11. Argument for accruing taxes.—The view that taxes accrue is supported by the following argument: The person who constructs a business establishment beginning after May, 1916, has no taxes to pay the next January, excepting on his land. He may have had his plant in operation during 1917, but he will have no taxes to pay until January 1, 1918. His plant will be valued for purposes of taxation in May, 1917. The tax levy will be determined in October, of that year, and the amount will become due January 1, 1918. Half of it may be paid before June 1, and the other half before October 1, 1918.
Since this person had no tax payable in 1917, he may well reason that the tax which will become 'due January 1, 1918, has been accruing. The fact that its purpose is to finance the government expenses of 1918, rather than of 1917, is of consequence to the government but not to him. If this view is permis sible an adjustment is required from month to month, to take the month's quota of accruing tax into account both as an expense and as an accruing debt.
In our illustration it is assumed that taxes accrue and that for the year they will be $1,000. Of course this is merely an estimate and is subject to correction when the actual tax bill is received. However, for the purpose of charging to each year as much of the expense of that year as is possible to estimate, the tax account is charged with enough to bring the total amount up to $1,000.
12. Prepaid expenses.—In every business many costs are incurred which pertain to a period of time. These costs are a part of the cost of the services which are employed in obtaining income. Obviously when these expenses are to cover services to be received in the future, the entire amount is not an immediate ex pense but should be distributed over the time which it covers.
Such, for example, is the amount entitled "insur ance on buildings and machinery." In our trial bal ance this account shows a debit balance of $1,200. This was paid on November 1 to cover the ensuing year. This money is the purchase price of a right to indemnity if, during the period covered by our con tract, we should sustain a financial loss thru the par tial or total destruction by fire of the goods covered. Originally the insurance account was charged at the cost price. If the financial statements were prepared
at the moment of closing the contract the entire amount, since this right to an indemnity is an asset until the contract expires, would be entered as an asset.
The amount of the insurance premium depends not only upon the amount of indemnity promised but also upon the duration of the contract. Therefore, if ten months out of the twelve have elapsed, we may say that one-sixth, or $200 of the premium, still remains unconsumed and will be the cost of future income. The $1,000 representing the cost of the services we have received, is a part of the cost of the income for the year. The charge against present or past in come then, is $1,000, and the portion deferred to a charge against future income is $200.
13. Other prepaid itents.—Insurance on stock and fixtures is handled in the same way as insurance on buildings and machinery. As the stock and fixtures are used not alone for manufacturing purposes, but are an aid to selling and to administration, the in surance charge here is not a manufacturing charge but rather an administrative expense.
14. Advertising.—This account might include merely the cost of space and the service by various advertising media, or it might also include all the services of employes in the advertising department, together with the stationery and postage used by that department, display of its equipment, heat, light, etc. In our present illustration the advertising activity is apparently not highly developed; the manufacturer appears simply to insert a few advertisements in trade papers and charges against this account only the in voice cost of the service received. Whether adver tising is to be considered as an asset or as an ex pense, depends on the following considerations: If the advertisement was inserted several months ago, there is little doubt that the greater part of its service will have been rendered. If the advertise ment was but recently inserted, only part of its ser vice will have been rendered; if the advertisement has not yet appeared, altho we have already been charged for it, it is obvious that none of the services have been received and the full amount of that par ticular bill or bills remains an asset at the time the statements are prepared.