In order to show the possible dangers arising from regarding as earned all the profits resulting from a sale when only a part (say one-half) of the selling price has actually been paid in, the example already given may be taken. In this, on the completion of the third payment one-half of the price has been paid. If no further payments should be made, there would remain unpaid $90,000, of which $60,000 would be unearned profits. These profits, it is assumed, have been anticipated and, together with the $60,000 actually earned, have been carried to the Profit and Loss account. The transaction being cancelled, it is necessary to write off the unpaid balance, which will ordinarily be to the Real Estate account, as already suggested; and the property which was purchased originally for $60,000 now stands on the books at a valuation of $90,000. If this operation were repeated several times, it becomes evident that the book value of the property would equal or exceed the selling price of $180,000. Further, if such a course were followed, it is obvious that, through a series of dummy sales, a fraudulent management could inflate to any amount the book valuation of the real estate holdings.
Other reasons, also, commend the practice of making earned profit dependent upon, and in proportion to, the part of the selling price actually paid in. It is not so much the duty of directors to pay out as dividends every cent as soon as it is apparently earned, as it is to safeguard the credit and stability of the company which they serve; and this is most effectively accomplished by creating a reserve for the protection of the future; this reserve will also serve to maintain the market value of the capital stock. Prudent management, a strong reserve, and a conservative method of handling profits go much further toward winning and retaining public confidence than the occasional payment of large dividends.
Moreover, as has been seen in the case of time sales under contracts, it is manifestly improper to consider all the profits as earned before the transaction is closed. It is very desirable to treat uniformly as to profits, accounts which are so similar as the two classes of time sales known as "mortgages" and "contracts."