Before discussing the form and content of the balance sheet and some of its major uses, the chief classes of assets, liabilities, and proprietorship or capital will be explained so that the student will have an intelligent notion of what is meant by each asset, liability, and capital item.

Kinds of Assets.—Accounting terms are not wholly standard. An account title is often used in one business to include items not mentioned under that title in another business. One finds also terms and titles peculiar to particular businesses. However, there is a tendency towards a standardization of the terms used in balance sheets. It is the purpose here to present and explain those which are common to practically all businesses. These include the asset titles Cash, Notes Receivable, Accounts Receivable, Merchandise, Investments, Deferred Charges or Expense Assets, Furniture and Fixtures, Delivery Equipment, Buildings, and Land.

Cash. Cash includes all kinds of money and usually whatever serves as a medium of exchange, which is in the possession or control of the business—deposits in banks, moneys in the safe and cash drawers, and sometimes funds in the possession of agents. Checks received in the regular course of business and not yet deposited in the bank are usually classified as cash.

Notes Receivable. The formal promises to pay, made by others for debts owed the business, are classified under the general title Notes Receivable. Time drafts drawn on the debtors of the business and accepted by them may be included under this title, although they are sometimes shown under a separate title, such as Acceptances Receivable. This is particularly true when the acceptances are trade acceptances. It will be seen later that the promissory note has a somewhat different legal status from the open account claim against a debtor, and should therefore be classified under such title as will indicate the exact nature of the item.

Accounts Receivable. These usually represent the claims of the business against its trade customers for goods sold on open account and not paid for. The term is, however, broader than this, being sometimes used—although the practice is to be deplored—to include all claims against debtors except those which are in the form of notes.

Merchandise. This asset represents the stock-in-trade in which the business deals. It is of course a sort of revolving asset, that is, merchandise is purchased and sold continuously, so that the stock-in-trade is constantly being turned over. The rate of turnover is very important, as will later be seen.

Investments. This asset represents the stocks and bonds of other companies, municipalities, school districts, and so forth, owned by the business. As a usual thing there are seasons of the year when the cash funds of a business are built up and lie idle in the bank unless they are invested in securities of some sort. These securities can be reconverted into cash when the business requires a larger fund of cash.

Deferred Charges. Certain types of expenditure are necessary in every business to secure operating supplies. Fuel must be purchased for heating and power purposes; brooms, oil, waste, and other similar supplies are needed for cleaning and maintaining the business plant; stationery, stamps, wrapping paper, twine, cartons, packing materials, and so forth must always be on hand; insurance policies giving protection against fire are usually purchased for from one to three years and so are seldom completely used up at any given date. All items of this sort, necessary for the operation of the business but not dealt in as stock-in-trade, are called “expense assets.” The portions of these assets on hand at a given time, the use of which will be deferred to a later period, are classified as “deferred charges.”

Furniture and Fixtures. A business plant must be equipped with furniture and fixtures suitable for the display of the stock-in-trade, for the accommodation of customers, for the care and protection of the necessary records of the business, for the efficient performance of duties by the employees, and for other similar purposes. Assets of this type which are not a permanent part of the business plant but are removable should the business desire to change location, are listed under the title of Furniture and Fixtures. This may be subdivided to suit conditions. Sometimes several titles—Store Furniture and Fixtures, Office Furniture and Fixtures, Factory Furniture and Fixtures, Machinery and Tools—are used.

Delivery Equipment. If a business delivers its commodities it will usually have its own delivery equipment. This may comprise horses, wagons, harness, automobile trucks, and so forth. The delivery equipment may be used for both inbound and outbound deliveries.

Buildings. All buildings owned by the business, whether used for business purposes or not, will usually be classified under the asset title Buildings. Store, office, factory, warehouses, residences owned and rented to employees—all assets of this type are to be listed here.

Land. This item represents land—city lots, plant sites, and so forth—owned in fee simple or subject to mortgage. Sometimes when a plot of land is leased for a term of years and a lump sum payment made at the beginning of the lease, the asset may be included either under the title Land, or under the broader title Land and Leaseholds.

Kinds of Liabilities.—Just as with assets, there is not entire uniformity in terminology for the various classes of liabilities. The more common types of items met with are: Notes Payable, Accounts Payable, Accrued Expenses, Mortgages Payable, Bonds Payable, and so forth.

Notes Payable. These represent the formal promises to pay, signed by the business or its owners. They represent the formal claims of others, that is, creditors, against the business. Just as with notes receivable, it is sometimes desirable to make a more distinct classification of notes payable. In such cases the titles Acceptances Payable, Trade Acceptances Payable, Long-Term Notes Payable, etc., are used.

Accounts Payable. Under this title are listed the liabilities to creditors on open account, as distinguished from those formally acknowledged by a written promise to pay. These include obligations to trade creditors for merchandise, supplies, equipment, and property of almost any kind purchased for use by the business. In a broad sense an account payable includes any item for which the business is liable.

Accrued Expenses. Accrued Expenses represent usually the accumulating but unpaid claims against the business for service rendered it, as distinguished from the Accounts Payable, which usually represent purchases of an asset of one kind or another. Thus the amounts due at a given time to employees for work done since the last date of payment of their wages, salaries, or commissions, to the landowner for the rent of leased premises, to lenders for interest on moneys borrowed, are items properly to be listed under this title.

Mortgages Payable. These represent the claims of creditors against particular properties owned by the business but against which the creditors have been given a lien or preferred claim as security for the borrowed or unpaid amount. Mortgages are evidenced by a formal legal document and are usually recorded in the county clerk’s office.

Bonds Payable. These are a type of long-term mortgage which is split into lots of more or less standard amount and so made available to a larger number of holders than is usually the case with the ordinary mortgage payable. This type of liability is limited almost exclusively to corporations.

The student should realize that usually the owner or owners of a business enterprise have both assets and liabilities other than those employed in the business. These personal properties and obligations of the owners are not to be taken into account when showing the proprietorship of a business unit or enterprise. They are to be considered only in showing the total proprietorship of any individual owner, when of course all of his properties, both inside and outside of the business, must be listed.

Kinds of Proprietorship.—Proprietorship, called also Net Worth, is shown under such titles as Capital, Investment, Capital Stock, Surplus, Undivided Profits, Reserves, and so forth. The title used depends largely on the type of organization under which the business is operated.

Capital. Under this title is shown the amount of the investment of each owner in a single proprietorship or partnership business. To show each owner’s share in the ownership the title Capital is preceded by his name. Illustration of this is given on pages 19 and 20.

Investment. This title usually is synonymous with capital. Sometimes it is used to indicate the amount of original investment in the business as distinguished from the present investment.

Capital Stock. Under this title is indicated the sum total of the portions of net worth owned by the shareholders as evidenced by stock certificates and subject to their individual control. On page 20 is given an explanation of the way in which the proprietorship or net worth of a corporation may be composed of two (or more) parts: (1) the capital paid in by the owners; and (2) the capital, representing profits made but not distributed to the owners. While capital stock usually represents the capital contributed by the owners, it sometimes arises from other sources, such as the distribution of a stock dividend; but the portion of the net worth owned and controlled individually by the owners is the capital stock.

Surplus. In a corporation this represents the second portion of the net worth, as indicated in the preceding section. Surplus is sometimes defined as the excess of the net worth over the capital stock. In other words, it is the difference between the assets and the sum of the liabilities and the capital stock.

Undivided Profits. This is a term used chiefly in financial institutions to indicate the portion of the net profits concerning the disposal of which no action has been taken.

Reserves. Under this title are included whatever portions of the surplus are set aside or reserved for specific purposes.

Where Surplus, Undivided Profits, and Reserves appear as parts of Net Worth, they together represent the difference between Net Worth and Capital Stock. The reason for the careful segregation of these items from the Capital Stock is given in the explanation of the corporate form of organization, on page 20.

Types of Business Organization.—Before proceeding with a discussion of proprietorship as it appears on the balance sheet, the three general types of business organization will be treated briefly, because the manner of indicating proprietorship is dependent to a certain extent on the type of organization. These types are: (1) the single or sole proprietorship, (2) the partnership, and (3) the corporation.

The Single Proprietorship.—The simplest form of business enterprise is that conducted by a single proprietor. This form is well adapted to businesses where the capital necessary for efficient production is small, where the processes are simple and capable of being handled by the average individual, and where the risks are slight. Very few legal obstacles are placed in the way of the individual desiring to go into business for himself, nor is a great deal required of him. In some cases registration and a license are necessary. The observance of the general laws, concerning the payment of taxes and of local regulations concerning disease and fire is all that is usually expected. Subject to the general restrictions which ordinary business acumen and foresight impose, one can enter practically any field of enterprise, as a single proprietor, have entire freedom and privacy in the conduct of his business, and share with none the results of his endeavor.

On the other hand, these conditions oftentimes prove to be decided disadvantages. As industry is at present organized, many fields of activity demanding large capital and many kinds of technical knowledge, are closed to the single proprietor. Freedom of action carries with it sole responsibility, and oftentimes the counsel and advice of others would prevent the disasters which sometimes overtake the single owner of a business.

The Partnership.—A partnership is “a contract of two or more legally competent persons to combine their money, property, skill, and labor, or some or all of them, for the prosecution of some lawful business and to divide the profits and bear the losses in certain proportions.” There are different kinds of partnerships, as will later be shown, but the essence of each from the point of view of a working organization is mutual agency, each partner being the agent of the others, and, within the limitations of the partnership agreement, capable of acting as a principal for the firm. The partnership is subject to practically as few restrictions as the individual. In some localities, to secure the right to sue and be sued in the firm name, it is necessary to file in a public office a brief statement of the firm name and the names of its members.

The chief advantages of the partnership are larger capital and therefore access to fields closed to the individual; the combining of the business wisdom, skill, and knowledge of several individuals; the subdivision of duties and therefore the opportunity for specialization. While in the view of the business community the partnership is an entity or a business unit, it is not so in the sight of the law, each member of the firm being held liable to creditors for the entire debts of the partnership as if it were his sole business. If any one member has to pay the firm debts, he has a claim against his copartners for contribution.

Some of the disadvantages of this type of organization are the possibility of friction among the partners and consequent delay of action; the extension to the firm of credit based not on the firm property but rather on the total property of the members, and the consequent liability of each partner and his entire private fortune for the debts of the firm.

It is important to note that the partnership agreement should be very carefully drawn to cover in detail the relations of the partners, their duties and their rights, particularly as to their shares in the profits or losses of the firm.

The Corporation.—The corporate type of business organization is distinguished from the other types discussed:

The owners of a corporation, or its stockholders as they are called, conduct the business through a board of directors which they elect for that purpose and they review its management periodically, usually annually. In this way they exercise indirect supervision over the business. This remoteness of personal interest and supervision has been somewhat overcome by electing to the board only those largely interested in the business, and by retaining on the board those whose ability as managers has been tried and proved. The board usually hires and delegates to others the active management of affairs.

The advantages of the corporate form of organization are: (1) it limits the liability of its owners; (2) it lends itself well to accumulation of the large funds of capital necessary for the promotion of large-scale enterprises; and (3) it secures through its board of directors a convenient and effective means of centralized control and management.

Showing the Proprietorship of These Types.—The methods of showing in the balance sheet the proprietorship for these three types of organization differ somewhat. The title under which proprietorship is listed is Capital. In a single proprietorship such title is preceded by the proprietor’s name, as shown in the following illustration:

In a partnership the capital is not shown in one item, each partner’s interest being stated separately, thus:

In a corporation, proprietorship is shown by the aggregate of the outstanding shares of stock, which are valued at a fixed par, or cost, under the single title Capital Stock, and if the proprietorship is greater than that indicated under this title, the excess is listed separately under the title Surplus or some of the other proprietorship titles already explained. This method of showing proprietorship is prescribed by law and is an effort to inform creditors, or those who may become creditors, that the corporation has observed the legal requirement not to distribute to stockholders any of its original capital. Hence, the capital stock of the corporation must be listed separately from the other items of proprietorship. Any changes in proprietorship during the life of the corporation are taken care of under these other titles, somewhat as illustrated below.