I —_—— TT

         
   
 
  
   
 
 
 
 
 
 
 
 
 
 
 
 
   
 
    
 
 
 
 
 
  
    

Sc. 6] CAPITAL ACCOUNTS 75

the capital, surplus, and undivided profits, on the opposite
side. A great responsibility, therefore, rests on those who
construct commercial accounts.

§ 6

Thus far we have considered the fluctuations of the
items of a capital account independently of any payments
between the company and the stockholders. When payments
 are made to the stockholders in the shape of dividends,
 the effect is to reduce both sides of the account, depleting
 the cash on the assets side, and the undivided profits
on the liabilities side, each by the amount of the dividend.
If a dividend is declared larger than the undivided profits,
the effect will be to reduce the surplus, or even the capital.
For most business concerns it is regarded as bad policy,
or even fraudulent, to pay dividends out of capital. However,
 there is no inherent reason why such dividends
should not be paid, and in some sorts of business it is not
only proper but necessary. In these cases when dividends
 are paid out of capital there should be a corresponding
 reduction in the amount of outstanding capital
stock, in order that those dealing with the concern may not
be deceived. For instance, land companies in Colorado
and California, such as the Redondo Land Company, are
formed for the express purpose of investing in land and selling
 it again. As fast as it is sold, the proceeds are divided
among the stockholders, and stock certificates cancelled,
until the whole capital of the company is cleared away.
Ordinarily, however, reduction in capital takes other forms
than dividend payments. The payment of dividends out
of capital is, generally speaking, unlawful, otherwise the
creditors of a company might suddenly find themselves
without any adequate security for their loans.
Payments are, of course, also made from the stockholders
 to the company. We will suppose that a company
is formed with a capital stock of $100,000, but that when its