It may be worth while, in passing, to mention a few methods of calculating earned profits not based on the principles above stated and to show the possible difficulties or errors which may arise in relation to each.
1. It is sometimes attempted to apply the formula for earned profits, as stated in Section 145, to the controlling account in the general ledger, instead of to the balances taken from the sub-ledgers. This is not to be recommended as it is often difficult to get the proper figures from the controlling account, owing to entries made in it relating to cancellations, transfers, etc., and this difficulty is materially increased if the accounts have been running for a number of years.
2. Another method is to use the following formula:
Profits in full on all lots deeded
proportion of profits on uncompleted sales
This method presents the difficulties mentioned in connection with the preceding method, together with others peculiar to itself. The chief source of error lies in the fact that partial profits on any given lot are taken each period as earned, and when the lot is finally paid for and a deed given therefor, the entire profit is taken, including the partial profits already taken - an evident duplication of profits, which leads toward disaster.
3. Another and more usual plan of calculating earned profits is to employ the following formula:
Total recepits / Total sales X balance of Gain account
The fallacy of this method is that the receipts and the sales cover all the transactions relating to the open contracts since the beginning of these contracts, while the balance of the Gain account is being periodically diminished by the profits regarded as earned. If sales have been made with regularity, the results may be approximately correct; if, on the other hand, they have been irregular, serious error may creep in.