If profits to shareholders had been delayed for several years, the president declared such action would not have been necessary. He stated further, that to go on without making an adjustment would necessi tate the profit for a number of years being applied to building up a reserve, and in providing for a deprecia tion of assets, thus precluding payment of dividends. This would not be a sound policy from the share holder's point of view as it would make the stock diffi cult to dispose of, except as a sacrifice.
From this proposed adjustment, the president said that the shares, on a par value of $50, should have a market value equal to that of the original share of a par value of $100, because: A reserve account will be established equal to 50 per cent of the paid-up capital of the bank, and after appropriating all debts which now appear to be of a doubtful nature, a sufficient sum will be placed in contingent account to provide for all emergencies. The business should be again on a divi dend paying basis, and we shall have a clear field before us.
12. Real and fictitious surplus.—Actual surplus is usually created out of net earnings from operation. Fictitious surplus may be created by a stroke of the accountant's pen, simply by writing up the value of assets or charging maintenance items to inventory accounts. In one recent case within the writer's knowledge a surplus account was increased one mil lion dollars by writing up a fictitious increase in plant value, under orders from the board of directors.
It is impossible to pay out fictitious profits con tinuously in cash dividends, so resort is had to sur plus, which may conceal a multitude of sins. When one contemplates the very small cash dividends which many of our large corporations have paid and the very large surpluses which their statements show, he is inclined to remark, as did the man who saw a hen get off a nest containing an ostrich egg, "I do not believe it." A certain large company near Cincin nati, for instance, continuously shows book profits running into the hundreds of thousands of dollars, but always in surplus, never in cash. Its sales have not been increasing as fast as its loans, and its cash dividends, tho slight, have been paid by borrowed funds. Has it a real surplus? Certainly not.
Real surplus may be derived from: 1. Net earnings from operation 2. Premium from sale of securities above par
3. Premium on sale of capital assets above their book values 4. Gifts to the corporation, such as inheritances, insurance paid on the death of officers, or the turning back of shares to become treasury stock 5. Interest or dividends upon securities owned, bank balances, etc.
In Canada also, the value of real estate has not in frequently, and without justification, been written up by corporations. The value of a head office or branch premises has sometimes been written up on the strength of a supposed increase, generally in the value of property in the surrounding district. Comparison of balance sheets for various years will reveal this dif ference and other changes of Vnterest.
At the same time, there are occasions when the writ ing up of real estate is quite legitimate. In Decem ber, 1911, for example, an important change was made in the treatment of bank premises account by the Bank of Montreal. This account had for years been represented by the comparatively insignificant sum of $600,000, notwithstanding the large expenditure re cently incurred for bank buildings and for providing suitable accommodation for the increasing business thruout the country. The directors had been fre quently criticized for having charged the full amount of the cost under this head against the profits of the year, and it was suggested that they sbould alter their system to conform to that of other banks in the pub lished statements. They, therefore, had a conserva tive valuation made of the property, which resulted in a total of $9,088,000; land $4,735,000, and build ings, $4,353,000. They took back less than half that amount, or $4,000,000, in order to represent more adequately that item in the balance sheet. To ad just bank premises, therefore, the sum of $3,400,000 was applied and the balance carried forward.
13. Investment of surplus.—Surplus is invested in the business in the same manner as original capital; in fact, is merged with it so as to be physically in separable. That is why surplus is often nothing more than a book entry, a child of the imagination, a clever deceiver. If certain funds are segregated en tirely, so as to be available only for certain purposes, as, for instance, depreciation or dividend reserves, they cease entirely to be surplus.