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102 HASKINS & SELLS October The Philosophy of the Income Statement THE statement of income and profit and loss has been regarded in the past as too much of a detached affair, having as its purpose the mechanical connection between two amounts of earned surplus at different dates. Rarely is there any thought of its relation to the balance sheet. The concept which it should have when it fulfills its maximum usefulness is a statement that displays historically the results growing out of the use of capital in an enterprise. Capital, whether contributed, borrowed, or left in the business as the result of profits not withdrawn, is represented by assets. These assets are distinguished from one another by groups according to their respective uses. But all represent capital, whether active or dormant. There is capital which is devoted to the turnover process; goods, goods in process, raw materials, accounts, notes, and cash. There is capital devoted to service utilities in the form of plant machinery equipment, etc. There is capital needed neither in the turnover process for the time being, nor for plant, and consequently invested temporarily in marketable securities. Or there may be capital invested in the securities of related enterprises held for purposes of control or for income. Last, there is capital invested in expense to be prorated over future periods. The relation of the turnover group to the income statement which portrays the development of profit or loss would not be difficult to explain if it were not for cash and for items of expense which are ignored in the main on the asset side of the balance sheet. Cash may be eliminated by regarding it as a substance which is used for the purpose of liquidating liabilities. For example, all value advanced to an enterprise gives rise to liability. The workman who supplies his services becomes a creditor precisely as does the merchant who delivers goods. Whether either is paid immediately or at some future date does not change the character of the relationship nor the nature of the obligation. Each either immediately or in due course is entitled to receive his compensation. Nor does it matter, in so far as the obligation of the recipient is concerned, whether the value received is represented by something tangible or intangible. All creditors, no matter what the substance or form of value advanced may be, are entitled to be reimbursed ultimately in cash. Thus, cash becomes merely a medium of exchange, notwithstanding that it has a value at balance sheet dates. Goods received seem easy enough to apprehend because they are tangible, they are entered in a record to be accounted for, and those that are sold are traced to a debtor from whom payment is expected to be received. But items of expense are more nebulous. They represent services, privileges, the use of facilities, or articles, the substance and life of which are so temporary as to make it not worth while to account for them in detail. If expense items were regarded as representing capital supplied to an enterprise by creditors and the expense values were treated for income accounting as asset values are treated, it would be an easy matter to explain the philosophy of the income statement. Therefore, in this discussion they will be so treated. The enterprise dollar, that is, the dollar representing the total capital employed in the enterprise, may be considered, for purposes of illustration, to be made up of two parts, twenty cents contributed by stockholders and eighty cents advanced by creditors. Upon taking up the consideration of those things by which the enterprise dollar is represented, namely, cash, goods, services, etc., the division of the dollar between the two groups which furnished the dollar ceases to be material, except that the lenders may have to be compensated for the use of the money and, if so, that part will have to be considered later.
Philosophy of the income statement
Haskins & Sells Bulletin, Vol. 13, no. 04 (1930 October), p. 102-106
|Source||Originally published by: Haskins & Sells|
|Collection||Deloitte Digital Collection|
|Digital Publisher||University of Mississippi Libraries. Accounting Collection|
|Identifier||hs bulletin 13-p102|