Philosophy of the income statement;

              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not withdrawn, is represented by assets.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.