If the corporation has an issue of bonds, it is im portant to note just what particular property of the organization is pledged as security for the debt. In all probability, the land, land improvements, buildings and structures are specifically pledged. But in this connection it must be remembered that much of the plant and machinery and building equipment, under the law, is technically realty or realty fixtures, and accordingly may be pledged under the mortgage.
20. Equipment purchased on the companies and other under takings often acquire equipment on the partial-pay ment plan. It is evident that equipment purchased under this method of financing will cost more than if it were paid for in cash. The difference between the price paid under the partial-payment plan and the cash price of the same equipment is the amount of in terest which the seller has charged as an offset to the postponement of the payment date. Usually it will 4 not be a difficult matter to determine what the cash price is. Then, the number of payments being known and a reasonable rate of interest assumed, it will be possible, thru the medium of instalment loan tables, to determine how much of each periodical payment is to be applied to the reduction of the debt, and how much represents interest.
The greater portion of the initial payment will be on account of interest, but the gradually decreasing principal will decrease the interest charge correspond ingly, with the result that the later payments will re duce the principal more rapidly. The agreement un der which equipment is sold in this way usually pro vides that the title shall remain in the seller until after a specified number of rental payments have been made. Then, upon the payment of $1.00 additional at the end of the rental period, the seller agrees to transfer title to the purchaser.
During the rental period, the purchaser will have to bear all the maintenance charges necessary to keep the equipment in its original condition. It also follows that depreciation enters into the problem, and that the buyer will have to set aside out of his earnings an adequate provision for the accrued depreciation on the equipment which will come ultimately into his possession. The proper method of treating the
periodical instalment is to set up in the balance sheet as an asset the amount paid each period on account of principal. This would be designated by a title such as, "Equity in equipment purchased under partial payment plan," or by some other suitable and descrip tive title. The balance of the periodical instalment should be charged to the income account.
Inasmuch as the title remains in the seller until the final payment is made, objection may be raised to this method of treatment. The ground for the objec tion 'Would be that the equity is not an actual asset and would be forfeited if the purchaser failed to corn plete the remaining payments. While this is true, yet if there does not appear to be any doubt of the firm's ability to meet the remainder of the payments when due, it seems to be better to set up the equity in the balance sheet.
Another method of handling the matter would be to express the full contractual agreement in the ac counts. This would be done by setting up an asset account showing the cost price of the equipment in the equipment account, suitably ear-marked by a con tra-reference to the total contractual liability due to the sellers. The amount of interest included in the purchase price could be set up as a deferred charge to income, and it also should be suitably ear-marked by a contra-reference to the contractual liability set up and representing the amount due to the seller. As each periodical payment is made in cash the con tractual liability created would be reduced and cash credited.
Furthermore, at each periodical payment a rateable proportion of the deferred charge, or the deferred asset, for interest would be transferred to the cur rent-income account ; thereby the amount of the de ferred asset is reduced. The amount standing at the debit of the equipment account, plus the amount of the deferred charge to income remaining on the books, would represent the firm's equity in the equipment, when offset by the balance remaining in the contrac tual liability account.