Reserves in Haulage Accountancy
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By S. Howard Withey, F.C.I.
ARESERVE, strictly speaking, is an amount charged against the periodical profits to cover an anticipated or probable loss or expense. The same term may be used in connection with apportionments of amounts owing, or sums unexpired, at balancing time.
During a period of vigorous trading, or at the end of a successful. year's operations, a portion of the profits may safely be reserved to meet the difficulties of less prosperous years. It should be borne in mind, however, that a road-transport concern may have reserves, and yet be sustaining a net loss, such reserves being definitely earmarked for the liquidation of specific liabilities.
From the accounting viewpoint,. reserves of this nature should preferably be shown on the balance-sheet as deductions from the book value of the particular asset in respect of which the amounts have been set aside, and not as separate items on the liabilities side. After all losses and liabilities, including depreciation, have been provided for, a reserve may be created out of profits fot the purpose of equalizing dividends in the future, or in order to conserve the financial resources of the concern.
"Capitalized Profits."
Such "capitalized profits," as the transactions are often called, generally result in an increase in the total available working capital. If, however, any net loss be sustained subsequently, the amount of the deficit must be wiped out, or reduced, by applying the balance standing to the credit of the reserve account. No real reserve can be in existence if a loss be shown in the final accounts.
In applying a reserve in the reduction of a net loss, the reserve account should be debited with the amount, and a profit and loss account credited. A reserve may remain undisclosed by an appreciation in the market value of road transport, or by an increase in the real value of such assets as land, buildings and investments.
These are referred to as secret reserves, which may also consist of excessive provision for liabilities and depreciation of assets, or the omission from the balance-sheet of such items as goodwill. Business premises and stock are frequently shown at lower figures than their .actua•l valne, and. in some cases, additions of .
nature are charged against the profits. There are also forms of secret reserve.
Provision for bad debts may be made B24 by calculating a certain percentage of the total amount outstanding under the heading of " sundry debtors," or " book debts." The amount is debited to a bad-debts account during the period under review and brought down on the credit side of the same account to commence the next period.
The amount reserved is, in this way, included in the amount charged against profits as bad debts, and deducted from the sundry +debts on the assets side of the balance-sheet. The better method, however, consists of carefully examining each item in the list of debtors, making at the same time an adequate allowance, in each case, for amounts uncertain of collection, or for sums definitely known to be bad.
The total of such allowances constitutes the amount to be reserved. In cases where the percentage of bad debts is fairly constant, however, the percentage method could be conveniently adopted, although special allowances would have to be made for large doubtful debts.
Discounts on Debts.
The sum reserved for discounts on sundry debts is usually based on a percentage calculated on the total of the debit balances of the personal accounts outstanding at the close of the period. This should represent the average percentage which the total of the discounts actually allowed by the operator daring the period bears to the aggregate of cash received.
As an alternative, the reserve could consist of the average rate of discount known by the transport operator to be actually allowable. In cases where it is practically impossible to ascertain a reliable percentage, the discount on each item enumerated in the list of debtors should be set down in a separate column, the total of these being the amount to be reserved.
In all cases, the reserve for discount on debts should be deducted from the sundrydebts on the assets side of the balance-sheet, after the reserve for bad debts has been deducted.
Provision for discounts on sundry creditors is usually based on a percentage of the outstanding credit balances of the personal accounts. This percentage should represent the aveiage which the total cash discounts obtained by the operator during the period bears to the total cash payments actually made. Otherwise, it could be the average rate known to be receivable.
Examine List of Creditors.
If the percentage differs considerably in the case of each item, it will be more reliable to examine the list of creditors in detail, and to show the discount receivable in each case in an inner column ruled for the purpose. In all instances, the total sum to be reserved should be deducted from the sundry creditors on the liabilities side of the balance-sheet, and not shown as an asset.
If the amount actually charged against the profits under the heading of repairs and renewals is less than the average, a reserve to cover wear and tear may be made, even if the repairs will not be actually effected for some time. A reserve made to cover any anticipated loss on bills of exchange which have been discounted by the operator should be -shown on the liabilities side of the balance-sheet. It should not be deducted from amount outstanding under bills receivable, otherwise it would appear that the reserve has been provided in respect of all the bills in hand.
A reserve fund is a sum set aside out of the divisible profits for the specific purpose of meeting certain liabilities, or for strengthening the general financial position. It differs from an ordinary reserve in that the latter is simply a charge against the periodical profits, whereas a reserve fund is created out of the actual profits.
A reserve must be charged against the profit and loss accounts, even if by so doing a net loss is shown, but it is impossible to create a reserve fund except by appropriations from profits made. The following example will indicate the method of treating reserve funds :— The assets of II. Deacon and Co., road transport operators, total £30,000, and the liabilities £20,000, the balance to the credit of profit and loss account being £10,000. , The partners agree to• transfer £5,000 to a reserve fund. The balance-sheet before and after the transfer would: be shown in the table on the preceding page.
Accounts set aside to constitute a sinking fund for a special purpose, and invested outside the business, may be created out of the profits, or treated as charges against the profits. Sums set aside to provide for depreciation of vehicles, or any other wasting asset, ars charges against the profits. A sinking fund created to liquidate a liability is built up out of the divisible profits.
Creating a Sinking Fund.
A sinking fund may conveniently be created in order to recoup the cost of a lease upon expiration, and the example given below indicates the necessary entries to be made in the books of account in order to give effect' to such transactions:— A transport operator buys business premises on January 1, 1936, on a five years' lease for £5,,000. He takes a leasehold redemption policy on the same date, for the purpose of securing £5,000 upon expiration of the lease.
• The original £5,000 paid for the lease
should be debited to leasehold building account, and transferred against the profits each year. At the end of the .five -years the £5,000 received should he credited to the leasehold buildings account, which will balance, the cash being available for the pur
chase of a new lease. • .
The table reproduced below shows the annual instalment. of £1 required to provide £1 at the end of 5, 6, 7, S. 9 and 10 years at 3 per cent., 4 per cent. and 5 per cent. respectively :— No. or Yrs. 3 nor cent. 4 per cent. 5 per cent.
.188354 .184627 .180975 6 .154597 .150761 .147017 7 .130506 .126609 .122819 8 .112456 .108527 .104721 9 .098433 .094493 .090690 10 .087230 .085'191 .079504
To find Ire annual amount necessary to provide £5,000 at the end of 10 years, for instance, with interest accumulating at the rate of 4 per cent., multiply .083291 (the amount required to produce £i at the end of 10 years) by £5,000, which gives a result of £416.455, or £416 9s. 1d.