The acquisition of material, fuel, water, machinery, labor, and the use of a leased building is but the first step in this cycle. The conversion, by means of these factors of production, of the raw materials into sal able but unsold articles is the next step in the cycle. They still remain unturned funds, and for profit com putation purposes, or for recording value at any time, their value is simply the accumulated cost of the component parts which form the goods. Expended labor, consumed material, and other similar items en tering into finished goods become a new unit valued at the accumulated cost of the constituents. In ef fect, this includes cost of the durable instruments of production such as buildings, machinery and others which have been of service in producing or storing the goods.
4. Sales values.—If these goods are sold for so much cash, the cash constitutes the income and com pletes the cycle. It again becomes the controlling consideration in valuation and the sales account is credited at the cash value. When a sale is made the basis of valuation is shifted from the cash cost, or outlay, to cash production or income.
But these goods may be sold on account or for a note. In this case, the condition is not altered, as the income, altho not yet received, is definitely promised and therefore the seller has a legal right to collect the amount of cash in accordance with the terms of the sales contract. In charging the receipt of these rights against the purchasers, a valuation of the amount which is promised is placed on them, namely the cash production value. Therefore, accounts receivable and notes receivable which represent income promised but not collected, are, for purposes of record, valued at the amount promised.
5. Valuation of sources of future income.—Let us return to the subject of the valuation of instruments with which we expect to obtain income in the future. We saw that, at the time of acquisition, they should be valued at their cost to the business. Of what does this cost consist? Perhaps the answer to this ques tion will be more apparent if we analyze a practical illustration.
Suppose a customer buys from A in Chicago, 5,000 gallons of oil at the invoiced price of 5˘ per gallon, the terms being that he is to have 60 days in which to pay, but if he pays within 10 days he will be allowed a discount of 2 per cent. The freight charges of $100 are to be paid by him. What is the cash cost of this oil laid down at his establishment ready for use? As a matter of fact the actual cash cost is $345 and the account which includes oil should be debited at that valuation. Expressed in ordinary double entry
form, the customer's record of this transaction would appear as follows: Here the oil account is debited with $345—the in voice value of $250, less the discount of $5 offered, plus the inward freight charges. A is credited for the full invoice value, since, according to the terms of the contract, the customer is obligated to make pay ment at the end of 60 days at the latest, and if his credit privilege is exercised, he must pay $250. The inward freight payable account is credited with $100 to in dicate the obligation due to the railroad company for the transportation service received. Upon payment of the freight bill, the inward freight payable account would be debited thru the cash book.
6. Discount on purchases.—In this illustration, dis count on purchases is debited $5 because, while an outgoing claim of $250 is recorded, yet according to the terms of the contract, the customer receives a counter right against A by which, he may discharge the entire indebtedness by paying $245 within ten days. The balance of $5 would be covered by yielding up the discount right which he holds against A.
Discount, here, is treated as an asset and the account is debited because the discount right is received. It might be termed a contingent asset corresponding to a portion of the liability in A's account which would be decreased by the customer's right against him. If the right is not exercised within ten days, it ceases to be an asset and becomes a loss—i. e., valueless, while the con tingency in the liability also expires and becomes an actuality.
This treatment of cash discounts offered on pur chases is not the customary one. By using such a method to determine the valuation at which to debit an account with the thing purchased, the offered cash discount is deducted whether the discount privilege is exercised or not. Many persons will, at first, be inclined to deduct the discount only when it is taken. They cannot see how the question of the cost of the thing purchased is a thing apart from the taking or refusing of the proffered discount.
However, the cost of the thing purchased is an ac counting question, while the question of taking or re fusing discount is one of management or of financial expediency. If the discount is taken the customer pays only for the thing purchased. If it is not taken, the customer pays for the thing received and also pays interest on the loan made by the vendor when the lat ter allows him the privilege of retaining for 60 days the money which is due.