5. Explain the relationship between a sinking fund and an allowance for depreciation. It is claimed that in municipal enterprises the requirement that rates must be high enough to provide both for a sinking fund to pay off the bonds and also for a "reserve for depreciation" with which to replace the plant results in a double charge to consumers. Criticize or explain this theory.

Solution. There is no necessary relation between a sinking fund and an allowance for depreciation. A sinking fund is a setting aside of a certain sum each year, that, accumulated at compound interest, will be sufficient to pay off an obligation-usually bonds-maturing in the future. It has no relation to profits or rates, except that the money that must be periodically set aside must be provided out of profits or rates. It does not in any way represent a loss. Depreciation does represent a loss, and the reserve is established by a charge against operating profits or against the rates which are levied to carry on the operations. As the charge each year reduces the amount of money realized from profits or rates that can be expended for other things there must result an accumulation of money or other assets in a depreciation fund or as part of the general assets. This accumulation of money is necessary in order that a new plant may be bought or built to replace the old one.

Because the annual charge for depreciation has resulted in a fund equal to the value of the plant, and therefore presumably to the face of the bonds issued to pay for the plant, it will not do to claim that this fund may be used to pay off the bonds. This would be the case only if the enterprise for which the plant was provided should be discontinued, so that no new plant would be needed. The depreciation fund was established for the purpose of paying for a new plant. The object of the sinking fund is the liquidation of the bond liability. As there are two amounts to be provided there must be two funds. One single fund cannot pay two

amounts.

There is only one condition under which one fund would suffice, but the question does not seem to allow of its being considered. If the depreciation fund were used to pay off the bonds, another issue of bonds might be made in order to pay for the new plant, and there would have been no need of the sinking fund with which to meet the bonds. The question implies that the bonds are to be permanently paid off.

6. Argument has been strongly urged that aside from any question of possible mismanagement, or of the difficulty of making satisfactory investments to yield the same rate as is paid on the bonds, a sinking fund for bonds is more expensive than an arrangement for the serial repayment of bonds. This is illustrated by the case of $20,000 5% bonds. If these are paid off in a series, one each year, the total payment made will be principal $20,000, interest $10,500, total $30,500. The annual sinking fund to pay these bonds would on a 5% basis amount to $604.85, making in twenty years $12,097, and the interest paid on the bonds would be $20,000, total payments $32,097. The apparent excess burden is accordingly $1,597.

Discuss the above argument and show clearly just what the figures mean and in what the apparent saving actually consists.

Solution. If the bonds are serial, one bond being paid off at the end of each year, the average capital of which the company would have the use would be $10,500. As the interest is the same amount the company paid 100 per cent in 20 years, or 5 per cent per annum.

By the sinking fund method, the bonds were virtually paid off at the rate of $604.85 per year. This means that the available capital in use was diminished by that amount at the end of each year-that is, that the company had the use of $20,000.00 the first year, $19,395.15 the second year and so on. As the last payment was made at the end of the 20th year, they had the use of $20,000, less 19 times $604.85 ($11,492.15) or $8,507.85. This makes an average capital in use of $14,253.92. For the use of this average capital the company paid interest of $20,000.00, against which there is a credit of $7,903.00, the compound interest realized from the sinking fund. This makes the net interest charge $12,097.00. Paying $12,097.00 for the use of $14,253.92 means a rate of a trifle less than 84.87 per cent. for 20 years, or 4.1435 per cent. per annum. The advantage of the sinking fund method is apparent and is explained by the fact that the fund earns compound interest.

The apparent excess burden mentioned in the problem is not a true excess. It is reached by calling the $20,000.00 paid for coupons all interest, which is not true. Of this amount $7,903.00 was applied to the principal, being the difference between the face of the bonds, $20,000.00, and the actual payments to the sinking fund of $12,097.00. The true amount of interest was therefore $12,097.00, not $20,000.00.

The interest paid must be considered in relation to the capital of which the corporation had the use during the twenty years, not in relation to the face of the bonds.

7. When a corporation undertakes its own construction work on what basis is it permissible for it to make charges to property account in respect thereof? On what basis would you personally recommend that the charges should be made?

Give your reasons.

Solution. On the basis of actual cost only. It is sometimes argued that the corporation would be entitled to charge its construction account with the same price that it would charge an outside customer. It is claimed that the use of its facilities in its own work would prevent its using them for outside work on which it would make a profit. It is more than doubtful whether any concern would allow its own work to interfere with the taking of profitable outside contracts.

No profit can be made except through a sale. In this case the reduced cost of the construction results in a saving and not in a profit, since there is no sale.

In the end there will be no difference in the final effect on profits, whichever method is adopted. If the construction account is charged with the cost of the work plus the regular profit, the carrying value of the plant will be raised and the depreciation to be written off against the profits will be correspondingly increased. Therefore, if a profit is taken

at first it will be written off during the life of the plant, and will not be a permanent profit at all. On the other hand, if the work is charged out at cost, the annual depreciation will be less and the saving will be realized by the smaller yearly charge against profits for depreciation.

8. (a) How would you deal in the balance-sheet of a corporation with shares recovered from a vendor to whom they had been issued as fully paid and who had returned them in settlement of a claim for fraudulent misrepresentation in respect of the property sold by him to the corpora

tion?

(b) How would you deal with these shares for the purposes of a dividend?

Solution. It depends on how the accounts connected with the issue of the stock have been kept. If only the issued stock has been credited to capital stock and no account is kept with unissued stock, I would charge the returned stock directly to the capital stock account. If unissued stock account is or has been, on the books through the opening entries, I would charge the returned stock to unissued stock account.

The reason for this treatment is that the fraud has vitiated the transaction which led to the original issue of the stock. Therefore the situation is the same as if the stock had never been sold or issued for the property, and the books must be brought into the same condition as would have been the case if the fraudulent transaction had not taken place.

The returned stock cannot be charged to treasury stock account. Treasury stock is such stock as has once been issued fully paid and has since been re-acquired by the corporation. This stock was never paid for, since the consideration given for it was fraudulent.

The stock being no longer outstanding would not be considered at all for dividend purposes, unless as unissued stock it was used as the means of paying a stock dividend.

Ernest Crowther, C.P.A., and Charles C. Sheppard, C.P.A., announce the opening of offices at 1902 First National Bank bldg., Pittsburgh, Pa., under the firm name of Crowther & Sheppard, certified public accountants.

Jacobson & Greenfield, C.P.A., 51 Chambers street, announce that M. Morris, C.P.A., has been admitted to the firm and that the firm name will be changed to Jacobson, Greenfield & Morris.

George H. Penn, C. P. A. wishes to announce the opening of offices in the Liverpool & London & Globe Building, New Orleans, Louisiana, for the practice of accountancy.

Announcements

NOTICE TO THE MEMBERS OF THE AMERICAN

INSTITUTE OF ACCOUNTANTS

The President of the American Institute of Accountants announces the result of the ballot submitted to members under date of September 22, 1917, as follows:

Constitution, article II, section 2 (c) shall be amended to read as follows:

By-Laws, article I, sec. 4, shall be amended to read as follows:

There were five disqualified ballots.

Under the provisions of the constitution, article VI, section 1, amendments must be approved in writing by a majority of the membership before becoming effective. The membership is now 1,100. The amendments, having been approved by a majority, are now declared to be effective.

United States Civil-Service Examinations-Stenographers and Typists wanted-Men and Women-The United States Government is in urgent need of stenographers and typists. All who pass examinations for the departments and offices at Washington, D. C., are assured of certification for appointment. It is the manifest duty of citizens with this special knowledge to use it at this time where it will be of most value to the government. Women especially are urged to undertake this office work. Those who have not the required training are encouraged to undergo instruction at once.

Examinations for the Departmental Service, for both men and women, are held every Tuesday, in 450 of the principal cities of the United States, and applications may be filed with the Commission at Washington, D. C., at any time.

The entrance salary ranges from $1,000 to $1,200 a year. Advancement of capable employes to higher salaries is reasonably rapid.

Applicants must have reached their eighteenth birthday on the date of the examination.

For full information in regard to the scope and character of the examination and for application blanks address the U. S. Civil Service Commission, Washington, D. C., or the Secretary of the U. S. Civil Service Board of Examiners at Boston, Mass.; New York, N. Y.; Philadelphia, Pa.; Atlanta, Ga.; Cincinnati, Ohio; Chicago, Ill.; St. Paul, Minn.; St. Louis, Mo.; New Orleans, La.; Seattle, Wash.; San Francisco, Cal.; Honolulu, Hawaii; or San Juan, Porto Rico.

The University of Illinois has decided not to repeat the short course in business which has been given several years for the reason that the demands on both faculty and students for war service of one sort and another have become so insistent that it is felt that such energies as are available should be devoted to the promotion of this service. Members of the faculty who have been depended upon to conduct the short course have also been called into government work.

Illinois business men have received the short course work with favor and it is hoped that, with the return of normal conditions, the University will be able to take up this service again and extend its usefulness.

This is to announce that Ben Morris, C. P. A., a member of the American Institute of Accountants, has been commissioned a Captain in the United States Army, Quartermaster Department, and is now in France.