LIBRARY UNIVERSITY OF CALIFORNIA GIFT OF ' o frarttral Auditing A WORKING MANUAL FOR AUDITORS PRICE, TWO DOLLARS GEORGE B. RENN 267 Lincoln Avenue, CHICAGO, ILLINOIS PRACTICAL AUDITING A Working Manual for Auditors DESCRIBING THE DETAILS OF A COMMERCIAL AUDIT, IN PROGRESSIVE STEPS FROM THE PROPER POINT OF BEGINNING THROUGH TO COM- PLETION, WITH GENERAL NOTES ON AUDITING BY GEORGE B. RENN ACCOUNTANT AND AUDITOR PRICE, TWO DOLLARS PUBLISHED BY GEORGE B. RENN 267 Lincoln Avenue CHICAGO, ILLINOIS Jtyl- M Entered according to act of Congress, n the year 1905, By GEORGE B. RENN, in the office of the librarian of Congress, at Washington. All rights reserved. CONTENTS GENERAL NOTES Miscellaneous Page 7 Vouchers 8 Analysis of Accounts 9 The Controlling Account - 10 ORDER OF PROCEDURE The Cash Balance Page 13 The Bank Balance 15 Trial Balances 16 The Cash Book 17 The Voucher Register 21 The Purchase Book 22 The Sales Book "23 The Journal "24 REVIEW AND CONCLUSION Miscellaneous Page 27 The Profit and Loss Account The Balance Sheet 29 The Auditor's Report 31 The Auditor's Certificate " 32 154574 Preface. All the literature on auditing published heretofore presup- poses familiarity with the rules of practice on the part of the student; hence the information thus far obtainable upon this subject is of too indefinite a character to be understood easily by that large class of accountants who are otherwise excellently equipped for auditing, but who are lacking in experience. The purpose of this manual is, therefore, to set forth minutely the details to be pursued in making a commercial audit, and to indicate in proper order the procedure to be followed. With this brief explanation the book is respectfully sub- mitted to ambitious accountants, General Notes. For the sake of brevity the two dates limiting the period under audit will be termed respectively the "initial date" and the "terminating date." In a suitable note-book make memoranda, as you proceed with the audit, of such particulars as you will require in making up your report after the audit is completed. One of the first points to set down is a complete list of the books in use, giving their titles, and where the titles do not clearly indicate it, their purposes as w r ell, together with the names of the clerks who are responsible for the work contained in the individual books. With a rubber stamp, bearing the \vord "Audited" above your name, stamp conspicuously all loose papers of a fulfilled character as you inspect them ; such as returned bank checks, receipts, invoices, paid notes, pay-rolls, and other vouchers. This will forestall any possibility of the same vouchers being foisted upon you a second time in support of disbursements. As it is not permissible to stamp securities in this manner, it is neces- sary to observe caution when inspecting bills receivable, stocks, bonds, mortgages, and securities of all kinds, to the end that y< >u do not list them more than once. Adopt a personal check-mark, and check all items and foot- 7 ings (preferably with red ink) when you take them into ac- count during the audit. If you encounter an erased or doubtful item in any of the money columns, ascertain what it should be, and then write the correct amount above it in red ink. This will detect any erasures or alterations which may be made after you have audited the items, as such changed items will not bear your red ink iden- tification marks when you review the books. Be on the alert, when following footings from page to page, to see that they are properly carried forward, both as to the amounts and as to their location in columns. Verify all footings in all books of original entry. All books of original entry except the cash book should be checked into the general ledger and the Controlling Account, but the cash items should be checked from all ledgers into the cash book. Re-foot all personal ledger accounts from the point where last ruled up. Prove all footings of all general ledger accounts, balanced or unbalanced, during the entire period under audit. Inspect the general ledger to see that every item therein has received your check-mark. In case you find errors on the books of account, make mem- oranda of the same upon your note-book, but do not make cor- recting entries upon the books unless you are authorized to do so. A general principle to be observed in auditing is to guard against improper or fictitious credits in any account to which cash is posted on either side. Vouchers. A great many business concerns use a uniform voucher for disbursing cash, the same being approved and certified as cor- rect by certain officials and authorized employes. While this is 8 convenient and desirable, it should be understood that an in- voice itself, if properly made out to your client and duly ap- proved, is equally competent as a voucher. Therefore, wherever this manual calls for vouchers cither in support of cash pay- ments or for journal entries, any memorandum which will estab- lish the validity of the transaction should be accepted as satis- factory. Your report, however, should suggest the introduction of regulation vouchers, if considered desirable. Analysis of Accounts. For the purpose of analyzing the various expense accounts and capital accounts, use paper ruled with three-column per- pendicular divisions, the respective columns of which are to be allotted to book reference, debits, and credits. At the top of the sheet write the caption of the account under analysis, and sub-head the classification columns ; then from the books of original entry post the items into the proper columns of this analysis sheet ; when completed, the net balance of all the col- umns combined should equal the amount of the account as shown in the ledger. This analysis may be made at the time of checking the invoices against the particular items in the books, or it may be made a detail by itself ; the former is the preferred method when you have an assistant. Some auditors advocate the above method of checking all the general ledger accounts, but that is not necessary, inasmuch as the items in the general ledger accounts, including expense and capital accounts, should all be checked against the books of original entry, and this would consequently be mere duplication of work. This analy- sis, it should be understood, is chiefly for purposes of compari- son ; the audit proper is accomplished on these accounts, as well as on the others, by first verifying the correctness of the items in the books of original entry and then checking them into the ledger. e The Controlling Account. The purpose of the Controlling Account is to prove up the personal accounts by totals instead of checking them by indi- vidual items. (Where it is practicable, there should be a sep- arate Controlling Account for the personal accounts receivable, and another for the personal accounts payable ; but where the books are not so arranged as to make this expedient, it will be sat- isfactory to make one account answer for both.) Begin with the totals of the personal accounts as shown on the trial balance of the initial date, then post to the respective sides of the account the monthly footings, during the period under audit, of such books and columns as are posted exclusively to personal accounts. Should there be any book in use, however, that is not columnized in such a manner as to keep the personal account items separate from those relating to general ledger accounts, the personal account items from that particular book must be posted indi- vidually to the Controlling Account. After all postings have been made in this manner, the net balance of the Controlling Account should be in exact agreement with the total of this class of accounts as shown in the trial balance of the terminat- ing date. If found so, it establishes the aggregate accuracy of the personal accounts. Now, to prove their individual accuracy, take off statements of every open account embraced within this general summary, and mail them yourself to the various debtors. with the request that they check them over and return them to you, either endorsed "Correct,'' or with notation of any differ- ences. To make these statements effective they should be an exact transcript of the face of the ledger, particularly so far as relates to credits to customers, and the various classes of credits should be designated exactly as they are entered upon the ledger; i. e., cash should be designated "Cash" and other credits by the -name credited upon the ledger. This form of making up the statements will not only serve to prove the cor- rectness of the amount of the account, but will establish quite 10 effectively the truth of the component parts. In fact, this is the proper method for determining whether all receipts from customers have been entered upon the cash book, provided it is followed in conjunction with the customary precautions against allowing improper credits in this class of accounts. When the statements sent out to customers for comparison are returned to you, there will probably be exceptions noted on some of them, but your judgment will guide you as to whether they are of a character to require further investigation or not. Among a large number of accounts an occasional difference may exist without impropriety, though it should, of course, be sus- ceptible tof explanation. On books of account where the sales accounts and purchase accounts are not kept separately, it is sufficient for practical purposes to treat the total personal account debits as accounts receivable, and the total credits of the same class as accounts payable. The technical distinction need not be drawn except in case of liquidation, when it may become necessary to make pre- cise separation. 11 Order of Procedure. The following order of procedure for making an ordinary commercial audit will economize time and accomplish the best results; but, when conditions may make it impracticable to fol- low these directions exactly, you must accommodate yourself to circumstances. It will be observed that this outline of an audit is classified to accord with the basic books which make up a typical set of books of account. There are establishments, however, whcrj some of these principal books radiate into special or auxiliary books ; in such cases the same methods of auditing will apply to the auxiliary books as would be employed on the particular class of items contained in them, were those items entered upon the main books of account. The Cash Balance. Where the engagement to make the audit is entered into some time in advance of the terminating date, it is altogether the best plan to deposit in bank all funds on hand at the close of the last day, in order that the bank account shall constitute the entire cash balance of that date. The bank pass-book should 13 then be written up, and reconciled immediately with your cli- ent's books. If the above method is not deemed feasible, however, the next best plan is for the auditor himself to balance the cash on the night of the terminating date, and at that time to assure him- self that the proper amount in some form or other is at hand to substantiate the book balance. As a part of this method, he should get the bank pass-book written up not later than the day following, and should make reconciliation with the bank imme- diately on the return of the pass-book. If you begin the audit some time after the terminating date, without having previously balanced the cash, as directed here- tofore, the proper course is to balance when entering upon your work. First, count the actual currency on hand and list same, then add any memoranda that may be carried as currency. Inquire into the authority for all advances represented by these mem- oranda. (By thus listing the currency in advance of balancing the bank account, you will avoid the risk of currency having been replenished through a check not recorded.) Second, list checks on hand, after having assured yourself that they are entered upon the cash book prior to the point where balanced. Add to the above items the balance in bank, as shown by check book or wherever recorded. The sum of the foregoing three items should equal the cash balance, of which a summary should be incorporated in your report. To arrive at the cash book balance, you should verify careful- ly the footings of that book from the terminating date to the present, confirming the final footings in red ink, and with your check-mark. Compare the result with your summary of actual cash, previously made. The disbursement side of this intervening period should be audited later in precisely the same manner as you test the space 14 under direct review, namely, with returned bank checks ; and where the distribution is made direct upon the face of the cash book, with vouchers or other competent memoranda. As the receipts side for this additional period is not held in check by the Controlling Account, it is necessary that you apply special methods to its test when making the audit. After seeing to it that all cash sales have been entered up to date for this extra period, it is best to prove the face of the book by the inverse process of checking into the cash book by individual items the deposits made in bank during this time; and in similar manner follow into the book from their lodgment such other items as should appear upon the receipts side of the cash book ; namely, cheeks on hand and currency disbursed or remaining on hand. Sometimes you may meet with the condition that the cash balance of a certain date is not recorded. To determine what it was at that time, add to the present balance the total dis- bursements made since the date in question, and deduct the to- tal receipts during the interval the net difference is the bal- ance sought. The Bank Balance. As soon as possible after balancing the cash you should get the bank pass-book written up, and when returned to you recon- cile it with your client's account by deducting outstanding checks from balance shown by bank statement. The best way to accomplish this is to arrange the returned bank checks in numerical order, and then from the missing numbers construct the schedule of uncleared checks. Also see whether the re- turned checks are properly endorsed and stamped as having been paid through the bank. 15 Trial Balances. If trial balances of the initial date and of the terminating date are at hand, you can make use of them for present pur- poses as you find them ; but, where none is on file, it will be necessary to take off balances at both dates limiting the period under audit. For the purpose of verifying the personal accounts receiv- able, as described under Controlling Account, mail statements of their accounts to all debtors shown upon the trial balance of the terminating date. Dispatching these statements at this time will give opportu- nity for their return during the progress of the audit. As rapidly as these statements are returned they should be checked against the trial balance ; delinquents should be urged to return them until the last one possible is received. To verify accounts payable, the proper course is to procure statements from all parties with whom your client is known to do business, and compare them with the accounts upon the books. From the trial balance of the initial date determine the aggre- gate amount of personal accounts of that time, and with that amount as a basis open the Controlling Account, which is to be continued as described under that heading in General Notes. From now on you should audit the individual books in the following order, and make it a point t^ complete at one time every feature of the audit relating to each particular book, in- cluding verification of footings. " If possible, do not allow any book to pass out of your possession while it is under inspection. 16 The Cash Book. Receipts Side. Verify footings for entire period under audit. Check cash book balance of the initial date against cash bal- ance in ledger. Check cash sales from place of record into cash book. Several satisfactory methods for recording cash sales may be mentioned, such as modern cash registers (the inside record of which should be under the auditor's exclusive control), or dupli- cate cash sales tickets, numbered consecutively, any missing num- bers of which are to be accounted for to the auditor. When other methods are used, you should test their efficiency and. if deemed unsatisfactory, recommend improvements. If there are any other cash receipts of an impersonal charac- ter, similar to cash sales but differing in some respect so that they cannot logically be included with them, such as sale of old material, etc., they should be tested with such records of the transactions as may be obtainable. Cash discounts, if entered upon the cash book, and not other- wise verifiable, should be scrutinized to see that they are not ex- cessive. An occasional item at different periods of the time under audit should be compared with remittance letters to estab- lish their individual correctness, and thereby imply the general correctness of this class of items. Where miscellaneous credits r* "acle upon the cash book to customers, for such items as .a. owances, freights, etc., if made separately they should 1 subjected to the same scrutiny as they would receive were they entered upon the journals, where they properly belong. Should they be included, however, in the same item with the cash, they should be put to the most rigid test. You should procure copies from the bank of the deposits made for your client during the period under audit, and from them determine the actual cash portion of .these sundry credits. Of currency payments the amount would have to be determined 17 by deducting the offsetting charge from the total credit. Fortu- nately this is a condition not frequently met, and when encoun- tered should be condemned. Compare the deposits made during the last ten days preced- ing the terminating date with the entries in the cash book. From the general ledger check all cash credits into the cash book, including columnar footings ; and then make* sure that all of this class of items have been checked on the receipts side of the cash book. Post monthly footings of personal accounts column to Con- trolling Account. The Cash Book. Disbursement Side. Verify footings for entire period under audit. Check returned bank checks against items on this side of cash book, noting at the same time whether they are entered as drawn in respect to name of payee and amount. Stamp checks "Aud- ited." Check list of outstanding checks from bank reconcile- ment against items on cash book representing them, and prove with vouchers, where such have been returned, otherwise with invoices. If any of these items represent purchases of securi- ties, the same should be inspected; if charged to personal ac- counts as loans or advances, investigate. There should be vouchers ready at hand in support of all currency disbursements, since no cash should have been paid out in this form without taking a receipt at first hand. With these vouchers verify all items of this character. The foregoing should clear this side of the cash book, except- ing possibly the petty expenditure voucher, pay-rolls, and notes taken up at banks, or interest on same. These items are fre- quently paid without drawing individual checks for them; in such cases the original papers must be taken as evidence. 18 It should be recommended, however, that specific checks be drawn in the future for all classes of disbursements. The proper way to do this in regard to petty expenditures, is to draw a check in favor of the disbursing official for a round sum as a begin- ning, and thereafter reimburse him by check periodically for the amount of his expenditure voucher. This will leave the original amount in his possession, while at the same time covering his expenditures by check. This brings you to the cash balance, which has been proven up before. You have now established the fact of the disbursements re- corded upon the cash book, but it remains to determine the pur- poses for which they were made. Where the charges for moneys paid out are made upon the cash book direct to the various accounts, you should require vouchers with invoices attached, in order to check all items en- tered against impersonal accounts, and these vouchers should be certified "Correct" by some competent authority. Otherwise you should examine the invoices to see that they are of a date harmonizing with the time of payment, that they are properly made out to your client and that the amounts are correct; or at least that they have been so attested by some authorized person. Charges to personal accorrts should likewise be checked with vouchers which satisfactorily explain the purpose of the pay- ments. Pay-rolls charged up should bear the O. K. of some one in authority, as well as the signatures of the employes to whom paid. If not so attested, satisfy yourself as to their general cor- rectness, and recommend this safeguard. If footings are not certified, they should be verified by the auditor. Charges to Bills Payable account for notes taken up at the bank or elsewhere should be substantiated by the canceled note itself in each instance, which should be examined as to date and genuineness ; instances are known where the same note has been charged up more than once. 19 Petty Cash disbursements should be combined in one monthly voucher, properly attested O. K. by some responsible official. If you are asked to accept the face of a petty cash book as a voucher for this class of disbursements, you should require an authorized O. K. to be placed upon the book. Stamp all of the foregoing vouchers "Audited" when taken into account. Review the cash book to assure yourself that you had vouch- ers for all disbursements. Having thus satisfied yourself that the money was paid out as recorded, and also that it was disbursed for proper purposes, it remains only to make comparisons with the ledgers. From the general ledger check all items posted from this side of the cash book, including cash balance and monthly footings of columnar postings ; then make sure that this has checked all charges except debits to personal accounts. Post monthly footings of personal accounts columns to Con- trolling Account. Analyze items entered in columns which are charged in total to the respective accounts. This is particularly important in con- nection with the cash book, as it will betray improper distribu- tion, if made accidentally or otherwise. In establishments where the Voucher System is a part of the scheme of accounting, the distribution of disbursements is made in advance upon the Voucher Register at the time when the vouchers are issued, instead of being made upon the cash book when they are paid, as heretofore described. Under this ar- rangement all disbursements are charged to Accounts Payable upon the cash book, as an offset to the corresponding credits pre- viously made to the same account upon the Voucher Register. In such a case the audit of the disbursement side of the cash book has been completed practically at the point where it is indi- cated that the fact of the disbursements has been established. The following details, however, should be added : Check items in Accounts Payable column of cash book against 20 the corresponding column of Voucher Register, in order to deter- mine by the amounts remaining unchecked and, therefore, un- paid, the correctness of the balance of the Accounts Payable ac- count. Check monthly footings of Accounts Taxable column, as well as final cash balance, into general ledger. If there are any miscellaneous charges in the cash book, check them in the same manner as described heretofore. The Voucher Register. Crediting Side. Verify footings for entire period under audit. Having previously checked paid vouchers from cash book against Accounts Payable column in Voucher Register, list un- paid vouchers and verify with balance on ledger representing them. Check returned vouchers against paid items on this side of Voucher Register to determine missing vouchers, and follow di- rections given for incidental comparison with debit side of Vouch- er Register. Check total of Accounts Payable column to its proper ac- count on ledger. Check other general ledger items (if any) into ledger. Post footings of personal ledger column (if any) to Con- trolling Account. The Voucher Register. Debiting Side. Verify footings for entire period under audit. Incidentally with checking the returned vouchers against the crediting side of the Voucher Register, examine them to deter- 21 mine that they are properly O. K.'d, and that they have invoices attached or on file to substantiate the charges made from them upon this side of the Voucher Register, noting particularly whether the charges are properly distributed. Vouchers issued, but remaining unpaid, should be compared similarly with the items which they represent. This should clear the debiting side of the Voucher Register, except such items as are covered by vouchers paid but not re- turned ; for such items the returned bank check is usually deemed a satisfactory voucher, unless the nature of the distribution should seem to require corroboration. Make a list of these missing vouchers for your report. Stamp vouchers and attached invoices "Audited" as fast as they are compared with the entries upon the Voucher Register. Check general ledger items and columnar footings into gen- eral ledger. Post footings of personal ledger column to Controlling Ac- count. Analyze columns which are posted in total to any expense or capital account. The Purchase Book. The distinctive Purchase Book is often dispensed with en- tirely where a Voucher Register is used, all purchases being vouchered at first hand. In other establishments, however, the Purchase Book is used for the exclusive purpose of recording purchases of the commodities dealt in, and there may be still other conditions found that will further modify this arrange- ment ; but the principle of auditing the purchases of the stock-in- trade, wherever recorded, remains the same. Verify footings for entire period under audit. Check all purchases with original invoices, which should be examined in regard to details of date, both month and year; see that they are properly made out to your client ; and that they are 22 certified by the manager or an authorized employe in respect to receipt of goods, and correctness of price and extensions. Stamp invoices "Audited" when compared with entries. Purchases made for officials or employes should be traced to their respective accounts. If the charges for goods returned to shippers are entered upon this book, check the shipping clerk's record of same against the entries. Check footings into proper ledger account. Post footings to Controlling Account. The Sales Book. Verify footings for entire period under audit. For an audit of the character described here you may accept the total-extension of individual invoices as the basis from which to take sales into account, the assumption being that they were properly checked before they were entered in the books. Where there are numerous sales books in use, it may be found that the sales are transferred to a sales journal from which the postings are made to the ledger. In such a case it is optional whether you check the sales into the journal, or post the totals direct from the book of the original entry into the Controlling Account ; the last named is the more desirable method, where practicable, as thereby you will be taking original figures. Should credits for merchandise returned be entered in this book, call for authorized credit slips, or similar vouchers, with which to check the entries. Stamp credit slips "Audited" when compared with entries. Check footings into general ledger. Post footings to Controlling Account. 23 The Journal. Verify footings for entire period under audit. In auditing the journal a cardinal rule, previously stated, is to see that no fictitious credits are allowed to stand in any account to which cash is posted on either side. As nearly all falsifications are made with the ultimate object of diverting cash, this single rule, if followed, will in itself accomplish a large part of the ob- ject of the audit. This applies equally to all books of account; but it is here emphasized for the reason that the journal, with its various auxil- iaries, affords the best opportunity to falsify, and in consequence this book is usually favored with those entries, if any such are made. The larger establishments use journal vouchers from which entries are made upon the journal. By this system an individual voucher for each entry is drawn, which recites the details of the transaction and is then certified with an authorized O. K. ; after which it is journalized. This facilitates greatly the auditing of the journal, as it is then necessary only to check these vouchers against the entries in order to establish their correctness ; except in cases of extraordinary entries, when independent investigation should be made. Where the journal entries are made haphazard, however, without regard to any particular system as is often the case the inspection of the journal becomes a much more complicated matter. To verify the entries item by item would involve an amount of labor which would make auditing entirely too expen- sive. For an audit such as is here described the necessity for de- tailed inspection may be overcome by having some authorized official initial the individual pages of the journal as evidence that he assumes responsibility for the entries. While accepting such a general O. K. in the main, you should still verify entries so far as possible with such data or memo- randa as may be at hand, noting particularly whether entries for 24 purchases of every kind are supported by invoices, and whether the purchases were really made for your client. All such invoices and memoranda should be stamped "Aud- ited" when checked against entries. By thus checking a portion of the entries, those remaining unchecked will be brought more conspicuously to your notice when reviewing the book, and any unusual or exceptional items thus discovered should then be investigated. It should be noted in this connection that, where credits to customers have been made without a definite O. K., the receipt side of the cash book should be vouched by checking cash re- ceipts against the deposit slips of the period under audit. Analyze columnar charges to expense or capital accounts. Check general ledger items, and footings of columns posted in totals, into general ledger. Post footings of personal ledger columns into Controlling Ac- count. 25 Review and Conclusion of the Audit. After you have inspected all books of original entry proceed to examine the ledgers. Inspect the personal ledger trial balance to determine that all debtors' accounts have been approved ''Correct/' or differences reconciled, through statements previously sent out ; That all liabilities, as determined by statements requested from trade creditors, appear upon the books ; That the total of the personal ledger trial balance agrees with the independent Controlling Account which you have kept throughout the audit; and that the Controlling Account (if one is kept) upon the general ledger, in turn, agrees with yours. If some detail of the instructions heretofore given has been disregarded, as is sometimes done, it- may result that there is now no positive proof of the correctness of the personal ledger trial balance. In such a case it is necessary to foot all open personal accounts upon the ledger from the point where they were last ruled off, and in that manner confirm the balances shown upon the trial balance. It will be found, however, if the foregoing instructions have been followed exactly throughout, and if no errors have been 27 found in the books of original entry, nor developed through the medium of the statements sent out or received, that the personal ledger trial balance as originally taken will stand confirmed with- out footing the accounts. The general ledger is now to be re-footed for the entire period under audit, whether accounts are ruled up or remain open, and note is to be taken at the same time whether all items within that period bear your check mark. Following the inspection of each account, the net balance of same is to be checked against the trial balance. Compare your analysis sheets of the various expense and capital accounts with the totals of each of these accounts upon the ledger, and make sure at the same time that no error has been made in the distribution of charges. From the trial balance, verified as above, draw up the Profit and Loss Statement and the Balance Sheet. The Profit and Loss Account. Properly the Profit and Loss account should be used merely to receive the transfer of the yearly balances of the various reve- nue accounts, to determine the result of the year's business. If the account is restricted to the use stated above, it follows that the items brought over have been audited in their original loca- tion in the revenue accounts, and the only precaution then neces- sary in respect to them is to see that they have been transferred correctly. Frequently, however charges and credits are made direct to the Profit and Loss account during the year, and some- times even direct upon the ledger without journalizing. Such entries should receive especial scrutiny from the auditor, and particularly if customers' accounts have been closed into Profit and Loss for the reason that they are considered uncollectible. It is very important to see that any transfer of a personal ac- count which withdraws it from the "live" section of the ledger, is well authenticated, whether it is carried over into Profit and 28 Loss, Bad Debt, Suspense, or any equivalent account. Inquiry should also be made to ascertain whether such delinquent ac- counts are being properly followed up by the collection depart- ment. The Balance Sheet. The balance sheet is a condensation of the final trial balance, and should be in such form as to show in the most compact man- ner, and with due regard to proper relationship, the totals of each of the several classes of Assets 'and Liabilities of the busi- ness. Where necessary, the balance sheet may be utilized for cor- recting any vital omission from the books of account ; as, for in- stance, if it is found that no reserve has been provided for bad debts, depreciation, etc. This should be rectified upon the bal- ance sheet by deducting a proper percentage from each class of the assets liable to depreciation, such reductions to be offset by a corresponding charge to Profit and Loss. In a similar manner, when such items as unearned premiums paid on insurance, interest accrued on loans, rent paid in ad- vance, etc., are of a sufficient amount to warrant it, credit may be given on the balance sheet by inserting a Special Inventory account, and making a corresponding credit to Profit and Loss. In order to be perfectly exact, the stationery, fuel, etc., pur- chased but unused at the terminating date may likewise be taken into account in the same manner, though the position is usually taken that, if they are not of sufficient value to be regularly in- ventoried, they need not be considered. WagesSiccrued, and interest on notes given, should appear upon the books of account ; but if not entered, they must be pro- vided for upon the balance sheet as "Accrued Accounts." A great deal has been written in respect to the relative posi- tions which the assets and liabilities should occupy upon the bal- ance sheet, but the preferred arrangement when the double-page 29 form is used, is to locate the assets upon the left-hand side, with the liabilities opposite. In harmony with this, when the single- page form is employed, the assets should be placed before the liabilities. The various items of assets should be arranged in the order of their availability in the event. of liquidation, and the liabilities should be arranged similarly in the sequence of their respective preference in law. Review the balance sheet to determine how far your investi- gation has established the existence of the assets scheduled, and if any items still lack verification, they should now be investi- gated and confirmed. Satisfy yourself that values have not been inflated, and that proper deductions have been made from the various items to meet discounts, probable losses from bad debts, depreciation, etc. The inventory, particularly, should bear the O. K. of some one in authority, as certification that the goods scheduled had actually been purchased but remained unsold at the date of the inventory,, and that they were listed at prices not exceeding the original cost. In addition to this you should satisfy yourself of the correctness of the extensions and footings. Bills Receivable, or other securities, should be examined, their authenticity established, and they should be checked against the item which they represent upon the balance sheet. To secure ab- solute confirmation of the genuineness of Bills Receivable it may be necessary to write to the drawers of the notes, and thus obtain direct acknowledgment. If customers' notes have been discounted, but have not ma- tured, there is a contingent liability involved for which it is necessary that a reserve be provided. These instructions have advised the procuring of statements from trade creditors for comparison with the books of your client. Of course you should assure yourself that they agree, and also make a careful survey to determine that all miscel- 30 laneous liabilities, such as wages, rent, etc., are provided for upon the balance sheet. The Auditor's Report. From the information gathered and noted throughout the audit make up your report, reciting conditions as you found them. Call especial attention to any irregularities that you may have discovered, and recommend such changes or improvements in the method of accounting as you may deem advisable. Ordi- narily the report should contain the following schedules and sta- tistical statements ; and, under special conditions, still others may be required to meet the particular object for which the audit was undertaken. Balance Sheet. Trading Statement, or Profit and Loss Account, and compari- sons with previous years. Summaries of the analyses of the various Capital Accounts and Expense Accounts, and comparison with previous year?. List of Bills Receivable. List of other securities (if any). List of Bills Payable. List of Delinquent Accounts. Recapitulation of the cash balance. List of outstanding checks at time of reconcilement with bank pass-book. List of unpaid vouchers. List of missing "paid" vouchers (if any). List of missing returned bank checks (if any). Trial balance of the initial date. Preliminary trial balance of the terminating date. Final trial balance of the terminating date. 31 The Auditor's Certificate. The foot of the Balance Sheet should bear your certificate as follows : I hereby certify that I have carefully examined the books of account of the Smith-Brown Co., of Chicago, 111., and that the above balance sheet is a true, correct, and full statement of the condition of their business as on November 30, 1905, as disclosed by said books of account. (Signed)- Accountant and Auditor. Dated at Chicago, 111., December 31, 1905. 32 THIS BOOK IS DUE ON THE LAST DATE STAMPED BELOW AN INITIAL FINOF 25 CENT* ' WILL so DAY AND TO *I.OO ON OVERDUE. SEVENTH DAY APR 1 7 1953 Zj^^J^ni 'S^Bwaa /ecf to resell after - LD21-100m-7,'33