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5. A corporation organizes under the laws of Michigan to conduct a manufacturing business. Authorized capital $400,000.oo, half each common and preferred stock, shares $1oo.o.o. Five incorporators subscribe for ten shares each of common stock at face value. John Smith purchases from three manufacturing companies, their complete plants for $395,000.00 and transfers said plants to the incorporated company for the remaining $395,000.00 of common and preferred stock and $150,000.oo of first mortgage 5% bonds out of a total issue of bonds of $200,000.00, leaving $50,000.00 of bonds in the treasury.

Make opening journal entries and Trial Balance showing the company's condition after the transaction.

C. P. A. Mich.
(Continued from Chapter Twelve)

Transaction No. 3. As has been stated in Transaction No. 2, the General Manufacturing Company is to acquire all the assets excepting cash and to assume all the liabilities of the Williams Manufacturing Company. With this in view a firm of Certified Public Accountants was employed to make a Balance Sheet audit of the books of the latter company. The present investment of Williams, as shown in the accompanying Balance Sheet after deducting the cash, is $1,601,670.Oo. In Transaction No. 2, Williams subscribed for 5,000 shares common stock and 5,000 shares preferred stock of the General Manufacturing Company. Certificates for this stock have now been issued to Williams. The balance due Williams is to be paid later by issuing bonds. A preliminary agreement has been made whereby Williams will purchase the entire bond issue. For the present, therefore, an account with Williams is permitted to stand open until such time as the details of the bond issue may be completed. The Balance Sheet of the Williams Manufacturing Company, as certified by the accountants, appears as follows:

Balance Sheet—Dec. 31, 1919

ASSETS Bank Balance....... . . . . . . . . . . . . . . $ 68,000.oo Imprest Cash. . . . . . . . . . . . . . . . . . . . . I,330.OO Accounts Receivable. . . . . . . . . . . . . . . 89,256.00 Notes Receivable....... . . . . . . . . . . . 24,340.00 Merchandise Inventory. . . . . . . . . . . . 223,258.00 Land. . . . . . . . . . . . . . . . . . . . . . . . . . . . 500,000.00 Buildings....... . . . . . . . . . . . . . . . . . . 690,000.OO Machinery, Tools and Equipment... 1,130,000.oo Office Furniture and Fixtures. . . . . . . 8, I6O.OO Deferred Administrative Expenses... 9,279.OO Total Assets. . . . . . . . . . . . . . . . . . . . . . $2,743,623.00

(Concluded on next page)

Accounts Payable. . . . . . . . . . . . . . . . . $ 408,000.00
Notes Payable, Banks. . . . . . . . . . . . . 545,000.OO
Notes Payable, Trade. . . . . . . 57,000.00

Notes Receivable Discounted(Contra) 23,623.OO

Accrued Pay Roll . . . . . . . . . . . . . . . . 30,000.00
Accrued Salaries. . . . . . . . . . . . . . . . . . 9,000.00
Total Liabilities. . . . . . . . . . . . . . . . . . . $1,072,623.00
R. V. Williams' Present Investment. I,671,000.OO


Transaction No. 4. C. H. Bowser and R. O. Wiggins pay their subscriptions to the capital stock by conveying to the company title to patents valued at $1,000,000.00. Stock certificates are issued to each.

Transaction No. 5. Following the organization of the General Manufacturing Company, it was decided to issue bonds as follows: (Bonds, par value, $1,000 each.)

First Mortgage Bonds, 5%, 20 years, $120,000.00
Second Mortgage Bonds, 6%, 15 years, $398,000.00
Debenture Bonds, 5%, Io years, $153,000.00

R. V. Williams purchased the entire bond issue at par, thereby cancelling his account against the company, he paying the difference, $69,330.oo, in cash.

Chapter Fourteen


A Balance Sheet audit comprehends the preparation of a Profit and Loss statement. When the Balance Sheet is prepared, after proper verification of all stated and unstated assets and liabilities, it will show either a surplus or a deficit. If the networth has increased during the fiscal period, over and above any additions to the investments, there has been an addition to the surplus or undivided profits. On the other hand, if the net worth has decreased during the fiscal period, after properly considering any withdrawals from the investment, there has been a deduction from the amount of the surplus existing at the beginning of the fiscal period and if the amount of the assets are actually less than the amount of the liabilities an actual deficit will exist.

In as much as no conclusions can be definitely arrived at with regard to the causes for any changes in the net worth, from the Balance Sheet, it is necessary to prepare a Profit and Loss statement. The client will not be satisfied to simply be informed that his business has been conducted at a profit or loss amounting to a certain sum, but will naturally be even more concerned in knowing how these facts were ascertained. How were profits made or how were losses incurred? are natural questions.

To prepare an intelligent statement of profits and losses will require familiarity with the legal and economic phases of income and expense accounts, and ability to state the transactions in an intelligent manner. This implies ability to analyze the nominal accounts and to present the results so that the proper information is conveyed to the client in the best possible form.

In connection with the analyzing of income and expense accounts, and the best form for presenting the results, we will again refer to the Federal Reserve Bulletin on “Uniform Accounting.”

Surplus. “The auditor should give consideration to the surplus at the beginning of the period. This item represents the accumulated profits prior to the beginning of the fiscal period under review, and should be compared with the surplus shown on the Balance Sheet of the previous year, and with the ledger account, to see that it corresponds, and if it does not, a reconciliation statement should be prepared giving full details of the differences.

Profit and Loss. “The auditor should obtain the Profit and Loss statement for three years, at least, including the period under audit, and after verifying them by comparison with the ledger account, prepare a statement in comparative form. This comparison will furnish valuable information to the banker as to the past progress of the concern under audit.

“While it would be impracticable in an ordinary Balance Sheet audit, and, at the same time, somewhat useless to make a detailed check of all the transactions entering into the composition of the Profit and Loss account, there are certain main principles to be kept in view which are briefly outlined below:

Sales. “Whenever it is possible, the quantities sold should be reconciled with the inventory on hand at the beginning of the period, plus the production, or purchases, during the period, less the inventory on hand at end of the period.

“Where a good cost and accounting system is in force, the sales records will very probably be in good shape, but nevertheless, the auditor should satisfy himself from the shipping records that the sales books were closed on the last day of the fiscal year, and that no goods shipped after that date are included in the transactions.

“When an audit is being made for the first time, the auditor should satisfy himself that the sales at the beginning of the period were recorded in accordance with the dates of shipments. Such verifications can be made conveniently by a direct comparison of the shipping memoranda with the invoices billed.

“Allowances to customers for trade discounts, outward freights, reductions in prices, etc., should be deducted from the sales in the Profit and Loss account, as the amount of net sales is the only figure of interest to the bankers.

“The future bookings at the close of the fiscal year should be looked into, as a comparison of orders on hand with corresponding periods of other years furnishes the bankers with an idea of the concern's business outlook. "

Cost of Sales. “The inventory at the beginning of the period, plus purchases during the period, less inventory at the end of period, gives the cost of sales. In a manufacturing concern the factory cost of production takes the place of purchases. These items will have already been verified in auditing the Balance Sheet, but nevertheless care should be taken to see that this heading has not been made a dumping ground for charges which would be more properly embraced under the heading of special charges. The composition of the items entering into the cost of sales should be traced in totals into the cost ledgers Or a CCOunts.

Gross Profit on Sales. “This is obtained by deducting the cost of sales from the net sales. The ratio of gross profits to net sales should be calculated and compared.


Selling, General and Administrative Expenses. “Under these general headings should be set down the expenses itemized to correspond with the titles of the ledger accounts kept in each division. In checking the totals of each account with the statement for the period under audit, special attention to credits in these accounts should be given to see that none have been made for the sale of capital assets and for other items which should not appear in expense accounts. The percentages of the totals of each division and of the aggregate total to net sales should be calculated for each year for comparison.

Net Profit on Sales. “This is obtained by deducting the aggregate total of the selling, general, and administrative expenses from the gross profit on sales, and shows the net earnings of the concern on its real business. Ratio to sales should be calculated for each year for comparison.

Other Income. “Under this heading is embraced any income that may be derived from sources outside of sales, such as income from investments, interest, discounts, etc. Schedules should be prepared of each item, and the auditor should satisfy himself of their accuracy and of the propriety of including them as income.

Deductions from Income. “Under this heading are grouped such items as interest on bonded debt, interest on notes payable, etc. The same procedure of verification as in the case of other income should be followed.

Net Income—Profit and Loss. “Adding other income to gross income and deducting deductions from income gives the net income or profit and loss for the period, which is the amount that should be carried to the Surplus account.

Surplus Additions and Deductions. “Items of unusual or extraordinary profit which do not belong strictly to the period under audit, or cannot be said to be the legitimate result of the ordinary transactions of the concern, should be entered here and verified with the Surplus account. Similarly, deductions should be treated. Also dividends declared should be entered in the Surplus account and as an item under this caption, inasmuch as it is the usual custom to declare dividends “from net earnings and surplus.' After adding special credits to and deducting special charges from the net income, we have the total profit and loss for the whole period from all sources which, added to the surplus balance at the beginning of the period, gives us the surplus at the end of the period, which should agree with the surplus as stated on the Balance Sheet.

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