Mixed Accounts Defined.—In the course of business operations certain accounts which at the beginning of the period belong definitely to some one of the three groups, asset, liability, and proprietorship, with the progress of the period take on a mixed character. That is, included under one account title there is a mixed record of asset and expense, or other combination of two or more groups. For example, the machinery which belongs to the asset group at the beginning of the period depreciates in value day by day, both through use and the lapse of time. This daily decrease in value is of slight amount and in the management of the business it is not necessary that it be shown on the books. While it is theoretically possible to record this daily loss, practically nothing would be gained by so doing. Hence, the machinery account is allowed to carry both the asset value of the machinery at a given time and the amount of its depreciation. Only periodically, usually at the close of each fiscal period, is the account separated into its two parts, the one which shows the true asset value and the other which indicates the amount of depreciation and which is therefore the expense or proprietorship-decrease portion of the account.

In the previous chapter the way in which the Merchandise account takes on a mixed character was briefly explained. It was shown that the credit side reflected both a decrease of the asset and an increase of the proprietorship by the amount of the gross profit on the goods sold. Thus, because of the way in which accounts are kept practically, as distinguished from a theoretically correct method, which would maintain at all times a sharp line of division between assets, liabilities, and proprietorship, certain accounts are allowed to become mixed. It is the purpose of this chapter to discuss the proper handling of the more common mixed accounts.

Analysis of a Sale Transaction.—The impracticability of immediately separating each sale of goods into its two elements of cost and profit and the taking of a physical inventory as a means to this end, was discussed in Chapter VI. The necessity for this later separation may be made clear by analyzing a sale transaction.

Suppose an article costing $10 is sold for $12. At the time of its purchase a debit was made to Merchandise account and a credit, say, to Cash. When the article is sold, it would seem that the credit should be to Merchandise to show the decrease in that asset. However, in the sale price of $12 is included something more than the amount by which the stock of merchandise is decreased. This additional amount is the profit of $2. Hence, a credit to Merchandise of $12 would result in too large a subtraction from the asset Merchandise, if it is intended that the Merchandise account shall always show by its balance the value of the unsold stock. Theoretically the best method of entering this sale would be to debit Cash for $12, and to credit Merchandise with $10 and Profit with $2.

The Old Merchandise Account, Its Content and Significance.—It is impracticable, however, to compute and record the cost of every unit sold. Using the above illustration, instead of crediting Merchandise with $10 and Profit with $2, the entire $12 may be credited to the Merchandise account. There is a disadvantage in this procedure, in that the Merchandise account then no longer represents the one asset Merchandise, but is a mixture of an asset element, merchandise, and a proprietorship element, profit; two elements which must be separated at the close of the period.

Originally, the Merchandise account was kept in this way; it was a mixed account and followed the rules of debit and credit as shown below, the amounts being given for purposes of illustration:

Where the account is kept in this manner it is usually burdened with the additional data listed under (3), (4), (b), and (c). Sales being a credit item, it is plain that subtractions from sales (3) and (4), must appear on the debit side, and, purchases being a debit item, subtractions from purchases (b) and (c) must appear on the credit side. If these subtractions were actually performed instead of being indicated in the account, the debit side would show net goods to be accounted for, viz., goods on hand at the beginning, $10,000, plus net purchases, $17,900, making a total of $27,900; and the credit side would show net sales, $25,000 minus $1,500, or $23,500.

If, now, the cost value of the goods on hand at the close of the period (as determined by a physical inventory) equals $8,000, it is evident that the cost price of the goods sold is equal to the cost value of the goods to be accounted for, minus the cost value of the goods left on hand, that is, $27,900 minus $8,000, or $19,900. To secure this subtraction within the account, it is necessary to enter on the credit side this $8,000, the cost value of the final inventory. Accordingly, an additional credit item (d) is inserted, after which the account will show:

The account is now a pure proprietorship account, the balance showing the gross profit on sales, amounting to $3,600.

Modern Practice in Showing Merchandising Transactions.—Actual subtraction, however, within the account is contrary to the method of showing subtractions in the account. Therefore, the mixed Merchandise account cannot show the figures representing “net purchases,” “net sales,” “total goods to be accounted for,” and “cost of goods sold”—information which is very essential to proper management. While containing all the data necessary to give the final information, viz., the “gross profit,” the mixed account does not show the separate factors leading up to it. Analysis of the mixed account is necessary to find the elements of which it is composed. The best accounting practice provides for this analysis as the transaction takes place. The old Merchandise account is no longer used; in its place separate accounts are set up to represent the various elements mentioned above. Each account thus contains only one kind of item as indicated by its title. These accounts are:

Accounts (1), (2), (3), (7), and (8) correspond to the four classes of debits shown above in the mixed Merchandise account, and accounts (1), (4), (5), and (6) correspond to the credits. Explanation of the use of account (1) for both the initial and final inventories is given in detail in Chapter XV.

The advantage of the use of these accounts instead of the one Merchandise account is in the availability of the information they contain and in the saving of labor, because now there is no need to analyze the Merchandise account for information relating to returns, allowances, and so forth. By later transferring the totals of the Returned Sales and of the Sales Rebates and Allowances to the Sales account, the balance of this account will show the “net sales.” A similar transfer of the Inward Freight and Drayage, the Returned Purchases, and the Purchases Rebates and Allowances to the Purchases account, and a transfer to it of the initial and final inventories, make it show by its balance the “cost of goods sold” which set over against “net sales” shows the figure of “gross profit.”

The student will understand that the use of these detailed accounts does not free the record of merchandise transactions from the mixture of different elements, decrease of the asset and increase of the profits. It does, however, make the record more valuable because of the information it makes available.

Accounts with Assets Subject to Depreciation.—Another kind of mixed account requiring explanation is that of the fixed asset subject to depreciation. Due to ordinary wear and tear, and some other causes, most fixed assets lose part of their value as time goes by. At the end of each fiscal period the amount of this loss and the present value of the asset must be estimated, after an inventory has been taken, when necessary, of their number, weight, or other units of measurement. Such an estimate is called an appraisal. The difference between the present appraised value of the asset and its former cost or appraised value constitutes the loss from wear or other causes, and is termed depreciation.

Since depreciation takes place day by day, but for practical reasons cannot be recorded daily, fixed asset accounts, as they stand valued in the ledger, represent true asset values only for the date of their entry. Except on that date, these accounts, then, include depreciation and hence are mixed accounts including both asset and proprietorship elements. As with the Merchandise account, an adjustment is made periodically to separate the two elements. Since the asset account is a debit account, entry of the amount of the depreciation to the credit side would result in the account showing, by its balance, the appraised value of the asset at any given time. It is, however, desirable to leave the account in its original condition, in order not to lose sight of the cost of the asset. Therefore the usual practice is to enter this figure of depreciation to the credit side of a separate account called Depreciation Reserve for the particular asset, using the word “reserve” in the sense of “estimate.”

If the latter method is followed, each asset has two accounts, one showing original cost and the other estimated depreciation, and it is necessary for a true valuation of the asset to read the two accounts together; that is, from the asset account showing original cost, the amount credited to the reserve account must be deducted to show the true value of the asset. Because of this, the reserve account is often called a valuation account or an offset account, as it gives the amount of the offset to the original asset account necessary to show its correct value. Similarly, when an increment in the value of an asset is kept separate from its face or par value—as when the premium paid for stock or bonds is shown separately from the par value of the stock or bonds—the account showing the increment is called an adjunct account and must be read with the asset account to secure true valuation. The offset account, then, is a subtraction item and the adjunct an addition item to the corresponding asset account. The showing of the asset and its periodic valuation is made as follows:

A reading of the two accounts taken together shows the original value of machinery as $5,000, the value after one year’s use $4,500 and after two year’s use $4,000. The contra debit for the credit in the reserve account is made to an account called Depreciation, which represents the expense of the depreciation for the period, that is, the deduction from profit or proprietorship. Sometimes, this charge is made direct to Profit and Loss, as will be shown in a later chapter.

Capital and Revenue Expenditures.—The fixed asset accounts usually show the investment of some of the original capital and therefore are sometimes called capital asset accounts. A fundamental distinction must be made between expenditures for the purchase and installation of the asset itself and expenditures for expenses in connection with its repairs, maintenance, and upkeep. These two classes of expenditures are usually called “capital expenditures” and “revenue expenditures” respectively.

The asset account itself is chargeable with all costs incurred up to the point of putting the asset in shape for use in the business. It may be charged also with subsequent expenditures resulting in an increase in its value. Expenditures, however, which are for the purpose of repairs or of keeping the property from too rapid depreciation without adding anything to its original value, must be charged to a properly labeled expense account. These revenue expenditures for expenses, such as repairs, maintenance, upkeep, together with depreciation, are subtractions from profit and proprietorship, while asset expenditures usually constitute an exchange of the asset cash for some other asset, which exchange has no effect on proprietorship.

Sometimes two items of expenditure are seemingly of the same nature, while in fact they belong to separate groups, as the original painting cost of a building and the cost incurred later for repainting. In the first instance the expenditure is an asset, a part of the original cost necessary to put the building in a finished condition; in the other instance, it is an expense necessary to maintain the asset in something near its original condition. In order to secure accuracy in the records, careful discrimination between capital and revenue expenditures is a matter of great importance.