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p ref ce a .

T his contains all questions set in the Auditing


volum e

paper at the New York State semi annu al examinations -

for certified p ublic accou ntants from December 1 896 ,

( the date of th e fi r st examination held ) to June 1 902 , , ,

inclusive with fu ll answers and explanati ons


The student can ga ther f rom these answe rs certa
.
,

in
general p rin ciples ; the applica tion of th em c an only be
learned by practical experience under th e dir ection of a
public a ccountant and au ditor .

Attention is spe c ially called to a most admi rable paper


by Mr Arthur Lowe s Dickinson M A F C A C P A
.
, . .
, . . .
, . . .
,

on The Profits of a Corporation read before the ,

Congr ess of Accountants at St Louis recently It con


ta
. .

ins information on spe cific points too often overl ook ed


by the irrefiective treated in detail in an eminently
pra
,

cti cal manner An article on Auditing Insuran ce


.

Acc ounts by Mr George Wilkinson C P A will wel l



, .
, . . .
,

rep ay attentive pe rusal Both of these papers are pub


.

“ ”
lis hed in The Business World .

Sin ce the publication of the previous volumes of thi s


series ( The Theory of Accounts and Comm ercial
“ ” “

an excellent work on Executors A ccounts ’

ha s been w ritten by Mr Joseph Hardcastle C P A


.
, . . .
,

Profess or in the School of Commerce Accounts and ,

Finan ce of New York University It should be in the .

hands of every student who desires to famili a rize him


se lf with this important branch of acc ounting and audit

mg .

1 7 3 7 24
4

The las t vol ume of this s eries Practical Accou nting


, ,

w ill be published in April 1 905 , .

The following works have been consulted in the prepa


ration o i this book

A u diting , L R Dick s ee F . .
, . C
. A .

Auditing , F W Pixley F . .
, . C. A .

Executors Acco unts’

J Hardc a stle C P A
Encyclopa
.
, . . .

edia of Ac counting Geo rge Lisle C A F


, , . .
, . F . A .

Accounting in Theory
and Pra ctice Geo rge Lisle C A F , . .
, . F A
. .

My best thanks are du e to Mr Howard Greenm an .


,

C P A autho r of Reversible Cotton Tables for his


. . .
,
“ ”
,

kindness in reading ove r the proof sheets of this vol u me


-
.

FREDERICK S TIP SO N . .

Decem ber 1 5, 1 904 .


E ecember, 1 8 9 6 .

I Give a brief outline of the duties of an auditor and


.

of his respons ibiliti es .

The du ties of an auditor are to examine a nd pas s in t e

view the work oi others with the obj ect of determ ining
its a ccuracy as evidenced by absence of
( )
0 Fraud ;
b
( ) Technic a l errors
( )
c Er r o r s of principle .

This involves a complete examination o f all the books


of a ccou nts ; the passing u pon the p ropr iety of the vario u s
ch arges and c redits appearing in the revenu e accou nt ; and
finally the a sce rtaining of the exact state of a client s ’

aff ai rs u pon a certain given date as exhibited in a B alan ce


Sheet to the co rr ectness of which he can certify
, .

His responsibilities va ry conside rably as to the extent


to which he wou ld have to inspect subsidi a ry books con ,

tracts etc in the case of the audit of a corporation or


, .
, ,

partnership and f or individuals B ut in general he is


,
.
,

responsible for the accu racy of the figures to the cor re ct


ness of which he certifies and for the failu re to detect
fraud ; taking nothing for gra
,

nted he should verify every


,

thing .

II Explain the principal points to whi ch an auditor


.

shou ld direct his attention in conducting the audit of an


in corporated company .

The auditor should first ask for the minu te book whi ch ,

s ho u ld contain a cop y of the co rporation articles of in

c o rporation and the by laws


,
-
.
6

Having ca refully studied these he should see that


proper opening entries h ave been made in the j ournal
“ ”

a
,

nd that the stock ledge r and transfer book have been

properly written up The knowledge he has now g ained


.

will enable him to act with intelligen ce in determining


from his ex amination of the books o f account whether
the stockholders rights have been d uly pres erv ed

.

He should next see


a
( ) That the invento ry has been ta ken at cost p r ice
,

unless said price is hig her than market valu e in whi ch ,

case it should be figured at market va lu e ( on the p rin ciple


that it is genera lly a dvis able to cu t losses and let pr ofits

run ; and that it is made ou t and signed by the em


l
p y o ee s who “
too k ”
it ;
( )
b That capital a nd r even u e expendit u re have b e en
prope rly cl as sified
( )
c That the profit and loss acco u nt has been charged
with a p rope r pe rcenta ge of depreci ation off items s ub
j e ct to we a r an d tea r
,
and th at proper provi s ion h as

been made fo r discounts b a d debts and also all items of


, ,

incomes du e and unpaid u p to date of closing the books ;


( )
d That the b alance sheet states the assets under
prope r descriptive titles at fair valu e and th at the l ia
, bil i
ties are stated in fu ll ;

( )
e Fin a lly
, if divid e nds have been decl a red th at the y
have been paid ou t of su rpl u s and do not work an impai r
ment of capital .

The stu dent will find that a tho rough knowledge of cor
p o ra tio n law is a bsol u tely indispensable to th e e fi ec tiv e

au diting o f corpo ration books .

. s h on hand at the date of the ba


III If the a ctu al ca l
an ce sheet had not been veri fied by the au ditor on the day
of ba la
ncing what method should be employed to prove
,

its correctness before s igning the a ccou nts ?

He should count the actu a l ca sh ( cu rrency ) on hand ,

and list undeposited checks a fter seeing that they ar e all


entered in the cash book These am ou nts a dded to the
balance in bank a s shown by the check book shou ld a
.

gr ee
with the ca sh book balance Having pe rsonally deposited
cash a
.

nd checks in bank he shou ld leave the p a ss book


,
-

to be w ritten up requesting that it be delive red to him


As soon a
,

s elf pe rsonally s he secu r es the pass book with


-

cancelled checks he should d raw up a reconcili ation a


.

,
c

co u nt by ded u cting u ncle ar ed checks fr om pass book bal


-

ance so as to agree pass book with check book Then


,
-
.

by checking back all receipts deposits and payments to


date of ba
,

l anc e sheet he can ve r ify the cash balance which


appears there .

In an au dit where an exhaustive detailed exam


IV
ina
tion of the books is not stip ulated or not p ractica
.
,

ble ,

what examination is essentia l to insure their gene ral cor

Th e cas h book should be checked as to footings and


postings .

Cash payments shoul d be vou ched and the pass book -

balance at date of closing reconciled with the balance


s hown in the cash boo k .

Next the footings of all books of o riginal entry should


,

be carefully gone over and occasional test checks made of


postings .

If controlling accounts fo r sal es and purchase ledgers


do not e xi st they s hou l d be constructed ; so a
, s to verify
8

the aggregate amount due by customers a nd due to

creditors .

The clos ing entries should be examined and checked to


s ee th at the profi t ( if any ) is neith er under nor over

stated
Lastly the ba
.

lance sheet sho uld be tak en in hand to


a
,

se e that it is a fair exp r essi on of th e Assets and Li bil i


ties of the business as of the date it bea rs on its face .

V What means shou ld be employed to detect the w il


.

f ul omission to ente r in the books under audit sales made


or ca sh received ?

Probably the most eff ective method to detect s u ch


om issions wou ld be for the auditor to fo rwa r d to a ll

customers on the books complete statements of thei r a c

counts for the period u nde r investigation ; r equ es ting that

they be retu rned to him person ally at his official a dd ress


with no tifica tion of e rrors or omission s This is a
. n ex

treme meas ure b u t a most eff ective one worthy of more


, ,

frequ ent adoption .

Where cons ecu tively n u mbe red receipts with co rres


ponding stubs are u sed the detection of the omission of
,

cash receipts would be a comparatively ea sy matte r ; but


where they a r e not the eff ectiveness of the au dito r s wo rk
,

must largely depend u pon the system of internal check


employed .

The omission of s ales wou ld only be made with the


obj ect of appropri ating the cash pa id for same and it
,

mu st be admitted that this cou ld be done occasionally


w ithout mu ch cha nce of detection Shou ld the omis
.

s ions be continous and of l arge amo u nts the decreased


a
,

p e rc ent ge o f gr oss profi t in the trading acco u nt would


9
call for speci a l investig ation Like f alsification of pay
rolls by the a
.

, doption of prope r system the danger may


be reduced to a minimum the prevention being a com
a a
,

p r tiv el y simple matter th,e detection late r on one of


conside r able diffi c ulty .

VI State wha t should be requ i red of a company o r


firm by one who is to make a
.

n au dit o f its books .

When the au dit is to be made unexpectedly wi th the ,

object of ascertaining whethe r irregul a r ities have been


committed by any of the employees the au ditor will have
to take things in the condition he finds them in a
,

nd

trust to his own expe rience s a gacity and ingenuity to


,

suggest the p roper method of condu cting wh at might


be more aptly ca lled the exa

mination ”
.

But wher e the au dit is ente red on at the end of a


fis ca l pe riod he shou ld requ i re the p roduction of an a
,
c

cu rate trial balance ( a s fo rm al evidence o f the books


having been in balance be f ore the y we re clos ed ) a Profit ,

and Loss Accou nt and Balance Sheet .

He should obtain a list of all Books of Account and


the names of the sta ff by whom kept He should label
them so as to indi ca
.

te the period cover ed by their con


tents He should requ ire that all vou che rs be a rranged
in order ; th a t the stock sheets be p roduca
.

bl e signed ,

by the pa rties who m ade th em ou t .

Bonds mo rtgages and othe r evidences of existing


,

a ssets in all forms shou ld be listed and p rodu ced for


inspection simulta neo u sly The cash shou ld be bal anced
.
,

all cash deposited and the pa ss book and cleared check s


,
-

a r ranged in proper o rder fo r ex amin ation In the case


of a corpo ration he shou ld al so a
.

,
s k fo r the Min ute Boo k
IO

ad
n request that the S toc k Certifi cate Book Transfer ,

Book and Stoc k Ledger be written up and available fo r


examin a tion if neces sary .

VII Wh at eviden ce should be requ ired as to the cor


r ectnes s of va l u es of as sets ( other th a
n customers a
.


c
counts ) entered in the books ?

With regard to s ecurities such as S tocks Bonds etc , , .


,

the instruments themselves should be p rod u ced They .

shou ld be lis ted and compared with public p rice lists


( whe re they ex ist
, ) or w i th such evidence of value f r om
various sou rces a s may be otherwise procu rable .

As to real p roperty the title deeds themselves should


be carefully exa mined a nd co rrobo rative evidence a
,

s to

value obtained from real estate men etc to see tha


,

, . t if
,

the book value is above price actually paid it is war ,

ranted by existing conditions .

With regard to plant and machinery the account ,

should be carefully sc rutinized to see that repairs and


renew als have not been added to original cost Original
bills should be p roduced and great care taken to see tha
.

t
adequate provision ha s be en made f or depreciation .

As to the inventory of stoc k of goo ds on hand it ,

shou ld be signed by the p arties who took it Extensions .

and footings shoul d be check ed and if the gros s p rofit


,

on sales evidenced by th e Merchandise or Trading Ao

coun t exhibits am a rked increas ed or decreased per


centage a speci al investigation might be necessary
Rights a a
nd f r nchi ses goo dwill patents a nd o r ga
.
,

, , ni za
,

tion account should be thoroughly gone into so tha t there


c ould be no possible doubt afte r the auditor s certificate ’

is given in the mind of any interes ted person a


,

, s to the ,
II

real meaning and value of any i tem coming unde r these


“ ”
fancy designations .

VIII State what is necess ary in auditing ca


. sh pay
ments and how to p revent the reprodu ction and passing
,

of vo uchers a second time .

I n auditing cash payments the u tmost care should be


exerc i sed to see that prope r evidence of payment is fur
nis hed by checks r etu rned f r om the b ank with pass

book by r eceipte d bills and by p rope r a u thor iza tion


a
, ,

nd entr y in c a sh book The au dito r can gene rally s u c


- .

ceed in a rr anging th at a ll cash paym ents be made by

check except items paid th rough the petty cash book


, ,

and th at no Ledger accou nts be paid th ro ugh that source .

A little ingenu ity will s u ggest methods of obtaining


sa tisfactory vouche rs even for petty cash expenditures
The a udito r ca n p r event the rep rod u ction a
.

nd p a ssing

of vouchers a sec ond time by si g ning o r stamping his

nam e o r initi als on the paid portion of the voucher


in col or ed ink Wh ere the eff acement of vou che rs is


.

not pe rmitted the auditor should h a ve a ll vo u che r s pro

duced simulta
,

neo u sly and retain them all in his posses


s ion until his ca sh au dit is completed .

IX Sta te wh a t exam in a tion should be m a de of the


rec eivable book ac cou nts of a firm o r company to a
.

s cer
tain what ac c ou nts if any shou ld be w ritten o ff a s bad
, , .

The a udi tor sho u ld request the attendance of s ome

m ember of the fir m o r s ome responsible offi ce r of the


c o rpora tion and in his pre sen c e exa mine eve ry account
r eceivable open on the ledger to as ce rta
,

in :
12

mt , that every ba
lance con sists of certain unpaid for -

bills ;
2nd, that no old di ff erences which sho u ld have been
written off a re included ;
3 r d that, no old bills re m ain un p a
id while r e c ent ones
have been settled unless satisfactory expl anation is forth
,

coming ;
4 th th a t no ac co u nt is included as good whi ch is b a r r ed
by the sta
,

tute of limitations ;
s th ,th a t b a l a nces d u e by insolvent fi rm s are trans
f e rred to do u btfu l a c co u nts ; and
6th tha t where outsta nding balances be foun d of un
us u ally l arge amo u nts the sta
,

,
nding and c redit of the
fi rm be ca refu lly a scerta ined This l atte r p recau tion is
.

especi a lly val ua ble whe r e a cco unts have been partly
cl osed by notes receivable which remain in the safe or
, ,

on which there is contingent li ability if disco u nted .

X How m ay it be dete rmined whethe r cer tain expend


.

itures of a m an u factu ring business we r e of the n atu r e


of m a inten ance and r ep ai rs o r cons titu ted an actu al bet
term ent of the pl an t ? State how 1n ea ch ca se they sho u ld
be dealt with in the ba lan ce sheet and in the profit a nd
loss account .

The determining fa ctor should obvio u sly be the n atu re


of the wo rk fo r which the expenditu re was m a de If .

the wo rk pe rformed w a s rende red necessary to m a in


ta in pl ant and machine r y in its p rimary state of etfi
ciency the item wo u ld come u nder the head of r epai r s
,

and shou ld be charged to profit and loss account B u t .

if on the othe r hand the effi ciency of the pl ant as to


, ,

outpu t were increased then the work done would be in


,
13

th e nature of a betterment ; it should be charged to


nd a
Pl ant and M a chinery a ppe r under that heading in a
the ba l ance sheet .

XI . In a uditing the accounts of a business for the


fi rst time what books should be produce d ? Wh at would
,

be the fi rst du ty of the a u dito r respecting these books ?

The au ditor should requ ire the produc tion o f all the
books of accou nt and a l l s u bsidiary books to which ref
,

erence co u ld possibly be rendered necessa ry in the period


u nder review .

His first duty respecting them would be to list them


with descriptive designations and particula rs a s to periods
cove red by contents and the names of the employees by
,

whom kept He should then initi al each book to enable


.

him positively to r e identify it if necess ary In this way


-

bo oks ca
.

nnot be abstra cted o r withheld a fte r o riginal


p roduction without his knowledge and he will be able ,

to swea r whether he has or has not examined a particular


book submitted to him .

XII In auditing the ac counts at the conclusion of


.

th e first fiscal yea r of a corporation formed to acqui r e an


esta blished bu siness what documents and recor ds sho u ld
,

be examined in additi on to the o r din a ry books and sub


j e cts of a n a u dit ?

The audito r should fi rst call for the minute book


which conta
,

ins a copy of the articles of incorporation .

From this he can determine the amount of its autho r


iz ed c a pit al the natur e and scope of its business the
, ,

date of its for mati on etc


He should then ask f or copies of a
.
,

l l contra cts between


14

the vendor s and the corpo ration see that same ha ve


been du ly authorized by reco rded re solutions and a
,

scer ,

tain that prop er expressi on ha s been given to same in the


fin ancial book s .

The stock certificate book the transfer book and the


,

stock ledge r should be ca refully gone through to see that


all contracts in regard to issu ance of capital stock have
been ca rrie d o u t and that all t ransacti ons in regard
,

thereto have been per fectly regular .

Finally all deeds of re alty etc a cq u i red by the cor


a
.
, , ,

p o t a tion sho u ld be c re fully gone over with a view to


seeing tha t thei r val u e is d uly recorded on the books
,
,

togethe r with any liabilities g iven or ass umed on same .

XIII To what extent should an audito r hold himsel f


responsible for the correctnes s of ( a
.

) inventories , ( )
b
pay rolls ( c ) d ep reci ations and dis counts ?
-
,

a
( ) The au ditor shou ld hold himself r esponsible for
th e extensions and f ootings of invento r ies and s tate in ,

his ce rtificate th at he ha s a ccepted quantities and p rices


on the au tho rity of the sign atories It woul d be p r0per .

fo r him to u rge th at the v alu ation obt aining should be


m arket p rice if s ame is less than cost price and cost ,

price if s ame is less than ma rket p r ice


The consta ncy o r var i ability of the percenta
.

ge of gros s
profit in the Trading Accou nt shou ld be of great value
in determining the prima f a cie val u e of the reliability of
the inventory
a a
.

( )
b With re g r d to p y rolls-
the auditor
,
can che ck
time worked from fo reman s book into pay roll sheet

-
,

check calcu lations at g iven rate of wages check footings


of pay roll sheets and see that the final tota
,

-
,
l ag rees
15

w ith the amount of check drawn for wages He should


ma ke ca
.

reful enquiry as to the method pursued in m aking


up pay roll and paying off and pa
-
,y p articular a ttention
to any obvious weak spots in the system .

( )
e As to depre c iation he should see t h at a prop e r

percenta
,

ge ha s been w ritten off all assets subject the reto


a
,

nd should in his judgm ent the rate fixed be insuffi cient

a
, ,

nd the directors of a corporation object to th e a ltera

tions he recommends he should d raw attention to the


,

matter in his report and in the certifi cate he appends to


the ba lance sheet In the case of a firm or sole trade r -

his responsiblity w ould end after he ha


.
,

d cal led attention


to the fact B u t even in this latter cas e the auditor
s hould rem ember that his sta tement m a a a
.
,

y be used s

basis for procu ring trade credit and ba nk accommod ation ,

and that unless he uses the utmost circumspection he may


be made th e instrument of misrepresenta tion
Discounts may be checked by checking total cash pa
.

id
a nd re ceived and seeing that the average pe rcentage

a
,

l lowed and received on settleme nts is approximately


co rrect .

XIV In an audit stipul ating for the examination of


.

a l l vouche rs of every des c ription what would be proper


,

vouchers f or the following : purchases retu rned pur


chases sales returned sales ca
,

, , s h receipts c ash payments


, , ,

j ournal ent r ies ?

For purchases paid for the proper v ouchers would be


,

re ceipted bills ; those unpa id f or should be veri fied by

the p rodu ction of the invoices on fil e Both receipted


.

and unreceipted bill s should be initialed or stam ped


sh owing that the pur chas e s were authori zed and th a
,

t th e
16

good s ha d been received Where a stock book is kept .


,

th e invoi c es should be che cked with the entries th ere in .

Retu rn purchases recorded in the retu rn book should


be vou ched for by c redit memoranda supported by co r ,

respon dence transpo rt receipts etc Refe rence should


, , .

also be m ade to the o riginal purcha se invoices .

The best vouche r s fo r sales a re the o rigi n al o r de r


blanks signed delive ry receipts stock book entries and
a
, , ,

bills of l ding .

Retu rned s ales shou ld be vou ched for by evidence of


receipt correspondence stock book entries and reference
, , ,

to the o r iginal bill


Ca
.

sh receipts should be vouched for by stubs of re


ceipt book evidence of deposit in b a nk cash book entrie s
, ,
-
,

ledge r postings etc , .

Cash payments can be vouched for by receipted bills ,

receipt fo rms checks and notes which have passed


th rou gh the ba nk properly endorsed pa
,

y rolls properly ,
-

checked and signed et c , .

Journal entries shou ld be supported by journal vou ch


ers du ly autho r ized and by a consideration of the fact s
, ,

re corded .

XV On wh at b a sis shou ld the following assets be


val u ed in the pr eparation of a balance sheet : ( a
.

) man u
facture d goods ( )
b p a rtially m a n
,
u factu r ed goods ( )
0 ,

raw m ate rial ( d) open book accounts receivable ( e)


, ,

stocks bonds and othe r investments ( f ) bills rec eivable ?


, ,

a
( ) Ma n u fa ct ur ed goods should be val u ed at cos t ,

i e cost of raw materi al labor freight and a proper


. .
, , , ,

percentage of man agement expenses .

b
( ) Partially man u fa c tured g oods s hould be va l ued
Sum , 1 8 97 .

I . St ate the objects to be attained by an au dit .

The objects of an au dit are briefly , ,

( )
1 The detec tion o f fr a ud .

( )
2 The detection of techni cal errors .

( 3) The detection of errors of principle .

As frau d can only be concealed by a technic a l error or


an erro r of p r inciple it is obviou s that an audit involves
a complete examinati on of the books ; the ve r ifica
,

tion of
th e revenue account to ascertain th at the p rofit or l os s
for a fiscal period shown therein is correct ; and the
reviewing all the items appea ring upon the ba la nce sheet
so that the au ditor may be able to certify tha
,

t neither
assets nor li abilities a re over or under stated -
.

II How should one proceed in o r der to ascertain that


.

all the libil ities a re shown in a balance shee t ?

The p rimary proof th at a ll li abilities are shown is to


be found in the confirmation of the result disclosed in the
revenue a cco unt being co rroborated by the correspond
ing inc rease or decrease of assets over or under liabiliti es
in the b al ance sheet ; but it is a prima ry or mathemati cal
proof only .

With r ega rd to the item accounts payable invoices



,

of me rchandise m ay have been ente red in the stock


book and incl u ded in the inventory but yet not passed
,

th rough to the credit of the vendo r s on the boo k s


This were th e items large would cause a a
.

, , n in cre sed
I9

percentage of g ros s profit in the trading account a nd a

ca
,

reful examin ation wo u ld bring to light the omission


Again returned mercha
.

,
ndise by customers may have
been in cl uded in the inventory and not pa ssed through
the books to their credit The result would be th e same
a
.
,

nd could be proved by correspondence dates in receiv


,

ing book and names and d ates in ret u rns book


,
“ ”
.

Bills payable fo r loans could be proved by cash and


ban k pass book ent ries Notes receivable if discounted
a
.

nd unpa id wo u ld have to appea r as contingent lia

bilities The test of correctness wou ld be reference to


.

cash and note books


Next would come the item of a
.

cc rued liabilities .

Rent wages inte rest on bonds and mortgages and in


, , ,

ter es t on loans wo u ld come u nde r this heading for the ,

determination of the accu racy of which reference would


have to be made to subsidia ry books and do cuments .

Finally the matter of reserves for bad debts dis


, ,

counts and depreciation ( if not already charged off )


would call f or conside ration a
,

nd th eir correctness would


,

be easy of determinatio n where the audit has been con


du cted on scientific lines .

The r e wou ld be considerable variation in specific c as es


a
,

nd the auditor should in each br in his gener a l ex


g
p er ience to bea r u pon the m a tter .

III State briefly and in o rder of p rocedu re the dif


st eps to be taken in auditing a ba
.

f e rent nk .

Each depa rtment of a bank sho uld be taken se pa rately .

Th e au ditor sho u ld commence by counting the cash in


the possession of the Receiving Tel le r and see that it
ag rees with his p roo f

Al l.d e
posi t c hec k s on othe r
20

bank s should be listed a nd amounts a gr eed with thos e


appearing on clea rance house sheet The checks on hand
-

d rawn on the ba
.

n k under examination plus those on


other ba nks dep o sited du ring the day together with ,

cash shou ld equal the total amount of deposits recei ved


,
.

P roceeding to the Paying Teller s departm e nt he


sho uld count cash and see that it agrees with his proof “ ”

He should next list a


.

nd total checks paid out during the

day seeing that the amount a grees with his books


, .

Clearance Hou se trans actions should be c a refu lly ex


-

a m ined and the a udi to r shou ld be most parti cular to s ee


,

that the amou nt of check s on hand plus the total amount


of checks p aid out by the Telle r du ring the day and the
amounts charged to othe r departme nts and Teller s ’

ag rees with the amount of cash he claime d to h ave had


on h and at the close of the p rec eding day s bu s iness ’
.

The di scou nt dep a rtment should next be visited Bills .

discou nted should be ex amined listed and agreed with , ,

the General Ledge r b alances ; thos e sent away for colle e


tion acc epta
, nce etc m ay be proved by co r respondence
, .
, ,

etc Speci a l attention should be called to notes past


.

du e as well a s to collateral loans not cove red by proper


,

margin .

The depositors ledgers total b al ances should agree


with the am ount sho wn in the gene ral ledge r The d ay s ’

de posits sho u ld be exa


.

mined and compared with the


Receiving Telle r s sheet ; notes discou nted and d ra ft s

collected shou ld be checked with the discount and collec


tion regi ste r s and checks cha rged sho u ld agree with
Paying Telle r 3 Sheet .

Fin ally th e genera l ledge r shou ld be p roved ; all se


ent iti es c alled fo r by the b al ances ex amined and c ounted ,
2!

care being exe r c i sed to secure simultaneous production .

The auditor shou ld a t the s ame time persona lly w r ite


to the bank s agents and cor r espondents requesting them

to a dvise him at his office address o f the amo unts due by


them at the close of business on the day of the examina
tion and on receiving replies a care fu l comparison should
be ma de The a ccount wi th the U S Trea su rer ma
,

. . .
y
be p roved by his le tte r s of advice ; the ci r culation re
ceiv ed f r om W a shing ton should be verified also w hile
,

certi fi ca tes of deposit shou ld be p roved from the certifi


cate book and register .

As in eve ry oth er busine ss the corr ectness of earnings


,

sho u ld be proved and ca re taken to see that the a ssets


,

and liabilities on the bank balance sheet at the clos e of


the business day on which the examin ation is made are
neithe r over nor u nde r stated .

IV How should the interest recei ved on a bond


.

bought at a premium be treated ?


Suc h a proportionate portion of the inte res t should be
c redited to the Bonds Pu rchased Premium a ccount
periodically as will wipe out the total premiu m by the time
the bond matu res and is paid at pa r The balance of
.

the inte rest received should be periodically credi ted to


bond interest account whi ch in its turn is of course
,

c redited to revenue a c count as interest on investm ents .

V Should a reserve fund be inves ted in interest


.

bearing s ecuri ties ? State the custom If so inves tec


wha
.

t a ccount should be credited with the in come ?


I t should .

It is the custom to set aside periodi cally and invest in


quick ly reali z able securi ties from tim e to time su c h ,


2

amounts a s ma y b e d e eme d nec es s ary for th e purpos e

for which the fund is to be cr ea ted .

The interest received on the inves tment is either t e


invested thereby increasing the fund o r is cred ited to
th e rev enu e a ccoun t under the hea
, ,

d of interes t on in
ves tments .

Whe re it is desi r ed to rai se a fund of a certai n amount


in a certain number o f y ears s uch a proportionate amount
may be inves ted ann ually a
,

s will in the g iv en tim e ( with

out interest ) equal th e given a mou nt In this ca se the


inte rest should be c r edi ted to revenue a
.

cc ount On the
other ha
.

n d it may be deemed desirable to invest periodi


,

cally s u ch a s um as will at a given rate of com pound


inte rest equa l the amo unt desi red in a given time Here .
,

of course the interest is per force re invested


, , ,
-
.

VI In a n a udit of the a ccounts of a fi rm o r of a cor


pot ation how may the ca sh as s hown by the bank pa
, ss
book be reconciled with the amo u nt ca lled for by the
ca sh book or led ger ? After this cou rse ha
-
s been taken ,

is it ne cessary to check the pass book wi th the deposits


-

as s hown by th e cas h book ? -


What might s u ch detailed
checking s how ?
The ca
sh balan ce as shown by th e bank pass book -

may be re conciled with the amou nt ca


, ,
t

lled for by the


cas h book or l edger by deducting from the pas s book
- -

balan ce the amou nt of all checks charged in the cash


book and deducted from the check book balan ce but -
,

not retu rned by the ban k


After this course ha
.

s been taken it is s till n ecessary,

to check the pass book w ith the deposits as shown by the


-

cash book both as to amounts and dates Such detai l ed


-
, .

checking might show that the amo u nts were not depos ited
23

on the dates stated in the cash book The ca shier s bal



-
.

ance might be corr ect in the aggregate at the time of


bala —
ncing but w rong a t times between b al ancing the
,

infe rence being that he was making tempora ry use of


cash for his own purposes .

VII . How ma
y fraud in payment of wages be de
tected ?

As direct eviden ce of proper payment is almost im


pos sible th e audito r should fi r st thoroughly master the
s ys tem employed noting ca refully any weak pl a ces a
,

,
nd

pay greatest attention to them He shou ld check the


fo remen s boo ks w i th the pay roll a s to time and a
.


-mount
charged for piecework He should then go ca
,

reful ly
over the ca
.

lculations check the footings of the pay roll -

book and s ee that the tota


,

, l agrees with the amount of


the c heck drawn for wage s It may be admitted at
.

on ce that fraud in the payment of wages is ve ry diffi cult


to detect after perpetration bu t comp a ratively easy to
,

prevent by the adoption of proper precautions These .

consi st in divi ding the wo rk of making up the pay roll -

a s mu ch a s possible The calculations and footings


.

should be done by one clerk checked by anothe r the


a
, ,

p y
-
ro ll che ck made out by cashier and cash ac tually ,

drawn by him from the bank the money put into separate
,

envelopes by two other c lerks and the actual handing ,

ove r the envelopes pe rf ormed by othe rs Successful


f raud would here ne ce ssita
.

te so much collusion amongst


em p loyees as to be c onsidered a r emote contingen cy .

VIII In a statement of the earnings of a business to


be sold on the basis of its earning capa
.

city how should ,

the qu es tion of intere s t p aid on a c counts payable on


ns be trea
bi ll s payabl e and on loa
,

ted ?
24

Inasmuch a s these payments wo u ld indicate generally


the w ant of a dequate wo r king capital and in a sm u ch a s ,

such charges wo uld have the efi e ct of lessening the book


earning capacity of ab us iness these i tems shou ld be
,

placed in a separate section of the rev e nu e account so ,

that the real ea rning capaci ty of the b u siness might be


cl early seen The inte re s t th us paid cou ld be available
.

for profit sha ring were these cha rges not r ende red neces
s a ry
.

IX State a method of proced ure in an examination


.

of securities consis ting of bonds stocks and bills receiv


,

able.

The method p ur s u ed sho u ld be a s follows : The au ditor


should see that the bonds and stoc k certifi ca tes— all of
them—be prod u ced at the sam e time He sho u ld e xamine
them list a
.

, ,
nd total thei r f ace va lue He sho u ld next
.

compare them with market quotations Bonds having a .

redeem able va lu e a t a ce rtain time sho u ld be t aken at


,


cost c are being exe rcised to see that d u e p rovision
had been made for th e prope r appli ca tion of inte rest
whether bought a t a premiu m o r at disco unt
Stocks a s rega r ds va l ua
.

, tion for a balance sheet woul d ,

requ ire rathe r di ff erent treatment If m arket quotation


.

be above cost the stock ce rtificates m ay be taken at


,

p u rch a se p rice ; if below the val ua tion of stocks should


,

be written down to market val u e


Bills rec eiv able shou ld be either on ha
.

nd or in the
ban k for colle ction Those on hand m ay be verified by
exa
.

mination ; those a t the bank for collection by the ,

auditor a sk ing fo r a certifie d list of the notes in the


p os s ession of the ban k for collec tion .
26

New roa d beds new buildings new side tra cks less
- -

cost of those taken up new bridges cul verts a nd vi a


, ,

, ,

du cts ne w rails less co st of old ones These are the


principal items If the compa ny s s tocks a
, .

nd bonds are

.

so ld at a d is count to raise funds to be applied to cons truc

tion the construction a ccount should be charged with


,

the amount of the di scount .

XII In the books of a railw ay company what


.
p ro
vision should be made for destroyed equipment ?
The income ac co u nt should be pe riodically charged
an d a reserve a ccount c r edited w ith a c ertain percentag e

of original cost of equipment .

In this way the earni ngs will not va ry by reason of


extrao rdinary expenditure rendered necessary by acci
dents etc , .

XIII Give the headings for a condensed bala


. nc e
sheet of the accounts of a railway company .

AS SETS . LIABI LI TI E S .

a
O ri g i n l C ost of R o d a C a
p ital St Co
oc k , on mm
Ba p i ta
a
. .

C o n s tructi on of r nch es . C l St ock, P r efer red


B m nt B
.

etter e s . o nd s .

E qui pm nt ! o uch ers


a
e
E xp E qui pm nt
. .

r es s e P y - R o ll s
R a l E ta B
. .

t e Accrued Interes t on ond s


l a
e s
! a t ia
.

nd Supp l i B
,

o nd C o up o ns

a
er s es
Ag nt a
. .

n d C nd u t Accrued T xes
a a
c or s
nd Co mpa
o

I nd i idua l a
e s . .

v ni s es . Acc rued R ent l of Le s ed Li nes .

U S Gov enm ent p


E x r es s ! oney O rd e rs
aa aat a Baa
. . . .

St te nd C ounty W rr n s Tr flic l nces


au y
. .

S ecuri ti es in th e Tr e Sund r i es
pa
s r . .

S undr i es Div i dends Un i d


a a
.

m
.

C sh E q uip ent R enew l Fund


a
. .

R enew l Fund .

Und ivided P rofits .


27

X I! What test should be made of the prime cost of


ma
.

nufactured goods to guard aga inst loss of raw m ate ri al


through theft by employees ?

The auditor should fi rst a scerta in wha t ( if any ) system


of internal check is employed .

Al l pu rcha s es of raw m a ter i als and s u pplie s shou ld be


checked into stock ke epe r s books from invoices and
-

,

thence into the cons u mption books Labo r shou ld be


.

ch ecked also into the cons u mption book .

I f accurately kept any sho rtages du e to theft wou ld be


appa rent as soon a s the inventory w a s m a de up This
ma
.

y be illust ra te d a s follows

1 904 R AW ! ATERI AL ACC OUNT


Ja
. .

nuary 1 . To Inventory
June 30 . Pu rcha ses to date

1 904 .

June 30
. By consumption to da te
30 Invento ry
Shorta
.

ge to be accounted fo r .

If invento ry at the beginning of the period was


the
and w a s p urch ased the wo u ld
ha
,

ve to be accounted fo r .

If was consumed and rem ained in hand


worth of raw m ateri a l would ha
,

ve to be accounted
f or .
28

we re no mistakes in ca
ances ha d been made for ma
a
I t would be necessa ry for the auditor to see that there
l culation and th at p roper l low
n u facturing shrinkage and
w a ste .

Whe r e cost account s a re not kept the dec reased per


,

centage of gross p rofit in the tra ding account would put


the auditor on the a le rt and he wo u ld have to construct
for hims elf su ch accounts from existing r eco r ds as would
enable him to a rriv e at the sa me app roxim ate results
.

XV In an invento ry how should stock pu rchased on


c redit s ubj e ct to usua
.

, l discounts be valued ?
,

T ra de discounts should be deducted from purcha se


p ri ce but c ash discounts should not a s the re is always a
on ha
, ,

possibility th at the re may be insu ffi cient cash nd


on a particu lar day to en able advantage to be taken of
s u ch dis count
.
December , 18 9 7 .

I State briefly a p rope r course of proc edu re for mak


ing a co rrect au dit of the books and accounts of ( a
.

) a
m an u factur ing business ( b) a fire insuran ce company
, ,

( )
0 a b a nk .

a
( ) In au ditin g the books of a m a n factu ring bu siness
u ,

speci al a ttention shou ld be paid to those points whe rein


it di ff e rs from an o rdina ry t rading conce rn As in every .

othe r audit th e cash bo ok should be checked exhaustively


,
.

All receipts should be traced into the bank ; all paym ents
ve rified by vouc hers ; all footin gs and postin g s che cked ;
and the balance on hand agreed with the pa ss book at -

the clo s e of the period u nd er review by the constru ction


of a reconciliation account .

The footings of all bo oks of o riginal entry should be


checke d and where possible the postings a
,
lso .

The t ri al balance should be p roved ; the closing entries


i nto the p rofit and loss account rigidl y s c rutinized ; and
finally the balance sheet made up and certified to .

The above p rocedu re is common to the audit of most


businesses ; bu t in a manufacturing business the pay roll -

should be carefully checked and whe re cost accounts


,

a r e kept the purcha ses consumption and final invento ry


, , ,

of raw ma terial should be g one over .

( )
b In the au dit of the boo k s of a fire ins ur an c e com
p a ny the tot a l amount o f in co m e re c ei v able should be
first ascerta ined and ve rifi ed f rom the Policy Book and
the Renewal Register I f renewal r eceipts are given for
.
30

a
l l existing policies the un u sed receipts should be pro
,

duced a s vouchers for poli c ie s discontinued If blan k .

receipts are u sed at the head offi ces and at the branch es
and agencies the numbe r of receipts issued used and re ,

tu rned should be compar ed with the number of renewals


and discontin uances When the gr oss a mo unt receivable
is found the ins urance discontinued can be ve rified a
.

, nd ,

the net am ou nt receiv able arrived at .

The amou nt of c ash rece ived as premiums less the


o utsta
,

nding bal ances a t the commencement of the period ,

will agree with the net amount receivable less the bal
a
,

nces outsta nding at the time of Cl osing th e books .

The au dito r shou ld obt ain a list of th ese ba lan ce s and


see that they h ave been received since closing the books ,

o r that the agents have acknowledged the amou nts to


have been received by them .

R e ins urances c a ll for ca r eful examin ation and atten


-
,

ti on shou ld be given to the reserve for same


The ca
.

sh book should be checked and vou ch ed ; the


cla im book examined and care exercised to see that
,

p roper p rovision ha s been made fo r claims in process of


adj u stment .

As in othe r financial institutions the Bal an ce Sheet


calls fo r special conside ra tion so that the auditor ma
,

, y
be able to certify tha t the assets are neither over nor
under st ated and th at a ll the liabilities h ave been ta
-
, k en
into account .

( )
0 The method of a u diting the books a nd a cc ount s of
a bank h ave been expl ained fu lly in the answe r to ques
tion n umbe r III J un e 1 897 to which the reader is re
, , ,

fe rred It will be well for the auditor to bea r constantly


.

in mind the fact th at his responsibility is not confin ed to


3!

the mere safeguarding of the interests of the stockholders


of the bank :his certificate is o r should be a virtu al guar
, ,

antee to the public th at the accounts to which his signa


ture is attached m ay be accepted and relied upon as
co rrect in every respect .

II The check book of a company shows cash in bank


.
-

the bank p ass book fo r the s ame date shows


-

which is correct and which amount should be


included in the balance sheet ?

The am ount to be inclu ded in the bal a n ce sheet is

$ 5
1 2 00 a s it is ass umed ( a ctu a l ve rific ation having been
ma de by the audito r ) that the tota
, ,

l amou nt of checks
made ou t and charged th rou gh the ca sh book b u t not yet
-

presented for payment at the bank is which a dded


to the mak es u p the shown in the pass
boo k .

III Under wh at circumstances sho u ld deduction be


made for depreci ation ? W h at cl a
.

sses of assets a re most


subj ect to d epreciation ?

Dedu ction sh ould be m ade for depre ciation whe rever


the asset is s u bj ect to a continu al decline in value th rou gh
s ubjection to wea r and tear as in the c a se of plant

,

and ma chine ry ; or through expi ration of value as in the


ca
,

se of leas es etc
Fixed or capita
.
,

l assets a re mo st s ubject to dep reci a tion


—but e a ch item m u st be considered on its own me rit .

Th u s while the pl ant and eq u ipment of a rail road would


be consta ntly d ep rec i a ting in value and call for consta
,

nt
renewals the const ru c tion account might actu ally in
crease in val u e for va
,

rious reas ons .


32

IV An ins urance company b u y s for investm ent $ 50


000 7% 1 0 y e a r bonds a
.
,

t 1 16
-
Shou ld this p urcha se be
enter ed in the bal ance sheet at p a
.

r o r at cost p rice ? If
the l atte r wh at s ho u ld be done with the p remi u m in
, ,

view of the fact th at the bonds will be pa id off at p a r a t


a
the expi r tion f 1 0 years
o ?

The investm ent shou ld be ente r ed in the bal ance sheet


at cost p rice Th e p remi um he re .

ha s to be wiped o ut in ten ye ars The income is .

—o f which $800 ann uall y shou ld be c r edited


to the p remi um account and the b al ance to the ,


incom e from investm ents accou nts It will be well to

bear in mind th at while this is a pr a ctica


.

l answe r to the
q u es ti on the income on the investment is not a s the

bonds co s t 1 1 6 P rovision ha s to be ma de fo r the loss


.

of inte rest on the p remium which decrea ses year by ,

year A refe rence to tables speci ally constru cted fo r


.

this purp o se will show at a glance the am ount a ctu ally


nece ssary to be set aside ou t of in co me to p ro vide for
this item .

V In the case of an audit of the books of a corp ora


.

tion wh ere the vol ume of t ransa ctions is so l a r ge th at a


detail ed ch ecking o f all postin g s a n d fo oting s is ou t of
the qu esti on wh a t course sho u l d be pursu ed in the exam
ina
,

tion in or der to i ns ur e th e co rr ectne s s of the b al ance


sheet 7 ’

As in all othe r au dits ca s h receipts and expenditu res


,

shou l d be checked exh au stively ; c ash book footing s and


po s tings gone over and vou che rs examined ,
.

The footin g s of all books of o riginal ent ry should be


g one ove r a nd the in c o m e a nd ex p endit ur e a cco u nts
checked If cont rolling a ccounts for cu stome rs a
.
nd
34
The goods sent out on c onsignm ent should be c redited
to the me rchandise a ccount at cost and charged to a con
s ig nm ent acco u nt unde r the name of the cons ignee .

Wh en he renders the account sal es the consignee


charges himself with the sales pr ice of the goods and cred
its himsel f with expenses incu rred co mmission and th e
, ,

cash he remits in settlement The consi gnor now c redits


.

the consi g nment account with the sales p rice and charge s
a pe rsonal account with consignee with same ; credits a c

count of consignee with expense and commission a nd


charges same to consignm ent a ccount ; c redits cash re
mitted to consignee s account ( th us balan cin it ) and

g
c h arges his own cash ac cou nt with same . Should th e
credit side of the consignment account exceed the debit
side the di ff e rence is the profit on the t ransaction whi ch
shoul d be debited to the consignm ent ac count ( closing it )
and credited to the mercha ndise acc ount as profit on con
s ignm ent .

VIII I f any pa
. yments are recei ved by a company on
ac cou nt of wo rk in process how should su ch paym ents
,

on account be shown in the balance sheet ?

Any amou nts expended for wo rk in p rocess of compl e


tion at the time of closing th e book s should appea r on
the balan ce sheet as pa rt o f the inv ento ry under the
head of work in process of completion
“ ”
. Any payments
received On account of same should be dedu cted from
this unless the payments re ceived exceed the amounts
expended on the wo rk in which case the amount rec eived
on ac count should appea r as a liability under the hea
,

d of

paym ent received on account of uncompleted contra ct ”
,
35

and the am ount a ctually expended on the work be de


du cted therefrom a s le ss exp enditure on same
“ ”
.

IX In an audit of the books o f a company how m ay


.
,

the correctne ss of the following items in the bal ance sheet


be dete rmined : ( a ) o uts ta ndi ng acco u nts ( )
b sec ur ities , ,

( )
c invento r y of finished stock a nd ra w m ate r i a ls ( )
d
ba
,

nk balances ( e ) c r edito r s open a ccoun ts ( f ) c r edit ors


’ ’

bills pa
, ,

y able ?
Outsta ding ex—
accou nts by
a mination of e a ch
( )
0 n

account to see that it is good or if dou btfu l that p ro



, ,

vision has been made for same unde r the hea d of re


serve fo r do u btfu l accounts ”
Whe re possible the co r
.

rectnes s may be fur ther confi r med by th e au dito r person

ally m a iling a st atement to e ach cu stome r requ esting


ve r ification of same to be sent to his own offi ce Dis .

counts should also be provided f or .

( )
b Se cu ri tie s should b e all produced at the same time
e xamined listed and com pa
,

, ,
re d with m arket p rices cost ,

bills etc
a
, .

( )
c Inventory of finished stoc k and r w m a terial
should be checked a s to extensions and footings and
si gned by the pa rties who m a de up the invento ry Raw .

mate rial should be taken at cost if same be below m arket


value ; if above at ma rket v al u e
a
.
,

d
( ) Bank b l a n c es sho u ld be tested by h a ving p a ss
books written u p checks comp ared wi th stubs of check
,

books and outst anding checks ded u cted from the pass
,

book balances .

( )
e With r e g a r d to c r edito r s open a cco u nts’
the bal
a nces should be compa r ed with statements r ende r ed ,

w hi ch the auditor sh ou ld request to be s ent to his own


oflice The stock book should be carefully examine d
.
-
36

to see that all goods ta ken into stoc k and appearing on


the inventory have been actually credited on the books
to the par tie s from whom pu rchased .

f C r edito r s bills p a yabl —the amounts should b


( )

e e

compar ed with the stubs of the bill book and the entries
-

in the notes payable book Wh er e the notes g iven a


. re

n umbe red consecu tively the fo rme r is a most inval u able


check ; but where loose blank s a
,

re u sed the c ustomer

m ust fall back on the sta tement chec k f or absol u te con


fi rm ation of the acc ura cy of the amount a s there is ,

nothing to p r event a note being gi ven to a creditor and


his account being left still open .

X A comp any ha s cau sed to be m a de a revaluation


.

of its b u ildings pl ant and m achine ry and it is found th at


, ,

the new val u es ar e g re ate r th an those shown by the


books ; wh at does this la rger v al u e indicate and how
'

shou ld s u ch excess be treated in the books of th e com


pany ? W h at ent rie s shou ld be m ade to g ive eff ect to
these conditions in ( a ) the b al a nce sheet ( )
b the,
p rofi t
and loss acco u nt ?

The l arger val u e would ind icate either that items


h ad been charged to the revenu e account instead of
being capitalized o r that an excess amount had been
,

w ritten off for dep reci ation .

The excess va lu e shou ld be ch arg ed to buildin gs plant ,



and machine ry account and credited to a reserve f or
dep reci ation account

a
.

( ) In the b a l a nce sheet the ex c ess should be added


to the old valu ation and th e reserve account would a p
pe ar on the li ability side
a
.

( )
b It would be un desi r able th a t the it em sh oul d p
37
pear in the profit and los s account as an abno rmal ,
in
crease in p rofit would be shown .

XI A manufacturing corporation desires a certifi


.

cate of its ave r age ann ua l p rofits for th ree years ; after
charging up a ll costs expense s and dep reci ation and an
, ,

allow ance fo r bad debts it is found that the profits for


,

the fi rst year were for th e second year


plus p rofi t on sa le o f investments and for the
thi r d yea p rofit on the s ale of rea
,

r plus l
es tate Give the annual average profit to be ce rtified
. .

total
profit ; 3 th e ann ua l p r ofit to be
certified The p rofits on s a le of investments and r eal
.

estate a re a bnormal for a manufactu ring company ; and


w hile they a r e profits of the company they are not manu
facturing profits .

XII In some kinds of business the expenditure on re


.

p ai r s and r enew a ls a cco u nt va r ie s conside r ably f r om yea r


to year ; how should this expenditur e be de alt with in the
bo oks of the company so that th e p rofits need not fl uctu
ate by reas on of this va ri able expenditu re ?

The expen diture shoul d be provided fo r by charging


profit a nd loss a ccount and c r editing rese rve fo r de “

preciation a ccount with such an amou nt ann u ally a



s

would be about the average ( taking several years )


amount exp ended for rep a i rs and renew als Then a s

the expenditu r e was m a de it co u ld be ch arged a


.
,

, gainst
this reserve .

XII I I n an audit of the books of a company it is


found that the president s sa
.

la ry a ccount is credited with



38

a bonus of for e xtra services in addition to the ,

usual salary paid him ; what s teps should be taken to


as certain that this item is correct ?
As s u ch a bonus wou ld have to be granted by the
ofli c er s of th e company the min u te book should be ex

am ined by the au dito r to see th at th e amou nt w a s a


,

thor iz ed by a reso l u tion duly r eco r de d Should such .

a resolution not appear it wo u ld be his duty to noti fy the


,

di r ector s and if the t ransa ction were found co rrect to


ask them to ha
, , ,

ve a resol ution p a ssed and recorded .

XIV The p rofit and loss account of a manufacturing


.

company for six months ending J un e 30 1 896 contains


on the debit side ( a
, , ,

) stock on h a nd Jan u a ry 1 1 896 ( )


b , ,

purchases of raw m ate ri a l ( c ) m an u facturing expenses


, ,

d
( ) p
e x enses of selling ; on the c r edit side ( )
e sal es (f) ,

stock on h and June 30 Does the bal an ce of these


.

amou nts constitu te the net p rofit fo r the six months o r


should other charges be taken into account ? If so sta
,

te ,

them .

The balance of these amounts does not constitu te the


net profits a s the following charges should be taken
,

into accou nt
Reserve f or B a d Debts .

Reserve fo r Disco u nts .

B a d Debts
Depr eci a
.

tion .

Rep ai rs and Renewa ls etc etc , .


, .

XV An audit of a set of books fo r the half year


.

ending Decembe r 31 is begun J an u a ry 26 ; what course


shou ld be p u rsu ed to p rove the correctness of the cas h
on hand Decembe r 31 ?
39
The cas h book should be balan ced the pass book writ
- -

ten up to Janua ry 26 a
,

nd a r econciliation account d rafted


as of that date Then checking ba ckw a r ds to December


.

3 1
, the b a lance m a y be ve r ified on th at date also
. The
method to be adopted is fully explained in the answer to
question No 3 Decembe r 1 896
.
, , .
4 0

311116 , 18 9 8 .

I State as b riefly a s possible the duties of an au ditor


.

of an o rdina ry manufacturing conce rn .

He should ca ll for the p roduction of a ll the books of


ac count list them p u t distinguishing labels on them and
, , ,

take down the name of the clerk in cha rge of each As .

in every othe r kind of au dit he shou ld check all cash


t ransa
,

ctions exh au stively check the footings and post


,

ings of all books of o rigi nal entry and verify the


co rrectness of a ll t r i a l b a
,

l ance s previous to the clos


ing of the books He should go ove r the inventories
carefully and see that ra w m aterial and supplies a
.

re

valued at or below cu rrent market pri ces a nd wher e ,

cost accounts are kept it would be well for him to


,

recon cile consumption and invento ry at close with in


vento ry at beginn ing of period und er review plus s ubse

quent p u r chases The pay rolls shou ld next receive a


.
- t
tention Fin ally the closing ent ries should be s c rn
.
,

tinized ca r efully with a view to seeing th at all income


a nd expenditure prope r ly appli cable to the per iod under

review was in cluded in the reven u e accou nt and that the ,

Balan ce Sheet set forth fa i rly and truly th e position of


th e conc e rn .

II How should the following ass ets be v a lued f or


the pu rp ose of showing the t rue net capital of the pa
.

rt
ners in a priv ate conce rn a
( ) finished goods
. on hand ,

( )
b r a w m a te r i a l ( )
c wo rk in p
, r og r ess d
( ) a c co un ts ,

receivable ( e ) stocks and shares in other companies ?


,
42

in a sepa rate a ccount as rese rve for bad a nd doubtfu l



debts.

The most convenient method of ascertaining whether


accounts receivable are good bad or doubtfu l is for the
,

auditor to have the total balances entered in a three


column sheet and to ask the man ager or some responsible
offi cial who is familiar with the accounts to go over the
ledge r accounts with him seri ati m A ccou nts held to
.

be b a d or doubtful should be extended into the sec


ond and third columns respectively All bad accounts .

should be charged o ff and a liberal percentage ch a rged


,

to p r ofit and loss account and credite d to rese rve “

for do u btful debts account If an account is outl a



. wed
by the statute of limitations it should be classed as bad
,
.

Whe re firms are in the hands of a receiver the amou nt


and the a
,

ul tim a tely to be rec eived is p r obl em a tic a l c


,

cou nt should go into the dou btfu l column No old un .

settled balances should be accepted as good if more


recent bills have been paid unl ess a sa tisfacto ry explana
tion is f orthcoming . The auditor should see that the
bal ances actu ally consist of specific cha rges and a re ,

not composed of perhaps a se r ies of disputed balances .

Parti cular attenti on should be devoted to a ccounts where


notes have not been paid at ma turity and have been t e

charged to the customer N B For this reason when
ever anote is renewed the transaction should always
. . .
,

appear in the custom er s account and not as is freq u ently



,

the case simply consist of a transfer in the bills receivable


,

acc ount.

V How shoul d leases be treated in the balan ce sheet


.

and in the profit and los s account of a company ?


43

Wh ere a lease of property has been purchased the


am ount p a id f or sa
,

me shoul d appe ar on the balance


she et as an asset under the head of cost of lea sehold
,

premises This shou ld be w r itten off in propo r tionate



.

amounts to profit and l oss account ann ually so that ex


a
,

p ir tion of v a l u e will c oincide with expi ra tion of le a se .

VI St ate which of th e following should be charged


to ca pital accou nt and which to r evenu e ac count : ( a
.

)
repai rs to machine ry and plant ( b ) rep la cem ents of plant , ,

( )
c new plant p u rch a sed d
( ) cost of le as ehold
, premises ,

( )
e par tners salaries

.

( )
0 Repai r s to m chinery a and plan t— reven u e a cco u nt
a
.

( )
b Replace m e n ts of pl a n t— c pital acco u nt less r e

s idua
l value of th a t taken ou t
a
.

( )
c New plant —
purcha sed c apital
cco unt .

( )
d Cost of le a sehold p r emises— c a pit a l ac c ount
a a
.

( )
e Pa r tne rs s l 1i

es revenue ac co unt -
.

VII A m an u fa ctu ring company takes out a


. nd sells
a quantity of old machine ry and repl aces it by new ;
what account sho u ld be cr edited with the proc ee ds of the
sale ? Give reasons .

Plant and machine ry accou nt should be cr edited with


the proceeds of the s ale a s the new m achinery should be
,

charged up at cost If th e proceeds do not equ al the


.

amount at which the old m achine ry stands on the books


'

charge ofi the difi erence to reven u e account .

VI I I Difi erentia s fu lly a s possible a m a


te a nuf a
c
turing account a trading acc ount and a profit a
.

nd loss
a
,

ccount and state what the balance in each indicates


, .
44

A man u fact ur ing account is designed to show the


actual cost of goods man u factur ed dur ing a certain
period and the balan ce shows cost of outp ut
A trading account should show th e a
, .

ctual p rofit or
l os on go ds sold—d i ff e r ence between cost of acqu isition
i o
or manufactur e w ith incidental exp enses a nd s a le price .
, ,

The balance shows the profit o r loss on the trans a ctions .

A p rofit and loss account is designed to show th e net


p r ofit or loss of a business for a ce rtain period a fter all
,

item s of income and expenditure have been taken in to


account The balance shows the amou nt of inc rea se o r
.

decrease of capital or surpl u s resulting therefrom .

IX How should th e loss on share s issued at a dis


.

count be dealt with in the accounts of a corporation ?

The loss on shares so issued shou ld be charged to


dis count on shares issued account and be gradually

wiped out by periodic proportionate charges to reven u e


account .

X In examining the books a


. n d accounts of a business
for the pu rpose of giving a certificate o f the net profits
earned for a n umber of years how should inte r est paid
on pa rtners ca
,

pital be treated ? What other importa nt


points should receive attention in or der to state the profits


net ?

Inasmuch as su ch charges would h ave the e ff ect of


decre asing the amount of net profits shown it would ,

appe ar desi rable to eliminate these items from the p rofit


and loss account and show the net ea rnings sepa ra tely .

If l a rge amo u nts had been paid f rom time to time as


interest on loan s bills payable accounts payable etc
, , ,
.
,
45

the sam e p rinciple would apply as this would show a


,

deficiency of working capita l With suffi cient c apital


.

these charges wou ld not be incurr ed and the net ea rnings


,

wou ld consequ ently be inc re ased by these am ounts On .

the other h and it wou ld be most necess a ry to see that


,

a dequate amounts h a d been per iodicfi y written off for


dep reciation and that pr ovision ha d been m ade for t e
,

se rve fo r discou nts ba d debts etc All items of capital


, , .

expenditu re wou ld require to be care fu lly examined to


see th at no am ounts p rope rly chargeable aga inst rev
enu e ha d been inclu de d the r ein .

XI How may the auditor know th at the ba lance


sheet a
.

nd p r ofit and los s account of a corporation whose


books he ha s au dited inclu de all income and expenditu res
applicable to the year under review ?

With rega rd to the p rofit and l oss account the auditor ,

shou ld see th at th e closing entries h ave been prope rly

made of those items which appea r upon the books i e — . .


,

th a t the b a l a nces of the nomina l accounts a re co rr ectly


transferred He must then be guided by his e xperience
.

to a sce r ta in wh a t i tems of income and expenditure not


appe aring upon the books shou ld be ta ken into account .

These will necessa rily vary according to th e pa rticula r


n ature of di ff erent kinds of business S u ch m atters as
.

dep rec i ation rese rves for bad debts and discounts wou ld
,

ha ve to be taken into account as would a ll ac c rued lia


,

bilities s u ch a s interest w ages etc


, ,
On the other hand
.
,

p rep aid ch arges such a s rent u nexpi r ed insurance in


, ,

ter es t ea rned but not coll ected should be taken credit


fo r The accura cy of the result a r rived at in the p rofit
a nd loss account shoul d be confirmed by the ba la
.

n ce
4 6

sheet s u ch confi rm ation being prim a facie evidence that


,

the bal ance sheet is fu ll and correct .

XII In a l a rge dry goo ds b u siness it is considered


.

n ecessary to divide the bookkeeping in s u ch a w ay that


each ledge r shall be bal anced sep a rately ; how should this
be done ?

The ledgers shou ld be planned a s f ollows


A general ledger to contain the nominal and real
accounts with separate controlling accounts f or pur
“ ”

cha se a n d s a les ledge r s th u s conta ining all the materials


,

for a complete independent tri al b al an ce the cont rolling ,

accou nts showing the totals of the amou nts due by cu s


tom ers and d u e to c redito r s .

2
( ) A pu r ch a se ledge r con t a ining individ ua l a ccounts
with c r edito r s and a general ledger account W hi
“ ”
\

shou ld show a debit bal a n ce eq ua l to the total amo unt of


credit ba l ances in the ledge r and agreeing with the con
t rolling accoun t in the gene ral ledge r
a
.

( 3) As ma ny sales l ed g er s s m a y be deemed desirable


'

divided up to contain customer s accounts in alphabetical ’

order A F G I etc and each containing a general


- -

ledger acco u nt the tota


, , , .
,

, l c r edit bal ance a ppearing in


whi ch is equal to the total debit balances appe ar ing in it ,

agr eeing of cou rse with the controlling accou nt in the


, ,

general ledge r The c a sh book s ales books jou rnals


.
-
,
-
, ,

etc should cont a in sep arate colu mns fo r e ach ledger the
tota
.
, ,

ls of w hich a re posted p e r iodic ally to the several


cont rolling a ccounts in the gene ral ledger and to the
several general ledger acco u nts in the p u rch a se and s a les
ledge rs In som e cases instead of sepa rate columns fo r
.
,

separate ledgers in sales books journals etc it may be -


, , .
,
47

found more convenient to use separate books of entry .

Each ledge r can now be balanced separately The total .

sales cha rged in any pa rticul a r ledge r are at the end of


the month to be credited to its general ledge r acco u nt the
tota l ca sh cr edi ts to cu stome rs debi ted and thu s the a
,

c ,

cu racy o f the posting into each ledger separately demon


a
t d
s tr e .

XIII Is a t rial bal ance the s am e as a balance sheet ?


If not i n what way doe s it difi er ?
,

It is not .

The trial balan c e contains the ba lances of all the ledge r


accounts nomi na l real and personal ; while the bal ance
sheet conta
, , ,

ins only a list of resou rces and liabilitie s in


condensed form made u p from the trial balanc e after the
closing ent ries have been ma d e A trial bal ance made up .

after the closing ent r i es have been ma de contains the bal


ance sheet items in extended form .

XIV A partn ership contract betw een A and B p ro


vides that e a
.

ch partner shall contribute to a new


business and that on any c apital brought in by either
,

partner in exces s of this amount he sh all receive


A contributes a ddition al and the bookkeepe r
ma
,

kes an entry in the books at the end of the year credit


ing A with 6 % on viz $600 which is debited .
, ,

to B Is this co rr ect ? Give re a sons ?


.

It is incorrect A should have been credited and B


.

debited with $300 as the whole of the capital contributed


is of W t h A shou ld cont ribute h alf— Le $30 , ,

000 .To preserve this p roportion he ( in theo ry ) can only


lend B on whi ch s u m he is entitled to 6 % in
te res t vi z $30
, 0 .
, .
48

XV Wh at course shoul d be adopted in a


. n audit of
the books of a firm where defal cations are suspe cted ?

The au ditor should first ascertain by examination and


inquiry the most li kely sou rces of leakage and act accord
ingly He should count the cash on h and deposit it in
the ba nk h ave the pa ss book written up a
.
,

-
nd recon c ile its

balance with that of the check book and ca


, ,

sh book
- -
He .

shou ld then car efully check the footings of the cash book -

as most defalcations whe re cash has been appropriated a


,

re

covered by intentional false footings and making corres


ponding intentional errors of additi on in some ledger
account All ledger footings should be checked and cas h
.
,

items checked from the ledg er into the ca sh book -

Wh e re a colu mnar cash book is in use pa


.

-
rti cul ar atten
tion shou ld be paid to s ee that items a
,

re en te red in th e

p roper col u mns and that vo uchers ar e forthcoming for


,


a ll amou nts appearing in the expense column Re

,

turned merchandise book should be sc rutini zed and al l


items ve rified as false entries may be made to cov er ca
, sh
appropriations Finally statements should be mailed per
s ona
.
,

ll y by the audito r to a ll customers and c reditors


with a req u est that they be examined and returned to
his own c flice noted as co rrect or otherwi se Thi s is a .

matter whe re e xperience is the best teacher The au di


to r would have to be guided by the circumsta
.

n ce s of the
case relying upon his own ta
, ct and judgm ent a s to the

best methods to pursue .


so

see that all ch a rges and credits in the profit and los s
account are co r rect and proper and finally that the
, , ,

Balance Sheet exhibits the exact state of the corp ora


tion s a ff airs a s of the da

te he is called to certify .

He shou ld car efu lly examine the minu te book to see


that the remun eration p a id to offi ce rs of the corporation
h a s been au tho riz ed and to ascertain that dividends ( i f
,

declared ) have been passed on by the di r ectors .

He sho u ld see th at if dividends have been declar ed


they have been ea rned paid ou t of s u rplus ea rning s a
,
nd ,

not wo rk an imp airment of ca pital The stock ledge r


.
.

shou ld be examined to see that it is p rope rly written up ,

and that the am ount of stock iss ued does not exceed the
amount o f the au thorized capital stock of the corpo ra
tion .

The exa min ation of the books of a ccou nt wou ld ( bea r


ing in mind these points ) be conducted in p recisely the
same manner a s those of an individu a l or co p artnership - .

III Wh at is the significance of an au dito r s certificate


.

of profits of a bu siness abou t to be sold to a new com


pany ? To wh at extent is an au ditor responsible morally
and legally for his ce rtifica
,

, tes ?

The si g nificance of the au ditor s certificate is that he


is able a fter exhau stive examination of the books of a c

cou nts to give a


,

n a ss u rance th a t the earnings ar e co r

a
,

r ectl
y st ted and,
t h a t the a ssets a nd li a bilities ar e
neithe r u nde r no r ove r stated To en able him to do this
.

conscientio u sly he must p revi ou sly h ave a scertained that


the pe rcenta
,

ge of gross p rofit w as constant ; that the


reven u e a ccount had been pe riodically charged with a
p rope r p e rc ent a ge o f cost of pl a nt ma c,hine ry et c f o r , .
,
SI

depreci ati on ; th at all extraor dinary profits were shown


separately and tha , t in te rest on loan s p artne rs s a l a ries ,

,

etc we re not ove rlooked The fin al significance is this


.
, .

That the balance sheet which he brings befo re the t e


sponsible oflicia
,

l s of the pu rch a sing c omp any conta ining ,

the net res u lt is in su ch a form th at they thm eselves


,

can exercise thei r j u dgment upon it .

As to the responsibility of an a udito r morally from


an ideal standpoint he shou ld be held lia
,

, ble for any e r ror


of omission o r commission which mi ght su bsequ ently
appea r which he ha d eithe r intentionally o r unintention
,

al ly overlooked ; but legally it is qu estionable if he


, ,

could be held resp onsible fo r anything less that inten


tiona l ce rtific ation to a fraud u lent rep r esentation of facts ,

re sulting in pecu ni ary loss to those indu ced to par t with


thei r money relying upon his ce rtificate
, .

IV State wh at an auditor should do to ascerta


. in if
the following assets appe arin g in a b a l ance sheet a r e
taken at a fair v al ue : ( a r cha
, ,

) m e nd is e ( )
b m a chinery , ,

( )
0 r eal estate .

( ) 0Merchandise : Its v a l u e sho u ld be determined by


compar ing invento r y with stock book a nd pu rcha se bills -
.

If the cost p rice is equal to or below the cu rrent mark et


price it should be taken a s the fai r v al u e of the mer
cha
,

ndis e ; but if the cost p r ice is above the market p ri ce ,

then the inventory should be t aken a t current m arket


value .

( )
b M a chine ry : Th e v a l u e should be determined by
comp aring pu rch a se bills with ledge r ent ries ca re being ,

taken to see th at no repai rs were added to the ledger


acc oun t a nd to a scertain th at a prope r perc entage for
,
52

depreciation h a d been periodically dedu cted from the cost


p rice When o rigin al invoices of cost are not producibl e
.
,

the services of a competent appraiser shou l d be invok ed ,

whose v al uation shou ld be acc epted as correct .

( )
c Real Estate : The purchase pri c e should h ere be
taken plus any expenditu re for improvements Wh ere a
s ale is contemplated a professi ona
.

l appra ise r should be


,

employed ; but whe re it is held as a business capital in


vestment for use the purch ase pri ce shoul d obtain : any
,

increment in value being regarded as a secr et reserve .

V State wh at me ans s hou ld be employed to a scer


ta
.

in if the f ollowin g assets w er e p roperl y included in a'

b al ance she et at the valu ation g iven : ( a ) s to c ks and


bonds ( b) bills receivable ( c ) acco u nts receivabl e
, , .

a
( ) Sto ks and Bonds : These shou ld be fi rst exa
c m
ined counted a nd listed
, Those quoted on the Stock
.

Exchange can be put down at current market val ue ;


those not at val uation obtained by inqu iry trade reports
, , ,

etc

Bil l s Receivable : These shoul d be tak en a


.

( )
b t f ace
valu e a nd should either be on hand or le f t at the ban k

f or coll ection Those on h a


,

. nd shoul d be examined to see


th at none a re ove rdue and l isted ; those at the bank
shou ld be evidenced by a certificate f rom the ba nk a
,

s to

n umbe r and amou nt The qu estion of makers and in


.

dors ers is impo r tant and in certain cases referen ce woul d


,

have to be had to rating lists etc O f cours e no over , .


,

du e bi lls should be allowed to be includ ed


c ) Acco u nts Receivable : To determ in e their va
.

lue it
wou ld be necessa ry to examine each account to see that
non e w ere outlawe d cons iderab l y overdue bad, or doubt
, ,
53
ful in the u s ual manner and care exercised to see that
, ,

adequate provision had been made for bad and doubtful


debts dis counts etc
, , .

VI What measu res should be taken by an auditor to


satisfy himse l f that all liabili ties ha
.

d been b r ought into


the books and balance sheet of a manufacturing busi
nes s ?

The question is What wou ld be the liabilities whi ch


,

one woul d naturally expect to find in the b alance sheet


of a manufactu ring compa ny ? Bil ls and account s pay
able intere st ac crue d wages accrued and unpaid taxes
, , , ,

contingent liability on notes discounted and u ncompleted


contracts would probably be those whi ch would readily
occur to the auditor and he would have to dete rmine
by inquiry a nd exa
,

mination if there w e re others .

As to bills and accounts p ayable an examination of ,

the books and requests for sta tements fr om credito r s


would ena
,

ble the auditor to determine the amount which


should appear in the balance sheet .

Should the pe rcentage of gross p rofit appear to be


abnormal ly large he might be j ustified in s u specting that
goods had been ta
,

ken into stock appea r ed upon the in ,

v entory but had not been passed th r ough the books to


,

the cr edit of the sellers On the other hand he might


.
,

develop by examination the fact that l arge quantities of


go ods had been r eturned b y pur c hase r s taken into sto ck ,

and not passed through to the credit of the purchasers .

As to interest a ccrued an examinati on of the bill book


,
-

would enabl e him to figure out what was accrued at the


da te of the bala nce sheet
Wages a ccrued coul d be ascerta
.

ined f rom the pay roll -


54
book or a v ery cl ose estima te m ade by c ompa rison with
,

the p receding week .

Taxe s : These could be asce rtained by inqui ry or by


refe rence to the book recor ds of p reviou s yea rs .

Contingent liability on notes discounted co u ld be fig


ured by reference to th e bill book -
.

Lord Davey s wor ds m ay be app ropriately quoted here


The auditor is bou nd to know everyt hing the books


tell him to h ave all th e s u spicions that the books sug
gest and to ma
,

, ke a ll the infe rences to wha t he finds in


the books wou ld le a d him

.

VII How m ay an au dito r know that credits fo r


me rchandise r et urned are bonafide and not ma de to
.

conceal a sho rtage in cash ?

This depends materially u pon the system of internal


check If the system be tho rough and the auditor is
.

satisfied that there is no collu sion between th e cashier


and the credit clerk he can r ea dily dete rmine that the
me rch andise cr e dits are bonafide by refe ren ce to ship
,

ping inw ards book corr espondence etc B u t where col


-
, ,

lus ion is s u spected and this wou ld p r obably involve


,

cas hier cre dit clerk and stock cle r k then it wou ld be
necess ary to send sta tements to custome rs for verifi ca
, ,

tion .

We re th ese i rregu larities ve ry extensive the result woul d ,

be shown in the g ross p rofit of the me rchandise acco unt ,

but occ a sion al false ent ries wou ld be ve ry di ffi cu lt to de


teet The au ditor shou ld check fr om the ledger to the
.

c a sh book all moneys received and he might find entries


-
,

credited as c ash which we re not in the cash book but in -


,

the credit book This wo u ld be p rima facie evidence of


.

a shortage in cash which cou ld be absolu tely determined


,
55
by re f erence to the party in whose account the entry a
p
p a
e r ed
Th is is simil ar to fraud in pa
.

y roll s A good- syst em .

will render its perpetration exceedingly diffi cult and its


ex posure simple ; while its dicovery late r on is a matte r
of great d iffi culty .

VIII Wha t classes of sal aries a


. nd wages sh ould be
charged directly ag ainst the cost of m anufacture ? Give
reasons .

Against the cost of manu facture should be charged


wages of wo rkmen actua lly employed in the ma nuf a
c

turing of superintendent of facto ry ( be ca u se this is a


,

di re ct addition to th e c ost of labo r ) of those co nnected


,

with the managem ent of the light heat and powe r ( be


,

cau se the work could not be ca rried on withou t them ) ,

and of all the fo remen In shor t any wages paid for


work done in any w ay connected with actual m a nuf a
.
,

tu ring shou ld be charged directly against the cost of


man u facture .

IX How shou ld the right to rem u ne ration claimed by


.

offi cers and directors of a corpo ration be ve rified ?


The right to remu ne ration sho u ld be verified by re fe r
ence to the min ute book of the corporation which shou ld
conta
,

in resolutions authori z ing the payment o f the


amo unts cl a
imed .

X How should the bank b alance appea ring in the


books of a compa
.

ny be verified by the a u di to r ?
Supposing that the auditor has sta rted on his wo rk
before the books are closed at the close of busines s on
,
56

the last day of the fis cal period under review he should ,


.

balance a nd ru le off the cash book count cash a nd checks


on ha nd a
,

nd s ee th at they added to the che ck book -

ba
, ,

lance agree with the balance c alled for by the cas h


,

book He should then personally deposit the se checks


a
.

nd cash in the b ank and r equest that the p a ss book be


,
-

written up and retu rned to him at his own offi ce When .

he receives it he should make up a r econciliation account


by adding all checks entered in the c ash book not t e -

turned by the bank to the check book bal ance a s of the -

date of closing the books and the total should agree


,

with th at shown by the pas s book But sho u ld he com -


.

mence his audit at some da te subs equent to the clos ing


of the books then he shou ld p r oceed in the manner in

dica
,

ted in the answer to q u estion numbe r three De cem ,

ber 1 896
, .

XI To what shou ld the dis cou nt on bon ds sold for


.

construction and the expense of disposing of s uch bonds


be charged ? Give r easons .

The discoun t on bonds sold for cons truction and the


expense of disposing of such bonds sho u ld be charged
to construction account The reason is that the constru e
tion work ha
.

s cost not only the amo u nt actu ally expended

thereon bu t the discount on and expenses of disposition


,

of the bonds also .

XII Under what circumstances sho u ld pa id checks


.

be treated as vou chers ? Are checks prope r and sufli


cient vouchers for purch a ses ? Give rea sons .

Checks may be treated a s vouchers when the purpose


of the payment is s tated on the face of the che ck the ,
58

taken over what addition al assets ( if any ) were a o

qu ir e d a
,

nd w h a t agreements we r e made a s to the iss u ing

and disposing of new stock He should see th at a


,

. ll
assets and liabilities we re properly b rou ght on to the
books of accou nt ve rify the opening ent ries by compa ri
,

son with the info rm ation which he ha s th u s elicited and ,

finally by a ctual test assure himself that a ll the con


, ,

ditions of the l aw in rega rd to the a ccounts h ave been


du ly complied with .

XV How m ay the au dito r a sce rta


. in the p rofits for a
given period from the books of a co mp any kept on a
,

system of single entry ?

In single entry the p rofit or loss fo r a given period is


dete rmined by wh at is te rmed the Resource and Li a
.

bil ity method which consists in comparing all the as


sets a
,

t the end of the per iod unde r r eview with the li a


bil ities ( incl uding c apita l a cco unts ) ; the excess of the
assets ove r the liabilities con sti tutes the net profit The .

confi rmation of the a ccuracy of the res u lt by the s ame


figu res being arrived at by means of a p rofit and loss
a ccount is of course lacking All cash t rans actions
, , .

wou ld have to be most carefu lly gone ove r footings and,

postings of cash wo rk checked and ba lance ver ified The


, .

sales and p urch a se books shou ld be footed and the foot


ings checked Finally the bal ances of all the pe rsonal
.
,

accounts should be ext racted from the ledger and the sev
e ral sch ed ules of assets and li abilities constru cted which
,

are the component elements from which the Resou rce


and Liability statement is made up .
59

3une 18 9 9 , .

I . De fine adit adit


u , u or .

Audit:

( au dit h e heaLatin
r s —
) The ex a —
minati o n .

of an account by a per son appointed to tests its accu ra cy


by compa a
,

u r a u a
'

rin
g e ch ite m wi th vo che s dding p e ch ,

p age and at l a s t au thoritatively stating the sum owing


,

or at c redit The term is u s ed by Sha


. kespeare
Yet I can m a ke my adit u p
u .

— Coriol anus , I .
, 1 .

To ke ep your earthly au dit



.

K ing Hen ry !I II III 2

And how his a


. .
,

ud it s tands .

— H a mlet III .
, 3 .

An old w riter Ayl iff e in his Pare rgon w rites


Bishops ordina ries a
, ,

uditing a ll a ccou nts take twelve



, ,


pence .

Anothe r A rbu thnot says : I love exact dealing and


let Hoc u s a
, , ,

udit; he knows how the money was dis



bur s ed
a a
.

Auditor : ( L atin— au dito r— —


hea re r ) A pe rson p
pointed to examine accou nts .

Sh akes pe are w rites



If you s uspect my h u sband ry o r falsehood
Call me befor e the strictest a
,

uditors ,

And get me on the p roof ”


.

— Timon of Athens 11 , .
60

II . it the duty of an auditor of a ban k actua lly to


Is
inspe ct the s ecurities representing the bank s invest ’

ments ? I f so wha t cour se should be adopted in con


,

ducting s uch examination ?

It is The auditor should call f or the a ctual produ ction


of the s e curities s imulta
.

neou sly examine and list them , ,

and compare them with ( as to value ) current market


quotations The result arri ved at will weigh with him
.

in determining the fi gu re at which they should stand in


the balan c e shee t to the ac curacy of w hi ch he is asked
,

to certify .

II I I n the event of s uch a difl erence of opinion be


.

tween auditor and di r ecto rs concerning the rate of de


preciation on plant and ma chinery as would involve an
important a l teration in the propos ed rate of dividend ,

how can the matter be settled to the sati s fa ction of both


parties ?
The matter might be settled t0 the satisfa ction of th e ‘

a u ditor by agreeing to call in the servic es of a n expert

apprais er and to be bound by his dec ision But should


, .

such appraiser confi rm the audito r s views and the de ’


,

preciation to be w ritten 03 necessitated a redu ction in the


proposed rate of di vidend it is qu estionable wha t degree
,

of satisfa ction the director s would deri ve i

IV Is it a part of the duties of the auditor of the


.

accounts of a stock company to consider the question of


depreciation on assets s uch as buildings ma chinery
, , ,

plant etc ? Give reasons for yo u r an s wer


, . .

Yes ; it is a most essential part of his duties Al l


as sets s ubj ect to wear a
n d tear in cour s e of time ha
.

ve
to be replac ed If provision is not ma
. de for this out of
61

the ea rnings of the company by writing ofl to profit ,

and loss account periodi cally su ch a percentage of cost


as will make expiration of va l u e synchronou s with resid
u al valu e then the installation of new plant machine ry
, , ,

etc would have to be made by the introduction of fresh


capita
.
,

l ; as presumably that portion of the earnings which


sh ou ld p ro perly h ave been set aside for the purpose
wou ld h ave been distr ibute d to the stockholders in the
form of dividends .

V In examining cash vou chers in the cour se of an


.

audit is it ne cessa ry to place yo u r initials or some other


,

distinctive mark on each and if so why ? , ,

It is .

Be ca u se s uch mark w ould prevent the imposition on


the a u dito r of the same vo ucher for two distin ct pay
ments .

VI If the cash in hand of a firm or company under


.

a u dit consists in part of checks re ceived from c u stomers


but not deposited in b ank how may the auditor ass ure
,

himself that su ch checks are p roperly incl u ded ?

The au ditor should compare the checks with the


amounts and names entered in the cash book pr ior to the -

date of balancing and closing same to ascerta in that they


form a bona fide pa rt of the b alan c e of cash on hand at
that date .

VII Show how the bank transa ctions of a partne r


.

ship or company unde r a u dit may be utilized in verifyi ng


the ca sh book -
.
62

If p rinciple of depositing in the b ank a


th e ll moneys t e
ceiv ed is followed the tot a l deposits a s pe r pas s book -
,

will a
, ,

gree wi th the tota l receipts en te re d in the cash


boo k If all payments be m a de by check ( exc ept petty
.

ca sh disbursements ) the tot a l charges in the c a sh book


,
-

should agree with the tot al footing of the check book -

stu bs Th e deposits if entered on the check bo ok as -

ma de can be ve rified a s to da
.
,

,
te a nd a mo u nt with the
entries in the pas s book The check stubs can be com
-
.

p ared with c a sh book ent ries and by m eans of a recon


-
,

cili ation a ccount the pa ss book ba lance c an be m a de to


-

serve as a test of the a ccuracy of the cash book bal ance - .

The dispos ition of no tes rec eiv able can be traced a s can ,

also that of d ra fts etc , .

VIII Wh at the v al u e of a bank pa ss book fo r the


. is -

purposes of an au dit ? To what extent s houl d it be taken


as a vou ch er for cash book entr ies or for the bal ance
-
,

c arr ied for w ard ?

Its valu e consi s ts in the fact that the auditor can


s atisfy himself of the a ctua l existence in the b ank of a
ce r ta in s u m at certa in given date and th at the amounts ,

and dates of all deposits c an be ve rified


The pa ss book ( the au dito r having taken the p reca
.

-
u

tion to ascertain that he is in pos session of the gen u ine


one ) m a y be ta ken a s a vou che r fo r the re ceipt by the
bank of mo neys deposited and fo r the b al ance ca rried,

fo r war d in the ca sh book a f ter he h a s reconciled s aid


-
,

balance with the pa s s book ba lance in the u s ual man


-

ner ,
63

IX Is the re any satisfacto ry method of a u ditin g a


. c

counts not kept by double entry ? I f so ill u strate the ,

method .

The r e is .

The au ditor shou ld check a ll r eceipts and p aym ents


into the bank by the pa ss book a nd o u t th ro u gh the
— -
,

check book reconciling the p ass book bal ance with the
-
,
-

check book ba lance in the u s ual manne r All the foot


-
.

ings of and postings from the ca sh book should be -

checked the ch eck book stubs com mred with the cash
,
-

book ent ries and same vou ched a s completely as possible


,
.

The footings and postings of all books of o ri gi n al ent ry


should be checked the invento ry gone carefully ove r and
, ,

the ex istence of all othe r than book assets and the valu
ation of s ame p roved from the given d ata and all pos
sible sources The profit o r loss should be a rrived at by
.

com pa r ing the assets with the liabilities Althou gh the .

nominal accou nts and controlling accou nts are not kept
in single entry books the a u ditor is often able to con
,

struct them ; and where possible this sho u ld always be


, ,

done The eff ectiveness of the a u dit will depend mate


r ia
.

lly mu ch mo r e so th an in dou ble ent ry books— upon



the closeness and ca re with which the checking is pe r
fo rmed .

X In au di ting the a ccoun ts of a p rivate firm whe re


.

the re a r e seve ra l pa r tne r s to wh at points shou ld the


,

a u dito r look in o r de r to be a ss ur ed that the p artners ’

accounts are co rrectly stated in the balance sh eet ?

He should p rocure a copy of the co pa rtne rship a r -

ticl es of agreem en t a
nd tho rou ghl y familia ri z e hi msel f
64

with its provisions In this connection his duty wou ld


be to see tha
.

t they are carried out in th e bookk eeping .

The principal points to which he should give atten


tion are
I To see that each partner ha s act u ally contributed

the amount of capita


.

l agreed to .

II That all partners are charged with intere st on


.

withdrawals and credited with interest on investm ent of


capital if s o agreed
, .

III That no partner has with drawn more than was


.

stipu lated .

IV That any agreement as to interest on excess capi


t al brought in by any partner ha
.

s been com plied with .

V That no items p roperly chargeable to indi vidu al


.

p a rtne rs h ave been charged to the firm .

VI And lastly that p rofit or loss has been credited


.
, ,

or cha rged to individu al partners in the p roportion pro


v id ed for in the copartnership articles of agreement .

XI Wha t evidence shou ld an auditor requ ire as to


.

the existence of assets ( other th an book debts ) appea r


ing in a ba l ance sheet and as to the correctness of the
,

amounts a s ente red in the books ?

I
. Cash by
—actual cou nt of cash undeposited and ,

bank bal ance by compa rison of cash book balance with -

check book bal ance by means of a reconciliation ac count .

II Notes receiv abl e—by actual inspection if on hand ;


.

if at bank for collection by proc uring a ce rtificate f rom


the bank of the amou nts and other particulars of notes
in thei r possession .


III Pl ant and ma chine ry by a ctua l inspection by
a
.
,

compa r i son of i nvoi ces with ledge r ccounts seeing that ,


66

them and classify expenditure accordingly tha t one of


the chief values of an a u dito r consists .

An a u ditor wou ld be j u stified in refu sing his certificate


of au dit ( 1 ) shou ld r evenu e expenditure be found to
h ave been capitalized and shou ld his propo sal to p roper
,

l y adj ust s ame be r efu sed ; ( 2 ) should the offi cers and
directors of a co rpo ration refu se him pe rmission to pro
vide a dequate rese rve for dep reciation ; and 3) should
dividends have been paid where no surplus existed
against which to charge them .

XIII An audito r has to audit the accounts of a firm


.

o r comp any which is a l arge employe r of labo r fixed and


ext ra ; state ( a
,

) wh a t vo u che r s the auditor sho u ld ex


peet to find and in the ca se of the ext ra l abor how s u ch
, , ,

vou cher s sh ould be ce rtified ( b) what co urse the a u ditor


,

shou ld recommend his client to a dopt to m ake s u re that


the re we re no dead men cha rged on the fixed lists
“ ”
.

The au ditor shou ld ( in the case of fixed labor ) expect


to find a s vouchers the pay roll sheets or book signed by
-

the cle rk by who m it was made u p the f oremen s cer


,

tified time books


-
and can celled checks agreeing in
,

amou nts with the totals of the pay rolls


-
.

In the ca se of extra l abo r he shou ld be furnished


with sep arate pay r oll sheets conta
-
,
ining names a nd sig

natures o i r eceipt by the payees s aid sheets being also


,

certified by the foreman and by the manager or some


,

responsible offi ce r
a
.

( )
b To make sure that no de d men were charged
on the fixed lists the auditor should recommend that the
,

actual payer of wages shou ld occas ionally be changed ,

and that either the manager or he ( the auditor ) person


67

ally shoul d occasional ly put in an appeara


n ce while the
wages were being paid out .

XIV What res erves should the auditor expect to find


.

set aside out of in come be31des those fo r bad debts and


discounts in the ca se of ( a a
,

, ) steam ship company ( )


b ,

a telegraph company

a
( ) In case o f a steamship company the audi tor
the ,

should expect to find reserves for


1 Repairs and renewals ;
.

2 Casualties and other contingen c ies ;


.

3 Insurance
. and pensions .

b
( ) I n the case of a teleg ra ph company
1 Repairs and r enewals ;
.

2 Contingent legal expense s et c


.
, .

XV I n what way m ay an auditor form an opinion


.

as to the value of book debts and ou tstanding accounts


gene ral ly ?

He may form an Opinion as to their value by exa min


ing carefu l ly in the company o f some r esponsible em

a
,

l
p y o ee or member of the firm each outstanding account ,

so as to as certain that the b lan ces are made up of spe


c ific bills unpaid that no ol d disputed portions of bills
,

are in cl uded that the balan ce is of comparatively recent


,

d ate not ou tl awed by time expiration by refer ence to


trade ratings books and by seeing that provision ha
, ,

, s

ben made in th e f orm of r eserves fo r doubtful debts


, , ,

discounts etc , .
3aap 1
nu r , 9 00 .

I When an auditor employed to adjust the accounts


.

of a firm finds that the c u rrent work is behind and that


no t rial balan c e has been made for ov er a yea r what ,

cou rse should he pu rs u e having regard for his own in


teres ts a
,

s well as for those of the firm ?

He shoul d m ake an exhau stive cas h audit constru ct


controlling accounts so a s to be able to m a
,

ke up a bal
an ce sheet a nd by completing the posting of all charges

and credits to the nominal a ccounts obta


,

in the material
to con stru ct a pro fit and loss ac count to confi rm the a
,

cu racy of the resul t of the year s operation s shown on ’

the balance sheet While this is being done he should


employ extra assis ta nts to aid the offi ce s ta

a
.

fl in bringing
the wo r k up to date and in t king ofl a trial balan ce as
of the l ast day of the period under review He could .

then proceed w ith his a u dit of the whole period in the


u sua l manner .

II What bo oks and other s our ces of in f ormation


.

shou ld an a u ditor require in connection with the first


au dit for a corporation ?

He should require a copy of the arti cles of incorpora


tion a copy of the by laws the minute book stoc k cer
-

tifica
, , ,

te book transfer boo k and stock ledger


, In addi .

tion to thes e he should cal l for the produ ction of the


,

cash book journal s ales books purchase book s returns


- -

books ( sal es and purcha ledger and trial bala


, , , ,

ses ) ,nc e
69

book He would al so need a


. ll vouchers returne d check s
, ,

chec k books and pass books ; in short all the financial


- -

and s ubsidiary books in any way recording transa ca


,

tions
o f the cor oration
p .

III How should a


. n audi to r ve r ify the co r rectness of

a
the seve ral accounts rec eivable fou nd open on the books
of a mercantile fi rm whose ccounts he is called on to
a u dit ? Give reas ons .

Al l charges should be checked from the sales book o r -

copy book conta


- —
ining fac simile of bills render ed Cash .

credits shoul d be che cked into the cash book and -


,

c redits for go ods returned into the retu rn book and stock
book Discounts credited should be checked into the
ca
.

sh book or journal and notes credited should be com


-

a
,

p red with the bill s re c eivable book and cash -


book He
.

should check the footings of each a ccount and compare


the bala nces disclosed with the monthly balan ces entered
in the trial balance boo k When irregula rities a re sus
.

p ec ted a final ,
tes t c ould be made by th e a u dito r per so n
ally mailing statements to the customers reque sting that
they be returned to him at his offi c e approved as correct
The reason s are tha
.

t he may sa tisfy himself th a t all cash


received in settlement o f cha rges ha s been accounted for ,

and that no a ccounts stan ding open as u npaid have been


paid and the cash abstracted by a dishonest employee .

IV How shoul d the auditor treat a compa


. ny s ac

counts with its several agencies at the end of the fiscal


year each agency having been charged with a
, ll of the
goods shipped to it and each having some stoc k remain
ing on ha
,

nd ?
70

The trea tm ent would depend materially upon the sys


tem on whi ch the a ccounts were kept S u pposing tha t .

a separate merchandise acc ount was kep t for each ag ency


on the books at the main oflice ea ch agen cy would be
,

charged with goods shipped credited wi th s ales as re


,

ported monthly and with inventory on hand at the end of


a fis cal period I f an agency sales ledger controlling
.

acco unt be kept goods sold would be charged to it and


, ,

cash as re ceived credited ; the balance wou ld show amount


outs tanding A cash a ccount would show cash remitted
.

to the age ncy and re ceived from it as acco unts are co l


lected or cr edited if f or expen ses reported An ex
, .

p ense a c co u nt for each agen c y would show the co st of


runn ing the agencies and th u s the profit or loss on
,

each agen cy ascertained At the end of the fis cal yea r


.
,

on the main offi ce balance sheet the amo u nt of the cash


,

in agents hands inventories and a ccounts rec eivable



,

wo u ld fo rm separate items among the assets it being ,

made c lear that these items were in the hands of agents


and not at the main offi ce .

V If you we re called in to investigate the books of


.

account of a man ufact uring fi rm that contempl ate d s ell


ing its business to a co rporation and were required to ,

repo rt o n the net profits of the past five years what


wou ld be you r cou rse ? How wou ld you ascerta
,

in the
value of the pl ant and m achinery and of other assets ,

that might aff ect the net p rofits of the pe r iod under re
view ? Give a n indication of the repo rt you would make .

I shou ld make a tho rou gh and exhau stive examination


of the tra ding a ccou nt to ascertain that the percentag e of
gross p rofit was fairly constant ; that all purch ases were
71

cha rged u p a s well as retu rn sales ; and the inventories


ha d been co rrectly m a de u p as to va lu es and calculation s .

Procee ding next to the p rofit and loss account I ,

would scru tinize e ach item appearing therein ; see th at


there was no very gr eat fluctuation in the net p rofits ;
that no p rofits of an extraordin a ry nat ure ma de on out
side ventu res we re incl u ded ; th at p r ope r cha rges h a d
been m a de for dep reciation ; and that no expenditu re
properly chargeable therein h a d been capitalized H aving
ass u red myself th at the profit for each yea
.

r was correctly
stated I shou ld take the av er age ann ual r es u lt of the five
,

years t rading as a ba sis of calcu lation



.

I sho u ld ascertain the val u e of plant and machinery


by compa ring the p urchase bills wi th the ledger entries ;
see that a p roper pe rcentage o f d ep r eciation had been
periodically written off and that no outlays fo r repai r s
,

wer e in c lu ded therein The same p rocess would be fol


.

lowed in ar riving at the va lues of buildings etc , .

Accounts re ceivable wo u ld h ave to be examined and


s c rutinized to test thei r value ; bills receiv able and sec u ri

tie s produ ced and a ll othe r assets s ubj ect ed to review


, .

The report made would depend upon circu mstan ces but
'
,

in general might read afte r this fashion

Dear Sir
In acco r dance with your instructions I have m a de an
examination of the books a
,

nd a c count of Messrs So .

So for the five years ending December 31 1 904 and beg


to report that the ave rage net annu a l ea
, ,

rnings fo r the
per iod we re Appended plea se find a statement
72

of a ssets and liabilitie s to the cor r ectness of wh ich as


, ,

well a s to the net e arnings above st ated I hereby cer


, ,

tif y
. Yours faithfully C P A ,
. . .

VI In m a king up the bal ance sheet of a firm o r co r


-

po t ation how should the auditor t reat goods th at ( a


.

, )
have been sent abroa d on consignment and rem ain un
sold ( b) are in the hands of the agents at home ( c )
, ,

have bee n sent ou t on sale or ret u rn ?


“ ”

a
( ) In making up the bal ance sheet goods that have
been sent ab roa d on consignment a
,

nd rema in unsold

should appea r under a separate desc riptive hea ding as



an asset being p art of the invento ry and there should

a lways be a certain pe rcentage deducted as a reserve for
losses on s ame
a
.

( )
b Goods th at ar e in th e h ands of a gents t home
should be tr eated in the s ame way .

( )
c Go ods sent o u t on “
s a le or r et u rn sho u ld form
,

part of the inventory as they a re simply on memo ran


,

dum .

VII You are called in to examine the books of a


.

fi rm whose bookkeepe r and cashie r h as absconde d He .

is known to be an embezzle r to the amou nt of at lea st


The books h ave been kept by do u ble entry
and are a ppa ren tly cor rect How would you proceed
.

to determine the total amount of the embezzlement ?


Mention the di ff erent methods that the embezz le r might
have u sed to hide his stealings .

The ca sh on hand shou ld be co unted and the pa ss book


,
-

written u p and reconciled with check book balance The


-

st u bs of check book should be compa red w ith the ca


.

sh
74

Inventory of completed product on ha n d should be


va lu ed at cost of production ; product in p rocess to the
extent to which it has approa ched completion ; uncon
sumed materials at cost or ma rket p rice whi chever is ,

lower .

IX Should the audito r of a fi rm or corporation revise


the fo rm and wording of the ba
.

lance-sheet to whi ch his


certificate is to be atta ched ? Give reas ons .

Yes if necessary The assets a nd liabilities should be

so stated and worded a s to leave no dou bt a


, .

s to their

meaning even to the o rdinary laym a


— n The auditor
.

should bear in m ind the fact that he is acting not in the ,

inte res t o f the di recto rs and offi cers but in that of the
stock holders and the general p ubli c ba
,

-
nk s etc w ho rely
upon his bon a fides to state clearly the exa
.
, , ,

ct position
fina
,

nci ally o f a corpo ration as of a given date The


l umping together of such items as capital a
.


nd surplus ,

profit and los s sho uld a lw ays be res isted as being

utterly mislea ding .

X Give rea
. s ons f or o r aga
inst the nece ssity of a
n
audito r s verifying the sto ck ledger of a corporati on

.

It wou ld appea r des irable that the audito r should


ve rify the stock ledger to s ee tha
-
t the amount of a u
tho ri z ed capita l stock is not exceeded This ledger is
easily m ade self ba l ancing by charging in a bal an c e a
.

-
c

count the total amount of the capital stock and c rediting


individu al stockholders with thei r holdings This need .

only apply to the numbe rs of sha res i ssued and held


and so that that agrees with the capital stock a ccount in
75
the general ledger the auditor n eed not t ro uble himsel f
abou t fu rther deta
,

il s .

XII In balan cing a set of books consisting of cash


book pur chase book sales book j ournal a
.

- nd ledg er the
debit s ide of the trial ba
, , , ,

lance is found to be in
ex cess of the c redit side ; how shoul d the error be

Check the footings of all the books a dd to the tota ls


of the fo rmer trial bal ance the tota ls of a ll debit a
,

nd

c r edit entr ies since made and the res ult will be the cor
'

rect footings of the new tria l ba lan ce The s ide on


which the error is ma de will then be appa rent a
.

nd the

checking over limited accordingly This method pre


and a
.

s upposes that no ac co u nts have been ru l ed ofi l so ,

that the tot al debit and c r edit footings of eve ry account


app ears upon the trial balance Many devices so “ ”

ca lled are in use but it will be generally found tha


.

— t

the l ongest way round is the shortest way hom e a ”
nd

tha
,

t a fter these devices h ave been t ried and found want


ing ( as is most often the case ) th ere is nothing like the
,

g od old fashioned w ay of c alling over


-
“ ”
o .

XII Describe the steps necessa ry


. to mak e a compl ete
audit of a savings -bank .

Cash on hand should be verified by actua l count a ll


s ecu r ities should be prod uced at the same time li sted a
,

nd ,

compared with market values ; all other investments


by satisfactory eviden ce a s to cost and pres ent value .

The cash book shou ld be footed ; deposits checked to de


-

positors a ccounts ; inte rest checked a s to ca l cul ation


c redit to depositors and charges to the income a


,

, ccount .
76

Interest acc rued at time of clos ing the books should be


checked and the total amount due depos itors ( after ver i
fica tion ) comp ar ed with the gene ra
,

l ledge r controlling
account Whe re possible depositors pass books should
.

-

be compa red wi th ledge r balan ces and accounts The .

deposit slips and chec ks can be used to verify deposits


and withd rawals The income account should be ca
. re
ful ly examined to test the propriety and suffi ciency of
the entries and lastly the corre ctness of the ba l an c e
sheet proved Great ca
,

re should be exercised to see that


.

the methods employed in the conduct of the bu siness are


intr a wir es and th a t all statu tory p r ovisions h ave been
,

compli ed with .

XIII Des cr ibe the p ro cesses of verifying the cash


.

book of a partnership or company by means of the bank


transactions .

P roceeding on the a ssumption that all receipts are de


posi ted in the ba nk a nd th at all payments except th ose

ma de through the petty ca sh a


,

re made by ch eck
-— th e
auditor should see tha t the bal ance s per cash book at a -

the day of closing agrees with the check book balance


,
-
,

which should be reconciled with th e pass book bal ance -


,

by de du cting f rom it the amount of all che ck s not re


tu rned by the b ank Check book stu bs should be com.
-
,

p are d with cash book ent ries ; d epos its checked with the
-

pass book ent ries as to date and amount ; and bills re


-

ceiva bl e collected a t bank o r dis counted there as well as ,

notes payable p aid or discounted there compa re d with


p ass book entries and with the ca
, ,

-
sh book In this way -

the m onthly c a sh ba
.

l ances appearing in the ca sh book -

and tri al ba l ances can be absol utely veri fied .


77
XIV The Y CX Co ta
. kes a large number of notes
.

( bills r eceiv a ble ) f r om its cu s tome r s and when in,


need
of funds disco unts o r sells them ; how may the accounts
be man aged so as to show the company s liability as in ’

do rse r on the paper discou nted ?

All notes received in payment of accounts should be


c redited to the party from whom received and charged to
Bills Receivable account thro u gh the j ou rnal When .

no tes ar e discounted or sold the cash received should be


credited to a Bills Receivable Contingent Li ability a
“ ”
c

cou nt When pa
. i d this account shou ld be ch a rged and
,

Bill Receivable account cre dited through the j ournal


Th e c redit ba
.

l ances of the Bills Receiva ble Contingent


Li ability a cco unt will then always show the a mount of
the company s li ability as indorse r on the pape r dis

cou nte d o r sold The same result might be obtained by


.

the method s u ggested in the author s Theory of Ae ’

counts ”
.

X! . The m achinery used by a fi rm ha s been pur


chased on the inst alment pl an with monthly paym ents
, ,

and unde r the stipul ation that the title shall pass only
when the last payment has been made At the close of
the fi s cal year there are yet several pa
.

yments to be made .

Th e firm also pays a royal ty on the outp ut of some of


the m a chines secured on this plan How should the
auditor in his ann u al sta
.

tement deal with the machine ry ,

the instalments paid and the royalty , .

An accou nt should be opened for M achinery Account


Special a ”
n d at the top of the ledge r shou ld be ente red

particu l a rs o f the price d ates a


nd amount of insta
,

llments
to be paid As ea ch in sta
,

. llment f all s due the account ,


78

shou ld be debited and the vendors credited with the


amount The installments as paid wo ul d be ch arg ed
through the cas h book to vendor At the end of a fis ca
.

- . l
pe riod the machinery account would figure as an as set
— paid on accoun t of machinery — with a note stati ng
“ ”

am ount necessary to complete the purchas e.

Th e royalty due at time of closing should be charged to


profit and loss account and credited to the parties to
whom due This would appear amongst the o rdinary
acco unts pa
.

yable
.
79

311m , 1 9 00 .

I Explain generally the duties of a n auditor State


the qualification s and training neces sary to fit a
. .

n au di tor
for the discharge of his duties .

The duties of an auditor are to pas s in revi ew the work


of other s a nd to determine the co r rectness of a ccounts a s

evidenced by absence of fraud techni cal errors a


,

nd

e rro rs of p rinciple Having as certained that the a


, ,

. c

counts a re cor rect it is the auditor s duty to c ertify to ’

the cor r ectness of the ea


,

rnings of the undertaking for a


gi ven period an d of the
,
b a lance sh eet as o f a given mo

men t of time .

To fit an audito r for the dis charge of his duties he


shou ld poss ess a thorough knowledge of eve ry bran ch of
book keeping ; an exact knowledge of commercial and
-

corpo ra tion law ; considerable acquaintan ce ( ga th ered


from actual experience ) with the methods on whi ch va
rious kinds of busine s s a re c ondu cte d ; and in general a , ,

libe ra l education His training should always be


.

obtained in the oflice of a duly quali fi ed publi c a ccount


ant and the measure of the degree to whi ch he ha s

profited by it is evid ence d by the a


,

cquisiti on of s u ch qual

ities a s tact caution firm ness fairnes s good temper


coura ge integr ity discretion industry judgment pa
, , , ,

tience clea r headednes s a nd la s t but by no mea


, , , , ,

,
-
, ns l eas t
, ,

reliability .
80

II Is it a
. n audito r s duty to con c ern him self to any

,

extent with the validity of the transactions that come


,

under his notice ? Explain .

This m u st la rgely depend upon circumstances Th ere .

are ca ses e g corporation auditing where it might be


, . .
, ,

the audito r s d uty to refu se his cer tificate upon the


g round of inv alidity in certain t ra ns actions The s cope


of a co rp o ra
.

tion s b u siness is stated in its articles of in


incorp oration Acts out s ide of this would be ul tra wir es


and it would certainly be the au ditor s duty to d raw a
.


t
ten tion to the fa ct

Cha rging reven u e expenditu re up as ca


.

pital expendi
tu r e o r decl ar ing dividends where no su rp l u s exists out
,

of which to pay them would be oth er examples and ,

wou ld be gro unds fo r the a u di tor s refusing his certifi ’

cate.

Again :even in the case of a firm or individual trans ,

actions may be such and so recorded in the books that , ,

th e a udito r s ce rtifying to the cor re ctn ess of same would


ma ke him parti ceps criminis in fraud ; so the auditor


must be contin ually on the al ert .

III Describe the steps necessary f or a thoro u gh a nd


.

systemati c audit of the accounts of a partnership bu si


ness.

The articles of cc partnership shou ld be examined and -

the pa rtne r s ledger a ccounts gone over to see tha



t a ll
p rovisions contained therein have been complied with .

The cash balance in cash book shou ld be reconciled with -

the pass book balance by means of a re con c iliation a


-
c

count ; stubs of che ck book checked with cash book a nd


- -
,

cash book entries vouched All re ceipts should be


-
.
82

and of providing adequate reserves for discounts and bad


d ebts is even mo re absolute in the case of corporation s
than in the case of private firms ; as in the latter ca
,

se the
members of the firm a re a lways aware of the act ual facts ,

while in the fo rme r c as e the auditor is relied u pon by


th e p ublic to take s uch p rotecti ve me a su res for their in
teres t in dealing with the accounts as he may deem best .

V In a u diting the a cco unts of a man u f actu ring com


.

pany wh at steps should be taken to ve ri f y the following


,

assets ca sh b ank acco unt bills rece ivable accounts


, , ,

receivable manufac tu red stock real estate and machin


, ,

e ry ?

Cash :by actual count .

B ank a ccou nt : The au ditor sho u ld personally take


the p ass book to the bank requ es t that it be written up
-
,

to date and retu rned to him personally O n its receipt


, .

he sho u ld compare the checks returned w ith the stubs


of the check book ; then by dedu cting those unreturned
-

from the pass book b al ance the resulting balance should


-

agr ee with the check book ba


,

lan ce -
.

Bills receivable : These should be produ ced and in


spec ted to see that none a r e overdue that the n ames of

the m aker s a re good a


,

nd that the total amount agre es


,

with the bal ance sheet total If notes have been le ft at .

the bank for collection a certificate should be obtaine d


,

from the bank as to the amounts dates and other par


a
, ,

ticul rs .

Accounts receivabl e : The ledger shou ld be g one


th rough by the auditor in company with some res ponsi
ble pe rson who is a cquainted with the amounts and ea
ch ,
83

one exa mined se riatim Doubtful debts should be


.

t ransferred to a s u spense account and a rese r ve ,

created for possible losses ; bad debts shou ld be charged


to p rofit and loss a ccou nt ; good ones m ay be taken at
face v alu e.

Manu fact u red stock :This shou ld be ver ified by check


ing the inventory a s to exte nsions and footings and re

qui ring the pa rties who took it to sign it The auditor .

shou ld see that it is taken at cost or m arket whichever ,

is lower ; where cost books a re kept a refe rence to them


-
,

will be of materia l assistance in determining the correct


ne ss of the item .

Real estate and machinery : These may be verified by


inspection of receipted bills by seeing that revenue
cha rges have not been capita
,

l ized and by examining the


a
,

ledge r ccounts to se e that a p roper pe rcentage has been


pe ri odically w ritten off for dep reci ation .

VI In auditing a p rivate banking institution how


would you ascerta
.
,

in the amount of checks that have been


cha rged to depos itors ac counts bu t not p resented fo r

,

payment

Presumably s u ch checks have been iss u ed to custom


,

e rs at thei r request ma de payable to va r ious pa rties and


charged a
,

t once to the deposi to r s account Such checks



.

should be made out from a depositors check book g en


“ ’

eral ”
Ca n celled checks pa id wo u ld be at the bank a nd

should be compa
.

red with the stubs of this check book ; -

stubs unma rked wou ld show wha t ch ecks had no t been

res ented for ayment


p p ,
84

VII In preparing the ba lan ce -s hee t of a business a t


the close of a yea r how should ea
.

ch of the fol lowing be


treated : ( a
,

) bad a nd doubtful d ebts b


( ) pre m iums fo r ,

fire ins urance unexpi r ed ( c ) inte rest pa id in adv ance on


,

bills p ayable discoun ted ( d ) depreciation of fa cto ry


plant sto re and offi ce fixtu res a
,

,
n d similar item s ?

a
( ) B a d debts shou ld be charged to pro fit and los s
account ; dou btful debts to a su spense account o r doubt
fu l debt ledge r are serve for same bein g crea
— ted .

b
( ) P remi u ms fo r fi r e ins u r ance u nexpire d : A p ro

p o r tion ate a mo u nt sho u ld be w r itten o ff the ins u r a


nce a c
count to p rofit and loss account ; the balance should r ep
r esent the v al u e o f the unexp ired po rtion of the policies
which sho u ld appe ar amongst the asset on the ba l ance
sheet a s a p rep a id cha rge
a
.

( )
c Interest paid in advance on bills pay ble disco u nt
ed : The dis co unt accou nt ba
.
lan ce shou ld be charged
to p rofit and los s ac cou nt ex c ept such items as are t e
ferred to in the qu esti on This ba lanc e shoul d al so a
,

p
pear on the balance sheet as a
.

n asset amon g s t p re paid


charges
d ) Dep r e ciation of fa ctory pla
.

nt store and ofi ce fix
tu res and similar items : The items ma
,

y appear on the
ledge r and on the bal ance sheet at cos t if profit a nd l oss

account ha s been char g ed a nd a rese rve ac count f or de

preci ation cr edited with an adequate percenta


,

g e of th e

cost . If this h a s not been done then the percent a , g e f o r

dep reciation determ ined on sho u l d be charged to p rofit


and loss a ccount and c redite d to the ledger accounts .

VIII W rite. in p r ope r f o rm an auditor s certifica


te o f

correctness .
85

I h ave examined the books and accounts of X Y !


Co for the yea
. r ending and hereby certify
as to the corr ectnes s of the net earnings shown in the
profit and loss account annexed a nd of the assets a
,
nd

liabilities show n in the balance sheet a ppended .

C P A . . .

IX Under what circumstances if any would it be


.
, ,

prope r to open an account with goodwill ? On finding


a goodwill account on the l edge r of a business for which
you are to prepare the annua l statement how would you
treat the account or what spec ial a
,

, dj ustm ent would


you suggest in regard to it ?

An account fo r good will might be opened whe re a


-

s um of money h a s been p aid f or the a cquisition of a busi


ness in excess of the amount of the liabilities as s um ed
ove r the assets acquired a— value placed u pon it by the
computation of the capi tali z ed value of net ea rnings .

Again the initial expenses in starting a newspaper


, ,

,

magaz ine or periodical in short establishment ex
,

pen se s might be charged to this a ccount


Whe n the a
.

nnual statement is made up the item should

a
be placed a s sepa rate item in the balan ce sheet so th a t
no one can be misled on this subj ect As it repres ents .

initial cost there is no neces s ity to w rite it down ; but the


auditor might s ugg es t th e advisability of writing it ofi
by degrees to profit and loss account .

X You have in hand the exa min a tion of the cash


and bank a
.

ccount of a mercantile firm that uses chec ks


very freely Dra ft a reconcilement bring ing the cash
.
,
86

book and ba nk pass book into harmony - a


t the clo se of

the pe riod under review .

Chec k book balance


-

Undeposite d

Pass book bal ance


-

Less checks out

Agr eement with check book


Add u ndeposited
.

Reconciliati on with ca
sh book -

XI Wh at check has the audito r on ficti tious ent ri es


.

showing purchases and on returns of goods sold ?


,

As to p urch ases the au ditor should compare the pur


,

ch ase book and ledge r entries w ith the pu rcha se invoices


-
,

sto ck book statements et c


-
, , .

Returns of goods sold may be ve ri fie d by copies of


c redit slips re fe r en ce to co rres ponden ce receiving book
, ,
-
,

stock book etc


-
, .

Cash purchases should alw ays be vou ched by receipted


bills
.

XII In auditing the ac counts of a gas company wha


. t ,

evidence of the rec eipt o f amounts due from custome rs


should be required ?

Cash book ent ries stu bs of r ec ipt books ba


-
n k de e -

posits comparison oi amount of ga


, ,

,
s c onsumed etc with , .
,
87

total of charge co lum ns the d edu ction of total a


mounts
received f rom whi ch should leav e a ba
,

lan ce agreeing
with the total of a
mounts outsta nding and unpaid .

XIII Should an y fluctuation in th e valuation of


permanent assets be perm itted to a
.

fi ect the res ult of th e


lo ss and gain account ? Give reasons for your ans wer .

No The profit and los s account is des igned to show the


loss or gain on trading for a spec ific period If a
.

n in .

c rease or diminution in the value of permanent as sets


were recorde d in that account the loss or gain for the
period would show a fictitious result Such a va ria
,

t1on
should rather be trea
.

ted a s hav ing a dire ct connecti on

with capital rather tha n with revenue in come or ex


p enditure .

XI! Expenditures a re made by a corporation for


items of ea a
.

ch o f the follow ing cl a sses ( ) taking down


a m achine m one part of a facto ry moving it and putting
it up in a
,

nother part ( b ) expens es of incorporating th e


,

company in cluding S tate charges and lawyer s se rvic es


,

,

( )
c broker a ge on p ur chase of a piece of propert y (d) ,

commission on an issue of debenture bonds ( e ) costs ,

attending a mo rtgage ( f ) furniture and fittings of a


,

city offi ce and salesroom (g ) cost of patents including


, ,

solicitor s charges and government f ees Whi ch items


should be charged to capita l a


.

nd whi ch to revenue ?
Sta te rea sons for your ans wer in each case .

( )
0 Revenue : the earning capa c i ty is not nec ess aril y
increa sed by the O peration
a a
.

( )
b Capit l : these r e es tablishme nt expense s and ,
88

shoul d be cha rged ofi to pro fit a nd loss g radu a lly until

the whole amount is wipe d out .

( )
c Capi tal : it is p a rt of the cos t of the p r ope r ty.

d
( ) Capi tal : the cha r ge should be written o ff b y
cha rges to profit and los s periodically du ring the term
the bonds have to run .

( )
e Rev e nue : it is an addition a l cha r ge to interest on
borrowed money
a
.

(f ) Capit a l : t h e y ar e p er m nently necess a ry t o th e

cond u ct of a business .

(g ) Capit a l : t h e amount sho u ld be charged ofi to


p rofit and loss accou nt in amo u nts p roportionable to the
d uration of the patents .

XV The bal ance sheet of a firm is s u mma r ized a s


.
-

follows
A SSETS
Cash stock and accounts receivable $67 500
Ma
, .
,

n u factu r ing pl ant


LIABI LITI ES :
Notes and accounts payable

Would you conside r this fi rm insolvent ? Give reaso ns


fo r your answer .

No . So l ong a s the a s s e ts ar e equal to th e liabilitie s

( ex c l us ive of c a pi tal ) th e fi rm is solvent In


. this ca s e
they exceed them by

a
t ined in one general ledger s tate precisely the steps
a
,

y ou w ould ad opt in e ch c as e to v erify c as h s ales p ur , ,

chases c ustomers creditors


, , .

As to ca sh I sh ould che ck the footing of the cas h book -

a nd the footings of the monthly tota


,

l s of receipts and
disbu rsements into the ca sh account in the ledger and ,

see that the fina l balance agreed with the cash boo k bal -

ance I should next reconcile the cas h a


. nd che ck boo k
-

b al ances by d rawing up a reconciliation statement with


the pass book Sales book additions should be checked
-
.
-

and the monthly totals compared with l edger postings .

Th e sam e process should be adopted in che cking pu r


chases From the trial bal ance I s houl d extra ct the tota
. l
amounts due by cu stomers and due to c reditors and th en
raise controlling accounts by means of which these tota
,

ls
could be verified Much woul d of course depend on
tim e a Where a dmissable the cash t ra
.
, ,

n d fee nsactions
should be checke d exha
.
,

ustivel y .

III What evidence should be required a s to the cor


rectnes s of the follow ing assets shown on a ba
.

lance
sheet : ( a) la n d and buildi ngs b
( ) stoc k s and bonds ( )
,c ,

notes receivable ( d inventory of stock and supplies


, ,

( )
e prepaid insuran c e ?

a
( ) Land and buildings : the produ ction of the title
deeds receipted bil ls of sale examination of the accounts
to see that only capital expenditu re was in clud ed a
, ,

nd
that a proper a m ount had been periodi cal ly written ofl
for depreciation .

( )
b Sto c ks and bonds : their produ ction f or ex am ina
tion or if hypothecated certification as to equity therein ;
compari sons with market quota
, ,

tions etc , .
9 1

( )
c No tes re c eivable : the produ c tio n an d e xam ina
tion of the notes or if left at the ba nk a c er tifica te from
the bank as to a
, ,

m ounts etc , .

( )
d Inven to r y of stock and supp l ies : the pro du ction

of the invento ry signed by the parties w ho took it ; ch eck


ing of extensions and footings ; comparison with stock
books ; evidence that it has been taken at cost or market
price whicheve r is lowest ; the a pplication of the trading
,

accou nt g ross profit pe rcentage test


a
.

( )
e P r epaid insur nce : the production of the pol
icies and the receipted bills f or same
,
.

IV State gene rally what constitutes c apital expendi


ture in ea
ch of the following ca
ses ( a a a
.

) a m nu f ctu r

ing co mpany ( b) a gas company ( c ) a char itable in


, ,

s titution .

The following w ou ld consti tu te capital expenditure in


the case of
a
( ) A manufactu r ing comp any : r eal est a te buildings
plant and m achinery furnitu re a
, ,

nd fixt ur es

a a a
, .

( )
b A g s comp a ny : re a l estate buildings m n uf c

turing pl an t m a chin es sto ra


, ,

ge work s and other struc


tu res conne cted wi th m a
, , ,

nufactu r e new ma ins and service


,

pipes mete rs etc


a
.
, ,

( )
c A charitable insti tution : r e l estate b u ildings
furniture and fixtures perma
, ,

,
nent investments .

V What proportion of
.
— c ommission paid for

negotiating a s ale of bonds to run 1 0 years should be
trea
,

ted as an asset at the end of the first yea r ? Give


reasons .
92

Incert ain cas s the whole of the


e mmission might co

prop e r ly b
e ch a
rged up as capital expenditure e g c on , . .
,

struction accou nt whe re bonds are sold to obtain the


,

m oney to constru ct with But ordinarily it would


to a
.

se em more reasonable to charge the commission



cost of bond issue account and write off to profit and
loss account annually such a proportion of th e a mount
as would extinguish it a t the time the bonds ma ture O n
sho uld be trea
ted a
.

this ba sis of calcul ati on ,


s an

asset at the end of the first year .

VI TO what documents should the auditor have a o

ce ss m each of the following cas es : a


( ) partners hip
accounts ( b) trustee s accounts ? Why ?
,

a
( ) In th ca se
e of pa rt e r ships the
n a udit r should o

have acc ss to th
e pa rtnership agreement in order that
e co-

he m ay dete mine that its provisions ha


r ve b n mm i d ee co e

with in the books of ac cou nt These would probably re


.

late to the amou nt of capital to be invested and with


drawn by each pa rtne r ; the p roportion in which profits
we re to be shared ; the ch arging or cr editing inter est on
investments and wi thdrawals and othe r matte rs inci,

dental to the equit able sus tenance of partnership rela


tions
a
.

b
( ) The a u dito r ,in th e c s e of trus tee s a ccounts ’
,

shou ld have access to the deeds of appointment minute


book and all lega l docum ents in orde r to s a
,

, ,tisfy himself
th at all statuto ry pro vision s have been duly complied
with .

VII In commen cing a n au dit say three m onths after


the close of a fis cal yea
.
,

r how woul d you verify cash on


,
93
hand and bills r ec eivable as they should stand at th e end
of such fisc al yea r ?

Wi th r egard to ca sh the auditor sho uld ba lance


and ru le off the ca sh book on the day he co m - mences the
work and pe r sonally deposit in th e bank a ll c ash and
checks on hand He shou ld obtain the p ass book from -

the bank when w ritten u p and d ra ft a reconcili ation a


.

,
o

count s o a s to agree the check and cash book b alance -

wi th th at in the pass book Then he sho u ld check back


-
.

wa r ds to the date on which the fisca l yea r ends He


wou ld then have to au dit the ca
.

sh in the o r din ary m an


'

ne r from the begi nning to the end of the fiscal yea r .

As to bills receivable he should check those on


hand and tho s e left at the ba nk for collection to see tha
,

t
th e amo u nt ag ree s with the total to th e debi t of the ledger
account and then compare e ach note book entry to s ee
,
-

that eve ry note w as collected disco unted or charged , ,

back as dish ono red which a ppeared in the schedule of


bills receivable a
,

t the end of the fi sc al yea r .

VIII What wo u ld be the eff ect on a statement of


a
.

ssets and li abilities of failur e to charge depreciation


against the following assets : ( a ) le a seh old b u ildin g s ,

( )
b fixed m a chine ry ( )
c loose machine ry ( )
d ho r ses
and tru cks ( e ) patterns and molds ? Give rea
, ,

, sons in
each case .

a
( ) L asehold buildings
e : being held for a limited
time only a t th expi r ation of the lea
e se the whole a m ount
paid fo r th a
,

cqu isition of the leas woul d be come a


e e

charge agains t r even ue ac unt a nd new ca pita l would


co

be introduced to obta
,

have to in a renewal .
94

Fi x d ma chinery and ( ) loose ma chinery— the


( )
b e c

e fi ect to fail to charge off dep reciation on a statement of


as sets a nd l i abilities would he th at the a ssets ( and p roba
!

bly the surp lus ) would be ove r stated and th at dividends ,

might be erroneously dist ributed out of capital from sur


plus ea
,

m ing s be ing shown ; whe reas if depr e c iation had


been cha rged a deficit instead of a surp lus might possibly
,

have a ppea red .

( )
d Ho r ses and tru ck s : the former get old and die ;
the l atte r wear ou t fa ilu r e to w rite off depreci ation

causes an oversta tement of assets with a l l the evils l ikely
to accrue therefrom .

( )
e Patents and molds : the forme r h ave only a limited
life ; th e latter become old fashioned and obsolete If this
-
.

depreci ation in v alue is not provided for the f ormer be


comes a
,

de a d loss of capital ; the latter will h av e to be re


pl aced by the int rodu ction o i new c apital unl ess the re is a
s uffi ciently la rge amo u nt of undistributed profits left in
the business to off set it .

IX What wou ld you conside r a satis f actory voucher


for wages paid in a ma
.

n u factu ring business ?

A satisfacto ry vouche r fo r w ages pa id in a ma nuf ac

turing b u siness wou ld be the p rod u ction of a can celled


chec k agreeing in amount with the total of the weekly
p a y roll which ( the pay r oll ) h a d b een p rope rly m a de up
-
,
-
,

cal cu lated checked p aid ou t unde r a good system of in


, ,

ternal check and finally O K d by the m an age r one of the


,

,

pa rtner s o r som e responsible offi ci al


, .

X In an audit of a bu siness in which discounts a re

fr eely given and received a nd the accoun ts a


.

re char ed
g
95
and credited in gros s wha t general ch eck should be
adopted in veri fication of ( a
,

) di s co u nt s a ll owe d ( )
b ,

dis counts receiv ed ?

a
( ) A g eral check on discounts al lowed might be
en
obta ined by extending the amounts of sal es into various
columns according to the various rates of discounts ; by
figuring out the di scounts on the tota l s in gross ; dedu cting
outsta nding a c counts ; a nd then comparing the result

with the tota l discount allowed in the ledger ac count .

1
( )
7 As to di s counts received the , auditor c
test by arriving at an approximate average percent ge of
the disc ounts on purc hases for a few years past and com
a
ould onl y

paring the res ult with that shown in the p eriod under re
view In the case of both discounts allowed and di scounts
.

received a clos e sc rutiny of the va riou s person al accounts


shoul d be made It wou l d be compar atively easy to find
.

out which customers take advantage of their dis count



habitu al l y and which do not and thu s a v ery eflicient ‘

test coul d be applied Where it is customary to us e a


columnar l edger to sepa
.

rate charges subject to va rious


rates of discount the task of checking is considerably

XI State the special uses to which an auditor may


.

p u t controlling l edger accounts su ch as cu stomers led


,
“ ’

ger account ” “
,
purchase ledger ac count ”
.

By the use of contr ol ling accounts the general ledger


keepe r is abl e to tak e OE a complete trial balance ve ry
rapidly without waiting for the v erifica tion of the totals
of the individual acc ounts in the sale s and purchase led
g er,s a
nd so th e aud itor can c h eck the f oo ting s of the v a
96

rions books of origin al ent ry and the postings of the


tota ls into the controlling accou nts and be cert a in that
,

the bal ances shown ar e co rrect in gr oss Whe re the .

accounts are nume rous and detailed checking too lengthy


to be p ra ctic a b le the amo u nt of time s aved by the use of
,

controlling accounts is eno rmou s


I f each ledge r is made self balancing the audito r ca
.

verify in a very short pe riod of time the tota l am ou nt of


sales purchases discounts received and allowed c ash re
retu rned pur chases and sa
, , ,

c eived and p a id , l es ; he ca n
also maintain a check u pon the gene ral led ge r tri al bal
ance If the plan be adopted of chan ging the ledge r
.

clerks aro u nd pe r iodically fraudulent entries will be


,

easily detectable .

XII State wh at means shou ld be adopted to verify


a
.

( ) c as h sales b
( ),discounts allowed ( )
c discoun
,
ts t e
ceived ( d ) sold goods r et urned ( e ) allowances on s ales
, ,
.

( )
0 W h ere c a sh sales ar e numerous the method
,
of
verification will depend largely u pon the system employed .

Where ca rbon copies a re p reserved of all c ash sales made ,

these should be comp are d with the da ily ca sh slips the ,

totals che c ked and compa red with the daily ent r ies in the
,

cash book B u t whe re this system is not in vo gu e the


.
,

detection of petty thefts wo uld be al most a m atter of im


possibility The au ditor should find a
. n d approxima te the
ave rage amount of daily or monthly c a sh s ales and make
us e of his expe r ien c e in dete rmining wha t va r iations
might be n atu rally expected in va rious kinds of busi
n esses .

b
( ) With r egard to disco u nt allowed the a udito r should
app ly the law of average test a
“ ”
,
n d by examin ation of
98

To A B Co
. . .
,

DEAR S IRS
I have examined th e balance sheet submitted to me and
beg to repo rt as under
I I t is unusual to put capita
. l and s u rplus under one
heading The capital might be
. the s u rplus
Were this so the position of the company ,

would be very di ff erent from what it would be we r e the


capital and the surplus In the way the
ba lan ce sheet is made u p it is impossible to dete rmine the
amount of either capital o r surplus .


II The s econd i tem current liabilities is indefinite
Of w hat do they consist ? Notes have an awkw ard ha
.
.
, ,

bit
of falling due on ce rtain d ates fixed whe reas the paym ent
of Op en accounts payable may so metimes be ma
,

de in part
o r deferred
III The item s u spense ac count cer ta
.

. inly ne eds ex
planation Is this a disputed liability or is it a r eserv e
.
,

account ?
IV With regard to the fixed assets it ma
.
y be said at
once that they are ou t of all proportion to those whi ch

may be called cash o r quick assets being plus
stock as against in other words there is
available s u pposing same could be immediately reali z ed
cu rrent lia
,

at f ac e va lue only to discharge


,

bil i
ties


amou nting to $87 5oo this of cou rse is withou t
ta
,

king into account stock which would have to



be sold and which might shrink considerably in value
during the p rocess .


These matters a re self appa rent although in addition
-

the questions would arise :


Has provision been made for depreciation ?
How wa s stoc k v al ued ?
99
Is there a rese rve f or bad a
nd d oubtful debts ?

How were the good will and patents valued ?


You rs tru ly ,

C P A
. . .

XIV Given the following reconcili ation of cash at


.

th e close of an au di t st ate c a tegor ically how it may be


,

veri fied :
J u ne 30 c ash on h and a s per cash
,

bOO k
B al ance as per bank p a ss book a
t
close of b u siness
Add check of J B Jones not de
. .
,

posited

7
- 2

Dedu ct checks d r a
wn , not pre
sented

Cash 1n drawe r

Balan ce as per pass book :this shou ld be ve rified by the


a u dito r ta king the pass book to the ba nk personally and
obtaining a ce rtificate or the ve rba l a ssurance of the bank
cashier that the bala nce shown in the pa ss book at that
pa rti cu la r date agreed with the bank ledge r account that—
the pa ss book is gen u ine and the b al a nce sho wn c orrect
, .

The check of J B Jones not deposited shoul d be pro


. .

duced and the auditor should s ee that it is included in the


amount entered in the cash book prior to the balanc ing
a nd closing of the cash boo k .

Checks drawn and not presented should be verified by


( )
1 th e audito r c hecking all st u bs with the cash bo ok
00

entries ; ( 2 ) by marking the stu bs of those checks returned


by the bank ; 3) by listing and totalling the stubs nu
marked ; said tota l deducted from the pass book bal a nce
should agree with check book balan ce
Ca
.

sh in drawer should be verified by the auditor actu


a lly counting it .

This method is on the ass u mption that the auditor is


p resent at the time the cash book is closed at the end of
afis cal period Should his auditing commence a t some
later date it would be necessary for him to check ba
.

ck

wa rd fr om the date at w hich he begins the ca s h verifica


,

tion to the date of closing .

XV .A corpo ration sell s its first m ortgage bonds a t


premi u m and its second mortgage bonds at $ 1 0 ,

000 discount .Give you r views as to the proper tr eat


ment of these items of premium and discount .

As these items counterbalan ce ea ch other the re wo ul d


be no objection to c rediting the premium and debiting the
discount to profit and loss account .

On the other hand supposing the bonds were short


time rs — say ten years the cha rges a
,

, nd c redits might be

spread over that pe riod so that their disappearance might


be synchronous with the redemption of the bonds .
02

II Withou t definite inst ru ctions what in your j u dg


.
, ,

ment wou ld constitu te a tho rou gh and p roper au dit of a


,

set o f books ?

The ca sh ba lance on hand should be ve rified by actual


cou nt ; the bank bal ance a s pe r pass book by the constr ue
tion of a reconciliation accou nt agreeing check book

bal ance therewith ; the stu bs of check book shou ld be com
p ared with c ash book ent ries and the deposits com pa red
with the p a ss book entr ies a s to dates a
,

nd amo u nts of

same The c a sh book footings and postings shou ld be


.

checked and a ll p ayments vou ched The footings and


, .

postings of all books of o rigin al ent ry shou ld be checked


into the ledge r ; jou rnal en tries sho u ld be sc ru tinized a s

to thei r correctn ess and m anife st p rop riety and the cl assi
fica
,

tion of inc om e and r even u e expenditur e be const a ntly


bo rne in mind Bills receivable and p ayable a ccounts
shou ld be compa
.

red with note and cash book ent ries The .

invento ry shou ld be checked a s to extensions and foot


ings ; the closing en tri es c arefu lly examined— c are being
exercised to see that ample provision ha s been m a de fo r
dep reci ation b ad debts discou nt etc and fin ally the ba l
, , , .
,

ance sheet d rawn up in p rope r fo rm and if co rrect cer


, ,

tified to P ay roll books and petty cash shou ld receive


.
-
,

due attention and an u ncea sing ale rtness fo r the detec


,

tion of frau d m a inta ined throughou t the au dit .

III What are the p rinci pa


. l points to which attention
should be given in a s ce rtaining the amount of the net
e arnings o f a company desi ring to u se your ce rtificate ?

To asce rtain that no ou tl ays ch argable against revenue


had been capitalized ; th at p rop e r p rovision h a d been
periodic ally m a de fo r dep reciation ; that such items as
1 03

interest on loans etc were stated sepa


,
.
,
rately ; that profits
of an ext rao r dina ry na ture extran eo u s to the ordina ry
,

business of the comp any were excl u ded ; that the inven
tory had been taken at cost o r m a rket whichever was ,

lowest that rese rves we re created for b a d debts dis ,

counts etc ; th at the pe rcenta


, . ge of gros s p rofit w a s con
sistent wi th th at realize d in former ye ars ; and that the
res u lt disclosed in the p rofit and loss account was co r
robora ted by the bal ance sheet .

IV What evidence should the au dito r requ i r e as to


.

the autho rity given to offi cials of a municipal corpo ra


tion to expend money ? Sta te what methods shou ld be
used in a uditing the a ctu al p ayments .

He should a sk for the minu tes of the meetings of the


controlling boa rd of the m u nicip ality and a im
s certa tha
t
the o ffi ci a ls whose signatures v a lida te disbur sem ents have
been duly elected o r appointed ; and that a finance com
m ittee has been chosen .

With respect to the au dit of actual payments he should


see that all w arrants are p rope rly recorded and cha rged
in a warrant registe r ; that they are sig ned by the p roper
offi ci als ; that there is on file an attested copy of every
resolution authorizing a pa yment with a voucher or bill
passed by the fina
,

nce comm ittee and S i g ned by the p ayee .

In the p ayment of m atured bonds he sho u ld see that


they are on file and so mutilated as to be absolutely unu s
able.

In the p ayment of interest he should see that the in


teres t is due as pe r reco r ds in Bond Register and if ,

cou pon interest that the paid coupons are on file so ,

mu tilated as to prevent re presentation If the bonds or


-
.

coupons are not on file he should as certain by a com


1 04

pari son of the municipa lity s accou nts with the deposi

tory where su ch bonds and coupons ar e pa yable th at they


are legitim ately outsta —
nding as non presented -

Redeemed ce rtifi cates of indebtedness sho u ld a


.

lso be on
file and cancelled .

Payments to Sinking Fund should be ve rified f rom the


records of the Sinking Fund Commissioners
All returned w a rrants bonds coupons and certifi ca
.

, , tes ,

of indebtedness shou ld be stamped o r initi alled by the


auditor himsel f .

V How sho u ld the


. accountan t proceed if requi red to
audit th e accou n ts of a fi rm which ke t only a cash book
and journal bu t ha d
, p rese rved a
l the invoi ces and
vou chers pe rtaining to the business ?

The audit of th e c ash book should be m a de in the us u al


ma nner As all vouche rs have been p rese rved there
s hould be no diffi culty in vouch ing pa yments ; bank t ra
.

ns
actions ca n be verified by check book and p a ss book

As all s ales have been j oum a


.

l ized the dedu ction from



the totals charged of the amou nt of cash received should
s how the a mount of a ccounts r eceiv able o u tstanding .

This co u ld be verified by compari ng cash book rece ipts


with jou rnal charges and sending ou t statements to cu s
,

tom ers of unsettled bills As all purch a ses have been


a
.

j ou m l iz ed— the entries c a n be com pa red wi th invoices


and the total amount of a ccounts payable determ ined by
deducting total cash paid as per c ash book with tota l
credits thro ugh journal The amount c an be ve rified by
ch ecking payments with c redits listing outstanding a
.

, c

counts and obtaining statements from c reditors in con


a
,

firm tion .
1 06

value ; furniture and fixtu res seven to twelve and a half


,

per cent on diminishing value


. .

VII What is meant by the term sinking fun d ? Show


how a sinking fund is opened or established a
.

nd explain ,

its ope r ation from year to year .

A sinking fu nd is a fund set aside out of assets and


accumulated at inte rest for the purpose of meeting a
debt .

Having determined the s um neces sary to be set aside ,

which will am ount with interest in a certain number of


, , ,

year s to the a mount of the debt which it is design ed to


liquidate this sum is ann u ally cha rged to revenue or ln
,

come a ccount and credited to sinking fund account The .

amount is then invested ann ually and the investment


termed sinking fund The inte rest is pe r iodic ally t e
invested added to the sinking fund a
.

, nd credited to sin k

ing fund account Fin ally the fund is converted into


.

cash th e fund credited and the indebtedness ( general ly


, ,

in the form of bonds ) charged and wiped out The .

sinking fund account then becomes a surplus .

n a
VIII Expl ain the diff e rence betw een a ccount of
receipts and payments and an account of income a
.
!

nd ex
p endl tur e .

An account of rec eipts and paym ents is one whi ch


sho w s the actu al amount of ca
s h received and paid during

a certain period Starting with the ba


. lance of ca sh on
hand at the beginning of a fis cal peri od there should be ,

added to it the total of all cash received ; the total cash


paid out being dedu cted should show the ba lance of cash
on hand at the end of the period .
1 07

An acco unt of income and expenditure shows the tota l


income from all sources ( whether collected or not ) for
a certain pe riod and the tota l expenditu re ( whether paid
,

or not ) the excess of the income ove r the exp enditure is


called the net income net reven u e o r net p rofit We re
, , . a
su ff ering app arently f rom a r ed undancy of te rm s all ,

meaning the same thing ; all desi g ned to show the same
res u lt Thu s a n income and expendi tu re account revenue
.
,

account and p rofit and loss acco u nt a re all designed to


,

show the net income earnings o r p rofit fo r a specific


, ,

period .

IX In au diting the books of a b u ilding and loan


assoc iation what method sho u ld be u sed in verifying ( a
.

, )
deposito rs pa ss books ( b) mo rtgages held by the asso

-

cia
,

tion ( c ) the income ?


,

a
( ) E a ch pass book shou ld be p rod u ced and every
entry checked with the cont ribu tion book stockholders ’

ledger withdrawa l book trea s urer s receipt book a


,

nd

, ,

cash book Care Should be exe rcised to ascertain th at


.

each membe r h as paid all necess a ry fees and tha t before


each pass book is issu ed all the req u i rements of the a
,

-
s

s oc iation h ave been complied with by the holde r .

b
( ) As to mo r tga ges the title deeds, sho u ld be ex a m
ined receipts for c a sh ve rified inte rest cha rges and re
, ,

ceipts c a lcul ated and checked and the fa ct ascertained


,

that they are systematic ally reco r ded and s a fely kept
a
.

( )
c As to incom e the a u dito r sho u ld ascert a in nd li s t
the sou rces whence the income is received ve rify cash ,

book receipts and vo u ch all payments ; see that all ex


p en d itur e is duly au thorized a nd p r ove th e existence of
the c ash balance shown in the ca
,

sh book .
1 08

X How should the auditor deal with the ledger a c


counts of partne r s ( a
.

) in th e division of p r ofits ( b ) ,

in the assessment of losses ( c ) in case a partner s d raw ’

ings exceed the a


,

m ount specifi ed in the p artne rship


agreement ( d ) in case a p artn er s drawings are less
,

than the amount to whi ch he is entitled ?

In dealing with th e ledger accoun ts of pa rtners the


au ditor sho uld alw ays ask for a copy of the co p artne r -

ship articles of agreement and his a im should be to see


,

that all p rovisions ther ein have been du ly complied with


a
.

( ) In the division of p r ofits if the r e is no stipulation


a e to be ta
,

s to th e p roportion of sam ken by each partner ,


in the a rticles of co partnership then the pr ofits must be,


divided equally i r respe ctive of the amount of capital in
vested by each pa rtner The au dito r shou ld s ee th at each
.

par tner is so c redited If the p rofit is agreed to be


.

sh a red in definite p roportions then the au dito r should see


that this is given e ff ect to on the ledger .

( )b In the a ssessment of l o sses r efe r ence sho u ld ag a in


be m a de to the pa rtnership articles In the abs ence of .

specific agreement losses should be borne eq ually .

( )c In case a pa r tne r s d ’
ra wings exceeds the a mount
specified in the partne rship agreement he should be re ,

quested to repl ace the amou nt overd rawn by cash or note ,

and be charged with intere st on the actua l ove rdraft .

( )d In c a se a p a rtn e r s d r

awings ar e less t h an the
amount to which he is entitled he m ay by consent of his
, ,

pa r tne r be credited with interest on the di ff e rence


, .

XI What ru les woul d you recommend fo r loc alizing


.

the erro rs in a tri al balance ?

There a r e many rules ; but only one of them which


annua l bal a
nce sheet only afew of the p remiums have
been distribu ted How should this matte r be trea
,

. ted in
the bal ance sheet ?

The value of the premi u ms shou ld appe a r at cost on


the bal ance sheet and a rese rve a ccou nt fo r the same
amount appe a r as a li ability As issu ed the valu e of the .

premi ums co uld the rea fte r be pe riod ically c r edited to the
p remi um a ccount and ch arged aga inst the rese rve a c

count .

XIV In the ca se of a company which h as issued


.

preferred stock ca rrying a c u m u l ative dividend b u t ha s ,

not e arned eno u gh to pay su ch dividend in f u ll f or


severa l year s how wou ld you deal wi th the a rr ears of
,

dividends due if at a ll on the co mpany s b al ance sheet ?


, ,

Give rea sons .

The arrears of unpaid dividends shou ld not be dealt


with in the balance sheet but in the au ditor s report ,

.

The li ability of a company in the matte r of dividends to


its stockholders is only contingent u pon their being
ea r ned The prefe rence only extends to this : the sta
. ted
amount and rate of dividend m u st be pa id to p referred
stockholde rs before any dividend c an be pa id to holders
of common stock .

XV Explain the di ff e rence between capital expendi


.

ture and reven u e expenditure Wha t ru le controls in


determining whether ce rta
.

in p aym ents belong to capital


or to revenue ? W hen in doubt to which should the ,

paym ent be charged ?

Capital expenditu r e is the replacem ent of one form of


asset by another e g cash by buil dings plant and ma
, . .
, ,
chinery , etcRevenue expenditure is that which is m a de
.

to cond u ct a business but by means of it no perm anent


, ,

as set is acqui r ed
In short ca
.

,pital expenditure appea r s upon the bal ance


sheet ; revenue expendit u re is ch arged to p rofit and loss
account ; this is the broad, gene ral distinction and is
,


the answe r to the second section of this qu estion what
rule controls in determining whether certain payments
belong to capital or to revenue ?
W hen there is a do ubt the payment Should be charged
to ca pita
,

l account Shou ld this afte r wa rds p rove to have


.

been erroneous it is a simple matter to transfer the item


,

to the revenue account ; but afte r the charge has once


been ma de to revenue accou nt and that account closed ,

conside rable explanations wo uld have to be fo rthcoming


to exp lain the matter .
31
1 111111112
, 19 02.

I What should the a u dito r require of a company or


.

firm who se books he is to audit ?

He should require the books to be written up to date ,

the cash book bal anced a correct tri a l b alance to be f orth


,

coming all checks and vouche rs to be p rodu ced arranged


, ,

methodically a list of a ll the books of accounts with t he


,

dates they cover and the names of the e mployees by


,

whom they are kept .

If a corporation he shou ld require in addition the


, , ,

minute book to be written up and p roduced for examina


tion the transfer book to be written up and the stock
ledger fo rthcoming in bal a
, ,

a nce In the case of a p artne r


.

ship the rticles of co partnership should al so be asked


for
,
-

The au ditor will now be able to ascerta


.

in th e ex tent
and scope of his work a nd decide on the be st method of
,

condu cting his work and of the means to be adopted to


bring it to an e ff ective concl u sion .

II Describe in deta
. il your method of conducting an
audit of a man u factu ring corp oration desiring your cer
tificate where no instructions hav e bee n gi v en a
, s to the
extent or scope of the audit .

In su ch a ca se the audit shou l d be exhau stive The .

cash book should be checked thoroughly ; the bal an ce


therein at the end o f the period under review reconc iled
4

prevent the rep roduction of vouchers alre ady passed ,


in
cases where the auditor is not permitted to defac e the
vou che rs by stamps o r writing ?

Wh ile the audit is in p rogr ess the auditor should keep


all passed vouche rs in his ow n possession .

When all the vo u chers a re p a ss ed they should be


handed ove r to a responsible offi ci al for safe keeping
preferably in sealed packages
, .

IV Des cr ibe in detail the method that shoul d be


.

u sed to ve rify the secu rities rep resenting the investm ents
of a company u nde r au dit in the case of ( a
, ) r ea l e s tat e ,

( )
b mortgages on re a l est a te ( )
c c ertifi c,
ates of sto c k ,

d
( ) r ailway bonds .

a
( ) In the case of real estate the most satisfac tory
evidence wou ld be the production of the title deeds t e ,

ceip ted bills and checks showing cost The au dito r would .

have to exercise g reat care to see th at a ll items charged to



the acco u nt were c apital expenditu re e g expenditu r e . .
,

for imp rovements should be ch arged but not maintenance ,

expenses .

b
( ) Mortg a ges on r e a l est ate should be verified by
p ro d uction of the checks p a id o u t a nd of the deeds them
s elves The recording the reof shou ld be exa
. mined a nd ,

the matter O f inte rest thereon ca refully looked into


a
.

( )
c Certific a tes of stock sho u ld be produ c ed s im u lt
neous ly with

d
( ) R a ilw a y bonds They
. sho u ld be exa m ined ,

co u nted and listed


, Their value should be dete rmined
.

from m a rket qu ot ations and all othe r ava il able sou r ces of
inform ation The au ditor sho u ld take the precaution to
a
.

scertain their genuineness al so ,


1 15

If the bonds are c oupon bonds he should see that the


,

cou pons are attached and that a ll those paid sin ce the
,

date of the a cquisition of the bonds have been d uly en


tered in the cas h boo k .

V How may the auditor know tha t the b alance sheet


a
.

nd profit and loss a cco u nt of his c lient have incl u ded


all income and expenditure applic able to the period under
review

By making first a complete au dit of the books of a c

count and thoroughly fa


, mili a rizing himself with the
methods employed in condu cting the business the sou rces ,

of income and the nature of the expenditu re These will


, .

vary mo re o r less in every undertaking and the auditor


,

must be guided mainly by his expe rience in determining


the fact He ha .s one final test in that the p rofi t disclosed
,

by the p rofit and los s account must be always confirmed


by the balance sheet .

VI What means should the auditor a dopt to ascertain


.

that all remittances made by regula r customers and t e


c eip ts f rom cash sales h ave been p roperly entered on

the ca sh book ?
-

With regard to the remittances made by regular cus


tom ers he may obta in confi rm ation of thei r correct entry
by examining each ac count noting the terms of payment
, ,

and the gene ral way they h ave of paying .

If a ccou nts are generally settled monthly and the audi


to r finds remittances unc redited he should request an
,

explan ation from the cashier or a member of the firm


and if the ex lanatio n is not s ati s fa a
,

p c tory s tatement
,
1 16

shou ld be mailed by the a u dito r personal ly reque sting that


it be returned to him marked cor rect or othe rwise
As to c ash s ales the a u ditor should a scerta
.

in carefully
the method of h andling them and a
,

ct ac cordingly A .

conside rable sh rinkag e on any partic u lar da y would of


course need explanation .

I f carbon sales stubs are preserved these may be com


pared with the c a sh sale sheets Petty thefts would be .

ve ry di ffi cult to detect but were they conducted continu



ous l y on a la rge sc ale the deficiency would be evident in

the tra ding account .

VII An auditor on completion of his work certifies


.
, ,

that the accounts a re co rrect in accordance with the


books Is this fo rm of ce rtifi cate subject to criticism
.
,

and if so why ? ,

It is becau se the accou nts may be co r rect in accor dance


wi th the books and yet the books m ay not record facts
fa ithfu lly and it is this point whether they do or do not
, , , ,

which the auditor shou ld determine from his work If .

they do he should so certify ; if th ey do not he should


re f u se to give a ce rtifica
, ,

te .

VIII What gene ral p rinciple shou ld an au ditor apply


.

in dist ributing expenditu res regarding which his client


is uncertain a s to whether they should be charged to
capital or to revenue a ccount ?

If th e expenditure is for a pe rmanent asset or is of ,

s u ch a cha racte r as to incre as e the e arning capacity of a


b u siness the cha rge should be made to capita
,
l account ;
if not to reven ue accou nt If the re is any doubt on the
m atte r ca pita
.
,

, l account should be charged .


1 18

XI What a r e the mos t impo r tant things to whi ch an


au ditor is ex pected to certify in ( a
.

) the balan c e sheet


a
,

( )
b the p r ofit n d loss a cco u nt ?

a
( ) In the bala nce sheet the auditor is ex pected to
ce rtify that it is fu ll and correct ; that the assets and lia
bilities a r e neither over no r unde r stated ; a -
nd that it is a

co rrect statement of the financial position of a concern at


a given moment of time .

b
( ) In the p rofit and l oss a cc o unt the au di tor is ex
p ec ted to c e r tify that the earn ings a r e co r r e c tly stated
and that all expenditur es and income p rope rly cha rgea
,

ble
or cre ditable ther ein have been in cluded whethe r same ,

have been actually paid or r eceived d uring the fis cal


period the accou nt cove rs o r not .

XII Explain tw o methods by whi ch depreciation on


buildings machinery and plant ma a
.

, y be st ted in th e
books of acc ount State which method you p refe r and
give rea
.

s ons .

I A certa in pe rcentage of the o ri g inal cost may be


a
.

nnually w r itten o ff b a sed u pon the s u pposed life of th e

assets and thu s the total cost is cha rged to revenue a


,

count by equal periodic insta


,

ll m ents .

II A certain pe rcenta ge may be w ritten off On the


.

diminishing valu e peri odic ally until the resid ual val u e is
arrived at
The second method is g enerally p r efe rable be ca
.

u se
while in the fi rst case the amounts w ritten off do not va ry ,

yet value is eventually extinguished and there is gene ral ,

ly so m e r esid u al value rem a ining .

In the second case the amount written off diminishes


periodi cally and wh ile the g reate r a
— mount is w ritten off

1 19

at first w hen there is the least w ear and tea r this is off set
,

by the fact that in the latter yea rs the amounts expended


fo r repairs are greater .

In the books of account dep reciation may be


I Cha rged to P rofit and Lo ss Accou nt and cr edited
.
'

to a reserv e fo r dep r eci ation accou nt ; o r


II Cha rged to P rofit and Lo ss Accou nt and c redited
.

to the specific account d ep reci ated .

XIII What is meant by a suspense accou nt ? Give


thr ee insta
.

nces of items ca rried to a s u spense a ccoun t ,

and state how they may be r emoved f rom that account .

A suspense account is a n a c co u nt op ened for the p ur

pose of having posted to it items which the bookkeeper


is un able fo r the time to determ ine the p r ope r acco unt to
w hi ch they should be posted ( Lisle )
I A doubtful debt may be c redited to the debto r s a
. .


. c

count and cha rged to s uspense account When its val u e


.

is determined s u spense accou nt may be c redited and


p rofit and loss account charged if ba
, ,

d ; cash ch arged if
good ; o r p roft and loss and cash cha rged if part of the
debt is p aid and the bala nce pronou nced uncollectable .

II An item of cash m ay be r eceived and the sender s


.

name over looked The amount shou ld be c redited to s u s


pense a ccount a nd w hen the paye r s n ame is a scerta
.

,

ined
the account should be debited and the payer s account ’

c r edited .

III A dispute m ay arise as to the li ability of a firm


.

to one of its c reditors Pending settlement the suspense


.
1 20

a
ccou t is the proper r e c ipient of the c redit When the
n .

matter is settled the amount shou ld be debited to s u spense


,

account ; the c redito r cr edited with th e am ou nt decided


on and that accou nt c r edited with the balance which
,

originally was charged with the fu ll amount credited to


s uspense a ccount .

XIV What p rinciple should be applied in va l u ing the


stock of m ate r ial and supplies on hand a
.

nd to what ,

ex tent is the auditor responsible for this item in th e


balance sheet ?

M aterial and supplies on hand shou ld be valued at cost


or ma rket whicheve r is the lowe r
, .

The a u dito r while not a p rofession al val u er shou ld


, ,

a
consider himself responsible fo r the co rrectness of the
invento ry of these items a s to c lcu lations and a
mount
Any g ross ove rval uation wo u ld of cou r se manifest it
.

self in the t ra ding accou nt and the au di tor wou ld then


know what steps to take It is always w ell for the a
. u

ditor in his ce rtificate to except a s to invento ry the -

valuation of which he has accepted as m a de up by Mess r s .

So and So .

XV When auditing the books and accounts of a


.

concern ope rating a l arge m a chine shop you find that


the machinery and tools have been reg ul ar ly dep r eciated
each year that thei r val u e a s shown by th e books is con
s iderably less than the v al u e a s shown by a
,

n independ ent
appraisal and that the firm ha s set up the higher val u es
as shown by the appraisal on the books To wha t a
,

. c
count wou ld you recom m end the corresponding credit to
go a nd fo r wh a t re a sons ?
,
1 22

3une 19 02 , .

I De sc ribe f u lly the duties and work of an auditor


for a man u factu ring concern sta ting in deta
.

il the orde r
in whi ch the audit should be ca
,

rried through and draw ,

ing attention to thos e points in the accounts w hi ch should


rec eive spe ci a
l ca
re .

In the audit of a manufactu ring conc ern the cash trans


actions as in every other class of bu sines s should be fi rst
, ,

verified : receipts by checking deposits ; payments by


check s receipted bills and other vou chers ; the balan c e on
,

hand as per cash book at clos ing date by reconciling check


book balance with pass book ba lan ce
-
.

The footings of the cas h book should be gone over and


the posting s checked .

Al l sales books purchase books retu rn books and


, , ,

jou rnal should be footed and the postings checked .

Th e t rial balance book should be verified ; the closing


entries checked ; and the balance sh eet items gone over
ser iatim Th e petty cas h book and pay rolls sho uld t e
.
-

ceive c a r eful att ention All purcha ses of ma terial and


.

supplies shou ld be checked into the vario u s stock books


then ce into the consumption books and the outpu t of ma
,

uf a
,

ctured goods ve ri fied All inventories should be


.

checked as to extensions and footings etc compa r ed ,


.
,

with market value s .

The t rading ac count should be examined and the per


centa ge of gross profit c ompared with that of f ormer
yea rs .
1 23

The costing system should be examined and te sted


as to adeq u a cy and accuracy . Care should be exercised
that the distinction between capital and revenue exp en
d iture ha s been a d h ered to in the ac co unts ; that ample
p rovision has been m ade fo r dep reciation and that re
se rv es have been set aside for ba
,

d debts discounts etc


A cc rued assets and liabilities shou ld be ca
.
, ,

refu lly figu red


out and incl u ded in the profit and loss account and bal
ance sheet .

Bills receivable and payable should be made up in


sched u les and com pa red with the balance sheet item s
unde r these heads Opinions wou ld di ff er as to the exa ct
.

or d er in which the a udit sho u ld be made ; but condu c ted

on the above lines a fa i rly comp r ehensive review of al l


the important points may be fairly said to be included .

II State your views a s to the functions of


. th e journal .

In what does it di ff er from the cashbook ?

The function of the j ournal is to act as a book of


o riginal ent ry fo r all trans actions f or whi ch no other in
dependent books of reco r d exist Thus the opening and
closing entries and tr a ns fers f r om one a ccount to a
.

othe r could sca


,

rcely be made with p rop riety in any other


account book .

The cash book reco r ds all cash received and expended ;


is a book of independent o r iginal entry ; and ca pable of
independent proof In some concerns it is s till the cus
tom to pass a ll ent ries thro ugh the journal ; b u t the sa
.

me
results are obtain able with a great saving in labor by ,

the use of sep a rate books of original entry and th e ,

adop tion of the columnar system .


I 24

I II Draft a
. bank reconcilement acco unt dealing , w ith
checks o u tstanding not cleared
, .

Pa ss book balance
Check book balan c e
Add chec ks outstanding not retu rned
by bank

Reconciliation with pass book balance

IV Describe the va riou s steps to be taken in au dit


ing the accounts of an exec u tor fo r the first yea
.

r after
the death of the testa
tor .

The auditor should as k for a copy of the will letters ,

testamenta ry and appraiser s inventory He should


,

.

make himself tho ro u ghly acquainted with their contents ,

and see that the accounts have been opened in such a


way as to give adequate expr ession to s am e If a min u te
.

book h as been kept o f p roceedings in s urrogate s court ’


,

it shou ld be carefully inspected Check books retu rned


checks and receipted vou che rs should be gone ove r a
.
,

, nd

checked with the cash book All secu rities shou ld be


inspected and the ca
.

sh book balance reconciled with that


of the pass book He shou ld see that the distinction be
tween p rincipa
.

l and income has been rigidly adhe r ed to


in the a ccounts and make s u ch fu rthe r ex amination a s

would ena ble him to certify to the correctness of execu


tor s transa

ctions .

V Dra ft a form of auditor s certificate to be atta


.

ched
to a bal ance sheet on completion of an audit of the books
of a ma nu f a
cturer .
1 26

A reserve or reserve a ccount is created by charging


the re venue a ccount and crediting a specific rese rve a c

count with a c ertain amount Thu s while the amount of


.
,

the res erv e is in cluded a m ongst the assets there is no


a
,

p arti cu l r asset w hic h c o rr espo n ds to it— e g reserve . .


,

for bad debts W hen an account is pronounc ed uncol


lecta
.

bl e the amount m a y be credited to the debtor and


,

debited to the reserv e account which has been c reated


and p rovided f or this purpose

A reserve fund is a ca
.

s h as set and is an amo u nt r e

serv ed for some spec ifi c pu rpose ; e g Building r eserv e


. .
,

fund : when the fund reaches the requi r ed amount the ,

bui lding is p u rcha sed or built w ith the amount set aside
for that pu rpos e .

IX What points requ i re special attention in exam


.

ining bills receivable at the end of a fi scal period ?

The notes should all be produced and examined ; if left


at the bank for collec tion certified pa rti culars should be
obtained from the bank The dates sho u ld be exa
,

. mined
to see that none are overdue ; the amo unts to see that
the tota
,

l a grees with the ledger accou nt ; the make r s ’

a
nd end rser s names so that inqu i ry may be made
o

, ato s

their c redit .

X .What is meant by deprec iation ? Mention four


items of assets subj ect to depreciation in the bal ance
sheet and state the ann ual rate that you would recom
,

mend to be cha rged .

By depreci ation is meant diminution in value cons e

quen t on wea r a nd tea r la ps e of time


, etc , ,
1 27

Horses a nd wag ons 20 p er cent .

Plant and machinery 5 to 7%


Buildings
Furniture and fixture s 10 to 12 %

XI How sho uld the following assets be va lued in


p reparing a balance sheet : ( a
.

) manu f a ctured g oods ,

( )
b a c c ounts re c eivable ( )
c goods in pro
, c ess of manu
facture ( d ) bills receivable ?
,

a
( ) Manufa ctured good s at cost ; ,

( )
b A cc ounts Re c eiv able if good at f a ce value ; if
doubtful a reserve should be crea
, ,

, ted to cover the


amount ; if bad at nothing , .

( )
c G o od s in p r oc ess of manufact u re should be valued
at the extent to wh i ch they have approached completion
—c ost of material and supplies labor p roportion of , ,

fixed charges etc , .

( d Bills rec eivable if c urrent


,
should be taken , at
face value .

XII How should the discount a nd prem ium a rising


from the sale of a com pa
.

ny s own securiti es held in its


treas u ry be treated on the books ? Give examples .

Taking bonds a s an example :if th ey be sold at a pre


mium the par valu e rec eived should be c redited to the
,

bond ac count and the premium received to a bond issue


,

prem ium account This latter could be closed out to


.

profi t and loss a ccount at the end of the next fiscal p e


riod ; or c ould be transferred to the c redit of a reserve

account in connection with the purpose for whi ch the


bonds were i ss ued .
1 28

If the bonds a re so ld a t a discount the discount co uld


be charged to a cost of floating bonds accou nt


“ ”
.

This might be closed ou t by cha rging it a s pa rt of the


cost of the asset fo r the acqu isition of w hich the bonds
were issu ed On the other hand it might be closed ou t
.

by periodically c rediting it with and cha rging to reven u e


an amount proportion ate to the time the b onds have to
run .

XIII What ar e the special points to which an au di


.

to r s attention shou ld be directed in examining and ve r i


f y ing an invento ry consisting of raw stock s u pplies


, ,

goods in p rocess and man u factu r ed g oods ?

As to raw stock and s upplies he should r equi re the


invento ry to be sign ed by the pa rties who took it .

He sho u ld see that the prices a re cost or m arket ,

whichever is lower Good s in p roc ess and manufactu r ed


.

goods shou ld be taken at actual cost of p rodu ction He .

shou ld ve rify this by comp a rison with cost books .

In all cases he shou ld check extensions and footings .

XIV In a u diti ng the acco u nts of a firm comprising


.

seve ral pa rtne rs to w hat thr ee points should particular


,

attention be given in ascerta ining whether the pa rtne r s ’

accounts a re cor rectly stated in the balance sheet ?

Having au dited the cash transactions he should see


,

( ) 1 Th at each pa rtne r has contributed th e a


m ount o f
capita l stipulated in the pa rtner ship ag reement and that
,

he has been credited therewith Having made up the


.

p rofit and loss ac co unt, he should see


( )
2 That eac h partne r has b een cr edit ed wi th h is
Certified P ublic Accounta
nt

a a
Ex m in tions

FREDERICK S . TIPSON . C P . . A
Fel low of the A m e rica
n A ss oc i a tion

of P u blic Accou nt a nt s ,

150 NASSAU STREET. NEW YOR K.

ad t
is pr ep ah adida
re t o f C co c c n es or . P .

exam ina
ti n N w Y k S ta
o t
s, and b
y e or e, cor r es pon

d n e— al l Sta
ce t wh C P A l gi l a
esti er e . . . e s on is in
f or ce . Fee f or th e f ul l cou r s e , w h ich incl udes

com p l ete ins tr uction in a ll u bjs ec ts cov er ed by th e

ex ami a
ti n ons , $ 1 00 a
; p y abl in e f our m on th l y in

s ta
llm t en s of $ 25 ah
e c .