The proprietor may also set aside out of his profits other reserves as prudence may dictate. The use of such reserves, however, is more common in the business of partnerships and corporations. In brief, then, the proprietary interest of a sole trader will be represented by the aggregate of his capital and salary accounts— including the reserves that may have been created, as a result of prudence and conservatism, eliminating the reserves for depreciation—minus any balance that remains in the drawing account.
The fact that the law does not recognize the busi ness undertaking of a sole trader as an entity separate and distinct from the proprietary account, is impor tant enough to bear repetition. If the assets of John Jones, proprietor, are not sufficient to liquidate the liabilities of John Jones, proprietor, the creditors have a right to satisfy themselves out of any other assets that John Jones may own in any other capacity. This point is important because of the fact that there is considerable discussion as to whether or not the pro prietorship constitutes a liability or an accountability. While this discussion is more theoretical than prac tical, it may in some instances help to determine whether a business organization is solvent or insolvent. For illustration, let us assume that a corporation has assets amounting to $10,000, liabilities to out side creditors of $4000, and capital stock outstand ing to the amount of $6000. Let it be assumed that at the end of the period the assets are found to be $9000, while amount of the liabilities and the outstand ing capital is the same as it was. Clearly, the $1000 loss sustained during the period must be charged against the capital. A business organization is in solvent if its assets are less than its liabilities; and if in this case, capital is a liability, the organization is clearly insolvent. On the other hand, if capital is not a liability, the organization is still solvent, but the capital has been impaired to the amount of $1000. It was decided by the court in a very important New York case that the capital stock of a corporation is not a liability. This is not only good law but sound accounting. The late Colonel Charles E. Sprague, one of the foremost thinkers of his time, stated the matter very clearly in his volume entitled, "The Phi losophy of Accounts": Thus the right-hand side of the balance sheet is entirely composed of claims against or rights over the left side. "Is it not then true," it will be asked, "that the right-hand side is entirely composed of liabilities?" The answer to this is that the rights of others, or the liabilities, differ materially from the rights of the proprietor, in the following respects: (1) The rights of the proprietor involve dominion- over the assets and power to use them as he pleases, even to alienating them; while the creditor cannot interfere with him or them except in extraordinary circumstances.
(2) The right of the creditor is limited to a definite sum which does not shrink when the assets shrink, while that of the proprietor is of an elastic value.
(3) Losses, expenses, and shrinkage fall on the proprietor alone, and profits, revenue and increase of value benefit him alone, not his creditors. For these reasons, the proprietary interests cannot be treated like the liabilities, and the two branches of the right-hand side of the balance sheet require distinctive treatment.
Furthermore, as Colonel Sprague has pointed out in another place, those who consider capital a liability are put in the position of treating insolvency as an asset.
3. Proprietary accounts of a partnership.=—The proprietary accounts of a partnership are similar to those of a sole trader, and present no difficulty if we bear in mind that the proprietary interest is sub divided in accordance with the partnership agreement. The accounting records must reflect the intention of the parties as evidenced by their articles of copartner ship. There will be for each partner a capital ac count, a salary account and a drawing account; there will also be the firm's reserve accounts. Interest on partners' capital may be allowed, under the partner ship agreement, as a means whereby to equalize capi tal, and the proper method of treating this in the accounts will be fully discussed in a later chapter of the present volume.
4. Firm capital.—The firm capital consists of the amount of money or property that the partners have agreed to contribute to their joint enterprise. Some times one or more of the partners will contribute to the enterprise only their skill or labor, and not infre quently these contributions of skill and labor are rela tively more valuable than money and property. It is not possible, however, to register in books of account the value of these latent or hidden assets, so that the labor or the skill which such a partner may contribute can be considered as capital only in a restricted sense.