FUNDAMENTALS OF BOOKKEEPING-DOUBLE ENTRY 1. Peculiarity of the merchandise account.—Before the introduction of double-entry bookkeeping when an account with merchandise was set up, this account was debited when merchandise was purchased because the (probably fictitious) custodian of merchandise was considered as getting into debt to the business. Credits to this account were accordingly the sales of merchandise. When the balance in the merchandise account was considered, in connection with the actual cost value of the merchandise on hand, there was in variably a discrepancy between the value of mer chandise indicated by the books and the value shown by actual count. Consider the following merchandise account in which explanations have been omitted.
Here the debits represent the purchases of mer chandise and the credits the sales. The former amounted to $6,500, the latter to $2,500, leaving a debit balance of $4,000. The natural course was to conclude that this represented the value of merchan dise on hand. But an actual count revealed merchan dise which cost possibly $5,000. This discrepancy was doubtless puzzling until it occurred to someone that the merchandise which had been sold had been credited at selling value, whereas when it was pur chased it had been debited at cost. The cost and sell ing prices represented two values which were widely apart. Since' normally the merchandise was sold for more than it cost, it was discovered that the balance of the merchandise account tended normally to be less than the cost of the merchandise on hand—in deed, less by exactly the amount of profit on the mer chandise that had been sold.
The mechandise account, when interpreted in con nection with the inventory of unsold merchandise, was found to represent a source of business profit—in deed, in a merchandising business, the principal source of profit. We might assume, in the illustration just given, that at the end of the business day, merchandise to the amount of $4,700 was found to be on hand. It was evident that merchandise costing $1,800 had been sold for $2,500. The profit was therefore $700. It
was noticed that by crediting the inventory to the mer chandise account, this account had then a credit bal ance equivalent to the amount of profit made.
2. Nominal Accounts.—This information conveyed a valuable suggestion. Why not keep accounts with the other sources of profit and with the causes of loss and expense? Such practice would enable the pro prietor to know not only his net profit or loss for a given period, but also the income or profit from each source and the expense ascribable to each source of expense. This information furnished a valuable guide to business judgment and a valuable aid in en forcing economical operation.
Thus, there came to be introduced the "economic ac counts" which represented sources of income such as merchandise sales, and causes of expense such as mer chandise purchases, salaries, rent, and the like. Op posed to these "economic" accounts which were the means by which the progress of the business was meas ured we have the "specific or financial" accounts which indicated the condition of the business rather than its progress. Land, buildings, accounts receiv able from customers, accounts payable to creditors, proprietor's investment and the like are examples of specific or financial accounts.
3. Double entry bookkeeping.—Eventually every transaction was seen to have a double effect. If we sold goods for cash we decreased our supply of goods and increased our cash. The sale of goods repre sents income and must be recorded with the re ceipt of the cash. Moreover, when we pay cash for goods we must record the cash paid out and the receipt of the goods. Every business transaction must cause a change in our condition in that we give one article of value for another. This change in the rela tion of things owned and owed must be expressed. Moreover, if the double exchange, consisting of ex changing money for something and later re-exchang ing this for money resulted in our getting back more money than we gave up, a profit will have accrued which we must express in our accounts.