cost of removing a disused ma

chine, type B, to make room for new machine..

160.00 Cost of installation of two new machines.....

280.00 Alterations to four type C machines,

necessitated by change in product. 640.00 *Cost of moving two machines from

building A to building B to permit of more economical operation, including reinstallation..


The balance on Machinery Depreciation account shows an increase for the year of the amount provided out of income, which is computed at the rate of 4% on the balance of Machinery account at the commencement of the year. The method of keeping the Machinery and Machinery Depreciation accounts has been in force from the commencement of operations. Draft your comments as auditor of these accounts, assuming that no items other than those above mentioned call for any comments.

Inst. Ex. 1918. 2. You are called upon to audit the books of a partnership which has been in existence for one year. You find that A's Balance Sheet, prepared just before B was admitted as a partner, shows the following accounts:

Cash in the bank, $500.00; real estate, $20,000.00; machinery, after 10 per cent depreciation, $40,000.00; accounts receivable, $7,542.50; stock on hand finished, $10,000.00; stock in process of construction, $1,000.00; raw material, $957-50; bills payable, $20,000.00; accounts payable, $30,000.00.

After examining the copartnership agreement, you find that A agreed with B to sell him one-half interest in the business for the sum of $20,000.00 to be contributed to the new firm, the new firm to take the assets of A with the exception of the real estate and assume the liabilities, and that the good will of the business of A should be rated at $20,000.00 in the new firm's books.

During the course of your audit you discovered the following discrepancies:

(a) The inventory of finished stock was incorrect. The value should have been entered at $8,000.00 instead of $10,000.00.

(b) of the accounts receivable, $6,500.00 were collectible. One of the debtors owing $500.0o failed, leaving no assets, previous to the formation of the copartnership, which fact was known to A but his bookkeeper, who had been instructed to charge off the account had failed to do so. $1,000.00 of the accounts receivable represents accounts ascertained to be worthless since the copartnership was formed.

The Trial Balance at the end of the year's business showed as follows: A Capital Account..

$ 25,000.00 B Capital Account.

25,000.00 Merchandise..

75,000.00 Accounts Payable...

40,000.00 Accounts Receivable.

$10,000.00 Machinery..

40,000.00 Factory Wages.

35,000.00 Non-productive Labor.

5,000.00 General Factory Expense. 20,000.00 Rent....

1,500.00 A Personal Account.

2,500.00 B Personal Account.

2,500.00 General Expense..

2,000.00 Good Will.

20,000.00 Cash..

26,000.00 Profit and Loss..


$165,000.00 $165,000.00
Inventories at close of year:
Stock on hand finished...

Stock in process of construction..

2,500.00 Raw Material..



30,000.00 No correction was made of the discrepancies and no amount has been charged off for depreciation of machinery, which should be 10 per cent.

Make proper entries to correct books with reasons for such entries in full, also formulate Balance Sheet showing the standing of the firm after the books were closed. C. P. A. Mich.

(Note. In connection with the second Accounting Problem, there are several legal principles involved. You may assume that B accepted the Assets and Liabilities of A as stated on A's books with the exception of the Account Receivable amounting to $500.00 known to be worthless by A, but which was included in his assets through an error on the part of the bookkeeper.

The overvaluation of the inventory probably was unknown to both A and B until the auditor ascertained this fact. The accounts proved to be uncollectible, excepting the account mentioned above, could not be foretold, and were accepted by A without a reserve for such a loss, therefore, you may assume that these two items are losses of the partnership to be borne equally by A and B.

As a result of this information, two correcting and two adjusting entries are necessary. These should be set up in journal form and posted to the accounts, after which a Trial Balance should be taken and a Balance Sheet made.)



I. Name the two divisions of property and explain each.

Define personal property.
3. What is chattel property?

4. When are trees real property and when are they personal property?

5. (a) Name four methods by which title to personal property may be transferred by acts of law.

(b) May personal property be transferred by acts of the parties? If so, explain how.

Chapter Ten

DEPRECIATION Depreciation Defined. Depreciation is the shrinkage in value of an asset due to deterioration through wear and tear caused by use or by a mere lapse of time, accidents, inadequacy, or obsolescence. The importance of its being considered from an accounting standpoint can hardly be overestimated. Without a doubt, failure to provide for the depreciation of the fixed assets, has contributed to the failure of many concerns in the past.

In a decision by the New York Court of Appeals, the following statement appears:

"Judicial notice may be taken of the fact that in the conduct of many industrial enterprises there is a constant deterioration of the plant which is not made good by ordinary repairs and which, of course, operates continually to lessen the value of the tangible property which it affects. The amount of this depreciation differs in different enterprises, but the annual rate is usually capable of estimate and proof by skilled witnesses. No corporation would be regarded as well conducted which did not make some provision for the necessity of ultimately replacing the property thus suffering deterioration; and we cannot see why an allowance for this purpose should not be made out of the gross earnings in order to ascertain the true earning capacity."

A few years ago an underwriting syndicate undertook the reorganizing of the Rock Island Companies. Its plans were to issue 7 per cent preferred stock on the basis of an 8 per cent income. To the dismay of the members of the syndicate, the Interstate Commerce Commission ruled that all the railroads under its control must include, as a charge against their profits, a satisfactory percentage of the railroad equipment, such percentage being the estimated amount of depreciation of the property. As a result of this ruling the net income of the Rock Island Companies fell to 372 per cent. This rate of income was insufficient to warrant the issue of 7 per cent stock and the syndicate collapsed. The practice of most of the railroad companies had been to disregard the theory of depreciation. They simply discarded old equipment made worthless through wear and tear and borrowed money to buy new equipment. It dosen't require much wisdom to see the folly of such a plan and the ultimate results are quite clear. A firm that divides all its net income without providing for depreciation on its fixed assets is simply "robbing Peter to pay Paul" and it reminds one of the story of the two men, shipwrecked on a deserted island, who during the time they were stranded became rich trading knives with each other.

Causes of Depreciation. There are four principal causes of depreciation. These have been so ably and clearly described by Professor M. E. Cooley that we will quote him in detail:

"1. Depreciation Due to Wear and Tear and Exposure to the Elements. This is continuous. All elements have a wearing life varying with the element itself. No element can be completely worn out; it can be worn only to a point below which it becomes unsafe or no longer serves its original function. In practice, the average condition of all elements must be maintained at a high percentage of the original cost if the property is to serve its purpose properly. This percentage varies from 75 per cent to 85 per cent of the cost of the property. The difference between this percentage of from 75 to 85 and the original 100 is a depreciation which is inherent in the property and cannot be dispensed with. It must be met by a sinking fund, or its equivalent, otherwise this part of the original investment is lost.

2. Depreciation Due to Accidents; Sudden Depreciation. An engine or a boiler may be wrecked, and with it, other machinery. This might, and probably would, involve a considerable expense for repairs or replacements besides possibly crippling the plant in part. Cars may collide or a car may drop through a bridge. A bridge itself may fall or be carried away by flood. A storm or a cyclone, may work havoc, entailing costs in excess of those proper to be charged to ordinary maintenance of property.

"3. Depreciation Due to Inadequacy. Cars suitable in the past had already been superceded several times by larger and better cars. This has rendered the track, structure, and bridges inadequate, and as more power is required to propel the larger cars, the power plants have become inadequate. The public demand is largely responsible for this depreciation due to inadequacy.

"4. Depreciation Due to Obsolescence. This, while closely allied to the depreciation due to inadequacy, is different in that it embraces changes due to advance in the art. More efficient and effective machinery has appeared which must be substituted for the old to keep abreast of the times. For example, in steamengine practice the turbine has come into general use during the past five years and the art of steam turbines is at the beginning. Generators adapted to piston-engine practice are not adapted to steam-turbine practice and must be changed. Boilers adapted to piston-engine practice must be replaced to carry the higher pressures required. Condensers must also be changed to secure the better vacuum required to realize the full advantage of the steam turbine. Owing to the rapid disappearance of coal beds, the price of fuel must advance. and this presumably will, before many years, force the adoption of the gas producer and the producer gas engine. Water powers are wisely being developed, but to utilize them requires the scrapping of large parts of the machinery in use at present.”

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