CORPORATION REPORTS: LIABILITIES-INCOME ACCOUNTS 1. Capital liabilities.—Liabilities may be classed as capital, current and deferred, in analogy with the di version of assets. Capitalization may be divided into preferred stock, common stock and funded debt ( bonds, debentures, etc.) . The difference between tangible assets and capital obligations will gen erally give a clue to the discount at which the com pany's securities were originally issued. Thru a series of years, the growth in capitalization should not much exceed the growth in gross earnings. If it does so it is a sign that recent capital is being un productively applied. An observance of this danger signal would have aroused the investors in the New York, New Haven and Hartford Railway between 1907 and 1911.
2. Current current liabilities should be included those liabilities which, in the nat ural course of business, will be liquidated from income within a brief period. Such are notes payable, short term notes, demand notes or commercial paper, and other evidences of temporary borrowing. To these should be added accounts payable, which arise chiefly from the purchase of materials and supplies. There is a great distinction between different kinds of cur rent liabilities, whether they are incurred in the nor mal course of business and so are a sign of business activity, or whether they are incurred in the course of securing funds from banks to make good a de ficiency in working capital.
To make capitalization appear small, some corpora tions carry note issues under current liabilities when they are renewed from time to time. If a floating debt continues indefinitely to float it is no longer merely a current obligation, but is permanent and ex ists as a perpetual threat of insolvency because of the peremptory nature of its claim. This threat is con tinued until the indebtedness either is paid and ex tinguished or is funded and so transferred to capital liability, where it belongs.
3. Deferred liabilities, or de ferred credits to income, consist of items of income such as rent, interest and royalties which have been received during the current fiscal period but which have not as yet been earned. As previously men
tioned,' these items are classified as liabilities since they represent a liability of the organization to de liver certain services at a later period.
4. word "reserve" is sometimes erroneously used to designate certain portions of as sets set aside to meet future capital requirements. These may be in the nature of sinking funds provided to liquidate some liability maturing in the future, such as bonded indebtedness. In its true sense, how ever, a reserve is merely a bookkeeping entry which allows for the ravages of depreciation, or the losses incident to debt-collection, or the decrease of wasting assets by scaling down some overstated asset. Such reserves deal with normal incidents in the production of earnings.
5. Contingent contingent liabili ties, often simply described as "other," imply that a company has guaranteed the securities of other cor porations, as the Denver and Rio Grande Railway guaranteed the interest on the first mortgage 5s of the Western Pacific, or that it has indorsed the notes of debtors and pledged them as security for loans, a practice not usual in good business.
6. true surplus earned in operation may or may not be in cash ; usually it will be found to be distributed among the several classes of cor porate assets. If recently earned, it is likely to be in some form of current asset; if of older stand ing, it may be a fraction of any sort of property. Generally a true surplus recently acquired will cause a corresponding gain in working capital. Such a surplus serves to protect the dividend rate from the immediate effect of fluctuations of trade. "It per mits," as Mr. Thomas F. Woodlock once said, "a cer tain class of expenditures which, while not properly maintenance, cannot safely be capitalized by reason of their not being immediately productive." At its worst, the entry "surplus" may be merely a pseudo-surplus, or balance sheet evener, finding ex istence merely as a claim of proprietorship in the stockholders of an inflated value set down in the as sets.