Full text of "Principles of auditing"

Principles of Auditing

JOHN RAYMOND WILDMAN, M.C.S., C.P.A.

Professor of Accounting in New York University

1916
THE WILLIAM G. HEWITT PRESS

61-67 NAVY STREET, BROOKLYN. NEW YORK

BY
JOHN RAYMOND WILDMAN

'- : , ".

DEDICATED

MR. ELIJAH WATT SELLS

PIONEER, AUTHORITY
GENTLEMAN

339433

FOREWORD

A young man came to New York with the intention of
entering the profession of accountancy. He was energetic and
ambitious; had a good general education and some experience
in accounting work. He obtained employment with a firm of
certified public accountants. The usual grind of footing and
checking followed for a while; always under the direction of
the man in charge of the engagement. Finally came the long
sought chance to go out on an engagement alone. He received
no instructions; in fact he never had received any instructions
about how the work should be done. What he had learned had
been learned by observation. He had been afraid to ask ques-
tions for fear such procedure would create the suspicion that he
did not know as much about his work as he should. For the
same reason when sent on the engagement alone he did not ask
for working papers and reports which would serve as guides.
The result of his work almost proved disastrous. Conscientious
and careful as the work had been the report, although prepared
with great pains, was not in the form used by the firm. When
it was reviewed by the report department it was not only torn
to pieces and made over but the accountant was held up to ridi-
cule before a number of persons who happened to be in the room.

This unfortunate experience would have broken the spirit of
some men. In this case it only served to lash the subject into
a frenzied determination to succeed in the field of endeavor which
he had chosen.

How he toiled far into the night for several years while
carrying on his daily work, at the same time getting a technical
education, as well as some of his many and varied experiences,
might make an interesting story but they have no place here.
Some of the things he was never able to find in books and about
which he was too proud to ask are set forth in this book.

It is dedicated to a man who- represents all that is fine and
noble in a professional man ; one who cannot help but be an
inspiration to all who come in contact with him.

FOREWORD

The author's one regret is that the book is not more thorough
and polished on account of the man to whom it is dedicated;
his one hope that it may lend a helping hand to some young
man struggling along the rocky road that leads to success.

JOHN RAYMOND WILDMAN.
New York University,
February 1, 1916.

CONTENTS

CHAPTER PAGE

I Auditing Defined I

II The Occasions for Auditing 3

III The Occasions for Auditing Continued 8

IV Audits Differentiated from Examinations and Investigations 13
V The Engagement 16

VI What to Do Before Beginning an Audit 21

VII Counting the Cash 33

VIII Counting the Notes and Securities 42

IX Taking Off the Trial Balance 48

X Reading the Minutes 61

XI The Mechanical Work 66

XII Reconciling the Bank Account 78

XIII Vouching the Disbursements 86

XIV The Petty Cash 96

XV Vouching the Purchase Journal or Voucher Register 102

XVI Inventories 108

XVII Analyzing Accounts 121

XVIII Some Accounts Which Require Analysis 130

XIX The Customers Ledger 135

XX Other Accounts Which Require Attention 142

XXI Accounts on the Credit Side 148

XXII How to End an Audit 159

XXIII What to Do After an Audit 165

Principles of Auditing

CHAPTER I

AUDITING DEFINED

Auditing is required because someone may through ignorance,
carelessness or intent, have failed to record, express or report,
carefully and accurately, facts concerning financial transactions.
If no one were ignorant, or careless, or had bad intentions, or
there was no lack of confidence on the part of any one, probably
one half of the occasions for auditing would be removed. If all
facts concerning financial transactions were carefully and accu-
rately recorded and expressed and reported it is almost safe to say
that the other one half of occasions in which auditing is required
would be removed. The familiar expression "to err is human" is
especially applicable in the case of auditing. All are prone to
make mistakes. Auditing then practically means searching for
mistakes; reviewing the work of others in an effort to discover
errors. It might be more charitable perhaps to say that auditing
is reviewing the work of others in an effort to prove its correct-
ness. The kind of an auditor which one is to become will depend
perhaps very largely on which attitude one assumes, namely,
searching for the mistakes of others or trying to prove the cor-
rectness and accuracy of the work examined.

Auditing is not accounting nor is it accountancy. Accounting
is the science which treats of the systematic record, compilation
and presentation in a comprehensive manner for purposes of ad-
ministration, or the information of other parties at interest, of the
facts concerning the financial operations of a business or other
organization.

Accountancy is most aptly defined in the Certified Public Ac-
countant syllabus issued by the New York State Education De-
partment as "a profession, the members of which, by virtue of
their general education and professional training, offer to the
community their services in all matters having to do with the
recording, verification and presentation of facts involving the

a. PRINCIPLES OF AUDITING

acquisition, production, conservation and transfer of values. "Ac-
countancy comprehends the conduct of audits, examinations and
investigations ; devising and installing systems ; criticising organi-
zations and management; and in some cases efficiency work.

Auditing is therefore seen to be a branch of accountancy, which
profession is as much broader in its scope than auditing is in turn
broader in scope than accounting. To perform the functions of
an auditor intelligently and successfully, one must have a thorough
knowledge of accounting.

Auditing may be defined as the art of reviewing the work inci-
dent to the record, compilation and presentation of the facts con-
cerning financial transactions. Autditing, it will be noted, is said
to be an art. With regard to accounting it was said to be a
science. Auditing is referred to as an art because it has a set of
rules. If one were able to conceive of all the possibilities in audit-
ing it is probable that a set of precise rules could be laid down
which would be sufficiently comprehensive to enable an intelligent
person with a knowledge of accounting to do everything that is
necessary to be done in auditing. For example, there being a
possibility of error in the footing of a column of figures, if one
wishes to determine whether or not the footing is correct, it is
only necessary to re-foot the column. If it were desired to ascer-
tain the correctness of certain cost statistics, such as the cost per
ton of a certain amount of coal mined, having the facts as to the
cost of the coal and the mining thereof and the number of tons
mined, a rule for accomplishing the purpose would consist in
instructions to divide the cost of the coal by the number of tons.
There is no disputing the fact that it requires ingenuity and judg-
ment to become a good auditor. That matter is, however, quite
apart from the distinction between accounting as a science and
auditing as an art.

Auditing may be professional or non-professional. Which it
is depends very largely upon the auditor. If he offers his services
to the public, it is professional auditing. If he confines his efforts
to one organization, it is non-professional auditing.

CHAPTER II

THE OCCASIONS FOR AUDITING

Modern business organizations in a great number of instances
have become so great and so complex as to have passed beyond
the limit of observation of the individual. It is impossible as a
rule for the president of a company or the proprietor of a business
to be in touch personally with what is going on in every division
or department of his organization. One striking exception to this
rule is the case of a young man in New York City, who is the
proprietor of a concern engaged in the manufacture and sale of
ladies' neckwear. The concern occupies one entire floor of a loft
building in a section of the city where similar concerns are found.
The plant, altho a comparatively small one, is organized and
arranged on a scientific basis. The receiving, stock, manufac-
turing, and the shipping departments are so arranged as to facili-
tate the proper routing of the work. The office and sales rooms
are accessible to all persons who have dealing with the concern.
The proprietor has his desk on a raised platform in the centre
of the plant so that by turning about in his revolving chair he is
able at all times to see what is going on in all parts of the plant.
If there is congestion in the manufacturing department or in the
shipping department he knows about it at once and may see that
the goods are moved along. If trouble arises in connection with
some machine it is brought to his attention immediately and the
trouble is remedied without loss of time. When goods are re-
ceived he is in a position to see that they are unpacked, counted
and put in stock; that requisitions are filled promptly and that
the stock is kept up. This arrangement is, of course, an ideal
one and a striking example of an individual who is in touch
personally with all the ramifications of the business.

By way of comparison it may be of interest to try and imagine
the president of the United States Steel Corporation with its thirty
or forty plants endeavoring to follow out the same scheme. It
will thus be seen how impossible in many cases it is for the chief
executive to be in personal touch with all that is going on. Such
an individual requires some artificial means of bringing into his
office a picture of what is going on throughout the organization ;

PRINCIPLES OF AUDITING

something which will enable him to visualize the situation. Ac-
counting is one of the artificial means which enables such men
to overcome these difficulties of time, space and distance, and to
carry on the work of administration from the results concerning
the financial operations which are supplied to them from time to
time.

The question may now arise as to whether such individual will
accept the information which is presented to him and act upon it
without question. The probabilities are that he will, if the organi-
zation is a small one where he knows personally the man who
prepares the report or furnishes him with the information. If
the organization is of any size the chances are that he will not
accept and act on the information without taking some steps to
satisfy himself as to its accuracy. There are probably many
reasons why he would not attend to this matter in person. One
reason may be that he is too busy to go out and check up the in-
formation himself, and in other instances he is not competent to
do it because he does not know where the information came from
and how it was compiled nor where the records from which it
was taken are kept. A further reason may be that the president
is too high-priced an employe to spend his time in work of this
nature. Accordingly he makes use of someone at his command.
As a rule he sends someone else to do the work for him. He
sends someone that he can trust and someone that is competent
to do the work. Since these are the results produced by account-
ing, it naturally follows that he must send someone to verify the
results who understands accounting in all its details. The re-
lation is confidential and the person sent, who has the function of
auditor, is his personal representative.

Generally speaking it may be said that auditing is done, first,
to satisfy someone as to the correctness of the accounts ; second,
to prove or disprove some contention ; third, to influence pros-
pective purchasers of goods or proprietary interests, and pros-
pective creditors.

While the occasions for auditing are numerous and varied,
they are probably all comprehended in the following category:

A. At the instance of someone within the organization.

1. To satisfy someone within

2. To satisfy someone without

THE OCCASIONS FOR AUDITING

3. To prove or disprove some contention on the part

of someone within

4. To prove or disprove some contention on the part

of someone without

5. To influence someone within

6. To influence someone without

B. At the instance of someone without the organization.

1. To satisfy someone without

2. To prove or disprove some contention on the part

of someone without

3. To influence someone without

The specific occasions may now be considered in the order in
which they would appear in accordance with their relation to the
above category.

First, at the instance of someone within the organisation to
satisfy someone zvithin.

A sole proprietor may frequently be at the head of a business
which is sufficiently large to require a more or less elaborate
organization. It is probable that except in rare cases such indi-
vidual will have someone to keep the accounts for him and that
he has not the time, patience or training to check up such work
himself and will probably realize the necessity sooner or later of
employing someone to audit the accounts for him in order that
he may be satisfied as to their correctness.

In the case of co-partnership the services of an auditor are
perhaps more frequently apt to be required because of the neces-
sity for accuracy in the determination of profits. Since partners
are interested in the sharing of profits it is of mutual importance
to them that the profits be correctly stated. Here it is that the
auditor is frequently needed, not only for the purpose of giving
his independent opinion as to the results under normal conditions,
but also in case of dispute between or among partners. Parties
to a joint venture which is a special form of partnership except
that the parties combine their money or efforts in connection with
one particular piece of business rather than a series of miscel-
laneous business transactions extending over a period, are de-
sirous of knowing whether or not the accounts are correct and
whether the profits are properly stated in order that each party
may know whether or not he is getting his proper share.

PRINCIPLES OF AUDITING

Associations or societies supported by membership dues or
contributions require the services of an auditor in order that the
supervising or directing heads who are responsible for the affairs
of the organization may know that the funds have been properly
handled and accounted for and in order that proper reports may
be made.

Officers and directors of corporations probably have more fre-
quent and greater need for the services of an auditor than any
other type of organization. This is occasioned by the elaborate
division and departmental organization which is apt to exist under
such organizations. Written reports are made use of to an ex-
tensive degree. Each employe or group of employes, or depart-
ment, is in turn reporting to someone higher up. Officers and
department heads are constantly having occasion to receive re-
ports from subordinates. The geographical location of various
plants or activities of the same organization make it all the more
necessary that reports be depended upon. It is undoubtedly in
connection with the work of corporations that the auditor, both
professional and non-professional, finds the most frequent need
for his services.

Analogous to this situation is that in which supervising en-
gineers and companies which finance and manage public utilities,
employ a staff of non-professional auditors for the purpose of
auditing the accounts of operating companies over which their
supervision extends.

Second, at the instance of someone within the organization to
satisfy someone without.

While there is a theory to the effect that stockholders are pro-
prietors and that like sole proprietors or co-partners they have a
voice in the management of the business, it is probable that such
is not actually the case except in a few instances. The average
stockholder probably invests his money and takes his dividends if
he can get them with little thought as to his rights of manage-
ment, except as he may present himself or his proxy at some annual
or other meeting of stockholders. It is probably not an extrava-
gant statement to say that in the majority of cases stockholders
are considered from the point of view of the management as being
outsiders who contribute funds with which in part to carry on the
business. Such at least is the status of the stockholder in his
relation to the management under the above category, and while

THE OCCASIONS FOR AUDITING

some liberty may have been taken in so doing nothing serious is
thought to be at stake.

The officers report to the directors and the directors report to
the stockholders. It is therefore thought quite important by the
directors of many corporations that a complete and comprehensive
report of the affairs entrusted to their care should be made to the
stockholders, and that such report should have the approval of
some qualified independent person before being submitted to the
stockholders. Since such reports cover very largely the financial
transactions, it is obviously necessary that before such report may
be approved by an auditor, that an audit of the accounts shall be
made.

CHAPTER III

THE OCCASIONS FOR AUDITING CONTINUED

The same kind of information which would be interesting to
stockholders would be interesting also to bondholders. Bond-
holders might have to be satisfied in certain instances by means
of an audit. In this same class of outsiders would be included
creditors in general, and banks in particular. Creditors who have
large accounts may be thought worthy of satisfaction through an
audit. Likewise, it may be considered desirable to satisfy banks
which have large amounts of commercial paper of any given
concern, or banks which have applications for loans which it
is desired they shall make. The position of any company or
organization seeking credit is always very much stronger if the
statements presented are supported by certificates of auditors.
Following out the same idea there are frequently seen in the daily
newspapers published reports of insurance companies which pre-
sumably are given out for the purpose of assuring policyholders
that the business is being properly conducted and that the ac-
counts have been audited and found correct. In all of the above
cases the occasion for the audit arises at the instance of someone
within the organization in an attempt to satisfy someone without.

Third, at the instance of someone within the organisation to
prove or disprove some contention on the part of someone within.

In this connection it may be noted that disputes have been
known to arise among the officers as to the honesty, capability
or efficiency of employes who have to do with the accounts. Al-
most any professional auditor of experience will recall disputes
which have arisen between some of the officers on the one hand
and a plant manager or superintendent on the other. The dis-
cussion usually consists of an argument as to whether certain
items constitute charges to capital or to expense. The manager
is usually trying to make a record by keeping down the expense,
and attempts wherever possible to charge questionable items to
capital. The officers, on the other hand, are endeavoring to
guard against having an eggshell plant built up, the account for
which will be full of charges for intangible values which should
be charged to expense. Audits are frequently occasioned by the

THE OCCASIONS FOR AUDITING

necessity for determining whether or not such charges have been
properly classified.

Fourth, at the instance of someone within the organisation to
prove or disprove some contention on the part of someone without.

These cases usually take the form of some accusation against
the management in connection with the accounts, and an audit is
made at the instance of the management in order to refute the
accusation. Stockholders sometimes accuse the management of
creating superfluous reserves, or making excessive appropriations,
or needless expense in order to reduce the profits and consequently
keep down the dividends. Charitable agencies have at times been
accused of spending more of the funds contributed, for salaries
of the administrative officers than in carrying out directly the pur-
poses and objects of the association or society. In these cases
where the officers feel aggrieved at the unjust accusation they may
cause an audit to be made for the purpose of setting at rest these
contentions.

Fifth, at the instance of someone within the organization for
the purpose of influencing someone within.

The occasions of this character are perhaps not so frequent as
some of the others but one case will at least serve to justify the
inclusion of this item in the category. The cashier of a bank
in one of the southern cities felt that he was not being fairly
treated in the matter of salary by the officers of the bank. In his
struggle for an increase in salary he employed a firm of certified
public accountants to make an audit of the accounts of the bank
at his expense. The audit and subsequent report in this case was
used by someone within the organization for the purpose of at-
tempting to influence someone within the organization.

Sixth, at the instance of someone within the organisation to
influence someone without.

Striking examples of this class are cases in which an attempt
is made to sell stock or bonds or a proprietary interest in a business
concern. Banks also are frequently influenced in the direction of
making loans or discounting notes by the financial condition or
result of operations of an applicant, and they are more apt to be
influenced when the results are certified after an audit. An en-
terprising realty company not only had the accounts of its own
and the sixteen subsidiary companies audited and the auditor's
certificate appended to the published statements thereof, but had

PRINCIPLES OF AUDITING

the auditor instruct the salesmen as to the interpretation of the
financial statements and the effect of the auditor's certificate on the
situation.

Charitable institutions especially are considered to derive bene-
fit from having their accounts audited and appending the auditor's
certificate to the financial statements which appear in their printed
reports. Contributors past and prospective are thought to be in-
fluenced through the knowledge that the funds of the societies in
question have been properly used and accurately accounted for.
It is unquestionably true that publicity, especially when the in-
formation is supported by independent and competent opinion,
stimulates interest and support. It may be interesting to know
that there are some thirty-six hundred charitable agencies in the
metropolitan district, that is to say, charity organizations which
are supported either wholly or in part by public contributions.
This work is more or less correlated by a central association
known as the Charity Organization Society. The Charity Or-
ganization Society has a bureau known as the bureau of advice
and information which serves these agencies somewhat in the
capacity in which the Dun and Bradstreet mercantile agencies
serve the mercantile world, in that it classifies, rates and lists
these different agencies. If a man like Mr. Rockefeller, for ex-
ample, is approached by someone for a contribution to some charity
and he does not know the person or the society, or whether or
not it is worthy, he may refer to the book published by the
Charity Organization Society in which these agencies are rated,
and perhaps decide whether or not to contribute. The bureau
finds it difficult to rate these agencies properly because many of
them do not have proper and adequate systems of accounting, and
do not make comprehensive reports. It is now a part of the
bureau's program to insist that the accounts be audited before
agencies are listed.

Under the second division of the category come the occasions
which arise at the instance of someone without the organization.
These, as before, may be taken up as listed.

First, at the instance of someone without the organization to
satisfy someone without.

Subscribers to capital stock may cause an audit of certain
accounts to be made in order to satisfy themselves as to the disposi-
tion of funds which they have paid into the corporation. Stock-

THE OCCASIONS FOR AUDITING

holders may likewise have made at their own expense, audits in
order that they may judge of the efficiency of the management.
Directors sometimes want information as to the acts of receivers
or trustees. Here, of course, the normal situation is reversed.
Ordinarily, the director is an insider. There may come a time,
however, when the company goes into the hands of the receiver,
and subsequently the trustee carries on the business. Under such
circumstances both the receiver and trustee are representatives of
the court in behalf of the creditors, while the directors become
outsiders. Other illustrations of the above class are beneficiaries
under sinking funds, who at times have audits made. There might
also be included fidelity companies where bonded employes are
suspected of having defaulted. It should not be overlooked in-
cidentally that the employer companies frequently have the ac-
counts of bonded employes audited in order to avail themselves
of the lower premium rate which the bonding companies offer in
such cases.

Second, at the instance of someone without the organisation to
prove or disprove the contention of someone without.

Minority and other stockholders sometimes raise contentions
concerning the management of the directors or officers and cause
an audit to be made. Not long ago a holder of sixteen hundred
shares of stock in the Brooklyn Union Gas Company headed a
movement of minority stockholders who employed accountants to
go over the books for the purpose of proving that certain profits
had not been paid out of the dividends.

Bondholders may take similar steps in cases where interest
on bonds has not been paid and where it is contended that if
certain charges had not been excessive there would have been
sufficient profits to have met the bond interest.

Claimants of royalties frequently make the contention that
they are not receiving as much as they should and an auditor is
engaged by such claimants to determine whether or not the con-
tention is correct. An advertising man who recently closed a
contract whereby he was to receive a certain percentage of the
sales as his compensation for doing the auditing work, had written
into the contract the provision that the accounts should be
audited. This was taking the proverbial "stitch in time/'

Third, at the instance of someone without the organisation to
influence someone without.

PRINCIPLES OF AUDITING

Bond houses bringing out or selling securities of certain com-
panies serve to illustrate this class. A prominent bond invest-
ment house recently had a combination investment consisting of
five $1,000 bonds presenting diversity, safety of principal, market-
ability, liberal income and opportunity of appreciation. It is not
probable that the house in question would make a statement such
as the above without having satisfied itself through audits as to
the financial status of the companies whose bonds were offered.
Circulars offering investments are now rare which do not contain
a statement to the effect that the books have been audited by some
well known firm of certified public accountants. Included in this
group should be underwriters, who, preliminary to the consolida-
tion of a number of companies, have the accounts of the com-
panies in question audited. These like the above, it will be seen,
are usually occasioned by the desire on the part of someone out-
side the organization to influence someone also outside.

It may perhaps be said that the object of the discussion just
concluded is that proper cognizance may be taken of the party or
parties to whom the auditor is to report. It is important at all
times that the auditor should determine the party for whom the
work is being done in order that he may know to whom his report
is to be addressed and delivered. Considerable embarrassment
may follow the delivery of a report to the wrong person. In
some cases clients are known to have refused payment of the fee
because the report was not delivered to the proper person.

CHAPTER IV

AUDITS DIFFERENTIATED FROM EXAMINATIONS AND
INVESTIGATIONS

Auditing connotes reviewing accounting work. Reviewing ac-
counting work means reviewing the records which appear on the
books, extending from the books of original entry to the general
books as well as the financial statements which are prepared
therefrom. If one were to trace all the financial transactions of
a business it would be necessary to begin with the books of
original entry where all the details are shown; to follow these
transactions through the intervening stage of classification, com-
bination and grouping into the general ledger and from the gen-
eral ledger through the trial balance into the balance sheet and
statement of income and profit and loss. If one were to make a
complete audit it would be necessary to review in its entirety the
work incident to the financial transactions just mentioned. Un-
fortunately the occasions are rare in which it is possible to indulge
one's love of thoroughness to this extent. Great is the satisfac-
tion where the operations of the organization under audit are so
small in volume as to make it possible to check every figure. In
auditing the accounts of a large department store where thou-
sands upon thousands of sales are made in the course of a year,
a corresponding number of sales slips would doubtless be en-
countered. To be absolutely sure that all sales had been accounted
for, it would be necessary to examine and verify every one of the
sales slips. After verifying the amounts it would be necessary to
add them up and trace the totals into the general books. If the
work concerning all the various phases of the business were car-
ried out in such detail, the audit would be a complete one. Obvi-
ously, however, it would be quite out of the question, except in
rare instances, for the professional auditor to attain such degree
of thoroughness.

Audits may be complete or partial. The ideal audit is a com-
plete one. While perhaps one of the most unsatisfactory things
about auditing is the fact that oftener than otherwise the audit
must be a partial one, professional practice has dictated that
the client may not as a rule expect more than a partial audit. It

PRINCIPLES OF AUDITING

is doubtful if most clients understand what is really meant by
testing and it is doubtful if many clients are consulted as to
whether or not testing shall be done. It is probably not an ex-
travagant statement to say that testing is a device of which the
auditor avails himself in order to satisfy himself as best he may
where for one reason or another thoroughness and the amount of
time which necessarily accompanies it are out of the question. As
an illustration of testing, sales invoices might be taken. Picking
out from four to six months, say January, June, July, September,
November and December, the sales invoices would be checked
against the sales records unless duplicate invoices were used for
same ; the footings of the sales records for the respective months
should be proved and the monthly totals followed forward into
the general ledger. The individual invoices should be followed
into the customers' accounts. Such procedure is known as testing,
and testing usually accompanies a partial audit. Testing should
be accompanied by judgment.

An examination differs from an audit in that it attempts to
verify results rather than the processes whereby the results were
obtained. Results are usually expressed in a financial statement
called the balance sheet. An examination, therefore, practically
consists in verifying the assets and liabilities including the ac-
countabilities. An examination is frequently referred to as a
balance sheet audit.

An investigation is a matter which refers to a transaction,
series of transactions or phase of a business, and differs from an
examination in that it attempts to ascertain but not prove the
facts concerning a transaction or phase of the business from its
inception to its termination. In an investigation it might be im-
portant to know what details constituted a certain transaction or
series of transactions as a matter of information, but the details
would probably be accepted without attempting to prove them. It
is a difficult matter to state a definite rule for identifying or dis-
tinguishing investigations. Contrary to the impression just given,
some investigations lead to litigation wherein it is necessary to
prove in court all the details involved in the transaction. As gen-
erally understood, however, investigations frequently refer to the
determination of the earnings of an organization extending over a
period of years or a determination of the cost of production, in
which cases the records on the books are accepted as being true

AUDITS DIFFERENTIATED FROM EXAMINATIONS

and correct, no attempt being made to prove the details which
support the conclusion.

While it may not be clear from the preceding discussion as to
the exact difference between an audit and an examination or an
examination and an investigation, there is one thing about which
the student or the young man starting work in the profession
should bear in mind, namely, that all engagements are not audits.
It is perhaps of greater importance to appreciate this fact and to
know that a difference does exist among the various classes of
engagements mentioned rather than not to know exactly what
these differences are. One of the most pathetic exhibitions a
young man may be guilty of is to begin a thorough audit of a
set of books when it was intended by the client that he should
investigate only a certain matter.

CHAPTER V

THE ENGAGEMENT

The discussion which follows will deal principally with the
subject of auditing from the professional point of view. It may
be desirable at times to mention the work of the non-professional
auditor, but it should be borne in mind that the subject is being
generally discussed from the other point of view.

There are certain preliminaries preceding the beginning of an
audit which seem to require some attention before going ahead.
Some men have jobs, some men have positions; some concerns
speak about making sales, other concerns talk about taking con-
tracts, while others will be heard talking about getting jobs. The
accountant refers to his work as the taking of an engagement.
Engagement is the technical accounting term used to denote that
arrangement or agreement which the accountant makes whereby
he takes up certain work for a client. The word client as used
here is also a technical accounting term indicating the party for
whom the work is done. It is analogous to the word customer
as used in trading. In business it is considered important that
when two parties agree on a certain thing and there is a meeting
of the minds that some expression of the agreement or contract,
as it is now called, which has resulted shall be recorded. That
is, of course, contracts of any importance. Simple matters which
two persons are able to remember without any difficulty do not
need to be expressed in writing. When a contract becomes so
complicated that it is not possible for the parties thereto to re-
member the facts concerning it, it is usual to express those facts
in writing.

Usually in taking engagements there are a number of stipula-
tions to be made; certain things to be done; certain information
necessary in order that the work may be carried out intelligently by
everyone concerned, and for that reason an engagement blank is
prepared. The specimen engagement blank which follows ap-
parently needs no description since it is self-explanatory.

It does not always follow that the work of an engagement will
be done in the office of the client. The treasurer of some organi-
zation in Wall Street may employ an accountant to audit the ac-

THE ENGAGEMENT

counts of an institution in Forty-second Street. An accountant
may be employed at times by one party to audit the accounts of a
second party, with the permission, of course, of the second party,
so that it is important to have on the engagement blank as much
information as possible concerning the engagement. An accurate

HAS KINS A SELLS MEMO. OF ENGAGEMENT No. 15p

CIXTiritO PUVLIO ACCOUNTANT*

ASSIGNED TO

Office. February ?; S M15>

t. Client. War bur ton Desk company,

a Address. 265 Broadway, Hew York.

3. Conference, JO&a WOOd, President.

4. Letter, dated February 1, 191$.

5. Telephone. Barclay 1894

S~\ 6. Report to be addressed to. President.

7. Account to be charred in Ledger. WaTbUTtOn DeSfc Company

8. Examination to be made of, game .

9. Where located. as above.

10. Nature of business, Manufacturer of desks.

11. Nature of work. Audit for the year ended December 31, 191*.

12. When to be commenced, February 12 1915.

IS. Probable time required. f OUT Weeks .

14. Accountants required. one Senior.

15. Rates, usual.

ia Remarks, Report required not later than March 15, 1915.

(Noted: Foruseof New York office only)

Specimen Engagement Blank

description of the work to be done is very important since there
are a number of people interested in the information. The man
who manages the staff wants to know when the work is to be
commenced so that he may have the necessary accountants of the

PRINCIPLES OF AUDITING

right grade ready at the proper time. He needs to know the prob-
able length of time required so that he may know when such men
will be available for other work. It is not always possible to say
with exactness how long an engagement will take, but it is pos-
sible by using a small amount of time for the purpose of esti-
mating, to determine with a fair degree of accuracy, the length of
time required. Take, for example, the vouching of cash disburse-
ments and the footing of the cash book. One may determine very
easily the length of time required to check a page of entries con-
taining forty or fifty items and also how long it takes to foot a
column of figures that long. With this information it is an easy
matter to look through the book and find how many pages of cash
disbursements there are. By multiplying the time required for
one page by the number of pages, the total time required for
vouching and footing the disbursements is ascertained. By apply-
ing this test to the various units of work and putting together
the time of the various units it is possible to determine approxi-
mately the length of time required for the engagement. A liberal
percentage must also be added of course to allow for failure of
the man performing the work to live up to the schedule, and to
a certain extent, to cover unforeseen circumstances. A hasty ex-
amination of this kind may not disclose the fact that all vouchers
and documents are not of the same type and that numerous
vouchers, for example, are supported by many sub-vouchers,
which fact was overlooked in making the estimate. Neverthe-
less, a rough idea of how long a man will be engaged is better
than no idea at all.

The probable length of time required on an engagement is of
interest not only to the staff manager in order that he may
know when the man will be available, but to the man who makes
a flat or contract price for an engagement. Incidentally, it is
not a good plan to take contract engagements. The element of
risk is too great on all sides. The accountant is liable to under-
estimate the length of time required to do the work and con-
sequently one of three things may happen. Either the accountant
will lose money on the engagement or he will make money at the
expense of his staff by working the men overtime, or the quality
of the work will suffer. While theoretically contract engagements
are wrong, as a matter of practice they are common.

If an accountant is working for himself the engagement blank

THE ENGAGEMENT

is handy as a memorandum of conditions. If he is working for
some one else it is handy for purposes of information. An ideal
engagement blank is one that will convey to any one who has
occasion to use it, all the information pertaining to the engage-
ment. The number of copies to be made may differ in different
offices. The accountant working for himself needs but one or at
the most two. In a large office it is customary to make four
copies; the original and three carbons. One goes to the staff
manager in order that he may know what to do and when to do
it; one copy goes to the financial department in order that the
account with the client may be opened and provision made for the
charges as they come through ; a third copy goes to the file room
in order that the man in charge of the file room may be on the
lookout for working papers and reports from the respective en-
gagements and in order that he may know to whom to send the
report when it is ready to be delivered. The accountant who
takes up the engagement receives the fourth copy and requires
the information in order that he may proceed with the work
intelligently.

Most engagements are carried out in the offices of clients. It
would perhaps be more exact to say that the work on most en-
gagements is carried on outside of the office of the accountant.
There will occasionally arise, however, engagements where the
books are small and the vouchers are few in number and all books
and papers may be taken to the office of the accountant and the
work done there. In the majority of cases this will not be so.

It has seemed to the author that students might get a better
grasp of the subject if each student as he pursues the reading
of this text imagines that he is going out on a small engagement
where he would do personally all the work. Such, as a matter of
fact, is the best kind of experience for the young man. Out of
such an engagement where there is an opportunity not only to see
but to do the work in its entirety, most benefit is to be derived.
Young men about to enter the profession frequently ask the ques-
tion as to whether it is better to go with a large or with a small
concern. It seems to be difficult to decide since each has its
advantages and disadvantages. In one case the young man comes
in contact with small engagements where he learns all there is
to be learned about them. As a rule, however, he sees no large
engagements. On the other hand, where he is employed by a

PRINCIPLES OF AUDITING

firm of accountants which has large engagements he is apt for
a good while to do nothing but detail work and see only a small
part of the large engagements. While an ideal concern with
which to serve an apprenticeship is one whose work is sufficiently
broad in its scope to offer a variety of both small and large en-
gagements, there is one thing to be said in favor of the latter.
If the apprentice keeps his eyes and ears open and takes advantage
of all his opportunities, what he learns is how to run a large en-
gagement. This may be advantageous to him if he ever starts in
business for himself and is fortunate enough to obtain a large
engagement. Being familiar with the large engagement he has
no hesitancy in accepting it, as he is enabled to carry on the work
without fear of failure.

CHAPTER VI

WHAT TO Do BEFORE BEGINNING AN AUDIT

The practical hints which follow may seem to some too trivial
to warrant mention. They are admittedly small matters. Just
these little things, however, sometimes make the difference be-
tween success and failure, in so far as the novice is concerned. The
young man starting in the profession has a great many persons
to satisfy. There is not only the staff manager but the members
of the office force with whom he comes in contact, as well as
the senior accountant who has charge of the engagement. There
are, in addition, the employes of the client and perhaps the
client himself with whom he comes in contact on the engage-
ment. To have his work at all times beyond reproach as he
comes in contact with these various individuals, requires constant
vigilance. Attention to the small details undoubtedly goes a long
way toward giving him a satisfactory status.

The first instructions to be given to an accountant going out
on a small engagement might be, "get your engagement blank
and your letter of introduction." The engagement blank has
already been described. The letter of introduction might read as
follows :

JONES AND PARKER,

Certified Public Accountants,

32 WAVERLY PLACE,

NEW YORK CITY.

February 12, 1915.
MR. J. G. SHERMAN, Treasurer,
Warburton Desk Company,
265 Broadway,
New York.

Dear Sir:

This will introduce our representative, Mr. Arthur Read, who is
calling on you for the purpose of taking up the work of auditing the
accounts of the Warburton Desk Company.

Yours very truly,

(Signed) JONES & PARKER,

Certified Public Accountants.
21

PRINCIPLES OF AUDITING

It is not possible in these days and especially in the large cities
to walk into an office and begin an examination of accounts which
are frequently of a private and confidential nature without creden-
tials of some kind. The nature of the accountant's work and the
liberties extended to him are such as to require that he shall be
properly introduced and accredited.

Among the other things with which an accountant needs to
provide himself before leaving the office, especially if he is going
out of town, are time and expense reports, expense funds, railroad
and Pullman tickets. It has been said of the professional ac-
countant that one of his compensations is that he is permitted to
travel like a gentleman.

Specimen time and expense reports follow :

WHAT TO DO BEFORE BEGINNING AN AUDIT

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PRINCIPLES OF AUDITING

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WHAT TO DO BEFORE BEGINNING AN AUDIT

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Accountant's Expense Report

The accountant should always provide himself with analysis
paper, twelve or fourteen columns, preferably fourteen, since the
latter is better adapted to the use of the working sheet. There
should also be included in the equipment, journal paper, bank
certificates in blank, scratch paper, J2 black pencils, blue and red
pencils, a rubber eraser and a small ruler not over twelve inches
long. For the benefit of the uninitiated there follows a reproduc-
tion of analysis paper.

PRINCIPLES OF AUDITING

WHAT TO DO BEFORE BEGINNING AN AUDIT

The accountant's outfit is not complete without a memoran-
dum book or diary. In it he should note daily the engagement
on which he is working, the hours during which he has worked
and the particulars concerning the work on which he has been
engaged. For example, "October 15, Warburton Desk Company
9 to 12; 1 to 5, counting cash and reconciling bank account."
This information will be required when the accountant comes
to make up his time report. He should also note in this book
the details of his expenses so that he may supply these details
when making up his expense account.

It is well to preserve these diaries from year to year, since
they play an important part at times in case he is called upon
to testify in court, and requires something to refresh his memory
as to precisely what he was doing on a certain date and at a
certain time. The author had occasion during the year 1914 to
give testimony concerning work which he did during the year
1907. Two parties to a series of joint ventures which extended
over a period of ten or twelve years became involved in litiga-
tion. One party disclaimed all knowledge of the conditions of
the books and financial statements and pleaded ignorance in
these matters. The author was able, through reference to his
old diaries, to give dates and hours at which he discussed in
detail the conditions of the books and the statements with this
particular party. It is needless to say that this evidence was
damaging to the party just mentioned. The judge later referred
to the testimony as being "precise and convincing." This inci-
dent is mentioned simply to illustrate the manner in which an
accurate diary may be of considerable value to the accountant
in enabling him to appear favorably if called upon to give
testimony.

The supplies previously mentioned should be gathered and
put into an envelope or bag. A working bag with the name-
plate on the outside is of course desirable. A heavy paper or
linen envelope will, however, serve the same purpose if the sup-
plies are not too numerous or extensive in quantity. At any
rate, the accountant's name and address or the name and address
of the firm for which he is working, should be put on the out-
side of the envelope. This is in order that the envelope may be
restored to its owner in case of loss, which is of all the more
importance in case the envelope happens to contain old working

PRINCIPLES OF AUDITING

papers which may be private in their nature. Accountants have
been known to become so engrossed in thinking about their work
while traveling on cars and trains as to leave bags or envelopes
behind upon quitting the conveyance.

Upon reaching the office of the client the accountant should
conduct himself with humility and be polite. Politeness carries a
great deal of weight, and humility makes a good impression. To
walk into the office of a client with one's hat on and with no
regard for the people in the office, tends to create a prejudice in
the very beginning. It is perhaps almost unnecessary to say
"take off your hat and be polite and friendly but not familiar.'*
Due regard for the client and his employes will frequently open
the way for relations which will be pleasant, and in so far as they
concern the success of the accountant on that particular engage-
ment, profitable.

No time will be wasted which is spent in getting the em-
ployes with whom the accountant comes in contact into the
proper frame of mind. The man or woman whose work is to
be reviewed will react favorably if given credit for knowing
more about the details of the work than the accountant. A
man who has been keeping a set of books for some time, ob-
viously knows more about them than the stranger, no matter
how expert or learned in his profession he may be. The book-
keeper will appreciate being permitted to feel that this is so and
will resent being told that he does not know his business, that
the system is poor, or that his methods are old-fashioned. These
things may all be so but no good comes of impressing them on
the person affected. Because of the fact that he is a human
being to do so will be almost sure to make an enemy of him.
This, of course, should not be carried to the extent of becoming a
hypocrite. One may use tact and diplomacy in approaching a
client or his employes without becoming a hypocrite.

Above all things do not assume that all men are "crooks."
The auditor who gets that point of view has a miserable time.
A better point of view is that of assuming that the auditor is
there for the purpose of establishing the fact that everything
is right, and assuming that such is the case, until proved otherwise.

The auditor should not make himself objectionable on an en-
gagement by asking too many questions. He should use his
brains, think about things and study them out for himself. "Keep

WHAT TO DO BEFORE BEGINNING AN AUDIT

your mouth shut, your ears and eyes open" is a good rule. Many
instances have come to notice where accountants have made
themselves disliked through the habit of asking numerous and
unnecessary questions.

Ideals are excellent, but they should not be allowed to pre-
vail over commonsense. They should be tempered with judg-
ment. Procedure which might be quite proper in general would
perhaps need to be changed in a case, for instance, where the
stock of a certain corporation is all owned by one man, the re-
port goes to one man, affects no one in the organization but
himself and is used for no outside purpose. Certain opinions
of such a man may not coincide precisely with those of the ac-
countant. He may wish his books kept in a certain way. The
accountant need feel no offense because this is so. He may have
the opinion that the ideas of the proprietor are wrong and that
his way of doing things are not the most approved, but there is
no reason why he should drop the engagement because of this
fact. The position of the proprietor may not be a variation of
principle but represent rather a difference of opinion. If such a
man wishes the accountant to certify to the effect that the
accounts are right and properly kept and the accountant feels
that they are not all right, it is a different matter entirely. Ethics
and honor are two things to be zealously guarded.

Another important thing is to find a comfortable place to
work. A table or desk that permits papers to be spread about
is desirable. The work should be carried on by daylight if pos-
sible rather than by artificial light. The light should come in
over the left shoulder if such arrangement can be effected. The
auditor will as a rule be more comfortable in a room by himself.
This, however, is not always possible. He should learn to work
if necessary in a place where there is nothing but noise and
confusion. He should school himself so that if it becomes nec-
essary, he may work in a factory where all the machinery is
running. He should learn to pull himself into his shell as it
were, and shut out all the noise; to concentrate on the work
before him. The old-fashioned sign, "Don't talk to the book-
keeper," is a thing of the past. If the accountant were to dis-
play a sign, "Don't talk to the accountant," he would become the
laughing stock of those about him. He is expected to work if
necessary in a place where there is nothing but confusion ; people

PRINCIPLES OF AUDITING

talking to him; people bringing books to him and taking books
away from him. He may be in the act of footing a column of
figures when someone comes to take the book away. Conse-
quently he must learn to accommodate himself to circumstances.

How to Begin an Audit

CHAPTER VII

COUNTING THE CASH

The preliminaries over, attention should be devoted to count-
ing the cash, notes receivable, and the securities. These should
be counted at once because of the fact that they may move.
The make-up of cash to-day will probably not be the make-up
of the cash to-morrow. Securities on hand to-day may not be
the same to-morrow.

Having included in the outfit of supplies a quantity of jour-
nal paper, a sheet or more of same will probably be found best
adapted to recording the count of the cash. The sheet should
be headed up, showing at the top the name of the client or
the name of the organization whose cash is being counted,
together with the address of same, the date and hour of the
count and the name of the person who has the custody of the
cash. It is probably preferable to allow the person who is in
charge of the cash to handle same. There are two reasons
for this. One is that the auditor is not as a rule skilled in the
handling of cash. A man who is handling it all the time can
count it very much faster and with more accuracy than a man
who counts cash once in a while. Such a man is liable to be
clumsy and more apt to make a mistake than the other man.
The other reason is that if the auditor does not handle the
cash himself there is no possibility of his becoming involved
in any irregularity. He may thus avoid becoming a victim of a
sharp trick. Cashiers have been known where irregularities exist
to attempt to put a part of it at least on the auditor who counted
the cash. If the auditor does not touch the money he will not
be involved in any such altercation.

The cash should be listed on a sheet of journal paper show-
ing separately the bills according to denominations as well as
the total amount of bills ; the gold by denominations showing the
total and the silver by denominations showing the total. Any
I. O. U.'s, checks or vouchers, should be listed and full particu-
lars given. A check mark of some kind should be placed on
these papers individually, to indicate that they have once been
seen and to prevent any question from arising later as to whether

PRINCIPLES OF AUDITING

or not such is the case. Here, again, the auditor may be the
victim of sharp practice through papers being substituted after
the cash has been counted. It is not necessary to make an
elaborate check mark which will deface the papers or annoy
the person who is responsible for them. A small double tick
is equally satisfactory in every respect.

While on the subject of checking it might be desirable to
insert a word of caution about marking up the books and papers
of a client. The auditor has no right to deface, mutilate or
destroy the records of the client because he has the right to
examine them. A bookkeeper or clerk who has been neat and
careful in his work, resents having its appearance spoiled by
the auditor.

Care should be exercised in putting down everything in the
way of information connected with the count of the cash. This
is important because one never knows under what circumstances
the information may be needed. If it is put down on paper it
may be carried away and will be available in the future. The ac-
countant might, for example, count certain cash in Waco, Texas,
on one date and be obliged to discuss the cash account a month
hence in New York with some officer of the company. It would
be embarrassing under such circumstances, not to have all the
facts, and be obliged to communicate with the office in Texas
concerning the matter.

Having totaled up the sheet on which the cash account ap-
pears, the total according to the account should be compared with
the balance in the cash book; the debit and credit footings put
in the cash book in ink by the auditor; a line drawn above and
below the respective footings; the initials of the auditor with
the date placed alongside of each footing and the balance noted
in the explanation column on the debit side of the cash book
in ink.

If there is any difference between the cash as counted and
the balance called for by the cash book, the person handling
the cash should be given an opportunity to explain it or run it
down. The most honest cashier that ever lived may, under the
strain of having his cash counted, exhibit signs of nervousness.
He may count two bills as one as they stick together. In list-
ing some of the papers he may skip one or fail to put it down.
If the auditor is handling and listing the papers, he may make

COUNTING THE CASH

some error. It is not necessary to accuse a man of being short
until he has had an opportunity to look over the accounts. It
is not necessary to accuse a cashier of crookedness if he is out
of balance only to a small extent, which difference undoubtedly
signifies carelessness rather than dishonesty. If the discrepancy
is sufficiently large, even though it is straightened out by the
cashier, the fact should be brought immediately to the attention
of the proper person. The matter should not be left for two
or three weeks when it may be made the subject of argument.
The auditor should go immediately to the proper person, who
may be, depending upon the circumstances, the office manager,
the treasurer, or perhaps the president of the company, and
make the facts known. The question is sometimes asked, "If a
cashier is short and puts in the amount of shortage, should it
be reported?" The answer is that it depends on circumstances.
It is quite evident that a man may be 50 cents, 73 cents, perhaps
$2.00 or even $5.00 out of balance and willing to put in the
amount of the discrepancy. Under such circumstances it is not
probable that th,e matter would be worth reporting. Such a
condition will probably indicate carelessness or unfortunate in-
accuracy and nothing more. If, however, that condition is found
repeatedly in counting the cash from month to month, the in-
dications are that such person, altho not dishonest, is not suffi-
ciently careful and accurate to be entrusted with the handling
of the cash. It should be a matter of pride on the part of
cashiers that they balance to a cent. Constant shortages in-
creasing perhaps in amount may excite suspicion of dishonesty
which is well founded. Tellers in banks are perhaps an excep-
tion to the rule that cash should balance to a penny. On account
of the great volume of business handled by receiving and paying
tellers, it is not unusual for mistakes to occur and discrepancies
to result. This is a well recognized situation and is usually
allowed and provided for in an "over and short" account. In
fact, in some of the large banks the clerks and tellers are not
held at night for a balance if the discrepancy is less than $50.00.
All the cash should be counted. It does not matter if the
cashier insists that a certain envelope with money in it does not
belong in his cash, it should be counted anyway. The amount
need not necessarily be included in the regular count of the
cash, but the amount involved should be jotted down on a paper

PRINCIPLES OF AUDITING

so that a record will be had of it in case it is needed later. It
is probably not going too far to say to the novice, look through
all the drawers or compartments of the cash box or till and
see that everything is presented for verification. It is sometimes
desirable to look through the compartments in the safe where
cash is sometimes kept in order to be sure that nothing escapes
attention. Some authorities hold that small amounts of cash
need not be counted. The author's feeling in the matter is that
all cash, no matter how small in amount, should be counted, if
for no other reason than the moral effect which the procedure
has.

The auditor should not accept without visual examination,
canvas bags said to contain silver. He should insist that the
bags be opened so that he may assure himself of the contents
and proceed to have it counted or count it himself. Where the
quantity is extensive, as in the case of banks or trust companies,
it is possible frequently to save considerable time by taking the
money to some neighboring bank and have it put through a
machine for counting money. Some of these machines merely
count the money while others count it and put it up in pack-
ages. The auditor may save the man who follows him on the
engagement, considerable time, if after counting the small change,
he puts it into a bag and places a seal with his certificate on
the bag. The succeeding auditor upon finding that the seals have
not been broken will then be relieved of the necessity of counting
the money again.

Gold may be weighed. While ordinarily very little gold is
encountered in making a cash count, there will be times, as in
the case of banks where great quantities of gold will be found.
If the auditor will count a thousand dollars worth of gold and
weigh it, he will then have a basis upon which to calculate the
total amount of the gold involved. This method is generally
satisfactory, as gold runs fairly true to weight. The variation
on account of coins which have become worn more than usual
is negligible. Having weighed a thousand dollars worth, the
balance may then be weighed and the weight translated into
terms of dollars.

In some organizations there will be a general cashier who
will have a general petty cash fund, and who will in turn, dis-
tribute smaller amounts to other employes. This is especially

COUNTING THE CASH

apt to be true in hotels. The men behind the desk where the
guests go to register are known as front desk clerks. These
clerks usually act as cashiers and have their individual cash funds.
In addition there will be funds in the possession of the cashiers
at the bar, cigar counter and in the restaurant. It is always
advisable to make inquiry in the beginning before starting to
count the cash whether there are any funds other than those
held by the general cashier. It is sometimes embarrassing to
proceed with the audit and find petty disbursements coming in
from one source or another and upon inquiry to discover that
there are a number of individuals throughout the organization
who have petty cash funds. If the question had been asked in
the beginning and the cash all counted at one time, there would
not have been any possibility of one party passing money to
another to make up shortages. When the cash count is started
it should be completed as soon as possible so that one employe
will not have an opportunity to pass the word along to another,
or perhaps furnish him with enough to make up the shortage.
When counting the cash of two individuals who are in close
proximity one to the other, both individuals should be kept con-
stantly in sight by the auditor so that no assistance in the way
of supplying cash may be rendered one to the other.

It is preferable if possible, that the cash be counted on the
last day of the period which the audit covers. This remark
applies with equal force to notes and securities. If the fact that
an audit is to be made for the year ending June 30 is known
some time prior to June 30 it is well to arrange to count the
cash on June 30 if possible. This, of course, cannot always be
done because of the fact that many times it is not known that
an audit will be made until long after the period has closed. A
client may not decide to have the accounts audited until after
the close of the fiscal year. In such a case the next best thing
may be done, namely, count the cash and securities immediately,
or do it the first thing upon taking up the work. After the
count has been finished and the balance compared with the bal-
ance in the cash book, the balance should be "worked back" to
the date on which the period covered by the audit closed.

The illustration which follows attempts to present a sheet
of journal paper showing the manner in which the record of
the cash count appears.

PRINCIPLES OF AUDITING

-ff~

y& >^

Vtt

Record of Cash Count

COUNTING THE CASH

In the foregoing illustration Mr. Rockwell is the name of the
man who handles the cash, that is, the man who is responsible
for it; the cashier or the man whose cash was counted. The
count shows silver dollars, altho not very many. Silver dollars
are not numerous in the North and East, but in the South and
West are frequently encountered in large quantities. The reason
for segregating the money according to denominations is that an
error may be easily located if it exists. Suppose for example,
the cash were $10.00 out and the count had not been kept sep-
arately according to denominations. In attempting to discover
the error it would be necessary to count all the money. Where
the bills, gold and silver are kept separately and each class of
denominations is shown separately, recounting the ten-dollar bills
or the ten-dollar gold pieces may lead quickly to the discovery
of the error, in which case, it will not be necessary to recount
further. Concerning the I. O. U.'s and checks -it is important
that the date as well as the name of the maker and amount should
be set down. The I. O. U.'s and checks which have been in the
cash for any considerable length of time will naturally call for
explanation. It is not necessary for the auditor at this time to
express any opinion as to these items. He should, however, at
the time when they are before him make a complete record of
them and set down any explanation concerning them which may
be made to him while the explanation is fresh in his mind. The
vouchers shown will probably be receipts for small amounts which
have been paid out by the cashier and for which at the time of
the count he has not yet received reimbursement or has not
turned in.

The result of the cash count as per the foregoing illustra-
tion is shown to be $2,628.22. The count was made on July 17,
1914. The balance shown by the count should agree with the
balance in the cash book on July 17, at the hour when the count
was made. In order that this may be so it will, of course, be
necessary that all items of receipts and disbursements shall have
been entered by the cashier up to that time. It may be found
that the cashier has not had an opportunity to enter all receipts
and disbursements, in which case such opportunity should be af-
forded in order that the proper balance may be struck and the
balance agreed with the count.

Assuming that the balance in the cash book has been agreed

PRINCIPLES OF AUDITING

with the count, the following tabulation shows what is meant by
working back the cash :

February 12, 1915, balance per cash book, p. 263 $2,628.22

Add disbursements, January 2 to February 12 5,785.13

$8,413.35
Deduct receipts, January 2 to February 12 5,632.94

Balance December 31, per cash book, p. 257 $2,780.41

If any difficulty is experienced in understanding this tabula-
tion, the items may be reversed, when the procedure will prob-
ably be seen at once. The vouchers and figures as they appeared
in the cash book were as follows :

Balance, December 31 $2,780.41

Receipts, January 2 to February 12 5,632.94

$8,413.35
Disbursements, January 2 to February 12 5,785.13

Balance, February 12 $2,628.22

It should be noted that the real figure with which the auditor
is concerned ultimately is the balance of December 31. It is that
he has been trying to prove. Since he was not able to count the
cash on that date he has availed himself of the first opportunity
and used the intervening transactions as a means of checking
the amount which it is claimed was on hand on December 31. The
figures as shown by the cash book covering these intervening
transactions may be accepted for the present and the amounts of
receipts and disbursements respectively determined by footing
the items representing them in the cash book.

While the following suggestion may be a valuable one, it
should be put into practice only with discretion. Cashiers whose
funds were counted and found correct, have at times been found
short when the cash was counted a second time. This procedure
should not be set down as a general rule. It should only be put
into practice when the auditor has reason to feel dissatisfied

COUNTING THE CASH

with the first count. It is not always possible to confirm a sus-
picion when counting the cash the first time. It is not always
diplomatic to suggest any irregularity even if the suspicion is
present. It is not always tactful to show signs of dissatisfaction
if the person whose cash is being counted does not perform in
every way as absolute honesty dictates he should. In such cases,
or where the auditor has any reason not to feel perfectly satis-
fied with the count or the conditions under which it was made,
he may count the cash a second time during the audit or at
the end of the engagement just before leaving.

CHAPTER VIII

COUNTING THE NOTES AND SECURITIES

After having finished counting the cash the notes receivable
should be taken up and counted. Notes receivable are like cash
and securities, in that they may move. For the purpose of
recording these, analysis paper will probably be found more
satisfactory than journal paper because of the need to spread
out the information and classify it through the use of the col-
umns on the paper. The sheet should be headed up with the
name and address of the client or organization to which the
notes belong. Each note should be examined and listed, setting
down in each case the following information; date of the note,
name of the maker, the amount, date of maturity and rate of
interest. Some notes may not carry interest. If so, the fact
should be noted. Failure to make a memorandum of this kind
may cause the accountant to come to a false conclusion later
on when accruing interest, and perhaps after he has left the
office of the client, that he failed to set down the rate of interest
on the note in question. If the memorandum is made at the time
the note is examined such alarm will be avoided. Notes are
made in two ways; one kind reads substantially, "I promise to
pay John Smith one thousand dollars 60 days hence with in-
terest at 6%." The other kind reads : "Sixty days after date I
promise to pay John Smith one thousand and ten dollars without
interest/' In consequence of such variation notes should be
scrutinized very carefully.

As a memorandum the names of any indorsers appearing on
the notes should be taken down. It sometimes happens that a
concern will take a note from a corporation if the note bears the
personal indorsement of some officer of the corporation, when
it would not accept the note otherwise. A count of notes in a
certain case recently revealed just that situation. The notes were
those of a corporation not at all well known, but in which a
prominent inventor was interested financially. It had been the
custom of the client to accept notes from the corporation in ques-
tion only in case they were indorsed by a well-known individual.
One or two notes out of some nine or ten had come through

COUNTING THE NOTES AND SECURITIES

which had not borne the usual indorsement, had passed the cashier
and been filed away without the oversight having been noticed.
The absence of the indorsement was discovered by the auditor
in examining the notes. It was quite important that the excep-
tion to the rule should have been noted and the attention of the
client called to the fact that he had in his possession one or two
pieces of paper not as strong as the others, or at least not as
strong as he desired to have them.

The auditor will have occasion at some subsequent time either
to calculate or check the accrued interest. On this account it
is extremely important that all facts concerning the notes and
interest be made a matter of record in his working papers so
that such work may be done at any time, even after he has left
the office of the client. He should put some mark of identifica-
tion on the notes when they are counted, in order that others
may not be substituted and that he will be fortified in case a
dispute of any kind arises and it becomes necessary for him to
state specifically just what he saw and counted.

Securities embrace, generally speaking, stocks, and bonds, and
bonds and mortgages. Analysis paper is more convenient for
listing securities than journal paper. Such should be headed up
with the name and address of the organization and a description
of the contents of the sheets; also the date that the securities
were counted and the hour. Stocks may be considered first. The
stock certificates should be examined to see that they stand in
the name of the organization whose accounts are being examined,
or are indorsed in blank. It sometimes happens in close
corporations, where the stock is perhaps all held by one individual,
except such shares as are necessary to qualify directors, that stock
certificates will appear in the name of the principal individual
concerned. The stock that is owned by a corporation should
appear in the name of the corporation, or if the stock happens to
be in the name of the individual, it should either be transferred or
assigned in blank.

The list should show with regard to each kind of stock held
the name of the company that issued it, the number of shares or
the kind of shares (preferred or common), the par value of each
share, the par value of the block of shares held, and whether or
not the stock is fully paid and non-assessable.

Care should be exercised with regard to stock on which in-

PRINCIPLES OF AUDITING

stalments have been paid. A certificate will now and then be
found which appears on casual observation to be a stock certifi-
cate for one thousand shares, par value $100, amounting at par
to $100,000. If this certificate is examined carefully there will
be found perhaps in one corner or on the margin a statement to
the effect that 25%, or the first instalment only, has been paid.
While this is an exception to the rule that stock should not be
issued until paid for, it is nevertheless true especially where
large amounts are concerned that stock certificates are issued
with the indorsement as to the instalments thereon which have
been paid. It will make considerable difference in trying to bal-
ance out the total of the list against the securities ledger, if in
such cases, stock is listed as fully paid when in fact a percentage
only has been paid.

In the case of bonds, analysis paper should be used for list-
ing and the sheet headed up the same as for stocks. The list
should show with regard to each kind of bonds held (after having
been examined and counted) the name of the company which
issued the bond, a complete and accurate description of each,
par value of each bond, par value of the block of bonds and
the date of maturity, the rate of interest and the dates on which
the interest is payable. Each bond should be examined. If a
registered bond, the examiner should see that the last payment
of interest has been indorsed thereon. If a coupon bond, the
coupon should be scrutinized to see that the next one coming due
as well as all the succeeding coupons are attached and intact.
Provision should also be made on the analysis paper, through
appropriate columns, for the accrued interest and in some cases,
for amortization and accumulation. It is not probable in a small
organization where there are few investments and they are small
in amount that amortization and accumulation would need to be
considered. Where the reverse is true, they are matters of
importance.

With regard to the accuracy of the description, a word or
two should be said. There are at least two good reasons why
the auditor should be particular about describing a bond accu-
rately. Accuracy begets confidence. One can never tell when
this information may be needed. There is no end of embarrass-
ment when the information is not accurate. There is an equal
amount of satisfaction when the information is accurate. In

COUNTING THE NOTES AND SECURITIES

attempting to verify the figure at which bonds are carried, ref-
erence is usually had to some publication like the Financial and
Commercial Chronicle or the daily papers for the purpose of
getting quotations. Whether or not the correct quotation is ob-
tained will depend in certain instances on the description. For
example, the Chicago, Milwaukee and St. Paul General 4's were
issued in series. Series "A" will mature in 1952, series "B"
in 1962, series "C" in 1972. In looking up the different quota-
tions on these different series it will be found that they are quoted
as follows: series "A" 78, series "B" 87, series "C" 93. It
will be seen consequently that failure to note the series in a case
of this kind will later make a difference of from ten to twenty
points in the valuation.

The information concerning the rate of interest, the dates on
which the interest is payable, etc., will be needed either in order
to make or check the accruals of interest and to determine very
often whether or not the interest has been properly treated. A
bond may be bought at 102 and accrued interest and carried on
the books at $1,035.27, for example. Three things in reality
have been bought; a par value principal, a premium and some
accrued interest. When the coupon is paid it will be based on
the par value principal, but a part of the total of the coupon will
be earned during the period. The interest should be divided
into two parts. One part should be credited to the accrued
interest and the other to interest earned. It is important that all
facts concerning interest should be available in order that the
treatment of the interest may be properly checked. This, for
example, might involve ascertaining whether or not the whole
amount of the coupon in such case had been credited to interest
earned and the accrued interest which attached to the bond when
it was purchased allowed to remain as an asset, or whether
the amount of the coupon had been properly apportioned and
treated.

Where bonds are found in which coupons have been de-
tached inquiry should be made immediately to ascertain the
reason. Such an inquiry should of course be tempered with
judgment in case it is quite apparent that the coupons have been
detached for collection. If such is the case, however, the coupon
should be traced through and checked out.

It might also happen that bonds are out for the purpose of

PRINCIPLES OF AUDITING

being registered as to principal or interest. Where this is the
case a memorandum should be made as to the particulars con-
cerning them and they should be examined at some later date.
It is always advisable that they be seen sooner or later, altho
in some instances where litigation is going on they may be held
by some trustee. In extreme cases it may be necessary to obtain
from a trustee or the registrar a certificate to the effect that the
bonds are being held.

Again in the case of bonds and mortgages analysis paper
should be used for listing the documents. They should be ex-
amined and a record made of the date, the name of the maker,
the amount, the date of maturity, the rate of interest and the dates
on which the interest is payable, if specified. Two documents
or instruments are involved, the bond which is the evidence of
indebtedness and the mortgage which is the security for the bond.
It is the bond which should be examined for the information
just mentioned. The mortgage should be scrutinized to see how
it is made, by and in whose favor and whether or not in favor
of the client. If not so made it should be properly assigned.
The examination should include verification of the fact that it
was signed, witnessed and recorded.

In connection with the matter of record it sometimes hap-
pens that bonds and mortgages will at the time of counting the
securities be out for the purpose of being recorded. In certain
counties in New York, owing to the vast amount of work of
this character, it sometimes requires a considerable length of
time to have the record effected. Consequently in extreme cases
it may be desirable to get a certificate from the county clerk to
the effect that certain mortgages are being held for record.

Incident to the matter of record it is important that the audi-
tor in examining the bonds and mortgages in New York should
watch for mortgages recorded between July, 1905 and July, 1906,
and be sure that the entire mortgage tax for such period has
been paid. The tax on some mortgages executed during this
period still remains partially unpaid.

Insurance policies on property covered by mortgages should
be requested and inspected to see that the property is amply
protected. A mortgage on a building would not be of much
value if the building were to burn and not be protected by in-
surance. One who holds a mortgage usually sees to it that the

COUNTING THE NOTES AND SECURITIES

property is insured and usually insists that the insurance policy
be filed with the person holding the mortgage.

Tax receipts should also be produced as evidence of the fact
that the taxes have been paid up. Since a tax lien on property
takes precedence over everything else it is highly important that
the value of the property be not impaired in this respect.

Among miscellaneous securities, in addition to the three classes
above discussed may be found certificates of indebtedness, cer-
tificates of deposit, warehouse receipts, scrip, receipts for pay-
ment on account of capital stock, subscriptions and evidences of
syndicate participations. While these may not include every-
thing with which the auditor may come in contact they
are sufficiently indicative of what is meant by miscellaneous
securities.

As a word of advice to the young and inexperienced auditor,
it may be said that he is justified in taking as much time as he
needs to properly read and interpret the miscellaneous docu-
ments above mentioned. He should not be afraid to take all
the time necessary to read them through in order to find out
what they are. He should not allow anybody to worry him or
hurry him until he has satisfied himself in this particular. He
is charged with the duty of passing judgment on such instru-
ments and it is vital to him that he should not pass anything
without knowing exactly what it is and being satisfied con-
cerning it. He should never hesitate to take down all the facts
and all the details which he thinks necessary. While tact is of
course important, he should bear in mind that he is not counting
the securities in order to accommodate the man in whose cus-
tody they may be found, but rather to verify the fact of their
existence and propriety as an investment.

CHAPTER IX

TAKING OFF THE TRIAL BALANCE

The preliminary work having been completed possibly the
next thing to be done is to have the pass book sent out to be
balanced. It will sometimes happen that the pass books 'have
recently been balanced and the persons concerned in sending
them out will hesitate to do so. The auditor should, it seems,
insist on having them sent again if necessary. While this pro-
cedure is not absolute proof against collusion, it tends to pre-
vent it and to discover it if it exists. It is not considered suffi-
cient as a rule to accept the balance shown in a pass book even
after it has been balanced a second time, for the reason that
there may have been collusion between some clerk in the bank
and some employe of the company. In addition to having the
pass book balanced, a certificate signed by some proper officer
of the bank, setting forth the amount of the balance should
be obtained. The auditor will be called upon either to write a
letter to the bank requesting a certificate, or to send out a form,
letter containing the request. The request in either case should
have the approval of the client before being sent to the bank.
The bank should be asked to return the certificate to the auditor
direct and not through the client or his office. It is important
that the letter should be approved by the client since it is not
customary for banks to furnish information concerning balances
of depositors upon request without the approval of the depositor.
The question has sometimes arisen as to whether or not banks
have the right to give out such information without the permis-
sion of the depositor. Banks have frequently held that such
information is confidential and have refused to divulge the
condition of a despositor's account without a court order. Speci-
mens of the letter and blank form above mentioned will be
found below.

TAKING OFF THE TRIAL BALANCE

Jones and Parker,

Certified Public Accountants,

32 Waverly Place,

New York City.

February 12, 1915.
Second National Bank,
Fifth Avenue and 27th Street,
New York City.

Gentlemen :

In connection with our examination of the accounts of the
Warburton Desk Company, we are desirous of verifying the
amount on deposit with you to the credit of said company at
the close of business on February 12, 1915.

Will you oblige us therefore by sending your certificate to
our office at the above address?

Yours very truly,

(Signed) Jones and Parker,

Certified Public Accountants.
Approved :

A letter such as the above would probably be used by an ac-
countant with a small business or dealing with small concerns.
Many of the larger firms of accountants deal with large organi-
zations which have numerous bank accounts. It is not unusual
for railroads to have from forty to fifty such accounts. Where
there is occasion to request a great many certificates, the audi-
tors frequently avail themselves of a blank form. This form
is perforated, the upper part being a letter addressed to the bank
while the lower part is a certificate to be filled out by the bank.

PRINCIPLES OF AUDITING

HASKINS & SELLS

CtRTiriED PUBUC ACCOUNTANTS

30 BROAD STREBT

NEW YORK

1AM FOANCItCO

York, mruary 12, 1*15.

Dear Sirs:

Please complete and mail to us, in the accompanying stamped and addressed envelope, the attached
certification in respect nt Ibt WMTtUTtOn PMlt CTBIHinT
foi which we extend our thanks in anticipation of your prompt attention
APPROVED Yours very truly,

COPYABLE

Messrs. Haskins A Sells,

Certified Public Accountants

No __ L

Dear Sirs:'

At the rinse of business on JgbmtTJ It, 1915 1 <" balance on our books to the

of m wurturtcn 3*ik compaay

In the period from CCOD*r 31, 191t to

Inclusive, we credited or paid said Hit WWtoUTtOn D8lC COBpny

12, 1915,

interest to the total amount of

Dollars ($__aoM _ )

At the close of business on ?toruary 12, 1915, said XH WMrtxurton

was obligated or indebted to us on loans, notes, participations, or other accounts or contracts, as follows:

.191 . .(Title)

TAKING OFF THE TRIAL BALANCE

It will be noted in connection with this form that there are
certain inquiries made other than that contained in the first let-
ter above mentioned. Small organizations are not so apt to
have complicated relations with banks as larger ones. Getting
certificates from a bank very often, however, uncovers matters
not disclosed by the client or his employes. The author re-
cently had occasion to request a certificate from a certain bank
and took the letter personally to the manager of the branch
where the account was located. On presenting the letter he
was asked which account he desired. He promptly replied that
he wished to know the balances of all the accounts. He re-
ceived balances of three accounts instead of one, the two addi-
tional accounts being special ones which had been concealed.

In a similar manner the above form letter may develop the
existence of additional accounts of loans and interest which may
affect the situation.

Banks, as a rule, are very accommodating in the matter of
furnishing certificates. They sometimes object, however, to giv-
ing the details of interest credited to the account, except such
interest as may have been credited since the pass book was last
balanced. Some banks which render a statement every month
in which the interest is included, ignore the matter of interest
entirely in so far as a certificate is concerned, since they feel that
the monthly statement which they render should furnish sufficient
verification for the auditor.

The matter of having the pass books balanced, out of the way,
attention may be devoted to the taking off of the trial balance.
Before that is discussed, however, a word or two may be said
relative to making a list of the books. Some accountants ad-
vocate getting a list of all the books used by the client before
proceeding with the work. Other accountants ridicule the idea.
Making such a list may be scientific procedure. On the other
hand, doing so may give the impression that the auditor is in-
experienced and attempting to follow some set of rules in doing
the work. The auditor who understands his business should be
familiar with all the books generally used. If it so happens that
the peculiarities of certain lines of business require special and
unusual books, the fact will become apparent during the course
of the audit and should occasion no embarrassment if the audi-
tor is sufficiently self-possessed to ascertain the function of the

PRINCIPLES OF AUDITING

book or form even though it is unfamiliar to him. Professional
pride is a very worthy attribute. It should not, however, be
allowed to stand in the way of getting information. It is no
reflection on an auditor that he is not familiar with every book
and form which exists. There is no reason why he should hesi-
tate to confess this fact. Consequently there is no reason why
he should not be perfectly frank in asking about any book or
form which he does not understand. It seems therefore that it
is not necessary and perhaps undesirable on account of the im-
pression that it may make, to prepare a formal list of the books.
This argument is not against so doing in the case of an engage-
ment where the man in charge desires to be systematic in
planning the work of himself and his assistants and makes a
memorandum list as an aid in laying out the work.

By this time the auditor will probably be ready to take a
trial balance of the general ledger. The general ledger is the
key to the whole situation. Everything is supposed to be sum-
marized therein. If an auditor were to begin with the ends and
work toward the center, it is probable he would find some diffi-
culty in tying up his results. It is customary to begin with the
control which the general ledger is presumed to present, and
work from that as a basis.

Whether the auditor should take the trial balance of the gen-
eral ledger himself or accept one which has been prepared and
furnished to him, is perhaps a question. Tact will probably dic-
tate that he accept such trial balance if offered to him. There
is no occasion for hurting a person's feelings by refusing to
consider such an offer of assistance. The author is strongly in
favor of having the auditor take his own trial balance. Not
because of the fact that he is suspicious of the one offered to
him, or too proud to admit that the bookkeeper is not compe-
tent to take a good trial balance, but because of the fact that it
offers an opportunity to the auditor to familiarize himself with
the business and its transactions. He cannot help, in going over
the accounts one by one, thinking about them and in being obliged
to spend the necessary time on each account in order to take
the balance off, build up in his mind as he goes along, a general
idea regarding the organization as a whole together with its dif-
ferent ramifications and functions. This is not only true of the
first time which he handles the engagement but any repetition

TAKING OFF THE TRIAL BALANCE

of same. The act of taking off the trial balance even on repeti-
tion of the engagement, gives him an opportunity to refresh
his memory.

It might be well here to say that the books are not ready to
be audited if they are not in balance. The auditor should not
proceed with the work if the books are not in balance until he
has discussed the matter with the proper party and had an un-
derstanding as to what he is to do. As a theoretical matter, at
least, auditing is not accounting, and if the auditor is obliged
to finish writing up the books, make entries, hunt out errors and
put books in balance, he is doing bookkeeping or accounting
work and not auditing. As a practical proposition, doing such
work, unless specifically agreed to, is apt to result to his preju-
dice. If the work is being done under a contract, and the time
necessary to do the work has been estimated, putting in a lot of
time finding mistakes in bookkeeping, is apt to result in a loss
on the engagement. If the work is being done on a per diem
basis, the auditor is apt to become involved in a disagreeable dis-
cussion with the client because of the fact that time has been
spent in doing work which should have been done by the em-
ployes of the client. If a situation, such as the one above sug-
gested arises, it should be brought to the attention of the proper
authority immediately without proceeding with the work and
the client's wishes in the matter ascertained. While this may
delay the engagement somewhat, it will be found more satis-
factory in the end.

In taking off the trial balance two sheets of analysis paper
should be used. Each sheet should be headed up with the name
of the organization and marked "trial balance, general ledger
before or after closing," as the case may be, with the date. One
sheet should be used for the debits and one for the credits. The
sheets should be so arranged that the first column of each will
be used for the ledger folio, the second and third columns for the
titles of the accounts, the fourth column for references, the fifth
column for amounts. This arrangement provides for the begin-
ning of a working sheet, so that the columns to the right of the
fifth may be used respectively for the debit and credit adjust-
ments and the final balance sheet and income statement figures.
This will leave three columns (if 12 column paper is used) for
notations on accounts which do not require extensive analysis.

PRINCIPLES OF AUDITING

If more than one sheet is required, either in the case of debits
or credits, the sheets should be numbered with a separate series
for debits and credits in the upper right hand corner. In the
majority of cases there will be more debits than credits. These
perhaps are small matters, but it is a knowledge of these little
things and attention to them which may make the difference
between success and failure in the case of the young man start-
ing in. Too many accountants are apt to forget the fact that
someone else at a later date may have occasion to use the same
working papers. There is nothing more annoying than to go
back into old working papers and be unable to get any informa-
tion from them without spending hours in digging it out. On
the other hand, there is nothing more satisfactory than to refer
to old papers and find them not only full of comprehensive in-
formation but so arranged and labeled that the information may
be obtained quickly. A folder of working papers may contain a
number of trial balances. If they are not properly labeled and
described they are apt to be of little value and to cause great
annoyance to the person referring to them. If the trial balance
is not properly labeled and becomes lost from the folder, there
may be no way of getting it back to its proper place even if it
happens to be found.

Another minor point which the young man should keep in
mind, is that he should always write his name on all papers which
he makes. Seniors have been frequently heard to utter words
which are unprintable because in going over working papers
they were not able to discover who did the work. Papers which
are not clear in themselves may frequently be cleared up by
getting in touch with the man who made them. If it is impos-
sible to find out who did the work there is little possibility of
clearing up the points in question. Attention to these little
matters on the part of the junior frequently engenders a feeling
in favor of such a man. In fact, his continuation on the staff
at the time when men are being dropped on account of lack of
work may depend on just such little things as these. Many
times a senior is asked when starting out on an engagement,
which men he wishes to assist him. Knowing the men who
are available he goes over them mentally one by one. In the
decision the man who is careless about details, a poor writer,
or slovenly in his work, is apt to be eliminated. A man who

TAKING OFF THE TRIAL BALANCE

is careful about everything, and dependable, and a man who is
known to produce finished work, is apt to get the call. Being
repeatedly chosen under such circumstances tends to serve as a
recommendation and to make a favorable impression upon the
office manager or member of the firm. Being constantly refused
or criticised tends to produce the opposite impression.

On taking off the trial balance, each item should be proved
by deducting the footings in the respective accounts one from
the other, instead of taking the balance for granted because it
has been jotted down in pencil in the ledger. What appears
from a pencil notation to be the correct balance may, in fact, be
an old one. Its inclusion in the trial balance may produce an
incorrect result. The ledger should be paged through to the end.
That is to say, each page should be turned over and examined.
This procedure should be carried through to the end of the book.
The auditor sometimes has difficulty in getting a trial balance
because of the fact that one or more amounts have been omitted.
Sometimes a bookkeeper for one reason or another will run the
accounts along page after page and then suddenly skip a num-
ber of pages and go on. Sometimes most of the accounts will
be shown page after page beginning at the front of the book with
the profit and loss account or the surplus account or the pro-
prietors' account on the last page of the book. There is no
accounting for the manner in which the minds of some book-
keepers work. There is no accounting for some of the things
which they do. The auditor must therefore, in taking off a
trial balance, guard against the idiosyncrasies of bookkeepers.

Following out the thought above suggested, subsidiary ac-
counts will sometimes be found in the general ledger mixed in
with the general ledger account. Sometimes memorandum ac-
counts which have no place in the classification will appear. Cus-
tomers' and creditors' detailed accounts as well as the control-
ling accounts therefor are put into the general ledger because
there is room for them. All these things have to be kept in
mind and guarded against.

Another thing which should be remembered is that the trial
balance should contain a cash account. Someone, for some
reason or other, launched the theory a few years ago that if a
cash book was used it was not necessary to have a cash account
in the general ledger. It would be just as sensible to say that

PRINCIPLES OF AUDITING

because a customer's ledger is used it is not necessary to have a
customer's controlling account in the general ledger. Likewise,
it might be contended because there is a book for notes receiv-
able in which they are entered when they are received and a
line drawn through them as they are paid, it would not be nec-
essary to have an account for notes receivable in the general
ledger. The balances taken from the general ledger should yield a
trial balance of accounts. All other information necessary to a

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TAKING OFF THE TRIAL BALANCE

trial balance should be included therein, not excepting the cash
account. Anyone who favors good practice should not permit
an argument on this point.

The illustrations will show how the trial balance would
appear on the analysis sheet at this point, and also offer in
a way, the suggested outline which the discussion will follow.

It is to be understood that the items appearing in the trial
balance are such as might appear in any ordinary case. The

PRINCIPLES OF AUDITING

classification of accounts shown therein is not ideal or exhaustive
by any means. It presents a typical case and, in fact, offers a
better opportunity for study than an ideal classification.

A word in explanation of the working sheet and its opera-
tion as used by the auditor may not be amiss at this point. The
trial balance according to the ledger, represents the figures as
shown by the bookkeeper. Whatever errors are discovered dur-
ing the audit will require adjustment in the auditor's report. In
other words, if there is a difference between the figures ^ shown
by the bookkeeper and the correct figures, the auditor will present
the correct figures. It is important that the auditor shall be able
to explain the difference and to establish the connection between
the figures as reported by him and the figures shown in the
books, if necessary. It is the working sheet which offers an
ideal opportunity for this very thing. If the auditor will make
for his own papers, memorandum journal entries covering the
errors discovered, or any adjustments which may be necessary,
and will on the working sheet, post these journal entries in the
adjustment column, he will then be able, by applying these debits
and credits in the adjustment columns to the figures in the trial
balance column, to arrive at the correct results, which may then
be distributed into the balance sheet and income statement col-
umns. In this way the connection between one set of figures
and the other is clearly established and explained. The memo-
randum journal entries just referred to may be attached to the
trial balance in support of the figures in the adjustment columns.
It will be apparent at any future time and to anyone subse-
quently taking up the matter, exactly what happened. The
auditor will also have the correct and final figures from which
tto prepare his report.

What to Do During an Audit

CHAPTER X

READING THE MINUTES

The precise order which should be followed in making an
audit is a matter which is perhaps open to discussion. It de-
pends very much on personal choice. Reading the minutes im-
mediately after having completed the trial balance, seems to be
the next logical step, however. The reading of the minutes gives
one an insight into the organization; it prepares one to do in-
telligent work ; it suggests whom to consult in case any informa-
tion is needed; and in short, it enables one to size up the whole
situation before going further with the work.

In the case of a corporation, the minutes of the stockholders,
the minutes of the directors, or executive committee, or any
special committees should be read. The auditor should also ask
for the contract filed or copies of any contracts which are in
existence.

On a sheet of journal paper he should make an abstract from
the minutes of the stockholders. He should do likewise in the case
of the other minutes above mentioned. If the certificate of in-
corporation is not embodied in the minutes of the stockholders,
he should ask to see a copy of the articles of incorporation or a
certificate of incorporation. These words are used interchange-
ably at times. The articles of incorporation are also referred to
as the charter. The charter should be examined if a copy is
available, or if not, a certificate executed by the secretary of
state. There should be jotted down on the journal paper, the
exact name of the corporation, the date the certificate was filed,
the authorized capital stock showing the par value and the kind
of stock if there is more than one class, and the par value of
each share. There should also be noted the names of the in-
corporators, and it may be important to make a note of whether
or not directors must be stockholders. All these little matters
may become necessary in writing the comments. If such occa-
sion presents itself it is well to have all the facts at hand. It
would be very embarrassing for an auditor who had done a
piece of work in Arizona to be back in New York and wish to
know the date on which a certificate of incorporation was filed

PRINCIPLES OF AUDITING

if he did not have the information. There are certain things
which in writing comments must be said with exactness. If it
is necessary to give the date on which a corporation came into
existence, it is the exact date and nothing else which is required.
To say about January 7 or about January 9 is not sufficient. The
auditor is expected to be accurate.

Glancing through the by-laws will show the powers and
duties of the officers. While the information may be superfluous
to many, it is possible that certain readers will find it helpful to
have recorded here the general duties of the officers. The presi-
dent is ordinarily required to preside at meetings of stockholders
and directors, to present a report at the annual meeting, to ap-
point and remove, employ and discharge, and fix the compensa-
tion for all servants and agents, employes and clerks, sign all
contracts and agreements, all certificates of stock, countersign
the checks, notes, drafts, warrants or other orders for the pay-
ment of money. The vice-president usually performs these duties
in the absence of the president, and in addition any duties which
may be assigned or delegated to him. In large organizations
where there are several vice-presidents, one may have charge of
the purchasing, for example, whereas another has charge of the
sales. The secretary keeps the minutes, serves notices, has the
custody of the records and seals, keeps the stock and transfer
books, attends to the correspondence and lays matters before
the directors at the request of the president or shareholders. The
treasurer has the care and custody of funds and securities. He
has the power to sign, make or endorse in the name of the com-
pany, all checks, notes, drafts or warrants for payment of money,
sign all certificates of stock and render financial statements. This
latter would probably be true only in the case of companies which
do not have a comptroller. It is usually the duty of the comp-
troller, where such office is provided for, to prepare and render
the financial statements. The by-laws will usually contain a
provision concerning the bond of the treasurer. The minutes
should also be scrutinized for any action taken by the stock-
holders in the matter of authorizing the issue of bonds or placing
mortgages on the property, or ratifying the action of the direc-
tors in so doing. In certain states mortgages may not be placed
on company property until approved or ratified by two-thirds of
the stockholders.

READING THE MINUTES

As a practical matter it would perhaps be wise to note the
date of the annual meeting in order that the auditor may have
in mind if he does not already know, the time at which his report
will probably have to be in the hands of the company. Some-
times it is necessary to get the report in so that it may be printed
and placed before the stockholders at the annual meeting. Fur-
ther notation might be made of the compensation of directors
and as a matter of curiosity perhaps, whether an auditing com-
mittee is provided for, and if so, what the duties of the members
are. As a matter of fact, the auditing committee sometimes em-
ploys an accountant to do the work and make the report to the
committee.

The minutes of the stockholders should be examined with
regard to the election of officers, the compensation of officers,
extra compensation, bond of the treasurer, depositary or de-
positaries, contracts with manager, contracts for the purchase
of a business, resolutions fixing the value of property purchased
and the rates of depreciation, etc. There may also be found in
the minutes of the directors, provisions concerning the bonds
of employes other than the treasurer, altho as a rule such mat-
ters are left to the president with power to fix the amount of
such bonds.

The executive committee consists, as a rule, of three mem-
bers. It is simply a small committee from among the directors
for the purpose of facilitating certain features of the work. The
financial side of the concern is usually looked after by the execu-
tive committee. This committee often outlines the financial pro-
gram and makes appropriations, etc.

The auditor should examine co-partnership agreements, joint
venture agreements, operating or selling contracts, and in each
instance make an abstract showing the date, parties to the con-
tract, period to be covered and the substance of it. If at all
probable that the information may be needed later on, important
parts of the contract should be copied word for word. No time
will be wasted in thoroughness in this particular. It would be
preferable to spend, an hour or half a day if necessary copying
something that might never be of any use, rather than to fail
to get information which might be vital in the future to litiga-
tion. This precaution is especially desirable in out of town en-
gagements. It may possibly be of interest to have presented a

PRINCIPLES OF AUDITING

practical illustration of what one might come in contact with in
reading over minutes. The illustration is taken from the work-
ing papers of an engagement in the New York University division
of applied accounting. It is an abstract of the minutes of the
executive board of a certain organization, the name of which as it
appears being fictitious, relative to operations for the year ended
September 30, 1914. In this organization the governing board
instead of being the board of directors or board of trustees was
called the executive board.

READING THE MINUTES

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CHAPTER XI

THE MECHANICAL WORK

The work to be taken up next is what is sometimes referred
to as the mechanical work. Mechanical work may be divided,
generally speaking, into three classes vouching, footing and
checking postings. By vouching is meant checking entries from
supporting papers. The entry appearing on the books is not
accepted as being final and conclusive. Some further evidence or
support is considered necessary.

The vouching will be found necessary in connection with the
following books :

General cash book

Petty cash book

Purchase journal or voucher register

Purchase returns and allowances

Sales book

Sales returns and allowances

In addition there may also appear at times a payroll book. It
is probable, however, that vouching in connection with payroll
books is becoming less and less frequent. There was a time when
it was customary to find a receipt for each employe on the pay-
roll, that is, a receipt purporting to be signed by such employe.
The reason for a payroll book is that too much room would be
taken up in the general cash book if there were to be entered
therein the names of all employes who received wages with the
amounts received. The idea of a payroll book follows the idea
which has been brought out before, namely, that certain classes
of items have been withdrawn from the cash book in order to
facilitate the work and avoid filling up page after page in the
cash book with names and amounts. The payroll book is usually
so arranged that the names are written once and by using a
columnar book with short pages, the amounts are entered from
month to month opposite the corresponding names. This has the
effect of course of a special cash book for recording payments to
employes where employes are numerous. Vouchers support-
ing such payments are not always satisfactory. This is apt

THE MECHANICAL WORK

to be true in organizations where the number of employes is
so great that many of them are not known personally to the
cashier. The padding of payrolls and turning in of fictitious
receipts is perhaps encouraged rather than prevented where re-
ceipts are accepted without any personal knowledge of the em-
ploye on the part of the cashier. A better and more satisfactory
scheme consists in having a man who actually pays out the
money to the individual, and who must be a trustworthy em-
ploye, initial the payroll book and perhaps give a voucher for
the entire amount. The ideal scheme is to have the individual
employe present himself at the office and receive the money
from the cashier in the presence of a second party. This, how-
ever, in large plants where the employes are numerous results
in a considerable waste of time and is frequently objected to as
being uneconomical in this respect. Notwithstanding what has
been said, payroll books are frequently found. The individual
items are supported by signed receipts and a majority of them
probably should be examined.

Footing will be applied to the following books as a rule:

General cash book

Petty cash book

Purchase journal or voucher register

Purchase returns and allowances

Sales books

Sales returns and allowances

Payroll book

General journal

General ledger accounts

Customer ledger accounts

Creditors ledger accounts

It may appear offhand that the ideal course to pursue will be
to foot all these books. That this is not necessary will prob-
ably be apparent later on. As specific books are taken up in
detail, it will probably be found that the footings may in many
cases be dispensed with. It might seem ordinarily that because
someone has made all these footings in order to prove them the
same thing must be done. This will probably be found unneces-
sary in certain cases.

PRINCIPLES OF AUDITING

In the matter of checking postings the following books must
be considered:

General ledger
from

General journal
General cash book
Petty cash book
Purchase journal
Sales journal

Customers' ledger
from

Sales journal

Sales returns and allowances

General cash book or (customers cash book)

Creditors ledger
from

Purchase journal

Purchase returns and allowances

General cash book

No attempt has been made here to indicate more than gen-
eral procedure. It is planned to take up one by one and in
detail these different processes. While it has been said that the
customers' ledger should be checked from the sales book and
the general cash, it may be found as a matter of fact when
the customers' ledger is checked that the actual procedure
will be just the reverse. The above arrangement is only in-
tended to indicate the general relation of the books and the
work in connection with them. Just as it is considered sufficient
to do only a part of the vouching and footing, so it is usually
considered sufficient if a certain proportion only of the postings
are checked.

There should next be taken up the vouching of the cash
book. Before, however, going into the detailed work of vouch-
ing, cash books in general, on account of the great variety they
present, should be discussed. Cash books will vary in size, form
and ruling. The number of varieties will be surprising. There

THE MECHANICAL WORK

is one thing, however, upon which dependence may be placed
and that is, the principle that a cash book should record cash
receipts and disbursements no matter what its form, size or rul-
ing. It is the function of a book always which must decide
what the book is, regardless of what it is called or how it is
constructed.

The volume of business may be sufficiently large so that the
cash book will be divided into two parts, one for receipts and
the other for disbursements. Suppose for example, that there
are a great number of cash receipts and very few disburse-
ments, or a great part of the cash receipts comes from cus-
tomers. Instead of filling up the general cash book with all
these details, there may be what amounts to a subsidiary book
for cash receipts from customers showing with respect to each
customer the amounts received. The total from this book will
then be carried at the end of the day to the general cash book
where one entry for customers will be made. On the other hand,
there may be cases where the receipts will be large in amount
but few in number, or the disbursements small in amount and
great in number. Under such circumstances a number of books
for disbursements may be needed from which the totals will be
carried to the general cash book in which one entry only for
the day will be made. In some general cash books where either
one or the other of the above situations prevails, the total re-
ceipts and total disbursements will be shown so that the balance
may be ascertained, or either the receipts or the disbursements
may be split up into a number of different books for convenience.
Books combining both receipts and disbursements, or showing
either separately, may be alternated by days. One cash book
may be used for the odd days and another for the even days.
Such alternation is usually introduced in order to facilitate post-
ing. While one is in use for the purpose of making entries, the
other is being used for the purpose of posting details to cus-
tomers' or creditors' accounts. Offices which are run twenty-
four hours a day sometimes have a cash book for the day man
and another for the night man. This is frequently found in
hospitals and similar institutions. The day man when he goes
off duty will turn his cash book over to the night man.. The
night man will post from the book during the night so that in
the morning everything is posted up. For the purpose of con-

PRINCIPLES OF AUDITING

trolling the work of the individuals, the night man is compelled
to keep his receipts and disbursements in a separate book as
well as his cash in a separate box so that he can account for his
balance and turn it over in the morning. These possibilities are
mentioned in order to indicate the great variation and the possi-
bility of combination which exists in practice. To find four or
five different cash books in an office is not unusual.

Variations will also be found in the rulings. One kind will
have two money value columns on the left-hand page and two
similar columns on the right-hand page. This kind may per-
haps be found in a bank or a broker's office. The kind which
is probably met with most frequently is that in which the ruling
is especially arranged in columns. Beginning on the left-hand
page at the left side of the page there is the column for the
date. This, going from left to right, is followed by a narrow
column or columns for posting references, with subsequent col-
umns for the name, explanation, net cash, discount, customers
and general ledger items. The ruling on the right-hand page
is precisely the same. The headings for the columns are the
same except that the word "creditors" is substituted for "cus-
tomers." A further variation of this idea consists in introduc-
ing two additional columns for bank deposits and withdrawals.
This will be found with the deposits at the extreme right of
the left-hand page and the withdrawals at the extreme left
of the right-hand page. When the book is opened these two
columns will appear in the center of the double page. Where
there are more bank accounts than one, additional columns are
introduced.

In an institution or an association, the accounts for which
are run on a cash instead of an accrual basis, a cash book still
different in ruling is liable to be found. Where a cash basis is
used it is customary to find a considerable number of
columns taking the place of the general ledger columns in order
that the income and expense may be classified. Under
this basis the income is apt to be in the form of cash
receipts. The expense is liable to take the form of cash dis-
bursements. This situation gives rise usually to a long book
which may look very much like a purchase journal or voucher
register. There are many cases in which a purchase journal
is used where the accounts are kept in this way, but such a

THE MECHANICAL WORK

situation really modifies the true cash basis and the principal
purpose of the columnar cash book as just described is to
provide for distribution.

It may not be amiss to reiterate that the form or arrange-
ment of a cash book does not affect the function. Knowing
what the function of the cash book is, it should not make any
difference what physical means are employed for exercising the
proper function. The function of the cash book is to show the
receipts and disbursements of cash and the balance resulting
therefrom. The work of auditing a cash book should consist in
verifying the items which make up the receipts and the disburse-
ments, not only in detail but in aggregate, and proving the
balance by inspection of the cash in hand, or the certificate of
the depositary or both. It is necessary to include both because
of the fact that sometimes the balance in the cash book is all
represented by cash in hand; sometimes by cash in hand and
cash in bank. Sometimes the cash is all in one bank and some-
times in several.

Verification of the receipts may be first considered. This
operation so far as the auditor is concerned, is not always as
satisfactory as it might be. There is little hope of laying down
rules which will be absolutely proof against exception. All one
may hope to do is to indicate enough of the general principle
involved, or to state rules of a general nature, so that the novice
may exercise his ingenuity in applying the principles when he
comes in contact with these things in practice. It is not probable
that the young man will have as his first experience that of
plunging into the audit of a municipality, a railroad, or a bank,
alone. If his experience happened to be in the organization of
any one of these three kinds, it would probably be under the
supervision of someone else. What seems desirable, therefore,
is to discuss the matter in its relation to the kind of organiza-
tion with which the young man is most liable to come into con-
tact in the earliest years of his experience. Such organizations
are mercantile, manufacturing and trading, and institutions. The
mercantile or the manufacturing and trading organization de-
rives its principal receipts from cash sales and cash received
from customers. Miscellaneous receipts are derived from a
number of different sources, and may be said to consist princi-
pally of interest on bank balances, notes receivable and interest

PRINCIPLES OF AUDITING

thereon, interest on bonds and dividends on stocks. These items
do not exhaust the list but serve rather as typical illustrations.

The cash sales may usually be verified. The entries in the
general cash for cash sales may be supported usually in one of
three ways. First, cash register slips or a daily record taken
from the cash register; second, duplicate sales slips; third, a
detailed memorandum book. The form of record in these differ-
ent instances will differ. In the case of the cash register, all
that will be obtainable will be the mechanical total for the day's
receipts. This may be shown either by slips taken from the
machine or the record which is kept in the daily cash book fur-
nished by the cash register company. Duplicate sales slips
will probably give all the details of the transaction, so that the
auditor may go back as far as he likes on slips of that kind. It
will usually be found that such slips have been totaled up for
the day in some manner, either on the adding machine or per-
haps on the comptometer and such slips will usually have been
preserved, so as to show the details from which the daily totals
were made up. It is not possible to check the items where totals
are obtained through the use of the comptometer, because such
machine does not list. The quickest way to prove such totals
is to have the slips put through the comptometer a second time.
It is not probable that the auditor would go into the details of
the work to such extent. If the slips have been preserved and
are presented without question, the presumption is that there
has been no attempt at dishonesty. Mistakes may have been
made but the probabilities are that they are slight ones and not
worthy of discovery. It is not probable that the auditor would
check up the total sales slips against the daily list even if the
adding machine list were available. The particular point to be
observed is that the slips are there if wanted.

If neither of the two foregoing records exist, it is likely that
a memorandum book will have been kept. It may be just a
blotter as in the grocery store in which a clerk writes down 3 Ibs.
of coffee at 30 cents under the name of Mrs. John Smith. On
the other hand, not as much information as the foregoing may
be found. It is possible that only the item of 90 cents will be
entered into the memorandum book in the money column and the
receipts for the day added up. In some manufacturing concerns
where large quantities of supplies are sold, there are elaborate

THE MECHANICAL WORK

systems of accounting for cash sales. Comparatively few, how-
ever, it is thought, make a record of the articles and quantities
sold. Rather than not it is apt to be the case that the man in
the stores department who has charge of the sales, jots down the
amount he takes in, foots up the total at the end of the day, and
at the end of the day or month turns over the receipts to the
cashier, such record being the only one found.

Cash received from customers has in the past been a most
unsatisfactory item to verify. The auditor has had to be con-
tent with checking the amounts against the customers' accounts
with the hope that before the audit was completed, a statement
would be sent to each customer with the balance, with a request
for confirmation, and in that way a partial check of the amount
of the receipt would be obtained. Unfortunately many cus-
tomers are careless about returning statements, even when re-
quested to do so, all of which interferes with the completeness
of the proposed check. There has recently come into use in a
somewhat sporadic way, a scheme which seems to be an excel-
lent one, not only from the point of view of the merchant, but
also that of the accountant or auditor who is called upon to
verify receipts from customers. Within the past year a number
of leading department stores in New York City have adopted
the scheme. It consists in using a perforated invoice so that
one part may be retained by the customer and the other returned
with remittance. The invoice has been used in two ways. The
first is the regulation invoice made out in every respect as for-
merly, with the perforation at the top where the body of the
invoice begins. If the customer pays by check and no receipt
other than that on the back of the check is desired, he tears the
invoice apart at the point of perforation, returns the upper part
showing his name, address and ledger folio, as well as the amount,
and retains the lower part showing the items and total amount.
When used in the other way, the invoice is of the same form
and prepared in the same manner as before, except that the per-
forated portion is at the bottom and duplicates the information
relative to name, address, folio and amount which appears at the
top of the invoice. In this case, the perforated section is torn
off and returned with the check, the invoice being retained by
the customer. This scheme not only saves postal and clerical
labor to the merchant because of the fact that he has no receipted

PRINCIPLES OF AUDITING

invoice to return, but it furnishes a satisfactory voucher, as it
were, to the auditor in support of the receipts from customers.
It is in fact a remittance slip. It comes in with the check. The
check goes to the cashier to be entered in the cash book. The
remittance slip goes to the bookkeeper who keeps the customers
ledger. This procedure facilitates the work since it provides
the bookkeeper with something to post from immediately ; at the
same time the cashier is making the entry if desired. The re-
mittance ultimately goes back to the cashier to support the cash
receipts. The use of this scheme by an increasing number of
concerns would be a great boon to the accounting profession.
If slips of this kind are not found and they probably will not
be for some time, until the practice becomes more general, about
the only thing to do in so far as the verification is concerned, is
to check the cash received against the customers' accounts to
see that when cash was debited the customers' accounts was
credited. This, if followed up later by sending out a statement
for confirmation, will be as good a confirmation as an auditor
may hope for.

With regard to miscellaneous receipts, no fixed rule may be
laid down. Good sources of verification will have to be searched
out according to the items involved. A good source, for ex-
ample, with regard to interest on bank balances, would be the
usual monthly statements which some banks and trust companies
send depositors. These statements show the amount of interest
which has been credited to the depositor's account. There might
be obtained of course a certificate or statement from the bank
or trust company, showing how much had been credited during
the entire year. This might, however, not be possible as such
banks might take the position that having rendered a monthly
statement, they were not called upon to go further. Some judg-
ment must of course be displayed in determining how diligent
an auditor should be in verifying items of this kind, since their
size and importance may not justify the expense of any con-
siderable time in order to verify them.

Interest on bonds is not so difficult to check. Knowing the
par and the amount of the holding, and finding out the rate of
interest paid and the dates on which it is payable, the amount
of interest received or receivable should be determined without
difficulty.

THE MECHANICAL WORK

Dividends on stocks may be checked through newspaper rec-
ords such as dividend notices, or reference may be had to the
Financial and Commercial Chronicle, or Moody's Manual.

Institutions and associations usually derive their principal
receipts from subscriptions, donations, dues, collection boxes, col-
lectors, and in the case of hospitals, pay and dispensary patients.
Miscellaneous receipts of such institutions take the form of lega-
cies and bequests, interest on bonds, dividends on stocks and
interest on bank balances.

Some subscribers promise to pay specific sums at regular in-
tervals. It may be found that since these promises are usually
made in advance, a list will be made up prior to the day that
payment is due, or it may be found that the names of subscribers
together with the amounts involved are placed on cards. When
the payments come in there are four different ways in which the
details may be recorded. First, the list with the name and
amount to be received scratched off, indicating that it has been
received; second, the amount of the payment either checked on
the card if it has already been entered, or entered on the individual
card either front or back, the card occasionally taking the form
of a small ledger account where the subscriber will be charged
with the amount subscribed in the formal way and credited with
the money when it comes in ; third, a stub for the receipt which
has been sent out; fourth, a duplicate or carbon of the receipt.
The last is the best form since a copy of something which has
gone out to the individual is available.

There is a way of checking up the information found on the
stubs or entered on the card or a list, namely, publishing a list
of subscribers with the amounts subscribed. This is done by
many institutions. Such practice seems to be desirable and per-
haps should be suggested by the auditor if it is not the practice.
A person subscribing to a given activity upon seeing a list of
subscribers which has been published, immediately looks through
the list to find his name and ascertain if his subscription has
been reported in the right amount. There is no objection to
making use of psychology or any other fair means of verifying
things of this kind. Sending out such a list with the annual
report has the effect of an automatic check on the subscriptions.

What has been said of subscriptions may be applied equally
well to donations. Donations do not differ from subscriptions

PRINCIPLES OF AUDITING

except that they are usually smaller in amount and more or less
infrequent in their receipt. Rarely will a list be found in this
respect. They may, however, be accounted for through stubs
or duplicates or carbons of receipts.

Receipts through collection boxes are most unsatisfactory to
check. Without an elaborate organization and a somewhat elabo-
rate mechanical provision, it is almost impossible for a society
or institution to tell whether or not all collections are turned in.
The auditor has very little opportunity of verifying these amounts.
If the collection boxes are placed in stores or other public places
and sealed they may be opened and the contents verified in the
presence of some representative of the store, for example, who
furnishes an independent certificate as to the amount.

There is absolutely no way, so far as the author has been able
to discover, after having given what seems like an unwarranted
amount of thought to the matter, whereby receipts taken up by
collectors on the street and in other public places may be veri-
fied. The institution seems to be at the mercy of these collectors
and must be satisfied with whatever is turned in.

In the case of hospitals where some patients pay board a
receipt book with a stub or carbon copy of the receipt may be
found. Such institutions, except in the cases of the largest ones,
are not apt to be over-systematized and the auditor may consider
himself fortunate if he finds the name of the patient with the
amount paid and the date entered in the book. There is little
check on dispensary patients since all patients do not pay. While
the general impression is that dispensaries are free, it is probable
that most of them exact a charge of those who are able to pay.
Some dispensaries it should be said to their credit do keep records
which can be checked. These records show the total number
of patients treated in each clinic; the number of those who paid
and the number who were treated free of charge. It is more
than apt to be the case that no record, even such as that of a
cash register, is kept. After all, as a practical matter, the amount
involved is usually so small as not to warrant very much anxiety.

Legacies and bequests may be verified by correspondence
which will be found in the files or can be produced. If the
legacy or bequest is of sufficient size, a resolution extending the
thanks of the institution will usually be found in the minutes of
the governing board. These items, as a rule, are of sufficient

THE MECHANICAL WORK

size and importance to warrant following each one up separately.
Miscellaneous receipts in the case of institutions may also be
checked in the same manner as that indicated for mercantile
concerns.

The principle involved in the checking of receipts is to get
some confirmation from the second party to the transaction. If
such outside party can be gotten to verify the transaction it is a
better check than the records of the organization undergoing
audit. It need not be expected that verification will be gotten
by word of mouth but rather through some communication or
statement which has been reviewed by the second party.

No matter what the organization may be, receipts should be
checked with the bank deposits to see that all receipts have been
deposited and deposited promptly. The checking of receipts
insures the deposit of all receipts shown but not necessarily the
entry of all cash actually received. Such is the reason for going
back to the second party to the transaction. The mere fact of
the entry of the amount in the cash book being shown as having
been deposited in the bank does not prove that all the money
which a customer paid in has been entered in the books.

CHAPTER XII

RECONCILING THE BANK ACCOUNT

At this point it is probable that the bank account or accounts
should be reconciled. If all the checks are drawn on one bank
and entered in numerical order, it may be possible to combine
the reconciliation of the bank account and the vouching of the
disbursements. Take, for example, a case where the checks are
all on one bank and the cash book appears with regard to the
credit side in accordance with the illustration below;

Date

Check
No.

Payee

Net
Cash

Discount

Accounts
Payable

General
Ledger

The returned checks, by which is meant checks which have
been paid and returned by the bank, may be found arranged in
two ways. The first is in the condition in which they were
returned by the bank, namely, done up in packages and arranged
in accordance with the order in which they were paid and listed
by the bank. Otherwise, they will appear in numerical order as
issued. Some little thought needs to be exercised before disturb-
ing them if they are in the same order as that in which they
were returned by the bank. Finding the checks in the original
bundles, as they were returned by the bank, means probably that
the bank account has not been reconciled for some time. Some
banks use pass-books, while others have done away with the
pass-books and use a monthly statement on which the paid
checks as well as the deposits are listed. Having in mind that
the account, or list, as the case may be, was not checked up at
the time it was received, the lists as shown by the bank state-
ment or the machine lists alone, if a pass-book is used, should
be checked before the checks are put in numerical order. It is

RECONCILING THE BANK ACCOUNT

important that the order of the checks be not disturbed until
each statement has been proved ; otherwise it may be exceedingly
difficult to allocate the trouble in case a difference results in the
attempted reconciliation. Taking the statement for the month
of January, for instance, the returned vouchers should be checked
against the entries on the statement or against the machine lists.
The machine lists should be footed, since it is not safe always
to accept machine footings. The machines are probably accurate
ninety-nine times out of a hundred, but since there is a possi-
bility of their becoming deranged and not giving correct results,
it is always safer to foot machine lists. After having checked
the machine footings to the statement, the items on the state-
ment, both debit and credit, should be footed, the opening bal-
ance checked from a preceding statement and the closing balance
proved. Continuing with the succeeding months in the same
way, if all are found to be correct, the checks may be put in
numerical order since breaking up the order in which they came
from the bank is no longer a matter of importance. In putting
the checks in order a memorandum should be taken of the miss-
ing numbers and reference should be had to the cancelled checks
in order to ascertain if any of the missing numbers are repre-
sented by cancelled checks. In the case under illustration here
no stub book is used, the cash book takes the place of the check
book and the checks are arranged in numerical order and put
up in pads. Where this situation does not exist, reference to
the stub of the check book in the case of missing numbers will
usually show whether the check has been cancelled or is in reality
outstanding. Cancelled checks are, where good practice is in
force, pasted to the stub, or preserved in numerical order.

In the case used for illustration it should be remembered that
there is no check book. The auditor from the minutes or from
some other source will have ascertained who is to sign and
countersign checks. Remembering further that the process is a
combined one, namely, reconciling the bank account and vouch-
ing the cash disbursements, the procedure will be as follows :

First: Compare the number of the check with the number

in the cash book.
Second: Compare the payee on the check with the payee in

the cash book.

PRINCIPLES OF AUDITING

Third: Compare the amount of the check with the amount

entered in the cash book.
Fourth: See that the check is signed by the proper party or

parties.
Fifth: Put a small double tick to the right of the amount

in the net cash column.

There now arises a question as to whether or not the check
should be turned over and the endorsements examined. The
author is aware of the fact that certain authorities on the sub-
ject recommend turning over the check and examining the en-
dorsement, also that certain teachers advocate the same thing.
Personally, he is of the opinion that the auditor need not, except
under certain circumstances concern himself with the endorse-
ments if the check has passed through a bank, been paid, can-
celled and returned. Several years ago while reconciling an
account in the Market and Fulton National Bank, the follow-
ing printed statement was noticed in the front of the pass-book
"The United States Courts in recent decisions have held that a
depositor is bound personally or by his agent, and with due
diligence to examine his pass-book or statement of account, and
to report to the bank without unreasonable delay, any errors
which may be discovered, and if he fails to do so and the bank
is thereby misled to his prejudice, he cannot afterwards dispute
the correctness of the items shown in the pass-book." The thing
which stands out in the above quotation is the fact that the
error must have been discovered within a reasonable time. Most
banks nowadays, either in their pass-books or on their state-
ments, notify depositors that if no errors are reported within
ten days, the account will be considered correct. Ten days is
probably the general rule. Ten days may probably be considered
as a reasonable time within which the bank must be notified.
The reason for this precaution on the part of the bank is prob-
ably not the fear that some clerical error will have been made
in balancing the pass-book or preparing the statement, but that
the money will have been paid to the wrong party. This, not-
withstanding all the care which is taken in paying out money
on checks. It is difficult for a stranger who presents a check
at a bank to succeed in having it cashed. Paying-tellers invariably
ask for identification and a stranger in a place like New York

RECONCILING THE BANK ACCOUNT

City might have difficulty in getting anyone to identify him.
Even where the identifying party is known to the bank teller,
it is often necessary for such party to have an account with the
bank. Sometimes such parties will be asked to place their en-
dorsement on the check. It is well nigh impossible for a per-
son to go into a bank where he is a stranger and get a blank
check. Every safeguard is thrown around the cashing of checks,
but with all, the banks seem to stand in constant fear of having
been victims of a sharp trick or having paid the money to the
wrong party.

Even if such were the case the auditor would have little
chance of discovering it. He is not familiar with the signature,
whereas, the paying-teller is either familiar with the signature
or knows that the party to whom the money was paid was the
party whose name appeared on the face of the check and that
the endorsement on the check is the signature of that party.
The paying-teller is in a position to take every precaution, but
the auditor has no means whatever of discovering whether a
signature is good or not. It may be seen that the name entered
in the cash book is the same as that which appears on the face
of the check. It may even be seen further, that the endorse-
ment on the reverse side of the check shows the same name as
that appearing on the face of the check, and still there is no
proof that the person whose name appears on the face of the
check received the money. Even going so far as to grant that
the auditor might be familiar with signatures sufficiently to dis-
cover whether they were genuine or forged, there is not much
chance that the discovery of the forged signature would be made
within ten days after the rendering of the account by the bank.
It is possible, of course, that some auditors might take up the
vouching of the cash immediately upon beginning the audit, in
which case a few checks would probably come within the ten
days' limit.

If a check is drawn to cash it should be turned over and
notice taken of who is purported, through the endorsement, to
have received the money. Endorsements will not always be
found as paying-tellers will occasionally, if they know the party,
pay a check drawn to cash without requiring any endorsement.
It would seem well if all paying-tellers would require endorse-
ments even on checks drawn to the order of cash. The auditor

PRINCIPLES OF AUDITING

is put on special notice in examining checks drawn by executors
or trustees, to ascertain through the scrutiny of the endorsements,
who is supposed to have received the money on cash checks.
This matter of examining endorsements on checks drawn to the
order of cash is one distinct from the examination of the en-
dorsements where a check is drawn to order of a specific party.
The auditor should, it seems, exercise a trifle more care in the
case of cash checks, altho he will frequently discover that such
checks are entirely regular. A check may be drawn to cash
and the check cashed by some employe who has charge of the
payroll, so that while the practice is not a good one (the check
being preferably drawn in favor of the party who gets the money),
everything is in order so far as the use of the money is concerned.

A case has recently come to notice wherein the examination
of endorsements would probably have led to the discovery of
dishonesty on the part of an employe. A certain association, one
of the purposes of which was to provide insurance, employed an
adjuster to settle claims. The adjuster was provided with blank
checks bearing the signature of the proper official and empow-
ered to settle claims at such figures as he could arrange with
the beneficiaries. He was in the habit of obtaining, wherever
possible, the endorsement of the beneficiary, on the check before
making the settlement. He then agreed with the beneficiary as
to the amount and settled the claim in cash. He subsequently
filled in the check at any amount which he chose, being guided
by what would be a reasonable amount to pay on each claim
and deposited the checks in his personal bank account. Where
he was unable to obtain the endorsement of the beneficiary on
the check he forged the endorsement. It is said in this case that
the auditor did not examine the endorsement, failed to discover
the irregularity, and as the irregularity was discovered by rep-
resentatives of the association soon after the audit was com-
pleted, the client refused to pay the auditor's fee.

There appear to be several sides to this case. The society
was undoubtedly negligent in providing the adjuster with blank
checks and in allowing him to fix the amount of the claim.
These two functions should never be entrusted to one person,
namely, fixing the amount of the claim and making the pay-
ment. In the second place, the bank seems to have been negli-
gent in allowing so many checks of the association to pass through

RECONCILING THE BANK ACCOUNT

the personal account of a representative such as this man was,
without making inquiry as to the propriety of such transactions.
Banks are on notice to inquire as to things of this kind, just
as brokers are on notice to question checks of executors or
administrators used by such persons in stock trading transactions
of a personal nature. A certain firm of brokers was held on a
deficiency judgment not many years ago for having accepted and
credited to his individual account checks drawn by an executor
to the brokers' order. In the case of the adjuster above men-
tioned, the auditor was undoubtedly negligent in that he is said
to have been informed before beginning the work as to the
status and authority of the adjuster. Here were special cir-
cumstances surrounding this case which should have put the
auditor on notice. He presumably would not have discovered
the forged signatures, since it is not probable that the adjuster
personally forged all the endorsement, or if he did so, he would
have seen to it that there was sufficient variation in the signa-
tures not to attract attention. What the auditor would have
discovered was that all these checks went through the personal
account of the adjuster and this should have been cause for
concern and special investigation.

Having finished the vouching the reconciliation may be made.
For this purpose a sheet of journal paper will probably be found
most convenient. It should be headed up as usual, with the name
and address of the party whose accounts are being examined, and
should show the name of the bank in which the account appears.
Having received the certificate from the bank direct and not
through the office of the client, the statement may be set up as
follows :

PRINCIPLES OF AUDITING

,icd<-r~/

Bank Reconciliation

8 4

RECONCILING THE BANK ACCOUNT

The above reconciliation is of course a simple one. There
may be at times items of interest to be taken into consideration,
or possibly deposits. The principle involved, however, is shown
by the above illustration. There is no reason for beginning with
the balance in the bank and working to the balance in the cash
book, except that the figures which the accountant will use con-
tinually in his working papers will be those which represent the
balance in the cash book. It is easier in looking over working
papers and in checking up schedules supporting the working
sheet, to have the figures which are desired appear at the bot-
tom of the page and to stand out rather than to be obliged to
hunt over the entire sheet for the figure which is wanted. The
balance which the bank shows will almost invariably be different
from the balance which the cash book shows. The auditor is
verifying the figures of the client and not the figures of the bank.

If there are a number of banks instead of one as in the illus-
tration shown, a number of different sheets may be used put-
ting the reconciliation for each bank on a separate sheet and
then preparing a recapitulation sheet which will go on the top
in order to show the total for all banks. If the total for each
bank is obtained, then the total of all banks added together should
prove the cash, provided all cash has been deposited.

CHAPTER XIII

VOUCHING THE DISBURSEMENTS

The disbursements will, as a rule, be supported by checks.
A check is the best kind of a receipt. In some instances, however,
disbursements will be found which are supported, in addition to
the checks, by receipts signed by the parties receiving the money.
In some cases this will be a duplication of work so far as the
bookkeeper is concerned, but there will be times when it will be
found easier to vouch the disbursements from the signed receipts
than from the checks. Here, the procedure with regard to the
vouching will be the same as in the case of checks, namely,
comparing the date of the receipt with the date shown in the
cash book, the name signed on the receipt with that appearing
in the cash book and the amount of the receipt with that in the
cash book. Subsequent to these comparisons the receipts should
either be ticked or stamped with a rubber stamp as below :

EXAMINED

NEW YORK UNIVERSITY
DIVISION OF APPLIED ACCOUNTING

The reason for putting this stamp or tick on the receipts is that
receipts are not apt to be numbered, they are scattered about and
available for anyone who desires to use them and there is a
possibility, under such circumstances, of their being duplicated.
Very often it will be found on examining the books that there
will be regular payments which will be confusing. Some party
will get $8.33 every month, or on the twentieth of every month,
and it might be an easy matter to present to the auditor certain
receipts of this kind to support disbursements during the month
of January and after they had been used by him to take them
away and return them later as vouchers for the month of
November or December. This sort of irregularity is apt to exist
in connection with padded payrolls. If such receipts are stamped
or identified in some way there is not much likelihood of their
being used as a voucher a second time. The situation with the

VOUCHING THE DISBURSEMENTS

check is different. The checks are numbered and the checks
presumably are controlled by a series of numbers. If #1253
has been used once as a voucher, there is not much chance of
its going through a second time six months or more later. If
an irregularity of this kind were attempted it would undoubtedly
attract the attention of the auditor immediately. This would
hold true even though the amount happened to be exactly the
same the second time. Of course, if the auditor is not careful in
his vouching to watch numbers and names as well as amounts,
such a thing might happen. Vouching of this kind is a waste of
time and unless the check is properly examined and a comparison
made of all the points mentioned the vouching may just as well
be omitted. Where receipts are in a regular book and numbered
and controlled it is not so essential that they be stamped.

It is probable that a word should be said with regard to
institutions which are run on a cash basis and which take no
cognizance of expenses until they have been paid and make no
provision for accruals. Such institutions, it will be seen, would
have no purchase journal or voucher register and no way of
getting the distribution, that is, the charges to the various ac-
counts, except through the cash book. Such a cash book as is
suggested is usually found to be a big cumbersome columnar
affair. In connection with this cash book it is customary to find
a formal cash voucher. It will usually be a printed blank form.
The vouchers will be numbered in consecutive order with a
place for the date, the name of the payee, the amount and the
description of the purpose for which the disbursement is to be
made and a place for some person or persons to approve the
disbursement. These vouchers also show the distribution, that
is, the accounts affected. A voucher for $1,000 may represent
charges to five or six different accounts. If the classification
of the accounts is very extensive, it will usually be found on the
reverse side. Opposite each item in the classification will be
shown the amount to be charged to each account. In such cases,
it should be the auditor's task to run through these different
accounts, occasionally checking the distribution on the voucher
from supporting papers if there are any and proving the items
against the total. With regard to the vouching the procedure
will be the same as that previously indicated. Here, probably if
the vouchers are numbered, it will not be necessary to put a

PRINCIPLES OF AUDITING

rubber stamp on them. On the other hand, it will be necessary
or desirable at least, to check the distribution in the cash book,
that is, to see in addition to checking the total amount of the
disbursement, that the amounts entered in the respective columns
of the cash book are the same as the amounts indicated on the
voucher to be charged to the respective accounts.

The question is frequently asked, How often should distribu-
tion be checked ; should every voucher be examined for distribu-
tion, or how many? There is only one satisfactory answer to
the question, namely, "if you wish to be sure that the distribu-
tion is correct, check every voucher." This is as a rule out
of the question and the auditor will undoubtedly have to be
satisfied with testing. He will not generally be able to go further
than the arithmetical accuracy. He will not be able to decide
whether or not the sum was disbursed for the purpose stated in
the voucher and which the distribution represents. Some officer
or representative of the association will know, however, and
such person should so certify on the voucher. The auditor is
not required to go back of this certificate unless he has reason
to be suspicious. His duty seems to end with a careful examina-
tion of the voucher to determine if it is in order and reasonable,
has been properly approved, and is arithmetically correct. He is
more concerned with the total than with the distribution and
it will probably be sufficient if he tests the distribution on every
fifth voucher. If twenty per cent of the work, in so far as the
distribution is concerned, is examined and found correct, the
presumption is that there are few mistakes. Further, if the
work in the cash book is properly carried out by the auditor, a
somewhat automatic check on the distribution is obtained, pro-
vided the entries have all been properly made. If the distribu-
tion is checked into the cash book and the totals of the distribu-
tion columns in the cash book are cross-footed at the end of the
month into a total column, it would seem to be sufficient. It is
possible that twenty per cent of the distribution on a voucher is
not enough to check. Fifty or sixty per cent is advocated by
some authorities, the claim being made that if fifty per cent is
checked, one is sure that the person who did the work was
correct at least half of the time.

The footing of the cash book is so closely related to the
matters just discussed that it is undoubtedly appropriate to take

VOUCHING THE DISBURSEMENTS

up the question of footing here. The auditor should foot the
net cash and discount columns on both the debit and credit sides
from the beginning of the period to the end of the period, unless
all receipts have been deposited in the bank and all disburse-
ments have been made by check. Then, provided the disburse-
ments have been vouched and the bank account effectively
reconciled, no footing need be done in the general cash book. In
order that the reason for the above rule may be apparent, the
following illustration is presented:

PRINCIPLES OF AUDITING

^
S

VOUCHING THE DISBURSEMENTS

In this illustration there are so few items that it can be seen
at a glance that the balance as shown by the tabulation of receipts
and disbursements does not agree with the balance as shown by
the reconciliation. The error is seen immediately to be one in
the cash book. There are five possible ways in which the error
or errors might have occurred :

1. Some item in the receipts incorrectly entered.

2. A mistake in footing the receipts.

3. Some item in the disbursements incorrectly entered.

4. A mistake in footing the disbursements.

5. An error may have been made in subtracting the disburse-

ments from the receipts at the end of some month when
the cash book was balanced.

If all receipts were deposited and all deposits checked against
the receipts, the first possibility will then be removed. This
would show that all items on the receipt side had been correctly
entered. There may have been a great many receipts. Each
receipt may represent the account of a different customer. One
thousand receipts may be represented by one deposit in the bank
and it is an easy matter to list or foot up the receipts from the
pass-book or from the statement which the bank renders. This
may also be done on an adding machine and in such manner
the footings may be proved. Thus the second possibility is
removed. In checking the checks which have been through the
bank and returned, against the disbursements, it will have been
discovered whether or not an item has been incorrectly entered.
In taking off the list of outstanding checks and deducting the
totals of this list from the amount shown in the certificate, the
correctness or incorrectness of the vouching of the disburse-
ments will be established. By these two processes, possibilities
number three and number four have been eliminated. The
fifth is a simple matter since there are not likely to be more than
twelve times in which the balance in the cash book has been
struck during the year. Footings in a cash book are usually
carried forward according to receipts and disbursements respec-
tively until the end of the month is reached, when the balance is
ascertained. Consequently the work of investigating the closing
figures in the cash book at the end of the month is the work of
only a few moments.

PRINCIPLES OF AUDITING

If the procedure as indicated by the rule has been carried out
no footing need be done, provided the bank balance has been
effectively reconciled. If the reconciliation has not been effected,
comparison of receipts with deposits and disbursements with
checks having been made, the receipt side of the cash book
should be footed and a trial made of the twelve monthly balances.
This will exhaust all the possibilities except the disbursements
which it will then be necessary to foot. The task of footing
disbursements may be turned over to the employe of the client
who runs the cash book.

The auditor should discourage the practice of not depositing
all receipts. Some concerns follow the scheme of putting money
into a cash drawer while depositing all checks. Others draw
round amounts for payrolls and throw any unused portion in
the cash drawer. The practice of putting money into a cash
drawer, to be paid out without going through the bank account,
is, in the opinion of the author, wrong. From the point of view
of the client it offers an opportunity to employes for irregulari-
ties. From the point of view of the auditor it is undesirable
since it makes his task more difficult. Where this practice is
followed it becomes essential that the cash book be footed. The
footing should embrace both the debit and credit side and extend
from the beginning of the period to the end of the period. At
the end of each month's business, as shown in the cash book, the
cross-footings should be proved.

The cash book footings at the end of each month should be
checked with the general ledger. There are four ways in which
these postings may be checked. One is to check from the cash
book to the ledger; another is to check from the ledger to the
cash book. Still another way is to abstract the postings from
the cash book on a separate sheet and check them into the
ledger. The fourth is to abstract the ledger and check to the
cash book. This, of course, applies to the general monthly post-
ings from the cash book and not the posting of details to the
underlying ledgers.

A great deal of discussion is .frequently indulged in as to
whether the ledger should be checked from the book of original
entry or vice versa. That is to say, should the auditor begin
with the figure in the cash book and trace it to the ledger, or
begin with the figure in the ledger and trace it to the cash book ?

VOUCHING THE DISBURSEMENTS

A hypothetical situation will perhaps clear up certain ideas which
may exist on this point.

JANUARY", 1914

(Page) 32

Total

General
Expense

Salaries

Office Expense

1,000.00

500.00

300.00

200.00

(27)

(74)

(76)

(78)

GENERAL EXPENSE

(Page) 74

1914:

Jan.^31

c.c. \&\ 500:00:

In the above illustration the bookkeeper, or whoever did the
posting, probably credited cash on page twenty-seven with $1,000,
charged expense on page seventy-four with $500, salaries on page
seventy-six with $300 and office expense on page seventy-six
with $200 and went from the cash book to the ledger. If the
auditor were to follow the same order, it is possible that he
might, if the person who did the work originally made a mistake,
check the mistake. There seems to be, on the other hand, a
somewhat greater chance of his discovering the error, if in
checking he follows the reverse order. The question does not
seem to be an extremely important one, but if there is any choice
it is probably to be given to that procedure which checks the
postings in the reverse order.

A somewhat different and more convenient method of check-
ing postings, is to tabulate or abstract the postings on analysis
paper as they appear in the illustration below :

PRINCIPLES OF AUDITING

Total

General

Expenses

Salaries

Office
Expenses

1914
January

$1,000

$ 500

$300

$200

February .

5.000

4,000

500

The information concerning the months following February
will be put down as in the case of the months shown in the
illustration. It is then an easy matter to turn, for example, to
the general expense account in the general ledger and check the
twelve items one after another. This would take much less time
than turning to the general expense account on twelve different
occasions and checking one item each time. This, it is thought,
will bring out sharply the principle involved in the saving of
time through the abstract of postings.

What is known as abstracting the ledger will also offer the
same opportunity of facilitating the checking of postings. Ab-
stracting the ledger as commonly referred to, means going
through each account and setting out for instance, with regard to
cash, the debits and credits which appear in the account. It
will thus be seen that after all the accounts in the ledger have
been gone through in this manner, there should be shown the
total debits and credits of cash pertaining to the period, and the
respective totals of each should agree with the debits and credits
in the cash account in the general ledger and the cash book.
Abstracting the ledger usually means following out the procedure
just indicated with regard to all other books of original entry
in addition to the cash book. The author once discovered a
$10,000 shortage by analyzing or abstracting a ledger. The
practice should, however, be followed with judgment as it con-
sumes a great deal of time as a rule.

With regard to the checking of postings in simple cases, it
may be said that they may be checked from the cash book to the
ledger, if desired. Where the transactions are numerous, the
volume of business and the number of postings large, they should
be checked from the ledger to the book of original entry. In
either case the use of the abstract of footings will be entirely
satisfactory because of the fact that in so doing an independent

VOUCHING THE DISBURSEMENTS

posting medium will have been raised and an independent check
obtained which is likely to guard against passing over errors.

Detail postings where they affect underlying ledgers such as
creditors and customers, should be checked to the extent probably
of fifty or sixty per cent. This may seem rather high and will
perhaps be in some instances. The circumstances in each case
should dictate. The checking should also be spread about. It is
not desirable to take the first month or the last month, but rather
a month here and a month there, or perhaps every other item,
so as to cover in the checking as wide a field as possible.

Another point which should be mentioned before leaving the
subject of general cash, concerns the practice of holding the cash
book open at the end of the period in order to get in as many
receipts as possible. In a case which recently came to notice,
the fiscal year closed on September 30. The cash book was held
open and there were taken into the accounts for the fiscal year
ending September 30, actual cash receipts up to and including
October 23. It is important that the auditor should watch mat-
ters of this kind and throw out both at the beginning and the
end of the period receipts or disbursements which do not strictly
apply thereto.

CHAPTER XIV

THE PETTY CASH

The auditing procedure in connection with the petty cash
may perhaps best be brought out if discussion is first had of
the two ways in which petty cash accounts may be handled.

Let the illustration below represent a petty cash account in
the general ledger:

Petty Cash

$50.00
40.00
75.00
30.00

$42.82
37.50
32.43
76.82

One way of handling petty cash consists in transferring an
amount from the general cash to the petty cash and charging it
up to the petty cash account in the general ledger. The total
amount of the disbursements for the month, for example, $42.82,
becomes in effect the subject of an original entry through which
certain expense accounts are debited and petty cash is credited.
A further amount is then transferred to the petty cash and
debited to the account. This time it may be $40 and further
amounts in subsequent months may be $75 or $30, or any amount
which it is estimated will be needed. Each month in turn the
disbursements will be put through on the credit side.

The other way of handling petty cash is to have $50, for
example, transferred to the petty cash fund and charged up to
the petty cash account in the general ledger. This would appear
as below:

Petty Cash

$50.00

THE PETTY CASH

At the end of the month or at any other time convenient, the
disbursements are totaled up. A voucher is then made and a
re-imbursement check to the order of petty cash drawn. The
manner of handling the voucher will depend on the system in use.
In some cases where distribution is obtained through the cash
book, the voucher is treated like any other disbursement and put
through the cash book debiting the appropriate expense accounts
through the distribution columns of the cash book. In other
instances, where a voucher register is operated, the regulation
voucher is made up, the expense accounts debited through the
distribution and accounts payable credited. The cash book
entry then debits accounts payable when credit is taken for the
disbursement.

There are two ways of operating the general ledger account
even when the amount of the petty cash is fixed. In the first
way the account is credited with $42.82 when the voucher is
put through and charged with $42.82 when the re-imbursement
check is drawn. This idea is carried out from month to month.
The second of the two ways shows an account for the petty
cash fund in the general ledger which has been charged with
$50. No other entry is ever made in the account unless the fund
has increased or decreased.

Bookkeepers very often inquire whether the fixed or the
fluctuating fund is the better. Also in the case of fixed funds
whether the account should show just one debit and nothing
else, or whether subsequent debits and credits should be shown?
It is probable that the fluctuating fund is less desirable, not only
from the point of view of the auditor but from that of anyone
else who has to supervise the petty cash. This is because it is
necessary to ascertain before a balance may be checked how much
has been received by the person handling the fund. The advan-
tage of the fixed fund is the fact that one is able to tell by
looking at the ledger or the trial balance, that the person in charge
of the fund should have a certain amount, say $50 in cash or
paid vouchers. Most auditors should, it seems, prefer the latter
method over the first since it facilitates their work; also the
scheme of showing the subsequent debit and credit items even
though they represent only disbursements and re-imbursements.
If the debit and credit items are shown, one may see at a glance
the relation of the fund to the disbursements, which in substance

PRINCIPLES OF AUDITING

means determining whether or not the fund is adequate. Further
than this, it enables one to compare the amount of the disburse-
ments month by month. If they run at about the same amount
each month and then suddenly rise, the fact is brought to the
attention immediately by looking at the account. Where there is
a summary and the operation of the petty cash account can be
seen, a historical record of the transactions is afforded. This
record is sometimes convenient since it shows how much time
usually elapses between the preparation of the voucher and the
re-imbursement for same. This is specially true in the case of
branch offices where the petty cashier is at some distance from
the general office. The record shows that the voucher was re-
ceived on a certain date and that the re-imbursement check was
issued on a certain subsequent date.

The auditor who is having his experience of counting petty
cash for the first time will undoubtedly appreciate the advantages
of the fixed petty cash fund. Where the other method is in use
he will be obliged to get a transcript of all the petty cash checks
which have been issued to the person in charge of the petty cash
since the last accounting in order to know the total amount with
which to charge him. As a practical matter it is very embarrass-
ing to skip an item and perhaps accuse a cashier of being out
of balance. With the second method, where the fund is fixed,
the chances are that a mistake of this kind will never be made.
The amount which should be found 'is ascertained from the post-
ing of the original entry in the general ledger account and the
auditor may expect to find cash or vouchers in that amount. If
the amount of the original fund has been increased or decreased
the ledger account will show same.

So far as the auditing of the petty cash is concerned, both
these methods must be taken into consideration because of the
fact that they are both in general use. With the first it is
necessary to get a transcript from the general ledger which will
perhaps be supplemented by information from the general cash
book. It would not be sufficient to take a transcript from the
general ledger, if, for example, the auditor were counting the
cash in the middle of December. In order to assure himself
that nothing had been overlooked it would be necessary for him
to run through the pages of the general cash book in order to
discover if there were any items which had not been posted. In

THE PETTY CASH

the majority of cases probably postings to the general ledger
accounts are not made oftener than once a month, consequently
care must be exercised in cases of this kind with regard to the
possible transactions between the close of the previous month and
the date on which the verification is being made. In the second
case, reference must first be had to the general ledger in order
to determine the amount of the fund. It is also well to ask
someone in authority if the fund has been either increased or
decreased since the close of the last month.

So far as the procedure on the credit side of the account is
concerned, it will be the same in either case. The auditing of
disbursements is not affected by the system. The disbursements
should be vouched, giving particular attention to the large items
and using judgment as to how much vouching it is necessary
to do. If the petty cash disbursements are found to be made up
of a great many small items and the total amount involved is in
itself small, a great deal of time would be necessary in order to
vouch all the items and perhaps the expense incurred greater
than the amount of the petty cash disbursements involved. It
would not be good judgment under such circumstances to check
out all the items. On the other hand, if the disbursements run
into large amounts, it may be thought necessary to vouch every
item and it may be worth while to do so. At any rate, entries
for large amounts should be scrutinized and vouchers for same
examined. It is difficult to lay down any hard and fast rule as
to the amount of vouching to be done. The auditor must in this
particular be guided by what is necessary to satisfy himself in
each particular audit.

Items will sometimes be found for which no receipts or
vouchers can be produced. It is not probable that where postage
stamps are purchased in small amounts, a receipt could be ob*
tained from the post office department. There are other cases
where it will not be possible to get a receipt. Street car fare
and railroad fare and similar items are as a rule not supported
by vouchers. Very often it is necessary for the petty cashier to
take a receipt from some person such as an office boy or mes-
senger boy who pays out the money. Not infrequently entries
have to be accepted for which there are no vouchers.

The distribution of any large items should be checked, the
total columns footed, cross-footings proved, the posting of totals

PRINCIPLES OF AUDITING

checked, the balance in the petty cash account agreed with the
count of the cash. The balance should be worked back to the
date at the end of the period covered by the audit. The latter
will not be necessary if there is a fund in a fixed amount, since
such fund is presumed to have existed at all times in the amount
shown by the ledger.

It is rather difficult to formulate rules with regard to petty
cash books because of the fact that they take so many different
forms. Sometimes there will be simply a memorandum book
without any ruling at all. It is not unusual to find a stenogra-
pher's note book being used for this purpose. At other times it
will be a big formal columnar ruled book similar in appearance
to the general cash book. There seems no reason why it should
not be ruled and ruled in columns so that the distribution may
be made at the same time as the other entries. The author once
ran across a man keeping a petty cash account who was a porter
and general utility man. What he did was to jot down in a note
book the amounts disbursed, showing what they were disbursed
for and continuing this procedure for a year. At the end of the
year the bookkeeper took this book and on a big sheet of paper
(not even analysis paper) headed up with the various accounts,
put down the amounts under their respective heads until all the
disbursements for the year had been entered. Such procedure
seems to be rank waste of time. It is just as easy if distribution
is to be made, to distribute immediately after the entry has been
made in the total column, so that when the end of the month
or the end of the year arrives, the work is completed. In one
case it is ready when it is needed. In the other case, the work is
postponed and piled up and when the information is required it
is not immediately available. It is not improbable that the auditor
may do considerable missionary work in respect to small matters
of this kind by criticizing in a tactful way where work is being
improperly done and offering suggestions for improvement in
method or system. The opinion is ventured that the influence of
auditors as well as graduate students of the subject of business
and accountancy has been greatly felt in the business world in
the past decade. Untold opportunities, however, in this respect
still exist.

One other thought in connection with the subject of petty
cash suggests itself. This concerns petty cash funds at branch

IOO

THE PETTY CASH

offices. In such cases it is customary to find monthly state-
ments or reports sent in to the head office. Just like petty cash
books, these reports vary greatly in form. They depend, of
course, upon the system in operation. In substance they are all
the same. The information which they show is usually pre-
sented as an account. The amounts received by the branch
office appear on one side of the account; the disbursements on
the other side. The disbursements are usually accompanied by
vouchers. These monthly statements or reports should be audited
just as a person would audit the petty cash book. This would
involve checking first the balance brought forward, verifying the
receipts from the home office records, the disbursements from
the vouchers, footing both the debits and credits and proving
the balance.

101

CHAPTER XV

VOUCHING THE PURCHASE JOURNAL OR VOUCHER REGISTER

The title of this chapter may raise a question in some minds
as to what difference there is between the two books. This
perhaps is a matter which belongs to accounting rather than to
auditing and may not be entirely in place here. It is not the
intention of the author to deal with the theory of accounting
nor with system work. Matters such as pointing out the distinc-
tion between these two books seem, however, to warrant con-
sideration if the proper foundation is to be laid and the auditing
discussion made entirely clear. The rulings for the respective
books appear below :

PURCHASE JOURNAL

Total

DISTRIBUTION

Heat

Office
Expense

General
Expense

Billings and Bakner

$15.00

VOUCHER RECORD

Total

DISTRIBUTION

Heat

Office
Expense

General
Expense

Billings and Bakner

$15.00

In connection with the purchase journal there will be ledger
accounts such as the one appearing below :

Billings and Bakner

$15.00

If a single invoice from Billings and Bakner in the amount
of $15.00 might be taken as an illustration, the procedure would,
in the operation of the purchase journal, be as follows : Invoice
received, goods checked with invoice, price verified, extensions

102

VOUCHING THE PURCHASE JOURNAL OR VOUCHER REGISTER

and footings checked, invoice entered in purchase journal, show-
ing the name of the creditor, the total amount and the distribu-
tion. At the end of the month the purchase journal should be
footed, the amount in the total column credited to accounts
payable controlling account, the amounts in the respective distri-
bution columns posted to the appropriate accounts in the general
ledger. The details affecting creditors would be posted from
the purchase journal to the individual creditors' accounts in the
creditors' ledger. The account used for illustration would show
a credit of $15.00 when this posting was made and a debit of
$15.00 when the account was settled through the payment of
cash.

Where a concern has sufficient cash to pay all accounts
promptly and where the total of invoices will be paid at one
time instead of paying something on account, the bookkeeping
work may be greatly reduced by eliminating the ledger for such
individual creditors' accounts and combining the ledger and
journal function in one book called the voucher record. This
book is very often known by other names, such as the voucher
register, audited vouchers, audited voucher record, etc. If
the journal function is not altered, the entries are made pre-
cisely as in the case of the purchase journal both with regard
to total and distribution. Instead, however, of opening a ledger
account with each individual or creditor concern, a single line
in the voucher record is used, namely, the line opposite the
creditor's name in the paid column, the same thing is here ac-
complished as if the formal ledger account were opened. The
entry in the total column shows the credit. The date of payment
in the paid column serves as the debit and wipes out the account.
This scheme is only workable where the payment is in the same
amount as the credit. Some variations of this voucher record
have been seen where it was the practice to make payments on
account but such schemes are not usually satisfactory.

With the ordinary use of the voucher register the invoices are
handled in about the same way as in the case of the purchase
journal and the bookkeeping procedure is also similar. Invoices
instead of being entered individually as in the case of the pur-
chase journal are held in a file, being sorted according to creditors
until a sufficient number have accumulated, when they are entered
on the voucher form, totaled up and distributed. The name of

103

PRINCIPLES OF AUDITING

the creditor, total amount and distribution are then entered in
the voucher register. In this way only one entry is made in the
book, whereas fifty entries might have been necessary in the
purchase journal. There is no time saved since the same entries
have to be made under either system but where the voucher
register is used they are made on inexpensive voucher forms
instead of filling up pages of expensive paper in the books, which
pages have to be footed and carried forward. There may be
of course a slight saving in this latter respect. Having entered
the vouchers in the record, the footings and postings are made
in the same way as in the purchase journal.

If the above discussion has succeeded in establishing the
difference between the purchase journal and the voucher record,
attention may now be given to the matter of auditing in its rela-
tion to these records. It may be remembered that in discussing
the mechanical work, attention was called to the fact that it might
be divided into three parts, namely, vouching, footing and check-
ing postings. The footing and checking of postings will be
precisely the same whether a purchase journal or voucher record
prevails. The vouching is essentially the same in both instances.
The method of checking, however, differs slightly in one respect.
In checking a purchase journal there will be a separate invoice
for each entry in the purchase journal. In the voucher record
the auditor will perhaps, in most instances, see at first glance
only the voucher. He must bear in mind that these vouchers
are supported by invoices, and must spend a certain amount of
time in ascertaining whether or not the invoices agree in the
a gg re gate with the voucher and properly support it, and
further, whether or not the invoices themselves are in proper
shape. Having tested occasionally, perhaps every fifth voucher,
the make-up of same, that is, having examined the invoices and
checked them with the voucher and proved the footing on the
voucher, the following rules may be laid down:

1. Compare the number of the invoice or voucher with the

number in the book.

2. Compare the name of the creditor on the invoice or

voucher with that in the book.

3. Compare the amount on the invoice or voucher with that

in the book.

104

VOUCHING THE PURCHASE JOURNAL OR VOUCHER REGISTER

4. Tick the entry in the book at the right of the figures in

the total column.

5. Stamp the invoice or voucher "examined."

6. In the case of every fifth voucher compare the distribution

on the voucher with the distribution in the book.

In connection with this work practical difficulty will some-
times be encountered. As the vouchers are made out and entered
in the voucher record they appear in numerical order. Once
they have been entered they are filed away as a rule in alphabetical
order because of the fact that if occasion arises for referring
to a voucher, it is something that arises out of relations with the
creditor and is apt to be wanted in connection with the account
of same. As a rule no one except the auditor requires informa-
tion concerning a voucher other than that which arises out of
relations with creditors. If information were wanted with regard
to Billings and Bakner, it would be most logical to look for the
voucher in an alphabetical file. When the auditor comes to
check the voucher record he finds that vouchers are scattered all
through the files, some under A, some under B, some under C
and not at all in the order in which he wishes to use them. Then
arises the question of what shall be done. The thing to be done
is to go to the client or his representative who is in authority
and state the situation. It will take a great deal longer if the
auditor is obliged to get out these vouchers and arrange them
himself or check them as they exist than if someone else puts
them in order for him. It will probably cost five times as much,
so far as the auditor's services are concerned, to check the book
one way as the other. On this account the question should, as a
practical matter, be submitted to someone in authority. It will
usually be found that the task of putting them in order will be
given to some employe of the client whose time is not as valuable
as that of the auditor. If the engagement has been taken on
the contract basis, in which case the person making the estimate
should have taken such things into consideration, the auditor
will have to use his own judgment about asking for an increase
in the fee unless he is able, through tact, to succeed in having
some of the clerks do the work for him.

The total, and discount columns (trade discount), in case
the latter appears, should be footed and the cross-footings at the

105

PRINCIPLES OF AUDITING

end of each month proved. Postings of totals should be checked
to the general ledger. For this purpose an abstract of the post-
ings will be found very convenient. This way will be found
especially advantageous in the case of a voucher record where
the distribution is extensive, using sheets of analysis paper for
the purpose and if necessary pasting them together. These sheets
should be headed up as usual and the totals abstracted by months.
If this is done, one may turn to any given ledger account and the
entire twelve items or amounts checked at one time. In the
case of the purchase journal the individual items must be checked
to the creditors' ledger. In the case of the voucher record, if
such work has not already been done, the cash payments in the
paid column should be checked. In connection with this latter
point, while perhaps this matter does not come under the head of
mechanical work, a list of the outstanding or unpaid items, some-
times called the open items, in the voucher record, should be
made and the total compared with the credit balance in the
voucher record account in the general ledger. This is the same
thing as taking a trial balance of the creditors' ledger. If
there were a ledger account for each creditor and the credit
balance in each account were to be taken off and these balances
added together, the total should equal the amount in the con-
trolling account if the work has been correctly done. Here the
open items take the place of the creditors' accounts and should
prove up with the control in the same way.

It is not thought to be necessary to repeat the remarks con-
cerning the procedure, as applied above to the purchase journal
and voucher record, in the case of the purchase returns and
allowances. The voucher in the latter case will be a credit
memorandum received from purchase creditors.

While discussing the vouching of the purchase journal it
may be desirable to include in the discussion, the other books
which require treatment similar to the purchase journal. The
sales book, for example, should be vouched from sales invoices.
The number, name, and amount on the invoice should be com-
pared with corresponding entries in the book. The entry should
be ticked and the invoice marked "examined." Distribution
should be occasionally checked. The total and discount columns,
if there are any of the latter, should be footed. The discount
columns referred to are those for trade discount which are found

106

VOUCHING THE PURCHASE JOURNAL OR VOUCHER REGISTER

in some cases. Cross-footings if they exist should be proved.
Postings of totals should be checked to the general ledger, and
the details to the customers' ledger.

Sales returns and allowances may usually be checked from a
carbon copy of the credit memorandum. The procedure is the
same as in the case of the sales book.

The payroll book should be vouched from receipts if there
are any. The total column should be footed and the total foot-
ings checked to the general ledger. The distribution should be
checked.

With regard to the general journal, both columns should be
footed. The postings should be checked and any complicated
entries should not only be scrutinized but studied carefully. It
will be surprising at times to find how much light will be thrown
on the situation if time is taken to study and understand what
appears at first glance to be a complicated entry. The author has
always contended that a prospective accountant who can take
a series of transactions or statement of facts and put them into
the form of a journal entry, has solved about half of his problem.
A better test of a man's ability probably does not exist. If one
cannot state things in terms of journal entry there is not much
use in trying to go ahead since trouble will be sure to result.
Consequently it seems that if an entry is found in the journal
that is not at first understood, it merits attention and the auditor
should not drop it until he is sure that he understands it. There
is, of course, time wasted occasionally through stubbornness on
the part of the auditor in seeking to understand complicated
journal entries when he is too proud to ask someone to explain
them. Care should of course be exercised in this respect.

Included with the above discussion might perhaps be the
mechanical work in connection with the general ledger. Such
work consists in checking the balance brought forward from old
ledgers in case new ledgers have been opened ; footing the ledger
accounts and proving the balances if they have not already been
proved in taking off the trial balance.

107

CHAPTER XVI

INVENTORIES

Inventories may include materials and supplies, goods in
process, finished goods, packing material, stock in trade, goods
in transit, goods out on memorandum, goods out on consign-
ment, coal, oil, waste, postage, stationery and printing, and scrap.

Inventories are of two kinds, book and physical. A book
inventory is practically a trial balance of a materials and sup-
plies ledger, or of ledger stock cards which are frequently used
in connection with materials and supplies. There is no reason,
of course, why the term may not be applied to any kind of stock,
for example, goods in process, or finished goods, altho it is
most frequently used in connection with materials and supplies.
A book inventory of goods in process, etc., appears where there
is a cost system.

A physical inventory differs from a book inventory in that
it represents actual inspection and count of the stock at a given
time. The time is usually the end of the fiscal year period,
altho the count of certain articles may be made at the time during
the year when the stock of such articles is at its lowest point in
order to compare the count with the book inventory. Like the
book inventory the physical inventory shows units, prices,
amounts and total. In the one case the number of units has
been obtained by actual count, whereas in the other the figure
represents the balance which has been obtained by keeping track
of the receipts and issues.

It may be said that there are five things concerning which
the auditor will wish to satisfy himself with regard to the in-
ventories. Assuming that the auditor has gone into the office
of the client and has had presented to him a number of sheets
purporting to contain the inventories. The sheets will contain
a list of articles showing in each case, the number of units, the
name of the material, the price at which the material is carried,
the extension and the footings. In taking up the work the
auditor will endeavor to satisfy himself as follows :

First : That the units of stock represented by the inventory
were on hand at the date thereof.
108

INVENTORIES

Second : That the inventory contained no material which was

obsolete or unserviceable.
Third : That the figures used in pricing the inventory were

first correct and second, cost or lower.
Fourth : That the extensions are correct.
Fifth: That the footings are correct.

Taking these matters up in turn, it appears first that the in-
ventory contains a statement to the effect that there are certain
units of stock. These units were supposed to have been in the
possession of, or owned by, the company at the date of the
inventory. They were supposed to have been actually inspected
and counted on that date. In perhaps nine cases out of ten
the auditor was not there in person to inspect the articles and
see them counted. He may, of course, take for granted that
the inventory in this respect is correct. He should not, how-
ever, be satisfied with the fact that these articles have been
put on the list. He should satisfy and protect himself by requir-
ing a certificate from the person who counted and recorded the
inventory, or better, some officer or reliable representative under
whose direction the inventory was taken, certifying to the fact that
all articles included in the inventory were on hand on the date
in question.

The auditor should also ascertain whether or not the inventory
contains any old stock; stock for which there is no longer any
call; stock which cannot be sold, or at least not sold except as
scrap. It very often happens that there will be around a plant,
old material, partially completed goods, and sometimes finished
product, which has little or no value ; certainly not a value equal
to the cost. Such old material is often carried year after year
at cost. Concerning this matter, the auditor may satisfy himself
by obtaining a certificate to the effect that the inventory contains
no such material, and further, by making a casual trip about
the plant and through the stock rooms, if practicable, and inquire
particularly about any unserviceable material which he may
observe, as to whether or not it has been included in the inventory.
This point may raise a discussion at times and perhaps cause some
objection on the part of the client, if the auditor is insistent on
eliminating material which seems to be unserviceable.

Not long ago a case arose in which an inventory contained

109

PRINCIPLES OF AUDITING

certain articles which had been carried in stock for almost ten
years. It was a business in which styles played an important part
and the articles in question had become practically obsolete be-
cause of a change in the styles. While having had little value
for practically ten years the demand for goods in which they
played an important part having suddenly sprung up on account
of a new style, these goods had an inventory value on December
31, 1914, of about thirty-five hundred dollars, whereas, a year
previous they had scarcely been worth, figuratively speaking,
thirty-five cents. Through a change in style, these articles which
were as good as new, not only had an inventory value, but they
had actually cost about fifty per cent less than present market
prices when they were purchased. Similar cases are related
where goods have been carried in stock for a long time at little
or no value and have suddenly through the European war be-
come much in demand and consequently now have an inventory
value. Judgment must, of course, be exercised about things of
this kind.

The auditor should assure himself that the prices are correct.
He should see to it especially that there has been no mistake in
setting down the prices to be used. Articles which should have
been priced at one dollar and fifty-four cents may have been
priced at twenty-seven cents. Or just the reverse may have
happened. Occasionally prices become mixed. A concern may
have some materials which are used in small quantities but are
very valuable, whereas, other materials which are used in large
quantities may be worth almost nothing. It is rather important
to make sure that in setting down such articles high prices have
not been inadvertently set down against large quantities, and
low prices against small quantities. This may occur without
any intention at all on the part of the client or his employes to
over-value the inventory. It is merely a clerical error which is
quite apt to be made.

It is probably the consensus of opinion that the inventory
should be priced at cost unless the market is lower than cost, in
which case, it should be priced at the market. This may perhaps
seem inconsistent, since it is a difficult thing to get people who
believe in cutting down the price if the market is lower than
cost to increase the price if the market is higher than cost. This
matter seems to have two different aspects. One is the effect on

INVENTORIES

subsequent costs. The other is the effect on the financial condi-
tion of the organization as represented by the balance sheet and
taken in connection with the replacement of the items. If, for
example, a certain article is purchased at eighteen cents a pound
and the market price goes down to twelve cents, a manufacturer
is not going to fool himself in the next period, having eighteen
cent material on hand, by charging the material into his product
at twelve cents. If he has bought it at eighteen cents that is
what the material cost and that is the price at which the material
is going to be charged into the product and the price at which
it will effect the cost. Nothing would be gained by withholding
that material and buying other material at twelve cents so that
the latter might be temporarily put into the product in order to
reduce the cost. Sooner or later the eighteen cent material will
be reached and will have to be charged into the product. Whether
it goes into the product at eighteen cents or whether it goes in
at twelve cents while the difference of six cents is charged against
profit and loss makes little difference in the effect upon the profits.
It seems, however, that so far as charging the material into the
product is concerned, it should go in at material cost regardless
of fluctuation in the market.

There is, however, another point of view when the material is
looked upon as an asset. A manufacturer who paid eighteen
cents for certain material and may now replace it at twelve cents
may, if he desires to be conservative, carry it as an asset in the
balance sheet at twelve cents. Such course is conservative and
no one may reasonably object to that position being taken. On
the other hand, a person who accepts that theory will object to
the product being marked up if the market has gone up.
Whether the market goes up or down need not, it seems, concern
one. What is on hand was bought in a certain market and at a
certain price. The rise and fall in the market does not cause a
manufacturer to rush in and buy or sell for the purpose of regu-
lating his inventory. He may do so for financial reasons, which
is a different matter. Notwithstanding all these discussions, as
has been said, it is probably the consensus of opinion that con-
servative practice dictates the valuation of the inventory at cost
or less if the market is lower than cost.

Where the market is lower than cost and it seems desirable
to adjust the inventory figures for balance sheet purposes, such

ill

PRINCIPLES OF AUDITING

adjustment may be accomplished through the operation of a
reserve. This is preferable to actually adjusting the accounts for
materials and supplies, since any adjustment of the total figure
means an adjustment of the total figures from which the total
is made up and which may entail an endless amount of work.
If the market is lower on some of the items represented in the
controlling account the amount of the inventory may be allowed
to stand in the balance sheet as it was taken and the extent to
which the market is under the cost in the respective items may
be represented by an estimated amount which may be charged
against profit and loss and credited to a reserve. This has
the effect in the balance sheet of reducing the value of the
inventory without changing the actual figures in the controlling
account and consequently not requiring any changes in the figures
appearing on the subsidiary stock or cost records. If, on the
other hand, it ever becomes desirable to take cognizance of the rise
in the market, the book figures need not be changed. Again,
an entry may be made which will increase the balance sheet
figure representing the materials and supplies and credit a reserve
for the excess of market over cost. It is possible that some may
object to this being done with respect to the balance sheet and not
being done on the books. In such case an entry might be made
in the books for closing purposes and reversed after closing.

It sometimes becomes a part of the auditor's work to be
present at the time stock is taken, and at other times to suggest
plans for the taking of the inventory. It is always much more
satisfactory to him when he is present at the time the stock is
taken, especially if he is called upon to give a certificate in
connection with his audit. He may, however, be obliged to do
the work at a time which is not as convenient personally as he
would like to have it. Active retail stores and hotels, for
example, are frequently obliged to take an inventory of stock,
or in the latter case, of equipment as well as stock, at night.
The author recalls instances where he was obliged to spend the
entire night in observations of this kind. Mention is made of
these matters in order to bring to the attention of a young man
who aspires to enter the accounting profession the fact that the
work is not by any means a sinecure and that he must be prepared
to perform any kind of service required of him no matter how
disagreeable or inconvenient it may be.

112

INVENTORIES

If the auditor is not requested to be present at the taking of
the inventory, he may be asked to submit a plan for doing so. One
engagement which comes within the range of the author's ex-
perience may be used to illustrate this point. A large concern
manufacturing electric supplies requested a plan or scheme for
taking the inventory. The plan suggested contemplated the use
of slips made in two parts and perforated. One part was gummed
and the force which took the inventory went through the stock
systematically making the count and after noting the count on
the two parts of the slips, pasting the slips on the boxes contain-
ing the supplies. A second squad followed, verified the count,
tore off the perforated sections and initialed them. The slips
were subsequently priced out, the extensions made and the
record of the inventory completed. Where the prices were the
same, slips were consolidated as far as possible and then priced
out and extended as already mentioned. The slips served as
vouchers, as it were, to support the entries. In this case the
auditor had a first-hand voucher for the count from someone
who had counted the materials and supplies. This, while perhaps
not as satisfactory as seeing the material counted, was probably
the next best thing. The first count was verified by a second
squad and too many men were involved to make collusion possible.

In taking inventories it is quite important that boxes and
cases be opened and their contents inspected. If the auditor is
present at the taking of the inventory he is entitled to have all
boxes and cases open, and should satisfy himself that he is not
checking off empty containers as full boxes. While the auditor
has certain rights in this respect, he must exercise some judg-
ment and not make unnecessary work. If it so happens, as it will
in the majority of cases, that the auditor has neither formulated
a plan for taking the inventory nor been present at the time it
was taken, he may accept a certificate concerning it. It is usually
customary where certificates of this character are accepted, to
go into the matter with the person who is responsible for or
who had charge of the taking of the inventory, and ascertain just
how the stock was taken, how it was priced out, the basis used
for pricing and as much information concerning it as possible.

Another way in which the auditor may satisfy himself,
partially at least, is through an approximation or test more than
anything else which consists in working out the inventory from

PRINCIPLES OF AUDITING

the cost of goods sold, which cost has been obtained by using
the net sales and gross profits on sales. As an illustration of
this, supposing the inventory at the beginning of the period was
$10,000 and the purchases during the period were $25,000, the
total amount to be accounted for would then be $35,000. Assum-
ing that the sales during the period were $25,000 and that there
has been ascertained from the book in the preceding period, or
from the statement of income and profit and loss of the preceding
period, that the gross profit and loss was 25%, meaning 25% of
cost. The sales of $25,000 would then represent 125% and the
cost of the goods sold would be found by dividing $25,000 by
125%, or $20,000. By subtracting the cost of the goods sold
$20,000, from the previous figure of $35,000 (the total to be
accounted for), the inventory on hand at the end of the period
should have been $15,000. This would, of course, be an approxi-
mation and would vary in accordance with the fluctuation in the
different priced goods. If in this period under review there
had been a large volume of sales of high priced goods the calcu-
lations would be affected. They would be affected in the same
way if there had been a large volume of sales of low priced
goods, because under such circumstances as well as those pre-
ceding the profit would have been more than or less than 25%.
Since the 25% is an average on everything, the result of $15,000
might be slightly inaccurate. It would, however, it seems, be
sufficiently accurate to serve a useful purpose since any marked
variation such as a result of $6,000 on the inventory sheets or
$27,000, for example, would be too far off to be allowed to pass
without attention having been directed to the discrepancy. The
figures used in this illustration may have been slightly overdrawn,
but the purpose was to show how the result of $15,000 would
serve as a basis for comparison, offer an opportunity to investi-
gate more thoroughly and probably discover the real trouble.

Inventories, when considered with regard to prices, practically
divide into three groups. In the first group may be considered
everything except goods in process, finished goods and scrap.
The second group may be said to be represented by goods in
process and finished goods, the third group by scrap.

With regard to group one, the auditor should go into the
question of prices through reference to the invoices. It will be
out of the question to verify every item on the inventory so far

114

INVENTORIES

as prices are concerned. What should be done is to pick out
the most important and higher priced articles and verify the
prices from recent invoices. The prices used will, as a rule, be
found to be those on the invoices representing the last purchase
of goods. Sometimes an average price will be used and some-
times the price will include the allowance for inward freight
and cartage. These purchase prices will sometimes be some-
what arbitrary and at other times the prices used will be some-
what arbitrarily fixed by a person whose judgment concerning
prices is satisfactory. In a case of this kind it is desirable that
such person be asked to explain why the price used was selected
and why he thinks it is a proper price to be used. It is very
largely a matter, so far as the auditor is concerned, in a case of
this kind, in deciding whether or not he wishes to accept the
judgment of the man who put the price on. If, after talking the
matter over with him, it is thought that he is consistent, con-
servative and careful in fixing the price, the auditor may feel
satisfied in passing it.

What needs to be said concerning goods in process applies
in a large part to finished goods as well. The problem is much
simplified if there is a cost system. Reference to the manufactur-
ing or cost ledger will show the cost of the goods in process. If
there is no cost system an estimate will have to be accepted and
the goods will have to be segregated according to departments or
according to the various stages of completion in which they were
found at the time the inventory was taken. The estimate should
include material used in the process of manufacture up to the
point where the inventory was taken; the same with regard to
labor and a percentage added for manufacturing overhead.

It would perhaps be somewhat inconsistent to proceed with
an explanation of how to verify the inventory of goods in process
without having described the manner of taking and pricing
such an inventory. There may be used as an illustration of
such point, a plant in which there are eight departments. Assum-
ing, for example, that on December 31, the plant closed down
and that the force assigned to the taking of the inventory went
through the various departments counting such goods as were
actually found. From the tabulation which appears below it will
be seen that altogether there were two hundred units in various
stages of completion. The material unit cost is shown with

PRINCIPLES OF AUDITING

regard to each department; also the cumulative material unit
cost ; the departmental cost of the goods in the various stages of
completion, as well as the total material cost of $1,010.56. With
regard to labor there is shown the departmental unit costs, the
cumulative unit labor costs as well as the cumulative department
costs and the total labor cost of $146.56. The way in which the
overhead has been calculated will be described later.

In order to understand the situation better, it may be advisable
to take up one or two items as shown in the tabulation. Suppose,
for example, that the clerks working on the inventory, upon
arriving at department number one, which represents the first
operation in the process, find twenty-four units of goods partially
finished so far as that department is concerned. If sharp lines
of demarcation are drawn between departments or operations, it
should be an easy matter to determine the extent to which material
has entered into the product. The next thing is to find out how
much such material costs per unit. This task will be simplified
if there is a cost system. If there is no cost system, reference
may be had to invoices, the material identified, the price obtained
and the unit cost for the operation under consideration obtained
by a short "study." This study would consist of finding out how
much material was necessary to turn out a given number of
units, and after getting the price of the material dividing the
total cost of same by the number of units produced. Using
either figures taken from the cost records or the figures furnished
by the study as a basis, the number of units in department No. 1
(24) may then be priced out at the material cost of $1.12,
amounting to $26.88. The operation of labor may be taken either
from a bill of prices or the cost records or a study similar to the
one just indicated. In department No. 1, 24 units at 12 cts.
per unit would give the labor cost of $2.88. If each department
were to be considered separately and in the manner just sug-
gested, the results would be found in the columns marked material
cost and labor cost respectively. The figures in the column show-
ing cumulative cost are the result of building up the unit costs
by departments.

The basis on which the overhead is added is possibly more
scientific than those which are frequently used. In the case
under illustration, since there are eight departments, any goods
in department No. 1 will be one-eighth completed, and any

116

INVENTORIES

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117

PRINCIPLES OF AUDITING

goods in department No. 5 will be five-eighths completed. If
these figures are now reduced to a common basis for the purpose
of getting an average, one-eighth of 24 will give 3 as a result,
five-eighths of 32 gives 20, six-eighths of 64-48, seven-eighths
of 80-70, a total of 141, which divided by 200, the total number
of units, shows that product taken as a whole is 70.5% completed.
The prime cost is made up of materials $1010.56 and labor
$146.56. It is found by reference to the books in the previous
period or to statements which are available, that the percentage
of manufacturing overhead to prime cost in previous periods was
56. If the same thing were to hold true in this period the overhead
would be 56% of $1157.12 (prime cost) or $647.99. Such is the
amount which would be added to these goods in process if they
had all been completed but they have not. They are only 70.5%
complete so that 70.5% of this amount shows the correct amount to
be added to the prime cost. The amount in question is $456.83.
The total inventory value of the goods will thus be $1613.95.

The overhead is many times added through an arbitrary
percentage. Someone will be of the opinion that 40 or 50 per
cent, for example, should be added to cover the overhead. Where
this has occurred it is advisable to examine into the basis sug-
gested, question the person as to the foundation for the basis
and the reason for his judgment. If the manager advocates 32
per cent he should be asked to explain why 32 per cent has
been used.

From the above discussion of goods in process it will probably
be seen that the rule to be followed by the auditor consists in
ascertaining with regard to both goods in process and finished
goods just what basis has been used in pricing the goods, and
determining whether or not such basis is logical. From what
was explained in connection with the goods in process, it will
probably be possible to see what should happen in the case of
finished goods. It would be a question of getting all the material,
making a test, or rather making calculations concerning the
material, labor and overhead.

Scrap should be reduced to the basic element or elements of
which it is composed and priced at the market for same. The
tendency with regard to scrap is to overvalue it, so that if any
considerable quantity is involved the auditor should be cautious
about accepting the values.

118

INVENTORIES

The auditor must also satisfy himself with regard to the
extensions. The larger items may be tested. It is usually im-
possible, from a practical point of view, to attempt to check
every item and the extensions of all the items in an inventory.
Inventories are frequently very extensive. They sometimes cover
hundreds of pages. Again, in this matter the auditor must ascer-
tain how the extensions have been made. If they have been
made by hand and by only one person, or in other words, have
not been checked, the extent to which the auditor should go in
his work would be considerably greater than if the calculations
have been made by a machine and checked. Many concerns now
have their inventories extended by comptometer operators. This
is not only a means of great relief to the regular force but prac-
tically insures the accuracy of the calculations. Granting that
the prices are properly set down, or furnished by someone who
is accurate, there is little chance of an ultimate mistake existing.
One person makes the calculation, a second performs the same
operation, thereby checking the calculation.

If the inventory has been taken and machines such as Hol-
lerith or Powers used in getting the results, they may usually be
accepted as being correct. If the auditor is not satisfied with the
results he will usually find that the cards are available and may
have them put through the machine a second time, thereby getting
results which may be checked with those originally furnished.
The only possible mistake which may occur in the use of these
machines is in punching of the cards. The chances of serious
errors are rather remote.

With regard to the footing, there is not very much to be said.
The only way for the auditor to satisfy himself in this respect is
to go over the footings. If he has neither the time nor disposi-
tion to foot each column, he may cast them up roughly by glanc-
ing over the figures in the column and comparing them roughly
with the result. He may of course take them off on an adding
machine, but this will perhaps consume as much time as if he
were to foot them as they stand.

It may not be out of place to mention, in connection with this
topic, two articles which appeared in the Journal of Accountancy.
They are entitled "The Relation of the Auditor to Valuation of In-
ventories," by W. Ernest Seatree. The first appeared in the Sep-
tember, 1914, number; the second in the November, 1914, number.

119

CHAPTER XVII

ANALYZING ACCOUNTS

A great deal of the footing of the general ledger accounts
may be avoided if the accounts are analyzed. By analyzing an
account is meant taking it apart and classifying the component
items so as to get an idea as to what the account contains. It
will probably be seen that if an account is taken apart and the
items are grouped according to the different classes of things
which they represent and the totals of the groups are added, a
proof on the account will be obtained without footing the items
as they appear therein.

Aside from proving the additions in general ledger accounts,
analysis has four practical objects: first, to see that nothing has
been buried; second, to see that nothing has been charged to
the wrong account; third, to see that expenses have not been
capitalized; fourth, to see that assets have not been carelessly
written off.

The word "bury" may sound like slang, but it is not. It
conveys considerable meaning in accounting. It is almost a
technical term so far as accounting is concerned. It means some-
thing hidden, covered up, lost sight of.

Again, something may be charged to the wrong account
through error. It may be nothing intentional on the part of the
bookkeeper; merely a mistake in getting it into the wrong ac-
count. It may occur because of an error of principle; doing it
because he does not know any better, or as a mechanical error;
putting it into one account when he intended to put it into
another.

Very often expenses will be found charged to asset accounts.
This has the effect of capitalizing them. Such is more apt to
be the case where a concern is running behind; the profits are
not as large as they have been, or it was hoped they would be;
or there is an operating contract with the manager or superintend-
ent whose compensation depends upon the profits. There is
always more or less of a struggle going on between the adminis-
tration and the management. The manager is inclined to attempt
to capitalize everything possible in order to keep down the ex-

121

PRINCIPLES OF AUDITING

penses and increase the profits. The administration, on the other
hand, is exercising vigilance constantly in order to prevent the
capitalization of expense.

Concerning the fourth class, there is a tendency on the part
of many concerns and individuals to write off promiscuously
thoroughly good assets because there is in their opinion some
question about when or how they will be used up. Such concerns
or individuals are anxious that nothing shall appear in the list
of assets which is not absolutely sound and has a "convertible
value," as it is sometimes expressed. Anything like chairs or
small fixtures that are liable to become broken, lost or stolen,
are in such cases charged immediately to expense without any
consideration. Frequently these things are carried to extremes,
sometimes intentionally and sometimes ignorantly. In a recent
case which came to attention, several thousand dollars worth
of furniture was charged to expense when purchased because
it was argued that the furniture would wear out in a short
time, the concern could afford it and therefore it was the easiest
way of disposing of the matter. Such argument and procedure
may be quite proper but it appears to open the way and make
easy, crookedness where it might not otherwise appear. If
employes know that things of such character are charged off
and lost sight of, there is no reason why they may not help
themselves to things which may be carried away, especially if
no record of such articles is kept.

The four things above mentioned would not be brought to
the attention simply through the mechanical work of checking.
Checking would not disclose anything buried. It is not prob-
able that it would disclose anything charged to the wrong ac-
count. There may be, however, an exception to this statement.
If, for example, the bookkeeper is posting to the furniture and
fixtures account and such account in the ledger appears on
page 54, he may inadvertently turn to page 56, there make the
posting and note the posting reference in the appropriate column
in the voucher record as page 56. The item has obviously been
posted to the wrong account. It will be found on page 56 of
the ledger and 56 will be marked on the voucher record, so
that whether the auditor checks from the voucher record to
the ledger or from the ledger to the voucher record he will find
an entirely good posting from page 56 and the opinion may

122

ANALYZING ACCOUNTS

be ventured that in many cases the mechanical checking would
not disclose the error. If perchance the bookkeeper notes in
his voucher record 54 as the page to which he intends to post
the item and then posts it to page 56, such an error would un-
doubtedly be caught in checking. This illustration of course
raises a question with regard to the technique of checking, as
to whether or not the auditor in checking should observe the
title of the account affected rather than the pages. It is of
course true that the ideal manner of checking is one which takes
into consideration the accounts affected as well as the amounts.
The page numbers theoretically serve only as a means of assist-
ance in finding the proper accounts. Practically, when a person
settles down to the humdrum of checking, the page numbers
are probably more apt to serve as a guide to the amounts only
rather than the titles. While this argument of course departs
from the ideal it recognizes the weakness of human nature
when involved in work of this kind. It requires an unusual
man to glorify work of this nature to the point where every bit
of it will be done thoughtfully. Many begin this work with
good intentions. It is safe to say that most of these fall into
the same rut and after a short space of time has elapsed do this
work in the same old mechanical way. It is more apt to be
done well if done by two persons rather than one, since one
calls and the other checks.

Analyzing accounts is a part of the work which may not be
too carefully done. Above all the results must be comprehensive
and clearly expressed. The amount of time involved in making
an analysis is usually considerable. If the results when obtained
are not clear and understandable and do not permit of use the
time has been wasted.

It may be interesting to have the procedure involved in
analysis given first, to be followed by a typical case which will
be worked out.

Analysis paper should be used. It should be headed up with
the name of the organization, the period covered by the work
and a statement to the effect that it is an analysis of such and
such an account. One sheet (or more if necessary) should be
used for the debits and one sheet or more for the credits unless
it is quite obvious that both debits and credits will go on one
sheet. One may frequently be deceived about this and it is

123

PRINCIPLES OF AUDITING

probably safer always to take a separate sheet for debits and
credits. Beginning in the upper left-hand corner in the first
column, the date should be provided for; in subsequent columns
the posting references and amounts. After the amount there
should be noted any explanation which may appear in the ledger
account.

In the illustration about to be presented especially the tran-
script of the ledger account and the analysis, it should be remem-
bered that one is not asked to pass on the propriety of the account
or the items therein but rather to observe the technique involved
in analyzing the account. The ledger account is first presented
as below in order that each step in the process from beginning
to end may be observed.

^L^

Assuming now that a sheet of analysis paper has been headed
up, starting in the upper left-hand corner, a transcript of the
ledger account should o : J made. In this case one sheet of analysis
paper will suffice, since the debits and credits will all go on one
page. Reference to the illustration which appears below will
show the first three columns devoted to the dates, references

124

ANALYZING ACCOUNTS

125

PRINCIPLES OF AUDITING

and amounts. It should also be noted that care has been ob-
served in stating not only the total debits and the total credits,
but in showing clearly the balance in the account as it appeared
in the ledger account.

Little matters like bringing the balance out clearly as above
mentioned may not seem important. When the time comes,
.however, to use the figures it may be long after the analysis
is made. Little points like properly bringing out the balance in
the ledger account may either greatly facilitate or hinder the
work at the time the figures are "put together." Not long ago
in going over a report a skeleton ledger account appeared to
show a balance of $45,000. The books from which the figures
were taken were not available and it was necessary to take
off a trial balance of the skeleton ledger which had been built
up from the cash book before being able to tell whether the
account should show a balance or not. Half an hour of the
time of a busy man who was engaged in writing comments was
required in taking off the trial balance of the skeleton ledger
in order to determine whether the balance of $45,000 was open
or not. When upon completing the work it was found that the
debits exceeded the credits in the amount of $45,000, the con-
clusion was that the account had been closed. This expense
of time and annoyance was caused by careless work on the part
of an assistant who did not realize the importance of careful
attention to details. In just such ways as this, hours of time
are wasted by accountants. The man who put the figures to-
gether in a report wants to be sure when he picks up an analy-
sis that he is using the proper figures. He must know that
the figures are the same as those in the books ; that the difference
between the debits and credits which he is using is the same
balance as that for the particular account in question in the
trial balance.

Assuming now that the transcript of the ledger account has
been properly made on the analysis paper, the next step is to
find out what each one of the items represented therein means.
Explanations of postings sometimes appear in ledger accounts.
In such cases they should be jotted down when making the
transcript, but should serve only to indicate the content of the
account. It is probable that the tendency to-day is away from
showing explanations in the ledger. Sometimes in simple ac-

126

ANALYZING ACCOUNTS

counts it is practicable to give complete explanations for each
item. Usually, however, the postings are made at the end of
the month and may represent a considerable number of items
and variety of things. It is of course ideal when the complete
story contained in an account may be read from the explana-
tion columns. It will probably be an exceptional case, how-
ever, where this will be possible. In the transcript of the ac-
count appearing above the first item appearing is the balance
in the ledger account for furniture and fixtures. In a property
account such as the furniture and fixtures account is the bal-
ance should be traced back into previous ledgers if possible
and analyzed. On the first engagement this is essential. On
subsequent engagements it need not be done of course.

Taking up next the second item of $257.50 it will be neces-
sary to find out what this amount represents. Assuming there
is no information on the face of the ledger, which at best would
serve only as a guide, it will be necessary to go back to the
book from which the entry was made. The book in this case
is the voucher record, page 27. The term voucher record is
used here as synonymous with the purchase journal. Turning
to page 27 of the voucher record it will be found that this page
shows the footings for the month of January where the book
will probably have been ruled off and the totals for the month
of January inserted. Hunting out the column for furniture and
fixtures, if there is one, there will be found at the bottom of
the column the amount of $257.50. Tracing up the column
there will be found on a certain line the same item of $257.50.
Following then across the page to the left on this line the
voucher number will be discovered. It will next be necessary
probably to "pull the voucher" as it is called, or have the voucher
"pulled." Usually a list of the vouchers that are wanted is
given to the bookkeeper or clerk who has charge of them and
the vouchers are gotten out. Having obtained the voucher in
the amount of $257.50, it may be found upon examination to
represent the purchase of desks and chairs. The next step
consists in noting on the analysis sheet to the right of the amount
$257.50, the explanation, namely, "desks and chairs" together
with the voucher number, for example, 233.

In certain instances items for furniture and fixtures, for
example, will occur so infrequently that it will not be thought

127

PRINCIPLES OF AUDITING

necessary to provide a column for these items. If this is the
case, it would be necessary to hunt through the general ledger
column in the voucher records and pick out the items represent-
ing furniture and fixtures.

The next item of $300 will be found on page 32 of the
voucher record. This will be the footing for February, and
finding the column for furniture and fixtures it may be followed
up until the first item is found. It is possible a better way
would be to turn back to the beginning of the month and hav-
ing found the furniture and fixtures column, follow it down
until the first item is reached. In this case the first item may
be found to be voucher No. 273, which upon inspection will
show that the amount covered a bulletin board $25. Continuing
on down the column the next voucher may be No. 286 and
will be found to represent more desks and chairs in the amount
of $275. This information may then be carried to the analysis
sheet and jotted down in the appropriate place. Subsequent
items as they appear in the ledger account will be found ex-
plained on the analysis sheet. It is not thought necessary to
follow through the procedure in each case, since it has in two
instances been explained and illustrated. Up to this point it
will be noted that no consideration has been given to the content
of the account whether right or wrong. The work has consisted
entirely of noting facts.

On one of the sheets of analysis paper, if more than one is
used, and preferably the top sheet, there will usually be room
at one side where a summary of the analysis may be made. This
is necessary in order that one may look at the analysis and see
at a glance what the account contains without having to go
through it item by item. The summary will be found in this
instance on the analysis sheet. Where the account is extensive
and a number of pages are required for the items, or where
the summary is extensive, the summary should be placed on a
separate sheet which will go on top of the others where it may
be readily seen.

The information concerning the furniture and fixtures account
is now in such condition that when the time for preparing the
reports arrives, one may see at a glance what is in the account.
This person may be the one who made the analysis or some-
one else. The information contained in the summary may be
scrutinized and discussed with regard to the propriety of the

128

ANALYZING ACCOUNTS

entries and the propriety of the items with special reference to
discovering whether anything has been buried, charged to the
wrong account, expenses capitalized or assets carelessly written
off. A person looking at this summary has the story of the
account before him in crystallized form. It would be appro-
priate at this time to consider whether or not the old desk sold
for $25 should be credited to this account in the amount of $25 ;
also whether the amount representing branch office furniture de-
stroyed by fire is on the basis of cost or the amount in which
the claim against the insurance company was settled. With
regard to depreciation, the value of the summary might have
been enhanced somewhat if the man who made it had shown
the basis on which the depreciation was calculated. With ref-
erence to this particular analysis it would appear that everything
in the account is regular, that there is nothing out of propor-
tion and nothing to attract undue attention or cause undue
investigation.

In order to check the figure for depreciation, an analysis
of the balance at the beginning of the period would have to be
made unless this had been done in a previous audit and the
information was available. The depreciation it will probably be
seen is based not only on furniture and fixtures purchased dur-
ing the present year but that which came over from a previous
period. Time being an element in the calculation of depreciation,
the length of time which the respective articles of furniture have
been in use will have to be ascertained. This work may some-
times be facilitated by an underlying book kept by the client in
which the details of property accounts are shown. If no such
book is kept it is probable that the bookkeeper or company
accountant will have retained the figures on which the calculation
was based.

In the matter of analysis the question which frequently arises,
is how many and which accounts should be analyzed. In answer
to that question it must be said that it is not considered necessary
nor is it customary to analyze all the accounts. This work
should be applied particularly to the property accounts and ex-
pense accounts of any size. Irregularities are more apt to be
found in property accounts and in expense accounts than in
others. The other accounts, at least most of them, will be checked
out automatically in the course of the work.

129

CHAPTER XVIII

SOME ACCOUNTS WHICH REQUIRE ANALYSIS

After the work on the inventories has been completed the
trial balance should be gone over, account by account, analyzing
or checking up such accounts as need attention. If reference
is made to the specimen trial balance previously presented, the
first account will be seen to be land and buildings.

The land and buildings account should be analyzed. This
should be done not only on account of the four usual reasons
for analysis but also to determine how much of the account rep-
resents land and how much buildings. It is frequently desirable
to have this information in order to determine whether or not
the insurance is adequate. In a mixed account like land and
buildings it is impossible to form any judgment on this point
unless the two factors in the account are separated. An account
for land and buildings as it appears on the books may show a
balance of $187,000. It may also be ascertained that insurance
is being carried to the extent of $80,000. Before one can say
definitely whether or not $80,000 is adequate, the extent to
which buildings are represented in the $187,000 must be known.
It is likewise necessary to have information on buildings in order
to calculate or check the depreciation.

The analysis of the land and buildings account should show
with regard to land, the purchase price of the original parcel
plus any improvements, such as filling in, grading, laying out
streets, curbing, guttering, laying of sidewalks, setting out trees,
etc. There should also be shown, the sales of any part of the
land, and the auditor should ascertain whether any credit repre-
senting a sale is on a cost or selling price basis. It not infre-
quently happens that when land is sold the selling price is credited
to the land and buildings, or the land account, as the case may be.
Since the selling price includes the profit such procedure is doubly
detrimental. It not only fails to show the profit but it has the
effect of applying the profit to the reduction of the asset. What
should be done, of course, is to find out in terms of square feet
of acres, how much land was purchased and obtain the cost per
square foot or acre. If any part of the land is sold the number

130

SOME ACCOUNTS WHICH REQUIRE ANALYSIS

of square feet or acres should at cost be credited to the land
account while the difference is credited to profit and loss or to
surplus.

A request should be made to see the deed to the property
and the title insurance policies. This is also as good a time as
any to ask for the tax receipts. It is also well to note on the
working papers showing the analysis of the account, the fact
that the deed, title insurance policies and tax receipts have been
seen. Taxes should be distinguished from assessments. Taxes
may not be capitalized and should not appear in the land ac-
count, whereas assessments may with propriety so appear. As-
sessments may cover such things as removing cobblestones and
replacing them with modern paving, putting in sewers or water
systems and the like. All these things constitute improvements
to the property and may be charged to the land and buildings
account. In New York City assessments are being laid for cer-
tain branches of the subway system and there is probably no
doubt about the propriety of capitalizing such assessment since
the property along the subway routes will benefit accordingly.

An interesting problem with regard to assessments recently
came to notice. A certain institution had during a period extend-
ing as far back as 1868 sustained assessments which amounted
to $30,000. The institution had been contending against these
assessments on the ground that it should be exempt under cer-
tain privileges which the law extends to educational, religious
and other eleemosynary corporations. The efforts to have these
assessments abated not having been successful the institution
put the claims into the hands of a lawyer who makes a specialty
of getting abatements, with the understanding that if he suc-
ceeded in this case he should receive ten per cent. The lawyer
was successful and earned $3,000. The question which was
presented to the author was this, "Shall we capitalize the $3,000
or charge it to expense." The question is undoubtedly a trying
one. The assessments if sustained would have constituted a
bona fide addition to the cost of property. On the other hand,
the services of the lawyer were without question expense. The
expense, however, was incurred in saving a capital disburse-
ment of $30,000 and consequently takes on a capital appear-
ance. The solution which was suggested was in the nature of a
compromise. While perhaps not so stated by the institution it

PRINCIPLES OF AUDITING

was apparent that one of the principal points of objection was
the necessity of including an item of $3,000 in the operations of
one year, while the expenses were in connection with having
assessments abated which extended back forty-five years. The
suggestion was therefore made that the amount of $3,000 be set
up on the books and written off over a period of ten years.

The other part of the land and buildings account about which
nothing has yet been said is that representing the buildings.
This should consider the original purchase price of the build-
ings plus any additions or betterments. In lieu of the purchase
price there may appear payments on account of building con-
tracts. The account may also show credits for sales of parts
of the buildings and possibly credits for depreciation. It is of
course important to be on the lookout for repairs which have
been capitalized.

Regarding the insurance on buildings the auditor should bear
in mind that unless property is insured for eighty per cent of
its value, the holder of the policy becomes a co-insurer to the
extent of the difference between eighty per cent of the value
and ,the amount at which the property is insured. There are
different kinds of policies and of course policies in which full
value is received in case of a total loss. For such policies an
increased premium is paid. It is probable, however, that the
majority of policies are written with what is called the eighty
per cent clause. While it would seem that all owners of prop-
erty should be familiar with matters of this kind it sometimes
happens that they are not.

In a number of accounts which follow it is not thought nec-
essary to go into all the details concerning them. The pro-
cedure laid down in the preceding chapter together with the
explanation in connection with land and buildings should, it
seems, serve sufficiently as a guide. The other property accounts
especially, are the same in their nature as the land and buildings
account and may generally be treated in the same way.

The account for machinery and tools should be analyzed
and inquiry made as to whether or not the account contains
items of such equipment which are obsolete; also the extent
to which the account represents small tools which are subject to
loss or destruction, in order to compare the book value of such
tools with the physical inventory of same.

132

SOME ACCOUNTS WHICH REQUIRE ANALYSIS

Another account which should be included in the work of
analysis is the account for horses, wagons and motors. It seems
almost unnecessary to say that the analysis should show the
component parts of the account, that is to say, how much repre-
sents horses, wagons and motors respectively. Where the units
of equipment are so easily separable on account of their size
an attempt should be made to identify the equipment by units
and make it possible to compare the physical property with the
book record. It is also important that the date of purchase of
these units should be carefully set out so that depreciation may
be calculated or checked.

Furniture and fixtures should be analyzed. More difficulty
will probably be experienced in connection with this account
than in any other in identifying the units. While it is true that
the units may be fairly large it is not probable that the book
records will enable one to distinguish between expensive and
inexpensive units.

Securities owned may next be taken up. The extent to which
the account represents stocks, bonds, bonds and mortgages and
miscellaneous securities should be ascertained. In many instances
provision for this separation will be made in the ledger by keep-
ing the respective accounts and the title "securities owned" will
only be used in the balance sheet. It is quite usual, however,
to find all securities appearing in one general ledger account.
It is to be presumed, of course, that the securities were examined
and listed at the time the audit was begun so that at this point
after having ascertained the aggregate of the respective factors
in the account the result of the count should be compared thereto
class by class. At this time there should also be covered the
matter of checking up verifications which have come in as a
result of requests sent out at the beginning of the audit on ac-
count of securities which may have been out for various pur-
poses, such as collateral, etc. The question of valuation is not
one which arises at this time. It should be taken up rather at
the time of preparing the balance sheet and writing the comments.

Treasury stock, if such an account appears, should be looked
into with the view of ascertaining just what the conditions sur-
rounding the account really are. The thing to be determined
is whether or not something so-called is treasury stock. The
discussion with regard to this matter will depend upon the theory

133

PRINCIPLES OF AUDITING

which the auditor holds concerning treasury stock. Whether
or not it has been properly handled on the books in question will
be determined by the auditor through a comparison of the man-
ner in which it has been handled with his own idea as to how
it should have been handled. Since there are conflicting
theories on this point it behooves the auditor to make very sure
of the ground on which he argues. The suggestion is made that
there is but one safe theory concerning treasury stock. Stock
which has been once issued for value and subsequently acquired
should be so considered. Stock which has not been issued should
never, in the opinion of the author, be considered as treasury
stock.

Patents, trade-marks, copyrights and good-will may all be
included in one account. Again the discussion as to whether
or not they have been properly handled will depend upon the
theory which the auditor holds concerning each item. The
account should be analyzed in order that there may be set forth
the amount representing patents, trade-marks, copyrights and
good-will, respectively. Wrong treatment is perhaps of no
more importance than the fact that they have all been thrown
in together. The auditor should know the period for which
the patents, trade-marks or copyrights are issued and be guided
accordingly in deciding whether or not such items have been
properly handled. There are so many conflicting theories con-
cerning good-will that it does not seem wise to lay down any
rule for same. Having analyzed the account and found out
the amount which represents good-will one must be guided by
the circumstances in the case and decide whether or not the
manner in which the good-will has been treated is logical and
conservative. Information will sometimes be found in the rec-
ords, or in the minutes, or some contract which will satisfy one
as to the figure at which the good-will is carried. This may
at times be supplemented by the opinion of some official who is
qualified to pass judgment on the matter or to explain the basis
upon which the value was set up.

134

CHAPTER XIX

THE CUSTOMERS' LEDGER

The auditor may either take a trial balance of the customers'
ledger or check the one furnished. In the majority of cases it
is probable that the trial balance of the customers' ledger will
be furnished. It is also probable that in most cases the auditor
will check the one furnished rather than take off his own. Noth-
ing seems to be gained by making a new trial balance. Such
procedure was advocated in the case of the general ledger be-
cause the time consumed in so doing offered an opportunity to
study the business. The situation with regard to customers'
accounts is different. One customer's account is like every other
customer's account in its relation to the organization, conse-
quently no benefit seems to be derived from taking off a new
trial balance. On the other hand, a great deal of time is saved,
especially if the accounts are numerous, in using the one furnished.

The information being sought with regard to the customers'
accounts is whether or not the ledger containing the details is
in agreement with the controlling account and whether or not
the accounts are worth their face value. On the first point the
auditor may assure himself by taking or checking the trial bal-
ance of the customers' ledger. The determination of the sec-
ond point is somewhat more difficult. In order to assure him-
self concerning this matter he must endeavor to ascertain whether
or not the indebtedness as shown is admitted by the customer
as being correct and get the opinion of someone qualified to
judge as to whether or not the amounts shown will be collectible
in full.

In order to determine whether or not the indebtedness as
shown is bona fide and correct, it is customary to send out some
communication to the customer and obtain his acknowledgment
as to the balance. This may be done in one of several ways.
One way is to have the monthly statements turned over to the
auditor to be checked by him and sent out direct. It is impor-
tant that the statements should not fall into the hands of the
employes of the client before being sent out but should be in-
serted in the envelopes and sealed immediately after being checked.

135

PRINCIPLES OF AUDITING

It is also important that upon their return statements should
reach the auditor without being opened. This is sometimes
accomplished by having the statements mailed to the auditor's
business office. Objection to this procedure is sometimes made
by the client in that it draws attention to the fact that his
accounts are being audited. This, in the light of present-day
publicity, does not seem to constitute a valid objection. It is,
however, an objection which it is not always possible to over-
come even with tact and has to be endured. Where such is the
case the auditor is usually able to arrange to have such state-
ments returned in envelopes which may be identified and which
will be presented to him immediately they are received in the
client's office.

It is customary for the auditor to have affixed to statements
before they are sent out, a notice of some kind, to the effect
that the information is required for the purpose of verifying
the balance. The content of the notice which is usually affixed
by means of a rubber stamp takes two forms. One is that of a
positive verification. The other is that of a negative verifica-
tion. These verifications are in substance as they appear below :

Please verify the above balance and report at your
earliest convenience to John R. Wildman, Certified
Public Accountant, 32 Waverly Place, New York
City.

Please examine immediately. If not correct, please
address New York University, Division of Applied
Accounting, Washington Square East, New York,
stating difference.

Another method of obtaining verifications is to send out
with the statement a form letter with a perforated form attached,
requesting the customer to verify the balance and report on the
blank form provided. A specimen of this form as used by Haskins
and Sells follows.

136

THE CUSTOMERS LEDGER

Perm No. MZ-M-i li-S.T.

HASKINS & SELLS

CCRTIFICD PUBLIC ACCCOUNTANT5

90 BMOAO STMCCT

NEW YORK

ATLANTA C.lt po.l. "MAK(U-

DCMVCM

SAN FRANCISCO
LONOOM. C. C.

DEAR SIR:

'In connection with our audit of the books and accounts of.

we are sending herewith their statement of your account with them covering the inclusive period from

, , and shall be obliged if yon will examine it and advise us

on the afhd form of its .correctness or of any exception you may find to take thereto.
Stamped and addxessed envelope for your reply is enclosed!

Yonrs truly,

No.

MESSRS. HASKINS & SELLS,

Certified Public Aaottntonlt

DEAR SIRS:

I have examined the statement received from you of my account with.

covering the inclusive period from

find it*_

truly.

Insert the word " Correct " if yon M find the Utemcot.

All of these devices are at best unsatisfactory. It is a diffi-
cult matter to obtain verifications of all balances. It is probably
within reason to say that at least one-third of the customers
will pay no attention to the request, thereby making a complete
verification impossible. The larger balances should be followed
up with a second or third request if necessary. The positive

137

PRINCIPLES OF AUDITING

verification seems preferable to the negative. The latter, how-
ever, does place the burden on the customer and results in a
considerable saving in time in so far as the auditor is concerned.

In the matter of satisfying himself with regard to the prob-
ability of collection of the accounts the auditor is usually
compelled to rely on the judgment of the credit man or some
representative of the client who is in a position to state as a
result of his experience with the concern whether or not the
respective accounts will be collected. In accomplishing this the
auditor goes over the accounts one by one with the credit man,
for example, who gives his opinion with regard to each account
as to whether it is good, doubtful or uncollectible. By classify-
ing the individual accounts in this way the auditor is enabled
to ascertain with regard to the accounts as a whole the extent
to which they are respectively good, doubtful, or bad. In case
there is no credit department there will usually be found in the
employ of the client someone who will perform this function of
the credit man.

A valuable means of supplementing the opinion of the credit
man, which it must be said is not always as unbiased as it might
be, consists in ageing the accounts. This takes the form of
analyzing each balance or determining with regard to the bal-
ance in the account how long it has been outstanding, and classi-
fying the balance with regard to the length of time it has been
outstanding. In some cases the time may be classified as thirty
days or less, sixty days or less or more than sixty days. Circum-
stances in different cases will of course dictate different periods
of time. If goods in a particular case are sold on a six months'
basis, the thing of interest is to find out how many of the accounts
are over six months old. In such a case the periods of time
might be six months, nine months and a year.

Ageing the accounts is an expedient which is especially help-
ful to the auditor in enabling him to judge independently as to
the value of the accounts receivable and the adequacy of the
reserve for bad and doubtful accounts. If an account which
should have been settled within thirty days has been outstanding
two or three years, the chances are that said account is not a
perfectly good account even though so considered by the credit
man. Some credit men are capable and honest and give an
absolutely unbiased opinion. Others, while honest, may not

138

THE CUSTOMERS' LEDGER

have all the facts as to the accounts, or may fear to give a
frank opinion concerning certain accounts because of the un-
favorable showing which may result. Credit men have been
known to classify certain accounts as good when the concerns
in question were in the hands of receivers and there was no
probability that more than ten per cent of the amount involved,
for example, would be received. Having aged the accounts the
auditor is not obliged to rely on such opinions. He has a
definite basis for his own judgment.

In order to make clear what is meant by ageing the accounts
an illustration is presented below. There is first given an out-
line of the schedule, followed by a number of customers' ledger
accounts. The schedule should be made on analysis paper, pro-
viding for the ledger folio, name of the customer, amount and
classification according to the periods of time.

Trial Balance, Customers' Ledger, December 31, 1914

LF.

Name

Amount

30 days

60 days

Over -
60 days

Sheldon & Willis

1913

1914

Nov. 13,

S 32

$47.50

Jan'y 4, C 2

$47.50

Dec. 8,

S 47

18.37

March 25, C 18

18.37

1914

March 28,

S-S4

52.74

July 14,

S 122

15.96

$134.57

$65.87

(68.70)

Clarkson & Company

1914

Oct. 14,

S 173

$15.43

Nov. 2,

C 27

$15.43

Nov. 24,

S 185

5.81

Dec. 5,

C 32

5.81

Dec. 13,

S 194

4.62

$25.86

$21.24

(4.62)

139

PRINCIPLES OF AUDITING

S. Merrick

1914

Jan'y 1.

Bal.

$753.27

Feb. 2,

C 10

$27.45

" 31,

S 52

27.45

June 9,

C 21

425.00

June 7

S 115

225.00

Oct. 5,

C 25

172.43

Oct. 5,

S 170

172.43

(553.27)

$1,178.15

$624.88

Hoyt & Stetson

1914

Aug. 3,

S 151

$31.86

Aug. 27,

C 20

$29.43

Sept. 17,

S 165

16.52

Oct. 5,

C 24

16.52

Oct. 14,

S 173

19.43

Oct. 29,

C 25

19.43

Nov. 29,

S 187

27.18

Dec. 4,

C 32

27.18

Dec. 15

S 195

15.75

Dec. 24,

C 34

15.75

$110.74

$108.31

(2.43)

In the accounts as they appear above the first one is that of
Sheldon & Willis. It shows debits in the amount of $134.57;
credits $65.87; balance $68.70. Assuming that the date at the
end of the period covered by the audit is December 31, 1914,
if an attempt is made to classify the balance with regard to age,
it will be seen that it is over sixty days. The first entry may
now be made in the schedule showing ledger folio jfl Sheldon
& Willis $68.70, the latter to be entered first in the amount
column and subsequently in that marked "over 60 days." If
the same procedure is followed in the case of the other accounts
the schedule will then appear as below.

Trial Balance, Customers' Ledger, December 31, 1914

L.F.

Name

Amount

30 days

60 days

Over
60 days

1
2

Sheldon & Willis
Clarkson & Co. . .
S Merrick

$68.70
4.62
553.27

$4.62

$68.70

553.27

Hoyt& Stetson..

2.43

$629.02

$4.62

$624.40

140

THE CUSTOMERS' LEDGER

The study of customers' accounts is a very interesting one.
They will at times reveal a great deal. That of S. Merrick as
presented above illustrates one point in this connection. The
account is shown as having an old balance, just how old of course
is not disclosed. Notwithstanding this balance more goods were
sold to him on January 31 which it will be seen he paid for very
soon. On June 7 still more goods were sold to this party. He
not only paid for the invoice of June 7 but included in his check
something to apply on the old balance. The story told by this
account is that of an old balance being reduced. It is a hopeful
sign and indicates good intentions on the part of the customer.
Consequently with indications of this kind one should be cautious
about classifying the account as doubtful.

It is well that all transactions of every description should be
put through a customers' account. Sometimes in the case of a
customer, such as Merrick appears from the account to have
been, checks will be received for current invoices which when
presented for collection are returned marked "no funds." In a
case of this kind the check should be charged back to the ac-
count so that the account will show the full history of the cus-
tomers' relations to the house. This would also call for a record
of any notes which went through the account and which should
be charged back to the account if not paid at maturity. It also
seems desirable that a notation should be made at the top of each
account of the number and amount of customer's notes which
are being carried since it is the credit relation which is usually
desired in connection with a customer. Whether this is repre-
sented by accounts or notes is not so important as to know the
total amount of indebtedness. It is also desirable to have such
information all in one place.

In the case of Hoyt & Stetson it will be seen that the balance
of $2.43 is an old one. The indications are that it is a disputed
claim. In a case like this whether it be over sixty days or over a
year makes little difference. The important thing which is brought
out is the fact that the item is in dispute. An opportunity is
thus afforded to investigate the matter and have it adjusted in
some way. Such is one of the additional advantages of ageing
the accounts, namely, the bringing to the surface of all differences
which require adjustment and which are frequently allowed by
bookkeepers to drag on indefinitely when they should be closed out.

141

CHAPTER XX

OTHER ACCOUNTS WHICH REQUIRE ATTENTION

Drafts and notes receivable come under this heading. A list
of these will probably have been made at the time when they
were counted or examined. If this has not been done, a list
should be made. The total of such count or list should agree
with the balance in the ledger. Cognizance will have to be taken
of the accrued interest on notes receivable and drafts, but this
work will be facilitated if postponed until after the interest ac-
count has been analyzed. After the analysis of the interest
account, the auditor is in a position to check or accrue the
interest in each case.

An account is sometimes found which bears the title "sub-
scribers to capital stock." In this connection the auditor should
ask for a list of the subscribers, showing the amount of the
original subscription, the amount which has in each case been
paid and the amount remaining unpaid. It will not be necessary
to ask for a list if it so happens that the number of subscribers
is sufficiently large to warrant opening a ledger for such ac-
counts. This not infrequently happens. Where such is the case
it will be a matter of taking a trial balance of such ledger and
agreeing the total with the amount in the general ledger. In
the same way the total should be agreed in the case of a list.
As to the balances in the individual accounts, the auditor should
assure himself that they are bona fide and not simply dummy
balances which are being carried. An account with John
Smith may show that he subscribed originally for ten shares
of stock $1,000; that he paid the first call, or the first instal-
ment, 25%, $250, and that the balance is $750. It may appear
in the ledger as a good balance but upon investigation may develop
that Smith has refused to make subsequent payments and has in
fact forfeited his right to the subscription or to the stock.

With regard to sinking funds, reference should be had to
the indenture which provides for the sinking fund. By indenture
is meant the mortgage. This should be scrutinized in order to
see what the terms are and who the trustee or trustees are. If
the sinking fund is involved there will be found in the mortgage

142

OTHER ACCOUNTS WHICH REQUIRE ATTENTION

a sinking fund clause which will usually set forth all the facts
concerning it; that is, how much of a sinking fund is to be
provided, when the amount is to be set aside, the basis on which
it is to be calculated, sometimes the depositary and who the
trustee is to be. It is obvious that the auditor may not proceed
intelligently without having all of these facts at his disposal.

Having ascertained where the fund is on deposit, perhaps
through the courtesy of the trustee as it were, if the trustee is
other than the depositary, a certificate should be obtained as to
the amount of deposit and a statement covering any interest
recently credited. The procedure here is the same as that in
verifying a bank account. A request should be sent out to the
depositary. Each request should bear the approval of the trustee.
The amount of deposit should agree with the amount shown by
the ledger account in the books of the client. Frequently the
depositary will have credited interest on the sinking fund deposit
which will not yet have been reported so that it may be neces-
sary to take such interest into consideration in effecting the
reconciliation.

Subsequent to the reconciliation the amount of the sinking
fund should be verified in accordance with the terms of the
sinking fund provision. It sometimes happens that while the
account of the depositary will agree with the books of the com-
pany, the amount of the sinking fund will not be as large as it
should be under the terms of the sinking fund agreement. Cases
have been encountered where the company has made a certain
number of payments to the sinking fund and then ceased mak-
ing payments. This would not be disclosed by a certificate.
The account should be checked through from the beginning to
the end and verified chronologically. This verification may in-
volve in certain instances the detailed calculations such as in
the case of mining companies where the amount of the annual
or semi-annual sinking funds deposits depend upon the tons
of ore mined.

The sinking fund may exist in the form of cash in hand
or on deposit, or securities which have been purchased out of
sinking fund deposits. If the trust company in which the sink-
ing fund has been deposited says only 2% on daily balances, or
3% on time deposits, the trustee may be subject to criticism,
unless his duties are prescribed and restricted, if he does not

143

PRINCIPLES OF AUDITING

invest the funds in securities which will yield a higher return.
Gilt-edge securities to-day will yield 3%% and 4% and not
much difficulty is experienced in finding such securities.

Trustees who are permitted to invest funds in securities as
soon as the fund accumulates sufficiently, sometimes prefer and
sometimes are so required to purchase outstanding bonds of the
company which makes the deposit. It is frequently argued that
such bonds are the best possible investments. Since the object
of the sinking fund is as a rule to redeem an issue of outstand-
ing bonds it seems that such procedure is not only proper but
expedient and economical. If a company has an issue of bonds
outstanding on which 5% interest is paid, and on the other hand,
is depositing funds at 3% for the purpose of redeeming such
bonds, it seems unbusinesslike if the bonds may be purchased
at a reasonable figure to allow them to remain outstanding.
Purchasing bonds results in shutting off the interest and a saving
equal to the difference between the interest received on the
deposit and the interest paid on the bond, having regard, of
course, for any premium which may be involved in the purchase.
Under such circumstances the sinking fund may be found to
exist in the form of cash, outside credits or the company's own
securities. Here, a certificate as to the cash should be obtained
and the securities either examined, which is of course the best
method of verification, or a certificate obtained from the trustee
as to what securities he is holding for account of the fund.

Securities of the company may either be cancelled or kept
alive. If they are cancelled the interest stops and they are
returned to the company. If they are kept alive the trustee
treats them as outside securities and collects from the company
whatever interest attaches. The situation in this respect must
be taken into consideration by the auditor later when he reaches
the point of setting up the balance sheet. If the bonds have
been cancelled they should, it seems, be deducted from the out-
standing bonds on the liabilities side and the net amount out-
standing be shown. If they have not been cancelled, they will
have no effect on the liabilities and will be carried along and
considered as a part of the sinking fund. Here, again, the
opinion of the auditor may depend upon the theory which he
holds. Whether the action of the company is right or wrong
in his opinion must be determined by comparing such action

144

OTHER ACCOUNTS WHICH REQUIRE ATTENTION

with what he considers to be right or wrong, and such considera-
tion will depend on what his theory is. It is thus apparent that
before the auditor offers any criticism of the method, he should
be very sure as to facts and have a definite idea as to his own
theory.

One further point should be mentioned before leaving the
subject of sinking funds. This is the necessity of reading care-
fully and trying to understand the intent of the provisions with
regard to the creation of the sinking fund. The wording of
mortgages in this respect is not always as clear as it might be.
It is sometimes difficult to determine just what was intended.
One way of setting up the accounts in connection with the sink-
ing fund is to make a charge to profit and loss and a credit to a
reserve for the amount involved subsequently funding the reserve
by transferring the amount from the general cash to the sinking
fund cash. The other way is to ignore the charge to profit and
loss and the credit to the reserve and transfer the amount from the
general cash to the sinking fund cash. This has the effect of
creating the fund but it does not reserve the amount out of the
profits. It is not thought necessary here to discuss the relative
advantages and disadvantages of these two methods. It is the
desire rather to draw attention to the fact that these two possi-
bilities are present and that consequently the indenture should
be read carefully in order to ascertain if possible what the intent
was in this respect.

The account for discount on bonds should be analyzed. If
necessary discount should be distinguished and separated from
premium. The account should be observed with regard to
whether or not the discount is being written off over the life
of the bonds.

Legal expense deferred should be investigated in order to
determine what the account really represents and to see how
rapidly it is being written off. There is no reason as a rule why
legal expense deferred should remain set up very long. The idea
of going into it is to see that it is bona fide; that it is what it
purports to be. One of the things to look out for is that current
legal expenses have not been included in the amount.

Organization expense should be analyzed. The word analyzed
is here used in a general way, meaning to look into the account,
if necessary picking it to pieces and finding out what the details

145

PRINCIPLES OF AUDITING

or items represent. The auditor should satisfy himself that the
account is what it purports to be and that provision has been
made for writing off the amount involved within a reasonable
time.

Moving expense and advertising paid in advance are practi-
cally in the same class. What was said with regard to legal
expense deferred and organization expense applies to these ac-
counts. Moving expense is sometimes incurred in moving either
the plant or office from one place to another, and may with
propriety be set up temporarily with the intention of writing
it off afterwards.

Advertising paid in advance should be looked into to see that
the amount set up is proper and that it is not being carried too
long.

The account for freight on consigned goods unless abnor-
mally large will not as a rule require any special investigation.
The only thing that is liable to occur here is some slight clerical
error. This account is, however, sometimes used for the pur-
pose of burying items. Consequently the auditor will have to
be guided in determining how much work he is to do in connec-
tion with this account by the size of the account when considered
in relation to the volume of business and the nature of the
transactions.

Interest and discount account, if such an account is found,
should be analyzed carefully. While more will perhaps be said
about the items in this particular account when discussing the
preparation of the report, one thought which is of practical im-
portance should be noted here. This thought concerns the sum-
mary. A great deal of difficulty and annoyance may be avoided
if in summarizing the result of an analysis like that in the case
of interest and discount, care is observed in setting out in the
summary the dates in connection with the interest items. Sup-
pose for example in the analysis of the interest account there
is found interest on $10,000 worth of Rock Island 4's. Suppose
further that the interest received was for the six months ended
November 30. At the time of receipt it was charged to cash
and credited to interest earned on securities. It is obvious then
that if December 31 is the close of the period under audit that
interest for one month on these securities will have to be ac-
crued. By setting forth in the summary the details as to the

146

OTHER ACCOUNTS WHICH REQUIRE ATTENTION

period covered by the interest on the Rock Island 4's it will
be an easy matter to make the correct accrual at the proper time.
If this is not set forth in the summary the chances are that a
great deal of time will be lost by the person making up the report
in searching through the papers to find the period which the
interest covered. On the other hand, if such information is set
forth clearly in the summary it is only the work of a moment
in each case to calculate the accrual. These same remarks might
have been made with equal application in the case of notes re-
ceivable and bonds and mortgages or in other securities or
instruments on which interest runs.

Royalties may be either those paid or received. In either
case there will undoubtedly have been a royalty contract or
agreement. This should be requested and the instrument read
in order to ascertain the substance thereof and the terms. Royalty
is based usually on articles or goods manufactured or sold. It
is well to be sure concerning the basis since some contracts are
based on production and some on sales. The word "output" is
sometimes used and where used the auditor should have some-
one who is competent place the construction on the word for
him. He should make a schedule of the goods or equipment
involved together with the price on which the royalty is to be
computed and then ask for copies of the royalty statements
which he should check.

147

CHAPTER XXI

ACCOUNTS ON THE CREDIT SIDE

Perhaps the most important item in this group is bonds.
Bonds as a rule are secured by mortgages. Mortgages are fre-
quently referred to as indentures. It is essential if an intelligent
audit is to be made that the mortgage be read. Usually it con-
tains the description and wording of the bond. The original
document will rarely be seen. It is usual to receive a printed
copy in pamphlet form.

The mortgage should be read for specifications with regard
to such matters as the date of issue, the par of each bond, and
the dates of payment thereof and for special provisions such as
the following:

"Any bonds issued beyond the first five million dollars must
be limited to 80% of the amount expended for additional equip-
ment or property and no bond beyond the first five million dol-
lars shall be issued at any time unless the net earnings of the
company for the preceding year shall be equal to at least twice
the interest charged for one year on the bonds outstanding and
on those to be immediately issued."

If an auditor is to do his work intelligently, he should be
cognizant of special provisions of this kind and keep them in
mind in doing his work.

In regard to registration considerable variation will be found.
Some bonds may be registered as to principal and some as to
interest. Very often the following restriction will be found:

"Bonds may be registered as to principal or as to both prin-
cipal and interest. Bonds once registered as to principal and
interest cannot be exchanged for coupon bonds."

There may also be special stipulations as to redemption. The
arrangement is frequently made that bonds may be drawn after
a given number of years at a price, for example, not to exceed
105. Occasionally some of the provisions with regard to redemp-
tion are more complicated. In the case of a certain bond it is
provided "that bonds shall be redeemable on April 1, 1924, at
1071/2 and interest and thereafter due notice being given on any
interest date at a price decreasing at the rate of one-half of one

148

ACCOUNTS ON THE CREDIT SIDE

per cent yearly to maturity." All such things should be kept
in mind if the work of the auditor is to be of a higher order.

Some attention should perhaps be given to the distinction
between coupon bonds and registered bonds. The former have
sheets of small coupons covering the payment of interest and
which may be clipped from time to time as the interest becomes
due. There is nothing about a coupon bond to indicate owner-
ship. It may pass from one person to another very much like
cash. The issuing company is indifferent as to the owner.

Registered bonds are quite different. Such bonds must be
registered with the company or some designated registrar in
order that the company may know to whom the interest is to be
paid. The interest on registered bonds is paid by check. While
a coupon bond is very much like a check it is drawn to bearer
rather than to order. If one might imagine a number of minia-
ture checks drawn in advance, dated in advance, printed in sheets
and attached to a registered bond, a proper idea of a coupon bond
would be had. In other words, there is no difference between a
coupon bond and a registered bond so far as the bond proper is
concerned. The difference consists merely in the provision which
is made for the payment of interest in the one case. This is
arranged in advance by attaching the coupons to the bond. In
the case of the registered bond the checks are drawn to order
from time to time as the interest matures.

An interesting question which arises in connection with the
amount of bonds outstanding, is how to verify it. In the case of
coupon bonds the situation is different from that in which there
are registered bonds. There is one way, however, which is com-
mon to both, namely, in case the bonds are outstanding, tracing
the receipts through the cash book or journal. If the bonds are
outstanding it is apparent that something should have been re-
ceived in exchange for them and this may have been cash. If
from the inspection of the cash book this does not prove to be
the case, the auditor must go a step further and search through
the journal. In the case of coupon bonds the coupons are valuable
in establishing fairly accurately the amount of principal out-
standing. Each coupon bears the number of the bond to which it
was attached. After the coupons have been paid and returned,
by establishing the sequence of numbers and taking into con-
sideration the period covered by the coupon, the amount of

149

PRINCIPLES OF AUDITING

bonds outstanding may be checked. As a practical matter this
method may be subject to slight variation where coupons have
not yet come in. The method does, however, furnish an effective
check on the amount which is in the majority of cases sufficiently
accurate. In a similar manner, in the case of registered bonds,
the returned checks may be made to serve as vouchers not only
of payment of the interest but as a check on the amount of
principal outstanding.

Different concerns have different schemes for filing coupons
after they have come back as a result of having been detached
by the holders, put in the bank for collection, paid by the bank
or trust company and returned to the company. One scheme
consists in providing a book of cheap paper ruled off in
spaces corresponding to the size of the coupons and pasting
the coupons therein numerically. Other concerns instead of
pasting the coupons in books keep them done up in packages;
sometimes in small tin boxes. It is, of course, easier to count
them if they are pasted into a book, as for example, if there
are fifty to a page, one may count them in lots of fifty by
glancing at each page to see if it has been filled up. An out-
standing coupon is immediately brought to attention, whereas,
it might be overlooked in counting them if they were in packages.

The amount of registered bonds outstanding may be checked,
first by tracing receipts into the cash book or following the trans-
actions through the journal. Second, by obtaining a list from the
registrar or from the bond register kept by the company, and
third, from the interest payments as indicated by the interest
checks. The method used in the case of the interest check is not
different from that where there are interest coupons.

At the time of verifying the interest paid on bonds outstand-
ing, either through the cancelled coupons or cancelled checks
which serve as vouchers, the interest accrued on the bonds out-
standing may be checked. So far as the company is concerned
the usual practice, altho the practice may vary, is to make an
entry charging interest on bonds and crediting interest accrued
on bonds. There is then transferred out of the general cash, an
amount equal to the payment of interest, which amount is placed
in a special deposit account with some bank or trust company or
fiscal agent. As coupons or interest checks are paid and returned
by the fiscal agent, interest accrued on bonds is charged and

150

ACCOUNTS ON THE CREDIT SIDE

cash on deposit for the payment of interest is credited. Two things
then in the matter of verification have to be kept in mind, namely,
the balance of cash in the special account on the one side and the
liability for the unpaid interest on the other. The verification of
the balance of cash is effected by obtaining a certificate from
the fiscal agent and comparing the amount so reported with the
amount ascertained by totaling the coupons or interest checks
outstanding. The term fiscal agent is used here as a general
term to indicate banks, trust companies and fiscal representatives.
A specific illustration may serve to make clear the foregoing.
Consider, for example, that the period under review is the fiscal
year ended December 31, 1914. The bonds of the Blank Com-
pany bear interest which is payable at the rate of 6% per annum,
January 1 and July 1 ; the principal outstanding $100,000. Under
such circumstances $3,000 must be paid as interest on the first
day of July for the six months ended June 30 and a similar
amount on the first day of January for the six months ended
December 31. In examining the records for purposes of audit,
it is found that there appear in the books so far as the assets and
liabilities are concerned, an account with a debit balance in the
amount of $3,000 termed coupon deposit and an account with a
credit balance in the amount of $3,000 termed interest accrued on
bonds. The situation will depend, of course, on the date at
which the verification is attempted. If the fiscal agents were
requested to report the amount in the coupon deposit account of
the Blank Company on December 31, they would naturally report
$3,000. If, however, the report were requested some time in
January, the balance would not be $3,000 but something less in
accordance with the number of coupons or checks which had
been presented to and paid by the fiscal agents since the first of
January. If the balance under such circumstances as reported
happened to be $630, then provided the company had received all
cancelled coupons or checks, the auditor would expect to find
after having examined such cancelled coupons and checks, twenty-
one of same outstanding. Each coupon being in the amount of
$30 the amount of such outstanding coupons would be $630. This
amount being in agreement with the balance on deposit, the
verification would be complete.

In the above illustration the situation is fairly simple. Compli-
cations arise where the bond interest periods do not coincide with

PRINCIPLES OF AUDITING

the end of the year. In the illustration above mentioned if the
interest dates had been April and October instead of January
and July, and the company had been in the habit of accruing the
interest monthly, before the verification could have been effected,
it would have been necessary to have deducted from the amount
shown in the interest accrued on bonds account, the interest
accrued from September 30 to December 31. In other words, the
account interest accrued on bonds may, if the interest dates do
not coincide with the fiscal year, show two things, one, interest
accrued, due and unpaid, and interest accrued, not due.

Further complications in the interest accrued account will
at times be encountered. Where there are several series of bonds
especially where the interest is not collected promptly by the
holders of coupons, the balance in the interest accrued account
may, for example, be $630. This amount may be made up of
amounts corresponding to the different interest coupons; $420
may represent coupon No. 25, $150 may represent coupon No. 24,
$60 may represent coupon No. 23 and so on back. In the same
way different series of bonds may affect the situation. Conse-
quently in verifying statements received from fiscal agents care
should be had in seeing that the interest accrued which is due and
payable is not only represented in the aggregate by the coupon de-
posit account but that the deposit for each class of coupons or
numbers as the case may be, corresponds with the liability there-
for. Registered bonds are worked out in the same way except
that there will be checks instead of coupons for the interest. The
various outstandings should be listed and the respective accounts
reconciled.

Dividends declared and unpaid are similar in their nature to
interest accrued. Dividends are paid by check. The important
thing to ascertain in connection with this account is that the
fund on deposit equals the liability. The procedure is the same
as that in the case of interest paid by check.

Loans payable are among the accounts which merit
careful consideration. It might have been said while the
cash book was being discussed, that it is desirable for
the auditor to scrutinize the cash receipts for any receipts
on account of loans or notes payable and to make, for
further reference, a list of such receipts. If the auditor has
failed to make a list at the time of going through the cash receipts,
which might very easily happen, as it is not always convenient so

152

ACCOUNTS ON THE CREDIT SIDE

to do, he should go back and make such a list before attempting
to verify the loans payable. Such list should be checked against
the schedule of loans said, at the time of the audit, to be out-
standing. Altho perhaps it is not done as frequently as it should
be, it is a good plan to verify the loans and notes payable by
correspondence. In this connection it is important that care
should be exercised in the wording of the request. The party
addressed should be asked to report what notes or loans against
the client in question are being held. If one were to write and say
"Are you holding a note of $50,000 against A. Blackwell?" such
person might reply that he is holding such a note but say nothing
about a further note in the amount of $25,000. If the inquiry is
made sufficiently broad and is carefully worded, the information
furnished is liable to be more complete.

Frequently such an inquiry will develop loans other than those
shown on the books. In the same way such procedure will some
times establish an endorsement relation. It may be found perhaps
that a corporation has endorsed notes for some individual or
vice versa and such things may be interesting to the auditor in his
work. All such relations should be ascertained as far as possible
as they frequently throw light on the general situation which is
interesting. Of course, there is no way of ascertaining the facts
if a man goes to John Jones and borrows $5,000 from him giving
his note and makes no record of the note or cash on the books.
The auditor will find, however, that if he follows the rule of
spreading his net in every direction he will frequently discover
matters of this kind in the most unexpected manner.

In connection with accounts payable one may either take a
trial balance of the creditors' ledger or obtain a trial balance and
check it against such ledger, agreeing the totals of the accounts
payable with the control. As a general rule a trial balance will
probably have been already prepared. It is seldom that one has
to be taken off. This is true of the accounts payable as it is
generally true of accounts receivable. If a voucher record is
maintained without a creditors' ledger in connection with it as
seldom happens, it will be necessary either to check the list of
accounts unpaid and outstanding or prepare such a list. The
open accounts so listed should be totaled and the total agreed
with the balance in the controlling account in the general ledger.

PRINCIPLES OF AUDITING

Any accounts receivable which may be included in the ac-
counts payable ledger should be taken out and set up separately.
For example, the trial balance of the creditors' ledger might
amount to $10,000. Such an amount might be made up of
hundreds of credit items amounting to $10,000 with numerous
debit balances amounting to $100, acting as offsets. It is im-
portant that in going over the trial balance such debit items
should be listed and totaled in order that in preparing the bal-
ance sheet the true situation may be shown with regard to ac-
counts payable as well as that with regard to accounts receivable.
The point is that the accounts receivable may not be used in
settlement of the accounts payable, consequently they may not be
treated properly as offsets. Because such accounts are kept in
the creditors' ledger as a matter of convenience, is no reason why
they should be looked upon as reducing the liability in favor of
creditors. Accounts payable is a general term as is accounts
receivable. Individual accounts are something different. If such
individual accounts receivable could be treated as offsets there
would be no purpose in having accounts for them in the creditors'
ledger since they would be applied against various individual
credit balances.

Ageing accounts payable may be as interesting as ageing ac-
counts receivable. This work in connection with accounts pay-
able will show the relative need for funds and whether or not the
credit of the concern is being strained. This is as important at
times as knowing whether or not accounts receivable are good or
bad. This may not, however, be undertaken without due regard
for the length of time involved and the circumstances of the case
in question.

While it is perhaps not as common to send out for statements
with regard to accounts payable as it is to send out statements
showing accounts receivable, it is a very good thing to do. Send-
ing to creditors and asking for statements of account with them
in case they do not come in as a part of the regular routine is
very helpful in verifying balances. Frequently in so doing un-
adjusted items or items in dispute will be brought to attention.
This offers an opportunity of checking up the items in question
with a view to adjusting them.

Looking through the cash disbursements for invoices paid in
periods to which they do not belong is an important thing to

154

ACCOUNTS ON THE CREDIT SIDE

have in mind. It quite frequently happens that business con-
cerns will at the end of December, for example, ignore December
invoices which happen to be late. In closing the books no
cognizance is taken of the liability in connection with such
invoices and they are simply paid in the course of time and
charged in the month of January, or some succeeding month, to
the appropriate expense accounts. These invoices may be found
scattered along through January, February, March and some-
times as far as April. If the accounts are to be maintained on
an accrual rather than a cash basis, it is necessary that such
items be thrown back, as it were, so that any invoices applicable
to the preceding period will be taken up in such period. In
order to catch such items the auditor should observe carefully all
vouchers during the first three months of the period under review
as well as the three months succeeding the period. Items which
do not affect the period may thus be thrown out, while items
which do affect the period may be taken up. For similar reasons
and extending over similar periods the cash book should be
scrutinized. In connection with this work it should be kept in
mind that there may be items of cash receipts and disbursements
which work in the reverse way. Rent paid in December for the
month of January would need to be set up if a strict accrual
basis is to be maintained. Where the audit takes place immediately
after the close of the period, it may be necessary to examine the
vouchers of the last month with particular reference to items
which are in the nature of monthly expenses so that proper
accrual of these items may be made in the report. Some judg-
ment should be used, however, in matters of this kind and the
total amount involved with its effect upon the situation taken
into consideration before undertaking this work.

A few words should be said as to the manner of verifying the
amount of capital stock outstanding. A stock certificate book
looks very much like a check book. Stock certificates have stubs
just as do checks. The stub provides for the number of the
certificate, the number of shares, the name and address of the
party to whom it was issued, the date of issue, what it was issued
for and from whom transferred, if issued in exchange for stock
previously issued ; also the date, number of the original certificate,
number of original shares, number of shares transferred and a
place for the receipt of the party to whom the stock is issued.

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PRINCIPLES OF AUDITING

Of course, if the certificate is issued for cash, all this informa-
tion will not appear. The stub will show in such cases the number
of the certificate, the number of shares, to whom issued (name
and address) and a place for the receipt. If Mr. Smith wishes
to transfer two shares out of the ten which he owns to Mr. Jones,
he sends in to the company or its transfer agent, the certificate
calling for ten shares. The certificate is cancelled and pasted
back into the book on the stub. Two new certificates are then
issued, one for eight shares and one for two shares. The open
stubs in the stock certificate book should then represent the stock
outstanding. Consequently this offers one opportunity of verify-
ing the amount outstanding. If the auditor will go through the
stock certificate book, making a list from the open stubs show-
ing the number of the certificate and the number of shares repre-
sented by each stub and total up such list, he will have an amount,
which upon comparison, should agree with the capital stock
shown, by the ledger, as being outstanding.

Another way of verifying this amount consists in taking off a
trial balance, as it were, of the stock ledger. Corporations in
New York state as well as various other states are obliged by
law to keep a stock book. No matter what the form, the effect is
that of opening a ledger account with each owner of stock show-
ing the number of shares held by each individual owner. Taking
off a trial balance from such book and making a list of the names
and the number of shares held, will accomplish the same purpose
as making a list from the stubs. Under one procedure the in-
formation appears according to certificates; under the other,
according to owners.

Charge sales for three or four months should be tested by
checking the duplicate sales slips or invoices against the sales
books. Cash sales may be verified at times from the subsidiary
books in which the details of the sales are entered, by footing
such books and checking the totals into the general cash book.

As a check on the income which arises through interest on
bonds, the interest should be followed through in order to ascer-
tain whether or not any portion of the interest should have been
credited to interest purchased, accrued interest or amortization.
In a majority of cases it may be said the matter of amortization
need not be considered. An ordinary mercantile concern will
probably have no bonds. On the other hand, an insurance com-

156

ACCOUNTS ON THE CREDIT SIDE

pany or railroad will probably have large holdings and various
bonds may be held in large blocks, so that the matter of amortiza-
tion will be of vital importance. By following the interest through
is meant ascertaining with regard to each holding, the situation
concerning the interest at the beginning of the period and follow-
ing the period through in order to see that the interest has been
regularly collected and that no period has been skipped. To
make clear the matter of interest purchased and accrued interest,
assume for example, that a one thousand dollar bond bearing
interest at 6% was purchased on the first of November. The
interest dates are April 1 and October 1. Six per cent (6%) on
$1,000 would be $60 for the year. One month would be $5.
October 1 to November 1 would be one month. The interest
involved would be $5. If the bond in question had been pur-
chased on the first of November at par, $1,005 would have been
paid for it, the $5 representing the accrued interest. On the first
of the following April the coupon would be clipped and $30
would be collected. The entire $30 should not be credited to
interest earned because only $25 has been earned. The other $5
is interest purchased. If it so happens that interest has been
accrued on the books from the first of October to the end of
December, then the $30 would have to be divided still differently.
Five dollars ($5) should be credited to interest purchased, $10
to interest accrued and $15 to interest earned. Since the matter
of amortization may also be involved, it will be seen that there
might, under certain circumstances, be four credits in connection
with interest received, namely, interest purchased, accrued in-
terest, interest earned and amortization.

Income may also be received on account of dividends on
stocks. As a step precedent to the checking of this item of
income, the history of such stocks as are involved should for the
period under review be looked up with regard to the dividend
relations, in some publication such as The Financial and Com-
mercial Chronicle. This information should embrace the dates
of any regular, extra, special and stock dividends and the rates
in each case. This furnishes an independent basis from which
to work in checking the dividends receipts as shown by the books
of the client.

Commissions earned will be handled much like royalties.
Statements will be made up either by the principal or the agent

157

PRINCIPLES OF AUDITING

showing the volume of business on which the commissions are
computed. The amount of commission earned as shown by the
statements should be checked against the ledger account.

Exchange will usually be an account small in amount repre-
senting collection charges on out of town checks and will not
usually require any attention. The account may, however, in the
case of certain concerns represent the cost of foreign exchange
purchased or sold, or the profit and loss on purchases and sales
of foreign exchange. If the concern happens to be one which
deals in foreign exchange, a subsidiary book or statements of
some kind showing the details of the transactions will usually be
found. If the account is of sufficient size or the transactions are
of sufficient importance, the account should receive more careful
treatment than where only collection charges are involved.

The profit "and loss account should be analyzed. Explanation
should be required of all items which are not clear. If items
written off are large in amount, the auditor should ascertain by
whom such entries were authorized. It is perhaps not a bad idea
to analyze the profit and loss account during the early part of
the engagement rather than leave it until the end as it often
develops leads which may be used to advantage in analyzing
other accounts.

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CHAPTER XXII

How TO END AN AUDIT

Before leaving the office of the client or the place in which
the work has been carried on, the trial balance and supporting
analyses and summaries should be looked over and journal entries
made for any matters which require adjustment. If it is not
possible to make the journal entries at the time the information
should be jotted down so that it will be available when needed.
It is preferable that journal entries be made immediately while
the matter is fresh in the mind and so that proper and adequate
explanation may be made. This is so that if anything develops
which requires attention, access to the books and records may
be had or any questions may be asked before leaving. By adjust-
ments is meant any changes or corrections in the figures as shown
in the books, or any additions thereto.

Adjustments may be roughly divided into three classes:

First, adjustments to cover things done which should not
have been done. These are sometimes called errors of
principles or errors of commission.

Second, adjustments to cover things which have been done
but have been done incorrectly. Under this head come
clerical and offsetting errors and errors in the mechanical
work.

Third, adjustments to cover things which have not been
done. These are frequently referred to as errors of omis-
sion.

As an illustration of the first point may be mentioned capitaliz-
ing expense. One of the principles of accounting is that any debit
item which does not add to the value of property or otherwise
increase the assets should be charged to expense. The book-
keeper may not have a clear understanding of this point and may
charge certain items of expense to the property accounts. An
error not uncommon in this respect is that of charging taxes to
the cost of property. This it should be understood is property
which is being operated and not that which is being developed by

159

PRINCIPLES OF AUDITING

a real estate concern for sale. The charging of taxes to the
property account constitutes an error in principle.

In the second class there are of course many more possibili-
ties. Among these are incorrect figuring, extending or footing
of sales invoices, mistakes in preparing vouchers, mistakes in
making entries in the books, mistakes in posting, footings carried
forward, etc. These errors while perhaps of greater frequency,
are less liable to involve large amounts and are as a rule of less
importance.

Failure to set up unexpired insurance, if the amount is of
sufficient importance, at the time of closing the books, constitutes
an example of an error of omission. In fact failure to make
proper accruals at such time may probably be said to account for
most of the errors of omission. There may also be included such
matters as crediting sales of securities and accrued interest tempo-
rarily to the securities account and failing to clear the account
properly at the time of closing the books.

A few entries in illustration of adjustments follow :

Endowment fund $100.00

To Endowment fund reserve $100.00

To correct error in charging the reserve
and crediting cash when investing the
fund.

Subscriptions $25.00

To Sustaining members $25.00

To correct error in posting.

Interest payable $163.58

To Interest accrued $163.58

For interest accrued on note of $5,392.92;
six months at 6% per annum.

Accrued interest $23.77

To Interest $23.77

To set up interest credited by the Title
Guarantee & Trust Company and not
taken up in the income at December 31,
1914.

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HOW TO END AN AUDIT

Unexpired insurance $391.68

To Insurance $391.68

To set up the unexpired insurance premiums
at December 31, 1914.

Accrued interest on investments $335.52

To Interest on investments $335.52

To set up on the book the accrued interest
on investments at the time of closing the
books December 31, 1914:
Central Railroad of New Jersey

bonds $6.25

New York City corporate stock. . 3.54
Bonds & mortgages :

Baer 67.73

Dean 37.50

Chadwick 35.00

Munson 81.25

Wahlsen 104.25

$335.52

City of New York $165.57

To Care of patients, City of New York $165.57

To adjust the estimated charges against the
City of New York to the actual charges :
Actual :

November, 1914. .$1,600.57
December, 1914.. 1,265.00 $2,865.57

Estimated :

November, 1914. .$1,300.00
December, 1914.. 1,400.00 $2,700.00

Excess of actual over estimated $165.57

During the course of the work on the engagement there will
perhaps have been made a list of matters which the auditor de-
sired to look into or ask questions about. These notes may have
been made on a sheet of journal paper or any piece of paper
which happened to be convenient. Such lists should now be

161

PRINCIPLES OF AUDITING

looked over carefully to make sure that everything is clear; that
everything has been looked up; and that there are no questions
in connection with these memoranda which the auditor now
wishes to ask.

The papers and books should be returned in the same order
in which they were received. By that is meant that they should
not be out of order, scattered about, or disarranged. These may
seem like small details and highly theoretical. As a matter of
fact they are not. They count for a great deal. If papers are
received in a certain order they should be kept in that order if
possible and not disarranged. They should be given back in
the same order received and not left about so that they will have
to be hunted up by the client's employes. Some judgment will
of course be necessary in this respect. Papers may of necessity
have gotten out of order and it may be to the advantage of the
client to have a six dollar a week clerk put them back in order
rather than to have a man whose services cost twenty-five dol-
lars a day do the work. Under such circumstances it may be
better to go to the person from whom the papers were received
and explain the situation, arranging accordingly respecting the
matter. The thing which people dislike is to have the auditor
leave without returning the papers and without saying anything
about it. Psychology plays an important part in the auditor's
work. It operates for or against him in accordance with how
he uses it. A man will probably be forgiven for bringing back a
file of papers which are disarranged if he explains and apologizes
for the condition in which they are returned. The chances are
that they will be received gracefully and the matter will occasion
little disturbance. If they are thrown on someone's desk without
any explanation, the chances are almost certain that the impres-
sion created will be an unfavorable one. Consequently the im-
portance of being sure before leaving that everything has been
properly returned.

It is worth while before leaving to go around and bid the
employes with whom one has come in contact, goodbye. One
should not be afraid to shake hands. It will not do any harm
even though it soils one's hands occasionally. To grip the hand
of a man working on a lathe in a machine shop is not at all
beneath the dignity or position of the auditor. It will engender
a friendly feeling on the part of the machinist and the grease

162

HOW TO END AN AUDIT

and oil will come off later. It is not amiss before leaving to let
the employes know that one thinks enough of them to bid them
goodbye and perhaps say a word to the effect that the courtesies
extended by them have been appreciated.

It is not the practice to write the report in the office of the
client or the place in which the work has been done. The auditor
as a rule gathers his material and returns to his own office for
the preparation of the report. There are certain arguments for
and against this practice. Better reports would probably be
written if they were written in the client's office. If, under such
circumstances, there were any questions arising in connection with
the writing of the report, it would be an easy matter to make the
inquiry. If any questions should arise requiring reference to the
books, they would be immediately available. No matter how far
ahead one thinks or how carefully one plans there is apt to be
something overlooked or something which has not been provided
for. On the other hand, there is some objection to preparing
the report in the office of the client because of the fact that
portions of the report as it is being prepared might be overseen
by some of the employes of the client. It is quite natural that
the auditor should develop informal acquaintanceship with cer-
tain employes who might in stopping to chat during their spare
time, look at the papers spread out before the auditor and see
something which was intended to be conveyed in confidence to
the client. The tendency on the part of employes is to be curious
as to what the auditor is putting into the report. If the report
is not prepared in the client's office this opportunity is removed.

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CHAPTER XXIII

WHAT TO Do AFTER AN AUDIT

It should be understood that what is about to be said con-
cerning reports and their preparation, is not laid down as standard
practice. It is presented merely as the practice which has come
within the experience of the author. That it is used, however,
by one of the largest and most successful firms in the profession,
should give it sufficient standing.

After returning to his office the auditor proceeds with the
preparation of the report. The report is prepared first in the
rough by the man who has charge of the engagement. That is
to say, he writes out in pencil or pen and ink his entire report
in rough form, after which it is typed in the rough.

For purposes of discussion the report may be divided into
four parts: the presentation, the certificate, the comments and
the statements. It is customary to prepare the statements first,
then the comments, after which come the certificate and the
presentation.

Statements are prepared first in the rough on analysis paper
and journal paper. They may be divided for report purposes
into two classes: exhibits and schedules. Exhibits are usually
prepared on analysis sheets, while schedules may be prepared on
journal paper or analysis paper torn in two so that it will be
about the size of journal paper. The exhibits are denoted by
letters ; the schedules by numbers, and both exhibits and schedules
are marked as a rule at the bottom of the page. The typical
exhibits are the balance sheet, statement of income and profit and
loss and sometimes the statement of cash receipts and disburse-
ments. These exhibits are supported by schedules. Where there
is an item on one of the exhibits in which it is desired to show
the details, a schedule is used. The balance sheet, for example,
will be marked Exhibit "A". On this balance sheet there may
be, for example, an item "land and buildings". It may be
desirable to show the details of the item, when a schedule will
be used. The schedule may be designated "Schedule showing
details of land and buildings". It will be marked at the bottom
"Exhibit 'A', Schedule No. 1". The statement of income and

165

PRINCIPLES OF AUDITING

profit and loss will usually be designated as Exhibit "B". Again
there may be occasion for supporting some of the items by
schedules. The profit and loss charges may be numerous so that
instead of listing them all in the exhibit, it will be preferable to
show them in a schedule. Such a schedule might be headed
"Schedule showing details of profit and loss charges". It would
likewise be marked "Exhibit 'B', Schedule No. 1."

These statements will be made up from the working sheet
and the analyses of the different accounts which support the
working sheet together with the adjustments which have been
made. It is perhaps at this time that the novice will appreciate
better than ever before the practicable benefit of the working
sheet. Starting with the figures on the client's books, any changes
or adjustments or corrections having been journalized, if these
journal entries are now posted to the working sheet in the adjust-
ment columns, the figures will be brought into shape for use in
the report. This seems to make the work very complete. It
establishes a connection between the two sets of figures and saves
the auditor all anxiety as to what he may have done in adjusting
the figures on the client's books. Very often after having gone
out to another engagement, since as a rule he is unable to remain
in the office until the report is typed and delivered, the auditor
who did the work will be called upon to explain something in
connection with his report. Having his thoughts centered on the
work in which he is at present engaged, it is not an easy matter
to shift to the previous set of working papers and explain immedi-
ately just what was done. Possibly six weeks after the report
was written, someone in the office will want information concern-
ing it. Sometimes also it is necessary after the report has been
rendered, to discuss certain phases of it with the client or some
of his representatives. With the working sheet and the support-
ing papers properly arranged, the auditor has no difficulty in
answering quickly at any time, any questions which may arise in
connection with the report.

In making rough copies of statements it is important that
they should be written exactly as they are to be copied. Nothing
should be left to the imagination or intelligence of the copyists.
This is on the assumption, of course, that it is the practice to
write out the reports and have someone else copy them. Such
will be the case nine times out of ten. These copyists make what

166

WHAT TO DO AFTER AN AUDIT

they call "Chinese" copies. They copy just what they see and
they do not stop to think whether it is right or wrong. They
have all they can do to make the copy exact. Getting the proper
spacing is not the least difficult part of their work. Conse-
quently, if one wishes to have words like furniture and fixtures
spelled out in the typewritten copy, the words should be written
that way in the rough. If the abbreviation "furn. and fix." is
used in the rough, it will be typed that way in the copy. This
may not of course be invariably true, since some large offices
with elaborate report departments have a standing rule that no
abbreviations are to be used.

Comments, sometimes referred to as the essay section of the
report, have four main purposes :

First, to bring sharply to the attention of the reader a par-
ticular fact which might be passed over in the examina-
tion of the statements.

Second, to explain or make clear certain figures in the state-
ments.

Third, to describe the work which has been done and per-
haps tell what has not been done.

Fourth, to present criticisms, suggestions, or recommenda-
tions ; the latter only in case they are requested.

As an illustration of the first point, one might say "It should
be noted that the figures shown in the report are in this particular
the correct ones and not those which appear in the books of the
client."

In the same way in connection with the item land and build-
ings, for example, the following might appear "This account
represents the purchase price ($27,500) and improvements and
betterments ($3,892.90) of the property known as Waverly
House, No. 38 West Tenth Street, New York City." It might
be true in a case of this kind that both the purchase price and
improvements could be shown in the balance sheet. If that idea
is followed, however, it is apt to lead to a balance sheet which is
complicated and heavy rather than one which is neat and concise
as it should be. Comments therefore offer an opportunity of
maintaining the statements in a form which is clean and concise,
even though it is necessary to give detailed information concern-

167

PRINCIPLES OF AUDITING

ing matters of this kind. In connection with this point comments
are also used for the purpose of showing details, where the de-
tails are not sufficient in number to warrant the preparation of a
schedule. As an illustration of this, the following may serve :

Furniture and Fixtures as shown in Exhibit "A"

This account is composed of the following items :

General office in Waverly Place $1,500.00

Employment exchange 500.00

Mental work __ 525.00

Extension work 475.00

Protective league 800.00

$3,800.00

In the above illustration there are five items. It would not be
practicable to set these items forth in the balance sheet. It is
important, however, that the make-up of the item of $3,800 as
it appears in the balance sheet, should be explained, or the de-
tails shown somewhere. There are not sufficient items to war-
rant the preparation of a schedule. The comments therefore
serve admirably to bring out a matter of this kind.

In some cases the auditor desires to have understood precisely
what he has done and what he has not done. He may say, for
example, concerning the accounts receivable "I have tested the
accounts receivable by checking the subsidiary records to the
controlling account," or "I have not been able to verify com-
pletely the income from subscriptions because of the fact that
certain of the records were missing at the time of the audit and
were not subsequently produced."

There is considerable difference of meaning among the words
criticism, suggestion and recommendation. The auditor should
never hesitate to criticise anything in connection with the ac-
counts or the accounting. The criticism should be tactful and
above all constructive. A classic injunction of one of the leaders
in the profession, reproduced without the profane touch, which
it must be admitted gave it considerable force is, "be constructive
and not destructive." Fault must not be found simply for the
purpose of finding fault or making it appear that the auditor is
very efficient. Such is not the spirit in which criticism should

168

WHAT TO DO AFTER AN AUDIT

be made. It is a part of the auditor's duty to point out where
things are wrong. He should not, however, do this unless he is
in a position to say also what should be done to correct the trouble
or improve the situation. If the auditor is obliged to tear down,
he should have something ready to put in its place.

In a recent engagement a payroll book was found in which
it was the practice to write each month, the name of each employe,
with the amount earned, and have the employes sign the book
at the time of receiving their wages. There were about fifty or
sixty such employes. This situation offered an opportunity for
constructive criticism. The client was told that the practice was
not a good one ; that it resulted in waste time, and, furthermore,
permitted one employe to find out what others received, thereby
giving a chance for gossip and the breeding of dissatisfaction.
The criticism was followed by the suggestion that there be intro-
duced a book provided with columns and short leaves so that the
name of each employe need be written but once during the year,
and the amounts corresponding to the respective months inserted
in the appropriate columns. For the purpose of getting a receipt,
a printed slip was suggested. This required only the insertion
of the date and amount. The client saw immediately the whole
situation. He realized that the criticism was just and that some-
thing better had been offered to take the place of the part of the
system criticised. The suggestion was immediately adopted and
the new scheme put into effect.

Generally speaking recommendations should not be made
unless they are asked for. They should also be confined to mat-
ters of accounting. There is no warrant for the recommendation
by the auditor, that the lighting system be changed because the
light does not agree with his eyes, or that buildings covering
several acres be torn down and replaced by new buildings be-
cause the arrangements with regard to the routing of goods is
not ideal. As an illustration of a recommendation which was
presented in response to a request on the part of the client for any
recommendation which might seem desirable, the following is
given :

"Under the present method of handling commissions the cash
receipts only from these sources are taken into the general books.
There appears to be no control of the journal charges for these
commissions. It would seem to be advantageous to show upon

169

PRINCIPLES OF AUDITING

the books the commissions at the time they were earned; that
is, at the time of placing the applicant in the position. This plan
would also establish a control over the commissions charged,
which it is believed would assist the bureau in handling this, the
main one of its accounting problems.

"The introduction of two books known as the commission
register and the commission discount register respectively would
provide a medium for carrying out the work as above suggested."

Rulings for these books were then submitted to the secretary.
This could not have been done with propriety unless the person in
authority had said "We shall be glad to have you make any
recommendations or point out anything that occurs to you as
being possible of improvement."

Care should be observed as to the tone of the comments.
Above all things they should not give offense. Care should be
observed as to what is said and how it is said so as not to incur
the illwill of any person who reads the report or is affected
thereby. Remarks should not be abrupt or unduely frank. They
should be tempered and not made too harsh. This does not mean
that the truth as one sees it may not be told. There are two
ways of saying things. One may point to a light and say "That
is an indirect light," or it may be put in a different way, namely,
"That appears to me to be an indirect light." The latter has ac-
complished the same purpose as the former. Attention has been
directed to the light which was the object of the remark. If the
positive statement that the light in question is an indirect one is
made, it may be possible that someone whose attention is directed
to the light will be an engineer who will challenge the remark
and take the speaker up on a technicality and prove that it is not
an indirect light. It is well for the auditor never to make a
statement which he cannot prove. It is better to quality one's
remarks unless one is absolutely sure of the facts and ready to
prove them in court if necessary. These points are illustrated by
the following extract from a recent report :

ENDOWMENT FUND INVESTMENTS

"The following securities comprise the endowment fund:
"The above securities with the exception of the two guarantee
mortgages were verified by examination at the safe deposit vaults
of the Broadway Trust Company at Eighth Street." The mort-
gages of Sampson & Hendricks were at the time of the audit de-

170

WHAT TO DO AFTER AN AUDIT

posited with the Title Guarantee and Trust Company as security
for a note of $4,923.86 and were verified by correspondence with
the Trust Company.

"The authorization of the treasurer to deposit these endow-
ment fund securities as collateral for a loan was given by the
board of trustees as reported in the minutes of November 20,
1914, as follows: 'On motion, it was resolved that the treasurer
of the Bank Organization be hereby authorized to dispose of
investments and sell securities of this corporation to the amount
of $4,923.86 for account of building fund, and hereby is authorized
to borrow the said amount from the Title Guarantee and Trust
Company upon the guaranteed mortgages held by this corporation
pending an opportunity to dispose of same to advantage.'

"While therefore the pledging of the securities has the ap-
proval of the board of trustees, the moral aspect of hazarding
the endowment fund, by pledging securities representing it, for a
loan is perhaps unquestionable, since such procedure might
amount to a conversion of the endowment fund to current pur-
poses. It is in the opinion of the auditor desirable that the en-
dowment fund be analyzed with regard to the endowments which
were intended by the donors to be of a permanent character and
those which were not, and that in accordance with such classifica-
tion, the amount of the permanent fund be fixed by the board of
trustees with the idea of preserving it."

What had happened in this case was that securities which were
a part of the endowment fund had been deposited as collateral
for a loan to the building fund. If anything had happened that
the loan could not have been paid, the securities would have been
sold and it would have been equivalent to converting securities of
the endowment fund to the building fund.

The handling of this matter in the comments required a great
deal of tact. No offense was given, but no doubt was left in
anyone's mind as to what was thought regarding the situation.
The facts were pointed out in a forceful but inoffensive way,
and the remedy for removing any suspicion of error or moral
negligence was suggested. As near as could be ascertained none
of these funds were legal trusts. They were funds which had
been given in one form or another by persons who had asked
that they be set aside for special purposes. The board, it was
said, felt that since certain of the assets had been put into the
fund arbitrarily by action of the board, nothing wrong was being
done when the securities were taken out of the fund. The state-
ment was not made that the members of the board were legally

171

PRINCIPLES OF AUDITING

liable or that they were guilty of any illegality in what they did.
It looked, however, on the surface as if they were converting funds
and using them for the purpose other than that for which they
were intended. The comments in the case in question instead of
giving any offense, resulted in doing exactly what was suggested.
The feeling remained a friendly one. The board felt that it had
been criticised but that the criticism was a constructive one and
had been made in an inoffensive manner.

It is desirable as a rule that the impersonal form be used as
far as possible. Instead of using "we think," it seems better
to say "it is thought." Of course it sometimes happens that the
personal form will be desired, since the phrase "in our opinion"
is frequently seen in certificates. Such expressions as "your com-
mittee," "your treasurer," etc., are not good form. It is better
as a rule to use the title of the position which the person in ques-
tion occupies. As far as possible the mentioning of names should
be omitted. Instead of saying "Mr. Foote told us so and so," it is
better to say "upon information from the secretary," or "it is
understood from the secretary."

In writing the comments it is considered good practice to
follow the order in which the items appear in the statements. In
beginning it may be necessary to write an introductory para-
graph, but immediately following the various matters should be
discussed in the order in which the items- to which they relate,
appear in the statements. In accordance with this rule, land and
buildings is usually the first item to receive attention.

Good construction advocates the use of simple words, short
sentences and non-technical expressions as far as possible. By so
doing someone may be bored, but it is much better to use language
which the ordinary man understands rather than to attempt to
impress readers with literary style. It is not necessary to indulge
in literary style. All that is required is to express such thoughts
as a person may have in connection with a technical subject in a
clear, concise way which the layman will understand. The pro-
fessional auditor is not expected to be a literary expert. He is
expected to have an accounting sense and to understand account-
ing, and to be able to use English sufficiently well to express
clearly what he has to say on the subject.

Before taking up the subject of the certificate, it is probable
that some consideration should be given to the object thereof.

172

WHAT TO DO AFTER AN AUDIT

A person would not think of building a house without engaging
an architect. This is because of lack of technical knowledge of
materials and construction work. An architect is skilled in such
matters and accordingly there is confidence in his judgment. He
is engaged to draw the plans and, in most present-day cases, to
supervise the construction work. In the same way a lawyer is
engaged where legal matters are involved. Not understanding
the law nor being skilled in its practice, a person is unable as a
rule to defend himself. If he becomes involved in a legal action,
the layman is not supposed to know anything about the technique
concerned with the preparation and trial of a case. Such is the
business of a lawyer. Being skilled in these matters, one has
confidence in his judgment and feels that he will extend the
proper advice and care of the interest involved. In precisely the
same way should the relation existing between, client and ac-
countant or auditor be looked upon. Generally speaking, the
client knows little about accounts or accounting. To him their
philosophy or theory, their treatment, and interpretation is at
least far from being thoroughly understood. He may employ an
accountant to do this work for him. Not knowing whether the
statements are correct or incorrect, or what they mean, he puts
his case into the hands of the auditor who is skilled in accounts
and accounting as a result of training and experience, for the
purpose of obtaining his opinion as to the accuracy thereof. It is
a technical matter of which most clients are not competent to
judge, and an auditor is employed to represent the client and
advise him as to the results. The object of a certificate then is to
obtain from an unbiased person who is skilled in the matter of
accounts and accounting, an opinion as to their accuracy.

Certificates are of two forms. One is known as the short
form ; the other the long form. The following is a specimen of
the short form :

173

PRINCIPLES OF AUDITING

THE WARBURTON DESK COMPANY
CERTIFICATE

We have made an audit of the accounts of the Warburton
Desk Company for the year ended December 31, 1914, and

WE HEREBY CERTIFY that the accompanying General Balance
Sheet and Statement of Income and Profit and Loss are correct,
and, in our opinion, subject to the accompanying comments, set
forth the true financial condition and result of operations respec-
tively on said date. JQNES & PARKER>

Certified Public Accountants.
New York, March 20, 1915.

It should be noted that the certificate may take the form of a
separate sheet or appear at the bottom of the balance sheet. In
the latter case, the wording would need to be changed a trifle so
as to read "the above balance sheet and accompanying statement
of income and profit and loss, etc."

The long form which follows is taken from a semi-public
report and is that of a firm of certified public accountants. It
appears as sent out, except that the names have been changed.

THE AMITY MANUFACTURING COMPANY
CERTIFICATE

We have audited the books and accounts of The Amity Manu-
facturing Company for the year ended October 31, 1914; we
have verified the cash and notes receivable and checked the prices
and calculations of the inventories on hand taken by the com-
pany's employes ; we have tested the accounts receivable by check-
ing the subsidiary records to the controlling account and believe
that the reserve provided for doubtful accounts is sufficient to
meet the losses which may be sustained in the collection thereof.
The other reserves provided are believed to be sufficient for the
purposes for which created, and

WE HEREBY CERTIFY that, in our opinion, the accompanying
General Balance Sheet as of October 31, 1914, and Statement of
Income and Profit and Loss for the year ended that date are

correct - (Signed)

STREET & BROWN,

New York Certified Public Accountants.

November 27, 1914.

174

WHAT TO DO AFTER AN AUDIT

The above certificate is sometimes referred to as a qualified
certificate. Very often, however, the qualifications are of a nega-
tive character instead of positive as above. Some time the certifi-
cate reads : "We have not inspected the securities," or "We have
not verified the inventories in accordance with the understanding
with the secretary of the company to the effect that we should
not do so."

While it is not the intention to enter into a lengthy discussion
of the merits and demerits of the two certificates, one thing should
be pointed out. The first certificate shows that the statements
are correct and set forth true financial condition, etc. The second
one shows only that the statements are correct. While it is per-
haps the intention to imply in the latter case that the statements
show financial condition and result of operation, the fact is not
so stated. Apparently the statement might be correct according
to the books while the books might not show true financial con-
dition. This form of certificate has been criticised considerably
in this respect. Lawyers have given the opinion that the second
certificate would not have as much value to the client at law as
the first. It has been suggested that the testimony of the account-
ant signing the second form of certificate would not have as
much weight in court as if the first form had been used.

One thing seems certain that if an auditor is to occupy the
proper position in the business field, that of high professional
standing, and be well compensated for his services he must accept
a certain amount of responsibility for the work which he does.
To do work as an auditor and accept money for it without the
corresponding responsibility seems neither fair nor ethical. If
such things take place, the profession instead of being elevated
to a high plane, will degenerate into a money grabbing vocation.

The presentation consists of a letter typed on the business
stationery of the auditor, submitting the report. It serves in a
way as an index to the report, since it sets forth and describes
the exhibits and schedules. The presentation is usually the last
part of the report to be prepared, but occupies the first position
when the report is made up. The main parts into which the
report is divided are arranged as follows : presentation, certificate,
comments, statements. A specimen presentation will be found
on page 179, followed by other specimen parts of the report.

As to the form which a report shall take, there is a choice of

175

PRINCIPLES OF AUDITING

top or side binding. Where the top binding is used the single
sheets are inserted in the fold of the cover, punched through and
strapped or otherwise fastened. The report in this form may be
folded if desired. The other form is bound on the side. Single
or double sheets may be used, the single sheets preferably, be-
cause of the fact that if mistakes are made on double pages, the
entire page has to be rewritten. If single sheets are used the
possibility of rewriting is reduced. The sheets are inserted into
the cover and fastened at the back with wire staples or cloth
fasteners. In such form the report may be opened and read as a
book.

In typing the report it is customary to make six copies ; that
is, an original and five carbons. This is in order that one copy
may be used for proving purposes, another for the file and four
copies for the client if required. Sometimes clients will desire
two copies and sometimes three. This leaves one as a margin in
case an additional copy is required later. While the report is
being typed it is easier to make more copies than are required
than to be obliged to re-type the entire report.

The report department does the comparing, the proving and
checking of figures and the checking of references. The report
is first prepared in the rough and then written on the typewriter
by the copyists. After being typed it is compared with the rough.
As far as possible all figures are proven. Any additions, sub-
tractions, multiplications, divisions, percentages or rates are care-
fully gone over. Wherever figures appear which may not only
be checked but proven, such proof is obtained. Wherever figures
appear in the comments they are checked to the statements in
order to be sure that the accountant in writing the comments has
not made mistakes in setting down the figures.

The last step in so far as the auditor is concerned is not the
least important. It consists of putting the papers away. The
analyses, the sheets showing details which support the trial bal-
ance, will have been numbered. These numbers should appear
on the trial balance on the line with or in front of each corre-
sponding account. The amount shown by the analyses should
agree with the amount shown in the trial balance. If, for example,
it becomes necessary later to look at the items making up the
account "land and buildings,'" reference may be had to the trial
balance where finding the reference to be No. 1, analysis sheet

176

WHAT TO DO AFTER AN AUDIT

No. 1 may be located when the information will be available. The
trial balance should be folded into which, arranged in numerical
order, the analyses should be inserted. All miscellaneous papers
or scraps of papers should be saved and inserted in the trial
balance. On top of the trial balance should be placed the rough
statement and report and a copy of the finished report. All this
should then be inserted in a stiff paper folder, writing on the
outside of the folder the title of the engagement and the period
covered. The papers may then be left with the satisfaction of
work well done and the feeling that no matter who nappens to
refer to the papers in the future everything will be found in order.

[FINIS]

177

PRINCIPLES OF AUDITING

CHITERIOK MANOTACTPRIKQ COMPAKY

MCPORT

ON AUDIT Or THB ACCOUHTS
TOR TEE YEAR 2ZTOID DICEWB2R 31,

178

WHAT TO DO AFTER AN AUDIT

JC>HN R. WILDMAN

*<JL-IC ACCOUNTANT

Mew York, March 20, 1915,

Mr. 11 is H. Reed,

President, Criterion Manufacturing Company,

165 Broadway, New" York.
Dear Sir:

in accordance with engagement, X nave made an audit of tne
accounts of tne Criterion Manufacturing Company for tne year ended
December 31, 191^, and submit herewith a certificate, five pages of
comments, and the following exhibits and schedule:

XZEIBIT

A- - OZVXRAL BALAKCB SHEET - D2CEKBZR Jl.
191*.
Schedule

f l - Statement of investments In

ton as of kindred companies.

07 INCOME AND PROFIT t LOSS
TOR THE YBAR HfDKD , DBCSKBJ5R 31. 191%.

Yours trniy,

><^

+**^~s

Certified Public Accountant.

179

PRINCIPLES OF AUDITING

OOHN ft. WILD MAN

CRITERION MANUFACTURING COMPANY

I nave made an audit or the accounts of tne criterion
Manufacturing Company for the year ended December 31. 191*,
and

I HEREBY CERTIFY that the accompanying General Balance
Sheet and statement of Income and Profit fc Loss are correct,
an4 In my opinion, subject to the accompanying comments, set
forth the true financial condition and result of operations
respectively on said date.

Certified Public Accountant,

Hew York,

March 20. 1915.

180

WHAT TO DO AFTER AN AUDIT

CRITBBIQH MAUPACTPRIKO CQMPAflY

coiocmrcs OH THS AUDIT

TOR THB TEAR SJTDSD DECEMBER 31.

PROPERTY AHp PLAMT

The figure at which these assets are snown in the balance sheet 10
that at which the property was appraised when taken over from the firm
of Lanson ft Hlgglns.

H(?TE3 RBCEIVABLE

This item represents notes of the National Products company tear-
ing Interest at six per cent. These notes were taken from tne above
company and discounted for the purpose of supplying same with current
funds. The notes win mature JUne 30, 1915 They are set up, with
the contra, in order to show the contingent liability of the Criterion
Manufacturing Company.

The trial balance of the customers' ledger was checked and the
ledger agreed with the controlling account. The Individual balances
were not confirmed owing to the objection raised by the company with
regard to the sending out of statements.

GENERAL

The practice of the company In the handling of remittances re-
ceived through the mall is open to some criticism. At the time of the
audit, checks received In the mall were being turned over immediately
to the customers' ledger bookkeeper to be credited to the individual!
accounts affected after which they were entered in the cash. This it
was explained was because checks are frequently wrong in amount and
have to be returned, or held pending correspondence concerning them.
This practice should be discontinued. The checks should be first
entered In the cash in order that proper control may be established and
maintained. Subsequently the checks, or preferably a remittance sheet,
aay be given to the bookkeeper for posting purposes. All checks should
be deposited as soon after receipt as possible.

Page 1,

181

PRINCIPLES OF AUDITING

CRITERION_MANUFACTURING COMPANY
GENERAL BALANCE SHEET - DECEMBER }1 , 191*4.

PROPERTY AND PLANT:

Land, 4 10,000.00

BUI Idings , 50 ,000 . 00

Machinery and equipment , 65,000.00

Automobile trucks , 8,000.00

Total property and plant, 4133,000.00

INVESTMENTS - BONDS 07 KINDRED COMPANIES - Schedule #1

( par value ) , U4,500;oo

WORKING AMD TRADING ASSETS:

Raw material, 4 38,000.00

wort in process , 22 ,000.00

Finished goods, 57,000.00

Total working and trading assets, 117,000.00

CURRENT ASSETS:

Cash in hand and on deposit, 4 i4-,500.oo

Accounts receivable, 195*300.00

Notes receivable, 10,200.00

Notes receivable accommodation (see contra) It-, 500. 00

Total current assets, 23^,500.00

DEFERRED CHARGES TO EXPENSE:

Unexpired insurance premium, 4 500.00

Mercantile agencies fees, 200.00

Warehouse charges prepaid, 300.00

Total deferred charges to expense, 1,000.00

TOTAL ASSETS, ^530*000 .00

182

WHAT TO DO AFTER AN AUDIT

CRITERION MANUFACTURING COMPANY
GENERAL BALANCE SHEET - DECEMBER 31,

LIABILITIES
AND CAPITAL

CAPITAL 3TOCK - 2,000 SHARES OP |100.00 EACH, ............. |200,000.00

REAL ESTATE BOND AND MORTGAGE, ............................ 1*0,000.00

CURRENT LIABILITIES:

salaries and wages accrued, ................ $ 2,500.00

Accounts payable , .......................... 53 ,000.00

Hotes payable , ............................. 62 ,000.00

Notes receivable accommodation discounted

(see contra), ............................ 14,500.00

Dividends declared , ........................ K),OOQ.OO

Total current liabilities, ................. 178,000.00

RESERVES:
Depreciation of buildings, ................. | 5,000.00

Depreciation of machinery and equipment,... 13,000.00
Depreciation of automobile trucks, ......... 3,200.00

Contingencies, ............................ . 5,000.00

Total reserves , ............................ 26 ,200.00

PROFIT c LOSS SURPLUS - EXHIBIT B- , ...................... 91,800.00

TOTAL LIABILITIES AJTO CAPITAL, 1530.000. 00

183

PRINCIPLES OF AUDITING

CRITERION MAHUPACTURIBG COMPACT

STATEMEBT 07 ISVZ8THEST8 IB BOID8 07 KIHEREE COMPABIZS -

DECEMBER 511 1Q1U.

Alliance Manufacturing Company, 6 Bonds*

due 1925, Interest payable January and July -

par value, ... $10.500.00

Affiliated Manufacturing Company, 7# Bonds,

due 1920, Interest payable January and

July - par value,.. 10,000.00

Hatlonal Products Company, 6# Bonds, due

1915, Interest payable January and July -

par value, ,000.00

American Company, 6# Bonds, due 1928,

Interest payable January and' July - par

value 12,500.00

Consolidated Trading company, 6# Bonds, due

1917, Interest payable January and July -

par value.

TOTAL.

7.500.00
pW.50p.00

WHAT TO DO AFTER AN AUDIT

CRIT5RIQ11 MANUFACTURING COMPANY

STATEMENT OF INCOME AHD PROFIT & LOSS
FOR THZ YEAR ENDED DECEMBER 31. 1914

SALES 1750,682.90

LESS - RETURNS 1.560.80

NET SALES , 4749 122 .10

DEDUCTIONS FROM SALES:

Allowances, 4 428.00

Outward freight ana cartage, 6.015.52

Total 6.443.32

INCOME FROM SALES 4742 ,678 .?8

MANUFACTURING COST OF GOODS SOLD:

Purchases of raw materials., $265,826.48

Inward freight and cartage, 5.820.00

Total, 4271,646.48

Add - Decrease in Inventory of raw material 3.842. 6$

4275,489.17

Direct labor, v 197,823.32

Super Intendenc e, 2 ,478 . 23

Factory office salaries 7,859.65

Heat, light and power, 25,800.00

Factory supplies, 15,306.50

Factory expense, 5,380.75

Factory repairs, 3,181.00

Depreciation of operating equipment........ 6.500.00

4539,818.62
Deduct - Increase in Inventory of goods In

process , 5. 600 .00

Total manufacturing cost, 4534,218.62

Add - Decrease in Inventory of finished

goods , 2.628.00

Total manufacturing cost of goods sold 536.846.62
GROSS PROFIT ON SALES 4205,832

SELLING EXPENSE:

salaries of sales manager and clerics, 4 15,900.00

Salaries of salesmen, , 10,000.00

Salesmen's commissions, , 37,%3470

Traveling expense 6,743.47

Advertising 14. 105. 94

Total, _ 84.184.11

SELLING PROFIT - (Forward), 4121,648.05

EXHIBIT "B (Continued) - 1.

185

PRINCIPLES OF AUDITING

CRITERION MANUFACTURING COMPACT.
STATEMENT OF INCOME AKD PROFIT & LOSS.

SELLIXG PROFIT - (Forward), |121,6W.05

ADMINISTRATIVE SIPHTflj:

Salaries of officers, $ 25,000*00

Salaries of clerics, 17,850,55

Stationery and printing .. ^,6^0.00

Postag 2,800.00

Telephone and telegrapn,., 1,^75.89

General expense , 5.6H8.00

Total , 57.i.W

NIT PROFIT OH SALZS - INCOME FROM OPERATIONS, t 6^,233.61

OTHtR INCOME:

income from securities, * | 2,770*00

Interest on notes receivable,* 4lO.OO

Caen discount on purchases,, **... ^ 916*53

Total, .Q96S?

TOTAL INCOME, | 68.330.1U

DEDUCTIONS FROM INCOME:

Interest on tond and mortgage payable, $ 2,000*00

Interest on notes payable, 3,100.00

Casn discount on sales, 3,285*76

Insurance, 1,000*00

Taxes aso.oo

Total,. ... 10.255*76

NET INCOME - PROFIT It LOSS,.... I 58,09^.38

PROFIT ft LOSS CREDITS:
Profit on purchase of Consolidated Trading

Company 6# Bonds, | 300.00

Profit on purchase of National Products

Company 6 Bonds, 160.00

Total, '.. t^o.Qp

PROFIT ft LOSS - GROSS SURPLUS FOR THE PERIOD,.. $ 58,55^.38

PROFIT & LOSS CHARGES:
Provision for depreciation of buildings, * $ 2,500.00

Provision for contingencies......... 2. 500.00

Total,.,. 5. OOP. 00

'PROFIT * LOSS FOR THE PERIOD, $ 53,55^.38

PROFIT ft LOSS SURPLUS AT BEGINNING OF PXRIOD 78.2^5.62

PROFIT ft LOSS SURPLUS BEFORE DEDUCTING DIVIDENDS,... 1 131, 800. 00

DIVIDENDS DECLARED, f . HO.OOQ.OO

PROFIT ft LOSS SURPLUS, DECEMBER 31, 1911 |, 9^.800.00

(Concluded) -..

186

INDEX

ABSTRACT OF POSTINGS, 94, 106
ACCOUNTABILITIES, 14
ACCOUNTANCY, i, 2
ACCOUNTANT :

Apprenticeship of, 20

Conduct of, 28, 29

Designation of his work, 16

Engagement of, 18, 19

Instructions to a young, 21

Supplies of, 22, 25, 27

Working conditions of an, 29, 30
ACCOUNTING, i, 2, 4, 13, 53, 121, 173
ACCOUNTS :

Advertising, 146

Aging of the, 138-141, 154

Asset, 121

Bank, 78

Capital stock, 155, 156

Care in carrying, 55

Cash, 55

Charge sales, 156

Commissions earned, 157, 158

Controlling, 56, 103, 112, 153, 168

Coupon deposit, 152

Creditors' ledger, 67, 68, 69, 103,
106, 153, 154

Customers' ledger, 67, 68, 69, 74,
135-140

Discount on bonds, 145

Dividends declared and unpaid,
152

Exchange, 158

Expense, 27, 96, 97, 129

Freight on consigned goods, 146

Furniture and fixtures, 122, 127,
128, 129, 133

General expense, 94

General ledger (See "General
Ledger" under "G")

Horses, wagons and motors, 133

Income, 156, 157

Individual, 142, 154

Interest, 142

Interest accrued on bonds, 150-

152

Interest and discount, 146
Land and buildings, 130, 131
Legal expense deferred, 145, 146
Loans payable, 152
Machinery and tools, 132
Moving expense, 146
On the credit side, 148-158
Organization expense, 145, 146
Patents, trade-marks, copyrights

and good-will, 134
Payable, 97, 103, 153, 154
Petty cash, 96
Premium, 145
Profit and loss, 145, 158, 165, 166,

174

Property, 127, 129, 132

Receivable, 138-141, 153, 154, 168

Royalties, n, 147, 157

Securities owned, 133

Someone to keep and audit, 5, 7

Subscribers to capital stock, 142

Treasury stock, 133, 134

Unexpired insurance, 160, 161

Unpaid, 153

Which require analysis, 131-134
ADJUSTER, 82, 83
ADJUSTMENTS :

Classification of, 159

Illustration of, 160, 161

Meaning of, 159
ADVERTISING, 146
AMORTIZATION, 156, 157
ANALYSIS (See "Analyzing of Ac-
counts")

ANALYSIS PAPER, 25, 26, 42, 43, 44,
46, 53, 54, 93, 94, 106, 123, 165

I8 7

Index

ANALYZING OF ACCOUNTS:
Definition of term, 121
Importance of details in, 126
Must be carefully done, 123
Objects of, 121, 130
Procedure to be followed in, 123,
124, 125

APPROPRIATIONS, EXCESSIVE, 9
ARTICLES OF INCORPORATION, 61
ASSESSMENTS :

Distinguished from taxes, 131

What may be covered by, 131
ASSET, 14, in, 121, 122
ASSOCIATIONS :

Checks of, 82, 83

Receipts from, 75, 77
AUDITED VOUCHERS, 103
AUDITED VOUCHER RECORD, 103
AUDITING :

As an art, 2

Committee, 63

Compared with accountancy and
accounting, 2, 53

Definition of, i, 2, 13

Discussion of, from professional
point of view, 16

Occasions for, 4, 5, 8

Of cash book, 71

Of petty cash, 98-101

Principles of, 2

Professional or non-professional,
2

Reasons for, 4
AUDITS :

Balance sheet, 14

Complete, 13

Conduct of, 2

Difference between examinations,
investigations and, 15

Occasion for the, 8-12

Of a municipality, railroad or
bank, 71

Order to be followed in making,
61

Partial, 13, 14

Period covered by, 37

Preliminaries preceding begin-
ning of, 16

AUDITOR :

Attention to details by, 54, 55

Care of, in handling cash checks,
82

Care of papers and books by, 162,
176, 177

Certificate of, 8, 9, 10

Courtesies extended by, to em-
ployes, 162, 163

Examination of money bags by,
36

Functions of, 2, 4

Handling of cash by, 33

Handling of records by, 34

Inability of, to verify signature
on checks, 81

Need of, 5, 6

Presence of, at taking of inven-
tories, 112, 113

Professional and non-profession-
al, 6, 13, 16

Relation between client and, 173

Report of, 12

Services of, 5, 6

Test of, as to correctness of in-
ventories, 113, 114

Time required by, 47

Working conditions of, 29, 30

BALANCE :

Bank, 75, 85

Importance of bringing out, clear-
ly, 125

In individual accounts, 142

Of books, 53

Of cash, 33-40, 100

Old, reduction of, 141

Verification of, 136, 137, 138, 154
BALANCE SHEET:

Audit, 14

Definition of, 14

Grouping of accounts on, n

Items shown on, 165, 167, 168, 174

Representing financial condition,

III, 112

BANKS, 8, 9, 80, 81, 82, 83
BANK ACCOUNT:
Error in, 80

188

Index

BANK ACCOUNT Continued

Reconciliation of the, 78, 79, 83,

84, 85, 89, 92
BANK CERTIFICATES, 25, 48, 49, 50,

51,83

BANK STATEMENT, 78, 79
BENEFICIARIES, n
BEQUESTS, 75, 76
BOND HOUSES, 12
BONDS :

As securities, 44, 133, 144

Coupon, 149

Coupons on, 45

Description of, 44, 45

Interest on, 11, 45, 47, 74, 75, 147,
149, ISO, 151, 156, 157

Method of recording, 44, 149-152

On credit side, 148

Outstanding, 149, 150

Quotations on, 45

Redemption of, 148

Registered, 45, 46, 148, 149, 150,
152

Secured by mortgages, 148
BONDS AND MORTGAGES:

Definition of each document, 46

Insurance on mortgaged prop-
erty, 46, 47

Interest on, 147

Method of recording, 46

Mortgage tax, 46, 47
BONDHOLDERS, 8, n
BOOK INVENTORY:

Description of, 108

Difference between physical in-
ventory and, 108
BOOKS :

Audited vouchers, 103

Audited voucher record, 103

Cash, 68, 69

Commission discount register, 170

Commission register, 170

Cost ledger, 115

Creditors' ledger, 67, 68, 103, 106,
135-140

Customers' ledger, 67, 68, 107,
135-141, 156

General, 13

General cash, 66-69, 98
General journal, 67, 107
General ledger, 67, 68, 92, 94, 96,

103, 106, 107
List of, 51, 52
Original entry, 13, 94
Payroll book, 66, 67
Petty cash, 66, 67, 68, 100, 101
Purchase journal or voucher

103, 104, 105, 106
Purchase returns and allowances,

66, 67, 68, 106

Sales book, 66, 67, 106, 156

Sales journal, 68

Sales return and allowances, 66,

67, 68

Voucher record, 103, 104, 105, 106

Voucher register, 66, 67, 68, 70,
87

When ready to be audited, 53
BUILDINGS :

Betterments to, 132

Depreciation to, 132

Insurance on, 132

Purchase price of, 132

Repairs to, 132
BURY, Definition of term, 120
BUSINESS, Phase of a, 14
BY-LAWS, 62

CASH:

Count of, method of recording,
33-41

Discrepancy in, 35

Examination of, by auditor, 36

Handling of, 33, 34, 39

Received, receipts from, 71

Sales, receipts from, 71

Segregation of, 39

Working back the, 40
CASH ACCOUNT, 55
CASH BOOKS:

Auditing of, 71

Balance in, 34, 39, 40, 71, 85, 91

Cash receipts, 152

Checking between ledger and, 92,
93, 94, 95

189

Index

CASH BOOKS Continued
Credit side of, 78
Discussion of, 68
Errors in, 91

Footing of, 18, 88, 89, 90, 91, 92
Function of, 69, 71
General, 66-69, 98
Handling of bonds in, 149, 150,

iSi

Holding open of, 95

In place of check book, 79

Of an institution, 87, 88

Of bank or broker, 70

Petty, 66-68

Ruling of, 70

Scrutiny of, 155

Varieties of, 68-70

Vouching of, 68
CASH DISBURSEMENTS, Vouching

the, 78-80

CASH RECEIPTS, 152, 153, 165
CASH RECEIVED:

Methods of recording, 73, 74

Receipts from, 71
CASH REGISTER, 72
CASH SALES:

Entries of, 72, 73

Receipts from, 71

Verification of, 72
CASHIERS, 35, 37, 40
CAPITAL, 8
CAPITALIZATION OF EXPENSE, 121,

122, 159, 160
CAPITAL STOCK, 61, 155, 156
CERTIFICATES :

As to correctness of inventories,
109

For reports, 165, 172, 173, 174,

175

Of Bank showing balance, 50, 51

Of Deposit, 47

Of Incorporation, 61

Of Indebtedness, 47
CHARITABLE ORGANIZATIONS, 9, 10
CHARGE SALES, 156
CHARTER, 61
CHECK BOOK, 79
CHECKING, 33, 34, 40, 121, 122

CHECKING POSTINGS, 66, 68, 92, 93,

94, 95
CHECKS, 33, 39

As receipts, 86, 87

Cancelled, 79

Cashing of, 80, 81

Checking of, 79, 91

Depositing of, 92

Drawn to "Cash," 81, 82

Endorsements on, 80-83

Reimbursement, 97

Returned, arrangement of, 78, 79
CLASSIFICATION, 13, 56
CLIENT, 15, 16, 28, 34, 48, 173
COAL, 108, 114, 115
COLLECTION BOXES, 75, 76
COLLECTORS, 75
COMMENTS ON REPORTS, 165, 167,

168, 170, 171, 172, 176
COMMISSION DISCOUNT REGISTER,

170

COMMISSION REGISTER, 170
COMMISSIONS EARNED, 157, 158, 169,

170

COMPTOMETER, 72, 119
CONTRACTS, 16, 63
CO-PARTNERSHIP, 5
CO-PARTNERSHIP AGREEMENTS, 63
COPYRIGHTS, 134
CORPORATIONS :

Minutes of directors or stock-
holders of, 61

Officers of, 6, 62

Stock books of, 156
COST LEDGER, 115
COST SYSTEM, 115, 116
COUPON BONDS, 149
COUPON DEPOSIT ACCOUNT, 152
COUPONS ON BONDS, 45, 150, 151
CREDIT, 8, 53, 54
CREDIT MEN, 138, 139
CREDITORS, 8, n
CREDITORS' LEDGER, 67, 68, 103, 106,

153, 154

CRITICISM, 168, 169
CUMULATIVE DEPARTMENT COSTS,
116

190

Index

CUMULATIVE MATERIAL UNIT COST,

116
CUMULATIVE UNIT LABOR COSTS,

116

CUSTOMERS' CASH BOOK, 68
CUSTOMERS' LEDGER:
Aging of, 138, 139, 140, 141
Agreement with controlling ac-
count, 135

Checking postings of, 68, 69
Classification of, 138
Collection of, 138
Face value of, 135
Footing of, 67
Study of, 141
Trial balance of, 135
Verification of statements of, 136,
137

DEBITS, 53, 54

DEPARTMENT STORE, 13

DEPARTMENTAL COST OF GOODS, 116

DEPARTMENTAL UNIT COSTS, 116

DEPRECIATION, 129, 133

DETAILED MEMORANDUM BOOK, 72

DIARIES, 27

DIRECTORS, 7, n, 61, 63

DISBURSEMENTS :

Entry of items of, 39, 40
Footing of, 18, 92
Invoices for, 154, 155
Of an institution, 87, 88
Petty cash, 96, 97, 99, 101
Statements of, as exhibits, 164
Supported by checks, 86
Supported by signed receipts, 86
Vouching of, 18, 78-83, 86, 87,
89, 91

DISCOUNT :

In Sales Book, 106, 107
In Voucher record, 105, 106
On Bonds, 145

DISTRIBUTION, 87, 88, 97, 99, 100,
106, 107

DIVIDENDS :

Declared and unpaid account, 152
Keeping down of, 9, n
On stocks, 71, 75, 157

DIVIDEND NOTICES, 75
DONATIONS, 75, 76
DRAFTS, Interest on, 142
DUES, 75

DUPLICATE INVOICES, 14
DUPLICATE SALES SLIPS, 72

EFFICIENCY WORK, 2
EMPLOYES, Bonded, n
ENDORSEMENT RELATION, 153
ENDOWMENT FUND, 170, 171
ENGAGEMENTS, 15, 16, 17, 18, 19, 20
ENGAGEMENT BLANK, 16, 17, 18, 19,

ERRORS (See "Adjustments")
EVIDENCES OF SYNDICATE PARTICI-
PATIONS, 47

EXAMINATIONS, 2, 14, 15
EXCHANGE, 158

EXECUTIVE COMMITTEE, 61, 63
EXHIBITS, 165

EXPENSE, 8, 9, 27, 96, 97, 121, 122,
131, 132, 145, 146, 155, 159, 160
EXPENSE FUNDS, 22
EXPLANATION COLUMN, 34
EXPLANATIONS OF POSTINGS, 127
EXTENSIONS, 119

FIDELITY COMPANIES, n
FINANCIAL STATEMENTS, 10, 13, 14
FINANCIAL TRANSACTIONS, i, 2, 7,

FINISHED GOODS, 108
FISCAL AGENT, 151, 152
FIXED FUNDS, 97, 100
FLUCTUATING FUNDS, 97
FOLLOWING THE INTEREST THROUGH,

156, 157
FOOTING :

Meaning of, 66, 67

Of Cash book, 18, 88, 89, 90, 91,
92

Of inventories, 119
FREIGHT ON CONSIGNED GOODS, 146
FUNDS :

Building, 171

Cash, 37

Endowment, 169, 170

Index

FUNDS Continued
Expense, 22
Fixed, 97, 100
Fluctuating, 97
Petty cash, 37, 97

FURNITURE AND FIXTURES, 122, 127,
128, 129, 133

GENERAL CASH BOOKS, 66-69, 72, 98
GENERAL EXPENSE ACCOUNT, 94
GENERAL JOURNAL, 67, 68, 107
GENERAL LEDGER:

Abstracting the, 94

Analyzing of, 121

Column, 127, 128

Controlling account in, 56, 153

Footing of, 67

Grouping of accounts in, n

Importance of, 52

Items, in cash book, 70

Mechanical work in, 107

Method of operating, 97

Paging of, 55

Petty cash account in, 96

Subsidiary accounts in, 55

Taking trial balance of, 52, 53, 54
GOLD, 36
GOODS:

Finished, 108, 114, 115

In process, 108, 114, 115

In transit, 108, 114, 115

Out on consignment, 108, 114,
H5, 146

Out on memorandum, 108, 114,

US
GOOD-WILL, 134

HORSES, WAGONS AND MOTORS AC-
COUNT, 133

INCOME, 13, 156, 157, 164, 173
INCORPORATORS, 61
INDENTURES, 141
INDIVIDUAL ACCOUNTS, 154
INSTITUTIONS :

Receipts from, 75, 77

Vouching disbursements of, 87
INSURANCE, unexpired, 160, 161

INSURANCE COMPANIES, 8
INSURANCE POLICIES, 46, 131, 132
INTEREST :
Account, 142, 146
Accrued, 150-152, 156, 157, 160
And discount account, 146, 147
Checks, 150, 151
Earned, 157

Following the, through, 156, 157
On bank balances, 71, 75
On bonds (See "Bonds")
Purchased, 156, 157
INVENTORIES :
Auditor present at taking of, 112,

113
Certificate as to correctness of,

109, no, 113
Classes of, 108
Extensions of, 119
Footing of, 119

Matters to be understood by
auditor in examining, 108, 109
Plan for taking, 113, 115, 116
Prices used on, no, in, 114, 115,

116, 117, 118
Test of auditor as to correctness

of, 113, 114
Valuation of, no, in
What is included in, 108
INVESTIGATIONS, 2, 14, 15
INVOICES :
Duplicate, 14

For cash disbursements, 153, 154
Individual, 14
In sales book, 106
In voucher register, 103, 104
Sales, 14
LO.U.'s,33, 39

ITEMS, open, 106

JOINT VENTURE, 5, 27

JOINT VENTURE AGREEMENTS, 63

JOURNAL ENTRIES, 56, 58, 107, 159,
166

JOURNAL PAPER, 25, 33, 61, 83, 161,
165

JOURNAL PURCHASE (See "Pur-
chase Journal")

192

Index

LABOR, 116, 117, 118
LAND:

Improvements on, 130, 131, 132

Purchase price of, 130

Sales of part of, 130
LAND AND BUILDINGS ACCOUNT, 130,

167, 172

LEGACIES, 75, 76

LEGAL EXPENSE DEFERRED, 145, 146
LETTER :

Of introduction, 21

Requesting amount on deposit at

bank, 49, 50, 51
LIABILITIES, 14
LOANS PAYABLE, 152, 153

MACHINE LISTS, 78, 79
MACHINERY AND TOOLS ACCOUNT,

132

MANAGEMENT, 9, n
MANUFACTURING ORGANIZATION, 71
MATERIAL UNIT COST, 115-118
MATERIALS AND SUPPLIES, 108, HI,

112, 114, 115

MECHANICAL WORK, Classes of, 66
MEETING, ANNUAL, Date of, 63
MEMBERSHIP ASSOCIATIONS OR SO-
CIETIES, 6

MEMORANDUM BOOK, 100
MERCANTILE ORGANIZATION, 71
MINUTES :

Illustration of abstract of, 63-65

Of directors, 61, 63

Of executive committee, 61, 63

Of special committees, 61

Of stockholders, 61, 63
MISCELLANEOUS RECEIPTS, 71, 74,

75, 76, 77

MISCELLANEOUS SECURITIES, 47
MODERN BUSINESS ORGANIZATION,

3, 4
MORTGAGES :

As securities, 133

Definition of document, 46

Reading of, important, 142, 143,
145, 148

Special provisions of, 148

Tax, 46, 47

MORTGAGE TAX, 46
MOVING EXPENSE, 146

NOTES PAYABLE, 152, 153
NOTES RECEIVABLE, 33, 37, 56, 71
Count of, 42, 43
Forms of, 42
Indorsement on, 43
Interest on, 43, 142, 147
Method of recording, 42

OIL, 108, 114, 115
ORGANIZATIONS :

And management, criticism of, 2

Charitable, 9, 10

Manufacturing, 71

Mercantile, 71

Modern business, 3, 4

Trading, 71

ORGANIZATION EXPENSE, 145, 146
OVERHEAD, 116-118

PACKING MATERIAL, 108, 114, 115

PARTNERS, 5

PASS BOOK, 48, 51, 78, 80, 91

PATENTS, 134

PATIENTS, pay and dispensary, 75

PAYABLE, ACCOUNTS, 97, 103, 153,

154
PAYING-TELLER, 80, 81

PAYROLL, 66, 67, 82, 86, 107
PETTY CASH :

Accounts, handling of, 96, 97, 98

Auditing of, 98-101

Books, 66-68, 100, 101

Funds, 37, 97, 98, 101

Reports, 101

PHASE OF A BUSINESS, 14
PHYSICAL INVENTORY:

Description of, 108

Difference between book inven-
tory and, 108
POLICIES, 46, 131, 132
POSTAGE, 108, 114, 115
POSTING OF TOTALS:

In Voucher record and Purchase
Journal, 106

193

Index

POSTINGS :

Abstract of, 106

Checking of, 66, 68, 92, 93, 94,
95, 107

Explanations of, 126, 127

Mistakes in, 160
PREMIUM, 145

PRESENTATION OF REPORTS, 165, 175
PRICES ON INVENTORIES, no, in,

H4, US

PRINTING, 108, 114, 115
PROFIT AND Loss, 13, 112, 130, 131
PROFIT AND Loss ACCOUNT, 145, 158,

165, 166, 174
PROFITS :

Determination of, 5

Reduction of, 9

Relation of, to interest and divi-
dends, n

Sharing of, 5
PROPERTY ACCOUNT, 127
"PULLED" VOUCHER, 127
PURCHASE JOURNAL (OR VOUCHER
REGISTER), 87, 127:

Checking of postings, 68, 104

Difference between, 102, 103

Footing, 67, 104

Handling of bonds in, 149, 150

Invoices in, 102, 103

Method of operating, 102, 103

Uses of, 70

Vouching of, necessary, 66

PURCHASE RETURNS AND ALLOW-
ANCES, 66, 67, 68, 106

RECAPITULATION SHEET, 85
RECEIPTS :

Checks as, 86

Depositing of, 92

Entry of, 39, 40

For payment on account of cap-
ital stock, 47

Miscellaneous, 71, 74, 75-77

Verification of, 71, 77, 86, 91
RECEIVABLE, ACCOUNTS:

Aging of, 139, 140

Checking of, 167

Inclusion of, in accounts payable
ledger, 154

Trial balance of, 153

Value of, 138
RECEIVERS, n

RECOMMENDATIONS, 168, 169, 170
RECONCILIATION OF BANK ACCOUNT,

78, 79, 83, 84, 85

REGISTERED BONDS, 45, 46, 148, 149
REIMBURSEMENT CHECK, 97, 98
REMITTANCE SLIP, 74
REPORTS :

Expense, 22, 25

Extract from, 170, 171

Form of, 175, 176

Parts of, 165, 166, 167

Petty cash, 101

Preparation of, 162, 165, 172, 176

Time, 22-24, 27

Typing of, 166, 167, 176

Written, 6, 7
RESERVE, in

RESERVES, SUPERFLUOUS, 9
RESULTS, 14
ROYALTIES, n, 147, 157

SALES :

Book, 66, 67, 1 06, 107, 156

Invoices, 14, 106, 160

Journal, 68

Records, 14

Returns and allowances, 66-68

Slips, 72

SCHEDULES, 168, 169
SCRAP, 108, 109, 114, 118
SCRIP, 47
SECURITIES, 33, 37 :

Bonds as, 44, 133

Cancelled, 144

Certificates of deposit as, 47

Certificates of indebtedness as, 47

Definition of, 43

Evidences of syndicate participa-
tion as, 47

Kept alive, 144

Method of recording, 43

Mortgages as, 133

Owned, 133

194

Index

SECURITIES Continued

Receipts for payment on account
of capital stock as, 47

Sales of, 160

Scrip as, 47

Stocks as, 43, 44, 133

Subscriptions as, 47

Warehouse receipts as, 47
SILVER DOLLARS, 39
SINKING FUNDS :

Beneficiaries under, n

Certificate as to amount of de-
posit, 143

Clause, 142, 143

Creation of, 145

Form of, 143, 144

Object of, 144

Reconciliation of, 143

Statement covering interest, 143

Verification of, 143, 144

Where deposited, 143
STATEMENTS :

Bank, 78, 79, 80, 91

Financial, 10, 13, 14

For reports, 165, 166, 167
STATEMENT OF INCOME AND PROFIT

AND Loss, 13, 14
STATIONERY, 108, 114, 115
STOCK CERTIFICATES, 43, 44, 155, 156
STOCK IN TRADE, 108, 109, no, 114,

STOCK LEDGER, 156
STOCK, TAKING, 112
STOCKHOLDERS, 6, 7, 9, 10, n, 61, 63
STOCKS :

As securities, 43, 133

How recorded, 44
SUBSCRIBERS TO CAPITAL STOCK, 10,

142

SUBSCRIPTIONS, 47, 75
SUB-VOUCHERS, 18
SUGGESTIONS, 168, 169
SUMMARY OF ANALYSIS, 128, 146,

147, 159

SURPLUS, 130, 131
SYSTEMS, devising and installing
of, 2

TAX:
Distinguished from assessment,

I3i

Mortgage, 46
Receipts, 47, 131

TESTING, 14

TICKETS, 22

TITLE INSURANCE POLICIES, 131

TOOLS, AND MACHINERY, ACCOUNT,
132

TOTAL MATERIAL COST, 116

TOTAL LABOR COST, 116

TOTALS :

Discount in sales book, 106, 107
Posting of, in sales book, 107
Posting of, in voucher record
and purchase journal, 106

TRADE DISCOUNT:
In sales book, 106, 107
In voucher record, 105, 106

TRADING ORGANIZATIONS, 71

TRADE-MARKS, 134

TRANSACTIONS, 14

TRANSCRIPT OF LEDGER ACCOUNT,
123, 126

TREASURY STOCK ACCOUNT, 133, 134

TRIAL BALANCE:
Arrangement and labeling of

sheets of, 53, 54
Cash account part of, 55, 56
Illustration of, 57
Method of taking off, 53, 55, 56
Necessity of going over, 130, 159
Of accounts, 56
Of accounts payable, 153
Of accounts receivable, 153
Of Creditors' ledger, 154
Of Customers' ledger, 135
Of General ledger, 52, 107
Of stock ledger, 156
Reference to, in closing audit,
176, 177

TRUSTEES, n

UNDERWRITERS, 12

UNEXPIRED INSURANCE ACCOUNT,

160, 161
UNITS OF STOCK, 109

195

Index

VOUCHERS, 18, 33, 39, 87, 88, 97, 127,

160

VOUCHER RECORD, 103
VOUCHER RECORD ACCOUNT, 106
VOUCHER REGISTER (or Purchase

Journal), 87, 97, 127:
Arrangement of vouchers, 105
Checking of postings, 104, 121
Difference between, 102, 103
Footing, 104

Method of handling invoices in,
T03, 104

Method of operating, 103
Uses of, 70

Various other names given, 103
Vouching of, necessary, 66, 104,
105

WAREHOUSE RECEIPTS, 47
WASTE, 108, 114, 115
WORKING BAG, 27
WORKING SHEET, 56, 166

196

THIS BOOK IS DUE ON THE LAST DATE
STAMPED BELOW

AN INITIAL FINE OF 25 CENTS

WILL BE ASSESSED FOR FAILURE TO RETURN
THIS BOOK ON THE DATE DUE. THE PENALTY
WILL INCREASE TO SO CENTS ON THE FOURTH
DAY AND TO $1.OO ON THE SEVENTH DAY
OVERDUE.

MAY 28 1934

SEP 241934

APR *G W*

17M?v 1 50C$

A * "**J

LD 21-100w-7,'33

YC 24929

UNIVERSITY OF CALIFORNIA LIBRARY