Records and Their Functions.—As far back as our knowledge reaches, records of some sort have been kept and used and they have frequently formed the basis on which our knowledge rests. In a broad sense a record may be defined as a written memorial, a register or history of events, a testimony. Even though the desire to make and hand on to the future a record of achievement is a deep-seated characteristic, record-making has seldom been an end in itself. Knowledge of what has been done has always been a starting point and a guide for future achievement. The longhand or narrative record is indispensable in some fields of knowledge; the shorthand or statistical record is equally necessary in others. The statistical method and accounting are, without question, most potent agencies for the advancement of human knowledge and for the control of human relationships. They provide the basis in fact on which judgments must largely rest. This book, therefore, may begin by sketching the relation of accounting to some of the larger fields of human endeavor—the economic organization of society and the law—to point out its place in the business unit and briefly state the basic function it performs therein.

The Business Unit.—To carry on its various activities, economic society has organized itself into numberless separate units or business organizations. These units are the means through which society operates, their ultimate purpose being the easy and efficient satisfaction of human economic wants. Individual business units, conducted as they are by members of society, are under the broad general supervision of society as a whole. This is evidenced everywhere by the laws, licenses, and regulations by which society attempts to regulate the activities of the individual for the larger interest of society as a whole. As business is conducted in most parts of the world, it is highly individualized rather than communized. There is a growing tendency, however, for society to exercise a larger control and supervision over all types of individual activity, particularly with a view to conserving the welfare of its members. The business unit is thus the medium through which society works to satisfy its economic wants.

Internal Organization of the Business Unit.—Society early found that only by means of a highly specialized division of its activities was it possible to satisfy without waste its rapidly increasing economic wants. Individual business units are thus organized for the purpose of carrying on some one or more of these greatly subdivided activities. Within itself the business unit is organized into departments or divisions for the efficient and thrifty handling of its work. The two large divisions in any business undertaking have to do with what the economist calls the production and exchange of wealth, that is, commodities, services, and so forth. In carrying on these activities of production and exchange it has usually been found desirable to segregate into separate departments certain major functions which are common both to production and to exchange. What the major departments may be depends very largely upon the size of the business unit, its relative complexity of organization, and to some extent on the individual ideas of its managers. Throughout the business world one notes, however, a quite general departmentization under the following heads:

• 1. Finance
• 2. Procurement or production
• 3. Marketing or distribution
• 4. Personnel
• 5. General administration

There are two main activities under the control of the finance division of a business: (a) the problem of original investment, including that of location and acquisition of a plant suitable for the conduct of a contemplated business; and (b) the problem of operating finance, that is, of providing the business with a fund of working capital for its efficient operation. The financing of purchases, sales, credits, operating expenses, and so forth, comprises a large part of the work of finance of an operating or going concern.

In the second of the major departments, that of procurement or production, one finds these activities: (a) the purchasing of the stock-in-trade to be dealt in, if the concern is a trading business; or (b) the manufacture of the stock-in-trade, if the concern is a manufacturing business.

In the department of marketing or distribution, the following activities center: (a) those having for their purpose the creation of a market or demand for the commodity dealt in—the sales organization, the advertising activities, and so forth; (b) the actual selling of the commodity; and (c) the transportation and delivery of the product.

In the personnel department are included the human relations between employer and employee. The hiring and training of the employee, his classification and rating, his welfare and promotion, are the major activities here.

The function of the department of general administration is in the main that of supervision and management of the business as a whole. The general manager must have a view of all of the activities of the business. He must see that the various departments through which its activities are carried on are properly correlated, that it is so organized that its departments function smoothly and efficiently in the performance of their several duties. A consideration of the means employed by the general manager for the proper performance of his duty indicates the place of accounting in the business unit.

Place of Accounting in Business.—In a small business where the owner and manager is in close and intimate contact with these several departments, or perhaps where he focuses all of them within himself, he has no need of special means of keeping himself informed concerning the activities of his assistants, nor does he require an elaborate system of records to indicate the condition and state of the business at any time. In large businesses, however, where the volume and complexity of the commercial activities make it impossible for the executive, on whom rest the responsibilities for the successful conduct of the business, to have an intimate personal knowledge of all phases of the business, it is very necessary that some means be employed for supplying him with this vital information. Two types of information are necessary to him: (1) information about the business unit itself, its activities and condition; and (2) information about general economic conditions in the country, and particularly about other businesses in the same line of activity as his own. It is the function of accounting to supply information of the first type; it is the chief purpose of statistics to supply information of the second type. The accounting department, therefore, deals largely with the internal activities of the business, while the statistical department provides knowledge of the external relations of the business. A proper control and management of business affairs cannot be exercised without the information supplied by both departments. In the accomplishment of its function to supply the internal information, the accounting department reaches out into all of the main departments indicated above for data from which to make its record of the various activities of the business unit.

Purpose of Accounts.—Accounts record the business history of a concern. Their main purpose is to secure information concerning the results of business activity and endeavor. The record required for this purpose can be condensed and made very brief, although the full history of every business comprises a multitude of transactions with a great mass of details. The whole scheme and method of account-keeping is designed chiefly to collect the detail and use it mainly for building up a summary which shall give in rapid review the entire record for the fiscal period.

Account-keeping is to the bookkeeper what shorthand is to the stenographer—an abbreviated method of making the record. The uses to which the records are put, however, differ radically. Stenography abbreviates the writing of the spoken word with a view to its transcription into longhand; accounting records business transactions in abbreviated form with a view to summarizing them further so as to secure a bird’s-eye view of the operations of the business as a whole and to use it in the formulation of administrative judgments and policies.

In a large business there are executive duties within each of the five main departments. Accounting must supply the information on which each departmental executive will base his judgments and policies. The student will see, therefore, that the accounting department brings together a record of the activities of each of the main departments of a business. He will see, too, how the final output or product of the accounting department must be a summarization and interpretation of these departmental activities in order to provide a basis for the various executives on which to formulate their judgments and business policies. Accounting is, therefore, a handmaiden of the executives in the conduct and management of the business. It is the purpose of this volume to develop the technique of the bookkeeping and accounting record and to indicate some of its uses in the management of business.

Relation of Accountancy to Economics.—Economics is sometimes defined as the science of wealth, by which is meant a body of classified knowledge relating to wealth in the aggregate. Under the present-day political and social system, the ownership of wealth is very largely private. Furthermore, the division of labor, as industry is now organized, has been carried to a very high degree. Because of these facts the present elaborate organizations for producing wealth have given rise to an urgent need for some effective means of keeping record of their activities.

The effort of every individual engaged in industry is to increase wealth. He labors to extract the raw materials from nature, to shape and mould them so as to supply the wants of his fellowmen. He then distributes them by means of markets and exchanges so as to secure the greatest possible returns for his effort. As competition becomes keener and the margin of return per unit of product becomes smaller, he has to increase his volume of business to secure the same amount of profit as when he did a lesser volume of business.

To produce goods it is necessary to use the saved wealth of former periods to pay the expenses of materials, labor, management, etc., of the present period. One must consume wealth to produce wealth. After his product is made, he must seek the best market for its exchange or sale. This necessitates the use of a complex system of transportation and communication. Finally, during the whole process of production and exchange the estimated returns from the article must be distributed among the several parties engaged in their creation. To make this distribution on the basis of estimated returns, gives rise to the need—the absolute necessity—of an accurate record of the costs of the activities and processes all along the line. The record, then, of the value of the rights and properties of the various parties to the production and distribution of wealth, as society is now organized for its economic well being, is the special field assigned to Accountancy as related to Economics.

Relation of Accountancy to Law.—The determination of the rights of the several parties to the creation, exchange, and ultimate consumption of a product is the field of Law, more particularly Business Law. The determination by means of its records of the value and extent of these rights is the province of Accountancy as related to Law. Accountancy is thus seen to be the handmaiden of both Economics and Law. None of them can progress far without the help of the other two. All being related to, and arising out of manifold human endeavors, their progress and development is dependent upon, and limited only by, the progress of these endeavors.

The Fundamental Problem of Accountancy.—The aim of all private businesses being the increase of wealth, the first problem of accountancy is to determine how much wealth is invested in a given enterprise and what ownership or proprietorship exists at given periods, so that by comparison the increases and decreases in the proprietorship may be known. When accurate information is obtained, an intelligent plan of action can be adopted to remedy such ills of the business as are shown and to increase any profitable line of activity. Accordingly, proprietorship and its changing values are the basic problems of accountancy as well as of business.

Definition of Terms.—Before proceeding to a definition or determination of proprietorship, it is necessary to understand what is meant by the terms “assets” and “liabilities.” The root idea of the word “assets” is “sufficiency.” Specifically, assets are the “entire property of all sorts, of a person, association, or corporation applicable or subject to the payment of debts.” Similarly, the liabilities of a person, firm, or corporation are his or its pecuniary obligations or debts. Proprietorship is the difference between the value of the assets and the amount of the liabilities, and is defined and measured by the equation:

Assets - Liabilities = Proprietorship

This proprietorship equation is a basic formula. It is also written:

Assets = Liabilities + Proprietorship

It will thus be seen that proprietorship represents the equity of the owners of an enterprise in its assets. The assets are first applied in paying the claims of creditors of the business, and whatever of them remains belongs to the owners of the business.

Development of the Proprietorship Equation—The Balance Sheet.—To indicate the basis of the standard form of the proprietorship equation, several illustrations will be given. The equation is in its simplest form when it indicates proprietorship in a new business immediately after the owner has invested cash to provide the business with capital. For example, assume that on January 1, 19—, James T. Runyon starts business by investing $5,000 cash capital in the enterprise.

Here the proprietorship equation is:

Assets (cash $5,000) = Proprietorship ($5,000)

As yet there are no liabilities. However, in order to carry on his business, Runyon must purchase a stock of merchandise and equipment for his store. Accordingly, he purchases store furniture and fixtures from Lowell Brothers for $500, of which he pays $250 in cash, and owes the balance. He also buys a stock of groceries for $2,500 from Reid Murdock & Co. on 10 days’ time. He now has more assets than the original $5,000 cash, but he has become indebted for the additional amount, so that the amount of his proprietorship has not changed—as is shown by the following equation, somewhat more complex than the first:

Runyon now begins operations and after six months finds that his activities have comprised the purchase of delivery equipment for $300 cash; sale of goods amounting to $6,000; the payment of $1,000 cash for rent, clerk hire, and advertising; and sundry purchases of stock-in-trade and other items as needed. As a result he now has $1,000 cash on hand; customers owe him $3,000; his stock of goods still on hand is worth $2,100; he owes creditors $1,000 for goods bought and his clerks $50 for services rendered.

It is readily seen that as the number of assets and liabilities increases, the method of showing them that was used above becomes awkward and cumbersome; therefore, still using the equation, we make the following vertical tabulation to determine and show proprietorship:

This method of expressing the proprietorship equation is called a “Balance Sheet,” or “Financial Statement.”

Further analysis of the above information discloses the amount of Runyon’s purchases and of his payments to creditors. Taking the transactions involving cash, we find that he had $5,000 to start with and received $3,000 from sales, or $8,000 in all. He bought furniture and delivery equipment for $800, and paid expenses of $1,000, in all $1,800. There is therefore a balance of $6,200 to be accounted for. $1,000 cash is still on hand, so that he must have paid creditors $5,200. Since he still owes creditors $1,000 for goods bought, his purchases must have been in all $6,200.

The ability to make accounting statements and to analyze accounting data for various purposes constitutes a very important part of the equipment of the accountant.