Scientific 
 Auditing 
 
 R.H. 
 SPEAR 
 
 PUBLISHED BY 
 
 COMMERCIAL WORLD PUBLISHING COMPANY 
 DETROIT, MICHIGAN, U. S. A. 
 
Copyright, 1912 
 By R. H. SPEAR 
 
 Detroit, Michigan 
 All Rights Reserved 
 
AUDITING. 
 
 During the past two decades so many volumes have been 
 written upon the subjects of bookkeeping, accounting, auditing, 
 cost accounting and systematizing that it might seem difficult for 
 any one to undertake the successful authorship of a new volume 
 complete with up-to-date ideas and suggestions. To a certain 
 extent this would be true if it was not for the fact that during 
 this period a remarkable change has been made in all lines of 
 commercial endeavor. Such marvelous improvements have been 
 effected as to require a corresponding development in the science of 
 accounting and auditing, to meet present day needs. Systems of 
 accounting or methods of auditing employed with the highest degree 
 of efficiency twenty or even ten years ago prove wholly inadequate 
 for present use. 
 
 Prior to entering upon a discussion of that particular branch of 
 the science of accounting known as "Auditing," it is considered 
 advisable to comprehensively define the position of the bookkeeper, 
 accountant, auditor, cost accountant and systematizer in the affairs 
 of the commercial world and their co-relation, which is similar to 
 the corresponding relations of bookkeeping, accounting, auditing, 
 cost accounting and systematizing. 
 
 THE BOOKKEEPER. 
 
 A person who keeps the accounts of another person, partner- 
 ship or corporation. An officer who has charge of keeping the 
 books and accounts in a public office is also designated as a 
 bookkeeper. 
 
 The duties of a bookkeeper consist in keeping an accurate record 
 of the business transactions of the party by whom he is employed, 
 prepare statements from time to time to show the condition of 
 affairs of the business and provide such other information as is 
 required. He should be always on the alert to make note of any 
 suggestions or ideas for formulating plans for improving the stand- 
 ard of the work, so that he will accomplish more with less labor, 
 and produce better results. 
 
 In assuming the responsibility of a new position the book- 
 keeper is not expected to immediately verify the entire accounting 
 records as he finds them, but, by all means, should verify the cash 
 
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 258793 
 
on hand, reconcile the bank account, and take a trial balance to 
 ascertain the equilibrium of the ledger accounts. Any differences 
 are noted and called to the attention of his employer, so that he is 
 not held responsible for any shortages which are discovered later. 
 He should devote his best efforts towards improving the system 
 of accounting in use and perfecting any ideas which he possesses 
 for simplifying the work. A bookkeeper has no difficulty in pro- 
 viding a check upon the accuracy of his own work, as it is a very 
 simple matter for him to establish memorandum accounts to which 
 he makes postings corresponding with the postings made to the 
 ledgers. If he is operating a system of sectionalized ledgers it is 
 unnecessary that he should have the entries to the private ledger 
 or balances of the controlling accounts therein in order to deter- 
 mine the accuracy of his work. 
 
 THE ACCOUNTANT. 
 
 An individual who is today looked upon by business men as a 
 person having exceptional analytical powers, and whose duty it is 
 to certify as to the correctness and exactness of transactions 
 recorded upon the books of record. 
 
 He is further expected to examine the distribution of charges 
 and to devise special accounting systems to meet special require- 
 ments in order that the bookkeeping or accounting work may be 
 accomplished in the shortest possible time with a minimum of labor. 
 
 The accountant should be qualified to pass expert opinion upon 
 any matters in the science of accounting in any line of business, 
 no matter what system is used. His examination of the accounts 
 should show any losses sustained, the particular department of the 
 business in which they are occurring, and to suggest special methods 
 or systems to prevent such losses, or to increase the profits of any 
 department. .He should be thoroughly familiar with banking and 
 financial methods, so that in outlining a system the minimum 
 amount of capital will bring the best profits in order that the funds 
 may be invested and reinvested as frequently as possible. 
 
 The professional or business man looks upon the accountant 
 as an unquestioned authority in the science of accounting, and 
 frequently thousands of dollars are invested upon his recommenda- 
 tion as to the financial condition of the business and the soundness 
 of his knowledge of business affairs. 
 
 4 
 
A careful distinction is made between the public accountant 
 and specialists. This is the age of the specialist, and owing to the 
 many and rapid improvements in the science of accounting public 
 accountants are beginning to train themselves for some particular 
 branch of the science. 
 
 THE AUDITOR. 
 
 A person appointed and authorized to examine an account or 
 accounts, compare the charges with the vouchers, carefully check 
 all receipts, etc. ; briefly stated, a person appointed and authorized 
 to examine the affairs of a business for any specified period, to 
 ascertain its true financial condition. 
 
 The auditor's investigation does not cease with merely checking 
 the figures on the books of account, but includes an examination of 
 the nature and substance of the various accounts to ascertain the 
 correctness of the various charges as stated. The duties of the 
 auditor, however, are governed largely by the circumstances under 
 which he is appointed. 
 
 Auditors are of several different classes or kinds, and their gen- 
 eral competency usually designates the particular class to which 
 they belong. During the experience of the editor he has had oppor- 
 tunity to examine the work of various auditors, some of whom, he 
 is sorry to state, were wholly incompetent to perform the respon- 
 sibilities entrusted to them. 
 
 The duties of the auditor represent an important responsibility 
 as the investment of thousands of dollars sometimes is made upon 
 his certified statement as to the financial condition of a business. 
 It may be well to state the possible result from the investment of a 
 large amount of money upon an auditor's investigation and certifica- 
 tion when he is unqualified for the undertaking; the loss of not 
 only the greater part of the investment, but the downfall of a busi- 
 ness giving employment to scores of individuals. The auditors in 
 this class are usually conscientious, but after failing to justify the 
 confidence reposed in them, they lose their foothold in the science 
 and art and are reduced to their proper level. 
 
 Another class of auditors is found, thoroughly efficient in every 
 detail, who usually employ a staff of trained assistants that enables 
 them to undertake audits that it would be impossible for any one 
 man to perform. The result of an audit conducted by a represent- 
 
 5 
 
ative of this class usually can be depended upon as being thorough 
 and complete, although there are certain instances where the work 
 is entrusted solely to trained assistants who do not possess the 
 excellent qualifications held by the auditor proprietor. 
 
 A third class of auditors of exceptional competency is found 
 who are usually engaged to audit the accounts of states and munici- 
 palities, or who are appointed by the courts to investigate estates, 
 although appointees for this latter purpose are invariably lawyers 
 possessing a practical knowledge of auditing, the science of accounts, 
 and law. 
 
 Another set of auditors are found in this third class, namely, 
 employes of national and state departments who secure their posi- 
 tions through political influence, but upon whom devolves important 
 responsibilities properly belonging to the work that should be per- 
 formed by the auditor for states and municipalities. 
 
 From close observation, it would seem that appointments thus 
 made usually result in certain reforms or the installation of different 
 systems of accounting, which is usually not entrusted to the em- 
 ployee. In the installation of a complete accounting system for any 
 department of a municipality or its various departments, the ser- 
 vices of public accountants of prominence usually are sought, in 
 order that the system installed may be effective and work to the 
 advantage of all conditions. Briefly stated, the auditors described 
 come under the following classifications: 
 
 First The auditor who is unqualified and incompetent, but who 
 accepts the responsibilities when he knows that he cannot justify 
 the confidence reposed in him. 
 
 Second The auditor who employs a corps of trained assistants 
 to assist him in large undertakings, but sometimes entrusts too 
 great responsibility to his employees without giving proper atten- 
 tion to the work himself. 
 
 Third Auditors for states or municipalities; auditors appointed 
 by courts for various estates to investigate and pass upon the ac- 
 counts of estates ; invariably lawyers. Employes of national and 
 state departments entrusted with the responsibilities of an auditor, 
 the national and state bank examiners, insurance examiners and 
 examiners connected with the Bureau of Corporations of the depart- 
 ment of Commerce and Labor, although this title is given to some 
 individuals who act in their official capacity as auditors. 
 
 6 
 
THE COST ACCOUNTANT. 
 
 A person entrusted with the responsibility of accurately -deter- 
 mining the cost of production of an article. The successful per- 
 formance of his duties requires a full knowledge of all of the sub- 
 jects involved in the science of cost accounting. 
 
 THE SYSTEMATIZER. 
 
 A person entrusted with the responsibility of a business or fac- 
 tory organization, evolving systems and methods the operation and 
 execution of which have a tendency to increased plant efficiency at 
 no increased cost, and with a probable saving of money by the 
 reduction of labor or other expenditure. 
 
 This brief synopsis of the duties of the individuals entrusted 
 with the responsibility of recording business transactions, studying 
 commercial conditions with a view to increased accuracy or effici- 
 ency in making such records, the verification of the books of record 
 and comparative statistical statements compiled therefrom, the 
 determining of accurate costs of production and a systematic organ- 
 ization of any factory or business has a tendency to point out clearly 
 the position occupied by the auditor in the execution of his duties. 
 
 AN AUDIT ESSENTIAL. 
 
 There are several reasons why the books of any business, 
 whether single proprietorship, partnership, society or corporation 
 should be audited under a continuous or periodical audit. Perhaps 
 the most important reason is readily made apparent by a consider- 
 ation of the methods used by a great many business houses or the 
 efficiency of the service rendered by the book-keeper in recording 
 the transactions. 
 
 Many book-keepers, in fact the majority, lack scientific training 
 or practical experience, assume too great responsibilities in attempt- 
 ing to record the transactions of a business. The result generally 
 is a badly tangled set of books that require the services of an 
 auditor for their verification and proper adjustment. 
 
 Incompetency, however, is not responsible for the necessity of 
 securing the services of an auditor in all cases. There are many in- 
 stances where the book-keeper, although fully competent to do the 
 work, is expected to do a greater amount of work than a single indi- 
 
 7 
 
vidual is capable of, thereby forcing him to neglect a part of the 
 work until he eventually loses his grip upon accuracy and errors 
 creep in. 
 
 A division of the most important reason is made, one of which 
 is inadequate system, the other inefficient service. Although the 
 book-keeper is expected to do the best he is capable of, he should 
 not be relied upon entirely for assurance that a proper system of 
 accounting is employed. He may do his work in an entirely satis- 
 factory manner, but unless provided with proper tools cannot get 
 satisfactory results. On the other hand, the most perfect system 
 ever devised will not produce satisfactory results at the hands of an 
 incompetent book-keeper lacking necessary judgment and discretion 
 in recording the business transactions. To get the best results a 
 good system of accounting and efficient service are essential. 
 
 In corroborating the above remarks extracts from the report of 
 several public accounting firms upon the municipal accounting rec- 
 ords of a western city are submitted. 
 
 "Nowhere in the departmental accounts is any distinction made 
 between capital expenditures (for the acquirement of permanent 
 properties and equipment) and revenue expenditures. The depart- 
 mental records, in fact, are in most instances merely chronological 
 lists of approved disbursements, and as such are without value for 
 administrative purposes. The Auditor is the head of the finance 
 department of the city in name only. There is no system of audit. 
 The finance committee of the Board of Supervisors employs an ac- 
 countant to examine the various departments, but the magnitude of 
 the work under existing accounting conditions is far beyond the 
 physical ability of any one man to execute efficiently. It follows 
 that the department books, with some notable exceptions, are not in 
 agreement with those of the Auditor a condition which opens the 
 door to charges to wrong accounts and to the making of fraudulent 
 entries without fear of detection. 
 
 Even the cash accounting is not complete. There is no ade- 
 quate check upon all collections, and thus it has been possible for 
 an embezzlement of over $90,000, which occurred in 1906, to remain 
 undetected for over a year and a half. A comparison of the depart- 
 ment reports of the Auditor and Treasurer will show marked differ- 
 ences both in receipts and expenditures possibly "mere matters of 
 book-keeping," but even so, misstatements of fact and indications 
 of possible hiding-places for error and fraud. 
 
 8 
 
The method of paying city employees is archaic, wasteful, time- 
 consuming, and is not surrounded with sufficient safeguards to in- 
 sure a day's work for a day's pay. It speaks volumes either for 
 the honesty of subordinate employees or against the efficiency of 
 the methods that there have been no scandals in connection with the 
 pay-rolls. 
 
 The remedy for such a state of affairs as we have referred to 
 lies, as it appears to us, in the installation of a modern and appro- 
 priate system of accounts, and this should produce results far more 
 important than the mere recording of revenue and expenditures or 
 of moneys received, moneys disbursed and moneys on hand. Such 
 a system should prove an essential factor in the safeguarding of the* 
 assets of the municipality, and in the economical administration of 
 its affairs. It should accomplish for the city all that is effected by 
 the book-keeping of a public service corporation or of a similar 
 enterprise, and we are confident that it is only by adopting such 
 modern accounting methods that a satisfactory system of municipal 
 accounts can be developed." 
 
 The above explanations should suffice for a general idea of the 
 conditions making the services of the auditor essential. 
 
 THE VALUE OF AN AUDIT. 
 
 The value of an audit should not be measured by the actual 
 discrepancies or irregularities discovered, since there are other con- 
 siderations in determining the benefits derived from the expenditure 
 of money. 
 
 There are instances where a comprehensive audit of the books 
 of a business does not disclose any discrepancies, the auditors find- 
 ing the records of the business transactions properly made. In 
 such cases the business man is usually too hasty in his judgment in 
 declaring that the audit proved of no special value to him and that 
 the amount he paid therefor represents so much money wasted. 
 
 As a matter of fact, there is a deep sense of security and satis- 
 faction in knowing that everything in connection with the account- 
 ing department is O. K., that no irregularities exist, that no defalca- 
 tions have been made, that everyone identified with the accounting 
 department in any manner is completely exonerated from all sus- 
 picion, even though prior to the time the audit was made they may 
 have been suspected. 
 
 
Is there no satisfaction to a business man in knowing that the 
 accounting department has not made expensive errors, that goods 
 have not been shipped out without being properly invoiced, that 
 purchases have been returned without having received proper credit 
 therefor, that discounts have not been overlooked, that the balance 
 sheet as prepared presents a thoroughly reliable statement of the 
 conditions of the business, that the profit and loss statement shows 
 a correct statement of the profits and losses? 
 
 The business man employs a cashier to properly record in the 
 cash book all cash receipts and disbursements, but he is not satisfied 
 unless he has some check upon the accuracy of the record. To 
 verify the transactions recorded he counts the cash in the drawer or 
 till. He employs a night watchman who is relied upon to prevent 
 burglary, fire, etc., and notwithstanding the fact that no burglary or 
 fire may ever occur he regards the services of the night watchman 
 indispensable, perhaps on account of the sense of security and sat- 
 isfaction to him in knowing that his property is protected. Does 
 it not naturally follow that he should have the same sense of secur- 
 ity and satisfaction in knowing that by having an audit of his books 
 made his resources are protected? 
 
 An audit is designed to serve a double purpose, namely, the 
 detection of irregularities or defalcations, etc., and their prevention. 
 It is more logical for a business man to employ an auditor to pre- 
 vent irregularities and discrepancies than for him to wait until they 
 are suspected or known to exist before steps are taken to locate 
 the errors of commission or omission and place a safeguard against 
 their possible recurrence. 
 
 DIFFERENT KINDS OF AUDITS. 
 
 Audits are classified under the headings Completed, Continuous, 
 Partial, Periodical and Special. 
 
 An audit is an examination and investigation of books of ac- 
 count for the purpose of determining the accuracy of the accounts 
 and the honesty of those interested. 
 
 They are usually conducted for the purpose of detecting any 
 fraud, any errors of a technical nature, or any misapplication of the 
 general principles of accounting which does not affect the accuracy 
 of the figures shown. 
 
 The three objects above classified have a common relation, as 
 
 10 
 
it is obvious that a technical error or an error of principle must be 
 necessary to conceal a fraud. The auditor should be constantly 
 vigilant and watchful in the minutest detail, as frauds are sometimes 
 perpetrated for very small amounts, although in many instances 
 large amounts have been involved. 
 
 COMPLETED AUDIT. 
 
 A completed audit is so-called because the auditor does not 
 begin his work until after the trial balance has been taken. 
 
 Whenever possible the books of account should remain in the 
 sole custody of the auditor during the period required for a com- 
 pleted audit, although this is hardly practical except in the case of 
 very small concerns where the work is so arranged that it requires 
 very little detail checking by the auditor. 
 
 The difficulty of allowing the books to remain in the possession 
 of the book-keeper during the period of the audit cannot be entirely 
 overcome with practicability, but if the auditor will bear in mind 
 this special feature and guard against any fraudulent intentions of 
 the book-keeper, he can undoubtedly save himself from any danger 
 from this source. This can easily be remedied if the auditor will 
 close the books of account himself, which is very often done. Any 
 changes which might then occur would certainly be detected. 
 
 A very important part of a completed audit is the necessity of 
 the auditor in completing his audit on any part of the work which 
 he may undertake, that is, if he audits the total ledger balances at 
 any particular time it is very essential that he take the sum total 
 of such balances at the same time to prevent the possibility of 
 changes being made prior to the time of making the addition of the 
 balances. 
 
 
 CONTINUOUS AUDIT. 
 
 A continuous audit has several advantages in its favor, among 
 which are the following: 
 
 Periodical visits of the auditor have a tendency to remind the 
 book-keeper that he must keep his work up-to-date so that the 
 auditor is not hindered on this account; frequent examinations of 
 the books readily detect any errors made, so that they may be cor- 
 rected without the necessity of opening special adjustment accounts; 
 
 11 
 
frequent examination of the books enables the auditor to give more 
 careful attention to the details of the entries and the general prin- 
 ciples of accounting, and the audit may be completed very soon 
 after the books are closed without the necessity of the auditor rush- 
 ing through the examination slighting smaller details, perhaps to 
 the detriment of the real value of the audit. 
 
 Where a continuous audit is made, the book-keeper is given 
 an opportunity to change any postings or figures he may wish, 
 ignorantly or intentionally, prior to the date of the final audit. The 
 auditor in charge of the work should be very careful to detect any 
 changes which may occur and to make special note thereof. 
 
 PARTIAL AUDIT. 
 
 A term applied to a system of auditing which does not cover 
 the principles of a detailed audit nor touch upon a continuous or 
 completed audit. 
 
 In conducting a partial audit it is customary to verify the cash 
 and bank balances upon the date the examination is started, by 
 comparing the same with the balances shown by the ledgers. 
 
 Special ruled paper is generally used for the purpose of opening 
 accounts with the various general or private ledger accounts, while 
 controlling accounts are opened for the sales and purchase ledgers. 
 Postings are then made from the cash book and journal to the var- 
 ious general or private ledger accounts, and from the purchase and 
 sales records postings are made to the controlling accounts. 
 
 This is a very simple matter where sectionalized sales ledgers 
 are used, and special columns provided therefor in the sales records, 
 but when this is not done considerable confusion will arise from 
 having many items of a different nature in a single column. 
 
 The balances then shown by the auditor's abstract ledger should 
 agree with the balances shown by the book-keeper's trial balance, 
 provided the book-keeper's work is accurate. If any differences are 
 discovered special mention should be made of each, and all the 
 errors located. It may be necessary to open a general adjustment 
 account for the purpose of correcting errors which usually occur. 
 
 The balance shown by the sales ledger controlling- account 
 should agree with the total sales as shown by the sales record, and 
 all receipts on customers' accounts, discounts and allowances as 
 shown by the cash book, journal and credit records. 
 
 12 
 
The balance shown by the purchase ledger controlling account 
 should agree with the total purchases as shown by the purchase 
 record, and all payments thereon, together with discounts and~allow- 
 ances, as shown by the cash book, journal and credit allowance rec- 
 ord. Of course, the balances must then agree with the ledger bal- 
 ances as shown by the trial balance. 
 
 A simple method of making this comparison is to take from 
 the trial balance at the commencement of the audit the debit and 
 credit balances showing sales and purchase accounts for totals. The 
 debit and credit postings, as shown by the auditor's abstract ledger 
 tor the audit period, should then be listed which when added to and 
 deducted from the previous trial balance should present the trial bal- 
 ance at the close of the audit period, which should in every way 
 agree with the figures as presented by the book-keeper. Of course, 
 the cash on hand at the commencement of the period should be 
 added to the amount of cash received during the audit period. From 
 this amount should be deducted the amount disbursed, balance rep- 
 resenting the cash on hand at close of the period. 
 
 In closing the audit, all revenue accounts should be closed into 
 profit and loss, and a statement of assets and liabilities prepared. 
 In addition to this the general verification of the various accounts, 
 pay roll, petty cash footings, bills payable, etc., should be made, in 
 order that the audit may be correct. 
 
 PERIODICAL AUDIT. 
 
 A term given to an audit conducted at certain specified times, 
 or a series of audits covering certain prescribed periods. Periodical 
 audits usually assume the nature of a completed audit. 
 
 SPECIAL AUDITS. 
 
 A term sometimes applied to the special considerations in dif- 
 ferent classes of audits, such as: public service corporation, commer- 
 cial accounts, and the accounts of various institutions. 
 
 AUDITORS' CERTIFICATES. 
 
 Auditors have not adopted any particular form of certificate as 
 conditions to be met vary slightly in different businesses and yet 
 the general principles of certifications are practically the same. 
 
 13 
 
Two or three forms of auditors' certificates are given which 
 meet ordinary requirements. 
 
 ; 'I hereby certify that I have carefully examined the books of account 
 of Fred Andrews & Company, and that the above statement of assets and 
 liabilities and balance sheet is a true and correct statement of the present 
 condition of the business as on the 30th day of June, 1908, according to the 
 said books of account, dated this 9th day of July, 1908." 
 
 ( Signed) 
 
 "We hereby certify that we have carefully audited the accounts of the 
 Wolverine Manufacturing Company for the fiscal year ending June 30th, 1907, 
 and that the same are apparently correct. We further certify that the state- 
 ment of assets and liabilities and balance sheet above shown is accurately 
 prepared from the accounts as shown by the books of the company, and to 
 the best of our knowledge and belief, and is a correct statement of the 
 financial condition of the company, as of the date above mentioned." 
 
 "I hereby certify that I have audited the above balance sheet of the 
 Land Improvement Company, dated the 31st day of December, 1907, and in 
 my opinion such balance sheet exhibits a true and correct statement of the 
 affairs of the said company, as shown by their books of account, as of the 
 date mentioned." 
 
 AUDITORS' DUTIES. 
 
 The duties of the auditor are governed very largely by the 
 agreements set forth in his contract for the audit or investigation 
 undertaken. 
 
 The duties of an auditor in behalf of a company about to be 
 amalgamated or sold to a combination differ greatly from the duties 
 of the auditor employed by a large corporation for the purpose of 
 conducting a continuous audit, and further difference in the nature 
 of the examinations and investigations cause wide differences in the 
 auditors' duties under varied conditions. 
 
 The auditor for a large corporation, when employed for the pur- 
 pose of making a continuous audit, is expected to verify all of the 
 accounting work of the corporation and prepare periodical compar- 
 ative statistical statements of the financial condition of the business, 
 after having verified the figures presented. He is further expected 
 to endorse the system of accounts in use and to make such changes 
 from time to time as in his best judgment is deemed advisable, and 
 suggest any labor-saving improvements or short cuts. 
 
 There is considerable difference between the auditor of a cor- 
 poration and the public accountant or auditor, inasmuch as the for- 
 
 14 
 
mer does not have the privilege of a free hand in his recommenda- 
 tions on account of certain restrictions and limitations being placed 
 upon the extent of his suggestions, recommendations, etc., the pub- 
 lic accountant or auditor is not bound by any personal responsibility 
 and conducts an audit from an impartial and unbiased standpoint. 
 
 The permanent auditor employed by the corporation usually 
 considers whether or not his recommendations will meet with the 
 approval of the higher authorities, and whether or not such recom- 
 mendations will cause personal embarrassment as regards the per- 
 manency of his position. This restriction or limitation places the 
 permanent auditor in a rather undesirable position, and gives him 
 very little advantage over the expert book-keeper. 
 
 The permanent auditor is governed in his work by the basis of 
 the contract with the principals for the work undertaken, and inas- 
 much as none of the courts or legislatures have attempted to define 
 an auditor's duties, the responsibilities of an audit rest with the 
 individual. It would be impractical for any court or legislature to 
 regulate the duties of the auditor, as such regulations might result 
 in failure in many cases. 
 
 AUDITORS' LIABILITIES. 
 
 There are wide differences of opinion as regards the liabilities 
 of the auditor and no definite conclusion can be gained as to the 
 auditor's liability in connection with accounts certified by him. 
 
 An auditor is expected to be honest and to exercise a reason- 
 able amount of care and skill to determine that his certification is 
 true and correct, and to exercise a reasonable amount of care and 
 skill in determining the truth. It would be unfair for the auditor 
 to assume the liabilities of the directors of a corporation, although 
 it is his duty to examine any and all features in connection with 
 the books of account, valuations, etc., and to specify any differences 
 found. 
 
 Should any valuations cause suspicion investigation should fol- 
 low, but if such valuations are unreasonable and the directors are 
 not in accord with the auditor as to the amount of such valuations, 
 then he can hardly be held responsible, but his certification should 
 embody the truth. 
 
 The auditor is expected to know and to certify to the truth and 
 accuracy of the figures shown upon the balance sheet after exercis- 
 
 15 
 
ing reasonable care to satisfy himself that the figures shown are 
 correct, although if his suspicion is aroused investigation should 
 result and in making his report to shareholders the details should 
 be so explained and illustrated that they may take whatever action 
 in the matter that they may see fit. 
 
 The liabilities of an auditor become a matter of serious regard 
 when the affairs of a company are wound up on account of dividends 
 having been declared and paid out of capital. Of course, the direc- 
 tors in such cases are responsible, and it would seem that an auditor 
 should be held equally responsible with the directors provided he 
 should discover this fact and fail to specify its importance in his 
 certification, although an auditor should not be personally liable for 
 innocent mistakes or ignorance. Corporations should exercise due 
 care to cover this latter point in engaging the services of an auditor. 
 
 It may be considered that under certain other conditions, such 
 as the following, the auditor might be personally liable. 
 
 Suppose the auditor has a contract with a large corporation for 
 the periodical audit of its books of account, and instead of auditing 
 the books promptly upon the specified date allows his audit to fall 
 jin arrears for a period of ten days or two weeks when he then dis- 
 covers that during the past two months or perhaps a longer period 
 continuous defalcation has been practiced, the question then arises 
 as to the liability of the auditor for not detecting and preventing 
 such defalcation upon the specified contract audit date instead of ten 
 days or two weeks thereafter. 
 
 In such an instance the auditor should be held liable for defal- 
 cations occurring by reason of his negligence, although the definite 
 conclusion on this question is conditional, inasmuch as it might 
 reasonably be expected that some elasticity should be endured at 
 certain periods, for example, January 1st, when the auditor is gen- 
 erally expected to undertake a far greater amount of work than is 
 possible for him to do within a limited period. 
 
 AUDITORS' RESPONSIBILITIES. 
 
 Although a great deal has been published concerning the au- 
 ditors' responsibilities and liabilities, it would be hardly considered 
 justifiable for an auditor personally to be held responsible for his 
 failure to detect or expose errors or frauds in his examination and 
 investigation, unless, in addition to negligence, such errors or frauds 
 
 16 
 
were overlooked with fraudulent intent, in which case it is clearly 
 evident that an auditor might personally be held responsible. 
 
 AUDITORS' QUALIFICATIONS. 
 
 Although a great deal has been published regarding the qualifi- 
 cations of a successful and efficient auditor there is undoubtedly lit- 
 tle difference of opinion regarding the qualification of the auditor 
 who is considered first-class in every sense of the word, as applied to 
 the accounting and auditing profession. 
 
 In order to achieve complete success in the accounting and 
 auditing field an auditor must have a very thorough and exhaustive 
 knowledge of every branch and department of bookkeeping, which 
 is merely the bottom rung to his art. He must also acquaint him- 
 self with the statutes regulating the different undertakings with 
 which he may associate himself or in which he may be concerned. 
 In addition to having a thorough and practical knowledge of com- 
 mercial business and commercial transactions generally, he must 
 possess a considerable knowledge of the particular methods by 
 which various lines of business are conducted. 
 
 An auditor should be a man of considerable knowledge, , prac- 
 tice, experience and skill, and should be equipped with a knowledge 
 of as many trades and customs as possible. A detailed knowledge 
 of banking and finance and stock exchange operations is an essential 
 to his complete success. He should be a man of exceptional ability 
 in the perception of details and plans, a man with originality so 
 that he may formulate ideal systems, and above all things a man 
 with a memory trained for detail work. 
 
 The auditor will be very much surprised to find how valuable 
 little experiences are to him after a period of time, and by having 
 a good memory for the little incidents which occur in his daily 
 work he will later be able to save much time and will thus be 
 equipped for better service. 
 
 It has been stated that among the qualifications of an auditor 
 should be considered those which are not acquired by careful study 
 but by living. Among these qualifications which make up the good 
 auditor are the following: Tact, caution, firmness, fairness, good 
 temper, courage, discretion, industry, judgment, patience, clear head- 
 edness and reliability, while that judicious and liberal education 
 
 17 
 
which is expressed by the word culture is most important for those 
 who would achieve the greatest successes. 
 
 Accountancy demands a width and depth of general knowledge 
 upon which it is impossible to place a limit, and any leading ac- 
 countant will gladly admit that something new is learned every day. 
 
 ESSENTIALS OF AN AUDIT. 
 
 There are many considerations under this heading in addition 
 to an outline of what an audit should cover or contain. 
 
 The twentieth century will ever be known as an era of large 
 corporations, amalgamations, trusts and combinations of capital, 
 some of which are conducted upon good business principles while 
 others attempt, and too frequently carry out, lawless practices, aim- 
 ing for success in the monopolization of trade or in deceiving the 
 public into buying their securities at fictitious values. Those cor- 
 porations conducted upon sound business principles endeavor to 
 keep their floating assets equivalent to their floating liabilities, with 
 a margin of profit which represents the excess of the former over 
 the latter. 
 
 That a corporation is regarded as honest which attempts no 
 lawless practices, issues or sells no watered stock, calculates its 
 earning power from a proper and conservative basis and declares 
 dividends out of profits payable in cash. The stock of such a cor- 
 poration is usually worth the value at which it is shown upon the 
 books of account. 
 
 The advance in accounting methods and principles has brought 
 enlightenment to the investor who does not now regard favorably 
 an investment in any enterprise unless the annual report is pre- 
 pared in a clear and comprehensive manner thereby making it un- 
 necessary for him to employ counsel or the advice of a credit man, 
 accountant or an attorney to determine of what the assets consist 
 and what constitutes the liabilities. A complete and comprehensive 
 report accompanying a dividend check greatly increases the confi- 
 dence of the investor in the proposition and is naturally productive 
 of the very best results, while, on the other hand, an annual report 
 inaccurately or improperly prepared and submitted to a stockholder 
 arouses suspicion and causes dissatisfaction. 
 
 A corporation requires no special analysis. It is sufficient to 
 say that it is a combination of capital. It is the result of a few or 
 
 18 
 
many investors putting their funds into an enterprise and obtaining 
 corporate power from the state under the laws of which the cor- 
 poration is organized. In many instances a large corporation in a 
 community depends upon the best citizens of that locality for the 
 sale of its securities. 
 
 It is universal knowledge that the primary object of the in- 
 vestor is a dividend from the money invested. While it is natural 
 for an investor to regard the dividend earning power of a corpora- 
 tion as its primary purpose he should not overlook the fact that a 
 large business enterprise is unquestionably an enormous power for 
 good in a community. The altruistic benefit derived from the em- 
 ployment of thousands of laborers may be regarded of more im- 
 portance than the small dividend the investor expects. A corpora- 
 tion having an annual pay roll of $100,000 might return to its stock- 
 holders dividends not exceeding $10,000. The circulation of the 
 labor expenditure in the community among the families, grocers, 
 merchants, druggists, etc., might be considered the existence of the 
 community. 
 
 The investor who receives a regular annual dividend upon his 
 investment accompanied by an annual statement for a period of a 
 few years may take it for granted that everything is all right and 
 become negligent in his regard for protection or the safety of his 
 investment. In the smaller communities the positions of trust and 
 responsibility with corporations should fall to reputable citizens who 
 are reliable and may be depended upon in any crisis to safeguard 
 the interests of the laborer and the investor alike. Very seldom do 
 we hear of defalcations in such cases. The larger concerns find it 
 necessary to employ auditors to check up cash receipts and dis- 
 bursements, in fact, at least an annual audit by a disinterested party 
 is now becoming the prevailing custom. 
 
 As already stated, an audit is essential; next for consideration 
 is the essentials of an audit, an audit that will protect the interests 
 involved. 
 
 In the first place it should be conducted as expeditiously as 
 possible to avoid unduly disturbing the regular routine of the work. 
 Sales are regarded as the foundation and the force which moves th^ 
 wheels of any enterprise, therefore they constitute the most im- 
 portant factor as an accruing asset of the business to be dealt with 
 by the auditor. The amount of this accruing asset, or sales, should 
 
 19 
 
first be definitely established. This is a comparatively easy under- 
 taking, where proper sales records are kept, especially where an 
 adding machine is used. Having established the definite amount of 
 sales next for consideration is the amount of cash receipts received 
 from this asset and the open accounts remaining uncollected. 
 
 Marketable goods place a responsibility upon the sales man- 
 ager, while goods parted with, sold to a customer or invoiced and 
 the account placed upon the ledger, place a responsibility upon the 
 treasurer or collector. The treasurer is expected to bring into the 
 business in cash the equivalent for the goods sold. If the sales 
 manager disposed of $7,500 worth of goods in a day and the treas- 
 urer received from the different customers remittances amounting 
 to $5,000 and there were $2,500 worth of accounts uncollected the 
 business might properly regard its interests protected. The treas- 
 urer can vouch for his cash receipts by depositing the funds in the 
 bank and taking the pass book entries as receipt therefor. 
 
 The company itself, as far as the protection of its interests is 
 concerned, cares to pay little or no attention to the manner or 
 methods of making the collections, its interest lying in the actual 
 cash returns. The customers may be relied upon to see that the 
 goods are properly invoiced and that they receive proper credit for 
 remittances, since they would neither allow themselves to be over- 
 charged nor would they pay an account a second time. 
 
 In striking a balance between the accruing assets, or sales, and 
 the actual cash receipts and open accounts uncollected a satisfac- 
 tory accounting of the first consideration or essential of an audit 
 is made. When this equilibrium is established it is considered 
 unnecessary for the auditor to examine each individual invoice, 
 although in all cases the billing department of an enterprise is 
 usually the heaviest item in an audit. 
 
 Having received the cash and deposited it in the bank many 
 safeguards are placed around the disbursements, while the treasurer 
 regards the endorsement upon the back of the check as sufficient 
 receipt for the disbursement and evidence of payment. In other 
 words, the closed transactions are the ones which bring the respon- 
 sibilities to the treasurer. His responsibility may be considered 
 two-fold. When the sales manager has created the account by 
 making the sale he is expected to get the return equivalent in cash, 
 and when he has received the cash he is held responsible for a 
 proper accounting thereof. 
 
 20 
 
A special column should appear upon the left-hand or debit 
 side of the cash book in which to enter the amount of all cash 
 receipts from sales. The sales record shows the amount of the 
 accruing assets. It is unnecessary to take the cash balance into 
 consideration in order to prove the reliability or unreliability of 
 the treasurer in his first responsibility. The total sales shown by 
 the sales record minus cash receipts shown by the special column 
 upon the debit side of the cash book must agree with the outstand- 
 ing accounts uncollected upon the ledger. If the sales for the 
 month are $50,000, the treasurer shows bank deposits upon his 
 pass book of the cash receipts from the sales amounting to $40,000 
 and $10,000 in outstanding accounts uncollected it is sufficient that 
 the company's interests are protected. This principle applies to 
 the transactions for one day, one week, one month, six months or 
 one year. This principle is outlined in its simplest form that it 
 may be properly understood. However, explanation is necessary to 
 provide for returned merchandise, unpaid drafts or errors in invoices. 
 
 In speaking of sales, net sales are understood, that is, gross 
 sales less returned merchandise or deductions for errors in invoicing, 
 etc. Cash receipts have reference to net cash receipts irrespective 
 of unpaid drafts, etc. An audit gives protection to the bookkeeper 
 or treasurer, and to the directors and stockholders. 
 
 In supporting the ideas suggested attention is directed to the 
 system of accounting employed by practically all of the railroads 
 of the United States. The ticket agent at each station is supplied 
 with a certain number of tickets, for various destinations. At the 
 end of each month or other specified period the agent is called upon 
 to produce the equivalent in cash for all tickets sold which, added to 
 the value of the tickets on hand unsold, must agree with the value 
 of the tickets originally given to him. The freight agent issues way 
 bills for all shipments outgoing and pros for all shipments incoming. 
 The traveling auditor visits the freight agent at varying intervals 
 unannounced and investigates merely to determine if the freight 
 agent has accounted for in cash the difference between the sum 
 total of the way bills and pros issued and the outstanding accounts 
 for freight charges. 
 
 These remarks are for consideration separate and apart from 
 the instructions for auditing outlined in succeeding pages. 
 
 21 
 
A PRACTICAL SYSTEM OF AUDITING. 
 
 The system of auditing described is designed to cover the fullest 
 requirements of a completed audit showing the progress of the audit 
 step by step, as well as an outline of the many smaller considera- 
 tions incidental to an examination and investigation of the account- 
 ing records of a business. 
 
 THE AUDITOR'S CONTRACT. 
 
 When employing an auditor for the examination and investiga- 
 tion of the accounting records of a business the management should 
 enter into an agreement with the auditor under which he is to carry 
 out certain performances. Unless the contract specifically states the 
 extent to which the auditor shall go in making his investigations an 
 unlimited opportunity for disagreement and dissatisfaction arises 
 because the employer may claim that the auditor was expected to 
 make a comprehensive investigation even to the minutest detail, 
 while the auditor may claim that he was expected to make a general 
 audit without going to the extreme in all cases. 
 
 The contract should also state in what manner the auditor is to 
 be paid for his services, that is, if he shall be paid so much per 
 hour or day for the full amount of time required to complete the 
 audit, or if he shall receive a stipulated sum for the work specified 
 in the contract irrespective of the amount of time required by him 
 to complete it. It is an easy matter for the average employer to 
 overlook the importance of this detail because so few understand 
 the exact nature and extent of the auditor's investigations. 
 
 The contract should also clearly set forth the period to be cov- 
 ered by the auditor in his investigation, that is, if he shall verify 
 the records of transactions as recorded for a period of six months 
 prior to the date upon which the work is commenced or for the 
 previous or current fiscal year of the company's existence, etc. He 
 may be employed for the purpose of making a pay roll audit only; 
 on the other hand his investigation may be confined solely to a 
 verification of the capital stock of a corporation and the number of 
 shares sold, issued, unsubscribed, unissued, shares in the treasury, 
 etc. He may be employed to investigate the nature of a reserve 
 shown upon the balance sheet, that is, he may be expected to deter- 
 
 22 
 
mine to his entire satisfaction if the reserve is an actual available 
 fund or if it is merely a book reserve. 
 
 However, experience has proven that practically all business 
 houses demand a completed audit covering every department of their 
 business involving an examination and investigation of the records 
 affecting all departments, as well as the various forms of records 
 kept in those departments. 
 
 A MEANS OF CO-OPERATION. 
 
 Upon completion of a contract between the employer and the 
 auditor setting forth the details of the performances required to be 
 carried out by the auditor and the agreements made by the employer, 
 both of which are in mutual accord and entirely satisfactory to both 
 parties to the agreement, the auditor is then in a position to take 
 up his work, conducting the investigation personally or through his 
 staff of trained assistants. 
 
 One of the very first things which the auditor should do is to. 
 cultivate the acquaintance of the individual who has been in abso- 
 lute charge of the accounting department of the business and who 
 has been held responsible for a proper record of the transactions of 
 the business during the period which the audit is to cover. The 
 principal purpose of the auditor in forming such an acquaintance is 
 one of profit, since there is no one else who reasonably may be 
 expected to know as much about the transactions of the period in 
 question as the individual in charge of the records. As a matter of 
 fact, the auditor should cultivate his acquaintance with the idea of 
 getting any co-operation which he may need to satisfy himself 
 beyond reasonable doubt that when his work is finished his investi- 
 gation has been thorough and comprehensive, and the results ob- 
 tained correct and according to the actual transactions of the 
 business as made. 
 
 It is in this particular that the auditor is expected to exercise 
 his very best judgment and discretion in order that no misunder- 
 standing shall arise between them which might hinder his making 
 rapid progress in the audit or decrease the value of the results 
 obtained even in the slightest degree. To a certain extent the 
 attitude of the auditor towards this individual may make his work 
 comparatively easy or extremely difficult and unsatisfactory, because 
 un the one hand the co-operation of the individual w r ho has made 
 
 23 
 
 
the records is unquestionably very beneficial, while on the other 
 hand his attitude of antagonism might cause an unlimited amount 
 of trouble. 
 
 The most valuable information sought by the auditor from the 
 individual in charge of the accounting department is a comprehen- 
 sive understanding of the nature of the business, the manner in 
 which the business is conducted, the nature of the transactions, the 
 methods of doing business, the methods employed by the accounting 
 department in recording the transactions and the methods employed 
 by the individuals in all other departments or branches of the busi- 
 ness, particularly the executive end of the work instead of the 
 manufacturing. 
 
 If a completed audit is made the auditor desires to familiarize 
 himself with the methods employed for handling incoming remit- 
 tances and making deposits, disbursements by check and petty cash 
 disbursements, confirmation of orders, invoicing, purchasing, pay 
 roll records, discounting notes or bills, accepting or drawing drafts, 
 taking or allowing discounts, methods of taking inventories, etc. 
 The auditor should also use his best efforts to determine what 
 records are kept of the transactions, that is, the nature of all books 
 used or card index records of any nature, loose leaf methods, etc., 
 voucher checks, purchase orders, acknowledgments, etc. 
 
 BOOKS AND RECORDS FOR INVESTIGATION. 
 
 In the majority of cases the books and records for investigation 
 consist of the cash book, check register or voucher register, petty 
 cash blotter or receipt book, bills receivable record or legister, bills 
 payable record or register, inventory records, purchase record, pur- 
 chase order, sales record containing copies of invoices rendered or 
 sales recapitulation record, confirmation of orders received or ship- 
 ping record, journal for cross, adjusting and closing entries (in 
 some instances a private journal) general or private ledger, (in 
 some instances the general ledger serves also the purpose of the 
 private ledger) purchase ledger, sectionalized sales ledgers, records 
 of returned goods from sales, records of returned goods purchased, 
 system of credit memoranda for rebates, allowances, overcharges, 
 railroad claims, etc., dividend register, corporation record containing 
 minutes of regular and annual meeting of stockholders and directors, 
 "by-laws, subscription records, stock ledger containing accounts with 
 stockholders, etc. 
 
 24 
 
The relative importance of each of the records above mentioned 
 is fully explained in the succeeding pages, containing a compre- 
 hensive outline of a practical system of auditing the books of any 
 individual, partnership, corporation, society or joint stock associa- 
 tion. Briefly stated, the auditor should have access to all books of 
 original entry, that is, those in which the preliminary record of a 
 transaction was first written, those accepted as authority on all 
 questions involved in a transaction or a series of transactions. 
 
 VERIFICATION OF CASH BALANCE. 
 
 As soon as the auditor's contract is satisfactorily completed and 
 the auditor or members of his staff have put forth their best efforts 
 to secure the co-operation of the individual who has been in direct 
 charge of the accounting records of the business about to be audited, 
 and has acquired a general knowledge of the manner in which the 
 business is conducted and the transactions recorded, as well as a 
 complete list of all books of record which will be required during 
 the investigation, they then verify the cash on hand, in the drawer. 
 
 The cash on hand usually consists of two separate funds. The 
 difference between the footings upon the debit side of the cash book 
 or record, showing cash receipts, and the record of bank deposits 
 which usually appears upon the check register shows the amount 
 of cash on hand for deposit. This amount may be in the form of 
 checks, drafts, currency, gold, silver or fractional coin. The auditor 
 then makes a detailed list of the cash on hand in the following 
 manner: 
 
 He makes a record of each check, giving the name of the 
 drawer, and of each draft, followed by the number of each denom- 
 ination of bills, gold, silver or fractional coin, that is, he shows the 
 number of twenty, ten, five, two or one dollar bank notes, the 
 number of double eagles, eagles, five and two and a half dollar gold 
 pieces, the number of dollars, halves, quarters, dimes, nickels and 
 pennies. Extensions are made and the footing taken which shows 
 the total cash on hand for deposit. The balance of cash on hand 
 should agree with the difference between the footings upon the 
 debit side of the cash book showing cash receipts and the footings 
 of the bank deposit record showing total amount deposited. If any 
 discrepancy occurs, whether the cash on hand is in excess of the 
 bialance as shown by the record, or if there is a shortage, the auditor 
 
 25 
 
makes note of this fact, as he will have occasion to further verify 
 the cash transactions as recorded as he proceeds with his audit. 
 
 He then turns to the petty cash fund, which is usually found 
 in every business. He first determines the original amount of the 
 fund and then deducts the amount of the petty cash disbursements 
 as evidenced either by a petty cash blotter or petty cash receipts 
 taken for the several disbursements. The difference between the 
 amount of the original fund and the disbursements gives the amount 
 of petty cash which should be on hand. The auditor then makes a 
 list of the petty cash showing the number of each denomination of 
 bills, gold, silver and fractional coin, making extensions and taking 
 the total verifying the amount of actual petty cash on hand as shown 
 by his list with the amount that there is supposed to be on hand, 
 According to the petty cash record. If there is any shortage the 
 auditor makes note of the fact. If, for any reason, there is more 
 cash on hand than is called for by the record he also makes note 
 thereof, as the bookkeeper or cashier may have made an error in 
 his favor in handling the money. 
 
 VERIFICATION OF THE BANK BALANCE. 
 
 In verifying the bank balance the auditor secures from each 
 bank with which the company transacts business a certificate show- 
 ing the balance on deposit to the credit of the company at the close 
 of the period the audit covers according to his contract. Each bank 
 should also be required to certify to a record of all notes which 
 they have discounted for the company which they are holding as 
 collateral security on loans and any liability of the company known 
 to the bank by reason of the company's having endorsed notes for 
 anyone else which thus become a contingent liability of the business. 
 
 A reconciliation of the bank balance at the date upon which 
 the audit closes naturally includes a record of all deposits made 
 during the period, a record of all checks issued, paid and returned to 
 the company and the final statement showing the numbers and 
 amounts of all checks issued, outstanding and unpaid. The differ- 
 ence between the bank balance as shown by the certificate furnished 
 by the bank and the amount of outstanding checks unpaid should 
 agree with the bank balance shown by the check book stub or check 
 register. 
 
 The auditor should bear in mind that the majority of large busi- 
 ness houses of the present day carry accounts with two or more 
 
 26 
 
banks, making it necessary for him to secure a certificate from each 
 one setting forth the information above specified and requiring a 
 reconciliation of the balance at the bank. 
 
 TRIAL BALANCE. 
 
 Having verified the balance of cash on hand, petty cash and 
 effected a reconciliation of the bank balance, the auditor then takes 
 a trial balance from the books as of the date upon which the audit 
 period closes. If a trial balance is already taken he obtains the 
 same result by checking the items appearing upon it with the bal- 
 ance of the accounts listed to prove the equilibrium of the ledger. 
 
 VERIFICATION OF FOOTINGS. 
 
 It is the duty of the auditor to verify the footings appearing 
 in all books of record, especially those records involving cash trans- 
 actions. In conducting an audit it is understood that the auditor's 
 : nvestigations and responsibilities apply wholly within the period 
 covered by the audit according to contract, unless the condition in 
 which he finds the records necessitates his investigating previous 
 records for the purpose of arriving at the proper and correct results. 
 
 In verifying the footings of the different records, such as the 
 cash book, check register, journal, purchase record, sales record or 
 recapitulation, bills receivable and bills payable record, etc., he finds 
 it necessary to add the amounts entered in the special columns for 
 each month. This process is necessary that he may guarantee that 
 the footings as shown are correct and that the bookkeeper has made 
 no errors in addition. Further reason for a verification of the foot- 
 ings is evidenced by an explanation of a verification of the postings 
 to the private ledger. Errors frequently occur in transferring foot- 
 ings from one page to another. 
 
 VERIFICATION OF POSTINGS TO PRIVATE LEDGER. 
 
 The private and general ledger, which are sometimes identical, 
 customarily contain controlling accounts with cash, purchase ledger, 
 sectionalized sales ledgers, bills receivable, bills payable, personal 
 accounts with officers, salary accounts, expense controlling accounts, 
 etc. Postings are made to these accounts direct from the footings 
 of the special columns in the cash book, journal and purchase and 
 sales records monthly. 
 
 27 
 
In verifying the postings to the private ledger the auditor 
 checks the amount of the footings of the special columns with the 
 entries made in the controlling accounts. He first verifies the post- 
 ings from the cash book, which are usually made to the cash account, 
 interest account, discount account, bills receivable account, accounts 
 receivable account, etc. He then verifies the postings to the private 
 ledger accounts from the check register, especially postings to the 
 bank account, discount account, interest account, bills payable 
 account, accounts payable account, etc. He then verifies the post- 
 lings to the private ledger acounts from the journal covering various 
 sundry and nominal accounts used when making cross, adjusting 
 and closing entries. He then verifies the postings as made from 
 any of the other records, such as purchases, sales, etc. 
 
 It is readily seen that his work thus far produces the follow- 
 ing result: A verification of the cash on hand, petty cash and 
 reconciliation of the bank account. By verifying the footings of 
 the various books of original entry and checking the postings of 
 those footings to the respective controlling accounts in the private 
 ledger he knows that the controlling accounts are correct except 
 for whatever adjustment may be necessary when his work of check- 
 ing progresses and the audit nears completion. 
 
 VERIFICATION OF TRIAL BALANCE. 
 
 In verifying the footings of the books of original entry and 
 checking postings to the private ledger controlling accounts the 
 auditor may find errors for adjustment or he may find the work 
 has been done accurately. However, he proceeds to verify the trial 
 balance taken after proving the cash and reconciling the bank bal- 
 ance. If the work has been done accurately there should be no 
 difficulty whatever in checking up the trial balance, but if errors 
 have been made and the bookkeeper has forced his trial balance the 
 auditor makes note of all differences that they may be properly 
 adjusted, so that his final report may contain a true statement of 
 the condition of the business upon the date on which the audit 
 period closes. 
 
 It is sometimes necessary for him to obtain a copy oi the trial 
 balance for the fiscal year, or other business period immediately 
 preceding the date upon which his audit period commences, in fact, 
 this is oftentimes essential in order that he may get correct results. 
 
 28 
 
VERIFICATION OF POSTINGS CASH RECEIPTS. 
 
 A completed audit involves a careful and systematic checking of 
 each and every individual cash transaction during the period under 
 audit. The cash receipts vary in nature from payments of subscrip- 
 tions for capital stock of the original issue, from the sales of treasury 
 stock, and the sale of capital resources to the regular revenue re- 
 ceipts derived from the sales of the product of the enterprise. 
 
 If the stock of a corporation is sold above par the company 
 receives actual cash in excess of the par value of the stock, when 
 the premium thus obtained is not considered a gain of the business 
 proper, and although in some instances it is carried directly to profit 
 and loss the practice in this respect varies considerably in the 
 manner of conducting the accounts. 
 
 If the business under audit is not comparatively new and has 
 been conducted for a considerable period of time practically all of 
 its revenue is derived from the sale of its product of whatever form. 
 In other words, practically all of the receipts will come in the form 
 of remittances from customers, therefore but very few postings of 
 individual amounts are made from the cash book direct to controll- 
 ing accounts in the private ledger, the majority of all individual 
 postings being made directly to accounts with customers in the 
 sectionalized sales ledgers. 
 
 Where sectionalized sales ledgers are used special columns 
 appear on the debit side of the cash book to permit a verification of 
 postings to each ledger separately. In a complete audit the auditor 
 is expected to check each individual remittance received from cus- 
 tomers, from sale of stock or property, etc., to the account in the 
 private ledger or in the sectionalized sales ledger to which it is 
 posted. The aggregate of all postings to the private and section- 
 alized sales ledgers from the cash book should agree with the total 
 cash receipts for the period under audit. 
 
 A question immediately arises with regard to the manner of 
 making postings to the sales ledger, that is, if the amount of the 
 remittance is posted in one item and the amount of the discount 
 upon the invoice taken by the customer is posted in another item. 
 It is recommended that the posting to the sales ledger account shall 
 be an amount equal to the sum of the actual remittance received plus 
 the discount deducted, in which case the aggregate of all postings 
 from the debit side of the cash book to the private ledger and sec- 
 
 29 
 
tionalized sales ledgers should agree with the total cash receipts as 
 shown by the cash book for the period under audit plus the discounts 
 allowed to customers during the same period. 
 
 It is suggested that in checking the work the auditor use some 
 distinguished check mark so that by referring to an account in any 
 of the sectionalized sales ledgers 'he can readily determine whether 
 a posting consists of cash or of cash and discount, also that the 
 posting is made from the cash book, as distinguished from journal 
 postings. 
 
 The auditor should always recommend to any company that 
 their entire cash receipts be deposited in the bank and that all dis- 
 bursements of whatever nature be made by check, even those made 
 from the petty cash, a voucher being drawn for the original sum. 
 Where this system is used the total cash receipts for the audit period 
 should agree with the total deposits for the same period, allowance 
 being made for cash on hand at the commencement of the period, 
 also at the end of the period, that is, the cash on hand at the com- 
 mencement of the period added to the total cash receipts during the 
 period, less cash on hand at the close of the period should agree 
 with the total deposits shown by the bank pass book or statement. 
 This plan is equally simple and effective whether deposits are made 
 in one, two or any number of banks. 
 
 VERIFICATION OF POSTINGS CASH DISBURSEMENTS. 
 
 A complete audit involves a careful and systematic checking of 
 each individual transaction involving a disbursement of cash. The 
 majority of business houses are now taking advantage of the sim- 
 plicity, effectiveness and convenience of a check register for record- 
 ing their disbursements. In nearly every case a general plan is 
 adopted under which each disbursement is made by check, except in 
 the case of sundry disbursements of petty cash for which receipts 
 are taken. 
 
 The check register shows upon the one side a record of bank 
 deposits which should agree with the record of deposits entered in 
 the bank pass book, duplicate deposit tickets or statements, and 
 upon the other side a record of all checks issued listed in numerical 
 order. The number of each check is given, in whose favor it is 
 drawn and the account to be charged. Charges are made to accounts 
 payable and to controlling accounts in the private ledger, as well as 
 
 30 
 
personal accounts with officers on account of salaries, etc. Postings 
 to accounts payable and private ledger accounts are distinguished by 
 separate columns. Additional columns appear in which to enter the 
 amounts of discounts upon purchases. 
 
 The auditor is expected to check each individual amount posted 
 to the accounts payable account in the purchase or accounts payable 
 ledger. In checking these postings he should use some distinguish- 
 ing mark, so that in referring to the accounts payable ledger he can 
 readily tell which of the debit amounts posted to an account repre- 
 sent cash payments and which are postings from the journal because 
 of any adjustment or rebate or allowance for returned goods. 
 
 It is readily seen that the sum total of all of the postings to the 
 accounts payable ledger for the audit period should agree with the 
 total cash disbursements to creditors whose accounts are carried in 
 the purchase or accounts payable ledger for the same period. 
 
 The question immediately arises relative to discounts earned. 
 It is recommended that postings to the purchase ledger be made in 
 single amounts, that is, that the cash disbursements shall not be 
 posted separately from the discounts earned. The auditor then finds 
 that in order to check the disbursements he must effect an agree- 
 ment between the accounts payable and discount column in the 
 check register and the total postings therefrom to the accounts with 
 creditors in the purchase or accounts payable ledger. 
 
 It is suggested that he use a distinguishing check mark for 
 discriminating between postings representing cash only and those 
 made up of cash and discount. He should then effect an agreement 
 between the total disbursements posted to accounts in the private 
 ledger and the amounts posted to the debit side of the private ledger 
 accounts from the check register. After verifying all of the postings 
 from the check register to the accounts payable and private ledgers 
 the auditor should make a statement for his own information show- 
 ing that the total disbursements per checks issued and recorded in 
 the check register during the audit period agree with the total post- 
 ings to cash and discount to the accounts payable ledger and debit 
 postings from the check register to the accounts in the private 
 ledger. 
 
 VERIFICATION OF PURCHASES DISTRIBUTION. 
 
 A comprehensive audit involves a careful and systematic check- 
 ing of each and every invoice received by the business for goods 
 
 31 
 
purchased and received during the audit period, that is, each invoice 
 is compared with the entries recorded upon the purchase record, 
 journal or factory voucher register in order that the auditor may 
 know that the goods covered by each invoice have been charged to 
 the proper accounts. This prevents an invoice of goods covering 
 sundry supplies of an expense nature being charged to a property or 
 asset account, or vice versa. In some instances the purchase invoices 
 are checked against the original purchase orders or quotations, but 
 this is not as essential as checking sales invoices against the shipping 
 record. 
 
 Where a large number of invoices are received daily, weekly or 
 monthly the majority of business houses employ a system of number- 
 ing in numerical sequence. As many invoices from each creditor as 
 can be conveniently assembled and entered upon the purchase record 
 are numbered in order before recording. When the invoices are 
 paid they are usually filed either by number or by the name of the 
 creditor. If by number it is a comparatively easy matter for the 
 auditor to check the invoices against the purchase record. If filed 
 under the name of the creditor the process is more difficult, although 
 no great amount of time is lost because the invoices for each creditor 
 are filed in both chronological order and numerical sequence. 
 
 VERIFICATION OF POSTINGS PURCHASE INVOICES. 
 
 When the auditor has completed checking the invoices against 
 the purchase record and is, therefore, positive that the amounts of 
 the various invoices as entered upon the purchase record are correct 
 and that the goods covered by the invoices have been distributed or 
 charged to the proper accounts, he then undertakes a careful and 
 systematic checking of the postings from the purchase record to the 
 accounts with creditors in the purchase or accounts payable ledger. 
 When he has checked each posting to the credit side of the accounts 
 payable accounts he should effect an agreement between the total 
 amount of all of the invoices recorded in the purchase record during 
 the audit period. The total purchases for the audit period as shown 
 are a credit to the accounts payable controlling account. The foot- 
 ings of the special columns of the purchase ledger have already been 
 verified, as well as the postings thereof to the accounts with materials 
 purchased, which are sometimes carried in a separate stores ledger, 
 although frequently made a part of the purchase ledger. 
 
 32 
 
TRIAL BALANCE OF PURCHASE LEDGER ACCOUNTS. 
 
 The progress made by the auditor in his investigations up to 
 this point has involved careful and systematic checking of the post- 
 ings to the purchase ledger covering invoices credited to the parties 
 from whom the goods are purchased, postings from the cash book 
 to the debit side of accounts with creditors covering cash disburse- 
 ments and discounts earned and postings from the journal to the 
 debit and credit sides of the accounts for sundry adjustments, re- 
 bates, allowances for returned goods, overcharges, etc. He has also 
 verified the footings in the check register, purchase record and 
 journal, as well as having made a verification of the postings from 
 these records to the accounts payable controlling account in the 
 private ledger. 
 
 He has now brought his work up to the point where he is in a 
 position to take a trial balance of the accounts in the purchase ledger 
 to effect an agreement between the aggregate balances of the pur- 
 chase ledger accounts and the balance of the corresponding accounts 
 payable controlling account in the private ledger. If the auditor has 
 done his work thoroughly and accurately the agreement mentioned 
 should readily be made, taking into consideration, of course, all 
 notations made by him during his investigation of the purchases 
 and cash disbursements for errors, etc. In other words, the total 
 credits to accounts with creditors for goods purchased, less remit- 
 tances made to them, discounts earned, allowances for returned goods 
 or deductions of any other nature should agree with the balance of 
 the accounts payable controlling account, which shows the amount 
 still owing to creditors for goods purchased. 
 
 VERIFICATION OF SALES CLASSIFICATION. 
 
 In fulfilling his responsibilities under a complete audit the 
 auditor is expected to carefully and systematically check each invoice 
 rendered to customers for goods sold, making comparison of the 
 amount appearing upon the manifold copy of the invoice or other 
 form of copy with the corresponding amount entered upon the sales 
 recapitulation sheet. Another very important matter is the check- 
 ing of sales invoices against the shipping record to make certain 
 that no goods have been shipped out without proper invoice having 
 been rendered therefor. 
 
 33 
 
The majority of business houses now use the manifold billing 
 system and the auditor will invariably find the manifold copies of 
 the invoice in a binder arranged in chronological and numerical 
 order. If a recapitulation has not been made the auditor should pro- 
 ceed to make a recapitulation of the sales for the entire audit period 
 upon a monthly basis. It is not considered the duty of the auditor 
 to make a comprehensive analysis of the sales according to their 
 nature, although if the business is using a sales recapitulation which 
 shows a classification of sales and this classification is to have any 
 important bearing upon the final statements to be prepared and sub- 
 mitted by the auditor then he should check the sales invoices with 
 the recapitulation sheets for the purpose of not only verifying the 
 amount of the invoices proper, but for verifying the classification or 
 distribution. 
 
 Upon completion of the recapitulation of sales by months the 
 auditor should verify the postings of the amount of sales for the 
 various months with the corresponding amounts entered to the debit 
 of the accounts receivable controlling account in the private ledger. 
 The amount is also credited to an account with sales. 
 
 VERIFICATION OF POSTINGS SALES INVOICES. 
 
 A comprehensive audit involves a careful and systematic check- 
 ing of the amounts of all invoices as entered upon the recapitulation 
 of sales for the different months, the corresponding amounts posted 
 to the debit of the accounts receivable accounts in the sectionalized 
 ledgers. 
 
 Where sectionalized ledgers are used the sales recapitulation 
 contains special columns corresponding with the different sales 
 ledgers in order that postings to each ledger may be proven separ- 
 ately. When the auditor has checked each indiviuai posting from 
 the recapitulation of sales to the accounts in the sales ledgers he 
 should then effect an agreement between the total sales for the audit 
 period, the customers whose accounts are carried in one of the sales 
 ledgers and the total debit postings to their accounts from the sales 
 record. The same agreement is effected in the same manner for 
 each of the sectionaldzed sales ledgers, while the aggregate sales 
 of the entire business for the audit period should agree with the 
 aggregate of all sales postings to customers' accounts for all of the 
 sales ledgers for the same period. 
 
 34 
 

 It is suggested that the auditor should use some distinguishing 
 check mark when verifying postings from the sales records to the 
 accounts receivable accounts that he may know in referring to the 
 sales ledger which of the debit postings are made from the sales 
 records and which come from the journal because of any adjustment. 
 
 TRIAL BALANCE OF SALES LEDGER ACCOUNTS. 
 
 The progress of the auditor in making his investigation up to 
 this point has involved a careful and systematic checking of the 
 postings to the accounts receivable accounts from the sales recapitu- 
 lation, from the cash book showing credits for cash remittances 
 received and discounts allowed, and from the journal for returned 
 goods, allowances, rebates and adjustments. The footings of the 
 various records affecting sales have been verified and a verification 
 of postings of these amounts to the controlling accounts in the 
 private ledger completed. 
 
 He is now in a position to take a trial balance of the sales 
 ledger accounts to see if the aggregate of the balances of the accounts 
 receivable in the sales ledger agree with the aggregate balance of 
 the corresponding sales ledger controlling account in the private 
 ledger. If he has done his work thoroughly and accurately he should 
 have no difficulty in effecting this agreement, taking into considera- 
 tion, of course, all notations made by him for errors discovered 
 during his investigation. In other words, the total debits to cus- 
 tomers for goods sold, less cash remittances received from them, 
 discounts allowed, allowance for returned goods and other deduc- 
 tions of whatever nature, should agree with the balance of the sales 
 ledger controlling account which shows the amount the customers 
 still owe for goods furnished. 
 
 VERIFICATION OF INVOICES WITH SHIPMENTS. 
 
 There is one opportunity in connection with an audit outside 
 of the verification of cash where the auditor may prove his services 
 to the company worth many times the amount he is to receive for 
 his work according to his contract. This opportunity lies in a com- 
 parison of the record of shipments with the invoices rendered. 
 
 It is not unusual for an auditor to discover shipments made to 
 customers for which no bill is rendered. To prevent the shipment 
 of goods without proper invoicing the auditor should carefully and 
 
 35 
 
systematically check each invoice rendered during the audit period 
 against the copy of the confirmation of the order mailed to the 
 customer when his order is received. 
 
 In the majority of businesses at the present time there is an 
 established custom of confirming or acknowledging orders for goods, 
 the confirmation or acknowledgment also stating when delivery may 
 be expected. It is against this acknowledgment or confirmation that 
 the auditor checks the invoice. Wherever a system of acknowledg- 
 ments or confirmations is not used the business invariably uses a 
 manifold system of recording shipments, that is, whenever a ship- 
 ment of goods is made to a customer a number is assigned to the 
 shipment and a list of all of the goods contained in the shipment 
 stated upon this shipping record. The manifold blanks bear con- 
 secutive numbering. 
 
 Where this system is employed and proper discretion used it is 
 practically impossible for the shipping department to ship out a bill 
 of goods without making a proper shipping record therefor. The 
 auditor obtains satisfactory results by making a comparison of the 
 sales invoice rendered with this manifold shipping record. In other 
 words, his audit of this particular item for investigation involves 
 checking the sales invoice against the acknowledgment or confirma- 
 tion of the order or the manifold copy of the shipping record. 
 
 TRIAL BALANCES OF SUBSIDIARY LEDGERS. 
 
 Not infrequently the auditor will find in use several subsidiary 
 ledgers in addition to the purchase, sales and private ledgers, con- 
 trolling accounts with which will be carried in the latter. After 
 proper verification of the footings and postings to the various 
 accounts in the subsidiary ledger the auditor then proceeds to take 
 a trial balance of the accounts in each subsidiary ledger to effect an 
 agreement between the aggregate balances of such accounts and the 
 balance of the corresponding controlling account in the private 
 ledger. The same method is followed out as outlined for taking a 
 trial balance from the purchase and sales ledgers. 
 
 VERIFICATION OF INVENTORY. 
 
 In order that the work of the auditor may be accurate and thor- 
 ough it is necessary that he be given an opportunity to audit the 
 record of the inventory taken at the close of the period under audit. 
 
 36 
 
He should also have a record of the inventory taken at the com- 
 mencement of the period under audit. It is regarded as the duty of 
 the auditor to verify the inventory extensions. He should also 
 inspect the stock listed on the inventory record to see that the values 
 are not fictitious or inflated, briefly, to satisfy himself beyond all 
 reasonable doubt that the inventory as furnished to him is approxi- 
 mately correct. 
 
 The inventory audit should not only call for a thorough inven- 
 tory record, a verification of extensions, a footing of the entire 
 inventory, an inspection of the stock, a verification of quantities 
 wherever possible, but a careful comparison of the prices of the 
 various articles as listed upon the inventory with the prices paid 
 for those articles by the company, according to purchase invoices 
 covering the same. This comparison of the inventory prices with 
 the prices upon the original invoices should convince the auditor 
 that the inventory as calculated contains no fictitious or inflated 
 prices. 
 
 Notwithstanding this opportunity for verifying the inventory it 
 is considered an excellent policy for the auditor to secure from the 
 secretary of the company, or from some other official with proper 
 authority, a certificate specifically stating that the prices used in 
 making the inventory calculations are correct. Such a certificate 
 shifts the responsibility of the values shown from the auditor to the 
 company itself, while the auditor's responsibility lies in a correct 
 calculation of the extensions and verification of the total. 
 
 Even though the certificate mentioned is secured it is not suf- 
 ficient reason to cause the auditor to neglect a thorough investiga- 
 tion of the inventory, as there are many instances where the secre- 
 tary or other official has certified to incorrect valuations, in conse- 
 quence of which the final report prepared and submitted by the 
 auditor to the board of directors has been inaccurate and misleading. 
 
 AUDITING PAY ROLL. 
 
 The exact nature of the pay roll audit depends largely upon 
 the agreements set forth in the auditor's contract pertaining thereto. 
 Where no special stipulations are made it is customarily understood 
 that the pay roll audit consists in a verification of the labor expen- 
 diture for the last pay roll date. The auditor calls for the last com- 
 plete pay roll and checks the time clock cards of the various work- 
 
 37 
 
men employed upon a day wage basis against the entries recorded 
 upon the pay roll record. Piece workers are usually required to sign 
 proper receipts for their pay which they are obliged to surrender 
 before their envelope is handed to them. These receipts are checked 
 against the pay roll record for verifying the labor expenditure for 
 piece workers; employes working under bonus systems and profit 
 sharing plans, etc. Briefly stated, a verification of the last pay roll 
 preceding the date upon which the audit under consideration closes 
 consists of checking bona fide receipts of the employes against the 
 entries recorded upon the pay roll record. The auditor is expected 
 to exercise reasonable care and judgment to detect "dead men" 
 sometimes carried upon pay rolls, and to conduct his investigation 
 in such a manner that he can certify that a proper receipt has been 
 taken from each workman for the money paid out, and that the re- 
 ceipts examined and approved are genuine. Absolute certainty in 
 this respect guarantees proper voucher for the pay roll expenditure, 
 preventing the carrying of fictitious names upon the records and the 
 falsification of receipts. 
 
 In some instances the auditor's contract calls for a comprehen- 
 sive investigation of all the pay rolls during the period under audit 
 and an exhaustive analysis of the labor expenditure. The process 
 of verification follows closely the outline used for checking up the 
 last pay roll, it being understood that the auditor pays no attention 
 to accuracy of the pay roll calculations with respect to the hours, 
 rates and amounts or in piece work the number of pieces and rates 
 per piece or bonuses and division of profits, it is considered suffici- 
 ent for him to merely verify the entries upon the pay roll record. 
 
 A proper analysis of the labor expenditure consists in its class- 
 ification under the headings, Productive, Non-Productive, Construc- 
 tion, Maintenance, Experimental, etc., as well as a departmental 
 distribution. In a completed audit it is seldom that any attention 
 is given to any of the pay rolls except the last and usually a labor 
 analysis is not required. It is well for the auditor to carefully 
 glance through the preceding pay rolls as he might notice some irreg- 
 ularity which would form the basis of comment in his final report. 
 The permanent auditor employed by a business for making a con- 
 tinuous audit is expected to have all pay roll expenditures properly 
 vouched for by genuine receipts and to make a proper analysis and 
 classification departmentally and under the headings above men- 
 tioned. 
 
 38 
 
STATEMENT OF BILLS RECEIVABLE. 
 
 In many lines of business the bills receivable controlling ac- 
 count in the private ledger requires considerable time for its proper 
 analysis. The balance of this account represents the amount of bills 
 receivable held by a business, and in this connection the auditor 
 should exercise his best judgment in determining the extent of the 
 liability of the business for bills receivable discounted, deposited as 
 collateral security, etc. It has already been stated that he requests 
 of each bank with whom accounts are carried statements showing 
 the contingent liability of the business for notes discounted, still 
 unpaid. 
 
 The statement of bills receivable as prepared by the auditor 
 shows a history of each note, proper calculations being made for in- 
 terest accumulations. Each note is usually assigned a number as 
 a means of identification. The auditor's statement shows the num- 
 ber, date of the paper, name of the maker with address, where it is 
 made payable, the names and addresses of any endorsers, length of 
 time the note is to run, date upon which it matures, amount of the 
 note, if interest bearing the rate per cent, the amount of accrued 
 interest and any other information of a special nature. Occasionally 
 the auditor finds that some of the notes have already been forwarded 
 for collection and he includes these in his report with proper nota- 
 tion, his record thereof being made as complete as possible from 
 information recorded upon the bills receivable record. 
 
 He may also discover that some of the notes have been depos- 
 ited as collateral security, and that bills payable have been issued 
 for the money borrowed upon them. Unless the interest has been 
 paid in advance upon the money borrowed he will have to calculate 
 the accrued interest due the bank, if it has been paid in advance 
 there may be quite an item of interest paid but unearned. Separate 
 statements are prepared for bills receivable current and bills receiv- 
 able past due. When the auditor's statements are complete the 
 total amount of bills receivable current added to the bills receiv- 
 able past due as shown thereon should agree with the balance of 
 the bills receivable controlling account in the private ledger. 
 
 STATEMENT OF BILLS PAYABLE. 
 
 The balance of the bills payable controlling account in the 
 private ledger shows the amount of bills payable issued by a busi- 
 
 39 
 
ness outstanding and unpaid. In presenting a statement of bills 
 payable the auditor shows the number, date of the paper, name of 
 the payee with address, where it is made payable, name of endorsers 
 if any, length of time it is to run, date of maturity, amount of note, 
 rate per cent of interest if interest bearing, the amount of accrued 
 interest and any other special information. When his statement is 
 completed the total amount of bills payable outstanding as shown 
 therein agrees with the balance of the bills payable controlling 
 account in the private ledger. Proper mention should be made of 
 accumulated interest due and the amount incorporated in the bal- 
 ance sheet as a liability of the business. 
 
 EXHIBIT OF LAST OFFICE PAY ROLL. 
 
 The auditor incorporates in his statements a copy of the last 
 office pay roll for the purpose of showing the amounts of the sal- 
 aries drawn by the officers of the company, the manager, superin- 
 tendent, and other officials engaged in the administration of the com- 
 pany's affairs. 
 
 Access is permitted to the record of minutes of the meetings 
 of the directors, and the auditor should peruse these carefully to 
 ascertain that the salaries drawn by the officers are authorized by a 
 vote or by votes of the Board of Directors. In the event of any 
 officer drawing a salary more than the sum authorized for payment 
 proper comment should be made. 
 
 TRIAL BALANCE FROM STOCK LEDGER. 
 
 The stock ledger shares minute investigation with all of the 
 other important records of a corporation during the auditor's work. 
 In the majority of instances even the smallest corporation will keep 
 a stock or shareholders' ledger containing accounts with stockhold- 
 ers. Where a separate ledger is not used for this purpose the ledger 
 record usually appears in a standard form of corporation record 
 commonly used by small corporations. A corporation record gen- 
 erally contains blank records of minutes of the first meeting of the 
 stockholders, first meeting of the directors, by-laws, regular meetings 
 of stockholders and directors, stock subscription register, stock led- 
 ger of original certificates issued, stock ledger of re-issue certificates, 
 dividend register, stock certificate transfer register, etc., etc. 
 
 A separate stock ledger as used for large corporations having 
 
 40 
 
several thousand stockholders is balanced in the same manner as the 
 ledger section of a corporation record. An account is carried in the 
 ledger with each stockholder showing the number of shares of stock 
 of record upon the books of the corporation issued in the name of 
 the stockholder. The account is debited with the number of shares 
 held and credited with the number of shares sold or transferred to 
 any one else. Postings to the debit side of the accounts are made 
 direct from the stubs of the stock certificate books. On the credit 
 side of the stock ledger appears a credit to an account with capital 
 stock which represents the total number of shares of authorized cap- 
 ital. If all of the stock is subscribed and issued, the sum total of 
 all debits to the accounts with stockholders agrees with the credit 
 to the capital stock account. In the event of only a part of the stock 
 being subscribed and issued leaving a balance of shares in the 
 treasury a debit to an account with treasury stock appears in the 
 stock ledger, then the number of treasury shares must be added to 
 the total shares debited to the stockholders in order to effect a 
 trial balance of the stock ledger. 
 
 It is explained that postings to the stockholders accounts are 
 made from the stubs of the stock certificate book. Upon the can- 
 cellation of any certificate for the transfer of stock a new certificate 
 is issued in its place, the old certificate being attached or pasted to 
 the original stub from which it was detached. Thus it is seen that 
 the total number of shares as represented by the sum of all shares 
 shown upon the stock certificate stubs from which the certificates 
 have been detached and issued agrees with the total shares outstand- 
 ing as shown by the total debits to accounts with stockholders in 
 the stock ledger. It is regarded the duty of the auditor to check 
 the number of shares as shown upon these stubs against the corre- 
 sponding entries upon the ledger. In a measure this prevents the 
 issue of shares in excess of the authorized capitalization. Proper 
 investigation of the dividend account and preparation of the divi- 
 dend statement coupled with the trial balance taken from the stock 
 ledger is considered sufficient evidence that the accounts with shares 
 of capital stock are regular. 
 
 VERIFYING DIVIDEND ACCOUNT. 
 
 The auditor is expected to check the dividend account and pre- 
 sent a statement in detail of all dividends declared and paid during 
 the period covered by the audit. His statement shows the number 
 
 41 
 
of shares of stock outstanding and the dividend rate percent as well 
 as the amount of the total dividends paid. Special dividend checks 
 are generally use instead of the regular check of the corporation. 
 Each dividend declared is assigned a number consecutively, there 
 being printed upon the special checks the following: "Dividend No. 
 21" etc. The auditor should total all checks for each dividend to 
 make certain that the dividend actually paid corresponds with the 
 entries appearing upon the records and to verify the amount of out- 
 standing dividend checks unpaid, if any, which are liabilities of the 
 business. 
 
 A proper audit of the business will serve to safeguard the in- 
 terests of the business against any dividend being declared out of 
 capital instead of earnings. The latter procedure is illegal, and the 
 directors may personally be held liable for any dividend so declared 
 since they are expected to pursue a reasonable and proper course to 
 ascertain if sufficient actual profit has been made to warrant a divi- 
 dend before passing a resolution declaring one and authorizing the 
 treasurer to pay the same out of the funds of the company. 
 
 TRIAL BALANCE FROM PRIVATE LEDGER. 
 
 After having carefully carried out the plan of auditing outlined 
 in the preceding pages the auditor will have practically completed 
 his work of investigation and be prepared to present accurate state- 
 ments showing the actual condition of the affairs of the company 
 and make such recommendations as in his best judgment he deems 
 advisable and necessary for simplifying the methods of handling the 
 work and making more efficient the accounting records. 
 
 The first step is the taking of a trial balance from the private 
 ledger after all accounts therein have been properly investigated, 
 and their accuracy proven. The details of this trial balance will 
 vary according to the custom of the management in keeping their 
 private ledger. Custom now prevails making it advisable to carry 
 in the private ledger controlling accounts with the subsidiary led- 
 gers, sales, purchases, expenses, etc., and in some instances a con- 
 trolling account with what is termed a General Ledger, although 
 the latter is frequently identical with the private ledger. 
 
 ADJUSTING ENTRIES. 
 
 A few words of explanation regarding adjusting entries may 
 serve to aid in giving an exact outline of the duties of the auditor. 
 
 42 
 
As the work progresses he finds errors in addition, postings made to 
 wrong accounts, incorrect distribution of purchases or analysis of 
 sales, etc. It is evident that where numerous errors occur the books, 
 even though they are in balance, do not present a correct record of 
 the transactions made, nor does the balance sheet exhibit a true 
 condition of the affairs of the company. As each error is discovered 
 the auditor makes a correcting journal entry giving an explanation 
 and referring to the record and page upon which it occurs. If a 
 very extensive audit is undertaken and the books have been kept 
 by an incompetent individual it is not uncommon for the auditor to 
 discover scores of errors, and in some instances they have been 
 known to number into the hundreds. 
 
 Although the auditor submits with his final report a list of all 
 adjusting entries necessary to place the books in proper shape he is 
 not expected to actually make the entries upon the books. This is 
 left to the individual responsible for their proper keeping. However, 
 in presenting trading and profit and loss statements and a balance 
 sheet he must take into consideration all adjustments covered by 
 the entries, otherwise 'his final statement would not be correct. It 
 is suggested that the auditor make considerable comment upon the 
 adjusting entries, if they are numerous, and in any event give them 
 the attention in his report which they deserve. His comment should 
 not only cover the extent of the errors discovered, but the nature 
 of them as well. Some of them may have been committed inten- 
 tionally, while others were due to negligence, carelessness or proper 
 lack of interest in the work. 
 
 There is one criticism which may be made by the auditor affect- 
 ing arbitrary entries. Often times a book-keeper during the course 
 of his work will discover that he has posted an item to the wrong 
 account, and to correct the matter, merely makes a posting of the 
 same amount under the same date on the opposite side of the ac- 
 count and then posts the item to the proper side of the right account 
 without going to what he may consider the "trouble" of making a 
 cross entry in 'his journal. It is one of the first principles of account- 
 ing that no entry shall be posted upon any record except from some 
 record of original entry. Arbitrary entries result in endless con- 
 fusion making it almost impossible for an auditor, or anyone else, 
 to affect an agreement between sales and postings to accounts with 
 customers in sectionalized sales ledgers, etc. 
 
 43 
 
PRESENTATION OF TRADING STATEMENT. 
 
 A trading statement is prepared in the proper manner for the 
 purpose of showing the gross profit of the business for the audit 
 period. The preparation of a trading statement involves an exact 
 knowledge of the following facts : 
 
 Amount of inventory at commencement of audit period. 
 
 Purchases made during the period less all returns and al- 
 lowances of any nature. 
 
 Productive labor. 
 
 Manufacturing and other trading expenses. 
 
 In-freight and drayage. 
 
 Proportion team expense for hauling goods purchased. 
 
 Sales made during period covered by the audit less returns 
 and allowances of any nature. 
 
 Amount of inventory at close of the period. 
 
 In speaking of "sales" it is understood that this item covers 
 the sales properly invoiced and charged to customers, orders on hand 
 unfilled are not included. 
 
 After determining the amount of the gross profit for the period, 
 which is the difference between the net sales and the cost of getting 
 the goods into a marketable condition, the auditor should calculate 
 the ratio of percentage between the gross profit and the net sales. 
 That is, if the gross profit is $10,000 and the sales amount to $100,- 
 000, the ratio is a ten percent profit on the net sales. He then estab- 
 lishes in similar manner a ratio between the gross profit and the 
 turnover, a term used to represent the cost of getting the goods into 
 a marketable condition. It is unnecessary to prepare a statement of 
 turnover as the trading statement suffices although if such a state- 
 ment was shown it would be found that the amount of gross profit 
 shown therein would agree with the amount appearing upon the 
 trading statement. 
 
 Whether or not the auditor shall prepare departmental trading 
 statements depends entirely upon the conditions of his contract with 
 the company covering the audit although when not specified a gen- 
 eral trading statement is considered sufficient. 
 
 44 
 
PRESENTATION OF PROFIT AND LOSS STATEMENT. 
 
 In the preparation of the profit and loss statement the gross 
 profit from the trading account is brought down to the credit side of 
 the profit and loss statement and all expenses including general 
 office expenses, managerial expenses, selling expenses, etc., are en- 
 tered upon the debit side, the difference between the two sides of the 
 statement then shows the net profit or loss. If the expenses exceed 
 the gross profits the difference is a loss, if the gross profits exceed 
 the expenses, then the difference is net profit. 
 
 In a profit and loss statement it is desirable to classify the sell- 
 ing expenses and the administrative or general expenses, showing 
 the amount of each classification separately, as the totals are fre- 
 quently used in preparing the statistical statements. Selling expense 
 might be pro-rated over sales, but this involves considerable labor 
 and does not result in any particular benefit. A comparative state- 
 ment of sales and selling expenses is desirable in order that an abso- 
 lute check may be provided upon an abnormal increase in the selling 
 expenses. A departmental profit and loss statement clearly exhibits 
 the net profit or loss of each department of the business or each line 
 of goods handled. 
 
 The profit and loss statement contains numerous items of ac- 
 crued liabilities or floating assets, as later explained in connection 
 with the preparation of the balance sheet. 
 
 All journal adjusting entries, made by the auditor, are taken into 
 consideration prior to presenting the trading and profit and loss state- 
 ment and balance sheet. Trading and profit and loss statements con- 
 tain valuable information which is used by the auditor in preparing 
 comparative statistics. 
 
 There are various lines of business in which it is practically im- 
 possible for the auditor to establish a unit of production unless the 
 audit is very broad and far reaching in its scope, involving the most 
 detailed examination and the preparing of departmental or classified 
 statements, balance sheets, etc. Many lines of business have a stand- 
 ard unit of production, such as a barrel of beer in the brewery busi- 
 ness, barrels of flour in the flour milling enterprise, an automobile in 
 the automobile industry, etc. 
 
 Perhaps the most valuable information embodied by the auditor 
 in his report is a table of correct percentages for the important items 
 
 45 
 
under consideration calculating upon a basis of a unit of production. 
 There are few instances where a manufacturing enterprise does not 
 keep an accurate record of their units of production, a brewery al- 
 ways maintains a record of the number of barrels of beer brewed 
 during any given time, while similar information is generally at hand 
 for all other lines of commercial endeavor. The auditor accurately 
 establishes figures showing the total output of the business during 
 the period covered by his audit. 
 
 Assuming that a brewery has an output of 50,000 barrels during 
 the audit period and that the profit and loss statement, prepared by 
 the auditor, shows the total expenses at $12,500, it is very evident 
 that the average cost per barrel is twenty-five cents. This does not 
 include the cost of material, manufacturing and trading expenses. 
 He then establishes the average selling price per unit by dividing 
 the net sales for the period by the actual number of units sold. Sim- 
 ilar calculations are made showing the exact amount of operating 
 expenses for each unit of production. In some lines of business all 
 manufacturing and trading expenses are designated Operating Ex- 
 penses, whereas this term is also used in a much broader sense in 
 some instances, covering not only cost of maintenance, repairs, man- 
 ufacturing and trading expenses, but administrative expenses, etc. 
 
 The auditor may arrange his calculations so as to effect an 
 agreement among the following items, using as a basis for his cal- 
 culations the unit of production : The average net selling price per 
 unit minus the average cost per unit gives the average net profit per 
 unit. In further consideration of these three items, the average net 
 selling price per unit multiplied by the number of units sold gives 
 the net sales for the period, the average cost per unit multiplied by 
 the number of units sold gives the total expenses for the period and 
 the average net profit per unit multiplied by the number of units 
 sold gives the total net profit for the period. 
 
 These statements are based upon the fact that a profit is not 
 earned upon a manufactured article until the article is placed upon 
 the market and sold. The auditor may establish his calculations, if 
 he so desires, upon the basis of units of production. 
 
 PRESENTATION OF BALANCE SHEET. 
 
 The preparation of the balance sheet is perhaps the most im- 
 portant duty of the auditor and it requires a practical knowledge of 
 
 46 
 
the science of accounting to exhibit a correct statement of the assets 
 and liabilities of a business. The balance sheet is a statement of the 
 actual assets and liabilities designed to show the true financial con- 
 dition of the business at the time the audit is completed. The follow- 
 ing diagram is considered very good form for a balance sheet as the 
 assets are classified under the headings, Active, Fixed and Passive 
 and the liabilities under the headings, Floating, Funded, Capital and 
 Reserve : 
 
 ASSETS LIABILITIES 
 
 ACTIVE FLOATING 
 
 Cash on Hand Accrued Wages 
 
 Cash in Bank Accrued Interest 
 
 Accounts Receivable Accounts Payable 
 
 City Ledger Bills Payable 
 
 Wholesale Ledger FUNDFD 
 
 Pennsylvania Ledger 
 
 Inventories First Mortgage Bonds 
 
 Coffee Second Moitgage Bonds 
 
 Ammonia Debentures 
 
 Sugar CAPITAL 
 
 Bluein S Common Stock 
 
 FIXED Preferred Stock 
 
 Real Estate Surplus 
 
 Buildings RESERVE 
 
 Power Equipment Sinkinc- Fund 
 Horses and Wagons 
 
 PASSIVE 
 
 Suspense Account 
 Good Will 
 Franchises 
 Patents 
 Copyrights 
 Promotion Expense 
 
 The nature of the assets classified under each of the three sepa- 
 rate and distinct headings is clearly shown by the diagram and does 
 not require further explanation since proper attention is given to 
 this subject in previous instructions. The same is true of the lia- 
 bilities classified under each of the four separate and distinct di- 
 visions. As a matter of fact the auditor incorporates in his balance 
 sheet all assets and liabilities accounts appearing upon the general 
 or private ledger as well as any special accounts necessary on ac- 
 count of his properly handling accrued assets or floating liabilities. 
 
 The intention of the instructions here given covering the details 
 of the balance sheet is to present an outline of the duty of the audi- 
 tor who is conscientious and painstaking in his efforts to present a 
 
 47 
 
balance sheet absolutely accurate. It is true that many auditors 
 fully aware of all of the minor considerations essential to the prep- 
 aration of a comprehensive balance sheet do not always apply this 
 knowledge to their best ability, but are negligent, thus making their 
 final statement incomplete. 
 
 An examination of the assets of any business by an auditor 
 should be thorough and comprehensive enough to convince him be- 
 yond all reasonable doubt that the assets included in the balance 
 sheet are worth the sum at which they are valued. In other words, 
 he should exercise reasonable care and discretion to guard against 
 incorporating in his statement any assets at inflated values. He is 
 not expected to record the value of the assets from the standpoint 
 of how much they would bring under forced sale unless he is audit- 
 ing the books of an insolvent business, it being sufficient for him 
 to consider their value from the standpoint of their actual cost and 
 their worth to the business under investigation. He is expected to 
 see that proper provision is made for the depreciation of fixed assets 
 and that all accounts receivable, known to be uncollectible, are elim- 
 inated from the statement. It is sometimes desirable for him to 
 establish a reserve for bad and doubtful accounts. 
 
 There is also the question of repairs upon which there is a 
 vast difference of opinion among business men, manufacturers, ac- 
 countants and auditors. Some regard the amount expended for re- 
 pairs as a capital expenditure, others consider that this item should 
 be properly charged against revenue for the period in which the ex- 
 penditure is made. 
 
 The auditor conducts his investigations with the intention of 
 establishing in his mind absolute certainty as to whether or not the 
 nature of the repairs makes them capital or revenue expenditure. 
 The auditor should see that all assets and liabilities of the business 
 are included in the balance sheet. This at first may seem an un- 
 necessary precaution, although proper explanation gives it consider- 
 able importance. Among the assets for which many business houses 
 carry no accounts are found such items as unearned insurance, ac- 
 crued interest, unexpired taxes, etc., among the liabilities, accrued 
 wages, accrued rent, accrued interest, etc. In explanation of the 
 floating assets reference is made to unearned insurance as follows: 
 If a corporation pays insurance premiums of $3,000 upon July 1st 
 covering policies upon their plant and equipment and stock for the 
 
 48 
 
fn QII it 
 
 ensuing twelve months, it is evident that if the audit period closes 
 December 31st following, there is $1,500 of unearned insurance 
 which should be incorporated in the balance sheet as an asset. In- 
 terest accrues upon the interest bearing bills receivable held by the 
 company. Unexpired taxes are included for the amount paid in 
 advance, but still unearned. 
 
 In explaining the floating liabilities: If the audit period ends 
 December 31st which happens to fall upon Wednesday and it is the 
 policy of the business to pay their employees upon Tuesday of each 
 week for the preceding week's work, it is evident that at the time 
 the books are closed there is accrued three days' labor for the entire 
 business, and as the benefit of this labor expenditure is incorporated 
 in the balance sheet by an increased inventory, manufactured goods 
 or goods in the process of manufacture, there should be a corre- 
 sponding liability upon the credit side of the balance sheet as the 
 amount is not paid. Accrued rent is not taken into consideration 
 except in cases where it is not paid in advance. Interest accrues 
 upon borrowed money unless paid in advance, then proper adjust- 
 ment is made for unearned interest, which is an asset. 
 
 Another item frequently of vast importance which deserves 
 mention in the final report consists of purchases and sales discounts. 
 Those actually taken and allowed appear in the trading statement, 
 but those which are expected to be taken and allowed do not appear 
 upon the books. A corporation purchasing several million dollars 
 of material annually upon a cash discount basis of two per cent 
 earns a considerable sum by paying their bills promptly. Suppose 
 that during the last ten days of the audit period purchase invoices 
 are received and entered upon the purchase or accounts payable 
 record and credited to the accounts payable controlling account 
 amounting to $100,000, their discount maturity date follows the date 
 for closing the audit. It is evident that they will be discounted and 
 that as a result the business will earn $2,000. Perhaps the auditor 
 is not justified in incorporating this profit in his report owing to any 
 uncertainty in regard to the payment of the bills, but nothing should 
 prevent his making comment upon it. On the other hand, $100,000 
 of sales may have been made during the last ten days of the audit 
 period and entered upon the sales ledgers at their face value, whereas 
 they will be paid and discounted during the ten days following the 
 date the audit closes, the company then suffers a loss of $2,000. 
 
 49 
 
At first it may seem that these two items will practically offset 
 each other, but upon further consideration it must be admitted that 
 any business operating at a profit must make sales greatly in excess 
 of its purchases, consequently the sales discounts taken by customers 
 will naturally exceed all purchase discounts taken by the business 
 itself. 
 
 A CONDENSED AUDITING PROGRAM. 
 The Auditor's Contract. 
 
 Covers specffic details of the audit, amount and method of re- 
 muneration, period to be covered by the audit, nature of audit ; 
 whether complete, pay-roll, capital stock, reserve, etc. 
 
 Solicit Valuable Co-operation. 
 
 Cultivate acquaintance of individual held responsible for account- 
 ing records during period under audit. Ascertain manner of 
 conducting business and recording transactions. 
 
 Books and Records for Investigation. 
 
 Ascertain the identity and purpose of all records of original en- 
 try and all subsidiary ledgers and records. 
 
 Verify Cash Balance. 
 
 Compare actual cash on hand with amount which cash records 
 show not yet deposited, that is, difference between cash receipts 
 and deposits. Compare actual amount of petty cash on hand 
 with difference between original fund and disbursements prop- 
 erly vouched for. 
 
 Verify Bank Balances. 
 
 Secure from banks with whom accounts are carried certified 
 statements of balances on deposit, notes discounted or deposited 
 as collateral, and any contingent liability for accommodation en- 
 dorsements, etc. 
 
 Take Trial Balance. 
 
 Take trial balance from general or private ledger or verify trial 
 balance already taken. 
 
 Check and Verify all Footings. 
 
 Add all columns in special columnar account books. Foot cash 
 book, check register, journal, purchase records, sales record or 
 
 50 
 
: 
 
 rii^b. 
 
 recapitulation, bills receivable and bills payable record, etc. -Note 
 particularly transfer of footings carried forward. 
 
 Checking Postings of Footings, etc. 
 
 Verify all postings to accounts in the general and private ledg- 
 ers, both debits and credits. 
 
 Check Trial Balance Previously Taken. 
 
 At this point compare balances of accounts in general and pri- 
 vate ledger with balances entered upon trial balance. 
 
 Check Postings of Cash Receipts. 
 
 Check in detail all postings from cash book to sectionalized sales 
 ledgers, to personal accounts in general and private ledgers, etc., 
 and in case of receipts from sale of stock, to accounts in stock- 
 holders' ledger. 
 
 Check Postings of Cash Disbursements. 
 
 Check in detail all postings from cash book or check register to 
 purchase or accounts payable ledgers where accounts with cred- 
 itors are carried. Also check all postings to accounts in the 
 general or private ledgers. Examine and check voucher register. 
 
 Check Purchases Distribution. 
 
 Examine all purchase invoices, compare amounts with entries 
 upon purchase record or voucher register. In some instances 
 compare invoices with original quotations or purchase orders. 
 Verify distribution of charges. 
 
 Check Postings of Purchases. 
 
 Check in detail all postings from purchase record or voucher 
 register to accounts payable, credit. 
 
 Take Trial Balance of Purchase Ledger Accounts. 
 
 Total credits to accounts payable for purchases made, less cash 
 remittances to creditors, discounts earned and allowances and 
 rebates of whatever nature, gives an amount which should agree 
 with balance of accounts payable controlling account in general 
 or private ledger. 
 
 Check Sales Analysis. 
 
 Examine' all sales invoices, check against shipping record to 
 prevent oversight in billing shipments, check against sales record 
 or recapitulation sheet. Verify sales analysis or classification. 
 
 51 
 
Check Postings of Sales. 
 
 Check in detail all postings from the sales records or recapitula- 
 tion sheets to accounts with customers in the sectionalized sales 
 ledgers, debits. 
 
 Take Trial Balance of Sales Ledger Accounts. 
 
 Total debits to accounts receivable for sales made less total 
 credits for cash remittances received from customers, discounts 
 allowed and rebates and allowances of any nature gives an 
 amount which should agree with the balance of the accounts- 
 receivable controlling account in the general or private ledger.. 
 Where sectionalized sales ledgers are used an agreement is ef- 
 fected between the items therein as set forth above and the bal- 
 ance of the corresponding controlling account in the general or 
 private ledger. 
 
 Check Sales Invoices Against Shipments. 
 
 Examine sales invoices and check against acknowledgment or 
 confirmation of order or manifold shipping record. 
 
 Take Trial Balances of Subsidiary Ledgers. 
 
 Effect an agreement between the aggregate balances of the ac- 
 counts in each subsidiary ledger, and the balance of the corre- 
 sponding controlling account in the general or private ledger. 
 
 Check Inventory. 
 
 Compare pi ices with purchases invoices covering goods and 
 verify extensions and additions. Secure certificate of assurance 
 from secretary of company that prices are correct. 
 
 Check Pay Roll. 
 
 Examine last pay-roll. Check time clock cards and piece work- 
 ers' receipts against entries upon pay-roll and verify total. Ef- 
 fect an agreement between total labor expenditure and pay-roll 
 disbursement properly vouchered by clock cards and receipts. 
 If labor distribution is made, verify the same. 
 
 Check Bills Receivable. 
 
 Examine each item carefully and effect an agreement between 
 the total amount of bills receivable on hand, deposited as col- 
 lateral security or otherwise used and still unpaid and the bal- 
 ance of the bills receivable controlling account in the general or 
 private ledger. 
 
 52 
 
Check Bills Payable. 
 
 Examine carefully the original record of each item and effect an 
 agreement between the total amount of all bills payable issued 
 and still unpaid and the balance of the bills payable controlling 
 account in the general private ledger. 
 
 Presentation of Last Office Pay Roll. 
 
 Incorporate in final report a copy of last office pay-roll. Ascer- 
 tain if salaries paid to officers are authorized by minutes of meet- 
 ings of Board of Directors. 
 
 Take Trial Balance from Stock Ledger. 
 
 Effect an agreement between the total number of shares issued 
 and outstanding as shown by debits to accounts with share- 
 holders in the stock ledger and the total number of shares of 
 authorized capital when the full number of shares are subscribed 
 and issued. If there is any treasury stock it must be added to 
 the total debits to stockholders' accounts to agree with total 
 shares of capital stock. Examine carefully the stock certificate 
 book. Check stubs with detached certificates against entries to 
 accounts with shareholders in the stock ledger. 
 
 Check Dividend Account. 
 
 Make list of all dividends declared and paid. Ascertain amount 
 of any dividend checks outstanding unpaid. 
 
 Take Trial Balance from Private Ledger. 
 
 Ascertain equilibrium of private ledger after making proper al- 
 lowance for all corrections and adjustments. 
 
 Prepare Trading Statement. 
 
 Present statement containing all trading account balances and 
 show percentage of gross profit upon net sales and turnover. 
 Present departmental or classified trading statements and cor- 
 responding percentages when opportunity is afforded and con- 
 tract calls for them. 
 
 Prepare Profit and Loss Statement. 
 
 Present statement containing all profit and loss balances includ- 
 ing gross profits from trading statement entered as a credit. 
 
 53 
 
Show net profit, establish unit of production, and the following 
 
 statistics : 
 
 Total output in units, 
 Average net selling price per unit, 
 Average operating expense per unit, 
 Total average cost per unit, 
 Average net profit per unit. 
 
 Prepare Balance Sheet. 
 
 Present statement containing all assets and liabilities accounts. 
 Do not overlook floating assets or floating liabilities. Exercise 
 proper precaution to prevent inflated valuations. Be sure all 
 liabilities are included. Consider purchase and sales discounts, 
 depreciation, reserves, etc. 
 
 Prepare Schedule of Adjusting Entries. 
 
 Present list of all adjusting entries necessary to put books upon 
 a correct basis. Comment upon entries, when necessary, that 
 they may be readily understood. Incorporate in final report any 
 suggestions for improvement in methods used, etc. 
 
 GENERAL INFORMATION. 
 
 After having carefully studied the complete audit program cov- 
 ering all of the important and minor details essential to the success 
 of a thorough and comprehensive audit and carefully reviewing the 
 condensed audit program, it may occur to the reader that there 
 should be no diversion from this plan. Notwithstanding this fact 
 there are nearly as many well defined plans of audit as there are 
 first class audit companies undertaking the work. The final results 
 are approximately the same, but their methods of getting the final 
 results differ materially. The plan selected and explained is consid- 
 ered complete and comprehensive and it is safe to say that it guar- 
 antees accuracy and conservatism which make the auditor's position 
 very secure. It is a plan which readily meets with popular favor 
 because it is easily understood and its thoroughness particularly 
 commends it. 
 
 It is an excellent policy for an auditor to proceed with an audit 
 verifying the records, etc., upon a monthly basis using the balances 
 which he knows to be correct for the previous month in connection 
 with the entries recorded upon the books in the succeeding month, 
 
 54 
 

 for the purpose of arriving at the balance to be used in connection 
 with the next succeeding month's work, etc. If the audit covers a 
 period of more than a year, or a period of years, he will find it ad- 
 vantageous to present monthly comparative statistical reports. 
 
 The accounting records in the majority of business houses 
 claiming even mediocre accounting efficiency are now simplified to 
 such an extent that satisfactory results are obtained by the use of 
 columnar accounting records and an auditor therefore customarily 
 uses special columnar sheets of four, six, ten and fourteen columns 
 upon which to make notes of necessary adjusting entries, etc. His 
 notes entered upon these sheets as the errors are discovered form 
 the basis of the final list of adjusting entries submitted and com- 
 ments made thereon. 
 
 The auditor should not be denied access to the record of min- 
 utes of the corporation for meetings of both stockholders and direct- 
 ors, and if a new corporation the original records as kept by the 
 secretary or other official from the time of incorporation. It is de- 
 cidedly to his advantage to read these very carefully to make certain 
 that the accounting records are in accord with all votes or resolu- 
 tions made and passed by the stockholders and directors as regards 
 salaries of officers, etc., and particularly with reference to the au- 
 thorized amount of capital stock, number of shares and the values 
 thereof. This suggestion is made partially for the reason that in 
 many instances the authorized capital stock of a corporation has 
 been not more than one thousand shares of one hundred dollars 
 each, whereas the directors have sold and issued stock greatly in ex- 
 cess of the authorized capital and have deliberately misused the funds 
 secured from the selling of the unauthorized shares. 
 
 It is regarded as good form for the auditor to incorporate in his 
 final report a detailed analysis of each account carried in the general 
 or private ledger. While he is naturally expected to present proper 
 statements of bills receivable, bills payable, copy of last office pay- 
 roll; trial balance, trading statement, profit and loss statement and 
 balance sheet of accounts in the private ledger and in some instances 
 he does not regard it necessary to present an analysis of every ac- 
 count, in view of the nature of the private ledger and the purpose 
 it is intended to serve it is recommended that a proper exhibit of 
 each account therein be incorporated in the auditor's report. Partic- 
 ular attention should be paid to an itemized list of all bad debts 
 having any bearing whatever upon the balance sheet or any suspense 
 
 55 
 
accounts included at their face value, or in connection with which a 
 reserve has been created. 
 
 There are varying conditions to be dealt with in different lines 
 of business. In certain lines it is customary to enter upon the 
 books accounts with contracts secured prior to their having done the 
 work called for by the agreements set forth therein. Such an oc- 
 curence should not escape the attention of the auditor who should 
 create a reserve to off-set any such contract accounts equivalent to 
 the estimated cost of completing the work which must necessarily 
 be performed under them. The same is true in some lines in con- 
 nection with unfilled orders. It is reasonable to suppose that every 
 business man has a perfectly natural desire to have his books make 
 as good a showing as possible, his ambition in this respect some- 
 times exceeds proper conservatism and he unconsciously includes 
 among his assets fictitious items such as unfilled orders. While it 
 is true that a good bunch of orders on hand possesses a certain 
 amount of value to the business, it is also true that there must be 
 an expenditure in time and money to complete those contracts with 
 the possibility of some of them being cancelled before being filled. 
 
 An adjustment account is very often opened in the general or 
 private ledger for the purpose of making necessary adjustments and 
 corrections in the records. 
 
 It would be difficult to estimate the number of elective auditors 
 serving some of the best corporations who are absolutely unqualified 
 to fulfill the responsibilities intrusted to them and who get their 
 monthly trial balances by deliberately making upon the books a 
 single entry equal to the difference between the debits and credits. 
 Such a condition is deplorable as well as hard to account for. In the 
 first place a person cannot understand how an individual can delib- 
 erately force his trial balance if he has any regard whatever for the 
 equilibrium of his ledger. There is reasonable excuse for anyone 
 making errors but there is absolutely no excuse for a person to de- 
 liberately overlook them and not make any effort to find them. 
 There is so much literature of a scientific and technical nature now 
 published covering the science of accounting that it is inexcuseable 
 for anyone with a medium amount of ambition to claim a lack of 
 knowledge of the proper methods of handling the work which in- 
 variably reduces the situation to one of carelessness, neglect or lack 
 of interest. 
 
 56 
 
Check marks used by auditors vary materially, although each 
 different form used by an auditor identifies the nature of his investi- 
 gation of the records checked. The simplest check mark is commonly 
 used for checking postings to the sectionalized and subsidiary ledg- 
 ers, while the double check mark is often used for checking postings 
 
 COMMERCIAL WORLD 
 AUDIT CO. 
 
 EXAMINED 
 
 AUG.I2.I9II. 
 
 R.H.5PEAR. 
 
 PRESIDENT. 
 
 to accounts in the general or private ledger. The permanent auditor 
 engaged in making a continuous audit customarily uses a small rub- 
 ber stamp for each day's work as it is audited and verified by him. 
 As a matter of fact, the science of accounting is reduced to certain 
 general principles which every expert bookkeeper, accountant, audi- 
 tor, cost accountant, etc., should be thoroughly acquainted with. In 
 the most extensive businesses a daily trial balance or proof of post- 
 ings is rapidly becoming the demand of the hour. This insures a 
 trial balance at the close of the business each day, at the end of 
 each week, each month or in fact the close of any business or sta- 
 tistical period. 
 
 The auditing program outlined in preceding pages is recom- 
 mended as suitable for use in any line of business, although the 
 auditor is naturally expected to exercise his best judgment under all 
 circumstances. The preceding program is regarded as a detailed 
 complete audit and is recommended in preference to a system of aud- 
 iting by totals, as explained in the succeeding pages. The system 
 of auditing, later described, serves excellently the purpose for which 
 it is intended, although the nature of some businesses prevents its 
 use with entire satisfaction. 
 
 SYSTEM OF AUDITING BY TOTALS. 
 
 In outlining a system of auditing by totals it is for the purpose 
 of explaining the nature of the audit made by some individuals in 
 
 57 
 
preference to a complete detailed audit, and while this system pos- 
 sesses a certain amount of merit, it is admitted that it does not 
 provide such an absolute check upon the work as will satisfy the 
 majority of business men who prefer to have an extensive investi- 
 gation made of their accounting records when an audit is under way. 
 
 The total sales for the period is used as a basis of the audit and 
 to a certain extent the principles involved follow very closely those 
 already outlined in connection with proof of postings to sectionalized 
 sales ledgers, etc. For the purpose of determining the total amount 
 of sales for the period it is suggested that an adding machine be 
 used taking the amount of each invoice from the manifold invoice 
 or sales record or recapitulation. Anyone familiar with the princi- 
 ples of the science of accounting will thoroughly understand the fol- 
 lowing explanations made. 
 
 The principles involved apply equally as well whether or not 
 sectionalized sales ledgers are used as the total sales form the basis 
 of this system. The auditor first determines the total accounts re- 
 ceivable at the commencement of the period represented by the net 
 'debit balance of the accounts in the sales ledgers. By the use of an 
 adding machine he readily determines the total sales for the period, 
 which, of course, are posted to the debit side of the sales ledger ac- 
 counts. In addition to these debit postings there will be a few more 
 from the journal, these are also determined. Briefly stated, the 
 total accounts receivable at the commencement of the period, plus 
 the total sales for the period, plus the total debits to accounts re- 
 ceivable from the journal for the period, gives the total debits to 
 the sales ledgers. 
 
 The next step is a consideration of the credits against the sum 
 total of debits explained. For this purpose the total accounts re- 
 ceivable at the end of the period is regarded as an inventory and 
 treated as a credit. There will be a few other credits posted from 
 the journal which will have to be verified. The auditor then adds 
 the journal credits to the accounts receivable inventory at the end 
 of the period, and deducts the amount thus obtained from the total 
 debits, comprised of the three items as explained, in order to arrive 
 at the postings to accounts receivable (credits) from the cash book, 
 in other words, net cash receipts from sales accounts. 
 
 The majority of book-keepers carry at least two columns upon 
 the debit side of their cash book, one is used for the amounts of all 
 
 58 
 
general cash receipts, the other, cash receipts from sales accounts. 
 However, if general cash receipts and the cash receipts from sales 
 accounts are both entered in one column, then the auditor is com- 
 pelled to determine the total cash receipts and deduct the amount 
 thus obtained from the total cash receipts for the period to ascertain 
 how much the net cash receipts from sales accounts for the period 
 should be. There will be invariably a few journal entries posted to 
 the sales division of the ledger which makes it necessary to de- 
 termine the total of such debits and credits. It is admitted that the 
 above explanation covers in a measure the proof of the postings to 
 the sales ledgers, although the postings of items comprising the gen- 
 eral cash receipts are not proven. These should be totaled and the 
 amount compared with the amount of total general cash receipts 
 shown. 
 
 Up to this point the auditor has endeavored to place reasonable 
 check upon cash receipts and sales, he now directs his attention to 
 the credit side of the cash book or check register. The average up- 
 to-date business house now makes all disbursements of whatever 
 nature by check, with the exception of petty cash, for which a check 
 is drawn creating the fund. Where a check register is used the 
 amount of each check drawn is entered in a special column. The 
 same is true if the cash disbursements by check are entered upon 
 the credit side of the cash book. In undertaking the work of aud- 
 iting the cash disbursements the auditor does not rely upon the 
 accuracy of the amounts entered in the special column mentioned 
 but endeavors to place a check against this record by referring to 
 the bank pass book which shows the total amounts of all checks re- 
 turned by the bank monthly when the pass book is balanced. In the 
 first place he determines the total of all checks returned by the bank 
 during the audit period, he then refers to the stub of the check book 
 at the commencement of the period for the purpose of determining 
 the total amount of checks outstanding at the commencement of the 
 period. This information is usually set forth in the reconciliation of 
 the check book and pass book balances as entered upon the check 
 book stub. He then refers to the check book stub at the close of 
 the period and determines the total amount of checks outstanding, 
 in the same manner. If the book-keeper has not already reconciled 
 the check book and bank book balances the auditor may do so him- 
 self and thus be certain that the list of checks outstanding is correct. 
 This explanation makes it clearly evident that the total amount of 
 
 59 
 
checks returned paid by the bank during the audit period, as shown 
 by the bank's entry upon the pass book, less the total of checks 
 outstanding unpaid at the commencement of the period, plus the 
 total amount of checks outstanding unpaid at the close of the period, 
 gives an amount which should agree with the total checks issued 
 as recorded in the cash book, or upon the check register in the 
 special column showing checks drawn. 
 
 It is rapidly becoming the custom among up-to-date business 
 houses to demand the deposit of all moneys received instead of ap- 
 propriating cash receipts for disbursements of any nature. If this 
 plan is followed it becomes evident that the total deposits for the 
 audit period should agree with the total cash receipts. The value of 
 this plan is increased by noting the simplicity of the following 
 method of proving cash receipts and disbursements: 
 
 The auditor refers to the bank pass book, which when balanced 
 monthly shows the monthly totals of deposits made by a business. 
 To the sum of the monthly totals for the audit period is added the 
 balance on deposit as shown by the bank pass book, and from the 
 amount thus obtained there is deducted the balance on deposit at 
 the commencement of the period for the purpose of determining the 
 actual deposits made. If all cash receipts are deposited, according 
 to the prevailing custom, then the bank deposits shown by carrying 
 out the above plan should agree with the total cash receipts on the 
 debit side of the cash book for the sum total of general cash receipts 
 and cash receipts from sales accounts. 
 
 It will, therefore, be seen that under this plan of auditing in 
 which sales are used as a basis the total cash receipts are proven 
 by the entries upon the ledgers and the total cash disbursements are 
 proven by the bank pass book, entries in which are made by the 
 bank, which is a disinterested party from an auditing standpoint. 
 
 This system of auditing eliminates the necessity of adding any 
 of the columns in the cash book or check register, or checking the 
 single posting to any of the accounts in the ledgers. It is consid- 
 ered reasonable proof that all cash receipts have been properly ac- 
 counted for and as the audit is conducted solely by totals it is not 
 a laborious task for the auditor to check the monthly footings of 
 special columns in the cash book, sales records or journal to the 
 controlling accounts in the general or private ledger. 
 
 The actual work in connection with this system of auditing con- 
 sists in adding the sales for the period, determining the amount of 
 
 60 
 
general cash receipts, petty cash disbursements are taken care of by 
 drawing a check for creating the original fund, the handling of the 
 totals indicated according to the plan outlined, proving the accuracy 
 of the accounts receivable and safe-guarding against inaccuracy in 
 any of the general accounts in the trial balance. Aside from this 
 work the auditor is expected to employ the usual methods for as- 
 certaining that the resources of the business as entered upon the 
 balance sheet are not inflated, that the inventory calculations are 
 correct and that all liabilities of the business are included. This 
 system does not guarantee that the disbursements have been made 
 properly to cover purchase invoices, etc., but it eliminates the neces- 
 sity of checking, in some instances, a few thousand purchase in- 
 voices. It disregards purchase distribution, etc. 
 
 A careful comparison between the auditing program outlined in 
 the preceding pages for a complete detailed audit, and this system 
 of auditing by totals, shows a considerable discrepancy in the latter. 
 Jn addition to there being no verification of purchases distribution, as 
 already stated, no attention is given to the stock ledger and to vari- 
 ous other considerations essential to an absolute guarantee that the 
 final trial balance, trading statement, profit and loss statement and 
 balance sheet presented by the auditor are correct and exhibit a true 
 condition of affairs of the business. It is designed for the purpose 
 of proving that no defalcation has occurred in the handling of the 
 cash. 
 
 61 
 
Index 
 
 Accountant 4 
 
 Adjusting Entries 42-43, 54 
 
 Audit Essential 7-9 
 
 Auditing 3 
 
 Auditor 5-6 
 
 Auditors' Certificates 13 
 
 Contract 22, 50 
 
 Duties 14 
 
 Liabilities 15 
 
 Qualifications 17 
 
 Responsibilities 16 
 
 Book-keeper 3 
 
 Books and Records for Investigation 24, 50 
 
 Condensed Auditing Program 50-54 
 
 Co-operation Sought 23, 50 
 
 Cost Accountant 7 
 
 Different Kinds of Audits 10 
 
 Completed Audit 11 
 
 Continuous Audit 11 
 
 Partial Audit 12 
 
 Periodical Audit 13 
 
 Special Audit 13 
 
 Essential of an Audit 18, 21 
 
 Exhibit of Last Office Pay Roll 40, 53 
 
 General Information 54-57 
 
 Pay Roll Audit 37, 52 
 
 Practical Auditing System 22 
 
 62 
 
Statements : 
 
 Balance Sheet _ ., . .46-50, 54 
 
 Bills Payable 39, 53 
 
 Bills Receivable 39, 52 
 
 Profit and Loss 45,53 
 
 Trading 44, 53 
 
 Systematizer 7 
 
 System of Auditing by Totals 57-61 
 
 Trial Balance 27,50 
 
 Private Ledger 42, 53 
 
 Purchase Ledger Accounts . . 33, 51 
 
 Sales Ledger Accounts 35, 5'2 
 
 Stock Ledger 40, 53 
 
 Subsidiary Ledgers 36, 5'2 
 
 Value of an Audit 9-10 
 
 Verifications: 
 
 Bank Balance 26, 50 
 
 Cash Balance 25, 50 
 
 Dividend Account 41, 53 
 
 Footings 27, 50 
 
 Inventory , 36, 52 
 
 Invoices with Shipments 35, 5'2 
 
 Postings Cash Disbursements 30, 51 
 
 Postings Cash Receipts 29, 51 
 
 Postings Purchase Invoices 32, 51 
 
 Postings Sales Invoices 34, 52 
 
 Postings to Private Ledger 27, 51 
 
 Purchases Distribution 31,51 
 
 Trial Balance 28, 51 
 
 Sales Classification 33, 51 
 
 63 
 

UNIVEESITY OF CALIFOENIA LIBKAEY 
 BERKELEY 
 
 DATE 
 
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 STAMPED BELOW 
 
 Books not returned on time are subject to a fine of 
 50c per volume after the third day overdue, increasing 
 to $1.00 per volume after the sixth day. Books not in 
 demand may be renewed if application is made before 
 .expiration of loan period. 
 
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