Depreciation for the present, may be estimated on a method known as the percentage of declining bal ance. Let us suppose that experience in our busi ness, or in similar industries, has taught us that our machinery will depreciate at the rate of five per cent per year; consequently, we figure depreciation at the rate of five per cent on a declining balance. In other words, the machinery which cost us $50,000 has al ready been depreciated $5,000, leaving a new balance of valuation of $45,000. Five per cent of this valua tion is $2,250, which represents the depreciation charge for the year under examination.
In the same way buildings are expected to depre ciate at the rate of two per cent, and furniture and fixtures at the rate of ten per cent. These deprecia tion charges are all costs of our income and, hence are charged in the economic summary column and entered as an adjustment as well.
15. Land.—Land is ordinarily recorded and car ried at a valuation different from that given to the other kinds of assets. The account is debited for the cost of land acquired, and for the cost of any improve ments, such as filling-in a water front, grading, and the like. Obviously, in the case of sales or other forms of disposal, this account will be credited at the cost value—namely at the value at which it was carried.
Like other fixed assets we buy land, not for its own sake but because of the service which it will render. Land, however, cannot be said to depreciate as does other kinds of serviceable assets. Unless the real es tate market is fluctuating extremely, we need take no cognizance of changes in the value of land when pre paring a profit-and-loss statement. Therefore, it is customary to consider the durability of land as prac tically infinite, and its service to be a steady non-cost ing item.
In the illustration in question, we have grouped land and buildings with the idea that the value of the land constituted a very small proportion of the total valua tion at which the asset was carried. We are thus be ing more conservative than is actually required be cause we are depreciating our land along with the buildings.
16. Accounts payable.—Having analyzed all the classes of assets which will customarily be carried on the books of a business, let us now turn our attention to the liabilities.
Accounts payable account is credited with the in voice value of all goods which are bought on open ac count. Like accounts receivable, it is a controlling
account the details of which are presumably found in a subsidiary ledger. The balance of this account amounting to $161,000 represents the amount which is owed the creditors of the business on open account. This is subject, of course, to the right to take such cash discounts as may be offered.
17. Notes payable.—Notes payable are tangible definite evidences of liabilities and must be recorded separately on the books. The balance of $21,000 in this account represents notes given to trade creditors in settlement of open accounts which they held against us.
In order to separate the amounts owing to trade creditors and the amounts owing to banks, it is cus tomary to carry a separate account in which such items will be recorded. They are a different class of liability, usually incurred under different conditions, and if the two are separated a better idea of the finan cial condition can be obtained.
18. Real estate mortgage bond payable.—The manufacturer in the illustration on page 170 has pre ferred to mortgage his buildings rather than to bor row money from the bank. This method is possibly more desirable because mortgage bonds can be paid at some far distant future, whereas bank loans must be met within a few months at the most. This ac count simply represents the liability entailed on ac count of the outstanding mortgage bond.
19. Reserves.—The question may have arisen in the reader's mind with reference to the credit that offsets these extraneous debits which have been inserted into the expense accounts. The- reserves which have been set aside for expenses expected in the future, but resulting from the current year's in come, are carried to a reserve account. As fast as any of these costs materialize they are charged against the reserve accounts.
Thus, the balance in any account, at any time, rep resents the amount set over against previous years' in come to cover expenses resulting from that income, or to cover losses which will result, because a part of that income will not be collected. For instance, the reserve for depreciation on buildings, plant and ma chinery is credited to apportion the cost of those per ishable assets to the service which they render. Re serve for bad debts is also credited to offset that part of the debts receivable created thru sales which will not be collected.