Accounting theory and practice, Volume 2 (of 3) : a textbook for colleges and…

Legitimate Use of Surplus Account There remains only a consideration of the Surplus account. The manner of handling the surplus as a clearing account for the appropriation of net profits has already been treated. After profits have been appropriated or reserved out of it for specific purposes, the surplus shows by its balance the portion still available for dividends. As has been indicated, it is not usually desirable to use all of it for dividends, a sufficiently large balance being always maintained for such purposes as stabilizing the dividend policy, strengthening credit, and other surplus contingencies. Surplus account is frequently as badly abused as the proverbial “general” expense account, by being used as a dumping ground. It has, however, a legitimate and an illegitimate use. As the Profit and Loss account is strictly limited to use as a clearing account for the normal items of income and expense applicable to the current period’s operations, manifestly all other charges and credits to proprietorship must be cared for elsewhere. With very few exceptions—such as premiums and discounts on capital stock, donated working capital, etc.—these charges and credits are made to Surplus. High accounting authority deprecates the use of Surplus for these purposes, on the ground that too often it is used as a convenient place in which to hide items properly chargeable to the current Profit and Loss but which would not make a favorable impression if shown there. Just as with many other abused accounts, its wrongful use hardly constitutes sufficient grounds for withholding sanction of legitimate use. Where it is felt that certain items should not go directly into Surplus they should be recorded in a final section of the Profit and Loss account, just before its balance is shown transferred to Surplus. As the financial statements are usually published, this method secures more certain publicity to these items. Occasionally, instead of the use of either Profit and Loss or Surplus for this purpose, an account is set up on the books called “Surplus Adjustments” through which these items are cleared into Surplus. The objection raised above to this use of Surplus applies with equal force to “Surplus Adjustment.” Statement of Surplus At the close of each period account must usually be taken of a group of items which cannot properly be treated as belonging to that period. Some of these may be items which were overlooked at the close of previous fiscal periods and cannot now be taken into the record for that period. Some things may wrongfully have been included in, or omitted from, the inventory; the inventory may have been under-or overvalued; errors may have been made in the separation of capital from revenue expenditures; wrong depreciation and bad debts estimates may have been made—these and similar items call for adjustment at the close of the current period. Where adjustments are few and simple, the statement of surplus on the balance sheet may be extended sufficiently to include them. Much better, however, is it to append as a schedule or statement in support of the balance sheet, a statement of surplus, showing therein the detail of all entries affecting it during and at the close of the current period. Particularly is this desirable when the statements of financial condition are prepared for internal use. Such a statement of surplus should start with the amount of surplus as at the close of the previous period. Then the adjustments applicable to that period should be shown, thus determining the true surplus for the period. Following that should appear the entries made directly to Surplus for the current period, the net profit transferred thereto, and finally all appropriations of profit, leaving as the balance of Surplus the same amount which appears in the balance sheet. In skeleton form the statement should appear somewhat as follows: X Y Z COMPANY STATEMENT OF SURPLUS, JUNE 30, 1918 Balance of Surplus as on December 31, 1917 $..... Adjustments applicable to period ending December 31, 1917: Additions: Inventory omissions, undervaluations, etc. $..... Items wrongly charged to Revenue ..... Over-estimate of Depreciation, etc. ..... $..... ----- Deductions: Inventory overvaluations, etc. $..... Items wrongly charged to Capital ..... Under-estimates of Depreciation, etc. ..... ..... ----- ----- Net Increase (or Decrease) ..... ----- True Surplus as on December 31, 1917 $..... Extraordinary Profits (or Losses) this period $..... Net Profit this period ..... ..... ----- ----- Amount available for appropriation $..... Appropriations of Surplus: Reserves (shown in detail) $..... Dividends ..... ..... ----- ----- Net Balance in Surplus as on June 30, 1918 $..... =====