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T HE PR I N C I PL E S O F

AU D I T I N G
A PR A C T I C A L MA N U A L FO R
S T U D E N T S AN D PR A C T I T I O N E R S

BY

F . R . M . DE PAU L A, O B E . . .

(
O F THE F IRM OF A LA TU RNER L AKE AND
DR P U , ,

FE L L O W O F T HE I N e r U rE O F C HAR TERE D AC C O U NTAN TS ;

L E cr U R E R TO TH E C HAR TERE D AC C O U N r AN r s sr U D E N r s

S O C IET Y O F L O ND O N ; AN D THE L O N D O N S C HO O L O F
EC O N O MI C S AN D FO LI I I C AL S C I EN C E

S EC ON D EDI TI ON

o b

LO N DON
S IR I S AA C PI TMAN S ON S , L TD .

PAR KER S TR EET KI N GS WAY W C 2 , , . .

B ATH MEL BO UR N E TO RO N TO N EW Y O R K
, , ,

1 922
 Db b /
D44 p
x
. PRE FA C E TO THE S E CO N D E D I TI O N
I HAVE tak e n th e O pportun i t y of th e p ub li c a ti on of a n e w
e diti on t o am e n d th e tex t an d t o m ak e v ar i o us a ddi ti ons
in p arti cul ar I h av e am plie d th e ch ap te r on th e sub j ec t
,

of Prots av ail ab le for d istr ib uti on as di vi d e n d .

t.

PRE FA C E TO THE FI R S T E D I T I O N

a
,
THE s ub j ect O f Auditin g is so v as t th at t h e stan d ar d
,

0 I
work s of n ec ess i t y ar e so m ewh at l en gth y an d c um b erso m e
, ,

b oo ks an d a cons i der abl e p art of th e m atter con t ain e d

,

t h er ein is in ten ded for p r acti ti on ers onl y . This book

h as b ee n written p rim ar il y for s t u d e nt s wi th th e ob j ec t
,

of p rovi din g a b oo k ofconv e ni en t s iz e an d at a r eason ab l e

3j ,

cos t t h at will d eal wi th all th e g en er al p rincipl es t h at

,

gov ern e v ery audi t ; an d so form a s tepp in g s t on e t o th e

-

l arg er w orks .

I h av e en d eavo ured t o cov er th e wh ol e of th e groun d

work wi th whi ch ev ery s tu d en t of au diting m ust b e
i fam i li ar an d t o explain th e princi pl es an d r easons und erly
x

in g ea ch s ubj ec t d ealt wi th O n t h e ot h e r h an d o win g t o

.
,

lac k of s p ac e I h av e om i tted s p eci ali s ed s ubj ec ts su ch as

, ,

t h e differ en t C l ass e s O f au di t s an d i nv esti g ati ons ; for i f

all th ese w e r e i ncl u d e d th e wh ol e b oo k w o uld h av e h a d t o
,

b e con d ense d so cons i d e r abl y t h at i t w ould h av e b een

,

im p oss ibl e a d e q u ate ly t o disc uss th e im portan t root p rin

ciples t h at a pply t o e v e ry a u di t For th e sam e r ea son all
.

V
vi PRE F ACE

t h e v arious Act s of P ar li am e nt t o whi ch audit ors h av e at

t i m e s t o r e f er h av e b ee n o m i tted b ut t h e s ec t i ons of t h e
, ,

C om pani e s (
Consoli d at i on) wit h whi ch e v e ry A ct , 1 908 ,

au di t or m u s t b e fam ili ar h av e b ee n i nclud ed , .

Th e appe ndi x contains one hun dr ed ex am i n ati on q u e s

t i ons whi ch run in ord e r wi t h t h e te xt oft h e b ook an d i t
, ,

is t h ought t h at t h ese will p rov e of v alu e t o s tu d e n ts for

t h e purpos e of testi n g t h eir knowl ed g e wi t h a V i ew t o
p r ep ari n g for e xam i n at i ons .

I wo uld tak e t hi s opp ort uni t y of t h an ki n g m o st s i nc er ely

Mr Herb ert J acob s B A Barris te r at L aw an d Mr D avi d
.
, . .
,
- -
, .

W C o ates MA L L B
. , . .
,for t h e v ery v alu ab l e
. .
,

assi stanc e t h at t h e y h av e afiorded m e .

I sh all app r ec i ate gr eatly an y sugg es ti ons or op i ni ons

from r ead ers wh om I h o p e t hi s li tt l e b ook m ay ass i s t t o
,

ac quir e a t h orough an d p r act i c al knowle dg e of t h e p ri nci pl e s

of audit in g .

F
. R M
. . DE PAUL A .

E AN S r R E E r
1 7 CO L M ,

L O DO
N N EC 2 , . .
 C O N T EN T S

C HAPTER I
I N TR O D U CTO RY
PAG E

DI FFERENCE B ET W EEN ACC O UNTANC Y AND AUDITIN G N

MEANIN G O F AN AUDIT M
AUDIT E MB RA C E S B O TH PR O F IT AND L o s s ACC O UNT AND
B AL ANCE S HEET
3
0

MA I N O B J ECTS O F AUDIT
DETECTI O N O F ERR O R S AND F RAUD 3
0

DI FF ERENT C L A S S E S O F ERR O RS AND THEIR DI S C O VER Y

E R R O R s O F C O MMI S S I O N h
E RR O R S O F O M I S S I O N bu

ERRO R S O F PRINCI PL E n
(

D I FF ERENT CL A S S E S O F F RAUD AN D T HEIR DETECTI O N

MI S APPR O PRI A I I O N O F CA S H O R G O O D S

q
F AL S I F ICATI O N O F ACC O UNT S u
R O UTINE C HEC KIN G o
o

EXTENT O F AU D I T O R s INVE S TI G ATI O N S

o
c

INTERNAL C HEC KS AND THE AUDIT O R S PO S ITI O N IN

RE G ARD T HERET O
C O M ME N C E M E N T O F N E w A U D IT
AUDIT PR O G RA MME
N O TE S DURIN G AUDIT
MET HO D O F W O R K TIC KS CAL L IN G B AC K
,

C O NTINU O U S AND PERI O DICAL Au D I Ts

DI FFE RENCE B ET W EEN THE PO S ITI O N O F AUDIT O R S
A PPO INTED UNDER S TATUTE AND B Y PRIVATE
,

I N D re U AL s O R FIR M S. 17
PARTIAL AU D I T s 18
QUAL I F ICATI O N S RE QUIRE D B Y AN AUDIT O R 19

C HAPTER II

RO UTINE C HEC KI N G AN D V O UC HIN G

C H E C K I N G C A S T I N G S AN D PO S T IN G S
C A S H B OO K 22
S AL E S AN D B O U G HT D AY B OO K S 23
RE T U RN S AN D ALL O W AN C E S B OO K S 23
PE TT Y C A S H B OO K 23
PO S TA G E B OO K 23
V111 CO NTENTS

PAGE

J O UR N AL 23
TR AN S FE R J O U R N AL 23
W AG ES AN D S ALA RI E S B OO K S
S T O C K S HE ETS
B ILL B OO K S 24
S ALE S AN D B O U GH T LE DG E R S
I MPE RS O N AL AN D PRI V ATE LE D GE R 24
D I FFE RE N C E S I N THE B ALA N C I N G O F B OO KS , AN D T HE

D ETE CT I O N THE RE O F N
VO UCHIN G S
CA S H B O O K S
B AN KER S PA S S B O O K S

V O UC HIN G DE B IT S IDE
PA YI N G I N B O O K
3
- 3

RECEI PT B O O KS 3
2

CA S H RE CEIVE D F RO M D EBTO R s 3
8
CA S H S AL E S 5
2

MI S CE L L ANE O U S RE CEI PT S
R E N T s RECEIVA B L E 8
INTE RE S T AN D D IVIDEND S 3
8

INTERE S T O N DE PO S IT 8
C O MMI S S I O N S RECEIVED 8
A MO UNTS RECEIVED F R O M A G ENTS 8
INTERE S T O N L O AN S 8
BIL L S RECEIVA B L E 8
S AL E S O F INVE S T MENT S
3
2
S AL E S O F S U N D R Y A S S ET S 8
A MO UNTS RE CEIVED UNDER IN S URANCE POLI C Y 3
S UB S CRI PTI O N S 8
VO UCHIN G CREDIT S I D E
RECEI PT S ETC ,
.

ACC O UNT S S ETTL ED B Y C O NTRA ACC O UNT 39

PA YME NT O F B O U G HT L E D G ER ACC O UNTS 40
END O R S ED C HE QUES 40
CA PITAL EXPENDITURE 40
W AG E S 41
S AL ARIE S 43
TRAVE L L ERS C O MMI S S I O N S AND EXPEN S E S

43
PE T I Y CA S H 44

PO S TAG E B O O K 45

C HAPTER I II

VO U C HIN G (
O NTIN U
C ED )
B O U G H T DA Y B OO K 46
B O U G H T D AY B OO K R E T U R N S AN D ALL O W A N C E S 49
S AL E S D AY B OO K 49
 C O N TEN T S ix

PL O !

S ALE S DA Y B OO K R E TU R N S AN D ALL O W A N C ES o o 51
B ILLS RE C E IV A B LE B OO K 51
B ILLS PA Y A B LE B OO K 52
J O UR N AL 52
B O U GH T LE DGE RS 53
S AL E S LE DGE R S 54

C HAPTER IV

R F
THE P O I T AN D L O S S ACC O UN T AN D

BALAN C E S HEET
I MPER S O NAL L ED G ER 58
G R O U PIN G ITE MS IN ACC O UNT S 59
T HE PRINCI PL E S GO VERNIN G PRE PARATI O N O F
TRADIN G ACC O UNT 61
PR O F IT AND L os s ACC O UNT 62
A PPR O PRIATI O N ACC O UNT 62
AD J U S T ME NT O F N O MINAL ACCO UNTS
PR O VI S I O N FO R O UT S TANDIN G L IA B I L ITIE S ETC, . 63
PA YMENT S IN ADVANCE 65
S UNDR Y A MO UNT S RECE I VAB L E 65
THE PRINCI PL E S G O VERN IN G T HE PRE PARATI O N O F THE
B A L ANCE S HEET 65
DE F INITI O N O F B AL ANCE S HEET 66
MAIN O B J ECT O F B AL ANCE S HEET 67
VAL UATI O N O F A S S ETS
F IXED AS S ETS 70
FL O ATIN G A S S ETS 71
AUDIT O R S PO S ITI O N As RE G ARD S VAL UATI O N O F

A S S ET S 73

C HAPTER V

VAL U ATI O N AN D VERI FI CATI O N OF A S S ETS

V AL U AT I O N AN D V ER IF I C AT I O N O F V AR I O U S A S S E TS
CAS H IN HAND 77
B AN K B AL ANCE S 77
INVE S T ME NTS
IN S CRI B ED S T O C KS 80
D E BE N TU RE S AN D RE G I S TERE D S HA RE S I N C O MPAN IE S 8]
D E B E N TUR E B O N D S AN D S HA RE W A RRA N T S T O B E A RE R
 CO N TENT S
PAG E

BO O K DE B TS 81
B IL LS RE CEIVA B L E 81
S T O C K I N T R ADE
- - 82
G O O D S O N C O N S I G N MENT 90
W O R K I N PR O G RE S S 91
PL ANT A N D MAC H INER Y
L O O S E TO O L S E TC ,
. 97
F URNITURE F IXTURE S AN D F ITTING S
,
97
HO R S E S
CART S AN D VAN S 98
H ARNE S S 98
F REE HO L D C O PYH O L D AN D L EAS E HO L D
,
L AND AN D
B UI L DIN G S 98
L O AN S 1 00
P ATENT S 1 01
C O PY RI G HT S 1 01
G O O D W IL L 1 01

C HA PTE R VI
D EPR E CIATI O N R ES ER VES AN D S IN KIN G F UN D S
, ,

DE PRECIATI O N
F L UCTUATI O N S IN T HE MAR KET VAL UE S O F F IXE D A S S ETS 1 04
F L UCTUATI O N S IN T HE MAR KET VAL UE S O F FL O ATIN G
A S S ET S 1 05
DE PRECIATI O N O F W A S TIN G A S S ETS 1 05
T HE MAIN O B J ECT O F PR O VIDIN G F O R DE PRECIATI O N
,

O B S O L E S CENCE AND E FF L UXI O N O F TI ME 1 07

E S TI MATI O N O F T HE W O R KIN G L IF E O F PL ANT AND
MAC HINE R Y 1 08
PL ANT RE G I S TER 1 09
C O S T O F MAINTENANCE AND MAINTENANCE RE S ERVE S 1 10
METHO D S FO R W RITIN G O FF DE PRECIATI O N
F IXE D IN S TAL MENT S YS TE M 111
REDUCIN G IN S TAL MENT S Y S TE M 111
DE PRECIATI O N F UND S Y S TE M 1 12
IN S URANCE PO L IC Y S YS TE M 1 13
ANNUIT Y S Y S TE M 1 13
R E VA L UATI O N
-
1 14
T HE AUDIT O R S DUTIE S AS RE G ARD S DE PRECIATI O N

1 15
RE S ERVE S
S PECIF IC RE S ERVE S 1 16
G ENE R AL RE S ERVE S 1 17
RE S ER V E F UND S 1 18
INVE S T MENT O F S UR PL U S O F A S S ETS RE PRE S ENTIN G
G ENERAL RE S ERVE 1 18
 C O N TE NTS X1

PAG E

S IN KIN G FUND S 1 20
S ECRET RE S ERVE S 1 22
THE AUDIT O R S PO S ITI O N RE G ARD S RE S ERVE S 1 22

As

C HAPTE R VI I

SE CTI O N S OF THE (
C OMPAN IES C O N S O L I D ATI O N )
ACT, 1 908 , PAR TI C UL ARL Y A FFEC TIN G AU D IT O RS

APPO INTMENT AND RE MUNERATI O N O F AUDITO R S 1 25

PO W ER S AND DUTIE S O F AUDIT O R S 1 29
ANNUAL L I S T AND S U MMAR Y 1 34
T HE S TATUT O R Y MEETIN G AND RE PO RT 1 36
UNDER W RITIN G C O MMI S S I O N S AND C O MMI S S I O N S O N
PL ACIN G S HARE S 1 38
PA Y MENT OF INTERE S T To S HARE HO L DERS DURIN G
C O N S TRUCTI O N 1 39
S TATUT O R Y B o o K s

(l) RE G I S TER O F ME MB ER S 1 41
(2 ) MINUTE B O O K 1 41
(3 ) RE G I S TER O F DIRE CT O R S 1 42
(4) RE G I S TER O F MO RT G A G E S AND C HAR G E S 1 42

C HA PTE R V I I I

CIAL
S PE PO INTS IN C O NN ECTI O N W ITH THE AU DIT OF

C O MPAN IES UN DER THE C O MPAN IES

A C TS 1 908 TO 1 9 1 7
,

ME MO RAN D U M A S S O CIATI O N
OF 1 43
ARTICL E S O F A S S O CIATI O N 1 44
EXA MINATI O N O F L E G AL D O CU MENTS PRI O R TO THE
C O MMENCE MENT O F THE AUDIT O F A C O MPAN Y 1 45
S HARE CA PITAL 1 45
I S S U E O F S HARE S 1 46
AUDIT O F THE S HARE B O O KS U PO N AN I S S UE O F S HARE S 1 47
TRAN S FER AUDIT 1 49
TRAN S F ER FEE S 1 50
DE B ENTURE S 1 50
DE B ENTURE S I S S UED As C O L L ATERAL S ECURIT Y 1 53
PRE L I MINAR Y EXPEN S E S 1 54
PR O FIT S PRI O R T O T HE DATE O F INC O R PO RATI O N
x11 CO NTE NTS
PAG E

C ALL S IN ARREAR
CAL L S PAID IN ADVAN CE 1 57
F O RFEITED S HARE S 1 57
DIRE CT O R S FEE S

'
DIRE CT O RS EXPEN S E S 1 59
MANA G IN G DIRE CT O R S RE MUNE RATI O N

1 59
MINUTE B O O KS 1 60
DIVIDEND S
INTE RI M D IVIDEND S 161
DIVIDEND S O N PRE FERENCE S HARE S 161
VO UCHIN G DIVIDEND S 1 62
UN PAID DIVIDEND S 1 62
ARREAR S O F CU MUL ATIVE PRE FE RENCE DIVIDEND S 1 62

C HAPTE R I X
PRO FITS AVAIL ABL E I I
FO R D V DE D N
R F ITS AVAIL AB L E FO R D IVIDEND
P O 0 1 64
CAPITAL PR O F IT S 1 67
W A S TIN G A S S ET S 1 68
DE PRECIATI O N O F PL ANT AN D MACHINER Y 1 70
CA PITAL L O S S E S 171
C O NCL U S I O N S 1 72
THE INTERE S T S O F CRE DIT O R S 1 75
PO S ITI O N O F THE AUDIT O R AS RE G ARD S T HI S QUE S TI O N 1 76
S U MMAR Y 1 77

C HAPTER X
THE L EG L P S I
A O TI O N OF AUD I TO R S
THE PO S I TI O N OF AN AUDITO R TO A PRIVATE F IR M 1 78
AUDITO R S
PO S ITI O N UN DER THE C O MPAN IE S ACTS , 1 90 8
TO 1917 1 78
'
AUDIT O R S L IAB IL IT Y FO R NE G L ECT 1 80
AUDIT O R S L IAB IL IT Y AS RE G ARD S T HIRD PARTIE S

1 80
L E G AL DECI S I O N S
L EED S E S TATE B UIL DIN G ETC S O CIET Y V S HE PH ARD
, .
, . 181
L O ND O N AN D G E N ERAL B AN K CA S E 181
IRI S H W O O LL EN C O V T YS O N
. . 1 84
L O ND O N O I L S T O RA G E C O v S E B AR HA S L U C K AND C O
. . . 1 85
THE K IN G S T O N C O TT O N MIL L S CA S E 1 85
 C ON TENT S xii:

PAG E

CENTRA L ADVANCE AN D DI S C O UNT COR

1 88
F IVIA EXPL O RATI O N S YNDICATE
BO L ,
L TD . 1 89
B AN KIN G c o L TD .
, . 1 90
O THER S V CAPE AND DAL G L EI S H
. 1 90

191

APPEN DI X
QU E S TI O N S 1 93

205
 T H E PR I N C I PL E S O F
AU D I T I N G

C HA PTE R I
INT R O D UCT O R Y
THE sc ienc e of auditing can b e trac ed b ack o v er man y
c en turi es but it is onl y wi thin rec en t y ears tha t th e full
,

ben et s tha t are deri ved fro m a periodi cal au di t h av e

.

be gun t o be apprec i at ed fu lly by th e c o mm erc ial world .

Th e grea t expansion of th e wo rld s t rade h as h ad th e

effect of c onsidera bly c o m pli ca t ing busin ess transa ctions ;

ag ain th e wh ole tren d of m odern business is t o war ds th e
,

for mat ion O f lar g e c on c erns c on trolling large volum es of

trade wi th th e res ul t th a t th e s m all bu sines ses are graduall y
,

dis appearin g I t h as th erefo re b een found a bsolut ely

.
, ,

ess en ti al th at th e proprie t ors o f a business S hall ha ve

so m e m eans of Ch e cking th e transa ctions c arried o ut by
th eir e mplo yees an d also th a t th e y m ay b e c ert ain th at
,

th e a cc o un ts laid b efore th e m are a ccurat e and in fact do

,

S h o w a t ru e an d c o rrect vie w of th e s t at e of th e a airs of

th e busin ess To full th ese req uire m en t s a body of

.
,

sp ec ially train ed profession al au dit ors and a cc oun t an t s

has c o m e int o exis t en c e and this has led t o th e enorm o us
,

and rapid gro wth o f th e a cc oun t an cy profession whi ch

h as t ak en pla c e during th e las t twen ty or thir ty y ears .

Th ere ca n b e no do ubt tha t this e xpansion is des tined to

c on t in u e no t only in this c o un try but all o v er th e wo rld

, ,

as th e c o mm ercial c o mmuni ty realises th e nec essi ty ,

an d app rec ia t es m ore th o roughl y th e bene t s of an a u di t

, , .

1
I - xsw
(
2 THE PR I N C IPLES OF AU D ITI N G

D i eren ce b etween Acco u n tan cy an d

In form er y ears th e work of professional a cc oun t an t s

was c onned ch iey to th e ch ec king o f th e ari thm e t i c al
a ccura cy of th e de t a iled re c o rds of t ransa ct ions in b oo k s

o f a cc o u n t th e a gree m en t of th e Trial Balan c e

,
and th e ,

p repara t ion of acc o un t s in fact t o wh a t m ay b e desc ri be d

as A cc o un t an cy Work but no wad ays th e all i mp o rt an t

, ,
-

par t of a professional a cc o un t an t s work is that of au di tin g

.

Th e dierence b e tween a cc o un t an cy and au dit ing is not

c learly unders t ood by m an y busin ess m en i t being th o ught ,

tha t if a cc oun t s are p repared by a professional a cc oun t an t ,

h e nec essarily gu aran t ees th eir a ccura cy Th is h o w e ve r .

, ,

is far fro m b eing th e c ase I fan a cc o un t an t is inst ruct ed

.

m erely t o p repare a cc o un t s fro m a se t of b oo k s th e work ,

in vol ved wo uld be th at of a greein g th e Trial Balan c e and ,

th ereaft er preparing th e Prot and L O S S A cc o un t and th e

Bala n c e S h ee t .He wo uld b e a ct in g si m pl y as an expert
a cc o un t an t and no t in an y wa y as an au dit or h e wo uld
,

no t ch e ck th e b oo ks th e m sel ves e x c ep t as far as w o uld be

,

nec essary t o a gree th e Trial Balan c e and h e would no t ,

c ert ify th a t th e posit ion s ho wn by th e Balan ce S h ee t was

c orrect all h e c ould sa y wo uld b e th at th e Balan c e S h ee t
,

w as in a cc ordan c e wi th th e b oo k s A cc ou n t an t s as .
,

expert s are oft en c alled upon t o dea l wi th gures in this

,

way but wh en doin g so th e y S h o uld b e part i cula rly

, ,

c areful t o point o ut t o th eir c lien t s tha t th e y are no t

c arrying o ut an au di t An d th e y c anno t c ert ify a Balan c e
.

S h eet as b eing c orrect unless th e y h a v e c ond uct ed a

,

p roper au di t of th e wh ole of th e transa ct ions of th e business .

An a u dit is qui t e dis tinct and apart fro m a cc oun t an cy

an a u dit does no t en t ail th e p repara t ion of th e Balan c e

S h ee t a t all but deno t es so m e thing much wider na m ely

, , ,

th e exa min a t ion of a Balan c e S h ee t p repared by o th e rs ,

t o g e th er wi th th e b oo k s a cc o un t s and vo uch ers rela t in g

,

th ere t o in such a m anner th a t th e a u di t or m ay b e a ble

t o sat isfy him self and h onest ly report th at in h is opin ion , ,
 I NTR O D U C T O R Y 3

such Balan c e S h ee t is pro perl y dra wn up so as t o exhi b it a

true and c orr ect Vie w of th e s t at e of th e a ffairs of th e
par t i cular c on c ern a cc ording t o th e inform a t ion and
,

explana tions giv en t o him an d as S h o wn by th e b oo ks

, .

A n audi t of a Balan c e S hee t in volv es th e v eri c ation of

th e Prot and L oss A cc o un t as th e balan c e of tha t a cc o un t
,

mus t be in clu ded in so m e form or o th er in th e form er and ,

i t e nt ails a det a iled exa minat ion of e very i t e m in th e

Balan c e S h ee t Th e Balan c e S h ee t ho w e v er is th e all
. , ,

im port an t do cum en t and is th e one t o whi ch in th e c ase

, ,

of a c o mpan y an au dit or s report refers and t o whi ch i t

,

is g ene rally afxed for th e Balan c e S h ee t c on t ains in sum

,

m arised form all th e b alan c es appearin g a t a g i ve n da t e

in a se t of boo ks k ep t by do uble en try in clu din g th e ,

b alanc e u pon th e Pro t and L O S S A cc o un t aft er th e ,

no minal acc o unt s h av e been c losed by transfe r t o this

la tt er a cc o un t Th e whole of th e t ransa ct ions of a bu sin ess
.

S h o uld b e rec o rded in i t s b oo k s of acc o un t and th e c o mb ined ,

e ffect of all such transa ct ions and th e wh ole nan c ial

posit ion of th e c on c ern S h o uld be re e ct ed in th e Balan c e
,

S h ee t and th e prim ary o b j ect of an au di t is th a t there

ma y be an independen t in ves tig at ion wi th a Vie w t o
asc ert aining wh e th er or no t such Balanc e S hee t S ho w s a
tru e ree ction of th e nan c ial posit ion of th e c on c ern .

I n pra cti c e a u di t o rs oft en do prep ar e th e Balanc e S h ee t

,

and Prot and L O S S A cc o un t wh ich a cc o un t s th e y th ere

,

aft er c ert ify but it must be o b serv ed th at when preparing ,

th e a cc o un t s th e a cc o un t an t is a ct ing as acc o u n t an t and

,

no t as audit or and tha t this work is addit ional t o and

,

qui t e o ut side his duties as a u di t or Th e duty of an .

a u dit or is t o ch eck and report upon th e c o mple t ed work

of o th ers .

Main O b j e cts of an Au ditD etectio n of

Er r o r s an d Fr a u d .

Th e
two main p urposes of an audit are th e pre v ent ion
and de t ection of errors and frau d E rrors ma y c onsis t .
4 THE PRI NCI PL ES O F AU DrrI N G

of cleri cal errors ei th er of c o mmission or of o mission and

, ,

errors of prin c iple Errors of c o m m i ssion are c o m par a

.

tiv ely S im ple t o disc o v er as th e o rdinary rout ine ch e ckin g

,

of th e b oo k s S h ould disclose th e m Under t his h ead will .

be inc lu ded inc orre ct p ost in g s c as t ing s and c alcula tions ;

, ,

mist ak es in po s tin g and c as t in g will a ffect th e agree m en t

of th e Trial Balan c e and th eir p resenc e will thu s b e
,

re v ealed al th ough th e a ctual det ect ion of th e variou s

,

errors th a t make u p th e t o t al di fferen c e in th e boo ks

m a y en t ail a c onsidera ble a m o un t of det ail ch ecking .

This wor k c an b e c onsidera bly reduc ed in larg e bu sinesses

if self b alanc in g ledg ers are in troduc ed as in this wa y i t
-
,

m a y b e seen a t on c e in whi ch le dg ers th e errors occur .

Th ere is no w a y of exa ct ly lo c a tin g th e errors ex c ep t by ,

ch ecki ng th e c as t ing s and pos tin g s un t il th e di sc repan c ies

are dis c o v ered Errors in c al cula tions oft en will no t b e
.

re v ealed by th e a u di t for s uch mis t ak es will no t a ffect

,

th e agree m en t of th e b oo k s for ex a m ple if by a mis t a k e ,

in th e workin g o ut of pri c es th e wro ng a m o un t b e ext ended

,

in th e S ales Day Bo o k this t o t al will b e in c lu ded in th e

,

c as ting up of th e Day Boo k and h en c e ev en tu ally w ill ,

nd i t s wa y t o th e c redi t of th e S ales A cc oun t while th e ,

sa m e a m o un t will be po s t ed t o th e de b it of th e cu st o m e r s

a cc o un t in th e S ales L e dg er and so th e Trial Balan c e will

,

no t b e a ffe ct ed I n th e ordinary wa y i t is no t c onsidered

.
,

t o be p art of an au dit or s duty t o Ch e ck th e wh ole of th e

c alcula tions of th e S ales and Bo ught Day Boo ks but h e ,

S h ould as c ert ain th a t th ese are all indep enden t ly ch e ck ed

by th e s t a ff of th e bu siness wh ose a cc o un t s h e is a u dit ing ,

and h e s h o uld t es t so m e of th e c alcula t ions h ere and th ere ,

in o rder t o sa t isfy hi m self th a t th e in t ernal ch eck is bein g

c arried o ut I mport an t c al culat ions s uch as th ose dealin g
.

with dep rec iat ion r eser v es in t eres t on c apit al lo ans

, , , ,

m ortg ag es e tc h o w e ver s h ould be ch eck ed

, .
, , .

E rrors of o mission are far m ore difcult t o disc o ver

th an errors of c o mm ission as th e form er will no t affect
,

th e agree m en t of th e Tri al Balanc e ; s uch errors will

 I NTR O D U CTO R Y 5

in c lu de th e o mission t o ent er in voic es in th e Bo ught Day

Boo k th e o m ission of sales fro m th e S ale s Day Boo k th e
, ,

no n p ro vision f
-
or in t eres t ren t salaries and o ther such
, ,

o ut st andin g a cc o un t s A lth ough th e disc o very of s uch

.

o missions whi ch poin t will b e dealt with a t so m e le ngth

,

la t er on form s a v ery i mport an t part of th e duty of th e

,

au di t or y e t in a larg e business h e is c o m pelled t o rely

,

t o a c ert ain ex t en t upon th e in t ern al ch eck s in th e bu siness

it s elf t o a ssi st h i m in th e pe rform an c e of this part of his
duty I f h o we ver his au di t p rogramm e is c o m ple t e a nd
.
, ,

is tho roughly and eiciently c arried out m os t of s uch ,

o m issions S h ould be disc o vered E rrors of o mission ma de

.

in t ent ionally m ay a ffect th e result s S h o wn by th e a cco unt s

,

very c onsidera bly and S O c onst itut e a frau dulen t

,

falsic at io n of s uch a cc o u nt s .

Errors of prin c iple m a y b e c o mmi tt ed p urposely or

a cc iden t ally and m ay a ffect th e a cc o un t s c onside rab ly ;
,

if in t en t ion al th e y m ay am o un t to falsic a t ion of a cc o un t s

, ,

but on th e o th er h and th e y m ay arise quit e unin t en t ionally

, ,

th rough lack of a c orre ct kn owledg e of th e prin c iples

g o vernin g th e prep arat ion o f th e a cc o un t s of a busine ss .

Hen c e i t is ne c essary th at an a u di t or s h ould h a ve an

e x t ensiv e kn owledg e of a cc o un t an cy and S ho uld m ak e a ,

m os t th o rough in vest ig at ion if h e is t o disc o v er such errors ,

wh ich will in c lu de for inst an c e th e in c o rre ct all oc a t ion

, ,

of ex pendi ture as b e tween c apit al and re venu e the valn a ,

t io n of ass et s up o n an in c orrect b asis and th e inadequa t e ,

prov ision for depre c iat ion and b ad de bt s I n this c onne c .

t ion it must be b orne in mind th a t as a rule no a m oun t , ,

of rout ine ch e cking w ill disc lose erro rs of prin c iple th ese
c an b e dis c o v ered o nl y by in t ellig ent en quiry and research .

E rrors of this nature m ay m ak e an enorm ou s differenc e in

the acc o un t s wh e reas th e effect of c leri c al e rro rs p ro ba b ly
, ,

will be very s ma ll .

Th e det ect ion of e rro rs is a very im port an t part of an

a u di t o r s dut ies a s in th is way th e p roprietors o fa bu sin ess

m ay feel c onden t th a t th e a cc o un t s are accurat e and tha t ,

6 THE PR I N C I PL ES OF AU D ITI N G

th e position of a airs is Clearly s h o wn ; but by far the

m ore im port an t part of th e au dit or s dut ies is the de t e ct ion

of fra u d and it s pre ven t ion by m eans of th e m o ral ch e ck

,

c rea t ed by a perio dic al au di t This is th e m ain reason for

.

his appoin tm en t in th e m aj o rity of c ases for ins t a n c e th e

(
,

C o mpanies C onsolida t ion ) A ct 1 908 p ro vides th at e v ery

, ,

c o m pan y S h all appo int an au di t or wh o s h all au di t e very

,

Balan c e S h ee t th a t is la id b efore th e s h are h olders Th e .

reason is no t th a t th e S h are h olders nec essaril y s uspe ct th e

direct ors of prep aring frau dulen t a cc o un t s but th at th e ,

S h are h olders as a b ody h a v e no m eans of asc er t ainin g h o w

th e business is b ein g c arried on and wh a t is th e nan c ial

posit io n of th eir c o m pan y exc ep t by referen c e t o th e
,

acc o un t s s ubmi tt ed t o th e m by th e direct ors wh o c onduct ,

th e business as th e represen t at iv es of th e S h are holders .

Th e S h areh olders th erefore w o uld be en t ir el y in th e h ands

, ,

of th e dire ct ors wh o c o uld m ak e th e a cc o un t s S ho w

,

wh at e v er posit ion of a ffairs th e y ch ose unless s uch a cc o un ts ,

w ere ch eck ed independ en t ly on b eh alf of th e S h are h olders .

I t is for this reason th a t an a u di t or is appoint ed wh o a ct s ,

on be h alf of th e S h are holders and is a b s olut el y independen t

,

of th e dire ct ors wh ose a cc o un t s h e au di t s Th e o b je cts .

of his appo in tm en t are t o sa tisfy th e s h ar eh olders th a t

no frau d is b ein g c o m mi tt ed by ei th er th e dire ct o rs or
th e e m plo y ees of th e b usiness and t o repor t as t o wh e th er
,

or no t th e Balan c e S h ee t exh i b i t s a t ru e and c orre ct

View of th e s t a t e of th e C o m pany s affairs I t m u s t no t

.

b e th o ught th a t an au di t or S h o uld adop t an a tti t u de of

s uspi cion durin g th e c onduct of his aud i t in fa ct h e S h o uld
endeav o ur t o avoid crea t in g a S piri t of h os t ili ty an d m is
t ru s t b e tw een him self and th e dire ct o rs and s t aff of th e
c o m pan y A b o ve all thin g s h e sh o uld b e t a ct ful His
.
,
.

posi t ion is th a t h e is th e re t o as c ert ain th a t e verythin g is

in o rder th a t i t is th is duty t o his e mplo y ers whi ch h e m u s t
,

carry o ut He need th erefore adop t no a tti tu d e of mis

.
, ,

t rus t th e S h areh olders are adop tin g an ordinary business

pre c aut ion and h av e appoin t ed h im t o see for him self
,
8 THE PR I N C I PL ES OF AU D ITI N G

c are and s kill and by m aking m os t exh aus t i ve en quiries

,

R o u tin e C h eckin g .

It mu st b e o b se rv ed th a t th e m ere ro ut ine ch e ckin g of

an a u di t will only disclose c leri c al e rrors and v ery S im ple
frau ds and will seldo m if e v er re v eal errors o f prin c iple
, , ,

or c le v e r fra u ds I n o rder t o disc o v e r th ese th e a u di t or

.
,

mu s t g o behin d th e a ctu al b oo ks of a cc o un t and exa mine

ori gin al rec ords and m ak e in t ellig ent en quiries ; in fa ct
, ,

h e mu s t g o t o th e fo un da t ions up on which th e b o o ks h av e
b een buil t up I n th e follo win g ch ap t ers an endea v o ur
.
,

is m ade t o S h o w th e lines upon whi ch an au di t or mus t

work in order t o dischar g e his duties but a t th e o ut se t it ,

c anno t b e t oo s tron gly e m p ha sised th a t an a u di t o r mus t

a void b e c o m in g s ubm erg ed in th e de t ail and ro ut in e w ork
of an au dit He must b e c ons t an t ly vigilan t ; h e mu s t
.

no t t ake thing s for gran t ed but mu s t in all c as es sa t isfy

,

him self on e v ery poin t by m a kin g p roper en quirie s He .

mus t w ork u pon a deni t e and in t elli g en t plan c ons t a n tly ,

b earin g in m ind th e weak spo t s in th e s ys t e m of b oo k

k eepin g in respe ct of whi ch errors or fra u d ar e m o s t lik ely
t o o ccur Alth o ugh i t is im possi ble t o disc o v er a c le ver
.

frau d or im port a nt err o rs of prin c iple if th e au di t c onsis t s

p urel y of wh a t m a y be c alled t ick w ork this ro ut in e ,

Ch e ck in g is of im port an c e but if th e au di t is b a ck ed u p by
,

no th ing else pro b ab ly onl y Cleri cal erro rs will b e disc o vered
, .

Th e ro ut in e ch ecking in an a u di t is ap t t o b e c o m e v ery
m ono t ono u s and c onse qu en tly som nifero us ; but i t is
, ,

m os t essent ial th at i t S h o uld b e done th oroughl y and

in t ellig en tly This part of th e w ork oft en devolves upon
.

th e j unior m e mb ers of th e au di t or s s t a ff and th e y S h ould

endeavo ur t o think o ut exact ly wh at part th e Ch eckin g

th at th e y ar e en g ag ed u pon t ak es in th e wh ole plan of th e
au di t wh at are th e lik ely errors or frauds th at mi ght
,

t ak e pla c e and h o w th ese latt er w o uld b e det ect ed by th e

,

ch ecking I n this w ay th e w ork will b ec o m e far m ore

.
 I NTR O D U C T O R Y 9

in t eres t ing and if th e j unior h as any natural ap t itude h e

, ,

will so o n c o mm en c e t o g ain a grasp of th e prin c iples of

pra ct ic al audi t in g an a cquisi t ion which is bo und t o adv an c e
,

hi m in his p rofession an d one m oreo v er whi ch will m ak e

, , ,

his wo rk m ore and m ore absorb in g in a w ay pro b ab ly th at ,

at th e c o mm en c e m en t w o uld h a v e b een th o ught im possib le .

Ex ten t of Au dito r
s I n v es tiga tion s .

I t is ufcien t for an au dit or m erely t o c o m pare th e

no t s

Balan c e S h e et wi th th e b oo ks of a cc o un t but h e mus t g o , ,

t o a c ert ain e x t en t behind th e b oo k s Err ors of p rin c iple

, .

and frau d as a rule will not b e disc o ve red up o n th e

, ,

surfac e but will b e det e ct ed only by in ves t igat ions o ut side

,

th e a ctu al b oo k s tha t form p art of th e s yst e m of do ub le

en try Th e au dit or th erefore mus t use e very reasona ble
.
, ,

c ar e an d p rec a ut i on in o rde r t o sat isfy him self th a t th e

boo ks th e m selves are c orrect and in c lu de all th e tran sac ,

t ions th at s h ould b e rec o rded th erein Th erefo re th e .

,

ext en t t o which an au dit or mus t c arr y his in ves t i ga t i ons

is a very im p ort an t p ract ic al qu es t ion and of nec essi ty ,

i t must dep end largely u p on th e whole o fth e c ircum st anc es

of ea ch c ase I n a s m all bu sin ess wh ere th ere is no p roper
.
,

in t ernal Ch eck th e au dit or mus t ch eck p ract ic ally all th e

,

it e m s in det ail and verify a c onsidera ble prop ort ion o f

th em by referen c e to th e ori gin al re co rds Wh ere for .
,

ins t an c e th e re is a h ead b o o k k e eper wh o h as c o n t rol of

,
-

all th e b oo k s and wh o is as sis t ed by a fe w j unio rs th e ,

h ead b oo k k eeper h a ving a cc ess t o th e wh ole of th e

-
,

bo ok s c an m ak e adj u s t in g en tries and h as e very oppor

, ,

tun ity to c o v er u p a fra u d I f th en h e is s kilfu l i t will

.
, , ,

b e alm os t i m po ssi ble t o d et ect such frau d by m e re ro ut ine

ch ec kin g of th e bo o ks .

I n ter n al C h eck s an d th e Au dito r Po s itio n

s
in r e gar d th er eto .

In l g e business where th ere is a s t a ff of so m e numb ers

a ar ,

en g ag ed u p o n th e b oo ks i t is quit e a S i mpl e m att e r to

,

o rg anise a s ys t e m of int ernal ch eck tha t m ay relie ve the

10 THE PRI NCI PL ES OF AU D ITI N G

au dit or of a c onsidera ble a m o un t of de t ail ch ecking and ,

thu s lim it his in v es t i g at ions b e h in d th e b ooks th e m selves

t o o cc asional t es t s A n in t ernal ch e ck m eans pra ct i c ally
.

a c on t in uo u s in t ern al au dit c arried on by th e s t aff it self ,

by m eans of whi ch th e w ork of ea ch indi vidual is indepen

d ently ch e ck ed by o th er m e mb e rs of th e s t aff For .

exa m ple th e c lerk s in ch ar g e of th e ledg ers s ho uld no t

,

k eep or b e allo wed t o m a k e en t ries in th e b oo k s of r s t

, ,

en t ry ; on no a cc o un t s h ould th e c as h ier b e allo wed t o

ha v e an y c on t rol o v er th e ledg ers A s y s t e m of self .

b alan c in g ledg ers m a y b e m ade t o for m a v ery v alua ble

par t of th e in t ernal ch e ck as also m a y a ut o m a t i c t ills for
,

ch e ckin g c as h re c eip t s and t im e re c o rdin g c lo ck s for

,
-

ch e cking wag es W h ere th ere is an ef c i en t s y s t e m of

.

in t ern al ch e ck it is very difcul t for any ext ensi ve frau d

,

t o t a k e plac e e x c ep t as th e res ul t of c ollusion b e tw ee n

vario u s m e mb ers of th e s t a ff I n t ernal Ch e ck s do no t
.

m a k e frau d im possi ble by any m eans but th e y m a k e it ,

m ore di f cult and th e chan c e of de t e ct ion much g rea t er ,

and th erefore a ct as a valu a ble m o ral ch e ck Th e

, , .

au dit or S h ould in ves t ig a t e th e wh ole s y s t em and wh en ,

ch e ck in g th e b oo k s pa y S pe c ial a tt en t ion t o an y w ea k
poin t s ; h e s h o uld also sa t isfy h im self th at th e int ernal
ch e ck s are c arried o ut and h e S h o uld t es t this by ch e ckin g
,

h ere and the re h ap h az ard I f th e sy s t e m is an eicient

, .

one an a u di t o r m a y rely th ereon t o a c onside ra b le e x t en t

,

as reg ards a larg e p ar t of th e de t ail work and thu s will ,

h a v e m ore t im e t o de vo t e h is a tt en t ion t o th e m o re
im port an t part s of th e au dit .

Th e e xt en t t o whi ch an a u di t or m a y rely safely u pon

in t e rnal Ch e ck s and o m it t o Ch e ck th e wh ole of th e de t ail
ent ries depends en t irely u pon th e wh ole of th e c ircum
,

s t an c es O i th e part i cular c a se and this ques t ion mu s t b e

,

de c ided by ea ch a udi t or for h im self I n this dir ect ion h e

.

re quires c onsidera ble S k ill experienc e and j u dgm en t and

, , ,

th e ef c ien cy of h is au di t w ill depend larg el y upon th e

sk ill wi th whi ch h e de als wi th th is qu es t ion .
 I N TR O D UCTO R Y ll

C om m en cem en t o f N ew Au di t .

Be fo re c o m m en c ing a ne w a u di t an au di t o r S h o uld ,

asc ert ain by referen c e t o s t a tut e or fro m th e in stru ct ions

, ,

rec ei v ed fro m th o se e m plo yin g h im p rec isely th e s c ope of ,

his dut ies He S h ould ne xt a cqu a in t him s elf with th e

.

e x act n atur eof th e part icular bu siness and ma k e hi m self ,

fa m ili ar wi th th e t ec h ni cal de t ails of th e v ario us transac

t ions I f for e x am ple h e is t o au dit th e a cc o un t s of a
.
, ,

fact ory if i t be p ossi ble h e S ho uld as k t o be S h o wn o ve r

,

th e fa ct ory as in th is way h e will see and app re c ia t e wh at

,

is th e na ture of th e t ran sact ions that are re c o rded in th e

boo ks and h e w ill unders t and roughl y th e proc ess and
, ,

th e n ature ofth e m achinery m a terials and la b our in v olv ed

, , .

Thi s kno wledg e will enab le h im t o ex erc ise a much m ore

c o m pl et e grasp o f a ffairs and h e will app re c ia t e th e
,

essent ials much m ore readil y th an wo uld b e th e c ase if

h e sa w no furth er than th e c o un t in g h o u se -
.

Th e ne xt st ep s h ould b e t o o bt ain a lis t of all th e b o o k s

of a cc o un t and th e n am es of th e c le rks in ch arg e of ea ch
, ,

a ft er whi ch h e s h o uld th or ou ghl y in v es t i g a t e th e wh ole

s ys t e m of boo k k eepin g an d th e in t ernal ch ecks if an y

-
, ,

in vogu e I n an y lar g e bu siness th e de t ail in volved will

.
,

be eno rm o us and th e au dit o r mu st th erefore c on sider

, , ,

c arefully th e whole s y s t e m in o rder th a t h e m ay de c ide

,

wha t ground h is in v est igat ions mu s t c o v er and h o w far , ,

and in wh at direct ions h e c an rel y upon th e in t ernal

,

check . His ende avo ur S h o uld b e t o see th a t th e s ys t em

is such th at e very t ransa ct io n does b ec o m e properly
re c o rded in th e nan c ial b oo ks th a t th er e is no p o ssi b ili ty
,

of i t em s b ein g o m i tt ed or alt ered p urposely or a cc iden t all y ,

and th at no frau dulent en tries c an be made Th e au di t or .

S h o uld also stu dy any leg al do cum en t s g o v e rnin g th e

c on c e rn such as th e A rti cles of Par tne rship in th e c as e of

,

a part ners hip th e Me m orandum and A rti cles of A ss o cia t ion

,

in th e c a se of a c o m pan y an y c on tr act s wi th vendors and

,

o thers S pe ci al A ct s in th e case of Parliam ent ary c o mp anies

, ,

the will o r settl em en t in th e c ase of a trus t He S h o uld .

12 THE PR I NCI PL ES OF AU DITI N G

m a k e no t es of th e C la u ses th a t are lik ely t o a ffe ct th e

a cc o un t s and with th e t erm s of which h e mu s t b e fa m ilia r
,

durin g th e c our se of th e au dit .

Au dit Pr o gr a m m e.

I f th e au dit is t o b e an annu al one during th e c o urse of ,

th e rs t y ear th e a u dit o r S hould prepare or superv ise th e ,

prepara t ion of an audit progra mm e in which s ho uld b e

, ,

re c orded th e e x a ct de t ails of th e w o rk t o b e pe rfo rm ed by

th e audit or and h is s t aff c olum ns b ein g pro vided in order

,

tha t th e persons perform in g e ach part of th e ch e ck in g

m ay ini t i al as and wh en th e y c o m ple t e th e sa m e Thu s .
,

i t will b e seen th a t in this wa y th e prin c ipal or h is respon ,

si b le c le rk m aps o ut th e exa ct s ch e m e of th e a u dit in th e

,

rs t pla c e aft er c arefully c onsiderin g th e wh ole of th e

,

c ir cum s t an c es of th e c ase He m a y th en b e c ert ain th a t

.

th e au dit s t a ff will c o v er th e wh ole of th e ne c essary gro und ,

an d if in fut ure y ea rs dif

, feren t m e mb ers of th e s t a ff are
,

en gag ed upon th e au dit th e y can S ee by refe ren c e t o th e

,

pro gra mm e e xact ly wh a t W o rk th e y are re quired t o

perform and fur th e r th e prin c ipal can see a t an y t i m e
, ,

wha t par t o f th e work h as b een c o m ple t ed and what ,

re m ains t o b e done I n a larg e p ra ct i c e unless s om e s uch

.
,

m e th od is adop t ed th e princ ipals mu s t of ne c essi ty lose

,

a v ery larg e a m o un t of c on t rol and will b e v ery much in ,

th e h ands of th eir s t a ff ; and in fact th e effic ien cy of , ,

th e a ud it will depend no t upo n th e S k ill and c o m pe t en cy

,

of th e prin c ipals but upo n th e S k ill and c o m pe t en cy of th e

,

m e mb er of th e s t a ff in ch ar g e of th e part i cular au dit .

Th ere is one o b j e ct ion t o th is m ode of pro c ed ure and ,

that is that th e C lerk s in charg e m a y lose a sense o f

,

responsi bility and c arr y o ut th e w ork in an aut o m a t ic

,

m anner I t S ho u ld b e im pressed u pon th e m th erefo re

.
, ,

th a t th e pro gra mm e se t o ut is th e b asis upon which th e

au di t is t o b e c onduct ed and th a t th e y mus t use th ei r
,

in t ellig en c e wh en c arryin g o ut th e sa m e and th e y s h o uld ,

 I N T R O DU C T O R Y 13

b e en c o urag ed t o rec o mm end addi t ions and im pro v e m en t s

in th e sche m e for it is m os t im port an t as t i m e g oes on
, , ,

th at th e s ch e m e s ho uld be k ep t c ons t an tly up t o dat e ,

as o th er wise s erio u s a ws m ay develop For this reason .

,

i t is im port an t th at th e p rin cipals S hould re c o nside r th e

p ro gram m e fro m t im e t o t i m e Pra ct i c al ex perien c e .

S h o w s th a t serio u s dis c repan c ies in a cc o u n t s are g ener ally

re v ealed by s ur ris e in v es t ig a t ions and en quiries ; th is

p
fact th e refore s h o uld b e C ons t an t ly b orne in m ind Th e
, , .

grea t es t d an g e r in p ra ct i c al au di t ing is th a t th e w ork

m ay b e c o m e m e ch ani c al .

N o te s d ur in g Au dit .

Th e qu est ion as t o wha t no t es an a u di t or s ho uld m a k e

during th e c o urse of an a u di t is one upon which th ere is
so m e diffe renc e of O pinion A ll uni m port an t querie s and
.

mist ak es s h o uld b e s ett led and a dj u s t ed as th e y o ccur ,

and i t is no t ne c essary t o m ak e n ot es th ereof ; but no t es

s h o uld be m ade of all im p ort an t ques t ions th a t arise and ,

of all im port a n t ve rb al inst ruct ions and inform at ion gi ven

by th e m anag e m en t N o t es s h o uld b e m ade of all miss n
.

vo uch ers in voic es e tc all queri es th at h a ve no t b een

, , .
,

se tt led and adj us t ed and all m a tt e rs that h a ve t o b e

,

re memb e red fro m one visit t o ano ther A gain all workin g .
,

papers S h o uld b e led and k ep t as also S h o uld th e dr aft s

,

of acc o un t s and th e sc h edules appert ainin g there t o I n

, .

thi s way s h o uld qu es t ions arise in th e fu ture th e au di t or

, ,

would b e in a posit i on to S h o w exa ct ly wh at wo rk h e

perform ed wha t qu eri es h e raised wh a t e xplanat ions and
, ,

info rm a t ion h e re c ei ved a nd by wh o m th ese latt er w ere

,

gi ven Th e i mport an c e of this will b e apprec ia t ed lat er

.
,

wh en th e qu es t ion of an au dit o r s lia bilit ies is c onsidered

.

I t mu s t b e re m e mbe red th at S h o uld an ything g o wrong

, ,

prob a bly i t will be y ears aft er th e wo rk w as a ctu all y

p erform ed when perhaps th ose wh o w ere a ctually in
,

charg e are no lo ng er a vailable so that if p rop er records

, ,
14 THE PR I N C I PL ES OF AU DITI N G

w ere no t k ep t th e au dit or mi ght nd him self in a posit ion

,

o f so m e c onside ra b le dif cu l ty .

Meth o d W or k
of .

AS re g ards th e a ctu al m e tho ds t o b e adop t ed wh en

c onduct in g th e wo rk of an au dit th e c o mm on p ra ct i c e is ,

for a cc oun t an t s t o adop t S pe c ial and dis t in ct iv e t ick s for

th e differen t c lasses of t ransa ct ions th a t ar e ch e ck ed such ,

as S pec ial t i cks for c as t ing s cross c as t ing s c arry forw ards
, , ,

pos t ing s vo uch ers pass b oo k c on t ras Th ese t i cks s h ould

, , , .

b e as dis t in ct i v e as possib le and a rule S h o uld b e m a de

,

th a t si milar t ick s are no t t o b e u sed by th e s t aff of th e

c on ce rn whose a cc o un t s are under au di t N a turall y th e .
,

m eanin g of th e variou s t ick s S h ould not b e explained t o

'

c lien t s or th eir c le rk s O n no a cc o un t s hould j unior a u dit

.

cler k s allo w th e m sel v es t o b e dra wn in t o discu ssin g th eir

work with th e e mplo y ees of th e r m wh o se a cc o un t s the y
are a u dit ing as th e o b j e ct m ay b e t o as c ert ain wh e th er
,

th ere are an y wea k poin t s in th e sch e m e of th e au dit ,

which m a y b e t a k en ad van t ag e of for th e p urpo se of

c on c ealin g frau ds Man y au di t o rs u se differen t c olo ured
.

in k s for th e di fferent periods as in th is wa y th e ent ries of

,

ea ch period s tand o ut c learl y .

Wh en c allin g b ack au di t clerk s s h o uld b e m os t c areful

,

t o spea k c learly as o th erwise mis t a k es m a y easil y b e

,

p assed For e x am ple 7 0 6 5 3 d m ay b e pos t ed 7 6

.
, . .

and in o rder t o a vo id this m is t ak e when c allin g b a ck th e

, ,

ty s h o uld b e e mp hasised thu s S e ven ty S ix three or ,
- -
,

"
this a m o un t S h ould b e c alled b ack as S e v en ty pounds ,

six three
-
. A ll b ad gures and alt erat io ns S h o uld b e
c are full y e x a m ined and i t S ho uld b e seen tha t th e sa m e
,

gure is t ak en in bo th c ast in g and post in g O n no a cc o un t .

s h o uld eras ures with a knife b e allo wed and an in varia ble ,

rule t o th is e ffe ct S h o uld b e m ade S o m e au dit o rs adop t .

a S p ec ial t i ck in th e c ase of alt ered i t e m s so tha t i t m a y ,

b e seen aft erw ards W h e th er al t era t ions we re m ade b efo re

or after th e i t e m s w ere t icked Ano th er g ood plan is for .
16 THE PRI N C I PLES OF AU DITI N G

end of th e period of th e acc o unt s when th e wh ole of th e

ch eckin g is e ffe ct ed a t one tim e .

Th e ad vant ag es of a c on t in u o u s a u di t are th a t m is t akes ,

are disc o v ered soon aft er th e y h a v e b een c o mmi tt ed wh en ,

th e y c an b e rectied easily th e wh ole of th e c ir cum st an c es

,

b ein g in m in d Th e opportuni t ies for frau d are lessened

.

wh en th e au di t o r a tt ends a t S h ort in t erv als a nd his ,

fre qu en t a tt endanc es a ct as a valua ble m oral ch eck and ,

keep th e b oo k k eepers u p t o da t e wi th th eir wo rk A gain

-
.
,

s h o uld frau d t ake pla c e i t S h ould b e disc o v ered b efore i t

,

h as att ained large proport ions AS th e a u dit or is no t .

p ressed for t i m e h e c an c arry o ut a much m ore de t ailed

,

a u dit th an is possi ble wh en th e wh ole of th e wo rk h as t o

b e a cc o m plis h ed a t one t im e A t th e end of the period.
,

as th e grea t er part of th e det ail ch eckin g will h a ve b een

c o m ple t ed th e a u dit or w ill b e a b le t o nis h th e a u di t soon
,

aft er th e a cc ou nt s are p repared By m eans of a c on t inu o us .

au dit th e a u di t or is kep t in c ons t an t t ouch wi th the

,

bu sin ess thu s o bt ainin g a kno wledg e of wh at is g oin g on

, ,

and th erefore h e is less lik ely t o o verloo k i m port an t

, ,

po int s th an is th e c a se if h e a tt ends say only on c e

, , , .

a y ear AS th e wor k is S p read e v enly o v er th e y ear i t

.
,

will pro b ab ly s ui t th e a u di t or s own arran g e m en t s far

b ett er th an if h e h as th e wh ole of th e w ork t o perform

a t one t im e .

Th e chief disadv an t a g e is th a t it e m s m a y b e al t e red

aft er th e a u dit or h as ch ec k ed th e m and this dan g er ,

s h o uld b e rec o gnised and S pe c ial pre c a ut ions t ak en as ,

sugg es t ed p re vio u sly such as S pe cial ti ck s for al t ered

,

it e m s and th e Ch ecking c o mple t ely through of each part

,

of th e wor k Th is dang er is no t en t irely elimina t ed in

.

th e c ase of a perio dic al au dit t a kin g so m e da y s t o c o mple t e ,

as th e b oo k keepers g enerall y h av e a cc ess t o th e b oo ks

-

durin g th e a b sen ces of th e audi t or wh en i t is qu it e possible ,

th at al t erat ions m i ght b e m ade Th ese da n g ers c an onl y .

be av oided by th e a u di t o r adop t ing s y s t e m a t i c m eth o ds ,

and b ein g c ons t an t ly vi gilan t .

 I NTR O D U C T O R Y l7

Di er en c e b etween th e Po s itio n o f Au di to r s
Ap p o in te d u n d er S ta tu te , a n d b y Pr iv a te
I n div id u als o r Fir m s .

Th e differen ce be tween th e po si t ion o fan au dit or who se

a ppoin tm en t is unde r s t a tut e and th at o f on e appo in t ed
,

by a pri va t e indi vidu al or rm S h ould b e no t ed c arefull y , .

For exam ple an a u dit or appoin t ed under th e Co m panie s

,

A ct s 1 908 t o 1 9 1 7 is a ct in g as th e ag en t of th e S hare
, ,

holder s t o au di t th e acc o un t s of th e direct ors wh o are ,

mer ely th e serv an t s of th e S h are h olders His po wers and .

dut ies are den ed by st a tut e and i t is his duty t o c arry ,

o ut tho se dut ies c o m plet ely He mus t act a b solut ely .

independen tly of th e direct ors altho ugh th at does no t ,

m ean tha t h e mu s t adop t an a tt i tu de of m is tru s t or

suspicion in fact h e s h o uld do n othin g t o eng ender a
,

host ile a tt itu de but s h ould seriou s qu e st ion s of prin c iple

,

arise h e mus t b e a b solut el y fearless and h avin g m ade

, , ,

up his m ind a s t o wh at is his duty in th e c ir cum s t an c es ,

h e mus t do i t reg ardl ess o f any p ressure th e dire ct ors

,

m ay brin g to b ear Th e au dit or s po wers and dut i es

.

are dened by s t a tut e a nd c anno t b e t ak en away nor

, ,

in any wa y li m i t ed by either th e direct ors or th e

,

sh are holders .

O n th e o th er h and an a u di t or appoin t ed by a pri va t e

,

rm is no t appo in t ed under an y s t atut e h e is m erely

a ct ing for th e part ners and h e mus t c ar ry o ut s uch instruc
,

t ions a s h e m a y rec ei ve fro m the m Th e grea t im po rt an c e .

of this ari ses whe re h e is no t ins t ruct ed t o c arry ou t a

c o m ple t e au dit but m erely t o c arry o ut a part ial au dit
(
, ,

and then as is gene rally th e c ase ) t o p repare th e a cc o un t s

of th e rm S o m e t i m es an a cc o un t an t is requ est ed t o
.

p rep are th e a c coun t s bu t is no t ins truct ed t o conduct an y

,

au di t of th e b o o k s a t al
l I n such c ir cum s t an c e s th erefore
.
, ,

h e h as no p ower nor h as h e any ri ght to insi st up o n

, ,

carr ying out a full au di t and h is duty is t o c arry out ,

faithfully and to th e lett er th e ex ac t ins tructions h e h as

rec ei v ed in o th er w o rds wha t h e h as c on tra ct ed t o do
, ,

2
 18 THE PR I NCI PL ES OF AU D ITI N G

for th e part ners m a y limi t th e sc ope of h is w ork in an y

wa y tha t th e y m a y please Bu t wh en an a cc oun t an t . ,

rec ei v es ins t ruc tions to c arry o ut a part i al a u di t or t o ,

prepare acc o un t s only in v aria bly h e s h ould see th a t his

,

ins truct ions are rec o rded in writ in g I f h e arran g es .

ma tt ers v e rb all y wi th his c lien t s a t th e int ervie w h e ,

s h o uld asc ert a in e xa ct ly wh a t i t is th a t th e y re quire him

to d o and h e S h o uld e xp lain t o th em th at h e c an a c ce p t
,

no respo nsi b ility o ut side th e wo rk c o v ered by his ins truo

t ions Th ereaf t er and before c o mm en c ing th e a ctu al
.
,

work h e s hould writ e a le tt er t o his clien t s e xa ctly se tt ing

, ,

out th e t erm s of th e a rran g e m en t s m ade e m p h asising ,

an y lim i t a t ions so th a t if ques t ions ari se in af t er y e ars

, ,

h e m a y b e in a posit ion t o S ho w exa ct ly wh a t w ere th e

t e rm s of th e c on t ra ct and th erefore for wha t h e was and
, , ,

for wh a t h e was no t responsib le I n o rder t o sa v e expe nse

.
,

c lien ts oft en arran g e for a par t ial au di t bu t th e y do no t ,

app re c i at e th a t th e au dit o r s lia b ilit ies are reduc ed a cc ord

ingly . I f th erefo re an ything g oes wr o n g for ins t an c e if

, , ,

an e m plo y ee h as been defrau din g th e mth e y m ay b la m e

th e ac co un t an t and see k t o hold h im responsi ble N o w .
,

in s uch c ir cum s t an c es i t will depend en t irely u pon wh a t

,

th e a cc o un t an t c on t ra ct ed t o do as t o wh e th er or no t h e
,

is responsib l e Th e qu es t ion will be t h is Ha v in g reg ard

.

t o th e work h e c on tra ct ed t o do S hould h e h av e dis c o v ered

,

th e fr au d I f th e ori gin al c on t ra ct is not in wri t in g th e ,

a cc o un t an t w ill b e in a very difcul t posit i on indeed for ,

in all pro b ability h is clien ts will sa y th a t th e unde rs t anding

was th at h e S ho uld c o ve r th e part icular gro und wh ereas , ,

h e rightly m ay say that h e ne v er rec ei ved ins t ruct ions t o

do th a t par t of th e work and thu s i t w ill b e a case of one
,

word ag ains t th e o the r Bu t if as sugg es t ed th e o rig inal

. , ,

a rran g e m en t had b een in writ in g no such diiculty

,

c ould h av e arisen as th e exa ct sc ope of th e work und er

,

t a k en c o uld be asc ert ain ed at on c e by referen c e t o th e ,

c orres ponden c e .

S o m e r m s of acc o unt a nt s m ake i t a cu s t o m in th e ,

 INTR O D UCTO R Y 19

case of partnerships t o writ e a report wi th e very Balanc e

,

S h ee t in whi ch a tt en t ion is dra wn t o an y poin t s of a o r

,

t an c e and also t o th e fa ct tha t th e Bala n c e S h ee t ha s no t

,

been or h as b een only part ly a udi t ed and a t th e foo t o f

, , ,

th e Balan c e S h ee t a referen c e is m ade t o this report s uch ,

as : !
Th e fo re going Balan c e S h ee t is t o be read in c on

j un ct ion wi th o ur report of su ch an d s uch a da t e Th e re .

is much t o re c o mm end this p roc ed ure as a cc o un t s are ,

c ons t an tl y b ein g p roduc ed t o third parties for v ario us

p urposes such as o bt aining c redit loans or adv an c es
, , .

A cc o un t s are often furnis h ed in this way t o in t ending

part ners or p urch asers of th e business an d t o o th ers wh o ,

h av e en t ered or p ropo se to en t er in t o business rela t ions

wi th th e rm S uch persons m a y b e serio u sly misled
.

by th e product ion of a cc oun t s b earing a professional

acc o un t an t s n am e and whi ch the y m a y b e inform ed ha ve

,

b een audit ed by him wh ereas in fa ct th is m ay no t b e

, , ,

th e c a se I f th e a b o ve c ourse were adop t ed invaria bly

.
,

th e acc oun t an t s posit ion would be a b solut ely secure in

th e c ase of diffi cul t ies arising wi th h is prin c ipals or with

third p ar ties wh o h av e a ct ed upon th e acc o un t s with o ut
referen c e t o his qualify in g repo rt .

Qu ali cation s of Au dito r .

Th e qualic a tions req uired by an a u dit or are many and

v aried F irs t of all h e mus t h a v e an a b solut ely c o mple t e
. ,

and thoro ugh kno wledg e of b oo k k eepin g an d a cc o unt an cy -

,

as an au dit or in co urse of t im e is c alled u pon t o deal wi th

m an y di fferen t sys t e m s of boo k k e eping in m an y differen t-

businesses and unless h e unders t ands exa ct ly h o w such

,

acc o un t s s ho uld b e prep ared h e c anno t Ch eck th e m ; ,

therefore h e mus t be c o m ple t e m as t er of his s ubj ect and

, ,

thus be a ble t o appl y his kno wledg e t o an y se t of c ircum !

s t an ces He mus t thoroughl y unders t an d pra ct i cal business

.
,

and be a ble t o grasp th e t echnic al de t ails and th e busin ess

m ethods of an y c on c ern whose acco un t s h e is ca lled upon
t o audi t A kn owledg e of a cc o un t an cy is essen tial but
. ,
20 THE PR I NCI PLE S OF AU D I TI N G

tha t alone will no t m ak e a c o m pet en t au dit or for th e ,

sc ien c e of au dit ing is quit e apart and dist in ct fr o m accoun

t ane y Man y b eginners see m t o think th at pro vided th ey
.
,

are a b le to follo w th e s ys t e m of boo k keepin g and th at th e -

Trial Balanc e a grees e v erything mu s t b e in order and th e

, ,

au di t or h as only t o ch e ck th e p rep ara tion of th e Pro t

and L O S S A cc o un t and Balanc e S h ee t and t o S ign his ,

report .Th e a gree m en t of th e Trial Bala n c e pro v es

no t hing ex c ep t th e ari thm e t i c al a cc ura cy of th e b oo ks
, .

An a u di t or re quires a c onsidera b le leg al k n o wle dg e and ,

must be c o m ple t e m as t er of th e prin c iples of au dit in g in

all i t s b earing s I n addit ion t o his sc ien t i c kno wledge
.
,

h e mu st be a b o v e all thin g s a m an of affairs and po ss e s ,

s

t a ct and chara c ter h e mus t no t be easil y led and inuen c ed

by o th e rs but kno wing wh at h is duty is h e mu s t b e
, ,

a ble t o do it in S pi t e of dire ct or indirect press ur e He .

m a y nd him self in posit ions wh en his duty t o his c lien t

is oppos ed t o his o wn int eres t s and in s uch c ir cum st an c es
,

h e mu s t h a v e th e c o urag e t o c arry o ut h is duty faithfull y ,

re g ardless of th e e f fect s i t m a y h a v e u pon h im self I n .

th e long run th e reput at ion h e will thu s gain for a b solu te

,

int egrity will pro v e of far grea t er v alu e t o h i m th an an y

t e m porary lO S S in th e rs t c ase An a u dit or mus t be .

m e thodic al and pains t aking and h e mu s t be endo wed,

with c onsidera ble perse v eran c e for much of th e work is ,

of a so m e wh at m echani c al na ture but i t is essent ial tha t ,

th e wh ole S h ould b e th oroughly and car efull y done He .

mu s t ne v er pass an y it e m unless h e unders t ands i t s nat ure

an d is a b solut ely sa t ised th a t i t is in order if h e is no t ,

h e mus t m ak e in t ellig en t and exh a us t iv e en quiries un t il

h e h as asc ert ained th e ex act s t a t e of a ffairs O ne of th e .

grea t es t dan g ers is to pass en tries wh ich are no t c o m plet el y

underst o o d b ec a use th e au dit o r is fearful of displaying
,

ig noran c e by as kin g qu est ions I f h e c anno t asc ertain .

for hi m self h e s h o uld with o ut fail a sk for th e nec essary

, , ,

inform a tion for S ho uld h e affect t o posse ss kno wle dg e

,

which in fa ct h e does no t h e ine v it a bly will ma k e mis t ak es

, , ,
 IN TR O D UCT O R Y 21

that will be far m ore da m agin g t o his reput a t ion th an

would b e th e c ase if h e as k ed for inform a t ion u pon for ,

inst an c e t echni c al de t ails o fwhi ch h e h as no t h a d p re vi ou s

,

expe rienc e A n au dit or mus t b e p ra ct ic al and if a sk ed

. ,

for professional advi c e mus t apprec ia t e th e p ra cti c al

,

req uire m ent s and c ir cum st an c es of th e business and thu s

,

a v oid m a k ing rec o mm enda t io ns whi ch though perhaps

,

the ore t ic all y perfe ct are en t irely untted to th e c ircum

,

s t an c es of th e parti cular bu siness But it mus t b e no t ed

.
,

th a t i t is no part of an au di t o r s duty t o gi v e ad vi c e unle ss

i t is as k ed for tho ugh in p ract ic e his a d vic e is g enerall y

,

much app rec ia t ed if i t is gi ven t a ct fu lly ; h ow e ve r h e ,

c ann o t insis t upon his rec o mm enda t ions b ein g c arried o ut .

But if for exam ple th e s ys t e m of b oo k k eepin g be S O

, ,
-

dec i en t th a t i t is i mpo ssible t o prepare a ccura t e a cc o unt s ,

then h e w ould be b o und t o report u po n th e unsa t isfact ory

st at e o f a ffairs.

I n th e fo re g oin g ch ap t er th e g eneral prin c iples u pon

which an au di t S ho uld b e b ased h a ve b een se t o ut at so m e
length ; in th e sub se quen t ch ap t ers it is proposed t o
desc ri b e th e de t ail wo rk of an au dit and th e v ario u s
,

quest ions and difcult ies tha t c onst an t ly arise in p ra ct i c e .

 C HA PTE R II

RO UTIN E C HEC KIN G AN D VO U C HIN G

C h eckin g C a s tin gs an d Po stin gs .

THE ch e cking of c as t in g s and p o sting s form s a c onsidera ble

p art of an au dit and th ough this work is so m e what
,

m e ch ani c al i t is v ery im p ort an t th at i t S hould be c arefu lly

,

and in t ellig en t ly c arried o ut Th e ex t en t to whi ch th e

.

audit or will t ak e h is ch e ckin g in this dire ct ion depends ,

upon th e s y s t e m of bo o k k eepin g and in t ernal che ck s in

-

vo gu e I n th e case of s m all bu sinesses wh e re th ere is

.
,

p ra ct ic ally no in t ernal ch eck th e wh ole of th e c as t ing s

,

and pos t ing s S h ould b e ch e ck ed in th ese c ases t oo th e , ,

a u di t o r is oft e n in s truct ed t o b alan c e th e b oo ks and , ,

c onse qu en t ly i t will b e fo und ne c essary in all pro b ab ility

, ,

t o do this ch eck in g for this purpose Th e b alan c ing of .

th e b oo k s and th e p rep arat ion of th e acc o un t s are no t

par t of an a u di t o r s dut ies th ough in pra ct ic e h e often is
,

re qu es t ed t o c arry o ut this work and i t mu s t b e re m e mb ered

,

th a t if h e does so h e is a ct in g as a cc oun t an t I n th e
, .

c ase of a larg e bu siness wh ere th ere is an eicient in t ernal

,

ch eck and th e b oo k s are b alan c ed by th e s t aff of th e

,

c on c ern i t is no t ne c essary or u s ual t o ch e c k th e wh ole of

,

th e c as t ings and pos tin g s Th ese are t es t ed by ch e cking

.

a proport ion only but so m e j u dgm en t is ne c essary in

,

de ciding wh a t t o do and wh at no t t o do th e C ircum st an c es ,

of th e part i cular c ase b ein g all im port an t and it is im pos

-
,

si ble t o la y do wn any h ard and fas t miles Ho w ev er . ,

ass um ing a proper in t ernal ch e ck and th at th e b oo ks h a v e

been b alan c ed th e follo win g is an o ut lin e of th e ch e ckin g
,

that w ould b e c arried o ut by a c aut iou s au di t or .

C A S H BO O K .Th e wh ole of th e c as t in g s and po s t ing s

sho uld b e ch ecked but if self b alan c in g S ales and Bought
,
-

Ledg ers are in use th e C as h Boo k b eing pro vided wi th

,

22
24 THE PR I N C I PL ES OF AU D ITI N G

(
th e t o t al a cc o un t s if an y) an d a proport ion of th e c as t in g s
an d pos t in g s S h o uld be ch e ck ed .

W A GES AN D S AL AR IES BO O KS AN D S TO C K S HEET S All .

th e c as t in gs of th ese S h ould b e ch e ck ed unless th e audit or ,

is sa t ised th a t th e y h av e b een ch e ck ed c o m ple t ely and

independen t ly by th e st aff of th e part i cular c on c ern as ,

i t m u s t b e rem emb ered th at th ere is no do ub le ent ry ch e ck

upon th ese t o t als .

BI L L S REC EIV A BL E AN D PAYABL E BO O KS Th e de t ail .

h e re will no t b e v ery grea t so th at th e wh ole of th e cas t in g s

,

and p o st ing s c an b e ch e ck ed th e t ot als b e ing ch eck ed

to th e t o t al a cc o un t s if th e ledg ers are k ep t u pon th e
self b ala n cin g sy s t e m
-
.

S AL ES AN D BO U GHT L EDG ER S Th e wh ole or a c onsider

.

a ble proport ion of th e c as tin g s of th e a b o v e S h o uld b e

ch eck ed and all th e b alan c es s h ould b e ch e ck ed on t o th e
,

sch ed ules of b alan c es as a t th e dat e of th e a cc o un t s and if ,

th e ledg ers are self b alan c in g i t S h ould b e seen th at th e

-
,

t o t als of th e v ario us lis t s of b alan c es a gree wi th th e b alan c es

upon th e respect i v e t o t al a cc o un t s .

I MPER S O NAL AN D PR IVAT E L ED GER S All th e c as t in g s

.

and b alan c es of th ese ledg ers S h o uld b e ch e ck ed while a t ,

th e sa m e t im e ea ch a cc o un t S h o uld b e c arefu lly s c anned for

unticked i t e m s which s h o uld be m os t c arefull y in v es t i g at ed
, ,

and on no a cc o un t t icked as h a vin g b een passed a ccident all y

by one of th e audi t s t aff unless th e au dit o r is a b solut ely
,

c ert ain th at su ch is th e c ase I n an y e v en t no t es s ho uld

.
,

be m a de of an y such unticked it e m s as in th e e v en t of ,

th e bo ok s no t b alanc in g it m ay b e dis c o v ered th a t u pon

,

furth er in v est ig a t ing th ese en t ries differen c es m ay be foun d

, .

Th e foreg o in g ch eckin g is b ased u pon th e ass um p t ion

t h a t th ere is an e cient in t ernal ch eck and tha t th e C as h ,

Boo k Pe rsonal L edg er s I m personal L edg ers and b oo k s

, , ,

of r st en try are all under separat e and indep enden t

c on trol I f this is not th e c ase th e Ch e c kin g will ha v e
.
,

t o be c arried fur th er and in this c onnection th e audit or

,

mus t exer c ise his j u dgm en t and experien c e but i t is a ,

 RO UTI N E C HE C KI N G AN D VO UC HI N G 25

wise policy t o err on th e side of o v er ch e cking ra th er th an-

under ch eckin g A n au dit or s h ould no t endea vo ur t o do

-
.

as li ttle ch eckin g as possi ble but rath er to do as much as

,

h e c an .

Ho w e v er i t mu s t b e e m ph asised th at this ro u t ine

,

ch e ck in g is u nlik ely t o reveal se riou s dis c repan c ies o r

f raud and th e re is a r eal d ange r of far t oo gr eat a p ropo r
,

t ion of th e t i m e eng ag ed upon an audit b eing de vo t ed t o

th is p art of th e w o rk wh ereas such t im e w o uld b e m o re
,

p ro t ab l y em plo y ed in o th er di rect ions For e x am pl e .

,

to ch eck th e wh ol e of th e S ale s L edg er po st ings in a larg e

bu sin ess will inv ol v e a c onsiderab l e am o u n t of t i m e but
, ,

p ro b ab ly o nly cl eri c al errors will b e reveal ed Th is Ch eck .

ing h o wever will in no way p ro ve th at th e wh ole of th e

, ,

sal es of th e business h ave b e en in clu ded or th a t all th e

sales ar e g enuine .

D iffer en ce s in th e B alan cin g of B o ok s , an d

th e D etectio n th er eo f .

I t so m e ti m es o ccurs th a t th e st a ff of a bu siness is un able t o

b alan c e th e b oo k s and th e qu es t ion arises wh e ther an audit or
,

in an y C irc u m st an c es can pass a cc o un t s in which th e re is

an undisc o v ered di fferen c e I n th e c ase of a s m all bu sin ess
. ,

wh e re th e de t ail in v ol ved is no t grea t a di fferen c e s h o uld

,

be disc o v ered but in a c a se wh ere th e de t a il in v olved is

very h ea vy a s m all differen c e m a y b e pass ed p ro vided
, ,

th at th e audit or is sa t ised th a t th e boo k s h a v e b een so far

ch e ck ed that i t is pract i c all y im possible th a t th e disc repan cy
represent s th e c o mb ined e ffect of several m is t akes There .

is c onsiderable dang er in passin g a di ffe ren c e in th e agree

m en t of a se t of b oo k s e v en th ough i t is s m all for unless
, ,

th e boo ks ha v e b e en ch eck ed exh au s t iv el y and prope rly ,

th ere m ay b e e rrors in v olvin g larg e am o un t s on b o th sides ,

th e di fferen c e b e tw een whi ch giv es rise t o th e discrep an cy ,

and these errors m ay a ect th e a cc o un t s c onsiderably or ,

might e v en represen t frau ds I fth e ledg ers are k ep t u pon

.

self b alan c in g prin c iples no di fferen c e S ho uld e ver b e

-
,
26 THE PR I NCI PL ES OF AU D ITI N G

allo w ed t o re main undis c ov e red upon th e I m personal and

Pri va t e L edg ers but onl y u pon th e S ales and Bo ught
,

L e dg ers and e v en in th e la tt er c ases this s h o uld b e

, ,

permi tt ed o nly wh en o win g t o press ure of wo rk th e s t a ff

, ,

canno t a fford th e t im e t o loo k for th e diffe ren c e s uch ,

differen c e b eing s m all in a m o un t and th e b oo k s h a vin g ,

b een ch e ck ed alr eady ex t ensi v ely Wh ere th ere is an .

ade qu at e s t a ff th ere s h o uld b e a rule tha t all le dgers mu s t

,

be a gr eed o th erwise th e ledg er clerks are ap t t o b ec o m e

,

c areless and sla ck ; furth er th e ledg e rs S h o uld b e a greed

,

a t as s h o rt in t erv als as p ossible as in th is way th e m a gnitu de

,

of th e t ask of b alan c ing th e m is redu c ed .

A cc o un t an t s are oft en ins t ruct ed t o balan c e b oo k s an d ,

th is is so m e t im es an arduo u s and la b ori ou s t as k in th e ,

c arry in g o ut of wh ich c onsidera b le c ar e and m eth od is

nec essar y e spe c i all y in c a ses where th e b o ok s h av e been
,

b a dly k ep t I f th e ledg ers h a v e b een k ep t upon th e

.

self b alan c in g s y s t e m i t will b e seen a t o n c e in wh i ch

-
,

ledg ers di fferen c es lie and i t will b e ne c e ss ary m erely t o

,

ch eck th e de t ail s of th ese part i cular ledg ers un t il th e

'

errors are disc o vered But wh e re this system is no t in

.

fo rc e th e eld is much wider and th e t ask m a y b e far

, ,

m ore tro ubleso m e O ne of th e rs t th ing s t o do w ould b e

.

to ch eck th e b alan c es of th e v ari ou s ledg ers on t o th e

Trial Balan c e and th e s ch edules of de bt ors an d c redi t o rs .

Th ereaft er th e c as t in g s of th e Trial Balan c e and th e

,

sch edules s h ould b e ch e ck ed wh en th e e x a ct differen c e ,

will b e asc ert ained Wh en ch e c kin g th e ledg er balan c es

.
,

th e c as t in g s of th e a cc o u n t s S h o uld b e ch e cked as also ,

s h ould th e b ringin g do wn of th e b alan c es A t th e sam e t im e .

it s hould b e seen th at th e t o t als of th e two sides of ea ch

.

acc o un t in fact do a gree errors are easily p assed if this

is no t th e c ase I f th e wh ole of th e pos t ing s h ave b een
.

ch e ck ed already and t ick ed ea ch ledg er a cc o un t S h o uld b e

,

sc anned for unticked it e ms as als o s h ould th e b o o ks of ,

rs t en try All b ad and do ubt ful gures S h o uld b e re

.

ch e ck ed and m ade c lear I t is so m e t im es possible fro m

. ,
 RO UTI NE C HE C KI N G AN D VO UC HI NG 27

th e am ount of th e dierence t o gath er so m e idea as t o ,

th e pro b able na ture of th e sam e For exam ple a di fferen ce .

,

of 1 0s 1 0 1 00 is pro b ably an error in a cas t ing or

.
, , ,

c arry forw ard I f th e diff eren c e is di visible by two i t

. ,

m ay b e an it em posted t o th e wrong side of a ledg er a cc o un t ,

for inst an c e a differenc e of 1 4 88 4d rep resent in g an

, . .
,

exc ess of deb it s o v er credi t s m a y be a cc o un t ed for by an

,

am o un t of 7 43 2d h avin g b een post ed t o th e d eb it

. .

ins t ead of th e credit of an acc o unt Th e bo o k s sh ould . ,

th erefore b e s can ned for i t e m s of t his am o un t Differ

, .

ences ar e oft en c au s ed by gur es b ein g en t ered in th e wrong

c olumns such as S S 4d pos t ed as 5

, . . in whi ch case
th ere w o uld arise a differen c e of 4 I 8 S 8d or 1 70 65 3d . . . .

post ed as 1 76 3 3 I t S h o uld b e calculat ed wh e th er an y

.

such mist ak e will gi v e th e am o un t of th e error and if so , , ,

an y such i t em S h o uld b e loo k ed for and if fo und ch e ck ed , , , .

A n y am o un t s e x a ctl y equalling th e differenc e sh ould b e

ch eck ed as th e y m ay represen t a S ingle en t ry for whi ch
,

th ere is no c orrespondin g credi t or de b i t as th e c ase m ay ,

be . O f t en in pra cti c e th e t im e S pen t in t ryin g t o n d th e

,

di fferen c e by th es e sh ort cut s is t im e w as t ed and th e ,

only w ay is t o c on t in u e ch eckin g un t il th e errors are re v ealed .

A ft er th e b alan ces h av e b een ch eck ed as sugg es t ed

a bo v e, i t is so m e tim es a g ood plan t o ch eck c o m plet ely
th e c as t in g s and po st ings of the I m perso nal and Pri vat e
L ed g ers and possib ly also th e Bo ught L edg er in whi ch
, ,

th e de t ail i t m ay b e is no t grea t I f th e e rror is no t

, , .

disc o vered i t will be nec essary th ereaft e r t o tu rn t o th e

,

S ales L edg ers I t is w ell t o h a v e th e c as t in g s of th e b oo ks

.

of rst en try ch eck ed but in th e c ase of th e C as h Boo k

, ,

if this h as b een a greed with th e Pass Boo k i t m ay b e ,

unnec essary t o ch e ck th e cas t in g s I f th e differen c e is .

s t ill undisc o v er ed th e acc oun t an t will h av e t o ch e ck th e

,

pos t ing s of th e S ales L edg ers un t il th e c ause of th e dis

,

crepancy is b ro ught t o light S o m e a cc o un t an t s p ref er

.

t o c all b a ck post ing s fro m th e ledg er t o th e b oo ks of

rs t en t ry thus c o mple t ely ch e cking ea ch led g er a cc oun t
, ,
28 THE PR I NCI PL ES OF AU D ITI N G

a t th e sa m e t i m e ch e cking th e c as t in g s and th e b alan c e

on to th e schedule o f b alan c es Wh en Ch e ckin g b al an c es
.
,

i t is as well t o ch e ck th e o penin g b alan c es wi th th e

S ch edules of th e p re vio u s peri o d as th e di f,feren c e m ay b e
a cc o un t ed for by an error in bring ing do wn th e c o mm en c in g
b alanc es .

A s a las t res ort i t is so m e t i m es ne c essary t o anal y se

,

th e ledg ers in o rder t o dis c o v er in wh i ch ledg er th e differ

,

en c e arises and also in wh a t dire ct ion it lies This m eans

, .

anal y sin g ea ch ledg er a cc o un t under vario u s h eading s ,

u pon S pe c i ally ruled analy sis paper F or ex am ple in th e

.
,

c ase of a S ales L edg er th e c olum ns on th e de b it S ide wou ld

b e as follo w s
O penin g b alan c e ;
Goods de b it ed ;
S undry it e m s ;
Transfers ;
To t al ;

and th e h eadin g s on th e c redi t side wo uld b e

C as h c re dit ed ;
Disc o un t s ;
A llo w an c es and R e turns ;
Bad De bt s wri tt en o f f;
Bills R e c ei v a b le ;
Transfers ;
S un dry I t e m s ;
Closin g Balan c e ;
To t al .

Th e c ross c as t of ea ch S h ee t will pro ve th at ari thm e t ic ally

th e analy sis is c orre ct and th a t th e ledg ers ha v e b een c as t
,

c orre ct ly Th e to t al of th e opening b alan c es s h o uld a gree

.

wi th th e lis t of th e pre vio u s period th e t o t al of th e g o ods

,

de b i t ed S h o uld agree wi th th e t o t al sales as S h o wn by th e

S ales Day Boo k sifth ere is a differen c e i t mu s t represen t ,

errors in pos t in g or c as t ing I n th e sam e wa y th e t o t als

.
,

of th e allo wan c es e tc and b ad de bt s c an b e a greed By

, .
, .
 RO UTI N E C HEC KI N G AN D VO UC HI N G 29

analy sin g th e C as h Boo k th e t o t al c as h an d disc o un t s

,

c redit ed t o th e S ales L edg er c an b e a greed wi th the t o t als

acc o rding t o th e analysis of th e ledg er O wing t o th e .

t im e and la bo ur in v olv ed it is doubt f ul ex c ep t in ex tre m e

, ,

c ases wh e ther i t is worth while t o analy se th e ledg ers in

,

this wa y and wh e ther ins t ead of doing so i t is no t b e tter

, , ,

at on ce t o c o mm en c e ch eck ing th e ledg er po st in g s e tc , .

,

as on c o m ple tion of th e analy sis the a ctual mistak e is

, ,

no t disc o v ered but only th e fa ct tha t i t lies so m ewh ere in

,

a c ert ain ledg er and in a c ert ain boo k of p rim e en try ;

,

for ins t an c e that i t is in the pos t ing of th e sales in which

, ,

ev en t th e pos t ing s of th e sales will ha v e t o be ch e ck ed

,

un til th e error is fo und .

V o u ch in g .

V o uchin g is th e v ery essen c e of audit in g and th e wh ole ,

succ ess of an au dit depends upon th e in t ellig en c e and

th oroughness wi th whi ch th is part of th e work is don e .

V o uch in g does no t m ean m erely th e inspection of rec eip ts

wi th th e Cas h Boo k but in c lu des th e exa m ina tion of
,

e v ery transa ct ion of a busin ess t og ethe r wi th do cum en t ar y

,

an d o th er e viden c e of s uf cien t v alidity to sa t isfy an

audi t or th at such transa ction is in o rder has be en p roperly ,

auth orised and is c orr ect ly rec orded in th e b oo ks By

, .

this m eans th e au dit or g o es be hind th e b oo ks of a cc o un t

and t races th e en tri es t o th eir so urc e and i t is in this way
,

alone th at h e c an as c ert ain the full m eanin g and cir cum

st an c es of th e v ario us transa ctions ; for if h e c onnes
him self t o th e en tri es as th e y ap pear in th e boo ks of
acc o un t his inform at ion will be in c o m ple t e an d h e m ay
, ,

pass m att ers of th e utm ost im port an c e whi ch a ffect th e ,

a cc o un t s very m a t eriall y Th e en tri es in th e b oo ks s h ow

.

only s uch inform a tion as th e boo k k eeper chooses to -

disclose and such informa tion m a y be purposely or unin

tention ally c on tr ar y t o th e t ru e f act sth erefore o nl y by
,

ex am inin g ext ernal e viden c e c an an au di t or possi bly

asc ert ain th e real s t a t e of a airs A n au dit or is blin dfold
.
30 THE PR I N C I PL ES OF AU D ITI N G

wh o does no t b ase his a u di t on th oro ugh and efc ien t

v o uching I n m os t c ases c le v er frau ds c an only b e
.

dis c o ve red by vo uchin g S O th a t i t is essen tial th at th is

,

part of an au di t s h ould b e c onduct ed wi th grea t c are and

in t ellig en c e .

Wh en ch ec kin g vo uch ers a spec ial t ick or be tt er a , , , ,

rubb er s t am p S h ould be im pressed u pon th e docum en t

,

insp ect ed and this c an c ella tion of th e vo uch er s h ould b e

,

dis tin ct iv e as th e o b je ct is th a t th e sam e m a y no t b e

,

p roduc ed ag ain in support of ano th er i t em I t is w ell t o .

den ot e by th e pla c e wh ere th e v o uch er is m ar k ed th e

, ,

p urpose for whi ch i t h as b een t ak en as for exam ple an , , ,

inv oi c e m ay b e produc ed t wi c e t o th e au di t or on c e wh en ,

v o uchin g th e Bo ught Day Boo k and s ub se qu en tl y if , , ,

rec eip t ed , wh en v o uchin g th e C as h Boo k Th e en t ry in .

th e b oo ks S h ould b e t i ck ed in a dis t in ct i v e wa y wh en th e
c orr espo ndin g v o uch er h as b een a cc ep t ed .

Whils t th e ori ginal vo uch ers are b efore th e au di t o r h e ,

S h o uld m a k e c aref ul no t e of v ario u s m a tt ers t o whi ch

a tt ent ion will h a v e to be paid sub se qu en t ly or of an y ,

s ub sidi ary inform at ion deri va b le fro m th e do cum en t s .

S uch c ases will in c lu de wh en furth er inform a t io n or

auth ori ty is re quired or wh en addi tional docum en t s su ch
,

as c on tra ct s A rti cles of A ssoc ia t ion or min ut es ha ve t o

, ,

b e in spe ct ed Wh en exa minin g vo uch ers for ren t ra t es

.
, ,

t a x es insuran c e c o mm issions salaries e tc th e period

, , , , . ,

c o v e red by th e pa ym en t S h o uld b e scrutinised an d no t es ,

m ade of any apport ionm en t s and o ut s t andin g s th at will

h a v e t o b e p ro vided for a t th e end of th e period O th er .

inform at io n m ay b e no t ed s uch as th e p urch ase pri ces of

,

im port an t m at erials this informa tion b ein g m os t val ua ble

,

for th e p urpose of v erifyin g th e pri c es a t whi ch s uch

m at e rials are t aken in t o s t ock By s uch m e th ods th e .

re exa m ina t ion of do cum en t s is o bvia t ed

-
and t im e is ,

th ere by sa v ed .

C A S H BO O K Before se ttlin g his pro gramm e for v ouch in g

.

th e C as h Boo k an au dit or S h o uld en quire c arefully in t o

,
32 THE PR I NCI PL ES OF AU DITI N G

( 1 4) Wh ch e cks th e ec eip t s for p ym en t s wi th th e

o r a

C as h Boo k and h o w are s uch re c eip t s led P

(
,

1 5 ) Wh m k es o ut th e s t a t e m en t s and wh o c on t ols
o a , r

th e desp tch of th e sa m e t o de bt ors P

a

( 1 6 ) Wh pos t s th e en t ries fro m th e C as h Boo k t

o o

th e ledg ers P
Upon th e c o m ple t ion of this in v es t ig at ion th e a u di t o r ,

will dra w u p th e S ch e m e of h is audit of th e C as h Boo k ,

pa ying S pe c ial a tt en t ion t o any w e ak p oint s in th e s y s t e m ,

and all pla c es wh ere fro m his experience h e sees th at

, ,

loop h oles are lik ely to b e fo und He s h ould poin t o ut .

t o his c lien t s an y W e aknesses in th e s y s t e m and alth o ugh , ,

i t is no part of his dut ies in pra ct ic e pro b a bly h e would

,

advise th e m as t o th e m anner in whi ch th e s y s t e m c o uld

b e im p ro ved and s trength ened Th ere are two m ain .

o b j e ct s of such a sy s t e m Th e rs t is to ens ure th at all

.

th e re c eip t s of th e business fro m all so ur c es ar e a cc oun t ed

for and th erefo re e very p re c aut ion s h ould b e t a k en by
, , , ,

m eans of in t ern al ch eck s t o m ak e i t as diicult as possible

,

for th e re c eip t s t o b e m isapprop ria t ed Th e se c ond is t o .

ens ure th a t no im p roper or frau dulen t pa ym en t s are m ade ,

th a t e v ery pa ym en t has b een properly authorised and is

a bond de bu siness expense th at th e transa ct ion is properly ,

rec o rded in th e b oo ks of a cc o un t and th a t th e pay ee ,

a ctu all y h as re c ei v ed th e am oun t .

B AN KER S PA S S BO O K O ne of th e rs t s t eps in v o uchin g

.

th e C as h Boo k S h o uld b e th e ch e ckin g of th e sam e wi th

the Ban k er s Pass Boo k Th e indi vidual it e m s in th e

.

C a sh Boo k S h ould b e c alled b a ck wi th th e Pass Boo k ,

b o th th e C as h Boo k and Pass Boo k en t ries b ein g t ick ed ,

and th e rec on ciliat ion s t a t e m en t a t th e end of th e period

S h o uld b e ch eck ed thus a greein g th e C as h Boo k and Pass
,

Bo o k b alan c es Th e ch e qu es b o th paid in and dr a wn

.
, ,

that are no t t h ro ugh th e Pass Boo k a t th e da t e of th e

a cc o un t s and whi ch appear in th e rec on c ili at ion s t at e m en t
, ,

S h o uld b e t ra c ed thr o ugh in t o th e Pass Boo k for th e

succ eedin g period in order th at i t m ay b e seen th a t such

,
 RO UTI NE C HE C KI N G AN D VO U C HI N G 33

o ut s t andin gs are bond dc transa ct ions whi ch do appear

in th e Pass Boo k tho ugh in th e foll owing pe riod I fth e
, .

au di t t ak es pla c e so m e t im e aft er th e close of th e n an c ial

period and th ere are o ut s t andings th at are st ill no t thro ugh
,

th e Pa ss Boo k en quiries S h ould b e m a de as t o th e reason s

, .

Wh en Checkin g th e de b i t S ide of th e C ash Boo k wi th th e

Pass Boo k i t s h ould be seen th a t th e da t es agreeex cep t
,

in th e c ase of c oun try ch equ es whi ch m a y no t be c redit ed

,

in th e Pass Boo k for a fe w da ys b e ca use m an y frau ds are

c o mm i tt ed by th e S im pl e exp edi en t of dela y ing th e b ankin g
of m one y s th e default ing pe rson ha ving th e u se of such
,

m o ne y s in th e m eantirn e and thus alwa ys b eing in possession

,

of part of th e funds of th e c on c ern .

Wh en checking th e c redi t S ide of th e C as h Boo k with

th e Pass Boo k i t S h ould be seen th a t th e da t es and nam es
,

in bo th c orrespond and tha t all b ank Charg es dish ono ured

, ,

ch equ es e tc h av e b een en t e red in th e C as h Boo k In

, .
, .

c ases wh ere the Pass Boo k h as been check ed already and

agreed by th e s t a ff of th e business and a rec on c ilia t ion ,

s ta t e m en t is pla c ed b efore th e au dit or so m e acc o un t an t s ,

m erely che ck th e c redit S ide of th e C as h Boo k in t o t al ,

though e v en in s uch c ir cum sta n c es th e wh ole of th e de b it

, ,

S ide s h ould be ch eck ed in d et ail all c o ntr as b ein g no t ed

, ,

en quired int o and t aken int o a cc o un t wh en a gree in g th e

,

c redi t S ide in t o t al S ho uld th e audi t or h av e t o prepare

.

th e rec on c ilia t ion st at e m en t h e will ti ck o ff th e Pass Boo k

,

it e m s wi th th e C as h Boo k as in di ca t ed a bo ve and th ere ,

aft er h e will scan th e C as h Boo k for unticked it e m s on

bo th S ides th ese s h o uld repr esent it e m s no t y e t thro ugh
th e Pass Boo k Fro m th e Pass Boo k b alan c e sh ould b e
.

deduct ed th e t o t al of th e ch equ es dra wn but no t y e t paid ,

by th e ban k and t o th is am o un t S h ould be added an y

,

Ch equ es paid in but no t y et c redi t ed in th e Pass Bo o k .

Th e result thus o bt ained S h o uld giv e th e C as h Boo k

balan ce I n th e c ase of an o v erdraft th e proc ess will
.
,

h av e to be rev e rsed .

Frau ds hav e b een c o v ered up in th e past by produc ing

3
34 THE PRI N C I PLES OF AU DI TI N G

t o th e au dit or a dummy Pass Boo k and th erefore in , , ,

order t o gu ard ag ain s t this th e au di t or s h ould o bt ain ,

direct fro m th e b an k ers a c ertica t e of th e b alanc e a cc ordin g

t o th e b oo ks of th e b ank as a t th e c lose of th e nan c ial
,

period of th e c on c ern whose a cc oun t s are being au dit ed ,

and i t mus t b e seen th a t this b alanc e agrees wi th th e

b alanc e s h own by th e Pass Boo k produc ed .

V O U C HIN G DEBI T S I DE
Th e v o uching of th e de b i t side of th e Cas h Boo k is th e
m ore difcul t of th e tw o as th e a u di t or is no t so much ,

c on c erned with th e en t ries tha t appear as wi th th e po ssi ,

b ilify th a t rec eip t s h a v e b ee n o mi tt ed ; c onse qu en t ly h e ,

is thro wn b a ck u po n th e int ernal ch ec ks and in direct ,

e viden c e .

PAYIN G IN BOO K -
I f th e c o unt erfoils of th e Paying in
.
-

Boo ks h a v e b een ini t ialled by th e b ank a proport ion of ,

such c o unt erfoils S h o uld b e Ch eck ed with th e C as h Boo k

th e o b j ect of this is t o as c ert ain th at th e wh ole of th e
m one ys rec ei v ed h as been paid in t o th e b an k pro m pt ly ,

and also th a t ch e qu es h a v e no t b een S plit im p roperl y .

Th e spli tt ing of ch e qu es m a y arise in th is w a y A p aym en t

(
.

by A B . C o of sa y ) 50 in se ttlem ent of th eir a cc o un t

. .
,

is misappropria t ed and c onsequen tl y does no t appear in

, , ,

ei th er th e C as h Boo k or A B C o s a cc o un t in th e S ales
. . .

L edg er I f i t is left in this st at e aft er a t im e a tten t ion

. ,

wo uld b e bo und t o b e direct ed t o this unli quida t ed a cc o un t ,

and on applica tion b eing made t o A B Co for paym en t . . .

,

th e frau d w ould b e dis c o v er ed imm ediat ely Th erefore in .

,

order t o c o v er this up a la t er ch equ e fro m ano th er de bt or

, ,

C D Co for 1 00 is en t ered in th e C as h Boo k as

(
. . .
,

A B
. . Co 50 and C D
. C o on acc oun t ) 50 and
, . . . ,

th e ch e qu e of 1 00 is paid in t o th e b an k I n t his w ay . ,

A B
. . .

C o s a cc o un t is c losed and th e defal ca tion is
transferred t o a ne w acc o un t and thu s for a c ert ain length
of t im e th e a cc o un t s m ay be m anip ulat ed A c o m parison .

of th e c o un t erfoils of th e Pa yin g in Boo k m ay re v eal this -

 R O UTI NE C IN G
C HE K AN D VO U C HI N G 35

frau d unless th e production of th e c o un t erfoils t o th e b an k

,

for wh en pa ying in h as b een o mi tt ed in wh ich

la tt er c ase th e c o un t erfoils m ay h ave b een made t o agree
,

with th e C as h Boo k by th e c as hier I n c ases wh ere frau d .

is s uspe ct ed th e au di t or s h ould endea vo ur t o O bt ain fro m

,

th e b ank th e original pa ying in S lips in it s possession -

,

and th ese h e S hould ch ec k wi th th e Cas h Boo k .

REC EI PT BO O KS Th e co un t erfoils of R ec eip t Boo k s m a y

.

b e t es t ed with th e C as h Boo k tho ugh if th is ch eck is ,

an t ic ipa t ed th e defaul ting party m ay m ak e th e m agr ee

,

wi th th e C as h Boo k I t mus t b e seen th a t p re c autions

.

are t ak en t o pre v en t b lank rec eip t form s b ein g o b tained .

I n th e sa m e w ay tra v ellers re c eip t b oo ks and c olle ctin g

b oo k s S h o uld b e t es t ed wi th th e c as h a cc o u n t ed for by
th e m a cc ording t o th e C as h Boo k I fi t e m s are disc o v ered.

in th e R e c eip t Boo k s and wh i ch do no t appear in th e C as h

Boo k th ese s h o uld b e c arefull y in v es ti g a t ed as i t m a y
, ,

w ell b e th a t th e y represen t misappropria t ions of c as h

rec eip t s
.

CA S H REC EIVED F R O M DEBT O R S Th e b es t ch eck upon .

th e c as h rec eiv ed fro m debt ors is t o arrang e th a t th ose wh o

c olle ct and h andle th e cas h can in no w ay c on trol th e
prepara tion or S en ding o ut of th e s t a t e m en t s if for ,

exa mple s t a t e m en t s are sent m onthl y in respect of e v ery

,

open a cc o unt on th e ledg ers an y m isappropria t ion of c as h

,

re c ei v ed is alm os t c ert ain t o be di sc o vered as th e de bt or , ,

on rec eip t of th e s t at e m en t will a t on c e draw a tt en tion

,

t o th e fa ct tha t c redit h as no t b een gi ven for th e pa ym en t

h e h as m ade .

CA S H S AL ES I n th e c ase of Cas h S ales an au di t or is

.
,

largely dependent u pon th e s y s t e m in vo gu e I faut o m at ic .

t ills are used th e till rec ords S h ould be t es t ed with th e c as h

,

a cc o u nt ed for under t his h ead I n lar g e S hops th e s ales m en

.

sh ould no t b e allo wed on an y a cc o unt t o re c ei v e th e c ash ,

but s hould m ake o ut a b ill c ar b on im pressions b ein g t ak en

,

aut o m a ti cally and upon th is b ill th e cus t o m er S ho uld pa y

,

t o a des k c as hier who S h ould rec ord such t ak ing s in a

,
36 THE PR I NCI PL ES OF AU D ITI N G

D es k C as h Boo k . Wh en such a s y s t e m is in u se th e ,

c o un ting h o u se s t aff S h ould p repare daily summ aries of

-

th e c as h s ales fro m th e S alesm en s D es k Bo ok s and th ese

t o t als S ho uld b e Ch e ck ed and ag reed wi th th e de sk c as hier s

summ aries and with th e t o t al of c as h sales paid in t o th e

,

b a nk an d in th e sa m e w ay th e audit or S h o uld v erif y a

,

p roport ion of th e c as h sales I f th ere is no s ys t e m or if

.
,

wh at s ys t e m th ere is is b ad and fa ul ty it is im possible for ,

an au di t o r t o vouch th e c a s h sales and in such c ir cum ,

s t an c e s h e s h ould poin t this o ut t o h is prin cipals in wri t in g ,

and disc laim all re sponsib ility in this c onne ct ion un t il an

ef c ien t s y s t e m is p ut in t o forc e .

MI S C ELL AN EO U S REC EI PT S Mis c ellaneo u s R e c eip t s are

.

so m ewh at dif cul t t o ch e ck and th e e viden c e re quired

,

depends upon th e nature of th e i t e m s Th e follo w in g are .

e x a mples t og e th er with th e m e th ods by whi ch an au di t or

,

s h ould v ouch th e sa m e
RENT S REC EIVA BL E Th e l eases and ag ree m en t s with
.

th e t enan t s s h o uld b e ex a m in ed and in th is w a y th e

,

ex a ct a m o u n t s re c ei vab le as c e rt ained Th e a m o u n t s .

d ue will th en b e ch e ck ed t o th e ren t roll if on e is k ep t , .

Th e ren t s r ec ei v ed a cc or ding t o th e C as h Boo k s h o uld b e

-

(
ch e ck ed t o th e ren t roll if any) and wi th ag en t s a cc o u n t s

if th e rent s are c olle ct ed by ag en t s All e m p t ies and .

arrears S h ould b e c arefull y en q uired in t o I n th e c ase .

of w ee kly propert ies so m e t im es ea ch t enan t h as a ren t

,

b oo k in whi ch th e c o lle ct or en t ers and ini t ials for th e

am o un t s re c ei ved I n such c ases th e au di t or s h o uld
.
,

occ asionall y c all for th e product ion of such b oo k s and ,

see tha t all th e rent s ent ered th erein h av e been a cc o un t ed

for .

I NT ERES T AN D D IVI DEN D S I n t eres t and di vidends

.

rec ei v ed fro m in ves tm en t s S h o uld b e ch e cked with th e

c o un t erpart s of th e int eres t and di vidend w arran t s or th e ,

le tt ers c o verin g th e ch e qu es I n th e c ase of b onds th e

.
,

bonds th em sel v es s h o uld b e inspe ct ed and i t will b e seen ,

by th e c oupons th at h a v e b een t orn o ff wh at in t eres t

 RO UTINE C HE C KI N G AN D VO UC HI N G 37

sho uld h a v e be en rec ei ved I f th e bonds are in th e h ands

.

o f th e c lien t s b a nk ers th e b ankers c olle ct in g th e c ou pons

wh en du e th e en tri es in th e Pass Boo k will be a sufc ien t

,

vou ch e r Th e a u di t or mus t see th a t all th e di vidends or

.

in t er es t in re spect of e very in v estm en t h a ve been rec eived

and a cc oun t ed for .

I NTERE S T 0 N DEPO S IT I n t eres t on Deposi t will be

.

vo uch ed wi th th e en try in th e Pass Boo k .

C O MMI S S I O N S REC EIVE D Co mm issions rec eiv ed will b e

.

vo uch ed wi th th e C o mm issi on A cc o un t s rendered .

AMO UN TS REC EIVE D FR O M A GENT S A m o un t s rec ei v ed .

fro m ag en t s will b e ch e ck ed with th e a cco un t s rendered by

th e ag en t s which a cc o un t s S h o uld h a v e b een ch eck ed and
,

p assed by th e m an ag e m en t .

I NT ERES T 0 N L O AN S Th e loan agr ee m en t or wha t e ver

.

o th er e viden c e th ere is of th e loan S ho uld b e inspe ct ed i t ,

being seen th at th e int eres t th e re pro vided for h as been

acc o un t ed for .

BI L LS REC EIVA BL E Th e am o un t s rec ei v ed s h o uld be

.

ch eck ed t o th e Bills Rec ei va ble Boo k i t being seen th a t ,

all b ills du e h a v e b een a cc o un t ed for .

PR O C EED S O F THE S AL E O F I N VES T MENT S Pr oc eeds of .

th e sale of in v es tm en t s S h o uld b e ch eck ed wi th th e s t ock

b ro k er s c on t ra ct n ot e which will S h o w th e ne t a m o un t t o

b e re c ei v ed .

PR O C EED S O F S AL E O F S UN DR Y A S S ET S Proc eeds of .

sale of sundry asse t s will be Ch e cked wi th wh at e v er eviden c e

is a vaila ble I n th e case of a s ale by auct ion th e am o un t
.
,

r ec ei v ed S h ould b e ch e ck ed wi th th e a ucti one er s a cc o un t

and a m ar ked c at alogue I n o th er c ases th e c orre

.
,

spon dence , c on tra ct of sale and an y o th er docum en t s in

,

c onnect ion th erewi th mus t be e x amin ed in order t o ,

asc ert a in th e am o un t of th e sale p ric e .

A MO UNT S REC E IV E D UN D ER AN I N S U R AN C E PO L ICY .

S uch a m o un t s sh ould b e ch e ck ed by m eans of th e c orr e

spo ndence wi th and a cc o un t s rendered by th e insuran c e
, ,

bro kers or the ins uran ce c o m panies .

f lQ HV R
38 THE PR INCI PL ES OF AU D ITI N G

S UBS C R I PT I O N S S ub sc rip tions recei v ed by a Club or

.

soc i ety s h o uld be ch eck ed wi th c o un t erfoil rec eip t boo k s ,

and with th e p ublis h ed lis t of sub sc ri b ers .

V O UC HIN G C RED IT S I DE
RE C EI PT S , ETC . Th e m aj ori ty
of th e doc um en t s produc ed
in c onne c tion wi th th e v o uch ing of th e c redi t side o f th e
C as h Boo k will c onsis t of rec eip t s invoi c es and rec eip t ed
, , ,

acc o un t s and wh en exam in in g th ese an au dit or s h o uld

, ,

c o m p are th e nam e of th e pay ee with th e nam e in th e Cas h

Boo k . He S h o uld no t e th e dat es u pon th e a cc o un t for in ,

this way i t m a y b e fo und th a t a cc o un t s th a t s h o uld h a v e

b een ch arged t o th e Pro t and L oss A cc o un t of th e p re vio u s
y ear are b eing borne by th e y ear under re view On th e .

one h and such a mist ak e m ay h a v e b een acc iden t al in

, ,

whi ch c ase it S h ould be seen th a t proper prec aut ions are

t ak en th a t no s uch m is t a k es are made in th e future ; or ,

on th e o th er h and i t m a y b e disc o v e red th a t th ere h as

,

b een frau dulen t su pp ression of a cc o un t s in th e pas t and ,

th a t thus th e p rot s hav e b een in a t ed Th e da t es s h o uld .

also b e sc rut inised in o rder t o gu ard ag ains t th e v ouch ers

,

of b a ck y ears bein g produc ed in s upport of frau dulen t

pa ym en t s in s ucc eedin g y ears Th e part iculars of g oods
.

s upplied or servi c es rendered S h o uld be s c rut inised wi th a ,

v ie w t o asc ert ain in g t h a t th e sa m e are p roper business

Charg es and th a t th e pri vat e a cc o unt s of in dividu als are

,

no t b ein g p aid by and ch arg ed t o th e business th erefore ,

th e nam e of th e party t o who m a cc o un t s are addressed

S h o uld b e exa m ined I fpri v at e a cc o un t s are paid thro ugh
.

th e business as so m e tim es occurs in o rder th a t th e in di

,

vidual m ay o bt ain th e benet of trade t erm s i t S h ould be ,

seen that th e am o un t is de b it ed t o th a t person s a cc o u n t

in th e boo ks .

Th e am o un t of e ach v o uch er S h o uld b e c o m pared wi th

th e am o un t in th e C as h Boo k i t b eing seen th a t an y ,

disc o un t s ha ve been properly deal t wi th in th e boo ks .

Th e a u di tor s h o uld see t h a t th e a cc o u n t h as b een init ialled

40 THE PR I N C I PL ES OF AU D ITI N G

PAYMENT OF BO U GHT L EDG ER

A C C O UNT S I n th e c ase .

of pa ym ent s in se tt lem en t of Bought L edg er a cc o un t s th e ,

invoi c es will h a v e b een e x am ined wh en vo uch in g th e

Bo ught Day Boo k and therefore i t w ill no t b e ne c essary
, , ,

t o c all for th ese ag ain wh en v oirching th e C as h Boo k th e ,

c redit ors re c eip t s b ein g suffic ien t I n th e c a se of paym en t s

.

that are de b it ed t o I m personal A cc ou n t s h o we v er m ere , ,

re c eip t s are not suicient but th e au di t or mu st insis t u p on

,

th e product ion of invoi c es and a cc o un t s gi vin g full par ,

ticulars of th e transa ct ion S O th a t h e m a y see th a t th e ,

sa m e are in order furth er h e m a y h a v e t o refer t o m inut es

, ,

c on t ra ct s and o ther sim ilar e viden c e b efore h e c an pass

, ,

s uch pa ym en t s This par t of th e v ouching of th e C as h

.

Boo k pa ym en t s re qu ires grea t c are .

E N DO R S ED CHEQU ES N o t es S h o uld b e m ade of all

.

m issin g v o uch ers and in c ases wh ere th ese c anno t b e found

, ,

th e au di t or S h o uld insis t upon dupli c at es b ein g o bt ain ed .

I n s uch c ases th e endorsed ch e qu es oft en ar e p roduc ed t o

,

th e au dit o r in lie u of a re c eip t but th ese S h o uld no t b e

, ,

a cc ep t ed as vo uch ers ex c ep t in spe c ial c ases A n endorsed

, .

ch e qu e is no t a leg al re c eip t it a ff ords no e v iden c e as t o ,

th e nature of th e pa ym en t nor is i t g o o d e v iden c e th a t th e

,

pay ee h as re c ei ved th e a m o un t as th e endorsem ent m a y ,

b e fo rg ed . Th e only c ir cum s t an c e in whi ch endo rsed

ch e ques m ight b e c onsidered s uf c ien t v o uch ers is wh en ,

th e si gna ture of th e pa yee is w ell kno wn to th e a u dit or ,

and th ere is o th er e viden c e as t o th e nature of th e p aym en t ,

th at i t is in order and th at it h as b een duly autho rised

, ,

exa mples b eing dire ct ors fees salaries and part ners
,

, ,

drawing s E ven in such c ases h o w e v er proper re c eip t s

.
, ,

S h o u ld b e o bt ained if possi b le and i t is ad visa b le

, wi th , ,

regar d t o part ners dr a wing s th at th e par t ne rs S h ould b e

,

re qu es t ed t o ex am ine th eir respe ct i v e dra win g a cc o un t s

periodic ally and if th e y nd th e m t o b e in order t o

, , ,

initial th e sa m e .

C A PITA L EX PEN D ITU R E C apit al e x penditur e S h o uld b e

.

m os t c arefully vo uch ed wi th a vie w t o asc ert ain ing th a t th e

,
 RO UTI NE C HEC KI N G AN D V O U C HI N G 41

pa ym en t s are in order and are p roper c apit al ch arg es

, .

Th e ques t ion as t o wh a t docum en t s will be requ ired depends

upon th e na ture of th e pa ym en t Th e follo win g are .

exa m ples
PL ANT MA C HIN ER Y F U R N ITU RE F I XTU RES ETC
, , , , .

I n voic es and rec eip t s will be required and en quiry s h o uld ,

be m ade in order t o as c ert ain th a t th e it e m s are bom i de

c apit al ch arg es and that no repairs and expense s of
,

m ain t enan c e are added t o th e c apit al a cc o un t .

L AN D AN D BUIL D IN GS Th e c on t ra ct of s ale and th e

.

soli c it or s s t at e m en t S ho win g th e p urch ase c onsidera t ion

,

paya ble S h o uld b e seen I fth e buil din g s are being erect ed
. ,

th e audit or S h o uld exam ine th e builders c on tract th e

,

builders rec eip t s and ar chit e ct s c ert ic a t es Th e t i tle

,

.

deeds S h ould also b e inspect ed S oli c it ors and ar c hit ect s

.

ch ar g es will b e vo uch ed by th eir rec eip t ed acc o un t s and ,

th ese expenses m ay b e trea t ed as being part of th e c api tal

c ost.

I NVES T ME NT S I fp urch ased thro ugh a s t o ckb ro k er th e

.
,

c on tra ct n ot e S h o uld b e inspect ed and this will S h o w th e ,

exa ct a m o un t p aya ble I n th e c ase of a ne w issue for

.
,

whi ch app lic a tion h as been m ade th e allo tm en t le tt er and ,

b an k er s rec eip t s for th e ins t alm en t s p aid S h o uld b e

in spe ct ed if th ese h av e not y e t b een e x ch an g ed for th e

,

c ert ic a t es Th e s h are c ert ic a t es b onds e tc will also

.
, , .
,

ha v e t o b e e x am ined wh en v erifyin g th e asse t s .

WA GES Th e qu es t ion of wag es is one of v ery grea t

.

im port an c e in th e case of m an y m an u fa ctur in g bu sinesse s ,

and i t is essen t ial th at th ere S ho uld be a m os t c o m plet e

in t ernal ch eck in this direction Th e au dit or S ho uld .

c arefull y e x am ine in t o th e s yst e m of rec ordin g and pa yin g

wag es and if i t is b ad and faulty h e sh o uld poin t o ut i t s
, ,

s h ortc o m in gs and disc laim responsib ili ty for in such ,

c ircum s t an c es i t is im po ssi ble t o pre v en t or be c ert ain of ,

de t ect in g frau ds Th e lin es upo n whi ch a wages sy st em

, .

S h o uld b e b ased are as follo ws

Th e t im es of t im e wor k ers s h o uld be rec orded by m ean s

-
42 THE PR I NCI PLES OF A U D ITI N G

of t im e rec ording clo cks and it is import an t th a t responsi ble

-
,

of c ials s uch as forem en S h o uld see th e h ands rin g in

, ,

and o ut u pon th e clocks as o th erwise lat e arri v als m ay , , ,

g e t th eir earlier c o mrades t o rin g in for th em .

Th e ti m es of ea ch e m plo y ee as S h o wn by th e c lo ck ,

rec ords for th e w ee k s h ould b e en t ered in th e W ag es

,

Boo k by one w ag es clerk and th e ra t es of pa y inser t ed ,

.

Th e am o u n t s S h o uld th en b e c al cula t ed all deduct ions s u ch ,

as N a tional I nsuran c e con tri butions Une m plo ym en t , ,

nes sub scrip t ions e tc m ade an d th en th e W ag es Bo o k

, , .
, ,

S h o uld b e c as t Th e wh ole of th is w o rk sh ould b e inde

.

penden t ly ch ecked th e cler k s t aking part in e ach s t ag e of

,

th e prepara tio n and ch e ck in g of th e W ag es Boo k ini tialling

for wha t the y ha v e done .

I n th e c ase of piec e wo rk ers as th e w o rk is gi v en o ut

-
,

an d t ak en b a ck by th e f ore m an part iculars S h ould b e ,

en t ered upon piec e work c ards or s h ee t s whi ch s h o uld b e

-
,

ini t ialled by th e pie c e work er and th e fore m an Th ese -

.

c ards or s h ee t s S h o uld b e h anded in t o th e wages of c e at

th e end of th e w ee k th e part i culars b ein g en t ered up in
,

th e Wag es Boo k and independen t ly ch eck ed as in th e c ase

of th e t im e wo rkers
-
.

Wh en c o m ple t e th e W ag es Boo k s h ould b e h anded t o

,

th e c as hier wh o S h o uld h av e no c on trol o v er th e a ctu al

,

p repara t ion of this bo o k Th e c as hier s h o uld pro c eed t o .

dra w and c a sh a chequ e for th e exa ct am oun t of th e

wee k s wag es He S h ould th en pla c e th e exa ct am o un t

.

du e t o ea ch wag e earne r in a li tt le b ag or can b e arin g th e

-

indi v idual s nam e or numb er a ft er whi ch th e Wag es Boo k

an d th e c as h thu s so rt ed S h o uld b e h anded t o so m e

responsi b le oicial wh o s h o uld pa y th e w o rkpeople as
,

th e y leav e th e wo rk s fore m en wh o kno w th e e m plo y ees

,

b eing p resen t t o iden t ify th e m Th e c as hier and th e .

person pa yin g th e Wag es S h o uld ini t ial th e Wag es

Bo o k , whi ch S h ould th ereaft er be re turned t o th e
wages of c e .

Th e a b o v e is but a b rief sk e tch of a wag es s ys t em but ,

 RO UTINE C HEC K I NG AN D VO UC HI N G 43

th e b asis u pon which e v ery s y s t em S ho uld b e buil t up is

tha t th e re c ords in th e works th e p repara t ion of th e ,

Wag es Boo k th e ch eckin g of th e sam e th e h andlin g of th e

, ,

c ash and th e pa ym en t of th e wag es s ho uld b e under

, ,

en tirel y separat e and independen t c on trol Th e prin c ipals .

o f th e bu sin ess S h o uld w a tch th e w a g es s y s t e m c arefull y ,

and o cc asion all y eith er t ak e part in or wa tch th e a ctual

p aym ent of th e h ands .

A ft er in v es t i g at in g th e s ys t e m and ass um ing tha t i t is

,

an eicient one th e audit or S ho uld ch eck th e Wag es Boo k

,

as follo ws
C h e ck th e c as t in g s and a p ropo rt ion of th e c alcula t ions
C h eck th e weekl y t o t als of th e Wag es Boo k with th e
ch e qu e dra wn as S h o wn by th e C as h Boo k ;
S ee tha t th e Wag es Boo k h as b een init ialled by all
t ak in g part in th e v ario us s t ag es
O cc asionally t es t th e s ys t e m by c allin g for th e t im e
rec o rds and pie c e work c ards for a wee k and ch e cking
-
,

th ese with th e en t ries in th e Wag es Boo k .

S AL AR IES A S alaries Boo k S h o uld b e k ep t in which th e

.

wee kly or m on thly salary of e v ery salaried of c ia l and

c l erk s ho uld be en t ered Th e b oo k S h ould b e ruled wi th
.

c olum ns in which th e a ctual paym en t s are en t ered Th e .

au dit or s h o uld ch e ck th e ch e qu es dra wn wi th th e S ala ries

Bo o k whi ch la tt er S h o uld b e ini t ialled by a part ner or

,

dire ct or All al t era t ions in the salaries pay able s ho uld

.

b e c onrm ed in the sam e w ay .

C O MMI S S I O N S AN D EXPEN S ES A b oo k

TR AVELL ER S .

S h o uld be k ep t for ea ch tra v e l ler in whi ch s h o uld b e en t ered

,

th e m on thl y am o un t s du e for c o mm issions and expenses .

I n so m e c ases tra v ellers ar e allo w ed a xed am o un t for

,

tra v elling but wh ere th e y are allo wed t o charg e th eir

,

actual expenses vo uch ers S h ould be insis t ed upon for all

,

expenses exc ep t s uch as railway far es e tc for which no

, , .
,

re c eip t c an b e o bt ained Wh ere this la tt er m e thod is

.

a dop t ed ,th e expenses S ho uld be carefully watch ed and

ch e ck ed by th e m anag e m en t Wh en th e tra v ellers are .
44 THE PRI N C I PL ES OF AU DI TI N G

paid th e am o un t s S h o uld b e en t ered in th e tra veller s
,

bo o k which s h o uld b e rec eip t ed by him Th e au dit or

,
.

S h o uld ch eck th ese b oo k s as f ar as p o ssi b le and v ouch th e ,

che ques drawn a cc ording t o th e C as h Boo k wi th th e

, ,

tra v ellers boo ks seein g th at th e la tt er h av e b een rec eip t ed

, ,

and th a t all unpaid c o mm issions and exp enses are brought

in t o a cc o un t at th e end of th e n an c i al peri o d .

PETT Y C A S H Pe tty c as h S h o uld b e k ep t u pon th e

.

I m pre st s y s t em by wh i ch th e pe tty c ash ier is gi v en a ro und

,

s um wh i ch is es t im at ed t o b e s uf cien t t o c o v er his expenses

for th e ens uin g w ee k or m on th as th e c a se m ay be , At .

th e end of this period th e pe tty c as hier S h o uld b al an c e

,

his b oo k and produc e i t t o th e c as h ier wh o S h ould ch e ck ,

and vo uch i t an d if i t is in ord er h an d th e pe tty c as hier

, , ,

a ch e qu e for th e e x a ct am o un t of th e t o t al dis b urse m en t s

for th e period Th e Pe tty C as h Boo k S h ould b e rul ed
.

wi th analysis c olum ns in order t o sav e a n umb er of

,

pos t in g s t o im personal a cc o un t s V o uch ers S h o uld b e.

insis t ed upon for all pa ym en t s ab o v e say and in , ,

c ases wh ere i t is im possible to o bt ain re c eip t s dock e t s ,

s h o uld b e m ade o ut gi ving de t a ils of th e expendi tur e and

, ,

such do ck e t s S hould b e ini t ialled by th e person a ctu ally

expending the m one y O n no acc o un t s h o uld a ny one
.
,

o th er th an th e pe tty c ash ier h av e a cc ess t o th e petty c as h

, ,

and clerk s s hould no t b e allow ed t o b orro w fro m pe tty

c as h O n th e la s t da y o f th e nan c i al p eriod all c as h
.
,

b al an ces in h and are so m et i m es paid in t o th e b an k and ,

on th e rs t day of th e ensuin g period th e pe tty c as h i er is ,

gi v en a ch e qu e for th e a gre ed x ed ro und s um Th e only .

sum s ut ilised for pe tty c as h s h ould b e th e Ch e ques dra wn

S pe c iall y for this p u rpose all s un dry s m all rec eip t s S h o uld

b e paid in t o th e b an k and passed through th e C as h

Boo k .

Th e a u di t or S h o uld c are fully en qu ir e in t o th e s y s t e m of

petty c as h and report if i t is we ak or faul ty He S h o uld
, .

ch eck th e c as t in g s and pos t in g s and th e ch e ques dra wn

,

fro m th e C as h Boo k in t o th e Pe tty C as h Boo k He S h ould .

 RO U TIN E C HEC KI N G AN D V O U C HIN G 45

see th a t th e boo k h as been ini t ialled by th e c ashier and h e ,

S h o uld ch e ck at leas t a p roport io n o f th e v o uch e rs at th e ,

sam e t im e o b servin g th e na ture of th e p aym en t s and th e ,

h eads under whi ch th e y ar e analy sed I f th e b alan c e a t

.

the end of th e period h as no t been paid in t o th e b ank ,

th e au dit or s hould c o un t th e c as h in hand and agr ee i t

wi th th e b alan c e S h o wn by th e Pe tty C as h Bo o k I f this .

is no t done a t th e da t e of b alan c ing th e b oo k S h o uld b e

,

ch eck ed t o the da t e a t whi ch h e a tt ends and th e b alan c e

,

th en c o un t ed and ch eck ed wi th th e Pe tty C as h Boo k

b alan c e at th at da t e .

PO S TA GE BOO K . Th e audit or sh o uld see th a t th ere

is an efc ien t in t ernal ch e ck upon th e post ag es and ,

h e s h o uld ch eck this b oo k o cc asionall y ch ec king th e

,

am o un t s dra wn from th e Pe tty Cas h Boo k in t o th e

Post ag e Boo k and c o un t ing th e b alanc e in h and if
, ,

the am o un t is la rg e .
 C HAPTE R I I I
VO U C HIN G (ti
con nued )
B o u gh t D ay B o ok .

THE wh o le s y st em as regards ordering g oods ch ecking ,

in v oic es and a uth orising pa ym en t S h o uld be inv es tig at ed

, ,

by th e au di t or as if s tri ct c on trol is no t exer c ised in this

, ,

direct ion th e opportunit ies for frau d are v ery grea t Th e

, .

qu es t ion wh e th er a really e ffect iv e s y st em c an b e e v ol ved

depends upon th e s t a ff a vaila ble and if th ere is no sy st em
, ,

or th ere is a b ad one an audit or s h ould exerc ise c onsidera ble

,

c are and ch eck exh a us t iv ely th e Bo ught Day Boo ks and

,

L edg ers .

A ll orders S h ould b e m ade o ut on S pe c iall y prin t ed and

numbered o rder form s b ound u p in O rder Books pro vided
wi th c ar bon lea v es so th a t e v ery order issu ed is dup li c a t ed
,

aut o m a t ic ally O rders S h o uld b e m ade o ut and init ialled

.

by th e h ead of th e depar tm en t re quiring th e g ood s and ,

c o un t ers igned by a responsi b le omcial s uch as a part ner ,

or d irect or .

A Goods I nw ards Boo k s h o uld b e k ep t a t th e en t ran c e t o

th e wor k s and as g oods are deliv ered th e qu an t it ies and
, ,

weight s S h ould b e ch ecked and th ese part iculars en t ered

,

in th e Goods I nwards Boo k .

Th e in v oic es S h o uld b e ch ecked by th e invoi c e c lerk ,

wi th th e Order Boo k and th e Goods I n wards Boo k as t o

part iculars quan ti t ies and w eight sreferen c es t o th ese
,

boo ks b ein g pla c ed upon th e in v oic e Th e p ric es S h o uld .

be ch eck ed wi th qu o t a t ions es t im a t es or p re v io u s inv oi c es

, , .

Aft er b eing ch ecked thus th e invoi c e s h ould be init ialled

,

by th e h ead of th e depa rtm en t by wh o m th e g oods or

servi c es were o rdered Ha ving b een ch eck ed init ialled
.
,

46
48 THE PR I NCIPL ES OF AU D ITI N G

(8) Th a t fro m th e part i culars i t appears t o b e a

p oper bu iness ch arg e
r s

(
.

9 ) I f part ne s or direct s pri va t e a cc o un t s are

r or

passed through th e Bo ught Day Boo k th a t th e y are ,

ch arg ed to th eir personal a cc o un t s

(
.

1 0 ) Th a t an y in voi c e Ch arg ed t o c apit al appears to

b e a p roper c apit al ch arg e and is de b it ed t o th e c orrect ,

a cc o un t .

Prot s c an b e in a t ed easil y by th e su ppression of

invoic es ; th erefore a t th e end of th e period th e a u dit or
,

s ho uld as k for th e Goods I nw ards Boo k and tra c e in t o th e

Bought Day Boo k all b ig lin es of g oods wh i ch h a v e c o m e
in during th e las t fe w w eek s Th e invoi c e le for th e .

ensuing period al so m ay b e c alled for and th e da t es of ,

th e in voic es th e rein exa m ined t o see wh e th er an y of th ese ,

S h o uld b e Ch ar g ed t o th e peri o d u nder re vie w .

I n o rder th a t th e a u di t or m ay b e sa t ised th a t all

inv oic es h av e been in clu ded his clien t s S ho uld arrang e ,

th at a t th e dat e of th e Balan c e S h ee t a no t i c e sh o uld b e

sen t t o e v ery credi t or wh o h as an a cc o un t in th e Bought
L ed g er requ es t in g hi m t o furnis h a s t a t e m en t S h o wing th e
,

b alanc e du e t o hi m a t th a t da t e or if th ere is n ot h ing ,

o win g a no t i c a t ion t o tha t effe ct Th ese s t at em en t s

, .

and no t ic es s h ould b e p ro duc ed to th e au dit o r wh o s h ould ,

c o mpare th e m with th e Bo ught L edg er a cc o un t s seeing ,

th a t s uch s t at e m en t s b ear th e da t e on which th e nan c ial

period ends I f all th ese agr ee i t is proof th a t th e indi
.
,

vidual c redit ors boo k s a gree wi th th e b oo ks of th e au dit or s

c lien t s and th erefore th at as reg ards th ese a cc o un t s a t

, , , , ,

an y rat e no in voic es h av e b een o mi tt ed

, .

A v ery sim ple frau d m ay be perpe tra t ed in c o nnect io n

wi th p urchases by en t ering inv oic es twi c e in th e Bo ught
Day Boo k in ea ch c ase th e c re dit or s a cc o un t being

,

credi t ed I n du e c o urse and a t di fferen t da t es tw o ch equ es

.
,

are drawn one be ing se nt t o th e credi t or and th e o th er

,

misapp ropria t ed Bo th ch equ es are de b it ed t o th e

.

c re di t o r s a cc o un t th e b alanc e u pon whi ch will agrw with

,
 VO U CHI N G 49

the c redi t or s periodi c al s t a t em en t s I n order t o p ro vi de

.

a re c eip t in support of th e se c ond and fr au dulen t p a ym en t ,

th e bon d de rec eip t m ay be produc ed twi c e unless the

au dit or t ak es th e prec aution of c anc ellin g vo uch ers in ,

which c ase th e in voic e might b e rec eip t ed frau dulen tl y ,

or the c redi t or might b e as k ed for a dupli ca t e rec eip t on

th e p re t ex t th a t th e ori ginal h ad b een los t S uch a frau d .

c anno t b e disc o v ered unless th e in voic es are c arefull y

ch eck ed wi th th e Bought Day Bo o k I f h o we v er th ere .
, ,

is a proper int ern al ch eck and th e Day Boo k L edg er and

, ,

Cas h Boo k are ea ch under separat e c on t rol th is frau d ,

c anno t be c o mmi tt ed unless th ere b e c ollusion .

B o u gh t D ay B oo k : R etur n s an d Allo wan ces .

In this boo k will b e en t er ed allo w an c es m a de by th e

c redit ors of th e c on cern wh ose boo ks are under au di t in ,

respect of goods rej e ct ed and re turned da m ag ed g oods , ,

S h ort w ei ght or qu an t i t ies erro rs in c al cula t ion e tc

, Th e , .

credi t o r g enerall y si gnies h is assen t t o such allo wan c es by

renderin g a credi t n ot e Th e au di t or S ho uld see th a t
.

th ere is a p roper sy st e m for dealin g wi th th ese it e m s and , ,

if th e re is as a rule h e will b e sa t ised by ch e ckin g th e

,

c ast in g s and pos t ing s of this boo k but of c ourse in c ases , ,

of su spic ion and exc ep tional i t e m s h e s h o uld c o m pare th e

,

en t ries wi th do cum en t s such as credi t no t es Goo ds

, ,

O utw ards Boo k s c o rresponden c e e tc

, , .

S ale s D ay B o ok .

Th e sy st em for dealing wi th o rders rec ei ved sh ould b e

in v es t igat ed and there S ho uld b e Order Boo k s in whi ch
,

th e y are ent ered up o n receip t Th e actu al ord ers m ay be

.

in th e form of le tt ers tr avellers or ag ent s re turn s or th e y

,

,

m ay be m ere v e rbal instruct ions but in all c ases th ere

,

S h o uld b e a perm anen t re c o rd so arran g ed as t o b e ins t an tl y

a vaila ble for referen c e .

Wh en th e o rder is exe cut ed by th e despatch of th e

g oods or th e c o m ple t ion of the work an in voice sh o uld be ,
50 THE PR I NCI PL ES OF AU DITI N G

p repared and despa tch ed i mm edia t el y Th e in voic es .

s h o uld b e p ress c opied or dupli c at ed by m eans of car b on

,

le av es and fro m th ese c opies of th e a ctu al in voi c es th e

, ,

S ales Day Boo k S h o uld b e wri tt en u p A ll g oods lea vin g

.

th e wo rk s s h ould b e Ch e ck ed o ut by a g a t e k eeper and -

,

rec orded in a Goods O utw ards Boo k .

Th e two m ain p o in t s that an a u dit or S h o uld gu ard

a gainst are th e o m issi on of sales and th e in at ion of th e
sam e I n th e c ase o f a s m all bu siness wh ere th e
. ,

h e ad cl erk h as c on t rol o v e r th e whole se t of b oo ks if h e ,

o mi t s t o ent er s ale s i t m ay b e po ssi ble for h im t o m is

,

appropria t e th e c as h or ch equ es re m itt ed in pa ym en t of

such i t e m s I n th ese c ir cum st an c es no re c ords of th ese
. ,

trans act ions will appear in th e b o ok s a t all and c ou se , ,

quen tl y this frau d c ould only b e de t e ct ed by c o m parin g

,

th e S ales Day Boo k wi th such ori ginal rec ords as th e

dupli c at e in voic es O rde r Boo k s Goods O utw ards Boo k s
, , ,

e tc Th e ina t ion of sales will be done wi th th e O b j ect of

.

im p rope rly in c re a sin g th e p ro t s or decreasin g th e loss es ,

and to gu ard ag a in st this also th e S ales Day Boo k en t ries

, ,

s ho uld b e t es t ed wi th th e ori g inal rec ords in o rder tha t ,

th e au dit or m ay b e sat ised th at all th e sale s en t e red are

bon d de t ransa ct ions I n c a ses of s u spi c ion th e S ales
.
,

Day Boo k s h o uld b e Ch e ck ed exh au st ively but in th e ,

ordinary way wh ere th ere is a relia b le s y s t e m of in t ern al

,

che ck i t will b e suffi c ien t t o t es t a p roport i o n of th e en t ries

, .

Th e fa ct th a t th e a u di t o r c alls for th e O rder Boo ks du pli ,

c a t e in v oi c es and Go o ds O utw ards Boo k s o cc asion ally ,

c re at es a m o ral ch eck of gr ea t valu e Man y au di t ors .

see m t o ele ct t o spend th eir t i m e ch e ck in g the S ales Day

Boo k pos t in g s wh i ch i t m a y b e h a v e b een ch e ck ed alr eady
, , ,

and p ro ved by th e client s s t aff wh ereas th eir t im e wo uld

,

be far b e tt er occu pi ed in t e st in g th e ent ri es wi th th e

ori g in al re c o rds .

Wh en ch e c king th e S ales Day Boo k th e au dit or S h o uld ,

be c ar eful t o see th a t if an y old ass et s h a v e b een sold and

,

ch arg ed o ut thro ugh th e Day Boo k th ese am o un t s h a v e ,

 VO U C HI N G 51

no t been in clu ded in th e t o t als c redi t ed t o th e sales acc o un t ,

but h av e be en c redi t ed t o th e part i cular asse t acc oun t .

A n e xc ellen t ch eck upon th e sales whi ch is so m e t im e s

m e t wi th in p ra ct i c e is for a s t at e m en t to be sen t t o all
,

de bt o rs of th e c on c ern a t th e da t e of th e Balan c e S h ee t ,

wi th a re qu es t th at th e y will c onrm th e fact if th e b alan c e

agrees wi th th eir boo ks and if no t po in t o ut any di ffer
, , ,

ences . Th is m e th od wh en p ro perly c on t roll ed by th e

,

m anag e m en t p ro v es t o b e a m os t v aluable ch eck u pon th e

,

boo k debt s it act s as a ch e ck u pon th e sales as en t ered in

,

th e S ales Day Boo ks an d is also e viden c e th a t th e wh ole

,

of th e c as h re c eiv ed fro m de bt ors h as bee n a cc o un t ed for

in th e C as h Boo k I n c ases wh ere frau d is s uspe ct ed one
.
,

of th e m os t eectiv e m eans for de t e ct in g disc repan c ies is

for th e a udit or t o c on trol th e sen ding o ut of s uch s t a t e m en t s ,

and th e replies re c ei ved .

S ales D ay B o o k s : Allo wan ce s

R etu r n s an d .

Th e s ys t e m as reg ards th ese credi t s to th e S ales L edg ers

sh ould be en quired in t o as i t is possi ble th at im p rope r
,

c redi t s m ay be pa ss ed thro ugh in this wa y in order t o ,

co v e r u p m isapp ro p ria t ions o f c as h rec ei v ed fro m de bt o rs .

Th e refore all c redi t s S h o uld re quire th e a uth ori ty of a

,

respon si b le omcial and th e credi t no t e S h o uld be init ialled

,

and p ress c opied or dupli c at ed by m eans of c arb on s Th e

, .

au dit or s h o uld c arefull y s c rut inise all l arg e c redi t s and , ,

if nec es sary e x am ine th e docum en t s such as c op y c redi t

, ,

no t es c orrespo ndenc e Good s I nwards Boo ks etc Th e

, , , .

c redit s m ade aft er the c lose of th e year S h o uld be ex a mined

if th e am oun t s are c onsiderable as s om e t im es in order to , ,

m ak e th e re sult s S h o wn by th e Prot and L O S S A cc oun t

m ore fa vo urable allowan c es e tc are h eld b a ck un t il
, , .
,

aft er th e dat e of th e Balan ce S hee t .

B ills R ec eiv ab le B oo k .

In this b o o k will b e ent ered all b ills rec eiv ed and ,

part i cula rs as t o wh en th e sam e b e c om e due and h ow ,

th ey are disposed of Th e au di t or S h ould see that th e

.
52 THE PR I NCI PL ES OF AU DITI N G

pro c eeds of e very b ill are a cc o un t ed for or if a b ill is , ,

dis h ono ured th e am o un t th ereof is de b it ed t o the p art i cular

,

de bt or s acc o un t in th e S ales L edg er Bill s that h a ve b een

.

m e t or dis c o un t ed will b e tra c ed in t o th e C a sh Boo k and

Pass Boo k and th ose that are s t ill curren t a t th e da t e of
,

th e Balan c e S hee t s ho uld b e in h and and s h ould b e ,

inspe ct ed by th e au dit orin this wa y e very b ill will b e ,

acc o un t ed f or Th e Bill Boo k S h o w s th e de t ails th a t

.

m ak e up th e b alan c e u pon th e Bills Re c ei va ble A cc o un t

in th e L edg er and i t s h ould b e seen tha t th e se are in
,

ag ree m en t .

B ills Pay ab le B o ok .

All b ills a cc ep t ed s h o uld b e en t ered in this b oo k and as ,

th e y are m e t th e y s h o uld b e m ark ed o ff th e rein Th ose .

b ills th a t h a v e b een paid will appear in th e C as h Bo o k ,

and th e re turned b ills S h ould b e p roduc ed as v ouch ers .

I t s ho uld b e seen th a t th e b alan c e u pon th e Bills Pa y a b le

A cc o un t in th e L edg er is in agree m en t wi th th e de t ails as
s h o wn by th e Bills Pay ab le Boo k .

J o u r n al.

Th e J o urnal of whi ch th e Bo ught and S ales Day Bo o ks

, ,

Bill Boo ks e tc are part s s h o uld b e v o uch ed m o s t c are

, .
, ,

fully for thro ugh th e J ournal will pass all ext raor din ary
,

t ransa ct ions for whi ch th ere are no spe c ial b oo k s of rs t

en t ry Th e en t ries appearing in th e J o urn al wi ll b e such
.

as all opening ent ries for exam ple th e a cquisit ion of th e ,

v ariou s asse t s fro m th e v endors th e issu e and allo tm en t of

,

sh ares and de b entures closin g en t ries such as th e pro vision

,

for o ut st andin g s depre cia t ion rese rves for b ad de bt s

, , ,

int e res t on c api t al ent ries c orr e ct in g erro rs e tc and

, , .
,

m an y o th er m i sc ellaneo u s i t e m s s uch as th e wri tin g o f ,f

of p rot s or losses upon th e sale of c api t al asse t s and ,

vario u s adj us tin g en t ries of th is na ture Fro m th e a b o v e .

exam ples i t will b e seen that th ese it e m s are of a v ery

,

v aried na ture and th at th e y are of gre at irnportance as

, ,

th e y a ffe ct th e nal a cc o u n t s t o a c onsidera ble ex t en t I t .

 VO UC HI N G 53

is th erefore essen t ia l tha t the audit or s ho uld vo uch

, ,

thoroughl y e v ery en try passing thro ugh this b oo k .

Th e a ctual e viden c e tha t th e a u di t or will re qu ire will

depend upon th e natur e of th e t ransa ct ion I n th e c ase .

of opening en t ries re c o rding the a cquisit ion of asse t s unde r

a c on tra ct th e a u di t or mus t inspe ct such c on tra ct and
, ,

see tha t th e t erm s th e reof are g i v en effect t o c o rrect ly in

th e ent ries To v o uch an allo tm en t of S h ares in th e c ase

.

of a c o m pan y th e p rospe ctu s direct ors m in ut es appli c a

, ,

,

t io n le tt e rs c on tra ct s e tc will h a ve t o b e inspe ct ed

, , .
, .

Pro visions for dep rec ia t ion c an only b e ch e ck ed by dis

cu ssion of th e wh ole qu es t ion wi th th e m an ag em en t In .

this w a y it m ay b e asc ert ained wh e th er or no t in th e ,

opinion of th e au dit or s uf c ien t depre c i at ion h as b een

,

wri tt en o ff Th e adequ a cy of th e am o un t reserved for

.

bad and do ubt ful de bt s c an o nl y b e v er ied by an inspe ct ion

of th e whole of th e a cc o un t s c on t ained in th e S ales L edg ers .

Th e a b o v e are o nly a fe w ex am mes of th e en t ries t o b e

fo und in a J o urnal t o g e the r wi th a rough idea of ho w
,

so m e of th e m s h o uld b e vo uch ed L a t e r th ese m a tt ers .

,

will b e dealt wi th in m ore de t ail but i t will b e realised at

,

onc e ho w im port an t it is th at an au dit or s h ould e xerc ise

grea t c are wh en v o uching th e J o urnal and wha t a larg e ,

a m oun t of S kill and e x perien c e h e needs t o b e a ble t o

perform this part of his work ef c ien tly .

B ou gh t L e d ger s .

Th e pos t in g s t o th e Bo ught L edg ers fro m th e C as h

Boo k Bo ught Day Boo ks R e turns a nd Allo wan c es Boo k s
, , ,

Bills Pay a ble Boo k and J o urnal w ill h a v e b een ch eck ed

, ,

or t es t ed Th e c as t ing s of th e L edg ers S hould b e Ch eck ed

.
,

and th e b alan c es ch ecked on t o th e sch edule of c redit ors .

I n th e c ase of c re dit o rs fro m wh o m g oods are p ur ch ased

regularly , th e au di t or sh ould see tha t in vo ic es u p t o th e
end of th e period h ave b een credit ed to th e a cc ou nt if no t ,

en quiries S h o uld b e m ade Th e b es t and m os t v alua b le

.

ch eck upon th e Bo ught L edg er b alan c es is th e p roduct ion

54 THE PR I N C I PL ES OF AU DITI N G

of credi t ors s t a t e m en t s as th ese p ro ve th a t th e a cc o un t s

,

are in agreem en t with th e b oo k s of th e credi t ors O f .

c ourse in so m e c ases such st a t e m en t s m ay not agree as

, ,

goods m ay h a v e b een de b it ed by th e c redi t or on or b efore

th e da t e of th e Balan c e S h ee t but s uch g oods m a y no t ,

h a v e b een rec ei v ed and c redi t ed in th e b o o k s of th e

a u di t o r s c lien t s un t il th e f ollo win g p eriod I n such c a ses

.
,

th e au dit or S ho uld c ar efull y tr a c e su ch g oods thro ugh th e

Go o ds I nw ards Boo kc onrm ing th e da t esand h e S ho uld
see th a t th ese g oo ds h a v e no t b een in c lu ded in st o ck It .

m ay b e fo und th at c er t ain acc o un t s are in d isput e and , ,

th ereforef th e s t at e m en ts disagr ee ln th es e c ir cum s t an c es ,

m os t c areful en quiries S hould be m ade and th e c orre ,

spon den ce s h o uld b e e x am in ed to see th a t ad equ a t e pr o visio n

is m ade in th e a cc o un t s for all o ut s t anding li ab ilit ies I f .

c laim s h a v e b een m a de by a credit or which h av e not b een

a greed t o or p ro vided for in th e acc o un t s th e au di t o r ,

S h o uld insi st if th e a m o un t s in v ol v e d a re lar g e u pon s u ch

, ,

claim a t le as t b ein g referred t o in the Balan c e S h ee t by

way of a no t e o th erwise h e S h ould r efer t o th e m att er in
,

his au di t report I n th e c ase ofc lai m s th a t are th e s ubj e ct

.

o f a pendin g la w sui t th e a u di t or s h o uld se e th at am ple

,

pro vision is m ade in th e a cc o un t s for any lik ely li abili ty

under this h ead in c ludin g th e legal ch arg es I f h e is no t
, .

sat ised with th e p ro visio n m ad e th e m att er will be one ,

tha t i t will be ne c essar y for h i m to de al wi th in his report .

A n y de b i t b alan c es upon th e Bought L e dg e rs S h ould be

c arefu lly exa m ined wi th a Vie w to asce rt ainin g th at th e y
,

are bon d de am o un t s o w in g ; f or e x a m ple for re turns , ,

allo w an c es e tc , I f an y of s uch de b i t b alan c es are of lon g

.

s t anding th e au dit or S ho uld go in t o th e m wi th a responsible

,

o icial and see th a t ade qua t e reserv e is m a de for an y

,

p ossible bad or do ubt ful de bt s .

S ales L e d ger s .

Th e pos t in g s c as t in g s and b alan c es of th e S ales L edg ers

,

S h o uld b e ch e ck ed in th e sam e w a y as in th e c ase of th e

56 THE PR IN CI PLES OF AU DI TIN G

au di tor S h o uld be g one in t o wi th a respo n si ble oicial

, ,

and his explanat ions as k ed for A g ood plan is t o h a ve

.

th e lis t of qu eried a cc o un t s ruled wi th c olumns h eaded

( 1 ) b alan c e as per ledg er , (
2) g ood 3 ) b ad 4) doubt ful
!
, ( , ( ,

and a furth er c ol umn for rem ark s A s ea ch de bt is .

discu ssed wi th th e responsible ofc ial i t S h o uld b e ext ended ,

in t o th e g oo d b ad or do ubt ful c olum n and if
, , , ,

do ubt ful his es tim at e as t o th e am o un t th a t pro b ably

,

will be rec eiv ed S ho uld b e no t ed Up on c o m ple t ion th e

.
,

c olum ns S ho uld b e c ast and i t S hould b e seen th at th e

,

reserv e for b ad and do ubt ful de bt s is suicient t o c o v er

th e wh ole of th e de bt s es t im at ed t o b e b ad and a large ,

p roport ion of th ose es t im a t ed t o be do ubt ful S uch .

proport ion will b e b ased u pon th e info rm a t io n s upp lied ,

and might b e fro m ab o ut 40 t o 50 per c en t of th e t o t al .

,

doubt ful de bt s but this depends upon th e c ircum s t an c es

,

of th e case I n addit ion th ere S h ould b e a furth er pro

.
,

vision in respe ct of th e re m aining de bt s th a t are es tim at ed

t o b e g ood as fro m pas t experien c e i t will b e c ert ain
,

th a t a proport ion will p ro ve t o b e b ad ; pro b abl y fro m 1 t o

5 per c en t will b e a s uf
. c ien t pro vision under this h e a d .

R eserv es for b ad and do ubt ful de bt s are c alcula t ed

S o m e t i m es by w a y of a perc en t a g e on th e t o t al b oo k

de bt s or u pon th e turno v er for th e period ; h o w e v er this ,

m e th od is no t rec o mm ended and if i t is adop t ed th e

, ,

au dit or S h ould proc eed as exp lained a bo v e and thu s ,

sa tisfy h im self th at th e rese rve is a suicient one .

Th e onl y w a y th a t a relia b le opinion c an b e form ed as

t o th e s uf c ien cy of a reserv e for b ad and do ubt ful de bt s
is by exa min in g th e v ari ou s de bt ors a cc o un t s and en quiring

,

int o th e c ir cum s t an c es of all do ubt ful loo kin g a cc o un t s .

This is a m os t im port an t part of an au di t or s duties for in

,

m an y c ases th e t o t al of th e b oo k de bt s am o un t s t o a
c onsidera ble s um and th e am o un t of th e reserv e m a t erially
,

a ffect s th e position S ho wn by th e a cc o un t s Th e de bt ors .

represent sales th a t hav e b een c redit ed t o Trading A cc oun t ,

but whi ch ha v e no t b een paid for and if in fact part O f , , ,

 V O U C HI N G 57

th e m are ne ve r paid for ins t ead of su ch sales rep res en t in g

,

in co m e th e y ar e an a b solut e loss th erefore unless th e loss

, ,

under this h ead is am ply pro vided for th e prot s will be ,

o ver s t at ed as also will b e th e b oo k debt s Th e difcul ty

-
, .

is that this loss has t o b e estirnated and it is th erefore of , , ,

th e utm os t im port an c e that e very prec aut ion S ho uld b e

t ak en t o arriv e a t as a ccura t e an es t im a t e as possi ble ,

and this c an only b e done by adop t ing so m e such m e th od

as is desc ri b ed a b o ve .

I f aft er c o m ple tin g his in v es ti g a t ion under this h ead

, ,

th e au dit or is of opinion th at th e reserv e is no t sumcient ,

h e S ho uld p ut his vie ws b efo re th e dire ct ors or part ners as ,

th e c ase m ay b e an d h ear wh at th ey ha v e t o say u pon th e

,

point I f th ereaft er h e is st ill of th e sa m e opinion and

.
, , , ,

ne v erth eless th e dire ct ors or part ners refu se t o alt er th e

,

a cc o un t s h e s h ould th en poin t o ut in his audit report

,

th at in his vi ew th e reserv e is inade qu a t e Th ese cir

, , .

cum stan ces are de alt wi th in th e c ase of Arthur E Green ( S .

C o v The C entral Advance and Discount C orporation L td

. .
, .
,

wh i ch c ase is dis cussed in Ch ap t er X .

 C HAPTE R IV

THE PR O F IT AN D L O S S ACC O UNT AN D BA L AN C E S HEET

I m p er s o n al L ed ger .

HAVIN G ch e ck ed th e S ales and Bo ught L e dg ers th e ,

au di t o r mu s t turn his a tt en t io n t o th e I mpersonal or

Gene ral L edg er th e ex hau st ive ch e ckin g of wh ich is of
,

th e utm o s t im p ort an c e Th e det ail po st ing s fro m th e

.

C as h Boo k and J ournal and th e t o t als fro m th e Day Boo k s

, ,

Bill Boo k s etc will h av e b een ch e ck ed an d no w th e

, .
, ,

c a s t ing s o feach a cc o un t S hould be v eried and th e b alan c es ,

ch e ck ed on t o th e Trial Bala n c e E a ch a cc o un t S h o uld b e

.

exam ined c arefully in order th a t th e a u di t or m a y s at isfy

,

h im s elf th a t h e h a s ch e ck ed s uffi ci en t ly th e de t ails m ak ing

up th e b alan ce and th at such i t em s are in o rd er p rop erly
, ,

cl as sied and des c ri b ed in th e part icular a ccou n t O n

, .

no a c cou nt s h ould this p art o f th e work b e carried out

m echanic ally bu t k een in t elli g en c e mu s t b e exe rcis ed as
, ,

th e I mpersonal L edg e r c on t ains m o st o f th e m at erial fro m

whi ch th e Prot and L oss A cc ou n t and Balan ce S h ee t are
built up and i t is th e au di t o r s duty t o see th at th ese are
,

p roperly drawn up so as t o e x h i b i t a t ru e an d co rr ect

,

v ie w ofth e s t at e of th e a ffairs o fth e c on c e rn ; and wh e th er

th is is so or not l arg ely d ep ends upon h o w a ccurat ely and
c orre ct ly th e I mpersonal L edg er h as b een k ep t A n .

au dit or S h o uld b ea r in m ind wh en eng ag ed upon th e ,

de t ail ch e cking o f an au dit th at e v ery it em dire ct ly or

,

indire ct ly a ffect s th e n al a cc ou nt s an d th erefo re h e mu s t , , ,

see th a t th e d et ails are re c o rded and c l assied c orre ct l y ,

and in such a w ay that th e y w ill nd th eir c orre ct plac e in

eith er th e Pro t and L O S S A cc o u n t or th e Balanc e S heet .

E v ery a cc o un t in th e I mperson al L edg er S h ould b e a s i t ,

were ali v e t o him and th e exa ct na ture of all th e de t ail

, ,

58
 THE PR O FIT AN D LO S S ACC O UNT , ETC . 59

it em s m aking up th e b alanc e s h ould b e apprec iat ed an d

G r o u p in g I te m s in Ac co un ts .

Th e Pro t and L o ss A cc oun t and Balan c e S h ee t are

summ aries tha t is t o sa y m o s t o f th e in dividual it e m s
, ,

in c lu ded th erein are c o m posed of a n umb er of separa t e

a m o un t s and i t is th e duty o fth e au di t or t o e xam ine s uch
,

de t ails and t o see th a t th e s umm arisin g and gro uping of

th e i t e m s is don e c orre ct ly He mu s t see th a t only tran s
.

a ct ions and it e m s of a lik e n at ur e are gro uped t og e th er ,

tha t is th at th e h eadin g g iven fairly des c ri b es e v ery

,

c o m ponen t i t em ; o th erwise by in corre ct c la ssi ca t ion

, ,

th e resul t s S h o wn by th e a cc o un t s m ay b e m ade t o b e
ab solut ely m isleadin g For e x am ple this will be th e c ase
.
,

if re venu e ch arg es such as rep airs t o p lan t are de b it ed to

Plan t and Machin ery A cc o un t or if in fr a m in g th e Balan c e
, ,

S h ee t de b i t b alan c es u po n s uch a cc o un t s as Prelim inary

,

Ex pense s A dv e rt ising S u spense Paym en t s in A dv an ce

, , ,

and to t ak e an ex t re m e c ase Prot and L o ss A cc o un t

, , ,

are in clu ded under th e h eading S un dry De bt ors For .

th e t er m S undry Debt o rs S ho uld c o ver o nly a m o un t s

!

o wing and p ay able t o th e c on c ern such as trad e b oo k ,

de bt s c on t ained in th e S ales L edg ers wh erea s th e i t e m s ,

a bo v e do no t rep resen t m one ys o wing a t all and are no t ,

ass et s in th e ordinary sense but rep resent m o ne ys S pen t

, ,

result in g in de b it balan c es wh ich as a m a tt e r of accoun

, ,

tancy mus t be c arried forward in th e Balan c e S h ee t un t il

,

the y are wri tt en o ff t o Prot and L oss A cc o un t S uch .

i t e ms th erefore s h ould no t b e in c lu ded wi th li quid a sse t s

, , ,

but S ho uld be s t at ed separa t ely and desc ri bed c learly so ,

tha t th e exa ct posi t ion of a ffairs m ay be app rec ia t ed .

Th e exa ct fo rm of th e nal a cc o un t s th e h ea ding s under ,

whi ch the t ransa ct ions s ho uld be c la ssied and th e o rder ,

in whi ch th e it ems S h o uld appear in th e Prot and L O S S

A cc o un t and Balanc e S h ee t are all ma tt ers of personal
,

o pinion , an d in respect of which opinions dier Th e .

 60 THE PR I NCI PL ES OF AU D ITI N G

audit o r is no t c onc erned with th ese qu es t i ons p ro vided ,

tha t th e posit ion s h o wn by th e a cc o un t s is a c lear and tru e

re ect ion of th e s t a t e of a f fairs He mus t see th a t only
.

i t e m s of a lik e na ture are gro uped t ogeth er th a t th ere is ,

suicient s ub di v ision t o m a k e th e a cc o un t s c lear and

-

in t elligi ble and th at th ere is no s uppression of m at erial

,

fa ct s
.

Th e nal a cc o un t s are m ere s umm aries built u p fro m ,

it m a y be tho u sands of de t ail it em s and such a cc o unt s

, ,

m erely gi v e an indic a t i o n as t o th e nan c ial s t a t e of affairs ,

and dis c lose th e c o mb ined e ffect of all th e bu sin ess t ran s

a ct ions th at h av e b een c arried o ut durin g th e period of
th e a cc o unt s o nly by goin g b e h ind th e a cc o un t s and
examinin g th e de t ails c an th e nature and res ult of th e
v ario us transa ct ions b e app re c ia t ed and th e a ccura cy of
,

th e s umm aries b e v e ried I t is for this p urpo se th erefore

. , ,

th at th e au di t or is app o in t ed nam ely tha t h e m ay exa m in e

, ,

int o all such de t ail and thu s sa t isfy h im self wh e th er or

,

no t all th e t ransact ions are in order a nd tha t th e a cc o un t s

,

are c o rrect s umm aries gi v in g a fair in di c a t ion of th e

,

res ul t s of th e tradin g for th e period and th e nan c ial ,

posit ion a t th e da t e of th e Balanc e S h ee t .

T h e Pr in cip les G o v er n in g th e Pr ep ar a tio n o f

T r a din g, Pr o t an d L oss , an d Ap p r o p r ia
tio n Ac c ou n ts .

A udit ors h av e t o c ri t ic ise th e f or m in which a cc o un t s

are dra wn up fu rth er th e y oft en are requ est ed t o prepare
,

th e a cc ou n t s or t o giv e advi c e in this c onn ect ion and

, , ,

th erefo re altho ugh this s ub j ect b elon g s m o re t o accoun

,

t ane y than a u dit in g it is tho ught tha t i t will no t b e o ut

,

of p la c e t o c onside r b riey so m e of th e prin c iples g o v erning

th e p reparat ion of th e Pro t and L oss A cc o un t and Balan c e
S h ee t befo re passing t o th e de t ailed w o rk c onnect ed wi th
,

th e au dit th ereof For i t is essen t i al that b efore c rit ic isin g

.
, ,

an au di t or mu s t h av e a c o rre ct kno wledg e as t o h o w s uc h

a cc o un t s s ho uld b e drawn up in order tha t all ne c es sar y
,
 THE PR O FIT AN D Loss ACCO U NT , ETC . 61

inform at ion m ay b e disc losed in a form th a t will be easil y

underst ood A cc o un t an t s are ap t t o forg e t that th eir
.

a cc o un t s are no t p repared f or a cc o un t an t s but for th e ,

inform a tion of th e g eneral p ub li c and th a t th erefore , , ,

a cc o un t s s h o uld b e m a de as sim ple as possib le .

Th e Prot and L oss A cc o un t of a m er ch an t or m anufac

turer is g enerally di vided in t o three sections v iz th e , .
,

Tra din g or Man ufac turin g A cc o un t th e Prot and L oss ,

A cc o un t and th e A ppropriat ion A cc o un t I n th e c ase of

, .

non t ra din g c onc erns such as h o spit als c lub s pri vat e
-
, ,

indi viduals e tc th e c orresponding acc o un t is c alled

, .
,

g ener all y th e I n c o m e and E xpenditure A cc o un t but th e .

o b j ect is th e sam e nam ely t o grou p th e resul ts of th e

, ,

v ario us re v en u e transa ct ions en t ered in t o durin g a gi v en

peri od so that th e nal p rot or loss m a y b e as c ert ained
, .

Th e e x a ct fo rm of an I n c o m e and E xpendi ture A cc o un t

depends u pon th e na ture of th e transa ct i ons c arried o ut
but th e acc oun t S h ould b e so drawn up as t o dis c lose th e
am o un t s re c eiv ed fro m th e v ariou s sour c es of in c o m e and ,

th e v ario us exp enses and los ses in curr ed in earn ing or

O bt ainin g th e sam e S o m e c o m panies u se th e t erm
.

Re v enu e A cc o un t ins t ead of Prot and L oss A cc o un t .

TR AD IN G A CC O UNT I n th e c ase of a m erch an t or trader

.
,

th e O b j ect o fth is acc o un t is t o S h o w th e differen c e b e tw een

th e t o t al am o un t for whi ch th egoods h av e b e en sold durin g
th e period and th e t o t al p urchase pri c e of such g oo ds
, .

Th i s differen c e is c alled th e gross p rot or loss and
!
, ,

th erefore represen t s th e di fferen c e b e tween th e buy in g

,

and selling pric es .

I n th e c ase o f a m an ufa cturer th e Tra din g A cc o un t will

,

be de b i t ed wi th th e c o st of th e raw m at erials in c luding th e ,

c arriag e th er eo n and th e m an ufa cturin g wag es expended

,

in order to co n vert such m a t erials in t o th e nis hed art icles

tha t are sold Th e Tradin g A cc o un t S h ould b e de b i t ed
.

o nly with th e direct c ost s of p roduct ion and th e it e m s ,

in clu ded sho uld be such as v ary direct ly with th e turno v er .

Th e op ening and c losing s t ock s will h a v e t o be b ro ught

62 THE PR I N C IPLES OF AU D ITI N G

int o th e Tradin g A cc o un t for a gainst th e sales of th e ,

pe riod th at are credi t ed mu s t b e ch arg ed only th e c os t of

th e g oods s old but p ro b a bly part of th e g oods sold will
, , ,

ha v e b een p urch ased in p re vio u s periods and a proport ion ,

of th e g oods p ur ch ased during th e period and in c lu ded ,

in th e p urch ases will no t h a v e b een sold

,
Th erefore in .
,

o rder t o adj u st this s t o ck mu st b e t a k en a t th e c lose o f

,

ea ch nan c ial period and thu s th e Tra din g A cc o un t is

,

de b it ed wi th th e openin g s t o ck a t c os t pri c e th a t is with , ,

th e c os t of g oods p ur ch ased during p re vio u s periods but

sold during th e period under revie w and c redi t ed wi th th e ,

c losing s t o ck th at is wi th th e g o o ds p urch ased during th e

, ,

curren t period but no t sold and whi ch mu s t th erefore , , ,

b e ch arged on t o th e ne x t period d uring which in th e ,

o rdinary c o urse th e sam e will b e sold

, .

O ne of th e chief o b je ct s of th e prepara t io n of th e Tradin g

A cc o un t is t o as c ert ain th e perc en t a g e th a t th e gr oss
prot b ears t o th e sales as th is inform at ion is of c on,

siderable c o mm er c ial v alu e t o th e proprie t ors of the

bu siness Th e v ariat ions in th is perc en t ag e as b e tw een
.

one perio d and ano th er S h o uld b e wa tch ed c arefull y by

th e au di t or and if th e rise or fall is c onsidera ble h e s h o uld
, ,

en quire m os t s t ri ct ly as t o th e reasons .

PR O FIT AN D L o s s A CC O U N T Th e b alan c e u pon th e .

Tradin g A cc o un t is c arried t o th e Pro t and L oss A cc o un t ,

whi ch latt er a cc o un t is c redi t ed wi th an y mis c ellaneo u s

in c o m e o th er th an th at fro m sales such as ren t s in t eres t
, , , ,

dis c o u n t s e tc re c ei ved I t s h ould b e de b it ed wi th e very

, .
, .

expense loss or ch ar ge of th e bu siness for th e period o th er

, , ,

th an th ose in th e Tradin g A cc o un t and th e b alan ce thu s ,

o bt ained is th e ne t pro t or 10 5 5 upon th e wh ole of th e

bu siness t ransa ct ions for su ch pe riod .

APPR O PR IATI O N A CC O U NT Th e ne t pro t or loss is .

c arried t o th e A ppropriat ion A cc o un t whi ch acc oun t in th e , ,

c as e of a part nership S h o ws th e di vision of such pro t or

,

10 55 b e tw een th e part ners in a cc ordan c e wi th th e t erm s of th e

partners hip I n th e c ase of a c o m pan y th e A ppropriat ion
.
,
64 THE PR I NCI PL ES OF AU D ITI N G

b etw een th at dat e and th e clo se of th e nan cial y ear a ,

c orresponding proport ion of th e ensuin g w ee k s wag es

s h ould b e c al culat ed and pro vided for .

S AL AR I ES Th e au di t or s h ould inspect th e S alaries

.
'

A cc ou n t and S alaries Boo k and no t e th e dat es up t o whi ch

,

salaries h av e b een p aid and see th at pro vision is m ade for

,

an y o ut s t anding a m oun t s .

TRAVELL ER S C O MMI S S I O N S AN D EXPEN S ES Th e au di t or

.

sh o uld inspect th e C o mm ission Boo ks of th e v ario u s

t rav ellers and see th a t any c o mm issions earned t o th e end
,

of th e nanc ial period but unpaid a t tha t da t e are pro v ided ,

for ; asc ert ain th e arrang e m ent s as re gards expenses and ,

see th at an y o ut s t andin g s are b ro ught in t o a cc o unt .

L EGAL CHA R GES E n quiries S h o uld b e m ade as t o

.

wh e th er th ere ar e an y am o un t s o win g under this h ead ; if

so th e audit or S h ould call for th e soli cit ors b ills of c os t s

and see th at th ese am ount s ar e in cluded in th e a cc ou nt s .

A U D IT FEE Th e fee for th e period c o v ered by t h e

.

accou nt s s hould b e p ro vided for .

I NT ERES T PAYA BL E I f th ere ar e an y loans m ortg a g es

.
, ,

de b entures e tc i t is ne c essary t o see tha t th e int eres t

, .
,

a cc ru ed t o th e da t e of th e Balanc e S h ee t is pro vided for .

S UN DR Y EXPEN S ES A ll th e o th er no minal a cc oun t s

.

S h o uld b e inspe ct ed t o see th a t all th e v ario u s e x penses

and ch arg es for th e period h a v e b een inclu dedth ese will

c onsis t for exam ple of repairs fuel freight c ar ri ag e do ck
, , , , , ,

du es s ub sc rip t ions adv ert isin g and m any o th er it e m s of

, , ,

e xpense Th e au dit or m a y b e a ble t o trac e o ut s t anding

.

a m o un t s by an exa m inat ion of th e re c eip t s and invoi c es

of th e am o un t s de b i t ed during th e period no t in g th e da t es ,

up t o which such inv oic es run and m a k in g en quiries wh ere ,

such da t es fall S hort of th e end of th e nan c ial period He .

m ay also inspe ct order b oo ks and an exa m ina t ion of th e ,

C as h Boo k en t ries and inv oi c e les for th e s ucc eedin g

period oft en discloses i t e m s for which no p ro vision h as
b een m ade I n so m e c ases wh ere a cc o un t s h a v e no t b een
.
,

re c ei ved th e a m ou n t s will hav e t o b e es t im a t ed

, .
 THE PR O FIT AN D L oss AC C O U N T , ETC . 65

PAYME NT S IN A DVANC E Under this h ead will b e

.

in clu ded ren t s rat es t axes ins uran c es s ub s c rip t ions e tc

, , , , , .
,

p aid for periods th at e xt end b ey ond th e end of th e nan cial

y ear of th e part icular c on c ern Th e audi t or S h o uld e x am ine
.

th e n om inal acc o un t s and th e de m a nd n ot es and re c eip t s ,

seein g that a c orrect c alcula t ion h as b een m ade of th e

prop o rt ion unexp ired a t th e da t e o f th e Balanc e S h ee t .

S UN D R Y A MO UNT S REC EIVABL E Th ere m ay b e v ario u s .

a m o un t s du e t o th e c on c ern and for whi ch c redi t S ho uld

,

be t a k en in th e a cc o un t s su ch as ren t s in t eres t on loans

, , ,

di vidends ro yal t ies c o m m issions etc a cc rued due but

, , , .
,

no t y e t re c eived Th e no m inal a cc o un t s s h o uld b e

.

inspe ct ed and an y a vail ab le evidenc e c alled for t o s ub

stantiate th e a m o un t s th a t h a v e b een p ro vided for as

o wing reserv e bein g m ade for an y a m o un t s th e re c eip t

,

of whi ch is doubt ful .

All th ese o ut st an din gs m ay b e en t ered in an O ut st andin g s

Boo k or in th e J o urnal and th e a m o un t s p ro vided s h o uld
, ,

be c o mpared wi th those of th e p re vio us periods as th is ,

m a y dr aw att en t io n t o any which h av e b een o v erloo k ed .

Th e p roper pro vi sion for o ut s t andin g s dire ct ly a ffect s

th e Prot and L O S S A cc oun t for in this way each no m inal
,

acc o un t is m a de t o in clu de th e e x act inc o m e or ch arg e

appli c able t o th e period of th e a cc o un t s Th ere is b o und .

t o b e a c ert ain am oun t of o verla ppin g of transa ct ions as

b e tween one period and an o th er but in order t o prepare , ,

accura t e and exa ct a cc o un t s i t is ne c essary t o draw a

,

line a t th e da t e Up on whi ch th e period closes and th erefo re , , ,

all these adj u stm en t s h av e t o b e m ade .

Th e Pr in cip les G o v er n in g th e Pr ep ar a tio n

o f th e B alan c e S h eet .

Th e Balan c e S h ee t is th e all im port an t do cum en t wi th -

wh i ch an au dit or h as to deal and it is th e one in th e c ase

, ,

o f a c o m p an y to wh i c h h e h as t o a tt a ch his report or t o
, ,

which h is report mu st refer Th ere is a c onsidera ble .

am oun t of m isu nderst anding in th e co mm er c ial wo rld as

5
-
1 1 52 4)
 66 THE PR I N C I PL ES OF AU D ITI N G

t o wh a t ex act ly a Balan c e S h eet is and wha t i t p u rport s ,

t o S h o w ; i t is th erefo re of th e utm os t im port an c e th a t

, ,

ev ery a u dit or S h o uld unders t and th e tru e m eaning and

p urp ose of a Balan c e S h ee t .

DEF INITI O N O F BAL AN C E S HEET A Balan c e S h ee t is not

.

a s t at em en t of asse t s and liab ili t ies as is c o mm onl y th o ught

, ,

but m erel y a s h ee t sh o win g a c la ssied s umm ary of all

th e b alan c es appe arin g in a se t of b oo k s aft er all th e ,

no m inal a cc o unt s h av e b een c losed by transfer t o th e

Pro t and L O S S A cc ou n t th e Balan c e S h ee t in c lu din g
th e b alan c e on th e la tt er a cc o un t Th e Balan c e S h ee t .

is no t an a ctu al a cc o un t in th e b oo k s as is th e ,

Pro t and L oss A cc o un t but m e rel y S h o ws in c lassied

, ,

form th e wh ole of th e b alan c e s open aft er th e no m inal

,

a cc o un t s h av e b een c lose d I t will in c lu de all th e ass et s

and li ab ilit ies of th e bu siness but in m an y c ases it in clu des
,

it e m s on bo th sides which are neith er th e one nor th e

o th er For exam ple : if th ere is a de b i t b alanc e on th e
.

Pr ot and L oss A cc o un t t h is b alan c e in th e c ase of a

, ,

c o m pan y mu s t appear on th e right h and S ide of th e

,
-

Balan c e S h ee t but this b alan c e c anno t b e t erm ed

, an

asse t. Ag ain wh en expendi ture such as p relim inary
, ,

C xpenses disc o u n t upon an iss u e of de b en tures adv ert ising

, , ,

alt era t ions e tc is bein g wri tt en o ff t o Pro t and LO S S

, .
,

A cc o un t o v er a period of y ears th e b alan c e c arri ed forw ard

,

mu st app ear in th e Balan c e S h ee t O n th e o th er h and .

,

s uch it e m s a s reserv e funds a m o un t s p aid on S h ares

,

fo rfeit ed and a credi t b alan c e on Prot and L oss A cc ou n t

, ,

mu s t appear upon th e left h and S ide of th e Balan c e S h ee t

-
,

but are no t wh a t are c o mm only unders t o od by th e t erm

lia b ili t ies .

F or th e foregoing reaso ns th erefo re a Balan c e S h ee t

, ,

S h o uld no t h a v e th e S ides h eaded liab ilit ies and asse t s
!
,

for if th e ri ght h and side is h eaded asset s i t mu s t m ea n

-

th a t e v ery i t e m underneath is an asse t and th a t th e t ot al ,

w
a t th e foot represen t s th e t o t al v alu e of th e asse t s of th e
c o nc ern wh ereas as e xpla in ed a bo v e oft e n th is is not th e
, , ,
 THE PR O I FT AN D L o ss AC CO U NT , ETC . 67

case . is v ery c o mm on e v en in th e a cc o un t ancy pro

It ,

fession t o h ead th e S ides of th e Balan c e S h ee t in this wa y

,

wi th th e result th at th e g eneral p ub li c ha v e form ed quit e

erroneo u s ideas as t o wha t a Balan c e S hee t is lo o king upon ,

it as S im ply and p urely a s t at em en t of asse t s and lia b ili t ies .

Th e form in whi ch th e Balanc e S h ee t h as been p resen t ed

t o the m is largely responsible for this and in fa ct j us ties , , ,

t h is false im p ression Th ese h ea din g s hav e b een h anded

.

do wn fro m th e past and if th ose wh o use th em ,

were t o ask th e m selv es serio usly why th e y ha v e

adop t ed th e m and exa ctly wha t th e y m ean and im ply ,

p ro b ably th e y wo uld see strong reasons for disc ont inuing

th e pra ct ic e .

A Balan c e S h ee t s h ould ha v e no h eading s t o th e two

S ides and as it is no t an acc o un t th e signs Dr an d
, , , .

Cr S h ould not appear nor sh o uld th e t erm s To
! !
. ,

and By be u sed for as it s nam e im plies it is m erel y a

, , ,

S h ee t of b a lan c es .

I f p roperly p repared a Balan c e S h ee t s h o uld S h o w a ,

tru e and c orrect View of th e s t a t e of th e aairs of th e

c on c ern and in par t icular will S h o w exa ctly th e na ture of
,

al l th e asse t s and lia b ilit ies but i t will oft en in c lu de o th er ,

it em s as w ell and th erefore th ese la tt er S h o uld b e clearly

, , ,

desc ri b ed so th at th e wh ole posit ion m a y b e perfectl y

c lear An au dit or s duty is t o sa t isfy hi m self tha t th e
.

Balanc e S h ee t is p roperly dra wn u p u pon th e foreg oing

prin c iples and t o report a cc ordin gly t o those e m plo y ing
,

MAI N O BJ ECT OF m ain o b j ect

BAL ANC E S HEET . Th e
wi th whi ch a Balan c e S h ee t is drawn up is t o asc ert ain th e
p rot or loss of th e c on c ern during a giv en period th o ugh , ,

in addi t ion i t is of gr ea t v alu e in s h o wing th e nan c ial

,

posit ion a t da t e and wh eth er th e capit al is int a ct or no t

, ,

and h o w such capit al is inv est ed Th e c apit al represen ts .

th e e xc ess of asse t s o ver lia b ili ties tho ugh for th is p urpose , ,

de b it balanc es car ried forward u pon su ch a cc oun t s as

p relim inary expenses adv ert ising su spen se etc , are , .,
 68 THE PRI N C I PL ES OF AU DITI N G

inc lu ded with th e asse t s I f th erefo re th e surplu s of . , ,

asse t s o v er lia b ilit ies h as increased during a gi ven period ,

this mu st m ean th at a p rot h as b een m ade S in c e th e da t e

of th e las t Balan c e S h ee t on th e oth er h and sh ould th e ,

s urp lu s b e less a 10 5 5 mu s t h av e b een incurred But in

, .
,

c o mparin g th e openin g and c losin g c apit al for this p urpose , ,

i t mu s t b e seen wh e th er an y fu rth er c api t al h as b een paid

int o th e business or wh e th er th ere h av e b ee n an y wi th
,

drawals during th e period I f so in o rder t o arri v e a t th e

.
,

pro t or loss th e addi t ions mu s t b e deduct ed fro m an d

, ,

th e wi th drawals added t o th e closing capi t al th e res ult in g, ,

gure b ein g c o mp ar ed wi th th e openin g capi t al and dis

closin g th e prot or loss A pro t m a y b e said t o b e an .

increase and a loss a decreas e in th e c api t al in ves t ed

,

in a business A Pro t an d L O S S A cc o un t m erely

.

am plies th e inform a tion dis closed by th e Balan c e

S h ee t th e form er S h o wing exa ctl y h o w s uch pro t or
,

loss h as arisen .

AS th e capit al rep resen t s th e s urplu s of asse t s o v er

lia b ilit ies and as th e in crease or de crease of s uch s urplus
,

rep resent s th e prot or loss i t will b e seen th a t th e ascer ,

tainm ent of th e p rot or loss is a b solut ely dependen t u pon

th e v alua t ion of th e asse t s I t is possible as a rule t o .
, ,

asc ert ain th e am o un t of th e liab ili ties e x actl y e x c ep t in th e ,

c ase of c on t in g en t lia b ili t ies such as c laim s whi ch are th e ,

sub j ect of dispu t e in whi ch c ase th e t o t al lia b ility under

,

this h ead will h a v e t o b e es t im at ed ; but on th e o th er ,

han d th ough th e asse t s b elongin g t o a business c an ea sil y b e

,

asc ert ain ed it is p ra ct ic ally impossi ble in m an y c ases t o

,

x th eir exa ct v alu e un t il s uch asse t s are s old But th e .

xed asse t s th at is th e asse t s by th e u se of whi ch th e

, ,

business is c arried on s uch as lan d and buildin g s plan t and

, ,

m achinery m ines c on c essions e tc are no t h eld wi th a

, , , .
,

vie w t o re sale and in fa ct m ay ne v er be sold unless and

, , ,

un t il th e bu sin ess is nally wo und up C onsequ en tl y in .

,

th e m eantim eth e v alu at io n of such asse t s is a m att er of

es t im a t e and personal opinion E v en if expert valu ers .
 THE PR O I FT AN D L o ss A C CO UNT , ETC . 69

were e mploy ed pro b a bly no two valu ers would arriv e a t

,

th e sa m e res ult for ins t an c e in th e c as e o f a f act o ry

,

eq uipped with m achinery being valu ed by tw o independent

exp ert valuers th e respect iv e t ot al v alua t ions m ight diffe r
,

by th ou sands of po unds I n a lesser de gree th e s am e

. ,

applies t o th e valu at ion of s t ock in t rade b oo k de bt s and

- -
, ,

o th er s uch asse t s which ar e h eld wi th a Vie w t o m ore or less

imm edia t e c onv ersion in t o c as h A nd th ough it is .
,

nec essary t o es t im at e th eir valu e i t is im possi b le t o ,

gu aran t ee tha t such v alua t ions will p ro v e t o b e e xa ct .

V AL UATI O N O F A S S ETS A no th er qu es t ion t o b e c on

.

sid ered in c onnection wi th th e v alu ation of asse t s for

Balan c e S h ee t purp o ses is wh e th er th e v alu a tion S h o uld b e

,

b ased u pon m ar k e t or ex chan ge able v alu es th at is th e , ,

am o un t th at i t is es t im at ed such asse t s wo uld realise if sold ,

or u pon th e v alu e of such asse t s t o th e business as a going

c on c ern th at is th eir v alu e t o th e p roprie t or for th e
, ,

p urpose for whi ch h e re qu ires th em A s will be seen .

lat er bo th th ese m e thods are adopt ed wh en v aluing

,

a ss et s for in cl usion in a Balan c e S h ee t .

Ag ain th ere c an be n o true pro t unless th e original

,

capi t al t o g e th er wi th an y addi tions th e re t o is in t a ct ;

, ,

th erefo re if an y of th e a sse t s in whi ch part of s uch c apit al

,

is in vest ed are of a w as t ing n a ture or are c onsum ed in ,

th e c o urse of earnin g re v enu e su ch wa st ag e mu s t b e m a de

,

good b efore th e tru e p rot can b e arriv ed at But i t is .

im possi ble t o s t a t e p rec isel y wh at for exam ple will be , ,

th e wo rkin g life of plan t and m achinery or wh at is th e ,

t o t al quan t ity of ore in a m ine and ho w lon g it will t ak e to

,

e x tra ct such ore .

For th e a bo ve reasons i t will b e seen th a t i t is im po ssib le

,

t o arri v e a t th e prot s or losses of a c on t in uing bus iness

exa ct ly and a ctual t ru e p ro t is seldom a sc ert a ined Th e
, .

res ul t s are a b solut el y depen den t u pon th e v alu a tion o f

th e asset s of th e bu siness and it is im possib le t o x su ch

,

v alu es with a b solut e prec ision Th ese fa ct s mu st be .

realised and apprec iat ed by a cc oun t an t s wh o s h o uld make ,

70 THE PRI N C I PLES OF AU DITI N G

th ese roo t princ iples c lear t o th eir c lien t s wh o m th e y mu s t ,

no t lead in t o th e b elief th a t a b solut e exa ct itu de and

c ert ain ty c an b e a c h ie v ed in th e p eriodi cal a cc o unt s of
th eir bu s inesses .

For c o m m erc i al p urposes th e asse t s are v al ued a cc o rdin g

,

t o c ert ain c on v ent ional rules and th e p ro t or loss arri ved

,

a t in this way is c onsidered suiciently near and a ccura t e

for ordinary bu siness p urposes and by m eans of c on , ,

serv ativ e es t im a t es and reser v es w ell c onduct ed c o n c erns

,

lea v e a m argin t o pro vide ag ain s t errors in valua t io n and ,

for unforeseen c on t ing en c ies .

For Balan c e S h ee t p urposes th e asse t s of a bu siness are

,

di vided under two h ea din g s i a Fixed A sse t s

. .
,and

Floa t in g A sset s .

F I XED AN D FL O ATIN G A S S ET S Fixed A sse t s are th ose

.

asse t s of a perm anen t na tur e whi ch are a cquired by an

undert a kin g with a V ie w t o earnin g prot s for a period of
y ears by th e u se of th e sa m e and su ch asse t s are no t h eld
,

for th e p urpose of re sale For e xa m ple th e plan t and

-
.
,

m ach inery of a fa ct ory is h eld wi th a Vie w t o m anu fa cturing

wi th th e sa m e for th e wh ole period of the working life of
such plant .

Float in g asset s are th ose asse t s whi ch are produc ed or

a cquired by an undert a kin g in th e c o urse of or for th e
p urpose of i t s t radin g and c onsis t of c as h and such asse t s
,

as are h eld with a Vie w t o c on v ersion in t o c as h as soon

as possible E x a m ples of oa t in g asse t s are : s t o ck in
.
-

t rade w ork in pro gress and b oo k de bt s ; and i t w ill b e

, ,

S ee n th at th ese asse t s are th o se in w h ich a t rader t rades ,

an d th eir v a rio u s s t a g es of c on v ersio n in t o c as h as ,

opposed t o xed asse t s wh ich are th ose with which h e

,

trades and wh i ch are no t h eld wi th a Vie w t o c on v ersion

,

in t o c as h .

F ixed asse t s are v alu ed upon th e b a sis of c os t and if ,

su ch asse t s are of a w as t in g nat ure th e orig inal c os t pric e ,

in m os t c ases is wri tt en o fft o re v enu e by m ean s of depre ,

ciation o v er th e period of th e es t im a t ed w o rking life of

72 THE PR I N C I PLES OF AU DITI N G

uct ua t ion but appear s t o repre sen t a m ore or le ss per

,

m anen t fall th en in eect a lo ss has b een m ade on th e

,

p urch ase and S ho uld th erefore b e pro vided for For if

, , , . ,

o wing t o th e high p ric es at whi ch th e g oods w ere p urchased ,

and t o th e sub se qu en t fall in m ark e t pri c es i t appe ars ,

th a t pro b ab ly i t will b e im possible t o sell th e go ods in

th e ensuing y ear a t a prot th en th e 10 5 5 s h ould b e p ro vided ,

for a t on c e and s ho uld fall upon th e y ear in whi ch th e

,

g oods were p urchased .

O n no a cc o un t S h o uld oa t in g asse t s b e valu ed a bo ve

c os t p ri c e as th e e ffe ct w ould b e t o t ak e in t o a cc o un t a
,

p urely ct it iou s an d unrealised p ro t For if c ert ain .

goods are p ur ch ased for 500 a nd re m ain u nsold at th e ,

da t e of th e Balanc e S h ee t wh en th e m arke t valu e of th e ,

sa m e is 600 it c anno t b e said that a p ro t of 1 00 h a s

,

b een m ade but m erely tha t if th ese p ric es are m ain t a ined
,

i t appe ars lik ely th at upon realisat ion such a p rot m ay

, ,

b e m ade A g ain if such g o ods w ere v alued a t 600 ap art

.
, ,

fro m o th er t ransact ions th e a cc o un t s wo uld S h o w a prot

,

o f 1 00 a v aila b le for th e p roprie t o rs of th e bu siness but , ,

in fact th ere wo uld no t b e a penn y pi ec e represen t in g such

,

supposed p ro t whi ch th erefo re would b e a m ere paper

, , ,

o ne .

Th e foreg oing rea sonin g might b e u sed t o argu e a gainst

th e ne c essity o f wri t in g do wn th e valu e of oa t in g asse t s
in c ases wh ere th e m ar k e t values are b elo w c os t But .

a cc o un t s S h o uld b e p repared upon th e b asis th a t lo sses

S h o uld b e an t i c ipa t ed bu t p ro t s ne v e r for if p ro vision is

, ,

m ade for an es t im at ed loss and it sub se quen t ly t ranspires ,

tha t th is e st im a t e was in c o rre ct and that in fa ct th e , , ,

transa cti o n result ed in a p rot no h arm will h av e b ee n ,

done and th e succ e eding year will b enet t o th e ext en t

,

tha t th e p re vio us y ear s prot s were under e st im at ed

-
.

But on th e o th er h and if a p ro t is an t icipa t ed and t ak en

, ,

credi t for b efore th e s am e is realised th en s uch e st im at ed ,

prot m a y h av e b een p aid a way t o th e proprie t ors of th e

business and u pon it b eing fo und sub se quen t ly tha t th is
,
 THE PR O FIT AN D L o s s A C C O UNT , ETC . 73

prot was unj ustied th e transa ct io n h aving result ed in

a loss i t m ay b e impossible t o rec o v er fro m th e p ro prie t ors

,

this o v er pa ym en t and c onse qu en t ly th e c apit al of

-
, , ,

th e business will b e reduc ed to th e ex t en t of th is

o ver es tim at ion of prot in th e pas t
-
.

'
Au di to r s Po sition as R egar d s th e V alu atio n
of As s ets .

Fro m th e fo reg oing i t will b e seen h o w dependen t th e

,

Prot and L oss A cc o un t an d Balan c e S h ee t are u pon th e

v alua t ion of th e vario us asset s of a c on c ern but i t mu st ,

b e o b served th a t an au di t or c anno t p o s si bly valu e th e

asse t s of th e bu sinesses whose acc o un t s h e audit s .

This v alua t ion mus t b e c arried ou t by th e p ar t ners ,

direct ors or o th er respon sible offi c i als all th a t an au dit o r

,

can do is t o asc ert ain as far as possible tha t such valuat ion s
appear t o be fair and reasona b le th a t th e y are b ase d u pon,

c orrect prin c iples and tha t all c on t in g en c ies appea r t o

,

hav e b een p ro vided for I n th e c ase of so m e asse t s such

. ,

as inv es tm ent s in se curi t ies of whi ch there are m arket

quo t at ions th e au di t or can Ch eck th e v alua t ions e xa ct ly
, ,

but in th e c a se of o th ers s uch as la nd buil d in g s pl an t

, , ,

and m a chinery th ere is no m eans by whi ch h e c an det er

,

mine th e p rec ise v alu e Th e st eps tha t an au dit or s hould

.

t ak e in o rder t o sa t is fy him self that th e v aluat io n s appear

,

t o b e fair and reasona ble W ill b e dis cussed in th e c o urse

,

of th e follo win g ch ap t ers but b efore p ro c eedin g further

, , ,

th e lim it a tions of a Balan c e S h ee t and th e li m i t at ions of

an audit espe c i ally with reg ard t o th e valuat ion of a sse t s
, ,

s ho uld be clea rly underst ood and app re c i at ed a cc o un t a nt s

s ho uld no t c lai m for an au di t ed Bala nc e S h ee t a b solut e
exa ct i tu de but m erely tha t i t s h o w s th e faires t po ssible
,

es t ima t e of th e posit ion of a ffairs arri ved a t in a cc ordanc e

,

wi th th e a cc ep t ed ru les and ch eck ed and t es t ed in e v ery

,

reasona b le m a nner O n no a cc o un t s hould th e imp ression

.

be gi ven th at an au dit guaran t ees th a t th e posit ion S h o wn

is c orrect in e v ery de t ail for th e future m ay S ho w tha t
,
74 THE PRI N C I PL ES OF AU DI TI N G

th e m os t c arefully prepared and a u dit ed Balan c e S h ee t

h as c onsidera bly m is s t a t ed th e real posit ion of affairs
-
.

Grea t harm only c an b e done t o th e profession if accoun

t an t s assum e for an au dit ed Balan c e S hee t virtues th at i t
does not and c anno t possi bly po ssess .
 C HAPTE R V
VAL UATI O N AN D VE R I F ICATI O N 0F A S S ET S
IN th e p rec edin g chap t er it h as been poin t ed o ut that th e
valu es of the asse t s of a bu siness for Balanc e S h ee t p urpose s
ha ve t o b e estim a ted tha t such v alu at ions are bo und t o
,

b e m ore or less app ro xim at e and th a t th e y are no t in all

,

c ases b ased upon th e m ark e t v alu es but upon c ert ain

,

a cc ep t ed rules O n th e o th er h and it mus t b e re c ognised

.
,

th at th e Balan c e S hee t is a b solut el y dependen t u pon th e

valuat ion of th e asse t s and th at th erefore this ma tt e r
, , ,

mus t b e g one in t o wi th th e utm o s t c are so th at th e result s

,

s h o wn m ay b e sufc ient ly a ccurat e for all pra ct i cal p urp o ses .

I t is no w p roposed t o de al wi th th e v al ua t ion of vario us

c o mm on asse t s whi ch are c ons t ant ly m e t with in p ra ct ic e ,

and t o explain th e au dit or s dut ies with reg ard th ere t o

.

But i t mus t b e b orne in m ind th a t th e a ctual v al ua t ions

are m ade by th e proprie t o rs or off i c ials of th e c on c ern ,

who h av e a p ract ic al kno wledg e of such asset s and th at ,

an audit or s duty is c onned t o t es t ing th e valua t ions as

far as h e can and in this wa y sa t isfying him self tha t th e

,

posit ion S ho wn appears t o b e c orre ct h e c anno t h o w e v er , ,

in an y way gu aran t ee th e a ccura cy of th e Balan c e S h ee t .

A t th e sam e t im e th e au dit o r s dut ies as re g ards th e

,

v eri c at ion of asse t s will also be discussed Th e asse t s of .

a business will b e as c ert ained fro m th e b oo ks of a cc o u nt ,

and it is th e audi t or s duty t o se e th at all those thus

disc losed are p roperly and Clearly se t o ut in th e Bal an c e

S h ee t and appear t o b e c o rrect ly v alu ed
, But this is no t
.

suicien t for
, , h a vin g fo und fro m th e b oo ks wha t asse t s
ought t o b e in th e possession of th e c on c ern h e mu st th en ,

sa t isfy him self that such asse t s w ere actu all y in it s posses
sio n a t th e da t e of th e Balan c e S h ee t and th a t th e sam e
,

were free fro m all ch arg es excep t th ose disc lo sed in the
75
76 THE PR I N CI PL ES OF AU DI TI N G

b oo ks This is a m ost im port an t part of an au di t or s
.

dut ies for alth ough h e m ay h av e v ouch ed th e o ri ginal

, ,

pa ym en t upon th e p urch ase tha t is no e videnc e at all tha t

,

tha t asse t was s t ill in th e possession of th e c on c ern a t a

sub se qu en t da t e Th e a u dit or th erefore S ho uld a tt end at
. , ,

th e c lose of th e peri o d for th e p urpose of v erifyin g th e

asse t s as a t th at da t e Th is en t ails th e in spe ct ion of such
.

e viden c e as will sa tisfy th e au dit or th a t such asse t s are

a ctuall y in th e posses sion of his c lien t s .

Wh en exa minin g se curi t ies for th is p urp ose c are and ,

m e th o d mu s t be a dop t ed t o p re ven t sub s t i tut ion ; th at

is t o say th a t wh en for e x a mple th ere are two or m o re
, , ,

se curit ies of a li k e nature one b a tch of securi t ies is no t

,

p roduc ed t o verify b o th in v estm en t s I f c onsidera ble .

c are is no t exer c ised this frau d is ext re m ely S im ple For

, .

ins t an c e suppose th e c ase of a c o m pan y h oldin g as an

,

in vestm en t c ert ain deb en ture bonds h aving in all one ,

hundred 50 b earer b onds unless all th ese b onds

are produc ed a t th e sa m e t i m e th e v eri c at ion w ill b e ,

u selessfor if th e au dit or h ad one b a tch offty p roduc ed

t o him by th e m anag er wh o th ereaf t er t ook th ese awa y
, ,

and th en p roduc ed ano th er b a tch of fty i t w ould be ,

im possi ble unless th e au dit o r no t ed all th e numb ers up o n

,

th e b onds p roduc ed t o ens ure tha t th e sa m e b onds w ere

,

no t produc ed twi c e I n fa ct this part i cula r form of frau d

.
,

in th e past h as been p erpe t ra t ed for ye ars in succ ession ,

c o v ering up seriou s defalc a t ions Th erefore wh en .

,

exam ining securi t ies such as th e t i tle deeds of freeh old

,

and lease h old p roperty S h are c ert i c a t es b onds b ills

, , , ,

e tc th e au dit or mu s t see th a t th e wh ole of th e s ecuri t ies

.
,

are p roduc ed t o h i m a t one t im e and th a t all re m ain ,

under his en t ire c on t rol durin g th e wh ole of th e t im e of

his exa m ina t ion A sim ple wa y of doin g this is t o h a v e
.

all th e k e ys of th e st rong roo m and safes wh ere th e ,

securit ies are k ep t h anded t o th e au dit or a t th e c o m

,

m encem ent and th ese h e s h o uld re t ain in his po sse ssion

,

un t il h e h as c o m ple t ed his exa m in at ion of th e se curities .

 VAL UATI O N AN D VER I FI C ATI O N O F AS S E S T 77

Furth er h e S hould c onduct th e whole of th e examina tion

,

him self assis t ed by his o wn sta an d as little as possible

, ,

by th e st a ff of his c lien t s .

Ca sh in Hand Th e audit or S h ould att end a t th e close

.

of business up o n th e dat e of th e Balan c e S h ee t or on th e ,

follo win g m ornin g and c o un t all c as h b alan c es in hand

, ,

c o mparing th e sam e with th e b alan c es acc ording t o the

b oo ks I f there are tw o or m ore c as h b alan c es s uch as
.
,

pe tty c as h c as h in t ill e tc th e wh ole of th e c as h S h ould

, , .
,

be produc ed a t one and th e sam e tim e in order t o p re v ent ,

S h o rtag es u pon one a cc o un t b eing m a de u p o ut of th e

cas h belon gin g t o an oth er .

I f th e a u dit o r c anno t a tt end i mm edia t ely upon th e

c lose of th e nan c ial period for th e p urpose o f c o un t ing
th e c as h h e s hould wh en h e sub se qu en t ly a tt ends ch e ck
, , ,

and vo uch th e petty c as h t ill boo ks e tc up t o dat e and , , .

, ,

th en c o un t th e cash c o mp aring th e S am e with th e b alan c e s

,

s ho wn by th e boo ks .

A v ery good plan is t o arrang e th at all c as h balan c es

at th e c lose of ea ch nan c ial period s hall b e paid in t o th e
b ank upon th e las t da y of such p eriod ch eq u es being ,

dr awn u pon th e follo wing da y t o re open th e c as h acc o un t s -

.

I n th is w ay all c as h balan c es are aut om at i c ally c o un t ed

an d a cc o un t ed f or and th e a u di t o r is thu s sa v ed fr o m a
,

so m ewha t in vidiou s t as k .

Unles s a b solut ely nec essary lar g e cas h b alan c es S h o uld ,

no t b e allo wed and if c as h b alan c es S ho w a t enden cy t o

,

in crease th e au dit or S ho uld m ak e c areful en quiries as to

,

th e ne c essity for th e m an d th eir a ctu al exis t en c e and ,

b rin g th e fact s t o th e no t ic e of th e prin c ipals of th e bu siness .

Ba nk Balan ces Th e C as h Bo o k S h ould b e ch ecke d

.

with th e Pass Boo k as p re vio u sl y desc ri b ed and th e two ,

b alan c es a greed by m eans of th e rec on c ilia t ion s t at em en t .

Th ereafter a c ert ic at e S h ould b e O bt ained by th e au dit o r

,

direct fro m th e b ank ers as t o th e b alanc e a cc ording t o

,

th eir boo ks a t th e c lose of bu s iness upon th e da t e of th e

Balan c e S h ee t i t b eing S een tha t this b alanc e agrees with
,
78 THE PR I NCI PL ES OF AU D ITI N G

th e b alan c e a cc ording t o th e Pass Boo k produc ed Any .

b alanc e upon Deposit A cc o un t S ho uld be v eried in

th e sam e wa y .

Investm en ts Wh en possible th e b es t way t o deal with

. ,

in ve stm en t s is t o h a ve a separa t e a cc o un t opened in th e

L e dg er for ea ch in v estm en t th e a m o un t de b it ed b ein g th e
,

a ctual c o st . I f s h ares or de b en tures h a v e b een iss u ed t o

th e c on c ern as c onsiderat ion for servic es rendered th en ,

wh at e v er o ut la y h as b een in curred in c onnect ion with such

ser v ic es S h o uld b e de b it ed t o th e part i cular in v es tm en t
,

a cc o un t as rep resen t ing th e a ctu al c os t of th e s h ares or

,

de b en tures rec eived I f h o we v er th ere are no s uch

.
, ,

expenses or o utla y an a cc o un t s ho uld b e opened for su ch

,

S h ares or de b en tures but no am o un t s h o uld b e plac ed in

,

th e c os t c olum n I n th is way e v ery in v es tmen t appears in

.

th e b oo k s a t th e a ctual b are c os t and re m ains a t this gure

,

un t il sold wh en th e am o un t realised will b e c redit ed t o th e

par t icular a cc o un t and th e p ro t or 10 5 5 upo n realisa t ion
,

will b e asc ert ained thu s and wri tt en o ff .

A t th e da t e of ea ch Balan c e S h ee t a sch edule s h ould ,

b e prepared and p resen t ed t o th e au di t or gi ving part icu lars ,

of ea ch inv es tm en t th e c os t th ereof a cc ordin g t o th e

,

L edg er and a fair v al ua t ion a t da t e b ased upon curren t

, ,

m ar k e t pri c es For th e p urpose of this v alua t ion t em

.
,

p o ra ry m ar k e t uct u a t ions m a y b e di sreg a rded fo r

example if upon th e da t e of a Balan c e S h ee t all m ar k e t s

,

w ere a b norm ally dep ressed o wing t o a war sc are whi ch , ,

by th e t im e th e au di t is b ein g c o m plet ed h as s ub sided ,

and th e m arke t s h av e right ed th e m selv es it would no t b e ,

nec essary t o v alu e upon th e b asis of s uch a b norm al pri c es ,

but a fair a v erag e pri c e s h ould b e t ak en But ex c ep t .

,

in exc ep t ional c ir cum s t an c es such as th e a bo v e each ,

in v es tm ent S hould b e in clu ded on th e list a t th e m arke t

pri c e
.

I n th e c ase o f h oldin g s in c o m panies wh ose sh ares are

not qu o t ed th e Balan c e S h ee t s of s uch c o m panies s h o uld
,

be inspe cted and a fair v al u e pla c ed upon such s h ares

,
80 THE PR I N C IPLES OF AU D ITIN G

sh o uld be ade qua t el y des c ri b ed so tha t th e Balanc e S h ee t

,

m ay s h o w wh a t p ropor t ion of c api t al is in v es t ed in wha t

are c o mm only c alled g ilt edg ed securi t ies and wh at ,

a m o un t in sp ecula t i v e in v es tm en t s in c onne ct ion wi th ,

whi ch th e ris k of loss is v ery much grea t er .

S o far as th e a u dit o r is c on c erned h e S h o uld ch eck th e ,

lis t wi th th e L edg er and ch eck th e valuat ion s seeing th a t

, ,

an ade qu at e reserv e is pro vided ag ain st p o ssib le losses

upon realisa t ion I f no s uch reserv e is m ade h e S h ould
.
,

see th at a no t e as t o th e m ar k e t v alu e appears u pon th e

Ba lanc e S h ee t or th at th e inv es tm en t s are dis t inct ly
,

s t a t ed as b ein g a t c os t and if th e fall in v alu e be v ery
, ,

h eavy h e S h o uld refer t o th e m a tt er in his au di t report

, .

O n n o a c co u n t S h o uld in ves tm en t s app ear in th e Balan c e

S h ee t at a v alu e ab o ve c os t s uch es tim a t ed in c re ase b ein g
,

c redi t ed t o Pro t and L o ss A cc o un t as if th i s is done cre dit

,

w ill b e t ak en for wh a t is b ut an es t i m a t ed and paper

pro t such s upposed p ro t no t b eing rep resen t ed by a
,

p enny pie c e wi th wh i ch in th e c ase of a c o m pany a

, ,

di vidend c ould b e paid .

AS reg ards th e v eric a t ion of in v estm en t s th e pro c edure ,

will b e as follo w s
I N S C R I BED S T O C KS An applic a t ion mus t b e sen t t o
.

th e b anker or ag en t s of c e wh ere th e st ock is ins c ri b ed ,

such appli c a t ion b ein g m ade upon oicial form s whi ch ,

mu st b e sig ned by one of th e st o ck h olders det ails mus t -

b e g iv en as t o th e na ture of th e s t o ck th e am o un t h eld , ,

th e na m es in whi ch i t is h eld th e da t e a t which it is t o b e

,

c ert ied and t o wh o m th e c ert ied form is t o b e sen t

, ,

wh o for th is p urpose S h ould b e th e au dit or Th e form

, , .

mu s t also b e a cc o mpanied by th e p resc ri b ed fee for v eri

cation . Th e b an k er or a g en t th en c o m pares th e par
ticulars wi th th e rec o rds in his b oo k s and if fo und t o ,

agre e c ert ies th e form as c orr ect and re turns i t as dire ct ed

, , .

For a u di t p urposes app li c a t ion will h av e to b e m ade in

,

th e sa m e way each y ear Wh en insc ri b ed st o ck s are bo ught

.
,

th e p urch aser is g iv en a c ert i c a t e by th e b an k er or ag en t

 VAL UATI O N AN D VER I FICATI O N OF AS S ETS 81

tha t the sa m e hav e b een duly in sc ri b ed bu t as this c er ,

ticate h as not t o b e p roduc ed wh en th e s t o ck is sold i t ,

is of no valu e t o an audi t or and on no a cc o un t s hould i t

,

b e a cc ep t ed as a v e ric a t ion of such h oldin g a t a sub se qu en t

da t e Th e fo llo wing are a fe w exa mples of insc ri b ed
.

s t o cks tha t will h a ve t o be veried in thi s m anner C onsols ,

annui t ies L ondo n C oun ty C o un c il st o ck s lo c al loans

, , ,

I ndia 3 per c en t and 3 ; per c en t s t o cks v ario u s Munic ipal

. . ,

and C olo nial st o ck s .

DEBENTU RE S AN D REG I S T ER ED S HA RES IN C O MPANI ES .

Th e de b en tures or S h ar e c ert i c a t es mus t b e inspe ct ed i t ,

b ein g no t ed th a t th e y are m ade out in th e n am es of th e

au dit or s c lient s or th eir no m ineesin th e la tt e r c a se a

,

c ert ic at e S ho uld b e o bt ained fro m th e no minees tha t

th e y h old for th e au di t or s c lien t s and th a t th e y h a v e no

,

ch arg e upon s uch in v es tm en t s .

I n th e c ase of ne w issu es in respect of whi ch de b entures

,

or c ert ic at es h av e no t y e t b een issu ed t o th e h olders th e ,

audi t or will require t o see th e allo tm en t le tt ers and th e

b an k ers re c eip t s for th e inst alm en t s th a t h av e b een paid

.

DEBENTU RE BO N DS AN D S HA RE W A RRANT S To BEA R ER .

Th e b onds or w arr an t s S h o uld b e inspe ct ed i t b ein g seen ,

th at all unpaid in t erest or di vidend c oupons are a tt a ch ed .

Boo k Debts Th e au di t o r s dut ies as reg ards th is asse t

.

ha v e b een deal t wi th already in c onn ect ion with th e au di t

of th e S ales Ledg ers his o bj ect be ing t o sa t isfy him s elf
,

th a t th e a m o un t s S ho wn as o wing appear t o b e bond de

de bt s and th at a suicient reserv e is p ro v ided for bad
,

and doubt ful de bt s I f in th e c ase of a c o mpan y th e

. ,

boo k de bts in c lu de a m o un t s o wing by dire ct ors or m an ag ers

fo r g oods or loans unless th e am o un t s in v ol v ed are v ery
,

sm all and appear fro m th e Ledg ers t o b e alwa ys pro m p t ly

and regularly settled th e au dit or s h o uld insis t upon s uch
,

de bt s b eing s ho wn separ at ely upo n th e Balanc e S h ee t ,

and if th e direct o rs refuse t o disc lose th ese am o un t s h e ,

sh ould draw a tt en tion th ere t o in his audit report .

Bills R e c eivable A sch edule of th e b ills in h and at

.

6
82 THE PR I NCI PL ES OF AUD ITI N G

th e da t e of th e Balanc e S h ee t s h o uld b e p roduced t o th e

au di t o r and h e s h o uld c o m par e th e sa m e wi th th e Bills
,

R ec eivab le Boo k and see th at th e t o t al of th e lis t a grees

,

with th e b alan c e u pon th e Bills R ec eiv a ble A c cou n t in th e

L e dg er He S h o uld th en exa m ine all th e b ill s a c tually in
.

h and n ot ing th a t th ey appear to b e p roperl y m ade ou t

, ,

c o mple t ed and s t amped and tha t the y are n o t o v erdu e

, .

I fc ert ain of th e b ills are in th e h ands of th e c li en t s b a n k ers

for c ollect ion th e b an k s h ould b e re qu es t ed to su ppl y th e

,

au di t or wi th a c ert ied list of such b ills I f th e au dit is .

no t c o mple t ed un t il so m e t im e aft er th e da t e of th e Balan c e

S h ee t a p roport ion of th e b ills p ro b a b ly will h a ve m a tured
, ,

and th e c as h for th ese sh ould be tra c ed in t o th e C as h Boo k

and Pass Book and any th at h a v e b een disho no ured or
,

rene w ed will thu s b e disc o v ered in wh ich c ase c areful ,

en quiry s h o uld b e m a de as t o th e reserv e nec ess ary t o

pro vide agains t possible b ad d ebt s W ith re g ard t o th e .

b alanc e of th e b ills th a t are s t ill curren t a t th e t im e of th e

au dit th e audit or s h ould g o through th e lis t of th ese with
,

a respo nsi b le of c ial a nd en quire as t o th e s u f c ien cy of

(
,

th e reserv e if an y ) th a t h as been pro vid ed under th is

h ea d Th e t o t al a m o un t of th e bills r ec eivable is in m an y
.
,

c ases c onsidera ble and th erefore th e audit o r mu st

, , , ,

sa t isfy h im self th a t th e s am e is a g o o d asset an d th a t an ,

adequa t e reser v e h as b een p ro vided for po ssi ble lo sses

thro ugh bad de bt s .

I fan y b ills are under disc o un t a t th e da t e of th e Balan c e

S h ee t th e au di t or s h o uld require a list of s uch b ills and
, ,

h e s h ould c o m pare this lis t with th e en t ries in th e Bills

R e c eiv able Boo k Th e t o t al a m o un t of th e b ills under
.

disc o un t S ho uld appear as a c ont in g en t lia b ili ty b eing ,

S h o wn by w a y of a n o t e u pon th e Balan c e S h ee t E n quiry .

s h o uld b e m ade a s to wh e th er an y of th e b ills that h av e

be c o m e du e s inc e th e da t e of th e Balan c e S hee t h av e b een
di sh ono ured and as t o th e reserv e nec essary t o p ro vide
,

for an y an ti c ip at ed bad de bt s .

S to ck in Trade
- - S t o ck in trade is a oa t ing asse t th a t
.
- -
84 THE PR I N C I PL ES OF AU D ITI N G

p urchased wi th a vi ew t o re sale as h ops but for th e -

,

p urpose of bre win g b eer Th e posit io n th erefo re is th a t

.
, , ,

th ese h ops h a v e b een p ur ch ased in one y ear bu t will no t ,

b e u sed un t il th e follo wing y e ar ; th erefore in order t o ,

asc ert ain th e tru e p rot or 10 5 5 upon th e ne x t y ear s bre w

th at a cc o un t mus t b e charg ed with th e a ctual c os t of th e

m at erials used wh e th er th e sa m e w ere p ur ch ased in th e
,

pre vio u s y ear or not Th erefore th ese h ops m ay b e t ak en

.
,

int o s t o ck a t c os t for supposing th a t aft er th e b re w ery

,

h ad p urch ased it s h ops th e m ark e t pri c e of hops fell it ,

would m ean n ot tha t th e b re wery h av e m a de a loss but

, ,

th a t if th e y h ad wait ed and p ur ch ased a t th e s ub se qu en t

lo wer p ric es th e y would h a v e m ade a larg er prot o ut of
,

th e nex t y ear s b re w wh i ch is qui t e ano th er m att er ;

,

therefore th e n ex t y e ar mu st b e ch ar g ed with th e a ctu al

,

c ost of th e m at erials c ons um ed so th at th at y ear s Bre wing

,

A cc o un t m ay S ho w th e a ctu al gross prot or loss th ereon .

Ra w m at erials are no t h eld wi th a v ie w t o re sale in -

th eir ori ginal for m but are h eld for th e p urpose of m anu
,

fa cture and th erefore in ordinary c ases th e c os t p ric e is

, , ,

a fair b asis of v al ua t io n for s t o ckt akin g p urposes But if .

th ere has b een a h ea vy fall in th e m ark e t p ric e of ra w

m at erials wh i ch h as result ed or will resul t in a fall in th e
,

pri c es o bt ainab le for th e m anu fa ctured g oods th e n th e ,

ra w m at erials s h o uld b e wri tt en do wn so th a t th e p ro b a b le ,

loss o wing t o th e b ad buyin g is an t i c ipa t ed and th e

, , ,

m a t erials are ch arg ed on t o th e ens uin g y ear a t a pri c e

th a t will enab le tha t y ear t o m anu fa cture a t a fair

In th e c a se of unnis h ed and c o m ple t ely m anufa ctured

g oods th e b asis of v alua t ion s h o uld b e th e c os t of th e ra w
,

m a t erials and d ire ct m an u fa cturing l ab o ur c ons um ed on

,

th e m t o th e da t e of th e Balan c e S h ee t S o m e t im es th ere .

is added t o this a pe rc ent ag e t o c o v er es t ab lis hm en t

ch arg es such a s th e wag es of fore m en s t ore k eepers ,
-
,

y ardm en and m ec h ani c s ; f uel po wer h ea t in g light in g

, , , , ,

deprec ia t ion of plan t e tc and t o a reasona ble ext ent t h is

, .
,
 VAL UATI O N AN D VER I FI C ATI O N OF A S S ET S 85

is perm issible Ho w e v er ea ch case mu s t b e c o nsidered on

.
,

it s o wn m eri t s and for s t ocktakin g p urpos es th e per c ent ag e

,

added t o c o ver es t a b lis hm ent ch arg es s h o uld be kep t as

lo w as possible and S hould c ov er work s expenses only
, ,

and no t a dm inist rat ion expenses s uch as direct o rs fees ,

de benture in t eres t s t a ff salaries t rav ellers salaries

, ,

c o mmission and expenses O f ce ren t rat es and t ax es e tc

, , , .

I t is true th a t th ese la tt er expenses S h o uld b e t ak en in t o

acc o un t for c ost a cc o un t p urp o ses but th e y S ho uld no t b e ,

a dde d f or s t o ckta k ing p urpo ses U nder no c ir cum s t an c es

.
,

how e v er m a y part ly or co mple t ely m an ufactured s t ock

,

be valu ed at a gur e a b o v e th at at whi ch sim ilar g oo ds c an

be p ur ch ased for in th e c ase of newly s t art ed wo rk s i t
, ,
-
,

is so m e t im es fo und that th e a ctual c os t of m an ufacture

e xc eeds th e sellin g p ri c e an d in such c ir cum st an c es of
,
'
,

c o urse th e c ost pri c e c ould no t be adop t ed for Balan c e

,

S h eet p urposes .

Th e a u di t or s posit ion as reg ards s t o ck in trade is one - -

of v ery g rea t diicult for th e a m u n t s in v l v ed oft en

y o , o

are v ery c onside ra ble an d m a t erially affect b oth th e Prot

and L o ss A cc o un t and th e Balan c e S hee t an d th e fraudu ,

len t falsic at ion of acc o un t s is m o st frequ ent ly eected

by m eans of th e st o ck But it is im possib le for th e au di t or
.

him self t o t ak e in spe ct or valu e th e s t oc k and unles s

, , ,

s t o ck b oo k s h a ve b een kep t th e b oo ks of a cc oun t do no t

,

dis c lose wha t s t o ck s h o uld b e in h and at th e da t e of th e

Bal an c e S h ee t . Furth e r th ere is no c ert ain m eans by
,

whi ch h e c an v e rify th e ex is t en c e o f this asset as in th e ,

c ase of such asse t s as c as h in hand b an k b alan c es in v es t , ,

m en t s fr ee h old and lea se h old propert ies e tc I n fact

, , .
,

th e au di t or h as less c on trol o v er this asse t th an h e h as

p ra ct ic all y o v er an y of th e o th e r a sse t s of a business and ,

h e is bo und t o rely v e ry larg ely u pon th e in t ernal ch ecks

in this c onne ct ion and upon th e c ert ic at es gi v en by th e
,

m an ag e m en t in fact th e s t ock p resen t s one of a n au di t o r s

,

grea t est dif cul t ies .

Th e prin c ipal e rro rs tha t h a v e t o be gu arded ag ains t all ,

86 THE PR I NCI PL ES OF AU DI TI N G

of which m ay be p urposely or unin t ent ionally c o mm i tt ed ,

are as follo ws
I n c o rre ct addit ions and c al cula t ions .

I n c o rre ct pri c es and v alu a t i o ns .

Th e in c lu sion of g o o ds in s t o ck th e in v oic es for wh i ch

,

ha v e no t b e en pa ssed through th e p urch ases .

Th e in c l usion of g oods in s t o ck th at h a v e already

b een sold a nd en t ere d as sales prior t o th e dat e of the
,

Bal an ce S h ee t .

Th e o m is sion of s t o ck in th e h ands of a g ent s a t do ck s , ,

in w are hou se e tc , .

Th e in clu sion of plan t t ools furni tu re e tc in s t o ck

, , , .
, ,

whi ch h av e already b een de b it ed t o a n asse t a cc o un t .

Th e o mission t o p ro vide for deprec iat ion in th e c ase of

da m ag ed out of fa s hion or o b sole t e st o ck
, , .

I f p roper st o ck a cc o un t s h av e b een k ep t th ese w ill b e ,

o fgrea t a ssist an c e t o th e a u di t or f or th e p urpo se o fch e ck in g

th e s t ock and any l arg e di ffe ren c es b e twe en th e qu an t i t ies

,

S h o wn by th e s t ock b o o k s a nd th e s t o ck s h ee t s S h o uld b e

m os t c arefull y in v es t ig a t ed .

Before c o mm en c in g th e a ctu al ch e ckin g th e a u di t o r ,

S h o uld c arefull y en qu ir e in t o th e wh ole s y s t em of t a k in g ,

en t e ring pri c ing and ch e ck in g s t o ck and nd o ut th e

, ,

exact b asis up o n whi ch i t h as b een v alu ed AS m an y .

persons as pos si ble s h o uld b e en g ag ed up on th e s t o ck

t ak ing and ea ch s t ep s h o uld b e ind ependent ly ch e ck ed
, .

Furth e r responsible of c i als s ho uld supervise th e work

, ,

as j uniors oft en h av e quit e e rrone ous ide a s c on c e rning

wh a t is ri ght ly in c lu d ed in s t o ck and th e p rin c iples ,

g o v e rn in g it s v aluat ion E a ch person wh o t ak es par t in

.

th e s t o ckt ak ing S h o uld ini t ial th e S h ee t s for wh a t h e h as

done and a re sponsible oicial S irch as a m anaging direct or
, ,

o r part ne r S h ould g iv e an o v er riding c e rt i c at e t o th e

,
-

e ffe ct th a t th e st o ck h as b een c orre ct ly t ak en is v alu ed ,

in all c ases a t c o s t o r under and th a t th e t o t al of th e s t o ck

,

rep resen t s a fair and p roper v alu at ion of this a sse t .

I n th e c ase of a m an ufa ctu ring bu siness th e a u di t or ,

88 THE PR I N C I PL ES OF AU DITI N G

s t o ck h as b een in h and for lon g periods and m a y thu s ,

b e o ut of da t e or o b solet e .

I n th e c ase of ra w m at erials and p ur ch ased g oods ,

c o m p are p ric es with re c en t inv oic e and m ar k e t p ri c es .

E xa m ine th e Goods I nw ards Boo k for th e las t fe w

wee k s of th e period and t ra c e all larg e i t e m s in t o S t o ck
,

and int o Bo ught Day Boo k .

Tra c e an y larg e s ales t o wards th e end of th e peri o d

int o th e Goods O utwards Boo k and if an y of th ese s ales ,

did no t lea v e th e w ork s un t il aft er th e da t e of th e

Balan c e S h ee t see th a t th ese g oods h a v e no t b een
,

inclu ded in s t o ck .

I n th e c ase of part l y and c o m ple t ely m an u fa ctured

g oods t est th e s am e w ith th e C os t Boo k re c ords and
, ,

see th a t an y addit ions f or es t a b lis hm en t ch arg es are

reasona b le I f th ere are no Cos t Boo k s see th a t full

.
,

p art i culars are g iven as t o h o w th e gures are arri ved a t ,

and that th ese are c ert ied by a pro m inen t oicial

.

Tes t th ese i t e m s as far as possi ble wi th an y a vaila ble

e viden c e .

I f S t o ck Boo k s ar e k ep t ch e ck th e qu an t i t ies wi th
,

th e S t o ck Boo k b alan c es c are full y en quirin g in t o an y

,

i mport ant differen c es .

I n so m e b u sinesses th e qu ant i t ies in s t o ck c an be

Ch e ck ed easily as for exa m pl e in th e c ase of a c oal
, , ,

m erch ant th e Bought and S al es Day Boo k s s h o uld be

,

ruled wi th qu an t i ty c olum ns and thu s th e t o t al t onn ag e ,

sold during th e peri o d deduct ed fro m th e t onnag e in

,

s t o ck a t th e c o mm en c e m en t plu s th e t onn ag e p urch ased

, ,

s h ould g iv e th e qu ant ity in st o ck a t th e end of th e pe riod .

Th ere will be alwa ys s m all di fferen c es o win g t o wa st e .

E n quiry sh ould b e m a de a s t o wh e th er th ere are any

g oods in th e h ands of ag en t s a t th e do ck s or wareh ou se , , ,

e tc th at m ay h av e b een o m itt ed fro m th e st o ck S h ee t s

.
, .

Wh en e x am ining th e s t o ck S hee t s i t S hould b e seen

th at no plan t t ools furniture e tc are in clu ded
, , ,
.
,
.

Wh en th e Trading A cc o unt is c o m ple t ed th e au dit or ,

 VAL UATI O N AN D VER I FI CATI O N T
O F AS S E S 89

S h o uld c o m pare the perc en t ag e of gross p rot t o sales

wi th th a t of p reviou s y ears and if th ere are any m ar k ed
,

uctu a t ions en qu ire int o th e reasons S uch uctua t ions

, .

in th e pe rc en t ages m ay b e a cc o un t ed for by varia ti o ns in

pri c es o fsales p ur ch ases or wag es t o exc ep t ional c on t ra ct s
, , ,

or t o im p ro v ed p roduction but if th e a u d it or is no t sa t ised

,

th at th e uctua t ion is ca used by one or o th er of th ese

c ir cum s t an c es i t mu s t b e th at th e openin g or c losin g s t ock
,

is in c orre ct or th a t th e openin g and closin g s t o cks h av e

,

b een t a k en upon a di fferen t b asis Th is perc en t ag e t est .

is of v ery grea t v alu e but it c anno t b e applied in all c ases

, ,

a s in so m e bu sinesses th ere is no c ons t an t pe rc en t ag e of

gross protth e gross prot m ade on th e indiv idu al

t rans act ions v ary in g c onsidera bly .

Th e fo re g oin g are t es t s th at m a y b e applied t o th e

s t o ck in t rade but an au dit or c an nev er b e a b solu t ely
- -
,

c ert ain tha t this it e m is c orre ct and h e is b o und t o depend

,

t o a c onsidera ble exten t upon th e c erti c at e of th e m ana g e

m en t But h e mu s t exerc ise reasona ble c are and S k ill in
.

order t o sa t isfy h im self tha t th e s t oc k h as b een c orre ct ly

t ak en and v alued and th erefo re h e m u s t m a k e exh au s t iv e
, , ,

en quiries and t est th e s t o ck S h ee t s as far as h e c an in th e

c ir cum s t an c es of th e p art icular c ase and if h e is no t ,

c o m ple t ely sat ised h e S hould wi th o ut fail deal with

, , ,

th e m att er in h is au dit report .

Th e leg al responsi b ili ty of a u di t ors as reg ards s t o ck in -

trade is a ques t ion of c onsiderable im port an c e and is ,

de al t wi th la t er in C h ap t er X I n th e m eant im e i t S ho uld
.
,

no t b e thought th a t i t is sugg ested tha t an au dit or m u st

apply all th e ab o v e t es t s in e v ery c a se but that r eali sing , ,

what an im po rt an t b earin g th e v al ua t ion of s t ock h as

u p o n th e a cc o un t s h o w eas y i t is t o falsify th e a c cou n t s
,

through th e s t o ck and h o w difcul t i t is for th e au di t or

,

to v e ri fy this i t e m i t is m o st ad visa b le th a t an a u di t or
,

S h ould pa y p art icular a tt en t ion t o this asse t and end eav our ,

t o v erify i t as far as be possi bly c an within reason and ,

th at h e S ho uld no t res t c on t en t wi th c o mpl ying with wh at

90 THE PR INCIPL ES OF AU DI TI N G

m ay appe ar t o be th e s t ri ct leg al re quire m en t s in th is

dire ct ion .

Goods on C onsignm en t This asse t s h ould b e v ery

.

c arefu lly v eried and it S h ould b e seen th a t p rop er a cc oun t s

,

are k ep t wi th refe ren c e t o e a ch c onsig n m en t th a t is t o say , ,

th a t in ea ch c ase th e re S hould b e a C onsi gnm en t A cc o u n t

and a Person al A ccou n t wi th th e a g ent th e form e r b ein g
,

p ra ct ic ally a Trading A cc oun t s h ow ing th e p ro t or 10 5 5

upon th e part icular c onsign m en t and th e la tt e r c o m prisi ng
,

a m o un t s du e t o or by th e a g en t.

Th e dupli c at es of th e de b i t no t es s h ould b e c o m pared

with th e C onsi gnm en t A cc ou n t so as t o ensur e th a t th e
,

g oods h av e b een de b it ed a t c os t pri c e Th e a cc o un t s .

sales re c eiv ed fro m th e a g en t s h ould b e ch e ck ed t o see ,

th a t th e gross s ales h av e b een c redit ed t o th e C o nsig n m en t

A cc o u n t and de b it ed t o th e ag en t and th a t th e ag en t s

e xpenses a nd c o mm is sion h av e b een de b it ed to th e

C onsign m en t A cc oun t and c redi t ed t o th e ag en t s a cc o un t

.

I f a t th e dat e o f th e Balan c e S h ee t th e wh ole of th e

g o o ds h av e not b e en sold th e ag en t s h o uld send c ert ied
,

st o ck S h ee t s s h owing th e g oods in hand a t th a t dat e and ,

th e audit o r s h o uld c arefully e x am ine th ese s t ock s h ee t s .

Th e s t ock s h o uld b e valu ed a t c os t p ri c e plu s freight and

,

ch arg es full allo wan c e h o we v er b ein g m ade for depre

, , ,

cia tion if g oods h a v e de t e rio ra t ed o r b een dam ag ed Th e .

s t ock valua t ion will b e b rought do wn as a de b i t b ala n c e

upon th e C onsign m en t A cc oun t a nd if a loss h as b een
,

in curred up on th e g oo ds sold t o da t e i t mu s t b e writt en

,

Of f t o Prot an d L O S S A cc o un t and mu s t on no a cc oun t

,

be bro ught do wn in th e b alan c e up o n th e C o n si gn m en t

A cc o u n t Th e gure in th e Bala n c e S h ee t S h ould represen t
.

only th e s t o ck in h and at a fa ir v alu at ion .

I f th e C onsi gn m en t A cc o un t s h a v e no t b een k ep t as
sugg est ed a b o v e th ese t ransact i ons will re qu ire v ery
,

c areful sc rut in y espe c i ally in order t o see th at no p rot

,

h as b een an t ic ipa t ed in respe ct of g oods sen t to a gen t s ,

but no t y et sold th at an y losses t o da t e up on g oods s old

92 THE PR I N C IPL ES OF AUD ITI N G

In th e Balanc e S h ee t th e work in p ro gress sh o uld be

,

s h o wn as a separat e it e m and an y c as h re c eiv ed on a cc o un t

,

th ereof s h o uld b e deduct ed .

I n pra ct ic e pr o t is so m e t i m es an t ic ipa t ed and alth o ugh

, , ,

th eore t ic all y this is no t c orre ct i t is a well kno wn cu st o m

, ,
-

wh i ch in proper c ircum s t an c es an au dit or m ay pass .

Th is p ract i c e is c o m m only adop t ed in th e c ase of lar g e

c on t ract o rs where th e indi vidu al c on t ra ct s oft en ext end
,

o v er periods of so m e y ears I f th erefore th e y onl y t oo k . , ,

credit for th e p rot s wh en th e c on t ra ct s w ere c o m plet ed ,

th e res ul t s S ho wn by th e g eneral Prot and L O S S A cc o un t

wo uld v ary v ery c onsidera bly fro m y ear t o y ear for in ,

o ne y ear a n umb er of p ro t a b le c on t ra ct s mi ght r u n o ut ,

wi th th e result th a t th e Prot and L oss A cc o un t w o uld

S h ow a lar g e pro t but in ano th er y ear though th ere
, ,

might be se veral larg e and p rot a ble c on tra ct s running ,

and in respect of whi ch c onsider a ble s um s of c as h h a ve

b een rec eiv ed on a cc o un t y e t v ery fe w c on t ra ct s might
,

h a v e b een a ctu ally c o m ple t ed durin g th e period and , ,

th erefo re o win g t o th e Pro t and L O S S A cc o un t h av ing t o

,

b e ar c onsidera ble s t an din g ch arg es th e a cc o un t s might ,

S h o w a 10 5 5 Th erefo re t o a v e rage th e result s prot s are

.
, ,

a n t ic ipa t ed But wh ere this is d one v ery gre at c are

.
, ,

mu st b e e x erc ised in es t im a t in g such prot and a m ple ,

res erv es mu s t b e m ade for c on t in g en c ies for i t mus t be ,

b orne in m ind that a c on t ra ct m a y b e pro gressing norm ally ,

and presen t gures indic at e th at a c onsidera ble prot will

b e earned but so m e unforeseen c on t in g en cy m a y arise
, ,

such as a s t rik e c ollapse of part of th e w ork s rise in th e

, ,

pri c e of raw m at e rial s o o ding in th e c ase of th e buildi ng

,

of a tu nnel failure t o c o m ple t e in th e c ont ra ct t i m e and

,

th e re by in curr in g h e avy nes and m an y o th er s uch ,

c ir cum s t an c es whi ch m a y result in th e c ont ra ct e v en tu all y

,

S h o win g a c onsid era b le los s .

Prot s s h o uld b e ant i c ip at ed only wh en th e c on t ra ct is

so far adv an c ed tha t th e c ost t o c o m ple t e c an fairly be
es t im a t ed and thu s th e p ro b a ble e ventu al prot arri v ed
,
 VAL UATI O N AN D VER I FICATI O N OF A S S ETS 93

at Th erefore all c on t ra ct s tha t are in an early s t ag e

.
,

should be in vari ably v alu ed at c o st W h en th e res ul t s of .

th e c on tra ct can b e reason ably est im at ed a h e avy reserv e ,

S h ould b e deduct ed f or c o n t in g en c ies ; for e x am ple th e ,

propo rt ion of th e nal p rot a cc ordin g t o th e work com ,

p le ted t o da t e sh o uld
, b e c a lc u la t ed and a b out on e third ,
-

of such p rot S ho uld be reserved th e re m aining tw o thir ds ,

-

o nl y being t ak en c re di t for A noth er m os t im port ant .

po in t is as t o wh e the r th e c as h re c eived under th e c on tr act

,

has b een suicient t o warran t th e an t i c ipat io n of p rot ,

for if for ex am ple th e c as h re c ei ved is less th an th e a ctual

, ,

expen di ture u po n th e wor k t o da t e and th ere is no c as h ,

paya ble in th e M edia t e fut ure th en if a p rot is ant i ,

cipated u pon th e s tren gth of whi ch div id en ds are paid

,

to s h are holders or p rot s paid o ut t o part ners

, th e ,

result of such pa ym en t of dividend or prot mu s t b e tha t ,

th e working c apit al of th e c onc ern is reduc ed by reason of

this an t ic ipa t ion and wi th drawal of p rot s tha t h av e no t
been in fact rec eiv ed in c as h Th e refore th e c as h
, , . ,

posit ion S h ould b e c onsidered m os t c arefully in all c ases ,

an d in a s m all bu siness h a ving onl y a s m all workin g

,

c apit al it is a v ery unso und p olicy t o an t ic ip at e p rot

,

upo n un c o m plet ed c on tract s at all as th e res ul t m ay b e ,

th at th e working capit al is reduc ed and a s erio u s n an c ial ,

posit ion thus creat ed th e re no t b ein g suicien t funds in

,

h and t o c o mple t e th e c on tr act s L arg e c on tr act s r equ ire .

v ery c areful nan c ing and th erefore this p o in t s hould

, , ,

ne v er be los t sight of .

Th e au di t o r S h o uld g o in t o th e wh ole qu es t i o n o f wo rk
in pro gress m ost c arefull y c o mparing th e Balan c e S hee t
,

gur es wi th th e Cos t Boo ks I f p roper Cos t Boo ks h a ve

.

been k ep t th ese will b e of grea t as sist an c e espec ially if

, ,

they h a v e b een sub j e ct t o an eicient in t ernal ch e ck as in ,

such c ase the y will aff ord a v ery valua ble ch eck u pon th e
work in p ro gress I f ho w e v er th ere are no relia ble C ost
.
, ,
.

Boo ks th e au di t or S ho uld insis t u pon full p art i culars

,

b eing in clu ded upon th e work in pro gress s h ee t s S howing ,

94 THE PR I N C I PL ES OF AU DITI N G

exa ct ly h o w th e re sul t s h a ve b een a rri ved a t and th ese ,

h e S h ould ch e ck as far as pos sibl e with wh at e v er e viden c e

th ere is a v aila ble .

Th e au di t or s h o uld ch e ck th e c as t ing s and t est th e

c alculat ions of th e S h ee t s see th a t th e latt er h av e b een
,

init ialled by all wh o hav e t a ken part in th eir p rep ara t ion ,

and tha t th e work in p rogress is c ert i ed as a wh ole by a

re sponsib le of c ial Th e au dit or S h ould c arefully enquire
.

in t o th e wh ole sy st e m for v alu ing t h is i t e m in th e Bala n c e

S h ee t and th e b asis upon whi ch such v alu a t io n h as b een
,

m ade He s h o uld c arefully en quire in t o an y o n c os t

.

added I f prot is an t ic ipat ed h e s ho uld in vest ig at e th e

.
,

gures m os t thoroughl y and in th is c ase h e S h o uld insis t

,

that th e a cc ou n t s s h ould disc lose th e fa ct tha t th e wo rk

in p ro gress in clu des an t ic ipat ed prot ; if th e y do no t ,

h e S h ould poin t o ut this im port an t fa ct in h is au dit report .

Th e au di t o r is b o u nd t o b e v ery much in th e h ands of

th e m anag e m en t when dealin g wi th this ass et but h e ,

S h o u ld endea v o u r t o ch e ck and t es t th e gures as f ar as

h e reasonab ly can and if h e is no t a b solut ely sa t ised

, ,

h e S h ould report t o th a t e ffe ct t o th e s hare h olders or

part ners a s th e c ase m a y b e I f th e wo rk in pro gress has
, .

b een falsied delib erat ely by sa y th e m anag in g dire ct or

, , ,

in all p ro b a b ility i t will b e im p ossible in th e ordinary ,

c ourse of an au dit t o dis c o v er th e wh ole ex t en t of this

,

frau d but c a reful and in t ellig ent in v es t ig a t ion m a y b e

,

suicient t o lead th e a u dit or t o th e c o n c lu sio n th a t th e

v alu at ion of th is asse t is u nsa t isfa ct ory a nd tha t th e ,

resul t s are no t reasona ble and if th erefore h e report s t o

, , ,

this e ffe ct th e s hare h olders in th e c ase of a c o m p an y

, , ,

m ay th ereupon inst itut e a much fuller in ves t ig at ion wh ich ,

m a y resul t in th e t ru e fa ct s b ein g as c ert ained .

Plan t an d Ma ch inery Plan t a nd m a ch in ery is no t

.

v alued upon th e b asis of it s realisab le value but upon th e ,

b asis of it s v alu e t o th e par t icular business as a g oin g

c on c ern ; in o th er w ords th e v alu e is b as ed upon i t s
,

earning c ap ac ity and no t up o n it s in t rinsi c v alu e

, .
96 THE PRI N C I PLES OF AUD ITI N G

plan indeed t o h a v e plan t re v alu ed o cc asionall y in o rder

-
,

th a t th e am o un t s of depre c ia t ion wri tt en o ff m a y thu s b e

ro ughl y Ch e ck ed . For it mus t b e b orne in m ind th a t i t is
qu it e im possib le t o x with a b sol ut e c ert ain ty th e peri o d
, ,

o f th e w ork in g life of plan t m a chinery and S im ilar asse t s

, , .

Th e v eri c a t ion o f this asse t by th e a udit or is a m att er

of so m e dif culty ; in fact i t is im possible t o v erif y th is
,

i t e m with an y degree of c ert ain ty as is th e c a se wi th so m e ,

of th e o th er asse t s Upon th e p ur chase of th e indi vidual

.

it e m s th e au di t or will vo uch th e pa ym en t s in th e o rdin ary

,

wa y wi th in voic es re c eip t s e tc and all addi t ions durin g

, , .
,

th e period of th e a cc o un t s s h ould b e thu s v o uch ed c areful ,

en quiry b eing m ade t o see tha t such it e m s do in fa ct , ,

represen t bond de addit ions t o c apit al R epla c e m ent s .

also mu s t b e c arefully en quired in t o wi th a vie w t o ascer ,

t ainin g th a t the O ld asse t h as b een ent irely wri tt en out of

th e Plant A cc o un t b efore th e ne w asse t is de b it ed in its
plac e.

Th ere s h o uld b e a plan t re g is t er or a s ch edule of th e ,

plan t and m a ch inery c ert ied by th e eng ineer and if S O , , ,

this s h o uld b e c alled for by th e au dit or I f possib le .

,

th e au dit or s h ould as k t o b e S ho wn ro und th e work s wh en ,

h e c an ro ug hly c o un t th e larg e i t e m s such as b oilers , ,

la th es etc and thu s v erify th eir exis t en c e an d th a t th e

, .
, ,

plan t and m achinery appears t o b e in workin g o rder .

I n th e case of plant and m a chinery ab road th e au dit or ,

S h o uld re qu ire th a t th e lo c al en g ineer S h o uld f urnis h a

report upon th e plan t as a t th e da t e of each Balan c e

S h ee t report ing as t o wh e th er th e sam e is in a proper
,

s t a t e of working eiciency and also as t o th e ade qua cy of

,

th e pro v isions for deprec ia t ion .

Th e au di t or S h o uld dis cu ss th e wh ole qu es t ion of depre

ciation full y wi th th e m a n ag e m en t and thu s endea vo ur ,

t o asc ert ain th e b asis upon whi ch th e y h a v e b ased th eir

est ima t es and pro visions and wh e th er th e y h a ve a ct ed
,

upon proper advi c e I t is im possi ble for an au di t or t o

.

v alu e or es t im a t e th e w or king life of plan t ; all h e c an do

 VAL U ATI O N AN D VER I FI C ATI O N OF AS S ETS 97

is t o m ake en qu iry and thus satiS IyZhim self wh e th er or

no t this m os t im port an t qu est ion h as b een p roperly fac ed
and c onsidered tha t c orrect prin c iples ha v e b een a ct ed
,

u pon an d tha t th e p ro vision made in th e a cc o un t s appears

,
z

t o be rea sona b le and suicient I t is oft en fo und th a t th e .

pro visio ns for deprec ia t ion h av e been xed hap h az ard ,

and wi tho ut reg ard t o an y of th e c onsiderat ions and

prin ciples g o verning th e ques t ion and in such c ases and , , ,

wh en th e au di t or is no t sa t ised tha t th e depre c ia tion is

s uf c ien t h e S h ould poin t t h is o ut clearly in his report
, .

Th e wh ole qu es tion of dep rec ia t ion w ill be c onsidered

at length in C hap t er V I but th e foreg o ing will per h aps ,

b e suicient t o indi ca t e th e lines u pon which an au dit o r

sh o uld deal with this asse t in a Balan c e S hee t .

L oose Tools Etc A s th e working liv es of th e v ario us

, .

it em s c o m ing under this h ead in m an y cases are v ery , ,

sh ort and repla c e m en t s rene wals and addi t ions are

, ,

c onst an tly ha ving t o be m ade th e only really sa t isfa ct ory ,

wa y t o deal With this asse t is t o m ak e a re val ua tion ea ch -

y ear in which c ase this it em is deal t with in th e sa m e

,

way as s t ock in trade th e au dit or exa minin g th e c ertied

- -
,

valua t ions and ch ecking and t es t ing th e sa m e as far as

,

possible .

Furniture Fixtures and Fittings Furni ture S hould be

, .

deal t wi th as in th e c ase of plant and m a chinery and an ,

ad a j ua te deprecia t io n s h o uld b e wri tten o f f b ased up o n ,

th e working life Th e dep rec ia t ion of s uch as sa fes des ks

.
, ,

ta bles e tc is v ery s m all and such asse t s al way s h av e a

, .
, ,

fair realisa ble val ue but x tures and tt ing s such as , ,

parti t ions b o oksh el v es electric wiring and tt ing s h a ve

, , ,

p ract ic ally no realisa ble valu e but m ay be writt en o ,

a cc ordin g to th eir es t im at ed li v es ex c ep t in th e c ase of ,

xtur es and tt ing s u pon lease h old p re m ises in whi ch c ase ,

th e wh ole s hould be wri tt en off o v er th e peri o d of th e

lease .

Horses Horses S h o uld be re v alued ea ch y ear th e

.
-
,

c ert i ed val uat io n being p roduc ed t o th e au dit or or th e ,

7
98 THE P RI N C I PL E S O F AUD I TIN G

a v erag e w or king life of a h orse s h ould b e es t im a t ed which , ,

for exam ple in th e c ase of c art h orses wor king in a c it y

,

is g enerally re ck oned t o b e a b o ut v e or six y ears A .

Horse R eg ist er s ho uld th en b e k ep t in whi ch ea ch h orse ,

is en t ered wh en p ur ch ased full part iculars as t o age , ,

desc rip t ion and c os t b ein g g iv en ; ea ch y ear th e v alu e of

ea ch h orse s h o uld b e reduc ed by sa y) on e six th of th e ( -

orig inal c os t pric e and in this wa y th e t o t al deprec ia t ion

,

is arri v ed a t U pon dea th or sale aft er c redi t in g in th e

. ,

re gis t er an y a m oun t realised upon th e sale of th e c ar c ase

or li v e anim al an y res ultin g de b it b alan c e s ho uld b e
,

wri tt en o ff as a loss I n th e e v en t of prot s b eing m ade

.

u pon s ales th ese s h o uld b e c redit ed ag ains t losses upon

,

death or sales Th e Horse R egis t er will s h o w th e de t ails

.

m aking up th e b alan c e upon th e Horse Acc o un t in th e

L edg er and s h o uld b e exa mined and c o m p ared th ere wi th
,

by th e au dit or wh o s ho uld als o see in th e light of a ctu al

, ,

experien c e wh e th er th e es t im a t ed wor king life appears t o

,

b e workin g out c orrect ly .

Carts and Van s Cart s and v ans s ho uld b e deal t wi th

.

in th e sam e wa y as plan t and ma chinery and o win g t o th e ,

ext en t t o wh ich th e w or kin g life m a y be ext ended by ,

m eans of repairs and rene wal of part s th e rat e of depre c ia ,

t ion m ay b e s m all But in th e c ase of m o t or v ans th e

.
,

depre c iat ion of th e eng ines is fairly rapid and as th e ,

init ial c os t is c onsidera ble th e m e th ods applied t o th ese

,

s hould b e c arefull y en quired in t o by th e au dit or .

Harn ess Harness s hould b e deal t wi th in th e sa m e

.

w ay as loose t ools and re valu ed and in pra ct ic e so m et im es

,
-
,

ea ch c o mple t e set of h arness is v alu ed ea ch year a t a

xed v alu e such xed a m o un t b ein g a lo w a v erag e v alu e
, ,

and ne w and old se t s are all v alu ed a t th e sam e a v erag e

gure Pro vided th e xed valu a t ion is lo w enough this
.
,

la tt er is a v ery sim ple and e ffe ct i v e w a y of dealin g wi th

th is asse t .

Freeh old , C o pyh old an d L ease h old La nd and Bu ildings .

Land s h o uld appear in a Balan c e S h ee t a t c os t p ric e and ,

1 00 THE P RIN C I PL E S O F AU DI TI N G

c anno t guaran t ee th at th e ti tle is g ood ; all h e c an do is

t o see th at th e deeds are in pos session and appe ar t o b e
in order ; if in do ubt upon an y poin t s h e sh o uld refer t o ,

th e c li en t s soli c it ors

.

I n th e c ase of c op yh old land th ere will b e no t i tle

,

deeds and th e au dit or s h o uld c all for th e c er t ied copy of

,

th e C o urt Roll of th e L ord o f th e Manor .

Lease hold property will be v eried by an inspe ction of

th e lease th e t erm s of whi ch s h o uld b e no t ed and th e
, ,

re c eip t s for th e las t paym en t of gro u nd ren t and th e

pre mi um s p aid under th e curren t re ins uran c e poli c ies
s h o uld b e c alled for in order t o as c er t ain th a t th ese are
,

no t in arrear .

I f property h as been m ortg ag ed th e t itle deeds will be

,

in th e possession of th e m ortg ag ees or th eir soli c i t ors and , ,

in th is c ase th e au dit or s h o uld appl y dir ect t o th e m for a

,

c erti c at e th at th ey h ol d th e deeds of th e part i cular

property as securi ty for th e adv an c e th e a m o u n t ofwhich ,

and th e dat e t o whi ch in t erest h as b een paid s h ould be

spec ie d .

L oans . I n th e c ase of adv an c es upon m ortg ag e th e ,

m ortg ag e and t it le deeds will b e inspect ed and i t s h o uld ,

be seen th at th e in t eres t h as b een paid t o dat e I f a .

v al ua t ion o f th e property w ere m ade at th e t im e of th e

advan c e such v alu a t ion s h ould b e inspe ct ed t o see th at
,

th e loan appears t o b e s ufc ien t ly se cured .

W ith o th er loans th e au dit or s h o uld inspe ct th e wri tt en

,

a cknowledgm en t of th e de bt and an y se curity th a t m ay

h av e b een lodg ed ; h e s h ould also see th at th e in t eres t is
regularl y paid and th a t a s ufc ien t reserv e is m ade for
,

b ad debt s I n th e c ase of a c o m pan y h e s ho uld see th at

.
,

th e art i c les g ive po w er t o m ak e advan c es and inspe ct ,

th e dire ct ors minut e auth orisin g th e sa m e I f dire ct ors .

hav e made adv an c es t o indi vidu al m e mb ers of the b oard ,

th e au dit or s hould insis t u po n s uch loans b eing s h o wn

separa t ely upon th e B alan c e Sh ee t ; if th e y are no t h e ,

sh o uld refer t o th e m a tt er in his a u di t report .

 VAL UATI O N A ND VER I FICATI O N OF A S S ETS 10 1

Paten ts Th e life of a pat en t is only fo urt een y ears

. ,

and th erefore th e c ost of a cqu irin g th e sa m e s h ould b e

, ,

wri tt en O ff o v er this period Th e c os t of all renew al fees .

s ho uld b e de b it ed dire ct t o Prot and L oss Acc o un t .

Th e audit or s h o uld c all for a list O f all th e pat en t s ,

gi ving part iculars of each pat ent th e reg ist ered n umb er , ,

da t es e tc and h e s hould inspe ct th e pa t en t it self and

, .
, ,

th e re c eip t for th e las t renew al fee t o see th at th e sam e

.
,

h as b een paid t o da t e .

Copyrights A c op yright las t s for th e lifet im e of th e

.

auth or and for a period of5 0 y ear s af t er h is dea th Th ere

,
.

are ex c ep t ions t o this and af t er th e auth or h as b een dead

,

for 25 y ears his w ork m ay b e reproduc ed on c ertain t erm s

,

whi ch are pres c ri b ed in th e C op yri ght Act Th e c os t of .

p ub li c a tion c anno t h o w e v er b e w ri tt en offo v er th e w h ole

, ,

of th is period as in th e m ajori ty of c ases th e valu e expires

,

long b efore th e end of th e t im e Th e onl y pra cti c al .

m e th od th erefore is for th e C op yright s t o b e re v al u ed

, ,
-

ea ch y ear .

Th ere is no docum en t of t it le in this c ase proof ofrs t ,

public a t ion c onst i tut in g a c op yright Th e au dit or s h o uld .

inspe ct th e v al ua t ions and see th a t t his asse t appears t o

,

b e t ak en a t a fair v alu e .

Goodwill G oodwill sh o uld not appear as an asse t in a

.

Balan c e Sh ee t ex c ep t in th e c ase of p ur ch ase wh en i t

, ,

sh ould appear a t c os t pri c e I f th e pri c e paid for goodwill .

h as not b een xed spec i c ally th e a m o un t will b e th e ,

di fferen c e b e tween th e t o t al p ur ch ase pric e and th e asse t s

a t th e agr ee d v alua t ions less any liab ilit ies t ak en o v er ,

fro m th e v endors Goodwill s ho uld appear in th e Balan c e

.

S h eet as a separa t e it e m and s h o uld b e desc ri b ed as ,

being at c os t if that is th e Case , .

Qu es tions are oft en raised as t o wh e th er depre c iat ion

S h o uld b e wri tt en o ff this asse t and al th o ugh this is ,

undoubt e dly a v ery wise c o urse t o adop t i t c anno t b e ,

c onsidered t o be either fro m a leg al or fro m an?accountancy

,

po in t of Vie w c o mp ulsory Goodwill is a v ery pe culiar

, .
1 02 THE PR I N C I PL ES O F AUDI TI N G

asse t it is insep ara ble fro m th e bu siness and i t is unlik e ,

such asse t s as plan t and m a ch inery e tc in th a t it does , .

,

no t h a v e t o b e rene wed or repla c ed and i t is no t depre c iat ed

,

or w orn o ut in th e c o urse O f earnin g in c o m e .

Th e gu re a t which g oodwill appears in a Balan c e S h ee t

does no t p u rport t o S h o w i t s presen t v alu e but m erely th e ,

a m o un t th a t h as b een expended in it s a cquisit ion or in , ,

o th er w ords th e am ou n t of c apit al th a t h as b een in v est ed

,

in this part icular asse t .

Th e presen t v alu e of th e g ood will of a bu siness mu st

depend en t irely upon th e nan c ial posit ion a t da t e and th e ,

presen t earnin g c apa c ity and prospe ct s of th e c on c ern ,

and a p ur ch aser wo uld no t b e inu en c ed in th e leas t by

th e v alu e plac ed upon th is asse t in th e Balan c e S h ee t .

I f th e prot s are larg e and in c reasing and part thereof ,

is u sed t o wri t e do wn th e v alu e of th e goodwill it s v alu e ,

will in re ality b e in c reasin g wh ereas if th e prot s are

, ,

s m all or losses are b ein g in curred it will b e im possi ble

, ,

t o writ e do wn th e g oodw ill th e valu e of which in this

, ,

c ase w ould b e de c reasing Ag ain a bu siness th a t is doin g

, .
,

v ery b adly t o da y and wh ose g oodwill m ay no t b e w orth

-
,

an ything lik e th e original c os t pric e wh ich appears in th e

Balan c e S h ee t in th e future m a y b e c on v ert ed through
, ,

new m anag e m en t in t o a m os t o uris h in g c on c ern with a

, ,

v ery v alu able goo dwill .

Goodwill is a v er y in t an gi ble asse t and it is th erefore , , ,

a very so und poli cy t o writ e th e c os t do wn if prot s are

a v aila b le and in this w ay ensure th a t th e wh ole of th e
,

c apit al of th e bu siness is represen t ed by t an gible asset s ;

but this is a m a tt er en t irely for th e proprie t ors of th e
bu siness t o de c ide for th e m selv es and an au dit or c anno t
,

in t erfere th o ugh h e m a y gi v e ad vi c e if spe c ially ask ed t o

,

do so .

Th e au di t or s h o uld see exact ly h o w th e b alan c e u pon th e

G oodwill Acc o un t is m ade up and th at i t does represen t
,

th e a ctual c os t only no im proper i t e m s h avin g b een de b it ed

,

th ere t o He sh ould see th at i t is separat ely s t at ed in th e

.
 C HAPT ER VI

DE P RE C IAT I O N RE S ERVES AN D
,
S IN KIN G F UN D S
D ep r eciation
THE subj e ct of depre c iat ion is one of th e m ost im port an t ,

and at th e sa m e t i m e difcul t m a tt ers wi th whi ch an

,

a u dit or h as t o deal th erefore it is proposed t o dis cu ss this

,

qu es t ion h ere and t o point out so m e of th e im port an t

,

poin t s th at mu s t b e b orne in m ind by an au dit or B ut i t is .

im possib le in th e Spac e a v aila ble t o deal c o m plet el y with

th e wh ole of this subj e ct and all acc o un t an t s tu den t s are
,

s t rongly ad vised t o s tu dy it exh au st iv ely in all it s b earin g s ,

for it is tho ught th a t c onsidera bly m ore a tt en t ion will b e

paid t o this qu es t ion by th e c o mm er c ial world in th e future ,

th an h as b een th e c ase in th e pas t th erefore e v ery ,

a u dit or s h o uld b e well v ersed in all th e g o v ernin g prin c iples .

I n pract ic e th e t erm depre c iat ion is c o mm onl y u sed

,

in a v ery wide sense c o v erin g de c reases in th e v alu es of

,

asset s c au sed by o ut side uctu at ions in m ark e t v alu es ,

and also th e s h rin kag e in v alu e c a u sed by th e w earin g out

of an asse t o win g t o i t s u se in th e bu siness .

FL UCT UATI O N S IN THE MA R KET V AL U ES O F F I XE D A S S ET S .

Fl uctu a tions in th e v alu e ofxed asse t s are no t g enerally

pro vided for wh en preparin g th e a cc o u n t s of a business ,

for th ese uc tu at ions are c au sed by o ut side fa ct ors in no

w ay affe cting eith er th e earnin g c apac ity or th e actu al
re v en u e earning s of s uch asse t s F or exam ple in th e c ase
.
,

of land upon which a fa ct ory is buil t th e m ar k e t uctu a

,

t ions in th e v alu e of such land are properly disr eg arded ,

for this asse t is not in th e m ar k e t for sale but is h eld ,

m erel y for th e p urpose of pro viding th e spac e upon which

t o er ect th e buildin g s nec ess ary for th e p urposes of th e
bu siness Th e trading res ult s of th e c onc ern and th e
.
,

earning c apa c i ty of this asse t are th erefore in no w a y

, ,

1 04
 DEPRE I C ATI O N , R ES ER VES AND S IN KIN G F UN D S 1 05

a ffec t ed by such out side uctua tions in v alu e C o u se .

qu ent ly an asse t of this nature appears in th e Balan c e

,

S h ee t a t c os t so th a t in this w ay is s ho wn h o w much
,

O f th e original c apit al w as s unk in th e a cquisi t ion of t his

property .

I f xed asse t s such as in v es tm ent s are h eld and i t is

, , ,

an t ic ipat ed th at th e y will b e sold in c ourse o f t im e th en , ,

if m ar k e t v alu es appear t o h a v e fallen perm anen t l y and ,

th erefore it appears th at losses upon realisa t ion will be

,

in curred i t is wise t o h old b a ck part of th e prot s and

,

thu s pro vide a reserv e ag ainst this c ont ing en cy and ,

ensure th at th e ori ginal c apit al s unk in th e in v es tm en t s

is k ep t in t act .

FL U CTUATI O N S IN THE MAR KET V AL UES O F FL O ATIN G

A S S ET S
. I n th e c ase of dec reases in th e m ar k e t v alu es of
oat in g asset s such uctu at ions if of a t e m porary nature
, , ,

m ay b e disregarded but ifthis fall in m ark e t p ri c es is li k ely

,

t o be m ore or less per m anen t and t o a ffect selling pri c es , ,

so th a t i t appears unlik el y th a t th e g oods will b e sold a t

a prot th en as a trading loss appears t o b e in e vit a ble

, , ,

such s t o ck s h ould b e wri tt en do wn and th e loss thu s ,

an t ic ipat ed and b rought in t o th e y ear wh en th e b ad

,

pur ch ase was m ade .

DEPR EC I ATI O N O F W A S T IN G A S S ET S Th e deprec iat ion .

th at mu s t be pro vi ded for if a ccurat e a cc o unt s are t o be

,

prepared is th e s hrin k ag e in v alu e of asset s th a t is c a used

,

by and is th e result of u sin g s uch asse t s for th e p urp ose

, ,

or earnin g re v enu e I n this c ase th e s h rin k ag e in v alu e

.
,

is th e na tural and ine vi t a b le resul t of e m plo ying th e asse t

for th e p urpose of earnin g re v en u e For exa m ple in th e .
,

case of plan t and m achinery m anufa cturing th ere wi th ,

nec e ssaril y h as th e eect of gradu ally wearin g out th e

m achines S uch deprec ia tion does affect th e earning
.

ca pac i ty of th e asset and th e c orrect tradin g prot s are

,

no t as c ert ained unless a proper ch arg e is m ade for th e

m achin ery u sed Th erefore deprec iat ion s h ould be pro
.
,

v ided for in th e ca se o f al l w as t ing asse t s that is asse ts , ,

1 06 THE P RIN C I PL E S OF AU D ITIN G
th at are used up or exh aus t ed in th e c o urse of see king t o
earn in c o m e exa m ples b ein g building s plan t and
, ,

m ach inery fu rniture and xtures h orses c art s v ans and

, , , , ,

h arness leases pat ent s c op yri ght s etc

, , , , .

THE MAI N O BJ ECT O F PR O VI D IN G F O R DEPR ECIATI O N .

Th e m ain o b je ct of pro vidin g for th e depre c iation of wasti ng

asse t s is t o k eep th e c apit al in t a ct A s part of th e c api t al
.

of th e c on c ern h as b een in v es t ed in th e p ur ch ase of th ese

asset s which h av e a wor kin g life of only a li m i t ed period

, ,

th erefore wh en this w or kin g life c o m es t o an end and

, ,

th e earnin g c apac ity of th ese asse t s c eases th e y will ,

b ec o m e v alueless for th e p urp oses of th e bu siness and ,

th e ori ginal c apit al sun k in th eir acquisit ion will h av e

b een los t Hen c e in order t o k eep th e c apit al of a bu siness
.
,

in t a ct if an y part th ereof is in v est ed in th e p ur ch ase

,

of w as t in g asse t s in c o m e mus t b e h eld b a ck by m eans of

,

depre c ia t ion ch arg es t o Prot and L oss Acc o un t in order ,

t o rep lac e th e c apit al th at is b ein g los t by reason of th e

fa ct th a t i t is represen t ed by asse t s th a t are b ein g c onsum ed
or e xh au s t ed in th e c o urse of t radin g or see kin g t o earn
in c o m e For exam ple in th e c ase of a fa ct ory in order
.
, ,

t o pro duc e th e nis hed g oods th at are sold i t is ne c essary ,

t o u se ra w m at erials la b o ur and m a chinery and th e c os t

, ,

of th e m a ch iner y is j u s t as much a ch arg e ag ains t th e

prot s earned as are th e m at erials and w ag es I f t o .

m anu facture c ert ain goods one m ach ine alone was neces
sary and th a t m a chine w as p ur ch ased a t th e c o mm en c e
,
.

m en t of th e nanc ial y ear ofth e bu siness but th e w orking ,

life of th is m a chine w as one y ear onl y th en in this c ase , , ,

wh en c al culat in g th e prot or loss upon th e g oods m anufac

tured ag ains t th e sales th ere w o uld h a v e t o b e ch ar g ed
,

th e c os t of product ion which wo uld b e th e c os t of th e

,

m a t erials u sed th e w ages and th e c os t of th e m a ch ine

, ,

whi ch h ad b een u sed u p in th e c o urse of th e m an ufa cture .

Th e c ost ofth e m ach ine is j u s t as much part of th e c os t of

produc in g th e nis h ed g oods as th e m a t erials and wag es ,

for in order t o c on v er t th e ra w m at erials in t o th e salea ble

1 08 THE PR I N C I PL ES O F AU D ITI N G

inst alled as o th erw ise th e p arti cular bu siness will not b e

,

a ble t o c o m pe t e s ucc ess full y with it s ri v als and thu s k eep ,

i t s pla c e in th e m ark e t s Th erefore in xin g th e w ork in g

.
,

life this e v en tu ali ty s h o uld b e c onsidered and th e period

, ,

xed S h o uld b e th e period during whi ch i t is es t i m a t ed th a t

th e m achinery will b e su it able for th e p urposes of th e
par t i cular bu siness and will b e a b le t o m anufa cture th e
,

re quired s t andard of art icles in sufc ien t qu an t it ies and ,

a t a c os t th a t will ena ble th e bu siness t o h old its p lac e ,

and t o c o m pe t e succ essfully in th e m ark e t s Eluxion of .

t im e is a fact or in s uch c ases as leases wh ere a t th e end of ,

a xed period th e lease t er m inat es and all v alu e th erefore , , ,

c eases Th e a m o u n t paid for a lease is in e ffe ct th e

.
, ,

c apit alised v alu e of ren t paid in adv anc e and mu s t , ,

th erefore b e wri tt en O ff t o re v enu e o v er th e period of th e

,

lease as also mu st th e c os t o f an y bu ildin g s ere ct ed upon

,

lease hold land and an y im pro v e m en t s eected by th e

,

lessor .

E S TI MATI O N O F THE W O R KIN G L I FE O F PL ANT A N D

MAC HIN ER Y Th e dif c ulty in dealin g w ith th e qu est ion of
.

depre c iat ion of s uch asse t s as plan t and m a chiner y is th at

th e wor king life h as t o be est i m at ed and there is no c ert ain ,

w a y of arri vin g a t this period ; th erefore pas t experien c e ,

and expert and t e chnic al k no wledge are re quired wh en

de alin g wi th this poin t I n pra ct i c e i t is g enerall y fo u nd
. ,

th at th e c os t of all the plant and m achiner y is inc lu ded in

one a cc o un t in whi ch c ase i t is i m possi b le t o est i m a t e th e
,

deprec ia t ion a ccu rat ely for th e liv es of all th e v ario u s

,

Classes O f m a chinery etc in c lu ded under th e one h ead

, .
,

will b e di fferen t ; for exam ple b oilers and such lik e ,

h ea vy plan t m ay last for a numb er of years but fas t ,

runnin g m a ch ines m ay h a v e a V ery s h or t life onl y and ,

s uch a cc essories as b elt in g will h av e t o b e renew ed c on

stantly I n th e a b o v e c ir cum s t an c es th erefore th e x ing
.
, ,

of th e depre c ia t ion is a m ere m a tt er o f gu ess w or k th e -

,

a ccura cy of whi ch can only b e pro v ed or dispro v ed in th e

light of af t er years I f then as is v ery pro b a ble i t is
.
, , ,
 DEPRE CIATI O N , RE S ER ESV AN D S I N KI N G FU N D S 1 09

fo und s ub sequ en t ly th a t th e depre c ia tion h as bee n under

est im a t ed t h e e vil will h a v e b een done in th at prot s
, ,

will h a v e b een o vers t at ed and if furth er m ore s uch

, , ,

prot s h a v e b een with drawn part Of th e c apit al of th e

,

c onc ern will h a v e b een los t S uch c ir cum st an c es h a v e in

.

m any c ases b een th e chief c au se of b ank rup tcy as i t h as ,

been fo und im possib le t o repla c e th e c apit al th at h as

been los t owing t o th e inade qu at e pro vision for deprec iat ion .

PL ANT REG I S T ER Th e only really sa t isfact or y m e t h od

.

for dealin g with th e depre c iat ion of plan t and m a chinery

is to k eep a Spe c ial Plan t Re gist er in which a re c ord is
,

k ep t Of each m achine Th e wh ole Of th e plan t and

.

m achinery s h o uld b e spli t up in t o c lasses so th at onl y ,

it e m s wi th approxim at el y e qu al wor kin g liv es would b e

gro uped t o g eth er Full part iculars s ho uld b e en t ered in
.

c o nne ct ion with ea ch m ac h ine and a spec ial c olum n s h o uld

,

b e pro vided in whi ch s h o uld b e ent ered th e c ost Th e .

scrap v alu e and th e w or kin g life of ea ch s h o uld b e
est im at ed and en t ered in th e reg is t er and a numb er of ,

c olum ns s ho uld b e pro vided for th e annu al a m o un t s

writt en o ff for depre c iat ion whi ch s ho uld b e an e qu al
,

a m o un t each ye ar so th a t th e c os t less th e s c rap v alu e

,

'
is writt en O f f o v er th e es t im at ed period of th e asse t s
workin g life I n th e li ght of actu al experien c e th e se
.
,

es ti m at es s h o uld be c ons t an t ly re vised so th a t as far ,

as possible a b solut e a ccura cy is att ained At th e end .

o f ea ch n an c ial period s umm aries s h ould b e prepared

,

fro m th e reg ist ers s h o wing in t o t als as reg ards each Class
,

of m a chinery th e openin g b alan c e th e t o t al depre c iat ion

, ,

writt en o ff and th e c losin g b alan c e Th e Plant and

, .

Machinery Acc o unt s in th e Impersonal L edg er S h o uld b e

adj u st ed t o a gree with such s umm aries U pon th e sale .

of a m a chine th e a m o un t realised s h ould b e c re dit ed in

,

th e regis t er and any deb it b alan c e writt en o ff as a loss

,

upon sale .

Th e foreg oin g m eth od m ay appear t o be unduly c o m

plic at ed but on c e th e reg is t er h as b een writt en up it will
, ,
1 10 THE PR I NCI PL ES O F AU D ITI N G

b e ne c essary only t o k eep it u p t o da t e and this will no t ,

en t ail a grea t a m o un t O f la b o ur O n th e o th er h and it

.
,

will b e possib le t o deal with th e qu es t ion o f depre c iat ion ,

which so m at eriall y a ffe ct s th e acc o un t s wi th a degr ee of ,

a ccura cy whi ch o th erwise is quit e i mpossi ble ; and ,

furth er m os t v alu a ble pra ct ic al infor m a t ion as reg ards th e

,

v ario u s m ach ines can b e accumulat ed whi ch will b e of ,

v ery g reat assist an c e t o th e m anag e m en t .

C os t O f Maint enanc e and Main t enan c e R eserv es Th e .

c os t of m ain t enan c e s uch as rep airs and renew als of par t s

, ,

S h ould b e ch arg ed dire ct t o re v enu e and if th ese ch arg es ,

v ary c onsiderab ly fro m y ear t o y e ar it is a v ery g ood ,

plan t o c reat e a Main t enan c e Reser v e Acc o u n t so th a t ,

th e annu al ch arg e t o re v enu e m ay b e e qu al T o e ffe ct .

t his th e a v erag e annu al ch arg e u nder this h ead o v er a long

,

period of y ears s h o uld b e arriv ed a t or if such m at erial , ,

is no t a v aila b le exp ert advi c e s h o uld b e sought and th is

, ,

a v erag e a m o un t s h o uld b e de b it ed ea ch y ear t o Prot and

L oss Acc o u n t and c redit ed t o th e Main t enan c e R eserv e
,

Acc o un t As th e repairs t ak e pla c e th e c os t th ereof

. ,

s ho uld b e C h arg ed dire ct t o th e Maint enan c e R eserv e

Acc o un t and if th e es t i m at e h as b een c orre ct th e c redit
, ,

b alan c e upon t his a cc o u n t s h o uld b e suicient t o pro v ide

for th ese ch arg es Th e c redi t b alan c e upon th e Main
.

ten ance R eserv e Acc o u n t s h o uld b e c arried for w ard as a

separat e it e m upon th e B alanc e S h eet I f this a cc o un t .

s h o w s a de b it b alan c e this wo uld m ean th at th e annu al

,

pro visions h av e no t b een s ufc ien t and th erefore such , , ,

de b it b alan c e s h o uld b e wri tt en o ff t o Prot and L oss

Acc o un t and this qu es t ion re c onsidered and th e annu al
, ,

pro vision a cc ordin gly in c reased It m ay b e h o w e v er .

, ,

th a t in th e r s t few y ears b efore th e reserv e has h ad t i m e

,

t o accumula t e th e a ctu al ch arg es m ay o utweigh th e

,

c redit s and in s uch c ir cum s t an c es if it is reasonab ly

, , ,

c ert ain th at th e c redit s in th e next fe w years will brin g

th e a cc o un t in t o c redit a de b it b alan c e might b e c arried
,

forw ard but in this c ase this i t e m wo uld h a v e t o b e

, , ,
1 12 THE PR I N CI PLES O F AU D ITI N G

m ain t enan c e reserv es This m e th od of wri t in g O ff depre

.

ciation is th e o ne m os t c o mm only u sed in c onne ct ion wi th

plan t an d m a chin ery as it is simple and Separa t e c al cula

, ,

t ions do no t h av e t o be m ade in th e c ase of addi t ions as ,

such addit ions in c rea se th e b alan c e upon th e Plan t Acc o un t ,

an d th e per c en t ag e is c al cula t ed u po n this in c reased gu re .

Th e grea t w eakness of this s ys t e m is th at i t t ak es a v ery,

long t im e t o wri t e an asse t do wn t o approxim at ely nil ,

unless a v ery high ra t e is used in wh ich latt er c ase th e

,

burden upon th e opening y ears is ex c essiv e For exam ple .

,

if an asse t c os t in g is depre c iat ed a t 1 0 per c en t .

under this s yst e m a t th e end of forty years th ere will s t ill

,

b e a b alan c e Of 1 4 upon th e asse t a cc o un t and t o writ e ,

Off o v er a period o ften y ears th e ra t e will h av e t o

,

slightl y ex c eed 25 per c en t but t a k ing 25 per c en t th e

. , .
,

ch arg e for depre c ia t ion at th e end of th e rs t year will b e

250 ; for th e fo urth y ear it will b e 1 05 ; for th e sixth
year 60 and th e nin th y ear 25 so th at it will b e seen
,

wh at an enorm o u s ch arg e is plac ed upo n th e rs t year or

tw o and h o w rapidly th e ch arg e in s ucc eeding y ears reduc es
, .

Th ese fa ct s are seldo m appre c iat ed wh en this s y s t e m is

adop t ed in pra ct ic e and th e rat e xed is g enerally qui t e
,

inade qu at e t o wri t e th e asse t do wn in a reasonable period

th erefore wh en this s ys t em is adop t ed an au di t or s h o uld
, ,

see th a t th e rat e per c en t is S uf c ien t t o wri t e th e

.

asse t do wn during th e period of it s est im a t ed wor kin g

DEPREC IATI O N FUN D YS T EM U nder this s ys t e m

S .
,

during th e period of th e est im a t ed life of th e asse t an ,

equal am o un t is writt en o ff each year for depre c iat ion ,

Prot and L oss Acc o un t b ein g de b it ed and a Deprec iat ion ,

Fund Acc o un t b ein g c redit ed a t th e sa m e t i m e a si m ilar

am o un t of c as h is withdra wn fro m th e business and s h ould ,

b e in v es t ed in gil t edg ed se curi t ies c as h b ein g c redi t ed,

and an I n v es tm en t Acc o un t de b it ed Th e int eres t yielded

.

by th e inv es tm en t s as re c eiv ed will b e de b it ed t o c as h

, ,

and c redi t ed t o th e Deprec ia t ion Fund Acc o un t ; a t th e

 DEPREC IATI O N , V
RES ER ES AN D S I N KI G N FUN DS 1 13

sam e tirn e this in t eres t s ho uld b e re in v es t ed c as h b eing -

,

credit ed and th e I nv es tm en t Acc o un t de b it ed After all

, .

in t eres t rec eiv ed h as b een re in v est ed th e c redit b alan c e

-
,

u pon th e Depre c iat ion Fund Acc o un t will e qual exact ly

th e deb it b alan c e upon th e I n v es tm en t Acc o un t U nder .

this s ys t e m i t will b e seen th at th e am o un t s ret ained for

depre c ia t ion are wi th dra wn fro m th e bu sin ess and thus a t ,

th e end O f th e life of th e asse t th e in v es tm ent s can b e

,

realised and will produc e a sum of c as h im m edia t ely

,

av aila ble for th e repla c e m en t of th e expired asse t Th e .

de b it b alan c e upon th e old asse t a cc o un t will b e wri tt en

Of f ag ains t th e c redi t b alan c e upon th e Depre c iat ion Fun d
Acc o un t This m eth od is a v ery g ood one t o adop t wh ere
.

it is desired t o pro vide th e c as h ne c essary for th e p urpose

of repla c e m en t .

I N S U R AN C E PO L ICY S Y S T EM U nder th e Deprec iat ion

.

Fund s y s t e m th ere is alwa ys a ris k that th e in v es tm en t s

m ay no t realise c ost pri c e and th at thus th e exa ct sum
,

re quired m a y no t b e o bt ained ; therefore t o o bvia t e this , ,

a poli cy is t ak en out with an ins uran c e c o m pan y under

which th e re quired sum t o repla c e th e asse t is payable a t
th e end of th e period Of th e asse t s es t i m at ed life I n this

.

c ase an a m o un t e qu al t o th e am o un t of th e ann ual pre m ium

,

is de b it ed t o Prot and L oss Acc o un t each y ear and c redi t e d

t o a Depre c iat ion Fund Acc o un t and th e premi um wh en
, ,

paid is c redit ed t o c as h and de b it ed t o a Policy Acc o un t

, .

At th e end of th e t erm th e a m o un t re c eived under th e

,

poli cy is c redit ed t o th e Poli cy Acc o un t whi ch a cc o un t ,

will S h o w a c redit b alan c e whi ch represent s th e in t eres t

allo w ed by th e ins uran c e c o m pan y This c redit b alan c e
.

is transferred t o th e c redit of th e Deprec ia t ion Fund

Acc o un t m a kin g th e c redi t b alan c e u po n this a cc o un t
exa ctl y e qual t o th e am o un t rec eiv ed under th e policy .

I f th e old asse t is no w of no v alu e th e de b it b alan c e upon

,

th e old asse t acc o un t will be wri tt en o ff against th e c redi t

-

b alan c e upon th e :D eprec ia t ion F und Acc o un t .

A N NUITY S Y S T EM This s ys t e m is so m e t im es adop t ed

.

8
1 14 THE PR I N C I PL ES O F AU DITI N G

in c ases wh ere th e am o un t s ch arg ed for deprec iat ion are

t o be re t ained in th e bu siness and int eres t upon th e ,

c apit al in v es t ed in th e asse t is t o b e t ak en in t o a cc o un t .

Fro m t ab les a xed a m o un t to b e writt en off for depre

ciation ea ch y ear is asc ert ained wh i ch sum aft er t akin g
, ,

c redit for in t eres t at an a gree d rat e upon th e reduc in g

b alanc e O f th e asse t will writ e th e asse t do wn t o nil at
,

th e end o f th e period of it s es t im at ed life Th e annu al .

ch ar g e for deprec iat ion will b e c redit ed t o th e asse t a cc o un t

and de b it ed t o Prot and L oss Acc o un t whils t th e in t erest , ,

c alculat ed upon th e reducin g b alan c e will b e de b it ed t o ,

th e asse t a cc o un t and c redi t ed t o Prot and L o ss Acc ou n t .

Th e a m o un t writt en o for depre c iat ion is th e sam e each

year but th e in t eres t t ak en c redi t for b e c o m es less each
(
,

y ear and th erefore th e ann ual ne t ch arg e th at is depre

, , , ,

ciation less in t eres t ) gro w s h ea vier ea ch y ear Th e reason .

for th is is th a t th e a m o un t s se t aside ea ch y ear for depre

,

cia tion are addin g t o th e a v aila b le w or k in g c api t al of th e

bu siness an d as th e bu sin ess will b e u sin g th ese s um s and

,

b e earning in c o m e th ere with th e qu es t ion of in t eres t is

,

tak en in t o a cc o un t For exam ple in th e case of a lease

(
. ,

for a period of tw en ty y ears and c os t in g sa y ) in

th e rs t y ear c api t al t o th e a m o un t of
, is lo ck ed
up in this lease but as th e deprec iat ion is pro vided each
,

y ear this c apit al is repla c ed and for ins t an c e during th e

, , , ,

las t year nearly h as b een pro vided out ofre v en u e

this a m o un t form ing addi tional w orking c apit al of which ,

th e bu siness h as th e u se in th e m ean t im e Th erefore th e .

,

in c reasing ch ar g es for deprec ia t ion c au sed by th e dim ,

in ish ing in t eres t t aken in t o a cc o u n t are c o m pensa t ed for ,

by th e earning s of th e a ccumulat ions o f deprec iat ion

whi ch are in c reasin g th e w or kin g c apit al This s ys t e m .

is seldo m u sed in pra ct i c e and th e only i t e m s t o whi ch i t is

,

so m e t im es applied ar e leases in whi ch c ase th e period

,

o f life is kno wn exa ct l y and th ere is no qu es t ion Of

,

additions .

RE VALUAT I ON
-
Under this sys t e m the asse t s are
.
 1 16 THE PRI N C I PL ES O F AUD ITI N G

R es erv es .

Th e word reserv e h as b een u sed so m e wh at 10 0 5e

in c onnect ion wi th a cc o un t s with th e resul t th a t misc on
,

ceptions h a v e arisen wi th reg ard th ere t o in th e m ind of

th e g eneral p ub li c Ev en in th e a cc o un t an cy profession
.
,

th ere is so m e differen c e of opinion in c onne ct ion wi th this

sub j e ct Th e reason for this is th a t th e t erm reserv e
.

h as b een u sed in wi dely differen t senses and t o desc ri b e ,

v ery div erse s t at es of affairs .

R eserv es m ay b e sub di vi de d un der th e follo wing

-

h eadin gs
S pec i c R eserv es R eserv e Fun ds
G eneral R eserv es S ink in g Fun ds
S e c re t R eser v es
and i t is proposed no w t o c onsider b riey ea ch of th ese
sub di visions
-
.

S PEC I F I C RES ER VES A spe ci c reser v e represen t s a sum

.

ch arged ag ains t prot s t o pro vide for a kno wn c on t in g en cy ,

th e exact a m o un t ofwhi ch h o we v er c anno t b e as c ert ained

, , ,

and h as th erefore t o b e es t im a t ed s uch as reserv es for

, , ,

b ad de bt s dis c o un t s deprec ia t ion future repairs and

, , ,

rene w als disp ut ed c laims etc I n th e c ase of reserv es

, , .

for b ad de bt s dis c o u n t s and depre c ia t ion i t is k no wn th a t

, ,

th e asset s are sub j ect t o loss under th ese h eads but th e ,

exact am ou n t of such loss h as t o b e es t im at ed and pro vided

for by m eans of spec i c reserv es I n th ese c ases th e.
,

reserv e s h ould b e ch ar g ed t o Prot and L oss Acc o un t and ,

deduct ed fro m th e c orresponding asse t in th e Balan c e

S h ee t . I n th e c ase of spec i c reserv es for a cc ru ing repairs
and rene w als and for disp ut ed c laim s it is kno wn th a t a
, ,

lia b ility will arise but th e exa ct am o un t th ereof c anno t b e

,

asc ert aine d and ag ain th erefore th e a m o un t h as t o b e

, , ,

es t im a t ed and de b it ed t o Prot and L oss Acc o un t I n .

this latt er c ase the a m o un t pro vided will appear upon th e

deb i t side of th e Balan c e Sh ee t and is in e ffect m erel y a
,

l iability that h as h ad t o b e est im at ed .

 DEPRE CIA TI O N , V
RES ER ES AND S I N KI N G FU ND S 1 17

Spe cic reserv es are a char g e ag ains t re v enu e and mus t ,

be pro vided for wh e th er th e Prot and L oss Acc o un t s h o ws

a prot or a loss I n fa ct if a loss it is m ore im port an t
. , ,

th an e v er th a t am ple pro vision s h o uld b e m ade under

th ese h eads in order th at i t m ay be seen exa ctly t o wh at
,

ext en t th e c apit al of th e c on c ern h as been los t .

I n th e a bo v e c ir cum st an c es i t is thought tha t th e t erm

,

reser ve has been b adly used and it wo uld be be tt er to ,

use so m e o th er t erm such as pro vision ; but if th e word

,

reserv e is u sed i t s ho uld alwa ys be follo wed wi th

,

explana t ory words such as for b ad de bt s, in respect ,

of disp ut ed c laim s so th a t th e exa ct c ir cum s t an c es m ay
,

b e c learly appre c ia t ed .

G EN ER AL RES ER VES A general reserv e represen t s s um s

.

set aside ou t ofprot s t o pro vide ag ains t u n kno wn futu re

,

c on t ing en c ies t o in c rease th e wor kin g c apit al t o equalise

, ,

di vidends or m erely t o s trengthen th e n an c ial posit ion

,

of th e c on c ern A g eneral reserv e pre supposes a prot

.
-

and is an approp riation of p rots I n o th er w ords a .

,

g ener al reserv e represent s prot s re t ained in th e bu siness ,

which are ear m ark ed for an y of th e ab o v e p urposes and

-
, ,

in fa ct t h ese reserv es m ight w ell b e des c ri b ed in th e

,

B alan c e S h ee t as undist ri but ed prot s A tru e prot .

mus t b e represen t ed by a c orresponding s urplu s of asse t s

o ver c apit al an d lia b ili t ies and th erefore as a g eneral, , ,

reserv e is c rea t ed by re t aining part of s uch prot s it mu st , ,

in it s turn b e represen t ed by a c orrespondin g s urplu s of

,

asse t s I n fa ct it is of th e essen c e of a g eneral reserv e

.
,

tha t it s hould c onsis t of such a s urp lu s of asse t s Th e .

c redit b alan c e u pon th e G eneral R eserv e Acc o unt whi ch ,

appears upon th e de b it side of th e Balan c e S h ee t represen t s ,

m erely th e g aug e which m easures th e am o un t o f th e

surplus of asset s th a t are withh eld fro m dis t ri but ion t o
th e propriet ors of th e bu siness Th e c on t inu ed exis t enc e .

of th e reserv e is ab solut ely depen den t upo n th e c on t in ued

exis t enc e of th e c orrespo nding su rplu s of asse t s so th a t ,

if for exam p le in the succ ee ding y ear th e business m akes

, ,
1 18 THE PR I N C I PL ES O F AU DITI N G

a loss in trading e qu al t o or ex c eeding th e am o un t of th e

,

g eneral reserv e se t aside out of th e pre vio u s y ear s prot s

,

th en such reserv e h as aut o m at ic all y disappeared as th e ,

surplu s O f asse t s h as disappeare d by reason of th e sub

se qu en t loss I n th ese c ir cum s t an c es th erefore th e
.
, ,

credi t b alan c e upon th e General R eserv e Acc o un t s h o uld

be writt en o f f ag ains t th e de b i t b alan c e upon th e Prot
and L oss Acc o un t .

As a g ener al reserv e represen t s a s urplu s of asse t s o v er

c apit al and liabili t ies it will b e appre c ia t ed th at it s exis
,

t enc e depends upon th e v aluat ion of th e asse t s for if th e ,

asse t s h a v e b een o v er v alu ed as for exam ple by in suicient

-
, ,

pro visions for b ad de bt s and deprec iat ion th en t o th e ,

ext en t of such o v er valu a t ion of asse t s th e s urplu s is

-

non exis t en t
-
. I n th e sa m e wa y th e o v er v alu at ion of
,
-

o th er asset s h as th e effect of in a t in g th e g en eral reser v es ,

and t o th e ext en t of th e exc ess th e reserv e s h o wn upon

th e Balan c e Sh ee t will b e a b solut el y ct it io u s and ,

non exis t en t
-
.

RES ER VE F UN D S A reserv e fu nd is th e sa m e as a
.

g eneral reserv e ex c ep t th at th e s urplu s of asse t s repre

,

sen t ing th e reserv e is in v es t ed o ut side th e bu siness Th ese .

in v es tm ent s S ho uld b e r s t class or gilt edg ed securit ies .

This d enit ion is no t a cc ep t ed by all th e auth ori t ies but ,

it is s ugg es t ed th a t th e u se of th e w ord fund c on v e y s

t o th e g eneral p ublic th at th ere is a dist in ct fund repre
sen t ing th e reserv e th a t can b e c on v ert e d in t o c as h
,

wh ene v er re quired .

A reserv e fund is c reat e d by de b it ing Prot and L oss

Acc o un t and c re dit ing a R eserv e Fund Acc o un t and a t
, ,

th e sa m e t im e an equ al am oun t of c as h is wi th dra wn and

inv es t ed Th ese in v es tm en t s s h o uld b e separa t ely s t a t ed
.

in th e B alan c e Sh ee t and S h ould b e des c ri b ed as b eing

,

h eld on a cc o un t of th e reser v e fund .

I NVES T MENT O F S U R PL U S O F A S S ET S REPRES ENTIN G

G EN ER AL RES ER VE C onsiderab le discussion h as t ak en
.

plac e fro m t i m e t o t im e as t o wh e th er th e surplu s of asset s

1 20 THE PR I NC I PL ES O F AU D ITI N G

o ut side th e bu siness does no t and c anno t x th e exis t en c e

Of s uch reserv e whi ch is a b solut ely dependen t upon th e
,

c on t inu ed exis t enc e of a s urplu s Of th e whole of th e asse t s

( in c lu ding th e ear m ar k ed in v es tm en t s ) o v er th e c apit al
-

and lia b ilit ies ; if sub sequ en tly losses are in curred th e
, , ,

s urplu s is th ere by aut o m a t ic ally reduc ed and th erefore , , ,

th e reserv e t o th is ext en t is also reduc ed e v en tho ugh th e ,

in v estm en t s m a y b e s t ill in exist en c e I f a loss e qu al t o

.

th e am o un t of th e reserv e fund is in curred th e reserv e ,

disappears en t irely and th e c redit b alan c e th ereon S h ould

,

b e wri tt en off ag ains t th e loss th e in v estm ent s are th en

p art of th e g eneral asse t s of th e c on c ern and are re quired ,

t o pro vide for th e lia b ilit ies and c apit al It is a b solut el y .

im possible per m anen t ly t o x th e a m o un t of a s urplu s ,

which mus t of nec essity in c rease or de c rease fro m t im e

t o t im e a cc ording t o th e fortunes of th e bu siness
, .

S IN KIN G F UN D S A sin king fund is v ery si milar t o a

.

reserv e fund ex c ep t th at i t is c rea t ed for th e den it e

,

purpose of redee m in g a lia bility Prot s are appropriat ed

.

and c redit ed t o a S in kin g Fund Acc o un t and a t th e sam e ,

t im e c orrespon din g a m o un t s are in v es t ed o ut side th e

bus iness Th e in t eres t earned by th e in v es tm ent s s h o uld
.

b e c redit ed t o th e S inkin g Fu nd Acc o un t and re in v es t ed -

.

Th e t er m Sink ing fund is also u sed wh ere pro vision is

m ade for th e repla c e m en t of a w as t in g asset but in th ese , ,

c ir cum s t anc es , depre c ia t ion fund is a b e tt er t er m A .

deprec ia t ion fund as h as already b een des c rib ed in th e

,

earlier part of this ch ap t er is c rea t ed in an exa ct ly sim ilar

,

m anner .

I n th e c ase ofa sin kin g fund c reat ed t o redee m a liab ili ty ,

th e perio dic al de b it s to Prot and L oss Acc o un t represen t

appropriat ions of prot s and aft er th e lia b ili ty h as b een
, ,

paid o ff a c redi t b alan c e is left upon th e S inkin g Fund

,

Acc o un t whi ch th en represent s a g eneral reserv e accum u

,

la t ed ou t o f div isi ble prot s F or exam ple s uppose th e

.
,

c ase of a c o m pan y h a ving a deb en ture de bt of

repay a b le at th e end of ten y ears and it is dec ided t o ,
 DEPRE CIATI O N , RES ER VES AN D S IN KI N G F UN DS 1 21

pro vide for th e repa ym en t ofth e de bt by m eans Of a sin king

fund At th e c o mm en c e m en t of th e period th e Balan c e
.

S h eet wo uld b e as fo llo w s

(1 ) B AL AN C E S HEET

6
Ass
:
C pi t
a a l ets
D eb en tu res

At th e end of th e period and b efore th e repa ym en t of

,

the de b entures th e Balan c e Sh ee t w ill b e as follo w s

,

(2) B A L AN C E S HEET

6
As
:
C pi t
a a l sets

D eb en tu res S i nki n g Fu n d I n v est

S i n ki n g Fu n d m en ts

I f no w th e sink in g fund in vestm ent s realise th eir c ost

exa ct l y th e , produc ed will b e u sed t o pa y Off th e
de b en tures and th e Balan c e S h ee t will b e as follow s
,

(
3 ) B AL AN C E S HEET
6
A
:
C pi t
a al ssets
Ge n era l R eserv e

Th e ab o v e Sh ould b e c o mpared wi th Balanc e Sh ee t N O .

1 wh en i t will b e seen th a t th e posit ions are iden t i c al

, .

ex c ep t th a t th e lia bility t o o ut side de b en ture holders h as

been repla c ed by th e g eneral reserv e whi ch represent s ,

undra wn prot s I f no sin king fund h ad b een c reat ed

. ,

wh en th e deb en tures b ec am e du e th e c o m pan y wo uld ,

ha v e h ad t o t e b orro w m oney or sell p art of its gener al

-

asse t s inst ead of which it h as v olun t aril y h eld b a ck

,

prot s and in this w ay h as a ccumulat ed th e ne c essar y

,

funds with whi ch t o pay o ff th e lia b ility O rig inally th e . ,

s h are holders h ad only in v es t ed in th e business but ,

no w th e y h a v e inv est e d th e fu rth er ,

1 22 THE PRI N C I PL ES O F A UD ITI N G

represen t ing divisi ble prot s th a t h a v e been left in th e

bu siness and which ha v e b een u sed t o pa y O a c apit al
,

lia b ili ty
.

A sin king or deprec iat ion fund c rea t ed t o repla c e a

w ast ing asse t is buil t up in th e sa m e w a y but upon , ,

c o m plet ion th e deb it b alan c e upon th e a cc o u nt of th e old

,

and no w expired asse t is wri tt en o ff ag ains t th e c redit

b alan c e upon th e S in k ing or Depre c iat ion Fund Acc o un t ,

which latt er a cc o un t thus disappears and th e in v es tm en t s ,

pro vide th e c as h wi th which t o p ur ch ase th e ne w asse t .

I n this c ase th e ann ual de b it s t o Prot and L O S S Acc o un t

,

are a ch arge ag ains t prot s as th e y represen t th e pro vision

,

for th e depre c iat ion of th e w ast in g asse t .

S EC R ET RES ER VES A se c re t reserv e is a reserv e th at is

.

no t disc losed in th e Balan c e S h ee t so th a t th e nan c ial ,

posit ion is in fa ct b e tt er th an appears fro m th e B alan c e

, ,

S h ee t
. S e c re t reserv es are c rea t ed for th e pur pose o f
equ alising di vi dends or t o pro v ide a fund out O f which
,

h eavy losses can b e m e t wi th out disc losing th e fa ct t o

,

th e s h are h olders and g eneral p ubli c ; also in so m e c ases , ,

t o av oid disc losing infor m at ion t o t rade ri v als .

S e c re t reserv es are c reat ed by writ ing do wn asse t s s uch ,

as s t o ck b oo k de bt s plan t and m a chinery and pre m ises

, , , ,

b elo w their tru e v alu e by m ak ing ex c essiv e pro visions for

,

o ut st andin g lia b ilit ies and by ch arg in g c apit al it e m s s uch

, ,

as addit ions t o plan t and m a chinery t o Prot and L oss ,

Acc o un t .

Th e Auditor s Position as re gards R eserv es I n th e

.

c ase of Spec ic reserv es th e au dit or mu s t en quire in t o

,

th ese m os t c arefull y wi th a Vie w t o sat isfy in g h im self th at

,

th e pro visions m ade are s uf c ien t His dut ies as reg ards .

th ese reserv es such as b ad de bt s depre c iat ion and

, ,

o ut s t anding c laim s h a v e b een discu ssed already

, .

Th e au dit or is no t c on c erned with th e c rea t ion ofg eneral

reserv es exc ep t th a t h e mu s t see th a t th e a cc o un t s h av e
,

b een properly t ak en and do s h o w a bond de s urplu s and

, ,

that th e reserv es are c learly an d properly s t at ed in th e

1 24 THE PR I N C I PL ES O F AU D ITI N G

this fact c lear in his au dit report B ut th e c ir cum s t an c es .

with larg e p ub lic c o m panies are en t irely di fferen t for th e ,

a cc o un t s are p ub lish ed and are thu s av aila b le for th e

,

g eneral p ubli c th e cu st o m ers c redi t ors and c o m pe t it ors

, ,

o fth e c o m pan y as w ell as th e s h are h olders and th erefore

, , , ,

it is a m a tt er of v ery grea t im port an c e t o c onsider th e

effe ct th a t inform a t ion disc losed in th e a cc oun t s m a y
h av e upon th e c redi t of th e c on c ern S uch c o m panies .
,

th erefore Often c rea t e th ese s ec re t reserv es so th at th ey

, ,

m a y b e a ble t o m eet e m ergen cies and h ea vy losses with o ut

dis c losin g t o th e wh ole w orld th a t th e y h a v e m e t wi th
such re verses Th is is in th e in t eres t s of th e s h are h olders
.

as a b od y as in this w ay th e p ub li c c re dit of th e c on c ern

,

is m ain t ain ed .

O n th e o th er h and sec re t reserv es m ight b e u sed by

,

unsc rupulou s dire ct ors for m os t i m proper p urposes for ,

exa m ple t o c o v er u p losses upon ultra vires t ransa ct ions

, ,

or for th e p urpose of priv at e spe cula t ion in th e s h ares

o f th e c o m pan y for th e m ar k e t v alu e of it s s h ares m a y
,

b e inu enc ed by m a kin g th e resul t s s h o wn by th e acc o un t s

uctu at e im properly by th e m anip ula t ion of se c re t reserv es
c rea t ed in th e pas t Th erefore it is m os t im port an t th a t
.
,

an au dit or s h ould en quire m os t c arefully in t o th e wh ole

qu es t ion of th e se c re t reserv es with a Vie w to asc er t aining
,

th a t th e y are nec essar y in th e in t eres t s of th e c o m pan y ,

and th a t th e y are b ein g u sed for bond de p urposes o nl y .

I f h e is sat ised th at th is is th e c ase h e m a y safely pass ,

th e m a tt er with o ut referen c e in his report though in th ese ,

C ir cum st an c es so m e a u di t ors m a k e a g eneral s t at e m en t in

th eir au dit report th at th e v alu e of th e asset s is under
s t a t ed th ere by disc losin g th e fa ct th at there is a se c re t
,

reserv e but no t s h o wing it s a m o un t I f h o we v er th e

, .
, ,

au dit or is no t a b solut ely sa t ised as t o th e bond des of

th ese transa ct ions h e s h o uld wi th o ut fail deal with th e
,

m att er full y in his report t o th e s h ar e h olders .

 C H APT ER VI I

T I O N S O F THE C O MPAN IES C O N S O L I DATI O N )

S EC (
ACT 1 908 PA R TICUL ARL Y A FFEC T IN G AU D IT O R S
, ,

IT is nec essary th at an au dit or sh o uld b e fa miliar with

pra ct ic all y th e wh ole of th e pro visions of th e C o mpanies
Act s 1 908 t o 1 9 1 7 but in th e spac e av aila ble it is only
, ,

po ssi b le t o deal b riey wi th th e fe w sect ions of th e 1 908

Act th at are of part icular im port anc e fro m an au dit or s

poin t of vie w .

App oin tm en t an d R em un er atio n O f Au ditor s .

Th e appointm ent and re munerat ion of au dit ors are

pro vided for in S e ct ion 1 1 2 ofth e C o mpa nies C onsolida t ion ) (
Act 1 908 as follo w s
, ,

Every c o m pan y S h all a t ea ch ann ual g eneral m ee t ing

appoin t an au di t or or audit ors t o h old offi c e un t il th e
next ann u al g eneral m ee tin g
S ec 1 1 2 .
( .

It will b e o b serv ed th at th e a bo v e S ub se ct ion refers t o -

e v ery c o m pan y regis t ered under this Act so th at ,

priv at e c o m panies are no t exe m p t ed as is oft en tho ught , .

Th e appoin tm en t is m ade by th e Sh are holders as a body ,

and th e au dit or is th erefore a ct in g as th eir ag en t t o a udi t

, ,

th e acc o un t s of the dire ct ors wh o th e m selv es are m erel y

,

ag en t s of th e S h are h olders on wh ose b e h alf and for wh ose

,

b enet th e direct ors c arry on th e bu siness This fact .

mus t be th oro ughl y apprec iat ed and bo rne in m ind by

an au dit or for th ough in th e c o urse of h is wor k h e is
, ,

c onst an t ly b ro ught in t o c on t act wi th th e direct ors wh o ,

c onduct th e bu siness y e t h e is no t act ing for th e m at all

, .

He is appoin t ed t o a ct as a ch eck u pon th e direct ors and ,

t o ens ure on b eh alf of th e s h are holders who are th e ,

proprie t ors of th e bu siness tha t th e direct ors c arr y on

,

th e undert a king hones tly for th e b enet of th e sh are holders ,

an d render t o th e m t r u e and c orrect a cc o un t s .

1 25
1 26 THE PR I N C I PL ES O F AU DI TI N G

I f an appoin tm en t of au dit ors is not m ade a t an

ann ual g en eral m ee t ing th e Board of Trade m a y on , ,

th e appli c ation of an y m e mb er of th e c o m pan y appoin t ,

an au di t or of th e c o m pan y for th e curren t y ear and ,

x th e re munerat ion t o b e paid t o h im by th e c o m pan y

for his ser vi c es
S ec 1 1 2 .
( .

I n this c ase al th o ugh th e Board of Trade m ak es th e appoint

,

m en t th e au di t or a ct s as th e ag en t of th e s h are h olders in
,

exa ct ly th e sa m e w a y as if h e h ad b een appoin t ed at th e

annu al g eneral m ee t ing and h e does no t a ct Spe c iall y on
,

b e h alf of th e m e mb er wh o app lied t o th e Board of Trade ,

but on b e h alf of th e wh ole b ody of S h are h olders .

A dire ct or or O icer Of th e c o m pan y s h all no t be

c apable of b eing appoin t ed au dit or of th e c o m pan y "
(
.

S ec . 1 12
I n this w ay i t is pro vided th at th e au di t or s h all be qui t e
independen t as w ould no t b e th e c ase if for exa m ple
, , ,

th e se c ret ary o f th e c o m pan y w ere als o appoin t ed au di t or .

As se c re t ary h e w o uld b e a ser v an t of th e dire ct ors sub j ect

, ,

t o th eir auth ori ty ; but i t is essent ial th at an au di t or

S h o uld b e a b solut ely independen t ofth e b oard of dir ect ors ,

and th erefore s uch an appoin tm en t is pro hib i t ed by th e

, ,

Act I n pra ct i c e i t is no t un c o mm on t o nd one p art ner

. ,

in a rm of a cc o un t ant s a ct in g as a direct or or sec re t ary

of a c o m pan y and ano th er part ner a ct in g as a u di t or and
, ,

alth ough th e s t ri ct le tt er of th e Act does no t for b id this ,

ye t i t is undo ubt edly c ont rary t o th e Spiri t of this Sub

se ct ion and s uch appoin tm en t s are c ert ainl y no t ad visa ble
, .

I f seriou s qu es t ions arose b etw een th e dire ct ors and

th e au dit or th e posit ion of th e in di vidual part ners of th e
,

r m w o uld b e one of v ery gr ea t difculty as th ere w o uld ,

arise direct ly c oni ct ing in t eres t s Th e posit ion of th e .

au di t or th erefore w ould no t b e one of disin t eres t e d

, ,

independen c e as i t al w ay s s h o uld b e
, .

A person o th er th an a re t iring au dit or Sh all no t be

, ,

c apable of b ein g appo in t ed au dit or at an ann ual g eneral

m ee t in g unless no t ic e of an in t en t ion t o no m in at e th a t
1 28 THE PR I NCI PL ES O F AU DITI N G

appoin t ed S h all h old oice un t il th e rs t annu al g eneral

m ee t ing unless pre viou sly re m o v ed by a resolut ion of
,

th e s h are h olders in g eneral m eet in g in which c ase th e ,

s h ar e h olders at th a t m eet ing m a y appoin t a u di t ors
(
.

S ec . 1 12
Fro m this c lau se i t will b e seen th at th e dire ct ors m a y
appoin t th e rs t au dit or prior t o th e s t atut ory m ee t in g ,

but e v en in this c ase th e S h are h olders h av e th e po w er t o

re m o v e s uch au dit or and appoin t ano th er in h is pla c e ,

s h o uld th e y desire it Th e dire ct ors wh en m ak in g th e

.
,

r s t appoin tm en t are m erely a ct in g as ag en t s for th e

,

s h are h olders wh o h a v e no t y e t m e t as a b ody and th e

, ,

au dit or th ough appoin t ed by th e dire ct ors a ct s for th e

, ,

s h ar e h olders in exa ct ly th e sa m e w a y as if h e were appoin t e d

dire ct by th e s h ar e h olders .

Th e dire ct ors m ay ll an y c asu al v a c an cy in th e

Of c e of au dit or but while an y such v a c an cy c on t in u es
, ,

th e survi ving or c on t in uing au dit or or au di t ors if an y

(
, ,

m ay act S ec 1 1 2
. .

I n this c ase ag ain th e dire ct ors act for th e s har e h olders

, , ,

and appoin t an au dit or t o ll th e c asu al v a c an cy but wh en ,

appoin t ed th e au dit or is as in all c ases th e a g en t of th e

, , ,

sh are h olders This Sub se ct ion does no t m ean th at th e

.
-

dir e ct ors th e m selv es m ay a ct as au dit ors durin g th e

v a c an cy as is so m e t im es th ought by s tu den t s but th at
, ,

th e y m ay appoin t an au dit or wh o mu st no t b e a direct or

,

or of c er of th e c o m pan y .

Th e re mu nerat ion of th e au di t ors of a c o mpan y

sh all b e x ed by th e c o mpan y in g eneral m ee t in g ex c ep t ,

th at th e re munerat ion of an y au di t ors appoin t ed b efore

th e s t atut ory m eet in g or t o ll an y c asu al v ac an cy
(
, ,

m ay b e xed by th e dire ct ors S ec 1 1 2 .

Th e re munerat ion of th e audit ors in th e sa m e way as th eir ,

appoin tm en t rest s en t irely with th e s h are h olders ex c ep t

, ,

wh ere as a m ere m a tt er of c on venienc e th e dire ct ors act

, ,

for th e s h are h olders in th e c ase of th e appoin tm en t prior

t o th e s t atut ory m eet in g and wh ere a c as u al v ac an cy
,
 THE C O MPANI ES (
C N
O S OL D I ATI O N ) ACT , 1 908 1 29

occurs and e v en in th ese la tt er c ircum st anc es th e appoin t

, ,

m en t m ade or re mu nerat ion xed by th e dire ct ors only ,

h olds un t il th e next m ee t ing of th e s h are h olders w h en ,

th ey m ay refu se t o re appoin t th e no m inee Of th e -

direct ors .

P o wer s an d D u tie s o f Au dito r s .

Th e pow ers and dut ies of audit ors are dened by S ect ion
(
1 1 3 of th e C o m panies Co nsolida tion ) Act 1 908 th e t er m s
(
, ,

of whi ch are of th e utm ost i mport an c e S ub se ct ion 1 ) .

-

reads as follo w s
Every au dit or of a c o m pan y s h all h av e a right of
a cc ess a t all t im es t o th e b oo k s and a cc o un t s and v o uch ers
ofth e c o m pan y and s h all b e en t i t led t o re qu ire fro m th e
,

dire ct ors and of c ers of th e c o m pan y such inform at ion

and explanat ions as m ay b e nec essary for th e perform an ce
of th e dut ies of th e au di t ors

S ec 1 1 3 .
( .

This S ub se ct ion denit ely gi v es th e au dit or th e ri ght of

-

a cc ess t o th e b oo ks a cc o unt s and v ouch ers ofth e c o mpany

,

a t all t im es and b oo k s will in c lu de all st at ist ic al and

,

m e m orandum boo k s such as min ut e b oo ks c os t b ook s

, , ,

st o ck boo ks s h are ledg ers etc F urth er

, , v ouch ers .
,

will in c lu de all do cum ent ary e videnc e th at th e au dit or

m ay require such as c ont ract s c orresponden c e in v oi c es
, , , ,

etc . I n addition t o his right of acc ess t o th e b oo k s etc th e , .

,

au di t or is en ti t led t o re quire fro m th e direct ors and of c ers

of th e c o m p an y inform a t ion and expla na t ions upon an y

poin t s th erefore it will b e seen th at h e is not c onned t o

,

th e b oo ks but wh ere th e b oo k s and v o uch ers are no t c lear

, ,

h e can c all for explanat ions Th e following Sub sect ion .

-

pro vides th a t if inform at ion is withh eld th e au dit or mu st ,

report t o th e s h are h olders th a t h e h as no t o bt ained all

th e inform at ion and exp lanat ions tha t h e h as required .

Th e au di t or s po w ers in this direct ion are v ery c o m plet e

and s trong and are c aref ully dened in th e Act

, .

Th e audit ors S hall m ak e a report t o th e shareh olders

o n th e a cc o un t s examined by th e m and on e v ery Balan c e ,

9
-
(
5 4)
I 2
1 30 THE PR I NCI PL ES O F AU D ITI N G

S h eet laid b efore th e c o m pan y in g eneral m ee t ing during

th eir t enur e ofoice and th e report s h all s t at e
(
,

a) Wh e th er or no t th e y h a v e o bt ained all th e

inform at ion and explana t ions th ey h a v e required ;

and
(
b) W h eth er in th eir opinion th e B alan c e S h ee t
, ,

referred t o in th e report is properly dra wn up so as

t o exhib it a tru e and c orrect View of th e s t at e of th e

c o m pan y s affairs a cc ording t o th e b es t of th eir
inform at ion and th e explanat ions g iv en t o th e m and
(
,

as S h o wn by th e b oo k s of th e c o m pan y S ec 1 1 3 . .

It will b e no t ed th at th e au di t ors h av e t o m ake a report

upon e v ery B ala n c e S h ee t subm itt ed t o th e s h are h olders
in g ener al m ee t ing d uring th eir t enure of oice and th at ,

such report is addr essed t o th e S h are h olders and not t o ,

th e dire ct ors I f th e au di t or is not sa t ised upon any

.

poin t s or th ere is an y inform a t ion th at in his opinion

, , ,

s h ould b e pla c ed b efore th e s h are h olders h e mu s t qualify ,

his repo rt a cc ording l y and m ak e an y such m att ers c lear

,

th erein It is th e duty of th e dire ct ors t o prepare th e

.

a cc o un t s and th e au dit or c an no t al t er s uch a cc o un t s in

,

an y w a y if dissat ised u pon an y po in t his duty is c onned ,

t o dealing wi th th e m att er in his report and thu s la yin g ,

th e tru e fact s before th e Sh are h olders I n th e sam e w ay.

,

if th e s ys t em of b oo k k eeping is b ad th e au di t or c anno t
-
,

insis t upon alt erat ions but if i t is so b ad th a t reliab le

,

a cc o un t s c anno t b e prepared th en in s uch c ir cum st an c es

, , ,

h e S h o uld report t o this effect t o th e s h areh olders Ho w e v er .

,

as a ru le dire ct ors appre c ia t e and v al u e th e ad vi c e o f th e

,

a u di t or on such m a tt ers .

Th e Balan c e S h ee t S h all b e Sig ned on b eh alf of th e

b oard by two of th e dire ct ors of th e c o mpan y or if ,

th ere is onl y one dire ct or by th at direct or and th e

, ,

au di t or s report s h all b e a tt a ch ed t o th e B alan c e S hee t

,

or th ere s hall b e insert ed a t th e foo t ofth e B alan c e Sh ee t

a referen c e t o th e report and th e report s h all be read
,

before th e c o mpan y in g eneral m eet ing and s h all be Open

1 32 THE PR I NCI PL ES O F AU D ITI N G

of th e bu sin ess s h ould th e au dit or h av e t o report adv ersel y

upon an y m att ers th e c re dit Of th e c on c ern might be
,

serio u sly a ffect ed Th erefore th e report s hould be m ade

.
,

a cc essi ble t o s h are holders onl y so th a t th e a u dit or m a y b e

,

in no wa y h a mpere d by th ese o th er c onsiderat ions .

It is m ost im port an t th at th e report s h o uld iden t ify

v ery c learly th e p art i cular B alan c e S h ee t t o whi ch it
refers so th a t th ere m a y be no roo m for aft er disput e or
,
-

c onfu sion and no dang er th at by m is t ak e or o th erwise

,

th e Balan c e S h ee t s ubm i tt ed t o th e s h are h olders th ough ,

b earing th e proper dat e s h o uld no t b e th e one actuall y

referred t o in th e repo rt I f th e repo rt is a separa t e
.

docum en t th e a u dit ors S h ould ini t ial th e part icular

,

B alan c e S h ee t th e y are referring t o and s h o uld st at e this ,

fact in th e report and in all c ases th e y s h o uld k eep a c op y

,

of th e Balan c e S h ee t sen t and pla c e a m e m orandum of

,

iden ti ty th ereon so th a t if th e qu es tion arises th e y m a y be

, ,

a ble t o t estify wi th c ert ain ty as t o th e m att er Th e b e tt er .

and safer c o urse h o w e v er is t o writ e th e report a t th e

, ,

foo t ofth e au dit ed B alan c e Sh ee t so th at in this w a y th e, , ,

tw o do cum ent s are m ade insepara b le This c o urse does .

no t pre v en t th e direct ors fro m sending t o th e s h are h olders

c opies of s uch B alan c e S h ee t with o ut th e report but wi th ,

m erely a referen c e th ere t o Th e follo win g is th e form of

.

report re c o mm ended by th e Co un c il of th e I ns t i tut e of

Ch art ered Acc o unt an t s in Eng land and W ales

R EP O R T OF T HE A UD I T O R S TO T HE
S H A R E H O L D ER S 0F L I M I T ED .

We have audited the Balance S heet fthe

o

L im ited , da ted

f the and h ere

day o (
iden tify it as abo v e se t forth or wi thin c on t ained , ,

or a c op y ofwhi ch is annexed h ere t o and ini tialled by

us , or a c op y of which h as b een init ialled by u s
,

We have obtained all the inform ation and exp lanations

we have required .

In our o pinion such Balance S heet is p rop erly drawn

 THE C O MPANIE S (
C O N S O L I D ATI O N ) ACT , 1 908 1 33

up so as to exhibit a tru e and correct vie w ofthe sta te o f

the p any s aairs according to the
com

best of ou r infor
m ation and th e exp lana tion s given u s and as sh ow n by

th e books ofth e com p any .

!
I f an y C op y of a Balan c e S h ee t whi ch h as no t b een
si gned as re quired by this S ect ion is issued c ir cula t ed or ,

pub lis h ed or if an y c op y of a Balan c e S h ee t is issu ed

, ,

c ir culat ed or p ub lis h ed wi tho ut either h av in g a c op y

,

of th e a u dit or s report a tt a ch ed th ere t o or c on t aining

such referen c e t o th a t report as is required by this

S e ct ion th e c o m pan y and e v ery dire ct or m anag er
, , , ,

se c re t ary or o th er of c er of th e c o m pan y wh o is kno w

,

ingly a party t o th e defa ult s h all on c onv i ct ion b e lia b le

(
,

t o a ne no t exc eedin g fty po unds S ec 1 1 3
. .

Fro m this S ub se ct ion it will b e seen th at th ere is a h ea vy

-

penalty if th e t erm s of this S e ct ion are no t c arried o ut .

I n th e c ase of a b ankin g c o m pan y reg ist ered aft er

th e ft eenth da y of Augu s t eight een hundred and ,

se v enty nine -

(
a ) I f th e c o m p an y h as bran ch b an ks b e yond th e
limi t s of Europe it s h all b e s uffi c ien t if th e au di t or
,

is allo wed a cc ess t o such c opies of and ext ra ct s fro m

th e b oo k s and a cc o un t s of an y such b ranch as h av e
b een t rans mi tt ed t o th e h ead Offi c e of th e c o m pan y
in th e U ni t ed Kin g do m and
(
b) th e Balan c e S h ee t mu s t b e signed by th e se c re t ary
(
or m an ag er if an y ) and wh ere th ere are m ore th an
three direct ors of th e c o m pan y by a t leas t three o f
those direct ors and wh en there are no t m ore th an
(
,

three direct ors by all th e direct ors S ec 1 1 3. .

Th is S ub sect ion refers onl y t o b ankin g c o mpanies

-
.

!
Holders of preferen c e s h ares and de b en tures of a
c o m pan y s h all h av e th e sa m e right to rec eiv e and
inspec t th e Balan c e S h ee t s of th e c o m pan y and th e
report s of th e au dit ors and o ther report s as is possessed

by th e h olders of or dinary s h ares in th e c o m pan y

(
.

S ec. 1 14
1 34 THE PR I NCI PL ES O F AU D ITI N G

This sect ion s h all no t appl y t o a p rivate com p any ,

nor t o a c o m pan y regist ered b efore th e r s t day Of

J uly nine t een hun dr ed and eight

S ec 1 1 4 .
( .

Th is w as an im port an t inno v at ion in t roduc ed by th e

C o m panies Act 1 907 by whi ch preferen c e s h are holders
, ,

and de b en ture h olders were gi v en th e ri ght t o re c eiv e and

i nspe ct th e B alan c e Sh ee t s of th e c o m pan y and th e ,

au dit ors report s ex c ep t in th e c ase of pri v at e c o mpanies

,

and th ose r egis t ered b efore th e 1 907 Act c a m e in t o forc e .

A n n u al Lis t an d S u m m ar y .

S ection of th e C o m p an ies C onsolidat ion ) Act 1 908

26 ( ,
.

pro vides th at e v ery c o m pan y s h all on c e a t leas t in e v er y

y ear m ak e a lis t of all th e m e mb ers of th e c o mpan y s uch ,

list c on t ainin g v ario u s part iculars as reg ards th e s h are

c apit al of th e c o m pan y th e a m o un t c alled u p and paid
,

on ea ch S h are th e t o t al a m o un t of c alls unpaid and

, ,

v ario u s o th er part iculars This annu al lis t and summ ary

.

mu s t b e c ont ained in a separat e part of th e reg is t er of

m e mb ers and a c op y signed by th e m anag er or se c re t ary
, , ,

mu st b e forw arded t o th e R egis t rar of C o m panies .

S ub se ct ion 3 of this S e ct ion pro vides as follo w s

-

Th e summ ary mu s t also exc ep t wh ere th e c o m pan y (

is a pri v a t e c o m pan y ) in c lu de a s t a t e m en t m ade up t o ,

such da t e as m ay b e Spec ied in th e s t a t e m ent in th e ,

for m of a Balan c e S h ee t au dit ed by th e c o mpany s,

au dit ors and c on t ainin g a s umm ary of i t s s h are c apit al

, ,

it s lia b ili t ies and i t s asset s gi vin g s uch part iculars as

, ,

will dis c lose th e g eneral na ture Of th ose liab ili t ies and
asse t s and h o w th e v alu es of th e xed asse t s h a v e b een
,

arri v ed a t but th e Balan c e S h ee t need no t in c lu de a

,

s t a t e m en t of pro t and loss .

I n m an y c ases th e las t au di t ed Balan c e Sh ee t of th e

c o m pan y is led t o c o m ply with this Sub se ct ion and -
,

pro vided th a t i t gi v es th e re quired inform at ion t his will ,

be suicient and th e au dit ors will not h av e Spec ially t o

,
1 36 THE PR I NCI PL ES O F AU D ITI N G

Th e S ta tu to ry Meetin g an d R ep o rt .

S e ction 65 of (
th e C o m panies C onsolidat ion ) Act 1 908 , ,

pro vides th a t e v ery c o mpan y s h all

no t less th an one m on th nor m ore th an three m on th s
fro m th e da t e a t whi ch th e c o m pan y is en t it led t o
c o mm en c e bu siness hold a g eneral m eet ing Of th e
,

m e mb ers of th e c o m pan y which Sh all b e c alled th e

,

s t a tut ory m eet in g .

Th e dire ct ors s h all a t leas t sev en da ys b efore th e day of

,

th e m ee t ing forw ard a report c alled th e s t atut ory report

, , ,

t o e v ery m e mb er ofth e c o m pan y and this repor t h as t o b e

,

c ert ied by th e dire ct ors and a c op y th ereof h as t o be

,

led wi th th e Re gist rar o fC o m panies B ut th e pro visions

.

as t o forw ardin g and lin g th e s t a tut ory report do no t

apply in th e c ase ofpriv a t e c o m panies .

Th e pro visions of Sub se ction 3 of Sect ion 65 are as

-

follo w s
Th e s t a tut ory report s hall b e c ert ied by no t less
th an tw o dire ct ors of th e c o m pan y or wh ere th ere are
, ,

less th an two dir e ct ors by th e sole dire ct or and m anag er

, ,

and S h all s t at e
( a) Th e t o t al n umb er of S h ares allo tt ed dist in ,

gu ish in g s h ares allo tt ed as fully or part ly pai d up

o th erwise th an in c as h and st a t ing in th e c ase of
,

S h ares part l y paid up th e ex t en t t o which th e y are so

paid up and in eith er c ase th e c onsidera t ion for whi ch
,

th ey h a v e b een allo tt ed ;
( b) th e t o t al a m o un t of c as h re c ei v ed by th e
c o m pan y in respect of all th e s h ares allo tt ed ,

dis t in gu ish ed as aforesaid ;

( c) an a b s t ra ct o f th e re c eip t s of th e c o m pan y on

a cc o un t of it s c apit al wh e th er fro m s h ares or de b en

,

tures and of th e paym en t s m ade th ereout up t o a

, ,

dat e wi thin se v en da y s of th e dat e o f th e report ,

exhi bit in g under dis t in ct iv e h eading s th e rec eip t s o f

th e c o m pan y fro m s h ares and de b en tures and o th er
 THE C O MP N I ES A (
C N
O S OLI D ATI O N ) ACT , 1 908 1 37

so urc es th e pa ym en t s made th ereo ut and part i cu lars

, ,

c on c erning th e b alan c e rem aining in h and and an ,

a cc o un t or es t ima t e of th e preliminary expenses of

th e c o m pan y ;

(
d) th e na m es addresses and desc ript ions o f th e

( (
, ,

direct ors au dit ors if an y ) m anag ers if an y ) and

, , ,

sec re t ary of th e c o m pan y and

(
e) th e par t i culars of an y c on tra ct th e m odica ,

t ion of whi ch is t o be subm itt ed t o th e m ee t ing for

it s appro v al t ogeth er wi th th e parti culars of th e

m odic at ion or proposed m odic a t ion .

C ert ain part s of th e s t a tut ory report h av e t o be c ertied

as c orrect by th e au dit ors if an y h a v e b een appoin t ed
,

prior t o th e st atut ory m ee tin g S ub sect ion 4 pro viding ,

-

Th e st a tut ory report sh all S O far as it relat es t o

!
,

th e s h ares allo tt ed by th e c o mpan y and t o th e c as h ,

rm eiv ed in respect of s uch S h ares and t o th e rec eip t s ,

-

and pa ym en t s of th e c o m pan y on c apit al a cc o un t b e ,

c ert ied as c o rr ect by th e au dit ors if an y of th e , ,

c o m pan y .

This will nec essit at e a c o m plet e au di t of th e sh are boo ks

of th e c o m pan ywhi ch is desc ri bed in de t ail in Ch ap t er
VIII and also th e c o m ple t e v o uching and ch eckin g of
th e C as h Boo k i t b eing seen th at th e Capit al R ec eip t s and
,

Pa ym en t s Acc o un t c on t ained in th e report is a c orrect

, ,

summ ary AS this summ ar y h as t o Sh o w particulars

.

c on c erning th e b alan c e re m aining in h and th e t o t al of an y ,

re v enu e rec eip t s and pa ym en t s mus t b e in c lu ded on ea ch

side so th at th e b alan c e of c as h rem ainin g is S ho wn Th e
, .

capit al rec eip t s and paym ent s must be fully desc ri b ed ,

but no det ails need be gi v en as t o th e re v enu e it e m s .

U pon c o m plet ion th e au di t or will h av e t o Si gn his c ert ic at e

,

which is as follo w s
I hereby certi that so m u ch ofth is rep ort as rela tes
to the sh ares by the com p any and to the cash received
all
otted

in resp ect ofsu ch sh ares and to the receip ts and p aym ents

ofth e com p any on ca pital account is correct .

1 38 THE PR I NCI PL ES O F AU D ITI N G

U n d er wr itin g C om m is sion s an d
C om m is s io n s o n P lacin g S h ar e s .

(
S ection 89 of th e C o m panies Consolida t ion ) Act 1 908 , ,

giv es a c o m pan y po wer t o pa y underw ri t ing c o mm issions ,

and c o mm issions on pla c in g or procuring sub sc rip tions for

s h ares pro vided th a t th e paym en t of such c o mm ission is
,

authorised by th e Art icles and th e c o mm ission paid or

, ,

agreed t o b e paid is dis c losed in th e prospe ctu s or s t at e m en t

, ,

in lie u of prospectu s or an y c ir cular or no t ic e in vi t ing

,

sub sc rip tions for S h ares and th at th e am o un t paid does

,

no t ex c eed th e a m o un t or rat e auth orised U nderwrit ing

.

S h ares m eans th at upon an issu e of S h ares t o th e p ub li c

, ,

c ert ain persons ent er in t o c on tra ct s with th e c o m pan y ,

th at in th e e v ent of th e p ubli c no t sub s c ri b ing for th e

whole of th e issu e th e y th e underwrit ers will sub
, , ,

sc ri be for and t ak e u p th e re m ainin g s h ares For exam ple

.
,

suppose th e c ase of a c o m pan y m a kin g an iss u e of

1 S h ares t o th e p ubli c th e wh ole issu e b ein g under wri tt en
,

by V ariou s indi v idu als wh o were en ti tled t o an under

wri t in g c o mm ission of 5 per c en t upon th e Sh ares under
.

writt en by each if th e p ub li c applied for sa y , ,

s h ares th e under wri t ers w o uld h av e t o t ak e up th e

,

re m aining s h ares b e tw een th e m pro ra ta Th e .

c o mm ission paid t o th e m is for t akin g this risk and it is ,

pa ya ble wh e th er th e y a ctu all y h a v e t o t ak e u p Sh ares or

no t Th e au dit ors mu s t see th at an y under writ in g c o m
.

mission is prop erly auth orised by th e Art ic les and h as ,

been disc losed in th e prospectu s ; th e y mu s t also in spect

th e under writ in g c on t ract with ea ch underwrit er and see ,

th at th e underwri t ers t ak e up th e re m aining s h ares if th e

issu e is under sub sc rib ed C o mm issions for pla c in g S h ares
-
.

are paid t o persons wh o in troduc e sub sc ri b ers in wh ich ,

c ase th e person c lai m in g th e c o mm ission Sh o uld init ial or

m ar k th e applic at ion le tt er of th e sub sc rib er and th e ,

au di t ors S h o uld exa m ine th e m ar k ed appli c at ion le tt ers

and th us ch eck th e c o mm ission pay able C o m panies .

h av e al ways b een en t it led t o pay a b ro k erag e upon Sh ares ,

1 40 THE PR I NCI PL ES O F AU D ITI N G

much of th at s h are c apit al as is for th e t im e be ing paid

up for th e period and sub j ect to th e c ondit ions and
res trict ions in th is sect ion m en t ioned and m a y ch arge
,

th e sa m e t o c apit al as part of th e c os t of c onst ruct ion of

th e w or k or building or the pro visions of plan t
, .

S uppose for exa m ple th e c ase o f a c o m pan y form ed t o

, ,

c arry o n a m anufa ctu ring bu siness th e fa ct ory h avi ng t o

,

be ere ct ed rs t U nt il th e fact or y is c o m ple t ed th e

. ,

c o m pan y c anno t t rade and can earn no prot s and , ,

th erefore th ere c an b e no possib ility of pa ying dividends

,

t o th e s h are h olders u pon th eir c apit al I n such c ir cum

.

st an c es it is c onsidered onl y fair th a t u pon th e c apit al

, ,

adv an c ed by th e S h are h olders Spe c ially for this p urpo se ,

th e y s ho uld rec eiv e in t eres t during th e period of c on

st ruct ion and this c an b e paid pro vided th a t th e t er m s of
,

this S ect ion are c o m plied wi th Th e in t eres t thu s paid is

.

paid out of c apit al and is de b it ed t o th e B uilding Acc o un t ,

as part of th e c ost of c ons t ruct ion Th e pro v isions th at

.

h a ve to b e c o m plied with are as follo w s

( 1) N o such pa ym en t s h all b e m ade u nless th e sa m e
is auth orised by th e A rt ic les or by spe c ial resolut ion
( 2)
!
N o s uch paym en t wh e th er a uth orised by th e
,

A rt ic les or by spec ial resolut ion s hall b e m ade wi th out

,

th e pre v iou s san ct ion of th e Board of Trade

( 3) Before san ct ioning an y such pa ym en t th e Board
of Trade m a y a t th e exp ense of th e c o m pan y appoin t
, ,

a person t o en quire and report t o th e m as t o th e C ir cum

s t an c es ofth e c ase and m a y b efore m aking th e appoin t
, ,

m en t re quire th e c o m pan y t o gi v e securi ty for th e

,

pa ym ent of th e c ost s of th e en quir y

( 4) Th e pa ym en t s h all be m ade only for such
period as m a y b e de t erm ined by th e Board of Trade ;
and such period S h all in no c ase ext end be y ond th e
c lose Of th e half y ear nex t aft er th e h alf y ear during
- -

whi ch th e w ork s or building s h a v e b een actu ally

c o m plet ed or th e plant pro vided ;
( 5)
!
Th e ra t e of int eres t s h all in no c ase ex c eed fo ur
 T HE C O MPANI ES (
C N
O I ATI O N ) ACT
S OL D , 1 908 141

per c en t per ann um o r such lo w er ra t e as m ay for th e

.

t im e being be presc ri bed by O rder in C o un c il ;

6)( Th e pa ym ent of th e in t eres t s h all no t operat e
as a reduct ion of th e a m ou n t paid up on th e s h ares in
respect of which i t is paid ;
7)( Th e acc o un t s of th e c o m pany Sh all S ho w th e sh are
c apit al on which and th e rat e at whi ch int eres t h as
, ,

b een paid out of c apit al during th e period t o which th e

acc o un t s rela t e .

It will b e seen fro m th e a b o v e th at th ere are v ery s t ring ent

regula t ions g o vern in g this m a tt er and th at such pa ym en t s
,

of in t erest o ut of c apit al are c on t rolled by th e Board of

Trade .

I n c ases wh ere in t eres t is paid in this w ay an au dit or ,

mus t see th at all th e pro visions of S ect ion 9 1 h av e b een

c o m plied with .

S ta tu to ry B o o k s .

Ev ery c o mpan y reg ist ered under th e C o m panies Act s ,

1 908 t o 1 9 1 7 mu st k eep th e follo win g b oo k s

( (
,

1 ) R egist er of Mem b ers S ec 25 of th e C o m panies

(
.

C onsolida t ion ) Act in whi c h mu s t b e en t ered th e

,

na m es addr esses and occupat ions of all th e m e mb er s of

, ,

th e c o m pan y th e s h ares h eld by each th e dis t in guis hing

, ,

n umb ers and th e a m o un t paid or a greed to b e c onsidered

,

as paid on such S h ares ; also th e dat es at which each

perso n w as en t ered in th e regist er and th e da t e at which ,

an y person c eased t o b e a m e mb er U nder S ect ion 26 in .

a separat e par t Of th e R egist er o f Me mb ers th e a nn u al ,

lis t of m e mb ers and s umm ary h as t o b e en t ered .

Th e R egist er Of Me mb ers is Open t o th e inspe ct ion of

an y m e mb er grat is and t o th e inspe ct ion of an y o th er
,

perso n on pa ym en t of a fee not exc eedin g ls for each

( (
.

inspect ion S ec 30
. C o mpanies Consolida t ion ) Act
. , ,

(
2) Minute (
S ec 7 1 Co mpanies Consolidat ion )
Boo k .
, (
Act , in whi ch mu s t b e ent ered m in ut es of all
1 42 THE PR I N C I PL ES O F AU D ITI N G

proc eeding s a t e v er y m ee t ing of th e s h are h olders and

dire ct ors or m anag ers of th e c o m p an y
( ( (
.

3 ) R egist er of D ire ctors S ec 7 5 C o m pan ies C onsoli

(
.
,

dat ion) Act 1 908 ; and C o mpanies Part i cul ar s as t o

,

Direct ors) Act , in whi ch mu st b e ent ered th e follo w

in g p art icular s r espect ing ea ch direct or present Christ ian
na m e or na m es and s urna m e ; any for m er Christ ian na m e
or na m es and sur na m e ; nat ionality ; nat ionali ty of origin
(if oth er th an th e present nat ionality) ; u su al residen c e ;
occupat ions A c op y of s uch re gist er h as t o b e sen t t o
.

th e Regis t rar of C o mpanies

( (
.

4 ) R egist er of Mortgages and Char ges S ec 1 00

(
. ,

C o m panies C onsolida t ion ) Act , I n this regis t er

part iculars of e v er y m ortgag e or ch ar g e Spec i c ally affe ct ing
property of th e c o m pan y mu st b e en t ered g iving in ea ch , ,

c ase a s h ort des c rip t ion of th e property m ortgag ed or

,

ch arg ed th e a m o un t of th e m ortg ag e or ch arg e and

(
, ,

ex c ep t in th e c ase of securit ies to bearer) th e n am es of

.

th e m ortg agees or persons en t it led th ere t o Th e regist er .

is open t o th e inspe ct ion of an y person on paym en t of a

fee no t exc ee ding l s for ea ch inspect ion
. .
1 44 THE PRI NCI PL ES O F AU D ITI N G

by c o m plying wi th c ert ain pro visions in th e Act and ,

c onsiderab le rest rict ions are pla c ed in th e w a y of such

alt era t ions Im port an t ones such as a reduct ion of
.
,

c apit al or alt erat ion of th e o b j e ct s O fth e c o m pan y require

, ,

th e san ct ion of th e C o urt ; and s h areh olders deb enture ,

holders and c re dit ors wh o m ay b e a ffe ct ed by th e al t era

,

tions are en t it led t o pla c e th eir Vie w s b efore th e C o urt

, .

Th e Me m orandum of A sso c iat ion m ay b e said t o g o v ern

th e ext ernal affairs of a c o m pan y and e v ery c lau se is of
,

in t eres t and im port an c e t o all persons en t erin g in t o

bu siness relat ions with a c o mpan y .

Ar ticles of A s s o c iatio n .

A c o m pan y need no t h av e a spe c ial set of Art i cles and

(
,

th e C o m panies C onsolida t ion ) Act 1 908 c on t ains a m odel

, ,

se t of Art ic les kno wn as T a ble A which go v ern all c o m ,

panies for whi ch spe c ial A rt i c les h av e no t b een dra wn u p .

B ut upon for m a t ion a c o m pan y m a y ex clu de th e wh ole

, ,

or part s of th e pro visions of T a ble A and sub s t itut e ,

th erefor it s own Spe c iall y dra wn Art icles A n au dit or .

mu s t see wh e th er T a ble A or part s th ereof h av e b een

, ,

thu s ex clu ded for h e mu s t b e fa m iliar wi th th e exact

,

regula t ions th a t g o v ern th e par t icular c o mpan y .

Th e Art i cles of A sso c iat ion g o vern th e in t ernal a ffairs

of th e c o m pan y and an a u di t or mu s t see th a t th e t er m s
,

th ereof are c o m plied with Th e Art i cles can b e alt ered

.

a t an y t im e by a spe c ial resolut ion of th e S h are h olders .

Th e follo win g are exam ples of m att ers th a t are go v erned

by th e t er m s of th e Art ic les
Th e right s of s h are h olders inter se .

C alls on s h ares .

Th e forfeiture of s h ares on a cc o un t o f th e non pa ym en t -

of c alls .

Al t erat ions of c api t al .

Th e appoin tm en t of a m anagin g direct or .

Th e appointm ent of direct ors .

Th e po wers and dut ies of dir ect ors .

 AU D IT OF C O MPAN IES U N DER THE C O MPAN IE S AC T S 1 45

Th e dec larat ion of di vidends .

Th e acc o un t s and au dit .

Th e bo rro wing po wers .

Th e pa ym ent s of underwrit in g c o mm issions and ,

c o mm issions on pla c ing sh ares .

Th e pa ym ent of int eres t out of c apit al during

c ons t ruct ion .

Ex am in atio n Of L egal D ocum en ts Pr ior to th e

C om m en c em en t o f th e Au d it o fa C o m p an y .

Before c o mm en c in g th e au di t of a c o mpan y an a u di t or ,

s h o uld exa m ine c arefully th e Me m orandum and Art ic les

of A sso c ia t ion and h e S h o uld m ak e no t es in his audit
,

no t e b oo k of all im port an t pro visions wi th th e t erm s of

-
,

which h e mus t be familiar while c onduct ing his au di t .

I n th e sam e way h e S h o uld examine th e prospectu s and

(
th e c on tract of sale if an y ) with th e v endors and fro m ,

th e latt er h e will asc ert ain th e p ur ch ase pric e parti culars ,

of th e asse t s th a t are b eing acqu ired and th e lia b ilit ies

(
,

if an y ) th at are being t ak en o v er It th en mus t b e seen .

th a t th e openin g J o urnal en tri es are c orrect and in accor

dan c e with th e c on tra ct and also th a t th e v ario us t erm s
,

o f th e la tt er are c arried o ut I n th e c ase of a c on t inuing

.

c o m pan y th e pre vio us y ear s B alan c e S h ee t and au dit or s

,

report s h ould be examined .

S h ar e C ap ital .

Th e sh are c apit al of a c o m pan y is often di vided in t o

preferen c e and ordin ary s h ares and th e right s of th e ,

respect iv e S h are h olders are g o v erned by th e t er m s o f th e

Art ic les Th e preferen c e s h ares as a rule are ent it led t o a
.
, ,

xed di vidend out of th e prot s th e surplu s prot s aft er,

th e pa ym en t of th e dividend on th e preferenc e Sh ares

belong ing t o th e ordin ary s h are h olders It depends upon .

th e t erm s of th e Art ic les wh eth er th e preferen c e S h ares also

c arry a preferent ial ri ght as reg ards capit al th at is t o sa y , ,

wh eth er in th e e v en t of li quida tion th e preferen c e S h are

, ,

holders are en ti tled t o the re tu rn of th eir c apit al b efore

w"(
1 5 2 4)
 1 46 THE PRI N C I PL ES OF AU D ITI N G

th ere is an y re tu rn on th e ordin ary Sh ares Th e Art ic les .

mus t expressl y pro vide th at th e preferenc e s h ares are t o

b e preferent ial as t o c apit al o th er w ise th e y rank equall y
,

w ith th e or dinary s h ares in this respect Th e preferen c e

s h are h olders right s t o di vidend m ay be eith er cumulat iv e

or non cumula t iv e ; if cum ula t i v e

-
it m eans tha t in th e
,

e v en t Of th ere no t b ein g suf c ien t prot s in an y y ear t o

pa y th e preferen c e di vidend s uch arrears h av e t o b e ,

m ade u p in an y future y ears wh en th e prot s are su cient ,

and thu s th ere c an b e no di vidend paid upon th e

ordin ary un t il all s uch arrears upon th e preferen c e s h ares
h av e b een paid I f non cumulat iv e th e preferen c e s h are
.
-
,

h olders are ent itled t o a xed di vidend o ut of th e prot s

of ea ch y ear and if s uch are in su icient th en th ere is no
, ,

ri ght t o m ake u p s h ort ag es out Of th e s urplu s prot s of

future y ears All preferen c e s h ares are cumulat iv e
.
,

unless th e Ar t i cles spec iall y pro vide th at th e y Sh all b e

n on cumula t i v e
-
.

Is su e of S h are s .

I n th e ordin ary c o urse th e rs t s t ep in th e raisin g of

,

s har e c apit al is th e iss u e of a prospe ctus in vit in g applica

t ions for sh ares s uch prospe ctu s bein g adv ert ised in
,

ne wspapers and c ir culat ed through s t o ckb ro k ers an d

,

o th ers c onne ct ed with or in t eres t ed in th e c o mpan y .

As a ru le appli c a t ions for s h ares h av e t o be s en t in on

,

Spe c ial for m s dire ct t o th e c o m pan y s b ank ers accom

,

p an ied by a deposi t th e b ank er,se nding th e appli c an t a

rec eip t th erefor Th ese appli c a t ions are n umb ered and
.

en t ered in an Applic at ion and Allo tm en t Boo k and in ,

due c o urse are c onsidered by th e direct ors wh o th en allo t ,

s h ares t o th e applic an t s I f m ore s h ares h a v e b een applied

.

for th an are b ein g iss ued a cc or din g t o th e prospectu s th e ,

dire ct ors m ak e a sele ct ion and refu se c ert a in ofth e app li c a

t ions no t i c e of this fact b ein g sen t t o th e appli c an t by
,

m eans of wh at is kno wn as a L e tt er of R egret and a t ,

th e sam e t im e th e deposi t pai d is re turned In o th er .

1 48 THE PR I N C I PL ES O F AU DITI N G

(8) S ee th at th e t o t al s hares iss u ed do no t exc eed th e

t o t al auth orised c apit al a cc ording t o th e Me m orandum
(
.

9 ) S ee th a t th e m inimum s ub sc rip t ion upon whi ch

th e c o m pan y m ay pro c eed t o allo tm en t h as been applied
for
(
.

1 0) V o uch th e ope in g J o u rn l en t i es i th e
n a r n n an c ial
b oo k s
(
.

1 1 ) Ch eck th e b alan c es th e Sh e L edg er on t o th e ar

s ch edule seein g th at th e to t al agrees wi th th e t o t al

,

n um b er of s h ares iss u ed
(
.

1 2) I f s h ares h a v e b een issu ed for c onsidera t ion o th er

th an c as h see th e c on tra ct s and th e m in ut es adop t ing
,

th e m and as c er t ain th at s uch c on tract s h a v e b een

,

led with th e Reg is tr ar of Co m panies

(
.

1 3 ) I f th e iss u e h as b een under wri tt en see th e con ,

tra ct s with th e underwrit ers and if th e iss u e is not fully

, ,

sub sc ri b ed th e direct ors min ut es allo tting th e b alan c e

,

of th e S h ares t o th e under wri t ers U nder wri t ers as a .

,

rule have t o Si gn appli ca t ions for th e n umb er of s h ares

,

th e y underwrit eif so inspe ct th ese V o uch th e , .

J o urnal en t ries
(
.

1 4) I f plac ing c o m missions and b ro k erag es are paid ,

ch eck th e a m o un t s p aid wi th s t am ped or m ark ed appli

c at ion form s I nspect th e rec eip t s fro m persons re c eiving
.

such c o mm issions and b ro k erag es

(
.

1 5 ) As a rule th e a u di t ors are re qu es t ed t o ch e c k and

,

init ial th e s h are c ert ic at es before th e y are Sig ned and

sealed by th e direct ors
(
.

16 ) U pon c alls b ec o min g pay ab le th e de t ail am o un t s ,

du e will b e ent ered in a C all Book or in spec ial c olum ns ,

in th e A ppli c ation and Allo tm en t Boo k and th ese en t ries ,

will b e C h eck ed in th e sa m e w a y as th e allo tm en t th at is , ,

with th e direct ors min ut e th e C as h Boo k and Pass

,

Boo k and t o th e Sh are L edg er

(
.
,

1 7 ) I f th e s h are c er t ic a t es h av e b ee n iss u ed th e ,

re turned allo tm en t le tt ers and b an k ers rec eip t s S h ould

b e ch eck ed with th e Sh are L edg er .

 AU D IT O F C O MPAN IES UN D ER THE CO MP AN IES ACTS 1 49

An au dit or must au di t th e s h are boo ks upon an iss u e of

sh ares and wh en c alls are m ade in order that h e m ay
, ,

sa t isfy him self th at th e whole of th e m one y du e h as b een

a cc oun t ed for I n s ub se qu en t y ears ho w e v er it is no t
.
, ,

part of his duty t o c arry out a t ransfer au di t all th at is ,

nec essary being th a t th e b ala n c es upon th e S h are L edg er

s ho uld b e ch ecked on t o a lis t O f b alan c es it being seen ,

th at th e t ot al th ereof agrees with th e t o t al issu ed c api t al .

Audit ors are oft en ins truct ed t o c arry o ut transfer au di t s ,

but this is a m a tt er of spec ial arrange m en t and one for ,

whi ch th e au di t or is en ti tled t o a spec ial fee Th e proc edure .

a t a transfer au di t s h o uld be as follo ws

1 ) Wh en tr ansfers are rec ei v ed th e transferor s h o uld
,

be no t ied imm ediat el y so th at in this w ay frau dulen t

,

transfers m ay b e det ect ed I f this s ys t e m is in forc e

.
,

ch eck th e dupli c at e c opies of such no t ic es t o th e Transfer

R egis t er and en quire as t o wheth er an y o bj ect ions h av e
,

b een re c eiv ed .

( 2) Ch eck t ransfers wi th th e T ransfer R egis t er seeing ,

th at transfers h a v e b een properly Si gned wi t nessed and ,

s t a m ped and ch eck th e dis tin ct iv e n umb ers of th e

,

Sh ares in t o th e R egis t er Th ereaft er c an c el th e transfer

.
,

with th e au dit or s au di t st am p

w
.

( 3) V erify th e signa tures of transferors i th pre vio u s

t ransfers or appli c at ion lett ers .

( 4 ) Ch eck old c ert ic at es with transfers and th ereaft er ,

c an c el th e c erti c a t es .

( 5 ) Ch eck en tri es in Transfer R egis t er t o th e c re dit of

th e transferor s acc o un t in S h are L edg er seeing th at

,

he h as th e s h ares and ch ecking th e dis t in ct iv e numb ers

, .

( 6 ) Ch eck en tri es in Transfer R eg is t er t o de b it of

t ransferee s acc o un t in Sh are Le dg er

.

( 7 Ch eck and ini t ial ne w c ertic at es and if t ransferor ,

h as no t sold th e wh ole of h is s h ares ch eck and init ial ,

balan c e c ertic at es issu ed t o him .

1 50 THE PRI NCI PL ES O F AU D ITI N G

(
8 ) At
s ubsequ en t au dit s see th e dire ct ors m in ut e
,

passing th e transfers pre vio u sl y ch e ck ed .

Tr an sfer Fees .

C o un t th e n umb er of transfers and see th at th e wh ole

,

of th e t ransfer fees h as b een a cc o un t ed for .

D eb en tures .

Upon an issu e of de b en tures th e allo tm en t e tc will b e

, , .
,

ch e ck ed in exactly th e sa m e w ay as an allo tm en t of s h ares .

Th e au dit or mu st see th at th e Art ic les gi v e th e direct ors

po w er t o b orro w m one y in this w a y and h e s h o uld exa m ine
,

th e direct ors m inut e exer c isin g th at po w er Th e a ctual

.

de b en ture or t ru st deed s h ould b e exa m ined in order th at ,

th e exa ct t er m s of th e issu e m a y b e asc ert aine d It mu s t

furth er b e seen th at th e ch arg e g iv en by th e de b en tu res
upon th e asset s Of th e c o mpan y is en t ered in th e R egist er
of Mortg ages and Ch ar ges in a cc ordan c e wi th S ect ion 1 00

(
,

o f th e C o m panies C onsolida tion ) Act 1 908 and th at th e , ,

nec essary part iculars h a v e b een led with th e R egis t rar

of C o m panies .

Th e en tries in th e n an c ial b oo k s s h o uld b e ch e ck ed ,

and if deb en tures are issu ed a t a disc o un t th e full no minal ,

a m o un t mu s t b e c redit ed t o th e De b en ture Acc o un t as ,

th at is th e a ctu al a m o un t of th e liab ility th at w ill h av e t o

b e repaid and th e am o un t ofth e disc o un t mu s t b e de b it ed
,

t o a separat e a cc o un t I f this dis c o un t is wri tt en o ff t o

.

Prot and L OSS Acc o un t o ver a period th e am o un t c arried ,

forw ard mu s t b e s h o wn as a separa t e it e m in th e Balan c e

Sh ee t t o c o m ply wi th th e t er m s of S e ct ion 90 of th e
(
,

C o m panies C onsolidat ion ) Act 1 908 Th e disc o un t upon

, .

de ben t ures s hould b e writt en O ff t o re v en u e as soon as

possible but subj ect t o th e pro visions of th e Art ic les of
, ,

th e p art icular c o m pan y an au dit or c o uld raise no o b j e ct ion

, ,

if th e disc o un t w ere writt en O ff o v er th e period of

th e de bentures S hares can ne v er be iss u ed a t a disc o un t
.
,
1 52 THE PR I N C I PLES O F AU D ITI N G

repay a ble a t th e end of t en y ears at a pre m i um of 5 per

c ent th e B alan c e Sh eet at th e c o mm en c e m en t of th e
.
,

period b eing as follo ws

B AL AN C E S HEET
C pi t
a a l S und ry A ssets
D eb en tures
a t th e en d o
(
re
f
p y bl
teny
a a e
ea rs

at 1 05 )

A sin k in g fu nd is c reat ed t o pro vide th e a m o un t

re quired and th e Balan c e S h ee t a t th e end of th e period
,

w ould b e as follo ws
B AL AN C E S HEET
C pi t
a a l S un d ry A ssets
D eb en tu res I n v estm en ts o n a cco u n t
S i nki ng Fu nd o f S i n ki n g F u n d

Th e De b en ture
Acc ou n t no w s h o uld b e c redit ed with
5 00 th e a m ou n t of th e pre m ium pay a ble this a m ou n t
, ,

b eing de b it ed t o th e S in kin g Fund Acc o u n t I f th e .

in v estm en t s re alised c os t th e exa ct sum re quired t o pa y

,

of f th e de b en tures at th e pre m ium w o uld b e produc ed , ,

and aft er s uch repa ym en t th e Balan c e S h ee t w o uld b e

, ,

as follo ws

B A L AN C E S HEET

6
S un d ry Assets
:
C pi t
a a l
S i nkin g Fu n d Accou n t
(n o w a gen era l reserv e
o f th e co m p a ny)

It will b e seen th at alth o ugh h as b een pro v ided

,

o v er th e period only re m ains upon th e S in k in g

,

Fund Acc o un t aft er th e repa ym en t of th e de b en tures .

 AU D IT O F CO MP AN IES UN DER THE C O MP AN IES ACTS 1 53

Th e reason for this is th at th e 500 pre mi um is a ch arg e

,

ag ains t th e pro t s in exa ct l y th e sa m e w a y as is th e in t eres t

paid upon th e de b en tures and wo uld h a v e h ad t o be

,

ch arg ed ag ains t rev enu e in an y ev ent but th e pro vision ,

of th e is an appropria t ion of prot s and is a

v olun t ary act by which prot s av aila b le for dis t ri bution
h av e b een re t ain ed in th e bu siness an d use d t o pay o ff
a c apit al lia bility or in o th er w ords th e s h are h olders
, , ,

h a v e inv es t ed of th eir prot s in th e c on c ern

inst ead of with drawin g th e sa m e thu s m ak ing th e t o t al ,

a m o u n t o win g t o th e m by th e bu siness inst ead

of th e ori gin al c apit al .

D eb en tur e s Is s u e d as C ollate r al S ec u r ity .

De b en tures oft en are issu ed t o c redit ors of a c o m pan y

t o secure loans and o verdraft s For exam ple suppose th e . ,

c ase of a c o m pan y b orro win g fro m it s b ank ers ,

and as se curity for th e repaym en t Of this sum iss uing

, ,

de b en tures as c olla t eral securi ty I n th e B alan c e .

S h eet th e b ank s h ould b e s h o wn as c redit ors for th e

,

loan of and ag ainst this it e m s hould appear a not e

in respe ct of whi ch de ben tures h av e b een issu ed

as c olla t eral secu ri ty Th e posit ion is th at th e prim ary
.

lia b ili ty of th e c o mpan y t o th e b ank is th e loan of

and th e de b en tures h eld by th e b an k are dorm an t and no ,

in t eres t is paid th er eon but if th e c o m pan y default ed

, ,

th en th e b ank c o uld t ak e up th e de b en tures and wo uld

rank as de b en ture h olders for b ein g ent i tled t o
th eir proport ion of th e securi ty gi v en t o th e wh ole de b en ture
issu e I f a rec ei v er w ere appoint ed for th e de b enture
.

h olders wh o e v en tu all y paid 205 in t h e th e b ank wo uld

, .

rec ei ve o ut of which it w ould retain th e loan of

7, 000 in t eres
, t t o da t e and c os t s and re tu rn an y s urp l us
,

t o th e c o m pan y
(
.

An audit or sh o uld see th e loan agree m en t if an y) and

.

th e direct ors m in ut e iss uing th ese deb entures for th is

p urpose and h e mus t see tha t th e posit ion is s ho wn

,
1 54 THE PR I N C I PLES OF A UDITI N G

c orrect ly in th e Balan c e S h ee t He S h o uld also as c ert ain

.

th at th ese de b entures h a v e b een ent ered in th e R egist er

of Mortg a g es and Ch arg es and en quire as to wh e th er th e
,

nec essary p ar t iculars h av e b een led with th e R eg is trar

of C o m panies .

Pr elim in ary Ex p en s e s .

U pon th e for m at ion of a c o m pan y th ere are v ario u s

init ial expenses i n c onne ct ion wi th th e form at ion and th e
o bt aining of th e s h are c apit al th at are de b it ed t o a Pre
,

lirninary Expenses Acc o u n t . An au dit or s h o uld refer t o

th e c ontr a ct with th e vendors t o see wh e th er th e y h av e
t o b ear th e wh ole or an y part of th ese expenses and if , ,

so, h e mu st see th at th e c o mpany does no t b ear an y

expenses th a t are pay a ble by th e v endors .

Th e au dit or s h o uld c arefully exa m ine and V o uch th e

it e m s de b i t ed t o th is a cc oun t and thu s sat isfy h i m self
,

th at th e y are a proper ch ar g e t o Prelim inary Expenses

Acc o un t. U nder this h eadin g w ill b e in clu ded th e
follo win g I

L EG A L C HA R GES in c onne ct ion with th e prepara t ion of

th e Me m orandum and Art ic les of Asso c iat ion th e pros ,

pectu s and th e c on t ra ct s wi th th e v endors and th ese will ,

b e v o uch ed by th e product ion of th e solic it ors re c eip t ed

b ill of c ost s
.

C O S T S O F PR INTIN G th e Me m orandum and Art ic les of

A sso c iat ion and th e prospe ctu s wh i ch will b e v o uch ed
, ,

by th e product ion ofth e print ers re c eip t ed bill of c os t s

.

CO S T S O F A D VER TI S IN G th e prospe ctu s whi ch will b e,

v o uch ed with th e re c eip t s fro m th e new spapers or if , ,

done through an ag ent with his re c eip t ed a cc o u n t

, .

S TA MP DUTI ES pa ya b le upon reg ist ra t ion which pro ,

b a bly will b e p aid by th e soli c it ors and will th erefore

, , ,

appear in th eir bill o f c ost s Th e a m o un t can b e v eried

.

by an exam inat ion of th e c ert i c at e of inc orporat ion upon ,

whi ch th e dut ies paid are st a t ed .

REPO R T S FR O M E N G IN EER S A C C O UNTANT S ETC for

, , .
,
1 56 THE PR I N C I PL ES O F AU D ITI N G

p ur chased and paid for out of th e s h are c apit al of th e ne w

c o m pan y and if wh en rec eiv ed such prot w ere paid
, , ,

a wa y as di vidend it would am o un t t o a re tu rn t o th e
,

s h are h olders of part o f th e c apit al th e y h a v e th e m sel v es

c on tri but ed .

I f as is cu st o m ary no a cc o un t s are t ak en a t th e da t e
, ,

of in c orporat ion it is al wa ys dif cult t o arriv e a t th e

a m o un t of th e prot s th a t h a v e t o b e tr ea t ed as c apit al .

I f for exam ple in th e c ase a bo v e th e nex t a cc o un t s w ere

, , ,

prepared at th e follo wing S lst D ec e mb er th e b e tt er m e thod ,

wo uld b e t o apport ion th e full y ear s prot s b etw een th e
two periods b efore and aft er th e l st March on th e b asis
, ,

of th e turn o v er for th ese tw o periods Ano th er m e th od .

is t o apport ion on th e b asis of t im e th at is t o say in th is , ,

c ase th at tw o m on th s out of th e twelv e are prior t o

,

in c orpora t ion ; th erefore one sixth of th e full year s

,
-

prot is c apit al ; but as th e prot s earned in differen t

,

perio ds of a y ear m a y v ary c onsidera bly this m e th od in , ,

m an y c ases is no t a good on e t o adop t Th e proport ion

, .

o f th e f ull y ear s pro t th a t is xed as b eing prior t o th e

da t e of in c orpora t ion s h o uld b e transferr ed fro m Prot

and L oss Acc o un t t o th e c re dit of a C apit al R eser v e
Acc o un t or u sed t o writ e do wn prelim inary expenses or
,

g oodwill I f an y in t eres t is paid t o th e v endors upon th e

.

p urch ase m one y th e in t erest for th e period prior t o th e

,

da t e of in c orpora tion s h o uld be de b it ed ag ainst th e prot s

prior t o th at da t e and an y in t eres t for th e period aft er
,

th e da t e of in c orporat ion Sh o uld be de b it ed t o Prot and

L OSS Acc o un t .

I n th e ab o v e c ircum st an c es an au dit or s h o uld exa m ine

,

th e wh ole fact s m ost c arefully and see th at th e prot s ,

prior t o th e da t e of in c orpora t ion are asc ert ained as

a ccurat el y as possible and are no t m ade a v ailable for
,

dividend or u sed for re v en u e p urposes .

C alls in Arr e ar .

I f an y calls h av e not b een paid a deb it b alan c e will ,

appear u pon th e C all Acc o un t in th e Im person al L edg er ,

 AU D IT O F C O MPAN IES UN DER THE C O MPAN IES A C TS 15 7

and th e de t ails m akin g up this b alan c e will be asc ert ain ed

by referen c e t o th e Sh are L edg er Th ese unpaid c alls.

Sh o uld be b ro ught to th e no t ic e of th e dire ct ors by th e

au dit or wh o Sh o uld see th at th e t o t al thereof is s ho wn
,

as a deduct ion fro m th e iss u ed c api t al in th e B alan c e

S h ee t.

C alls P aid in A d v an c e .

An y c alls paid in adv an c e s h ould appear t o th e c redi t o f

a sp ec ial a cc o un t or as c redi t b alanc es u pon C all Acc o un t s
, ,

and th e au dit or s h o uld v erify th e details m ak in g up th e

t o t al by referenc e t o th e S h are Ledg er Th e t o t al of th e .

c alls paid in adv an c e s h o uld appear as a separat e it e m in

th e Balan c e Sh ee t .

Fo rfeite d S h ar es .

S h ares m ay b e forfeit ed for non paym ent of c alls if -

,

express po w er t o this effect is c on t ained in th e Art ic les .

I n c ases wh ere sh ares are forfeit ed in this w ay an au dit or ,

mu st see th at th e Arti cles gi v e th e direct ors this po w er ,

and furt h er th at th e pro visions of th e Art icles h a v e b een

, ,

c arried o ut as reg ards gi vin g th e defaul ting s h are h older

proper no t ic es Th e minut e of the direct ors forfeit ing
.

th e s h ares mu s t b e inspect ed and it mu st b e seen th at th e

,

c orrect en t ries h av e b een m ade in th e n an c ial b oo ks t o

rec ord th is transa ct ion and th at th e S h are L edg er h as
,

b een adj us t ed acc ordingl y Th e a m ou n t c alled up u pon

.

th e sh ares forfeit ed mu s t be de b it ed t o Sh are C apit al

Acc o un t and c redi t ed t o a Forfeit ed S h ares Acc oun t ;
and th e de bit b alan c es upon th e C all Acc o un t s whi ch ,

represen t th e c alls du e u po n th ese S h ares but unpaid ,

S h o uld b e writt en o ff t o th e de b it o f th e Forfei ted S h ares

Acc o un t ; th e la tt er acc o un t will then Sh o w a c redit b alan c e
eq uallin g and represen t ing th e am o un t paid Up u pon th e
Sh ares forfeit ed I f th ese Sha res are re iss u ed a t a disc o un t
.
-
,

whi ch c an be done pro vi ded th e disc o un t does no t exc eed

th e am o unt already paid upon th e s hares by t h e old
s h are holder an y such disc o un t s hould be de b it ed t o the
,
1 58 THE PR I NCIPLES O F AU D IT I N G

Forfei t ed S h ares Acc o un t and if th ereaft er this a cc o un t

, , ,

S ho w s a c re dit b alan c e this represen t s th e nal prot upon

,

th e forfeiture whi ch prot s h o uld b e transferred t o g eneral

,

reserv e or u sed t o writ e do wn prelim inary expenses or

,

xed asse t s B ut th ere is no thing in th e Co mpanies Act s

.

t o pre v en t this prot b ein g c redit ed t o Prot and L O S S

Acc o un t sub j ect of c o urse t o an y res tri c tions pro vided
, , ,

in th e Art icles of th e part icular c o mpan y I f a t th e da t e .

,

of th e B alan c e Sh ee t th e S hares h a v e no t b een re iss u ed

,
-
,

th e au dit or S ho uld see th at th e c redi t b alan c e upon th e

Forfeit ed Sh ares Acc o un t is s h o wn as a separat e i t e m in
th e B alanc e S h ee t b ein g desc ri b ed as a m o un t s paid up
,
!

upon s h ares forfeit ed .

D ir e cto r s
Fee s .

As r eg ards th e v o uching of dire ct ors fees th e A rt ic les

,

sh o uld be inspect ed and th e pro visions th ereof c arefully

no t ed Th e a m o un t Of th e fees m a y b e xed by th e
.

Art icles or i t m ay b e left t o th e s h are h olders t o v o t e th e

,

a m o un t in which latt er c ase th e s h are h olders m in ut e S h ould

,

be exa mined O n th e o th er h and dire ct ors are so m e

.
,

tim es paid by th e a tt endanc e in whi ch c ase th e Dir ect ors ,

Att endan c e Boo k mu s t b e inspect ed and th e n umber Of ,

a tt en dan c es of ea ch direct or c o un t ed Th e a u dit or s h o uld .

also exam ine th e R egist er of Direc t ors and Manag ers t o ,

as c ert ain wh o are th e dire ct ors of th e c o m pan y and h e ,

s ho uld th en see th a t ea ch dire ct or rec eiv es only th e a m o un t

properly du e t o him R ec eip t s s h ould b e o bt ained th o ugh
.
,

oft en endorsed ch equ es only are produc ed t o th e a u dit or ,

and if t h e si gna tures are kno wn th ese m a y b e c onsidered ,

su icient.

I f th e I n c o m e T ax upon th e direct ors fees h as b een

paid by th e c o mpan y such t ax mus t b e deduct ed fro m

,

th e fee s wh en paying th e direct ors th ough no wada ys th e , ,

direct ors are g enerally assessed for I n c o m e T ax dir ect in

respect of th eir fees in wh ich c ase th e c o m pa n y pa ys the
,

fees in full Th e I nc o m e T ax upon direct ors fees mus t

.

1 60 THE PR I N C I PL ES O F AU D ITI N G

direct ors seein g th at th e re munera t ion paid is in a cc ordan c e

,

th ere with I f th ere is a c on t ra ct with th e m an ag ing

.

direct or this S h o uld b e inspect ed

, .

Min u te B o ok s .

It is m os t i mport an t th at an au di t or S h o uld in spect b o th

th e dire ct ors and th e S h are h olders m in ut e b oo k s for the

,

m in ut es are th e onl y auth ori ty for m an y of th e transa c tions

Of a c o m pan y and apart fro m t his by readin g th e min ut es
, , , ,

an au dit or oft en b ec o m es a w are of im port an t m a tt ers tha t

are t aking pla c e and which s h ould b e pro vided for in th e
,

a cc o un t s such as pendin g lit ig a t ion in c onne ct ion with

,

disp ut ed c laim s .

Th e follo w ing are exa mples of m att ers for which th e

S h are h olders min ut es are th e auth ori ty

Passing and adop t ion of th e a cc o un t s .

Transfers t o general reserv e .

D ec lara t ion of di vidends .

Appoin tm en t and re munerat ion of dire ct ors .

Appoin tm en t and re munerat ion of au dit ors .

Th e alt erat ion of th e Art ic les .

Th e follo win g are exa m ples of m att ers t o auth orise ,

whi ch direct ors m inut es are ne c essary

Th e issu e of Sh are c apit al .

Allo tm en t of s hares .

C alls.

Th e forfei tur e of s h ares .

A dop t ion of c on t ra ct s .

Appoin tm en t and re munerat ion of ofc ials .

D ec larat ion of in t erim di vidends and if a uth orised by ,

th e Art ic les nal preferen c e di vidends

, .

Appoin tm ent and re munera t ion of m an ag ing direct or .

D iv i d en d s .

Th e de c larat ion of dividends is v es t ed in th e s h are

holders exc ep t in th e c ase of in t erim di vidends and in
, ,

so m e c ases th e dividends u pon preferen c e S h ares in b o th ,

 AU D IT O F CO MP N ES
A I UN DER THE C O MP AN IE S ACT S 16 1

of whi ch c ases th e Art i c les so m etim es expressl y auth orise

the direct ors t o dec lare th ese Artic les often pro vide .

tha t th e direct ors s hall rec o mm end th e dividends t o be

dec lared by th e s hare h olders and that th e s har e h olders
,

S hall h a v e no po w er t o vo t e di vidends in ex c ess Of those

rec o mm ended by th e direct ors N o ent ries mus t be m ade
.

in th e book s or th e a cc o un t s un t il aft er a di vidend has

been dec lared and for this rea son di vi dends propo sed by
, ,

th e direct ors mus t no t b e in c lu ded in th e a cc o un t s presen t ed

t o th e s h areh olders ex c ep t by w ay of a no t e Imm edia t ely
, .

th e dividends are dec lared by th e Sh are holders th e en tri es ,

mus t be p assed thro ugh th e b oo ks for th e di vidend th en ,

b ec o m es legally pa ya ble .

I NTER IM D IVI DEN DS Th ere mus t bez express po wer in

.

th e Arti cles t o de c lare in t erim di vidends and an audit or ,

mu st th erefore inspe ct th e Arti c les and th e direct ors

, ,

min ut e dec laring th e dividend Before dec laring h o we ver

.
, ,

th e direct ors mus t u se reaso na ble c are in order t o sa tisfy

the m selv es th at such di viden d is j ustied and for this , ,

p urpo se acc o un t s for th e half year or period s ho uld be

,
-

prepared full pro vision being m ade for deprec iation

, ,

reserv es for b ad de bt s and o ut st anding s Th e c ondit ion

, .

of t rade and the prospe ct s of the c o ming half year or

,
-

period s h ould be c o nsidered for it is qui t e possi ble th a t

,

th e rs t h alf of th e y ear m ay S h ow a prot which m ay be ,

en tir ely s wallo w ed up by a loss in th e succ ee ding h alf y ear -

,

and it mus t b e re m emb ered th at an in t erim di vidend is

on a cc o un t of th e full y ear s prot s It s h o uld also be

.

seen th at th e c o mpan y h as suicient c as h a vaila ble t o

j u st ify th e dec lara tion of th e di vidend I f ask ed t o ad vise .

as reg ards th e dec lara t ion of an in t eri m di vidend an ,

au dit or s h o uld g o in t o all th e c ir cum st anc es m ost c arefull y ,

and see th at proper a cc o un t s ha v e been prepared and ,

tha t th e wh ole position h as b een adeq uat ely c o nsidered .

D IVI DEN D S O N PR EFERE NC E S HAR E S Th e Art ic les .

so me tim es gi ve th e direct ors po w er t o dec lare t h e di vidends

u pon th e preferen c e sh ares in w hi ch c ase again the y mus t
, , ,

I r (
-
s r z i)
1 62 THE PR I NCI PL ES O F AU D ITI N G

use e very pre c a ut ion t o see th a t th e a cc o un t s j u st ify s uch

div idends I f th ere is no such express po w er in th e
.

Art icles preferen c e di vidends lik e dividends u pon th e

, ,

ordinary S h ares can onl y be dec lar ed by th e s h are h olders

, .

V O U C HIN G D IVI DEN D S Th e au dit or mu s t inspe ct th e

.

m in ut e dec laring th e dividend and see th a t th e t o t al paid

agrees th ere wi th I n c o m e T ax mu s t b e deduct ed unless
.

th e di vidend is de c lared free of t ax but in th e for m er , ,

c ase th e gross am o un t of th e di vidend mu s t b e de b it ed t o

,

Pro t and L oss Acc o un t and th e t ax deduct ed mu s t be ,

c re dit ed t o th e I n c o m e T ax Acc o unt ag ainst th e t ax th at ,

will h av e b een paid un der th e asses sm en t m ade upon th e

c o mpan y Th e a m o un t s paid t o th e v ario u s S h are
.

h olders c an b e vo uch ed wi th th e returned and re c eip t ed

di vidend w arran t s .

U N PAI D DIVI DEN D S I f c ert ain s h are h olders c anno t b e

.

tra c ed th e di vidends de c lared and du e t o th e m Sh o uld b e

,

c redit ed t o a Spe c ial a cc o un t and s h o wn separat el y on th e ,

Balan c e Sh ee t Th e Art icles so m et im es x a period aft er

.

th e expirat ion of which if s uch di vi dends h av e no t b een

,

c laim ed th e y m a y b e forfeit edbut th ere mu s t b e express

,

pow er t o t h is effe ct o th erwise dividen ds do no t b e c o m e

,

st a tut e b arred u n t il th e expira t ion of tw en ty y ears fro m

th e dat e of dec larat ion and th e s hare holder can c laim
,

th em a t an y t im e wi th in this period F orfeit ed di vidends .

Sh o ul d b e t ransferred t o g eneral reser ve al th ough subj e ct , ,

t o th e Art ic les th ere is no t h ing t o pre v en t a c o m pany

,

c redit in g th e m t o Prot and L oss Acc o un t .

AR R E A R S O F C U MUL ATIVE PR EFER E N C E DIVI D EN D S If .

th ere are arrears of di vidend upon cumulati v e preferen c e

S h ares the a mo un t of such arrears S h o uld b e s t at ed upon th e
,

B alan c e Sh ee t in th e for m of a no t e but an au dit or c anno t ,

in sis t upon t his N o a ctual liab ili ty exis t s a t dat e and no

.
,

liab ili ty will arise unless and un t il sufc ien t prot s are
m ade in th e future and fu rth er u nt il th e arrears of
, , ,

di vidend are dec lared either by th e direct ors or by th e s h are

h olders a cc ording t o th e t erm s of th e Art ic les It will b e
, .
 C H AP TER IX

PRO F IT S AVA IL A BL E FO R D IVI DEN D

Pr o ts Av ailab le for D ivi d en d .

I N th e c ase of a c o m pan y th e a cc o un t s are prepared by

,

th e direct ors in wh o m also rest s th e po w er t o rec o mm end

,

th e di vidends t o b e dec lared by th e s h ar eh olders in g eneral

m ee ting Th e s h are h olders appoin t their au dit or for th e
.

express p urpose of asc ert aining wh eth er th e a cc o un t s laid

before th em Sh o w th e t ru e and c orrect posit ion of a ffairs ,

and c onse qu en t ly wh e th er or no t an y prot s S h o wn as

, , ,

a v aila ble for dis t ribut ion h a v e in fact b een earned Th e

, , , .

s h are h olders mu s t of nec essity depend alm ost en tirel y

u pon th e audit or in this respect and th erefore i t will b e
, , ,

seen th at th e qu es tion of wh at prot s are a v aila ble for

dividend is one wi th which an au dit or c ons t an t ly h as t o
deal It follo ws th a t it is essen t ial that h e s h o uld h a v e
.

a thoro ugh kno wledg e of this m ost c o m plic a t ed qu es tion .

I n Ch ap t er I V i t is s h o wn th at in m os t c ases it is im pos
sible t o O bt ain a bsolut e exact i tu de in asc ert aining th e
prot s of a business b ec a use such prot s are dependen t
,

u pon th e v aluat ion of th e asse t s Of th e c on c ern A tru e .

prot S h o uld be represen t ed by a c orresponding in c rease in

th e s urplus of asse t s o v er lia b ilit ies but as it is im po ssible
,

in m ost c ases t o arri v e a t th e exa ct v alu e o f all th e asse t s ,

it is nec essary that th e v alu e th ereof s h o uld b e es t im a t ed

in a cc ordanc e wi th c ertain a cc ep t ed rules Furth er tru e
.
,

prot is no t arri ved a t unless th e original c apit al plu s an y ,

addit ions th ere t o is in t a ct ; th erefore if an y p art of

, ,

such c apit al h as b een in v est ed in asset s th a t h av e depre

ciated in v al u e by reason of th e fa ct th a t th e y are Of a

w as t ing na tur e or are in pro c ess of b ein g c onsum ed in

,

1 64
 PR O F ITS AVAIL A BL E FO R D IVI D EN D 165

th e c ourse of earnin g re v enu e or if for an y o th er reason

, , ,

an y part of the capit al h as b een lost th en such w astage ,

mus t b e m ade g ood out of re v enu e before th e tru e prot s

can b e as c ert ained Ho w e v er th e C o m panies Act s 1 908
.
, ,

and 19 13 neith er pro vide as t o th e exa ct m anner in whi ch

,

th e prot s of a c o mpany are t o b e asc er tained nor enact ,

tha t only tru e prot s m ay b e dis t ri but ed as di vidend .

Th e periodic al asc ert ain m en t of th e prot s of a business

is an operat ion of such pract i c al im port an c e as t o be
essen tia l t o th e safe c onduct of th e bu siness it self but t o ,

follo w out th e s trict c onse qu en c es of th e a bo v e c on c ep t ion

of prot in m a kin g o ut th e ann u al a cc o un t s wo uld Oft en
be v ery difficult in pract ic e Henc e th e s trict m eanin g Of
.

th e word prot is rarel y o b served in drawin g up the

acc o u n t s of r m s and c o m panies Th ese are do m est ic .

do cum en t s desi gned for th e pract ic al guidan c e Of those

in t eres t ed and so lon g as th e prin c iple on whi ch th e y are
,

dra wn up is c lear th eir valu e is dim inis hed litt le if a t all

, , ,

by c ertain dep artures fro m th e st ri ct denit ion whi ch ,

lessen grea t ly th e difculty of m ak in g th em o ut Hen c e .

c ert ain ass um p t ions h av e b ec o m e so cu s t o mary in dr awin g

up Balanc e S h ee t s and Prot and L oss Acc o un t s th at it ,

m ay alm os t be sa id t o require Spec ial c ircum st an c es to

induc e par ties t o depart fro m th e m
S panish Prospe ct in g
.
(
Co .
,L td ) .

It will be fo un d th at in so m e c ases prot s m ay be

a vaila ble for dividend alth ough th e ori ginal c apit al of
,

th e c o m pan y is not in t act I n e v ery indi vidual c ase in

.

pra ct ic e th e pro visions of th e Me m orand um and Ar ti c les

,

of A sso c ia t ion of a c o mpan y are of th e utm os t im port an c e

wh en c onsidering th e qu estion of th e di visible prot s .

For if wh en a c o m pan y is form ed i t is pro vided in it

, ,
s

Art ic les th at losses of c apit al sh all b e m ade g ood out o f

prot s and th e m eth od of asc ert ain in g th e prot s a v aila ble
,

for dis t ri but ion is prec isely dened th ese pr o visions will ,

b e c o mp ulsory in this part icular c ase I f o n th e o th er .

,

h and th e Art ic les pro vide th at th e original c apit al nee d no t

,
1 66 THE PR IN C I PL ES O F AU D ITIN G

be k ept int a ct out of curren t re v en u e th en in such a c ase ,

it m a y qui t e w ell b e th at a c o m pan y c o uld pay di vidends

ou t ofbond de tradin g prot s wi th o ut rep la c in g pre vio u s
,

losses ofc apit al For in s uch c ases i t is wi th a kno wledge

.
, , ,

a ctu al or pres um ed of th e t er m s of th e A rti c les th a t s h are

,

holders h av e s ub sc ri bed and th at c redit ors h av e t raded

with th e c o m pan y and alth ough th e pa ym en t Of di vidends
might be dee m ed nan c ially im p ruden t th e C o m panies ,

Act s do not pro hi b it such a proc ee din g and nei th er s h are ,

h olders nor c redit ors c an s ub se qu en t ly c om plain of wh at

w as one of th e express in t en t ions of th e c o m pan y .

Fro m t im e t o t i m e c ir cum st an c es of diiculty h a ve

arisen in pra ct ic e in c onnect ion wi th th e q u es t ion of th e
prot s a vaila ble for dividend in p art icular c ases and h a v e ,

b ec o m e m att ers of disp ut e b etw een in t eres t ed part ies .

AS th e C o m panies Act s are no t den it e upon this subj ect ,

th e poin t s in disp ut e h av e h ad t o b e sub m itt ed t o th e

Co urt s for de c ision I n such c ases th e wh ole of th e
.
,

c ircum st an c es are in v est igat ed and th e C o urt dec ides

,

wh a t is fair and e quit ab le in th e c ir cum st an c es Of the

part i cular c ase Th ere are sev eral v ery import an t c ases
.

th at h av e been dec ided in this w ay and th e rules thu s ,

laid do wn are appli c a ble in c ases in whi ch th e c ir cum st an c es

are iden t ic al B ut i t mu s t be b orne in mind th at th e
.

C o urt s dec ide an y p art icular c ase en t irely u pon th e c ircum

s t an c es of th at c ase and fur th er th at pre vio u s dec isions
, , ,

m ay be re v ersed wh en a sim ilar c ase c o m es b efore th e

C o urt s ag ain Th erefore th e dec ided c ases c an be acc ep t ed
.
,

o nly as an in dic a tion of wh a t th e Co urt s pro b a bly wo uld

.

dec ide in Sim ilar c ir cum s t an c es Ag ain as th e r ulin gs in

.
,

dec ided c ases are not all en t irel y in a cc ord wi th one

anoth er i t is ex tre m ely diicult t o g eneralise upon this
,

sub j ect Ho w e v er tw o roo t prin ciples are th a t th e

.
,

S h are h olders c api t al m a y no t b e u sed t o pa y a di v iden d

,

and th a t a dividend c an onl y b e paid o ut of a bond de

surp lus or prot F or exa m ple if a c o m pan y w ere t o
.
,

dis tri but e th e proc eeds of sale of one of i t s xed asse t s ,

1 68 THE PR I N C I PL ES O F AU D ITI N G

pro t and m ak e i t av ailab le for dis t ribution as di vidend .

It was h eld th a t this sum c o uld no t b e dis t ribut ed as

di vidend wi th o ut h avin g re g ard t o th e res ul t s s h o wn by
th e acc ou n t s as a wh ole Par t of th e j u dgm en t reads
.

I mu s t no t h o w e v er b e u nders t ood as de t erm inin g

, ,

th at this s um or a port ion ofi t m ay no t properly b e b ro ught

in t o Pro t and L oss Acc o u n t in as c er t aining th e a m ou n t
av ailab le for dividend Th a t appears t o m e t o depend
.

u pon th e resul t of th e wh ole a cc o u n t for th e y ear It .

is c lear I th ink th a t an appre c ia t ion in t o t al v alu e of

, ,

c api t al asse t s if d ul y realised by sale or g e ttin g in of so m e

,

por t ion of s uch asse t s m ay in a proper c ase b e t rea t ed

, , ,

as a v ailab le for p u rposes of di vidend F ro m this i t is .

clear th a t a pro t on th e realisat ion Of on e c api t al asse t

c anno t b e dis t ribut ed as dividend wi th o ut h avin g reg ard
t o th e resul t s sh o wn by th e y ear s acc o un t s as a wh ole
.

W a stin g A s s ets .

I n th e c ase of L ee V N eu chatel Asp halte C o it w as

. .
,

dec ide d th at wh ere a c o m pan y w as form ed t o work a

w ast in g asse t s uch as a m ine and it s A rt icles Spec iall y
, ,

s t at ed th a t it was no t nec ess ary t o pro vide for th e depre

ciation of s uch w as t in g asse t th ere w as no th in g in th e ,

C o mpanies Act s t o c o m pel i t t o do so .

I n th e c ase of m ines deprec ia tion of th e m ine it self is

,

no t in pra ct ic e u su ally pro vided for ou t of th e curren t

, ,

pro t s b ec au se ordinaril y th e O b j ect of a m inin g c o m pan y

,

is t o wor k a part icular m ine only and no t t o a cquire and ,

w ork o th er m ines aft er th e ori g inal one is exh au st ed .

Th e life of th e c o mpan y is th erefore roughly e qu al t o th e

, ,

life ofit s prin c ipal asse t and wh en th e la tt er is work ed o ut

,

th e c o m pan y will wind up .

Th e posit ion th erefore is a so m e wh at pe culiar one for

, , ,

it will b e seen th at th e ore th a t is sold is part of th e c o m

pany s m ain c api t al a sse t and th a t wh en th e wh ole of th e

,

ore h as b een raised and so ld th e v alu e of th e m ine is

ent irely exh a us t e d apart fro m an y s c rap v alu e th ere m a y

,
 PR O FITS AV AH ABL E FO R D IVI DEN D 1 69

be in surfa c e works and land O rdin aril y th e m ain o b j ect .

,

of su ch a c o m pan y is t o a cquire this asse t sell th e whole ,

of th e v al ua ble part th ereoftha t is th e oreand th en t o ,

wind up N ow wh at is th e actu al e ffect of pro viding for

.
,

deprec iat ion in such a c ase P O u t of th e proc eeds O f th e

sale ofore will b e paid all th e expenses of raising the sam e ,

and all th e expenses losses and charg es of th e c o m pan y ;

,

and no w further i t is propo sed t o c h arg e against ea ch

, ,

y ear s Prot and L O S S Acc o un t a sum suicient t o accum u
lat e by th e t im e th e m ine is work ed o ut th e whole ofth e
, ,

origin al c apital su nk in acquirin g and e quippin g the

property ; th erefore if th ese pro visions for depre c ia t ion
,

are c orrect ly es t i m at ed th en wh en th e c o m pany is nally

, ,

wo und up th e Sh are holders c apit al will b e returned t o

,

th e m in full .

Du ring th e life of th e m ine th e wh ole of this c api t al

which is gra duall y b eing accumula t ed is no t re quired for
th e p urposes o f th e bus iness I f th e c o m pan y s t art ed .

wi th s uf c ien t w orkin g c apit al th erefore th e wh ole of , ,

th ese a ccumula t ed fun ds must be in v est ed out side th e

business and so re m ain un t il th e nal winding up wh en
, ,

th ey will b e realised and paid o ver t o th e s hare holders .

It will be seen th at th ere is no asse t requiring replac e m ent ,

and th at t his qu es t ion only a ffect s th e position u pon nal

windin g up Th e wh ole of th e am o un t s realise d upon th e
.

sale of ore after pa ym en t of all expenses are pa y a b le t o

, ,

th e s h are holders but if dep rec iat ion is pro vided for a
, ,

proport ion th ereof will no t be paid o v er as and wh en t h ey

are realised but will b e a ccumulat ed and pai d o v er only
,

a t th e end of th e life of th e m ine .

N ow in pra ct i c e S hare h olders as a rule prefer th at th e

, , , ,

whole of th e earnin gs aft er expen ses ha ve Of c ourse b een

, , ,

deduct ed s hould be paid o v er t o the m at on c e and no t th a t

, ,

large sum s S ho uld be a ccumula t ed in th e h ands of th e

direct ors Th e ori gin al c apit al in vest ed in th e m ine is
.

regarded as sunk and g one and if th e c o m pan y retains ,

asset s s uf c ien t t o pay it s de bt s any exc ess of m one y ,

1 70 THE PR I NC I PL ES O F AUD I TI N G

o bt ain ed by wor kin g th e pro perty o v er th e c os t ofw orking ,

it m a y b e di vided a m on gs t th e S h areh olders

,

Wi th .

ea ch dividend th e s h are h olders are in this w a y in e ffect

o bt ainin g a part ial re turn of c apit al and th erefore , , ,

indi v id uall y th e y s h o uld no t re g ard th e wh ole di vidend as

,

in c o m e but s h o uld trea t part as a retu rn of c apit al and

, ,

re in v es t th at part U pon windin g up of c o urse pro b a b ly

-
.
, ,

th ere w ill b e li ttle or no re tu rn t o th e S h areh olders but th e y ,

will loo k t o th e dividends paid durin g th e life of th e mine t o

repa y t o th e m their c apit al and also t o pa y th e m for th e ,

use of th e sam e .

It is sugg es t ed th erefore th at this is quit e a reasonab le

, ,

bu siness proposi tion and it wo uld appear th at th ere is

,

no thin g in th e C o m panies Act s t o pre v en t a c o m pan y

adop t in g this poli cy so th a t if th e S h ar e h olders dec ide on
, ,

this c o urse and for inst anc e pro vide t o this e ffect in th e
, , ,

Art ic les of th e c o m pan y th e law will no t pre v en t th e m

,

fro m doin g so I f on th e o th er h and th e y dec ide th a t th e

.
, ,

deprec ia t ion of th e wast in g asse t S h all b e ch arged ag ains t

prot s and pro vide t o this e ffect in th e Ar ti c les th en th e
, ,

c o m pan y is b o und t o pro vide for such deprec iat ion o ut

of th e curren t earning s b efore s ho wing pro t s a v aila b le
for dividend ; i t will b e seen th at th e wh ole m a tter in ,

th ese C ir cum st an c es res t s in th e h ands of th e s h are h olders

, ,

and i t is th e au dit or s duty t o see th a t th e wh ole situ at ion
is m adeT q uite c lear t o th e m .

D ep r eciatio n P lan t an d M a ch in ery

of .

Before g oin g furth er it m ay be w ell t o c on t ras t th e

,

a b o v e posit ion wi th th a t of a m an u facturin g c o m pan y as

re g ards th e c apit al s un k in plan t and m achinery I n this .

latt er c ase i t will b e seen th at th e O b j e ct o f th e c o m pan y

,

is n ot t o c on t in u e onl y for th e t erm ofth e life of th e ori ginal

plan t but t o c on t in u e t o trade m ore or less indenit el y
, .

Th erefore in order t o c arry out this o bj ect wh en th e

, ,

ori ginal m a chin ery is w orn out and useless th e sa m e mu s t

'
,

b e repla c ed or th e c o m pan y c anno t c on t inu e t o t rade

, .
172 THE PR I NCI PL ES O F AU D ITIN G

pay a dividend wi th o ut r s t m aking g ood th e c apit al w hich

h ad b een l os t ; i t was h eld th at al th ough this c o urse
,

might so m e t im es b e v ery i m p ruden t y e t th ere was no ,

law whi ch pre v en t ed it in all c ases and under all

c ircum st anc es Part of th e j u dgm en t reads as follo w s
.

Th ere is no law whi ch pre v en t s a c o m pan y fro m

sin kin g it s c apit al in th e p urch ase or product ion Of a
m one y m aking property or u ndert aking and in dividing
-
,

th e m one y ann u all y yielded by it with o ut preserving th e

c apit al sun k so as t o b e able t o reproduc e it in t a ct eith er
b efore or aft er th e win din g up of th e c o m pany A c o m pan y .

m ay b e form ed upon th e prin c iple th at no dividends s h all

b e dec lared u nless th e c apit al is k ep t un d im inis h ed or a ,

c o m pan y m ay c ont ract wi th it s c redit ors t o k eep it s

c apit al or asse t s up t o a g iv en v alu e B ut in th e a b sen c e
.
,

o f so m e spe c ial A rt i c le or c on t ra ct th ere is no la w t o this

,

effe ct and in my opinion for v ery g ood reasons It

, , , .

would in my j u dgm en t b e m os t inexped ien t t o la y do wn

, ,

a h ard and fast rule whi ch w ould pre v en t a o uris hin g

c o m pan y eith er no t in de bt or w ell able t o pay it s de bt s ,

fro m pa ying div idends so lo ng as it s c apit al s un k in c rea t in g

th e bu siness was no t represent ed by asse t s wh ich would ,

if sold reproduc e in m one y th e c apit al s unk Ev en a

, .

Sinkin g fund t o repla c e los t c api t al by degrees is no t ,

re quired by la w .

It will b e seen th at th e c o m pan y by de c laring th is ,

di vidend is no t pa yin g th e sa m e out ofth e s h are h olders

,

c apit al but is pa yin g it outofa bond de revenue surp lus

, ,

but with o ut pro vidin g for a previous loss ofcap ita l which ,

is qui t e a di fferen t m a tt er th e poin t th erefore is Mu s t

, ,

losses ofxed c apit al b e m ade g ood o ut of re v enu e b efore ,

pro t s are a v ailab le for dividend ? F ro m th is and o th er

c ases i t wo uld appear th a t th e m a tt er ag ain res t s with th e
, , ,

s h areh olders I f t h e c o m pan y pro vides th a t i t s c api t al

.

mu s t b e k ep t in t a ct b efore pro t s are a v ailab le th en th e ,

c o m pany is b o u nd t o do so but if th e sh areh olders do n ot

re quire th eir c api t al t o b e m ain t ained o ut of re v enu e ,
 PR O FIT S AVAIL A BL E FO R D IVID EN D 1 73

th en this c o urse is no t illeg al and pro vided th ere are

, ,

bon d de re v enu e s urplu ses th ese are av ailab le for di vidend

, .

B ut i t must b e o b serv ed th at this c ase clearly holds

that oat ing asse t s mu s t b e properly depre c iat ed b efore
arri v in g a t th e a m o un t of th e prot s av aila b le for di v idend ,

for part of th e j u dgm en t reads as follo w s

Per h aps th e s h ort es t wa y of expressing th e dist in ct ion
whi ch I a m endea v o urin g t o explain is t o sa y tha t xed
c apit al m ay b e s un k and los t and yet that th e exc ess of
,

current rec eip t s o v er current paym ent s m ay b e divided ,

but th at oat ing or c irculat ing c apit al mu s t b e k ep t up ,

as o th erwise it will en t er in t o and for m part ofsuch ex c ess ,

in which c ase t o divide such ex c ess with out deduct in g

th e c apit al whi ch form s p art of i t will b e c on trary t o
,

la w .

I n th e Si tu at ion raised by th e L ee v N euchatel Asp halte .

C o c ase i t was s h o wn th a t th e non pro vision for depre

.
,
-

ciation o f th e w as t in g asse t w as no t such a b ad bu siness

policy as a t rs t Sight it m ight appear but with referenc e ,

t o c apit al losses as in th e Verner c ase th e sa m e c anno t b e

, ,

said Here th e c o mpan y presum ab ly was no t form ed

.
,

with a vie w t o trading only for a denit e lim it ed period ,

and c onsequ ent ly th e non pro vision for c apit al losses

, ,
-

was un qu es t ionab ly a b ad nan c ial po licy ; but this c ase

w o uld appear t o Sh o w th at th ere is no thing in th e la w t o
c o m pel a c o m pan y t o run it s bu siness u pon so und nanc ial
lines so th at if for inst an c e a c o m pan y pro vides in it s
, , ,

Artic les th at it need no t k eep up c apit al out of re v enu e ,

then e v ery Sh are h older sub sc ri bes upon this b asis and , ,

c onse quent ly th ere is no thing illeg al in th e c o mpany

,

c arr ying o ut this poli cy .

I n th e c ase of Bolton v N atal L and and C olon isation C

.

th e posi tion w as th at in th e y ear 1 88 2 a b ad debt of

was in curred and w as w ri tt en off to R e venu e Acc o un t .

At th e sam e t im e th e v alu e of th e c o m pany s land was

wri tt en u p by this in c rease b ein g c redi t ed t o

R ev enue Acc o un t I n th e year 1 885 a t rading pro t
.
1 74 THE PR I N C I PL ES OF AU D ITI N G

w as m ade an d a div idend de clared Th is a ct ion was .

b rought t o res t rain th e paym en t of th e di vidend on th e ,

g ro u nds th at th e v al u e ofth e lan d w as o v ers t at ed an d th at

th e differen c e b e tw een th e t ru e v alu e of th e l an d and th e
b oo k v al u e S h o uld b e writt en off ag ains t th e av ailab le
pro t s It was h eld th a t e v en as s umin g th a t p ar t of th e
.

c api t al h ad b een los t in th e pas t and h ad no t b een subse

qu entl y m ade g ood th a t th a t w as not sui cient g ro u nd for
,

res t rainin g th e paym en t of th e dividend .

I n th e c ase of Wilm er v Mc N am ara i t w as h eld th a t th e

S h
.

c o m pany c o uld de clare a dividend with o ut pro vidin g for

depre c ia t ion of xed asse t s A t radin g pro t of .

h ad b een earned but no pro vision was m ade for depre c ia

,

t ion of leases g oodwill or plan t alth o ugh in pre vio u s y ears

, , , ,

depre c ia tion t o a c onsiderab le ext en t h ad b een pro vided

for Th e j udg e h o we v er appeared t o b e do ubt ful as t o
.
, ,

wh e th er suicient depre c iat ion h ad b een pro vided for th e

lease h olds .

I n th e m ore re c en t c ase of The Am m onia S oda C om p any ,

L im ited V C ham berlain and O thers th e c ir cum s t an c es

, .
,

w ere th at th e c o m pan y h ad a deb i t b alan c e upon Pro t

and L oss Acc o un t of I n b oring for w at er a new
b ed of ro ck salt of a thi ck ness of 666 fee t w as dis c o v ered ,

th e exis t en c e of whi ch was pre vio usl y en tirely u nkno wn

and uns u spe ct ed Th e valu e of th e c o mpany s land
.

was wri tt en u p by and th e de b i t b alan c e on th e

Pro t and L O S S Acc o un t was set off ag ains t th is in c reas e .

This transact ion w as m ade clear in th e p ub lis h ed a cc o u nt s .

S ub se qu en tl y pro t s w ere earned and paid aw ay as di vidend .

Th e c o m pany b ro ught this a ct ion ag ains t th e dire ct ors ,

c on t ending th at th e di vidend h ad b een paid out of c api t al

and see k in g t o m ak e th e dire ct ors liab le t o refund It .

w as h eld th at th ese dividends c ould no t b e res t rained ,

part of th e j u dgm en t readin g as follo w s

(
I n h is h is L ords hip s) Opinion th e dire ct ors in a ct in g

as th e y did w ere m erel y s t a t in g in th eir B alan c e S h ee t

wh at upon reasonab le g ro u nds th ey b elie v ed t o b e th e real

, ,
1 76 THE PR I N C I PL ES O F AU D IT I N G

Me m orandum is t o be th e fund which is t o pay th e c redit ors

in th e e v en t of th e c o m pan y b ein g w o und up Fro m th a t .

it follo w s th a t wh a t e v er h as b een paid by a m e mb er c anno t

b e ret urned t o h i m I n my opinion it also follo w s th at
.
,

wh at is des c ri b e d in th e Mem orandum as c apit al c anno t ,

b e di v ert ed fro m th e O bj e ct s of th e so c ie ty It is O fc o urse . , ,

lia b le to b e spen t or los t in c arry ing on th e bu siness ofth e

c o m pan y but no part of it can b e re tu rned t o a m e mb er
,

so as t o t ak e a w a y fro m th e f und t o which th e c redi t ors

h av e a right t o loo k as th at o ut of which th e y are t o b e
paid .
" ,

It will b e seen th erefore th a t in th e in t eres t s Of th e

, , ,

c re dit ors th e c apit al of a c o m pan y mu s t b e u sed exc lu sively

,

for th e p urp oses ofc arryin g out th e o b j ect s of th e c o mpan y .

S uch O b j e ct s are set out in th e Me m orandum Fur th er .

,

a dividend m a y b e paid only out Of a bon d de s urplu s or

prot as o th erwise th e c apit al a v aila ble for th e pa ym en t
,

of c redi t ors is re duc ed .

P o s ition o f th e Au dito r as R e gar d s th is

Qu es tio n .

Th e au dit or h as no c on c ern in th e pru den c e or i m pru den c e

of th e nan c i al poli cy of a c o mpan y ex c ep t in S O far as ,

h e m ay b e re qu es t ed t o gi v e h is advi c e Th e au di t or s .

responsib ili t ies are t o see th a t th e re gula t ions of th e c o m pan y

are c o m plied with and th at th e posi t ion Of affairs is m ade
clear in th e a cc o u n t s s ub m i tt ed t o th e Sh areh olders For .

this p u rpose th erefore h e mu s t b e f ully c on v ersan t wi th

, ,

th e prin ciples and ruling s g o v ernin g this qu es tion an d in ,

c ases th a t arise in pra ct i c e h e mu s t inv es tig a t e th oroughly

th e wh ole of th e C ircum s t an c es I f th e au di t or is of.

Opinion th a t th e a cc o un t s do no t S h o w a t ru e and c orre ct

View of th e s t a t e of th e c o m pany s affairs th en if th e

dire ct ors refuse t o am end th e a cc o u n t s h e mu s t repor t ,

t o th e S h areh olders wh en h is responsib ilit ies are c o mplied

,

wi th .
 PR O Frrs AVAIL ABL E F O R D IVID EN D 1 77

C on clus ions .

Th e c on cl usions t o b e drawn fro m a c onsidera tion of th ese

Cases m ay b e s umm ariz ed as follo ws
( 1 ) Th e law does no t a tt e m p t t o dene h o w pro ts
a v ailab le for dis tribution as di vidend are t o b e arri v ed
a t This qu es tion is left t o ea ch c o m pany t o dec ide
.

for i tself pro vided th a t th e c o m pany s regula tions are

,

co m plied wi th
(
.

2) S h are c api t al cann o t b e dis t ribut ed as di vidend

(
.

3) A di vidend pre supposes a surpl us or pro t

(
.

4) A di vidend c anno t b e p aid whi ch h as th e e ffe ct

oflea vin g th e c o m pan y in th e posi tion of no t b eing ab le

t o pa y its debts
(
.

5) A c o m p an y form ed t o w ork a was tin g asse t need

no t pro v ide out of pro ts for th e deprec ia tion of such
asse t pro vided th a t th is is in a cc ordan c e wi th th e
c o m pany s regulations

(
.

6) L osses of c api t al nee d no t b e m ade g ood o ut of

sub sequen t pro t s pro vided th a t th e regula t ions of th e
,

c o m pan y do no t pro vide t o th e con trary

(
.

7) C api t al pro t s are av ailab le for dis tribution as

di vidend pro vided th a t th e y are realised pro t s and
, ,

th at in arriving at th e am o un t av ailab le all ch ar g es ,

an d losses b o th capi t al and re venu e for th e period

, ,

are b ro ught in t o a cc o un t
(
.

8) I n th e c ase of a m anufactu rin g c o m pany pro vision ,

mus t b e m ade for deprecia tion of plan t and m achin ery

(
.

9) Th e wh ole posi tion of af fairs mu s t b e m ade clear

t o th e s h areh olders in th e ac co un ts sub mi tt ed t o th e m
and i t is th e duty of th e au dit or t o see th at th is is th e

( It is for th e s h areh olders t o de c ide wh at s h all b e

1 0)
dis tribut ed as di vidend and such di vidends can no t
,

be res t rained pro vided th a t th e y are in a cc ord an c e wi th

th e co m pan y s regula tions th ey c o m ply wi th th e

foreg oin g ru lin gs and th a t th e y are b ased u pon h ones t

,

a cc o unts .

r: (
- r 2
5 4 l
 C H AP TER X

THE L E G L A PO S ITI O N O F AU D IT O R S
THE subj ect of th e exa ct leg al posit ion of au dit ors is one
o f so m e c o m ple xi ty and diff i culty Th e v ario u s Act s of .

Parlia m en t dealing wi th th e appoin tm en t of au dit ors are

very indenit e as t o th e au di t ors responsib ili t ies and

lia bilit ies Th ere are se v eral im port an t c ases de aling wi th

.

th e s ub j e ct wh ich in dic at e th e leg al vie w but it is th ought ,

th at nali ty h as no t y et b een rea ch ed Ev en in th e .

a cc ou n t an cy profession opinions dier ; it is essent ial

, ,

th erefore th at e v ery audi t or s h o uld g iv e th is m att er m os t

,

c areful c onsiderat ion as ea ch pra ct it ioner mu st t o a large

, ,

ext en t x his o wn s t andard but by a ct in g up t o a high

, ,

sense of responsi b ility th e grea t es t ser vi c e is rendered t o

,

th e profession as a wh ole and in th e end t o ea ch indi vidu al

,

m e mber th ereof It is im possib le in th e spac e a v ailable

. ,

t o deal exh au st iv el y wi th th is sub j ect but so m e of th e ,

m ost im port an t c ase s will b e b riey c onsidered and , ,

th ereaft er th e c on clu sions t o b e dra wn th erefro m will b e

,

summ arised .

Th e P o s itio n o f an Au dito r to a Priv ate

I n th e c ase of pri v a t e rm s an au di t or is no t appoin t ed

,

under an y s t atut e but is responsi ble in da m ages if his

,

e m plo yers su ffer an y loss thro ugh his ne glect or default .

'
A u dito r s P o s itio n un d er th e C o m p ani e s A cts .

(
U nder th e C o m panies C onsolida t ion ) Act 1 908 S e ct ion , ,

28 1 if an au di t or in an y report c ert i c at e B alan c e S h ee t

, , , ,

or o th er do cum en t m a k es a st at e m en t false in an y m at erial

,

1 78
1 80 I
THE PR N C PLES I O F AU D ITI N G

An au dit or is en t i tled t o a cc ess t o all th e b oo ks a cc oun t s ,

and v o uch ers of th e c on c ern wh ose a cc o un t s h e h as t o

a u dit and in addi t ion h e is en ti tled t o such addit ional
, , ,

infor m a t ion and explana t ions as h e m ay require I n th e .

ca se o fregis t ered c o m panies th ese right s are giv en t o hi m

(
,

spec ic ally by S ect ion 1 1 3 C o m p anies Conso lida t ion) ,

Act 1 908 and h is po w ers an d th e sc ope of his a u di t

, ,

c anno t b e li m it e d in an y w ay by eith er direct ors or S h are

h olders but in th e c ase of pri v at e rm s th e sc ope of an
,

au di t can b e lim it ed by agree m en t in which c ase th e ,

au di t or s responsibilit ies are limi t ed a cc or din gly ; but in

such c ir cum s t an c es as is point e d o ut in Ch ap t er I i t is of

, ,

th e utm os t im po rt an c e th at th e exa ct t erm s of th e arrange

m en t S ho uld b e rec or ded in wri t ing o th erwise difc ult ies ,

m ay arise in th e fut ure .

Au ditor
Liab ility for N e glect
s .

Th e liab ili ty of an au di t or arises wh ere it is pro v ed th a t ,

thro ugh his neglect or defaul t h is Client s hav e su ffered ,

da m ag e Th is m a y arise for exa mple wh ere a ctual

.
, ,

defalc a t ions h a v e t aken plac e on th e part of Of c ers or

e m plo y ees of th e c on c ern such as m isappropria t ion of,

cas h or s t ock I n th e c ase of c o m panies th e au dit or s
.
,

lia b ili ty also m a y arise wh ere th e result s S h o wn by th e

a cc o un t s hav e b een o v ers t a t ed eith er thro ugh an error ,

or by reason of delib era t e falsic a t ion result ing in th e ,

pa ym en t ofdi vidends o ut ofc apit al This m a y b e e ffect ed .

by o v er est im at in g th e v al u e of asse ts such as de bt ors

-
,

and s t o ck by in suicient pro visions for deprec iat ion Of

,

o th er asse t s or by th e o m ission t o pro vide for lia b ilit ies

, .

I n such c ases th e audit or m ay b e h eld personally lia ble

, ,

if it is pro v ed th a t h ad h e exer c ised re asona ble c are and

,

skill h e mu st h av e disc o v ered th e di sc repan cy

, .

Au dito r s Liab ili ty

as R egar d s
T h ir d P arties .

It mus t also be rem embered th a t third pa rt ies m ay also

be misled and thus su ffer damag e by reason of a cc o unts
 THE L EG L PO S A ITI O N O F AU D ITO R S 1 81

c ertied by an au dit or for exam ple prospect iv e c redit ors , ,

de ben ture holders in v es t ors p ur chasers of the business

, , ,

or in t endin g part ners m a y h a v e prod uc ed t o th e m th e

au di t ed a cc o un t s of th e bu siness wi th whi ch the y are

proposing t o en t er in t o business rela t io ns Ho w e ver .
,

fro m th e c ase of L e L ievre and Dennes v Gould it would .

,

appear th a t in th e a b sen c e of fr au d an a udit or w o uld

, ,

no t be h eld lia ble t o third part ies wh o ha d s u ffered da m age ,

e ven th o ugh h e h ad b een neg lig en t He is no t e m plo yed .

by the m and appears t o owe th em no duty B ut a con .

scientious a u di t or s h o uld r ec o gn ise a m oral o b li g a t ion

t o w ards third part ies wh o o th erwise ma y su ffer through

his neg lect .

Le gal D ec is ion s .

Th ere are se v eral v ery im port an t dec isions upon this

subj ect all of which s ho uld be s tu died but th ere is onl y
, ,

Spa c e h ere t o c onsider a fe w of th e leadin g c ases .

Leeds Estate Building Etc S o ciety v S h eph ard

,
In .
, . .

this c ase it was h eld tha t it is no t s uffic ient for an audit or

m erely t o c o m pare th e Balan c e Sheet wi th th e b ook s of
a cc o un t and thus v erify its arithm e t ic al a cc ura cy but
, ,

t h at h e must sa tisfy him self th at th e Balanc e S h ee t is a

t ru e and accurat e represent at ion of th e c o mpan y s

a airs . I n this c ase th e t erm s of th e Art icles h ad no t
been c arried out and it was h eld tha t it was no ex cuse
,
!

th at th e au dit or h ad no t seen th e Art icles when h e kne w

of th eir exis t en c e As a res ult of th e au di t or s neglect

. ,

di vidends dire ct ors fees and b on uses w ere im properly

,

paid and h e was th erefore h eld lia ble for dam ages
, , , .

Lo ndon and Gen eral Bank Case I n this c ase it was .

h eld th at where an au dit or does no t report t o th e sh are

holders th at th e Balanc e S h ee t is in c orrect ly drawn ,

kno wing it t o be th e c ase h e is guilty of a misfeasan c e

,
.

I n this c ase th e c o mpany h ad adv an c ed c onsiderable s um s

t o cus t o m ers but the securi t ies h eld by th e b ank w ere
,

wh olly ins ufc ien t Th e c o mpany had h o we v er t ak en

. , ,
1 82 THE PR IN C I PLES O F AU D ITI N G

c redi t for th e in t eres t acc ru ed du e upon s uch loans wh ereas ,

th e in t eres t w as ne v er in fa ct paid O ne of th e chief

, , .

c au ses Of th e b ank s failure w as th e h eavy loss in respe ct

of th ese loans and h ad proper reser v es b een m ade for

, ,

b ad de bt s no prot s w o uld h av e b een S h o wn av ailable

,

for di vidend Th e au di t or apparen t ly was a w are of th e

.

real s t at e of a ffairs and report ed fully t o th e direct ors

, ,

wh o h o w e v er refu sed t o alt er th e a cc o un t s I n his

, , .

repor t t o th e S h are h olders th e au di t or m ade no m en t ion

,

of th e la ck of securi ty etc but m erely st at ed , Th e

.
, ,

v alu e of th e asset s as s h o wn by th e Balan c e S h ee t is

depen den t upon realisa t ion Th e au di t or w as fou nd .

gu ilty of a m isfeasan c e and w as h eld j oin t ly and se v erall y

,

lia ble with th e dire ct ors in respe ct of two di v idends

de c lared a m o un t ing t o so m e
, odd on th e gro und ,

th a t h e o ught t o h av e report ed th e t ru e fa ct s t o th e s h are

h olders th e words c on t ained in h is repor t t o th e m b eing
,

qui t e m eaningless and th erefore h e h ad failed in his

, , ,

du ty as a res ult of wh ich fail ure th e c o m pan y h ad paid

,

th ese dividends o ut of c apit al Part of th e j u dgm en t .

reads as follo w s
It is no part of an au di t or s duty t o g iv e ad vi c e eith er

t o direct ors or S h are h olders as t o wh a t th ey o ught t o do .

An au dit or h as no th ing t o do with th e pru den c e or im pru

den c e Of m akin g loans with or with o ut se curity I t is .

no th in g t o hi m wh e th er th e bu siness of a c o mpan y is b ein g

c onduct ed pru dent ly or im pru dent ly prot ab ly or unprot ,

a bly it is no th in g t o h im wh e th er dividends are properly

or i mproperly de c lared pro v ided h e disch arg es h is own
,

duty t o th e s h are h olders His bu siness is t o as c ert ain and

.

s t a t e th e t ru e nan c ial posi t ion of th e c o m pan y a t th e

t im e of th e au di t and h is duty is c onned t o th at B ut
, .

th en c o m es th e qu es t ion : Ho w is h e t o as c ert ain s uch

posit ion Th e answ er is By exa m ining th e b oo k s of th e
c o m pan y B ut h e does no t disch arg e his du ty by doin g
.

this with o ut enqu iry and with o ut t akin g an y t rouble t o

see th at th e b oo k s Of th e c o m pan y th e m sel v es S h o w th e
184 THE PR I NCI PL ES O F AU D ITI N G

t o th e m U nfortu nat el y h o we v er this report was no t

.
, ,

laid before th e s hare h olders and it b ec o m es ne c essary t o ,

c onsider th e leg al c onsequ en c es t o Mr Th eo b ald of th is .

c ir cum s t an c e .

A person wh ose duty i t is t o c on ve y infor m at ion t o

o th ers does no t disch arg e tha t duty by Sim ply gi vin g
,

the m so much inform at ion as is c alcula t ed t o induc e th e m ,

or so m e of the m t o ask for m ore I nfor m a t ion and m eans

, .

o f inform a t ion are by no m ean s e qui v alen t t er m s .

An a udi t or wh o gi v es s h ar eh olders m eans of infor m a t ion

inst ead of inform at ion in respect of a c o m pan y s n an c ial
posit ion does so a t his peril and r uns th e v er y serio u s
, ,

ris k of b ein g h el d j u dic ially to h a v e faile d t o disch arg e

, ,

h is duty .

I n this c ase I h av e no hesit at ion in sa yin g th at Mr .

Theo b ald did fail t o disch arg e h is duty t o th e s h are h olders

in c ert ifying and layin g b efore th e m th e Bala n c e Sh ee t of
Fe b ru ary 1 892 wi th o ut an y referen c e t o th e report whi ch
, ,

h e laid b efore th e dire ct ors and with no o th er warning ,

th an is c on v e yed by th e words th e v alu e of th e asse t s as ,

sh o wn on th e Balan c e Sh ee t is dependen t upon realisa

t ion . It is a m ere t ruis m t o say th at th e v alu e of
loans and securit ies depends upon th eir realisat ion We .

are t old th a t a s t at e m en t t o th at e ffe ct is so un u su al th a t

th e m ere presen c e of th ose w or ds is enough t o ex c it e
su spic ion But as already st at ed th e duty of an au dit or
.
, ,

is t o c on ve y infor m a t ion not t o aro u se en quiry and , ,

alth o ugh an a u dit or might infer fro m an un u su al s t a t e m en t

th at so m ethin g was seriou sly wron g it by no m eans follo ws ,

th at ordinary people w o uld h av e th eir s uspic ions aro u sed

by a similar s t at e m en t if as in this c ase it s languag e
, , ,

expresses no m ore th an an y ordinary person wo uld infer

wi th out i t .

I rish W oollen C O v Tyson I n this c ase th e au di t or

. . .

was h eld lia ble for da m ag es wh ere th e a cc o un t s h ad b een

falsied by th e suppression ofinv oic es it b eing h eld , ,

th at h ad h e u sed reasonable c are and sk ill h e s h ould h av e ,

 THE L E GAL PO S ITI O N O F AU D ITO R S 1 85

disc o v ered th e fraud . P art of th e j u dgm ent reads as

For th ese reasons I am of opinion th at if du e c are

and skill h ad been exerc ised th e c arrying o v er and the ,

su ppression of in v oic es wo uld ha v e b een disc o v ered and ,

th e au dit or is lia ble for an y dam ag e th e c o m pan y h as

sus t ained fro m th e un der st at em en t of lia b ili ties in th e
-

Balanc e Sh ee t du e t o this c a use sin c e 4th J an uary 1 892 , .

I c onsider th at no t only are Mr Kev ans and his assist an t s .

no t free fro m b lam e for this but also for th e m ech anic al
,

way th e au dit w as c arried o ut .

L ondo n Oil S to rage C O v S eear Hashi ck. . CO I n this .

c ase th e au di t ors w ere h eld lia ble for dam ag es on th e ,

gro unds th at the y h ad failed t o v erify th e exis t en c e Of th e

pe tty c as h in hand whi ch acc ording t o th e boo ks am o un t ed
,

t o 7 60 wh ereas in fac t th ere was only 30 the di fferenc e

, , , ,

represen t ing th e sec re t ary s misappropria tions

.

Th e Kingston C o tton Mills Case I n this c ase th e .

acc oun t s ha d been falsied t o a v ery c onsiderable ext ent

by th e m anaging direct or by m eans of ext ensiv e o v er
,

v alua t ions of th e st ock Th e st ock h ad been c ertied by

.

th e m anag ing direct or and i t was h eld on appeal th at th e

,

au dit or was en ti tled t o acc ep t s uch c ertic a t es and tha t ,

he w as no t lia ble in respect of th e dividends t h at h ad b ee n

paid o ut of capit al as a res ult of th e m anip ula tion of th e
,

st ock Part s of th e j udgm en t read as follo ws

.

For se veral y ears frau ds w ere c o mm i tt ed by th e

m an ager wh o in order to b ols t er up th e c o m pan y and
, ,

m ak e it appear o urishing wh en it was th e re v erse deli ber ,

at ely exagg era t ed bo th th e quan tities and valu es Of th e

c o tt on and y arn in th e c o mpan y s mills He did this at
.

th e end of th e y ears 1 890 1 89 1 1 892 an d 1 893 Th ere

(
.
, ,

was no b oo k of acc o un t exc ep t th e s t ock jo urnal t o w hich ,

I will refer presentl y) Sh o wing th e qu an ti ty or v alu e of

th e c o tt on or y arn in th e m ill at any one t im e Th e .

au dit ors t ook th e entr y of th e s t ock ih trade at th e b egin - -

ning Of th e year fro m th e las t prec e d ing B alan c e S h eet

, ,
1 86 THE PR I N C I PLES O F AU DITI N G

and th e y t oo k th e v alu es ofth e s t o ck ih trade a t th e end - -

o fth e y ear fro m th e s t ock j o urnal Th e bo o k c on t ain ed .

a series of a cc o u n t s under v ario u s h eads p urport in g t o ,

S h o w th e qu an t it ies and v alu es Of th e c o mpan y s s t o ck ih

-

t rade a t th e end of each y ear and a summ ary Of all th e ,

a cc o un t s s h o win g th e t ot al v alu e Of s uch s t o ck in trade - o

.

Th e s umm ary w as si gned by th e m anag er and th e v alu e ,

as s h o wn by it w as adop t ed by th e au dit ors and w as

insert ed as an asse t in th e B alan c e S h ee t but as per ,

m anager s c ert ic at e

Th e sum m ary al wa ys c orresponde d
.

with th e acc o un t s s umm arised and th e au dit ors as c ert ained

,

th at this was th e ca se But th e y did no t exa m in e furth er

.

in t o th e a ccura cy of th e a cc o un t s sum m arised Th e .

au dit ors did no t profess t o gu aran t ee th e c orre ct ness of

this it e m Th e y ass um ed no responsib ility for i t Th e y
. .

t oo k th e i t e m fro m th e m anag er and th e en t ry in th e ,

Balan c e Sh ee t s h o wed th a t th e y did so I c onfess I .

c anno t see th a t th eir o m ission t o ch e ck his re turns was a

b reach of th eir duty t o th e c o m pan y It is no part of an .

au dit or s duty t o t ake st o ck N o one c on t ends th at it is

. .

He mu s t rely on o th er people for de t ails of th e st o ck in -

t rade in h and I n th e c ase of a c o tt on mill h e mu st rely

.
,

on so m e s killed person for th e m a t eri als ne c essar y t o ena ble

him t o en t er th e s t o ck ih t rade a t i t s proper v alu e in th e
- -

B alan c e S h ee t I n this c ase th e au dit ors relied on th e

.

m anager He w as a m an of hi gh ch aract er and of un

.

qu est ioned c o m pet enc e He w as t ru st ed by e v eryone

.

wh o kne w h im Th e learned J u dg e h as h eld th at th e

.

dir ect ors are no t t o b e bla m ed for t rust in g h im Th e .

au dit ors h ad no su spi c ion th a t h e w as no t t o b e t ru s t ed

t o gi v e accu ra t e inform at ion as t o th e st o ck ih t rade in - -

h and and th e y tru st ed h im a cc ordingly in th at m att er

, .

It is th e duty of an au di t or t o b rin g t o b ear o n th e

work h e h as t o perform th at skill c are and c aut ion w hich , ,

a reasona bly c o m pe t en t c areful and c aut iou s au dit or

,

would u se Wh a t is reasona ble s kill c are and c aut ion

.
, ,

mus t depen d on th e part icular c ircum st an c es of each c ase .

 1 88 THE PR I N C I PL ES O F AUD ITI N G

in e v ery wa y y e t if th e au dit or m erely relies upon a

,

c ert i c at e as reg ar ds th e st ock i t m eans th at th e offi c ial ,

responsi ble for th e v alu a tion of th e s t ock can mak e th e

a cc o un t s Sh o w wh at e ver result s h e pleases by m anip ula t in g ,

th e st ock and th e au di t th erefore in such c ir cum s t an c es

, , , ,

would b e no gu arant ee at all th at th e a cc o un t s were

c orrect and w o uld th erefore in th e c ase ofa c o mpan y b e
, , , ,

no safegu ard for th e S h are h olders} I n order th erefore .

, ,

th at th e au di t m ay b e of so m e real v alu e th e au dit or mu s t ,

t es t th e s t o ck as far as is re asona bly possible I n Ch ap t er .

V i t is s h o wn th a t th ere are m an y w ay s in whi ch th e s t ock

,

m ay b e t es t ed ; in fa ct in so m e cases it is possible t o
, ,

ch eck th e s t o ck c o m plet el y but in o th ers espec ially wh ere

, ,

th ere are g oods in c o urse of m an u factu re it is alm os t ,

im possible for an audit or t o sa t isfy him self c o m ple t ely as

reg ards this asse t Ho w e v er h e c an and there is no
.
, ,

do ubt h e s h o uld m ak e enquiries and u se v ario us t es t s so

, ,

th at h e can S h o w in th e e ven t of his b eing ch alleng ed

, ,

th at h e u sed e v ery reasonab le prec aution in order t o ,

sat isfy hi m self as t o th e c orrectn ess ofth is m os t im port an t

it e m in th e a cc o un t s .

For th e foreg oing reasons a too li t eral c ons t ruct ion ,

S h o uld no t b e pla c ed upon th e ruling in th e Kingston

C otton Mill c ase but in duty t o his Clien t s and t o himself
, , ,

an a u dit or in e v ery c ase s h o uld in v est ig at e th e s t o ck m os t

c arefully and apply th ere t o e v ery reasonab le t es t S uch
, .

in v es tig a t ions are of far great er im port an c e than th e

m ech anic al ch e cking upon wh ich so m an y au dit ors exp end
such a lar g e proport ion of th e t im e de v o t ed t o an
au dit .

Arthur E Green . C o v Th e C en tral A dvan ce and

.
, .

Dis c o un t Co rporation L td I n this c ase th e audit ors

, .

w ere ch ar g ed wi th n egli g en c e on th e g ro unds th a t th e ,

pro ts of th e c o m pan y w ere c onsiderab l y o v ers t at ed ,

o win g t o th e reserv e for B ad D ebt s b eing ins uf c ien t ,

and als o on th e gro u nds th a t th e se curi ties in clu ded leases

th at h ad lapsed Th e b ook debt s in clu ded a great numb er
.
 THE L EG L A PO S ITI O N O F AU DI TO R S 1 89

of v ery old debts m an y of whi ch were s t a tut e b arred but

,
-
,

th e au dit ors relied u pon th e m anager s es tim at e of th e

reserv e for b ad debts U pon th e dea th of th e m an ag er

.

th e ne w m an ag er in ves tigat ed th e posi tion and b ad debt s

t o th e am o u n t of w ere wri tt en O ff Th e c o m pany .

c laim ed dam ag es ag ain s t th e au di t ors u po n th e grounds

th a t c o m missions h ad b een paid t o th e m an agers t o th e
ex t en t of 9 50 on th e o v ers t a t ed pro ts This c ase w as .

de c ided in fa vo u r of th e c o m pan y and j u dgm en t was for

61 3 1 43 1 1 d. Th e J udge s t at ed th a t He desired t o
.
!

say wi th reg ard t o th e c ases th a t h ad b een c i t ed t o h im

, ,

th a t th ere did no t see m t o b e an y report ed c ases in whi ch

th e exa ct duties of au di t ors wi th reg ard t o dealing wi th
,

b oo k debt s w ere laid do wn He th ought i t mu s t res t u pon

, .

th e g eneral prin ciples O fth e la w on professional neglig enc e .

O ne h ad t o fall b a ck u pon th e words of th e S t atut e If .

th ere w ere c ir cum s t an c es whi ch see m ed t o c all for in quiry ,

th e audit or mu s t m ak e th e proper in quiry and if h e did ,

not t ak e th e proper s t eps t o h a v e th e m a tt er sif t ed h e did ,

no t full th e duty h e o w ed t o th e c o mpan y as on e O f its

.
(
offi c ers He th e j udg e) regre tt ed v ery much th a t Mr .

G reen s rm po ssib l y o win g to th e m as t erful na ture O fMr

(
, .

F oo t th e lat e m anager) fell sh ort of th a t s t andard but

, ,

h e c o uld no t h elp arri vin g a t th at c on cl usion and h e ,

th erefore fo und as h e h ad s t at ed .

F ro m a c onsidera tion of th is c ase i t is clear h o w im

port an t i t is th at an audit or Sh o uld car efully ex amine th e
b oo k debt s wi th a View t o as c ertaining th a t th e reserv e
,

for b ad debt s is s uf c ien t t o m ee t all b ad an d do ubt ful

debts .

R epu blic of Bo livia Exploration S yndica te L td Here , .

it was h eld tha t audi t ors are prim a facie responsi ble for
ultra vires pa ym en t s m ade on th e faith of th eir Balan ce

S h ee t s but wh e th er and t o w h at exten t th e y are respon si ble

,

for no t disc o v ering and c allin g atten tion t o th e illeg ality

o f pa ym en t s made prior t o th e au di t must depend u pon ,

th e sp ec ial c ircum stan c es of each c ase .

1 90 THE PR I N C I PL ES O F AU D ITI N G

I n this c ase c ert ain pa ym en t s w ere m ade prior t o th e ,

au dit for whi ch th ere was no auth ori ty t his c o m pan y

, ,

b eing regulat ed by Tab le A Al th ough th ese

pa ym ent s w ere u ltra vires th e C o urt does no t appear t o ,

h av e b een sat ised th at th e c o m pan y su ffered a ctu al

dam ag e thro ugh th e au dit or s defa ult in no t poin t in g out
th is fact in his report Th erefore in th e spec ial c ir cum
.
,

st anc es oi th e c ase th e act ion ag ains t th e au di t ors was

,

dis m issed but with out c os t s as th e C o urt appears t o h a v e

, ,

b een far fro m sat ised wi th th e m anner in which th e au dit

was c arried out .

Dum bell s Ban king C o L td I n this c ase th e au dit ors

. .
, ,

t og eth er wi th th e direct ors w ere prosecut ed and sen t en c ed

,

t o v ariou s t erm s o f im prison m en t for c oncurring in th e ,

p ub lis hin g of three Balan c e S h ee t s which th e y kne w t o

b e false in m at erial part iculars wi th in t en t t o dec eiv e and ,

defrau d th e m e mbers s h are h olders and c redit ors of

,

Du m bell s Ban k in g C o m pan y

.

W ilde an d O th ers v C ape an d Dalgleish I n t his c ase th e

. .

a cc o un t an t s were s u ed for neg lig en c e and b rea ch of duty ,

th e gro unds b ein g th at th e y did no t C h e ck th e plaintifIs

Pass Boo k with th e Ca s h Boo k and thu s failed t o disc o v er ,

defalc at ions of th e c as hier a m o un t ing t o Odd, .

Th e poin t of th e c ase w as as t o wh eth er or no t th e accoun

,

t an t s w ere inst ruct ed t o c arry o ut a full au di t Th e c ase .

w as sett led by th e a cc o un t an t s agreein g t o j u dgm en t for

850 Fro m this and v ario u s o th er c ases it will b e seen
.
,

h ow im port an t i t is th a t an a u dit or s h o uld h a v e in all ,

c ases a Clear and denit e underst anding wi th his c lien t s

,

as t o wh a t exa ct l y be is t o do and wh a t gro und h e is t o ,

c o v er espec ially wh en only a p ar ti al au di t is required or

, ,

wh ere an a cc o un t an t is inst ruct ed t o c arry out acc o un t an cy

work onl y S e v eral a cc o un t an t s h av e h ad t o pay dam ag es
.

in c ases wh ere th e wh ole qu est ion h as b een as t o wh a t were

th e orig inal instru ct ions and th erefore wh at w or k th e y
, , ,

con t ract ed t o do .
1 92 THE PR I NCIPL ES O F AUD ITIN G

upon th e c ir cum st an c es of th e c ase and also upon th e

,

g eneral s t an dard adop t ed by th e profession

(
.

1 2) I n th e c ase of pri v at e r m s it is of th e utm os t

,

im port an c e th a t th e exa ct sc ope of th e au dit or s dut ies

s h o uld b e rec orded in writ in g

(
.

13 ) Au di t ors will no t b e h eld lia b le for no t trac king

out ing eniou s and c arefully laid sch e m es of frau d wh en ,

th ere is no thing t o aro use th eir s u spi c ion and wh en ,

th ese frau ds h a v e been perpet rat ed by t rie d serv ant s

o f th e c on c ern

(
.

1 4) I f an au di t or wilfully c er ties acc o un t s kno win g ,

th e m t o b e false h e m a y b e h eld c riminall y lia ble

, .

I n c on clusion i t m ay b e said th at it is v ery unlik ely

,

th at an audit or will b e h eld personally lia ble pro vided

h e is possessed of th e requisit e professional s kill and ,

th at h e h ones t ly exer c ises such sk ill in all c ases taking ,

e v ery reasonable prec aut ion t o sa t isfy him self u pon

e v ery poin t b efore h e c erties th e a cc o un t s and in th e
, , ,

e v en t of his b ein g dissa t ised upon an y m at erial poin t ,

if h e report s clearly in his a u di t report t o this e ffect It .

is th ought th at no b e tt er S h or t den it ion of an a udit or s

dut ies c an be gi v en th an th e follo win g which is p art of

,

th e j u dgm en t in th e L on don an d General Bank c ase :

S uch I t ak e t o b e th e duty of th e au di t or ; h e must b e
hones t th a t is h e mus t not c ert ify wh at h e does no t
,

b eliev e t o b e t ru e and h e must t ak e reasonable c are and

,

Skill before h e b elie v es th at wh a t h e c ert ies is true .
 APPEN D I X
E X AMI N ATI ON QU ES TI ON S
(
1 ) W HAT are th e p ri nc i pal o bj ec ts o f an audi t
(
2) S ta t e bri ey th e di fferenc e in princi p le betwee n th e
audi t o f th e accounts o f a pri vate p artn ership an d th ose O f ,

a lim i t ed co m p any
(
3 ) Wha t d o yo u un d ers ta n d by a
.

Co ntinuous Audi t " ,

an d wha t are th e advan ta ges an d di sa dvan ta ges O f such an

au di t
(
4) U pon ha vi ng been a ppo in t ed audi tor O f ( a ) a co m pan y

(
,

b) a p art n ershi p wha t wo uld yo u do in ea ch case p rior to

,

co m m encin g th e actu al work o f th e audi t P

(
5 ) Wha t are th e O bj ec ts o f k ee p in g a n Audi t Pro gra m m e ?
(
6 ) Wha t d o yo u un d ers tan d b y I nt ernal Chec ks
wha t i s an au di tor s posi ti on in regar d thereto


an d ,

(
7 ) Wh a t no tes S hould an au di t or m a k e durin g th e course
o f an au di t
(
8 ) Wha t st e ps wo uld yo u ta ke t o di sco ver an e rror in
th e Tri al Ba lan c e o f a se t o f boo ks whi ch th e sta ff o f th e ,

co m p an y h a d f ail ed t o d et ect an d w h i ch yo u w ere ask ed to,

n d
(9 ) Wh a t d o yo u un d erst an d by th t r V ouchi g i e e m n

e
(
1 0 ) S t t in d ta il th
a e work invo lv d in a o p l t
e
m i t au di t f th Cash Bo k f a a ufact i g bu i
c en O e
e d
o O m
e
n ur n
c m e e an

s n e ss.

(
1 1 ) To wh at p c i a l po i n t
en e ng
ho uld
s

e
e audi tor pay att ti o
wh ch c ki th Ba k r Pas Bo k wi th th Ca h B k n e

s
s S
s
an
o e s
en

oo
n

S ta t e ho w you would veri fy th e Balan ce at Ban k and th e

Cash in H an d
(
.

1 2) D esc ribe th e st ep s tha t yo u w ou ld tak e as audi to r to

ch e c k th e fo ll o wing
Cash S a les .

R ents R ec e i vabl e .

I n t eres t R ec ei vabl e on L oans .

Pro c eed s o f sale o f 5 00 Co n so ls

(
.

13 ) Wh y w ou l d yo u c o nsi d e r e n dorsed ch eq ues to be

in suf ci ent vouch ers for th e p a ym ent o f accoun ts ? U n d er
wha t c ircum stance s would you accep t endorsed cheq ues as
vouch ers for an y p aym ents
(1 4) I n vouchi ng a Cash Boo k yo u n d th e fo llo wi n g
pa ym en ts Wh at p roo f would you req uire o f th e co rrectn ess
.

o f th e pa ym en t i n ea ch case
'
T ravellers Co m m issi o ns and Ex penses .

S ta Sa laries .

1 93

(su )
ts t
1 94 THE PR I N C I PL ES O F AU D ITI N G

Pa ymen ts to build ers on a cco unt o f a contract for th e

e recti on o f buildi ngs .

Purch ase o f P lant an d Ma chinery .

Pur c hase o f so m e D e bentu res o f a R ailway Co m p any .

Paym ent O f Bo ugh t L e d ger A cco un ts

(
.

1 5 ) Y o u are c onsul t e d as au di t or o f a m a nufa ctu ri n g

co m p an y ,
e m p lo yin g a l arge num be r o f w or km en so m e o f ,

who m are d ay an d so m e p i e c e w orkers as t o th e mo d e i n ,

whi c h th e wages Sho uld b e rec orded an d th e p aym ent Ch ec ke d .

S tat e wha t yo u would r ec o m m en d und er bo th h ea d s an d , ,

i f th e s ys t em yo u suggest w ere a do p t e d t o wha t e x t en t woul d

,

yo u as audi tor ch e c k th e w ages

(
, ,

1 6 ) I n wh a t w a y w o uld yo u audi t a Pe tty Cash Ac co un t

( 1 7 ) A rm o f iron merc h an ts fo r who m yo u a ct as au di t or
h as c on tra ct e d t o purch ase
,

t o ns o f iro n at 2 1 03 per .
,

ton on t erm s O f S ix mont hs acc eptan c es fro m d at e o f i nvo ice

, .

Th e iro n h a d bee n d e livere d as fo llo w s

1 5 th A p ril 1 9 1 4
, t o ns
1 5 th J une 1 9 1 4
, t o ns
1 5 th O ct o ber , 1 9 1 4 t ons
Wh at boo ks o f th e rm would i t be req ui sit e for you t o see i n
ex am i ni ng th e rec or d O f t h es e transact i o n s H o w would
th e liabili ty i n res p ect O f i t be sho wn in th e Balanc e S hee t o f
S lst D e c e m ber , 1 9 1 4
( 1 8 ) I n au di tin g th e a cco un ts o f a tra di n g c o m p an y , wh a t
st e p s w o u ld yo u as au di tor , ta k e t o as c ert ai n i f th e a m o un ts
,

charge d i n resp ect O f p urch ases w ere corre ct P

(1 9 ) HO W wo uld yo u sa ti sfy yo u rse lf as au di t or th at th e
R eserve for Ba d an d Do ub tful D eb ts w as a suf c i e n t o n e
, ,

(20) H o w w ou ld yo u vouch t h e en tri es c on t ain e d i n th e

J o urnal
(2 1 ) To wh a t po i t Sho uld an au di t or p ay Sp e ci l a tt ention
wh en exa i ni ng invo i c s
m
n s
e
a

(22) D es c ribe th e s t e p s tha t yo u wo u ld ta k e t o ch e c k th

Bo ugh t D ay B o k o
e

(
.

23 ) In audi ting th e a ccoun t o f a anu factu i g bus iness

s m r n ,

you are as ke d p a ti cul a ly t o as rt ai n t h at all out st an di

r r ce ng
a cco un ts h ave been brough t in H o w would you sati s fy .

you rs elf on this po in t P G ive illustra ti ons

(24) Wh at are th e d uti es o f au di t ors wi th re feren ce t o th e
grou p i ng o f th e i t e m s i n a Bal an c e S h ee t Wh at evils h ave
t o b e avo id e d Wh a t genera l p rin ci p l es should b e act e d
upon P
(25 ) Wh a t i t em s w ou ld yo u exp e ct t o n d i n th e
A c co unt
" "
Prot an d L oss A c co unt an d App ro p ri ati on
Trading
, ,

A cco un t ,
an d wha t are th e O bj e cts o f p rep ari ng th ese
,

accoun ts
(26 ) D ene a Balan c e S h ee t an d ex p l ai n wh y i n th e m aj ori ty
,

o f c ases i t is no t a S ta t em en t o f Asse ts an d L i abili ti es

1 96 rm : PRI N C I PL ES or A UDI TI N G

ta k e to satis fy yours elf that the T ra ding A cco un t and Ba lan ce

S heet were c orr ec t P
( 37 ) The m a n a ging dir ector o f a limited com p a ny m an u fac
tu ring edged tools s ka tes and s aw s require s to kn ow a t the
,

, ,

end of ea ch qu a rter whether the s toc k in each of the three

de p artment s h a s increa s ed o r diminished A n a ccurate stoc k .

ta king was made on the 3 o th J une Ho w without agai n .

,

ta king s toc k could you give him thi s informa tion a ppro xi
,

mately on the 3 o th S e p tembe r ass uming tha t a p ro p er ,

T rading A ccount for each dep a rtm ent had been k ep t durin g
the p reviou s y ea r P
( 38 ) Ho w would you verify the item
app e aring in a Ba lance S heet P
W or k in Progre ss

( 39 ) A re there in y our o p inion any circumstan ces which

, ,

would j ustify the a ddition o f any antici p ated p rot to a ctu al

co st in the cas e of p a rtially m a nufa ctu red goods or of a n ,

uncom p leted engineering contra ct or in si m ila r ca ses P

(
,

40 ) Ho w s hould Plant and Ma chi nery be v a lued for Ba l a nce

S heet p u rpo s e s in the c a s e o f a m a nufa cturing com p a ny P
( 4 1 ) I n the event of an a u d itor being o f o p i nion th a t the
p rovision fo r de p recia tion was in s uf cient wha t course sho uld ,

he ado p t P
( 42) O n being a ppointed auditor o f a c o m p a ny whi ch ha s
pre s ented a nnu a l Ba la nce S heets to its sha reholder s fo r ten
yea rs you n d that s ome freehold buildings acquired at the
,

fo r mation o f the com p a ny an d some building s a cquired v e

,

y ears la ter o n a thi rty y ears leas e are ta k en cre d it fo r in

,

the tenth ann u a l Balance S heet at the price s p a id fo r the

freehold and leasehold re spe ctively W hat course would you .

advis e the directors to ado p t with reference thereto before ,

you ce rtify the eleventh Balance S heet P

( 43 ) W h a t i s G o odwill and u pon what s hould it be b a s ed P
(
,

44 ) I n a uditing a Balance S heet of a shipp ing co m p a ny ,

you n d a note on the Ba lance S heet a s follow s C ontingent

L iability o n Bills R eceiv a ble di s counted W ha t ,

d o e s thi s mean ? Is it n ece ssary to ve rify this st atement P

If s o how would yo u s ati sfy yours elf on this point P
(
,

45 ) W hat d o you under s tand by D e p reciation and wh a t ,

ar e the obj ects of p roviding fo r the same P

( 46 ) Exp lain wha t is meant b y
( a ) A S p ec i c R e s erve

(
.

b) A G ene ra l R e s e rve
(
.

a) A R e s erve F und
(
.

d) A D e p reciation F und
(
.

e) A S in king F und
(
.

47 ) The director s of a manu fa ctu ring co m p a n y o wning a ,

considera ble qu a ntity of va luable p la nt and machinery ,

decide to k ee p a Plant R egiste r They reque st you to advise

.

the m as to how thi s R egi ste r s ho uld be k ep t what info rm a tion ,

 APPEN DI X 1 97

should be entered therein an d how the question of de preci a tion

,

should be dea lt with S et out in the form of a re po rt to the

.

directors the a dvice th at you would give

(
.

4 8 ) Ha vin g s uggested the necessity of a p rovision for

D e p reci ation of Ma chinery in the a ccounts of ea ch of three
com pa nies the res pective bo a rds of directors ra i se obj ection
,

on the fo llowing grounds res pectively

(a ) The cost of simila r m a chinery h a ving ri s en

should be wri tten o ff as it is a ctu a lly mo re v a lu able

nothi n g ,

(
, .

b) R e pairs done h a ve fully m aint ai ned the m a chinery ,

which is as good as new

(
.

a) To ch a rge de p recia tion to the sa me extent as in a

good yea r wo uld p revent the decla ra tion of a dividend ,

with the result of di ssatisfa ction a mongst the shareholders

and a po ss ible fa ll in the p rice of sha res .

C ritici s e thes e arguments

(
.

49 ) I n a m a nufa ctu rin g bus iness where the expenditure ,

necessa ry to k ee p the works in pro per order a n d emcien cy

v a ri ed ve ry greatly from yea r to year how could thi s expen ,

ditu re be dea lt with in the yea rly a ccounts so th a t the p rots

a v a il a ble for dividend should not uctuate grea tly by t w on

of such ex penditure bein g so vari a ble P

(50 ) A s a uditor of a com p a ny you n d th at during the
yea r l a rge s ums ha ve been ex p ended on re pai rs renewa ls
,

, , ,

a lter a tions a n d a dditions to p lant and

,
ma chinery How .

would you veri fy these pa yments a n d by what p rin ci p le 3 ,

would you be guided in deciding whether they were pro perly

chargea ble to c a pita l or revenue P
(5 1 ) W h a t are the v a riou s methods used in practice for
writing o ff de p reci ation P S hortly de sc ri be ea ch
(
.

5 2) W h a t do you understa nd by S ecret R eserves and ,

wha t is an a uditor s position in rega rd thereto P

re the p rovi sions of the C om panies (

(5 3 ) W h at a
tion ) A ct 1 9 0 8 with reference to the a ppoin tm ent and
C on solida

, ,

remunera tion of a uditors P

(
5 4) S et out the power s and duties of au dito rs under
S ection 1 1 3 of the C om pa nies ( C onsolida tion ) A ct 1 908 and ,
,

the directions contained in th a t cla u se with regard to the

A udito r s R e port

(
.

'
5 5 ) H a ving com p leted th e a udit of a com p any s Ba lance

S heet a n d ha ving found eve rything in order give a cop y of

, ,

your re por t to the shar eholders in accordance with the

C o m p anies ( C onso lid a tion ) A ct 1 90 8
a ni es (
(
.
,

5 6 ) W h at ar e the requirement s of the C om p Co n soli

da tion ) A ct 1 90 8 with reference to the s ta tement in the

, ,

form of a Ba lance S heet required to be led with the A nnual

S umm a ry P
()
5 7 A co m p any regi s tered unde r the C om panies A cts ,

1 908 to 1 9 1 7 has i ss ued shares for the p urp o se of raism g

,
1 98 THE PR I NCI PL ES OF A U DITI N G

money to de fray the exp en s es o f the co nstruction o f some

wor ks wh ich will not be a ble to earn income for three years
, .

The directors a re o f o pinion it is not desir able to ch arge

interest on s uch shares a gain st the Prot an d L o ss A ccount ,

but tr eat such interest as ca p ital expenditure W hat ste ps .

must the directors ta k e to s a tisfy you as a uditor before you , ,

agree to ce rtify the a ccounts witho ut comment P

( 58 ) W h at p articul ars have to be entered in a R egister of
(
Mo rtga ges under the C om panies C on solida tion ) A ct 1 9 0 8 P
(
,

5 9 ) Y ou are a ppointed a u d itor on the form a tion of a limited

com p a ny an d a re instru cted to ex ami ne the boo k s for the
,

p u rpose o f ce rtifying the p a rticular s required for the S tatutory

(
R e po rt under the C o m p a nies C o n so lid a tion ) A ct 1 90 8 W h at
ste p s would you ta k e to enable you to give the nece ssary
, .

ce rticate P G ive the form of ce rti cate

(
.

60 ) W h en a com p any has not ado p ted a good s y s tem of

ac co unt k ee ping has an audito r an y sp ecial du ty to p e rform P
(
,

D oes the C om p anies C on solid a tion ) A ct 1 90 8 confer an y , ,

sp eci a l power u pon an au ditor in this res pect ?

( 6 1 ) I s an a uditor entitled to ex ami n e the Min ute Bo ok s of
a com p any and if so for what reas on s P
(
, , ,

6 2) C a n S hares and D ebenture s be i ss u ed at a di s count a n d , ,

if so how should the di s count be de a lt wi th in the account s P

(
,

63 ) F or what purposes should a n a uditor refer to the

Memorandum and A rticles o f As soci a tion of a com p any P
( 64) The directo rs of a co m p any of which you are a u d itor
i ns truct you to audit o nce a fortni ght the documents a n d
,

entri es in co nnection wi th the tran s fer of the co m p any s

shar es S et out fu lly what you r duties ar e

(
. .

6 5 ) How should fo rfeited sh ar es be tr ea ted in the

p ublish ed acco unts o f a co m pan y P
( 6 6 ) W h a t do you understand b y

D ebentur es i ss ued as
co ll ate ral secu rity for a L oan and how should this po sition
,

be shown in the Bal ance S heet P

( 6 7 ) W hat a re the dutie s o f an audito r o f a co m p any under
(
the C om p a nies C o nso lida ti on ) A ct 1 9 08 in resp ect of the
item Prelim in ary and F orm a tion Exp ens es a n d how should

, ,

the same be dealt with in the a cco unt s of a com p an y P

( 68 ) A limit ed com p a ny was formed and in corp o rated on
the l st N ovember 1 9 1 4 to acquire two p riv ate concern s as
, ,

on the 3 o th J une 1 9 1 4 a do p ting their tr a d ing f rom tha t date

, , .

The p urcha s es were com p leted on the 3 o th N ovember 1 9 1 4 , .

I t was decided to k ee p the accounts of the two bu s inesses

se p a rate until the 3o th J une 1 9 1 5 The net p rots at th a t
, .

d ate were found to be and respectively for the

year Y ou are ask ed to a dvi s e the di r ectors as to the a mount
.

of dividend they are j u sti ed a p art from n ancial co n sidera

,
'
ti o ns in pa ying on the co m p any s total ca p ital o f
, in
ordinary sh a res .
200 R
THE P I N C I PL ES U
o r A DITI NG

detail the extent to which you would chec k the i ss ue of

shares
(
.

77 ) A co m p an y issues d ebentu res s uch debentures ,

being redeem able a t the end of ten yea rs a t 1 0 5 I t is decided .

to crea te a S in king F und to p rovide for the re p a ym ent of the

debentures and the p remium How should these tran s a ctions
.

be dea lt with in the a ccounts an d wh a t will be the position a t

,

the end of the p eriod when the debentures h a ve been rep ai d P

( 78 ) I n wh a t circumstances is it l a wful for a com p a ny to
pa y commi ssion to a n y pe rso n in considera tion of his sub
s cri bing o r p rocu ring subs cri p tions for sh a res and how should ,

such p a yments be dealt with in the accounts P

( 7 9 ) I s a com p a n y formed to wor k a w a sting p ro perty bo und
to set a pa rt a S in king F und to meet the de p reci a tion of such
pro pe rty and wh at i s the lega l position of an a uditor of s uch
,

a com pa n y in thi s con nection a n d wh a t a re his duties P

(
,

of C a pita l .
"
80 ) I t is often s tated that D ividends have been p a id out
W h a t i s me a nt by this s tatement a n d how can ,

dividends be so p aid out of ca pital P

(8 1 ) I n the cas e of a m a nufa ctu ri ng com pa ny what is the
lega l position as regards the de p reciation of p lant an d
,

m a chi nery P
( 82) I n th e event o f a com p any is s uing sh a r e s a t a p remium
how should the p remium be trea ted in the accounts a n d is it
,

a v ail a ble for d ividend p u rpo ses ?

( 83 ) I f there a re not suf cient p rot s to pa y the dividends

on the Preference S ha re s how should the a rrears be dea lt
,

with in the account s of a com p a ny P

( 84 ) I s a com pa ny bound to re p la ce lo s t ca p it a l out of
revenue before it can declare dividend s P S tate fully the
reaso n fo r your a nswer
(
.

85 ) I f the directors o f a com p any info rmed you that ,

owing to bad trade they did not i ntend to draw their fees
, ,

wh a t cou rs e would you a do p t P

( 86 ) The ma r k et v a lue of the I nves tments of a tru s t com p any
has fallen conside rably wh ile the com pa ny has e a rned enough
,

in come to p ay the usual dividend How should you deal .

with thi s position of a airs i n au d iting the annu a l

accounts P
( 87 ) The directo rs of a com pan y limited by shares have
,

iss ued ca p ital at a p remium They are under the co ns titution

.
,

o f the com pa ny bound to p rovide for de p reciation in res p ect

,

o f wastin g ass ets out of revenue an d only entitled to declare

,

dividends out of the p rots of the com p any Y o u a re told .

that the Bo ard have been a dvi s ed th a t they ca nnot c a rry the
p remiums received to R evenue A ccount a n d they ha ve , ,

therefore decided to show the a mount as a s epa ra te item on

,

the lia biliti es s ide of the Ba lance S heet and app ly one tenth,
-

of it ann uall y in aid o f de p reciation o f leas ehold s W hat is .

 APPEN D IX 20 1

your duty as auditor in thes e cir cumstan ces ? Give your

rea sons
(
.

88 ) A re ca p ital prots a vailable for di stribution as

dividend ?
(89 ) I s a n auditor pe rs onally li a ble if it is s ubsequently
p roved th a t the a ccounts he h as certi ed a re fa lse or fra udulent ?
( 9 0 ) A n engineering com pa ny has built a new worksho p
a n d equi pp ed it with new l a thes A po rtion of the wor k
.

has been done by the com pa ny s o wn men an d a portion by

'
,

outside contra ctors The addition h as rendered it needful

.

to p ro vi de increa sed stea m power a n d co nsequently a n old

, , ,

engine has been sold an d been rep la ced by a la rger one p ur

cha sed S ta te wha t evidence you would re q u ire as a udi tor
.
, ,

th at the amounts charged to Buildings A ccount an d Plant

A ccount were correct and how the co st of the additio na l
,

stea m power should be dea lt with

(
.

9 1 ) A limited wm pa ny h as removed its business to new

wor ks which h a ve cost including F reehold L a nd
,
A ,

po rtion o f the m a chinery an d p la nt at an estima ted va lue of ,

h as bee n removed to the new wor ks a t a cost of

The rem ainder has been sold showin g a loss on the to ta l boo k
,

v alue of the m a chinery a n d p lant of The p rots for

the yea r including the ba la nce b rought forwa rd from the
,

p reviou s ye a r a fter m a king p rovision for dep reci ation on the

,

m a chinery a n d p lant are without ta king into a ccount

the a bove named lo ss an d are a bout the norma l p rots in
-
,

p reviou s years .

S tate your views as to the p ro per mode of dea ling with the
co st of remov a l an d the loss on the sa le and whether a pa rt
from na nci a l considera tions the directors would be j usti ed
, ,

i n declarin g a dividend
(
.

9 2) A s rega rds the leg a l li a bilities of a udito rs is there any ,

di fference between the po s ition of an auditor to a partn ershi p ,

and an a uditor appointed under the Co m panies A cts ?

(9 3 ) To wh a t extent is a n auditor respo n sible for the
va lu ation of the S t oc k in Tra de P -

(
-

9 4 ) Th e trading p ro ts of a manufa ctu ring concern fo r a

yea r in which the sales ha ve equalled the a vera ge o f pa st years
show a con sidera ble reduction on p receding yea rs Y ou a re .

ask ed to investiga te and re po rt to the partners the reasons for

this reduction in p ro ts .

S tate wh a t are the points to which you would give attention ,

a n d how you would p roceed to inve stigate them

(
.

I uditing the account s of a cha ri table i nsti tuti on

95 ) n a ,

where a pai d secreta ry is em p loyed who is a uthorised to ,

collect a n d give recei pts for dona tions and subscripti ons ,

wha t informa tion a n d evidence would you requi re before

ce rtifying the A nn u a l A ccounts to sa tisfy yourself that all
,

the subsc ri p tio ns an d do nations had been p ro perly accounted

20 2 THE PRI N CI PL ES or AU DITIN G

for an d wha t saf egua rds would you s ugges t to e ns ure

,

this P
(9 6 ) A com p a n y des iro u s o f extendin g its p rem i s es obta i ns
estim ates for the work from builde rs the lowest of which is
,

O n co n s idera tion of the C ir cum s tan ces the dir ecto rs ,

o f the com pan y decide to ca rry out the work by mean s of thei r
own sta and the a ddition al p remi s es gure in their Bal ance
,

S heet at m a de u p as follo ws

N et cos t of m a teri a l s purc h ased

D i sco un t th ereon transferred t o I nt eres t a n d D iscoun t
A ccount . 30
L a b our on erec tion
Man agi n g di rec tor s supe rvi sion (
part of hi s annu al sa la ry) 1 00
Pro porti on of of ce exp enses 50
I n t eres t on ou tl a y t o d a t e of compl etion 40
Pr0 t t ransferred to Pr o t an d L o ss A ccount
,
. 240

W hat view should an auditor tak e of this transaction and

of the v a riou s item s involved P
(
9 7 ) I n examining the C ash B oo k of S mith
n d th e fo llowin g item among the p ayments
B rown , you

19 13 .

Aug . 20 Jones Cc .
, for coal 42 10 0

The r ecei p t o n the le co rrespondin g in o rde r to this item

reads as follow s
MR A W IL L IAMS
. . . Dr . to J ON E S Co .

For co al suppli ed t o 3 1 st July 1 9 1 3 , 42 10 0

Receive d 3 l s t Au gu s t 1 9 1 3
(
, ,

S tam p) With th anks ,

J R O BI N S
. .

In what p a rticulars does this appear to be an insu i cient

v ouche r P

(9 8) I n exam i ning a li s t of D ebto rs an d C redito rs with the

L edge r A ccounts fo r the p urpos es o f a B a l a nce S heet to wha t ,

features o f e a ch acco unt S hould you p ay attention a p art from ,

the mere a rithmetical correctn ess of the extractions P G ive

exam p les o f e rro r o r fraud which may be detected in thi s
process
(
.

99 ) Blan k Co k ee p all Bills R eceiv able in their hands

.

until m a tu rity an d then p ay them into the Bank fo r collection

,
.

O n 3 lst J uly when yo u are exami n in g the Ba lan ce S hee t o f

,

3 oth J un e it a ppea rs that the ac tu al bills in the ca sh box

,
 I N D EX
'
AC C O U N TAN C Y an d Auditing . A u di tor s d u ty as regard s d epre
D i ere n ce b e tween 2 ciation , 1 15
iabili ty as re g ard s Third
,

Work 2 ,
L
A ddi tions C heck in g of 1 5
, ,
Parti es 1 8 0 ,

A dj us tment of N omin al Ao for neglect 1 80 ,

counts 6 3 Re po rt 1 29
Form of 1 32
, ,

A dv ice 20 , ,

A gents Recei p ts from 36

, , po n sibilities
reS ,
1 76 , 1 78
A llo tment L e tter 1 47 ,
Au toma ti c TI 115 3 5 ,

Altera ti o ns 1 4 ,

Amount s received from A gen ts , B AD an d Do ub tfu l D eb ts ,

55
37 F ig
res 1 4 26
u , ,

Analysi s of C as h B ook 28 ,
B alance S hee t 58 ,

of L edgers 27 , Au dit o f 3 ,

An nu a l L is t an d S umm a ry 1 34 , D e niti o n of 66 ,

Annu ity S ys tem 1 1 3 , M ain ob j ec t o f 6 7 ,

App li ca tion a n d All o tment B ook , Prep a ra tion o f 6 5 ,

1 46 B al ancing of B ooks 22 66 , ,

App i ca tions for S h a res 1 46

l ,
B ank B alance Ve ri ca tion of , ,

Appo in tment o f Au ditors of 77

C omp any 1 2 5 ,
Ba nker s
C ertica t e of B a la nce ,

Approp ri a ti on A ccoun ts 6 0 6 2 , , 33
Arrea rs of C umu l a tive Preference Pass B ook , 32
D iv iden d s 162 ,
B ank in g C omp any 1 33 ,

Arti cl es o f A ssocia tion 1 44 , B ills Payable B ook 24 5 2 , ,

Asse ts V a lu ati on o f 6 9 7 5 1 3 5
, , , ,
Receiv abl e 37 8 1 , ,

V erica ti o n o f 7 5 , B ook 24 5 1 , ,

Was tin g 1 6 8 , B ook D ebt s 8 1 ,

Au dit 2 , B ought D ay B ooks 23 46 , ,

B ank in g C ompany 1 33 , L ed ger A ccounts Pa yment ,

C o nunen cem en t of 1 1 , of , 40
C om p any 1 25 178 , ,
L ed g ers ,
24 ,
53
C o ntinuous 15 B rea k up V alue
-
71
Fee 6 4
, ,

, B roke rag e 1 38 ,

I nt ern al 1 0 , Buil din gs 4 1 ,

M ain ob j ec ts of 3 ,

o f S h are B ooks 1 47 , C AL L IN G B ack ,

14
Pa rti al 1 8 , C all s in Arre ar ,
1 56
Perio di ca l 1 5 , Paid in A dv ance 1 57 ,

Pri ma ry O b j ec t of 3 , C an cell a ti on of Vouch ers 29 ,

Progr amme 12 , C apita l Ex pend itu re 1 40 .

Transfer 1 49 , L osses 1 7 1 1 7 7 , ,

Auditor C omp any 1 25 1 7 8

, , , Pro ts 1 6 7 1 7 7 , ,

D u ties of 1 29 1 9 1 , , C arts an d V ans 9 8 ,

L e g a l Pos iti on of 1 78 , C ash B ala nce C h eck in g 44 , , , 77

Pri va t e 1 7 , B ook 22 30 , ,

Qu a lica tions o f 1 9 ,
Vouchin g C re dits , 37
und er S ta tu e l7 ,
D eb i ts 3 3 ,

A udi tor s C ertica te 1 3 7

, Received from Deb tors ,

35
 IN DEX

C a sh S al es 3 5 C om an R egister of Memb ers

p yil
,

C as ting s C h eck in g 22
, , 0 D

C h eck m g A ddi ti ons 1 5 , of M ortgag es b y

C as tin g s an d Pos ting s 22 1 42, 1 50
i
,

C ommencement of new A u d t 1 1 , Remunera tion of Au ditors

C omm i ss i on E rrors of 4, , of ,
1 28
C omm iss ions Receive d 37 , U h
S a re B oo ks of 1 47
U
,

nd erwri ting , e tc , 1 38 .
Q C apital of 1 4 5 ,

Co an y Annu a l S umm a ry of C erti ca tes of 8 1

gp
, , U ,

S ink in g fund s of 1 20 1 5 1 , ,

C ompany , Appli ca tion for S h ares S ta tu to ry B ooks o f 1 4 1 ,

in 1 46 S ta tu t o ry Repo rt of 1 36
S umm ary (
, ,

Appo in tment of Au ditors Ann ual ) of 1 34 ,

of ,
1 25 U nde rwriting C ommissi ons
Ar ticl es of Association of of 1 38
;
, ,

14 Vouching Dividend s of 1 6 2 ,

Au dit of 1 25 1 7 6 , , Was ting Assets of 1 6 7 ,

Auditor of 6 1 7 1 25 , , , C o nsi gn men ts 9 0 ,

L egal Position of , C on tinuous Au dits 15 ,

1 76 C on tra A ccoun ts 3 9 ,

Powers an d D uties C op yrights 1 0 1 ,

of ,
1 29 C o s t of M ain tenance 1 10 ,

B ank ing 1 3 3 , C re dit N o tes 47 ,

C a p ita l L osses of 1 70 ,
sid e Vouchi ng 38 , ,

Pro ts of C redi tors S ta temen ts

'
1 67 ,
48 54 , ,

C um u l a tive Preference C umu l a tive Preference S h are s ,

S h ares of 1 46 16 2 , ,
1 46
D eb en tures of 8 1 , ,
1 50 Arrea rs of
D irectors Minu te
B ook , Div id en ds ,
1 62
1 60
Fees , 1 58 D E BEN T URE S 8 1 1 50 , ,

Ex penses
1 59 ,
as C oll a tera l S ec urity 1 53 ,

Regi ster o f 1 42 ,
D e bit side Vouchi ng 3 4 , ,

D iv idend s of 1 60 D ebtors S ta te men ts 35 51

, , ,

I nterim 16 1 , D eb ts B a d an d D oubtful
,
55 ,

Du ti es of Au ditors o f 1 29 D ep reci a ti on 9 5 1 0 4 1 7 0 , , ,

F
,

orfeit ed S hares of 1 5 7 ,
Au ditor s D u ti es as regar ds,
'

I nteres t p aid b y during 1 15

F
,

C o ns truc tion 1 39 ,
und 1 20 ,

I nt erim D iv i dends of 1 6 1 ,
S ys tem 1 1 2 ,

Memoran dum of Associ M

ain obj ec t of p rovi ding

a tio ns of 1 43 ,
for 1 06 ,

Minu te B oo k 1 4 1 1 6 0 , ,
M
e th ods for Writin g o ff ,

O b j ects o f 1 43 ,
111
Preference S h are D ivi of ines 1 68 M ,

d en d s of 1 6 1 ,
of Plan t] and achine ry M ,

Prelim in ary Exp enses of ,

170
1 54 of Was ting Asse ts 1 05 , ,

Prots of ,
a v ailab le for 167
Div iden d 1 6 4 ,
De sk C a s h ook 35 B ,

Pro ts of , p rior to I ncor De tec tion of Errors 3 , 25 ,

1 55 D ifferences in B alan cm g 25
po ration ,
i
,

D rec tors Ex penses

'
Pro sp ec tus of 1 46 1 59 ,

Regis ter of
,

D irec tors of ,
ees 1 58F ,

1 42 M
inu te Book , 1 6 0
206 IN DEX

D irec tors , Re gis ter of 1 42 ,

I ncome Ex penditure
an d
D iscount on D eb en tures 1 5 0 ,
A cco unt 6 1 ,

D is tinc tive T i cks 1 3 ,

I nscrib ed S tocks 80 ,

Div id en ds 36 160 1 77 , , ,
I nsurance Policy Amounts ,

Arrears O f C umul a tive receive d under 3 7 ,

Preference 16 2 ,
S ys tem 1 1 3 ,

I n terim 16 1 , I nteres t , 36
on Preference S h ares 1 6 1 , during C onstruc tion 1 39 ,

Pro ts av ailable for 1 6 4 , , on D epo sit 3 7 ,

1 77 on L oan s 3 7 ,

U
np ai d 1 6 2 , Payabl e 6 4 ,

Vouching 1 6 2 , I n t er es ts of C reditors 1 7 5 ,

D ocke ts 44 , I n terim D iv idend s 16 1 ,

D ra win g s 4 0 ,
I nterna l C h ecks 9 30 , ,

Du ties of A u di tors un der C om I nves tmen t of surp lus of A sse ts

p anies A c ts 1 29 1 9 1 , , representing General Reserve ,

1 18
EFFL U X I O Nof T ime 1 07 , I nvestmen ts C h eck ing, ,
41, 78
End orsed C h eq ues 4 1 , S a l e of, 37
E rasures 1 4 , I nvoices 46 ,

Errors in C al cu la tions 4 ,

o f C ommi ssi on 4 ,
J O U RNAL , 23 ,
52
of O mission 4 ,

of Princi p le 5 ,
L A D an d
N B
uildin g s, 4 1 , 98
Esti mation of Working L ife 1 08 , L ea seh o ld Prope rty, 9 9
Ex amin a ti on Ques ti ons 1 9 3 L eg a l C ha rges 6 4
i
, ,

Ex tent of I nves tiga tions 9 D ecis ons as to Au di tors

,

FAL I I A I ON of A ccounts
S F C
F c titious P yments 7
L i ab iliti es , 1 7 9
T 7 Positi on of A udi tors , I 7 S
,

i a L e tt er of Regre t 1 46
Fin l A ccounts 58
, ,

a L i a bility for N egl ect , 1 80

Fi ed Asse ts 7 0
,

x , L o ans , 1 00 1 53 ,

ta temen t of 1 35 S ,
I n teres t 37 ,

I nstalment S ystem 111 , L oose Too ls 97 ,

Floating Asse ts 7 0 , Lo sses of C api tal , 1 7 1

Fluctu a tions in V alue of Asse ts
1 04 MAINTENAN C E Reserves 1 10
Forfeited S h res 1 57
,

a Machin ery an d Plan t , 41, 94 ,

Fr u d s 7
,

a 1 70
Freehold Property 99
,

M an aging Direc tor s R em uner '

Furnitu e n d F ttin gs
,

r a i ,
97 a tion 1 59 ,

M arke t V alue 7 1 ,

GENERA L Reserves 1 1 7 , M emb ers Register of 1 4 1

, ,

Goo ds I nwa r d s B ook 46 , Memoran d um of As soci ati on 1 43 ,

on C onsignmen t 90 , M eth od of Work 1 4 ,

O u tw ard s B ook 5 0 , Mines D ep reci ation O f 1 68

, ,

Goo dwill 1 0 1 ,
Minu te B ook 1 4 1 1 60 , ,

G rouping I tems in A cco unts ,

59 Misa pp rO p riation , 7
Miscell aneous Recei p ts 36 ,

HARNES S 98 ,
Missin g Vouch ers 4 1 ,

Horses 9 7 ,
Mortg ag es an d C h arg es Regis ,

ter of 1 42 1 50 , ,

I M PERS ONAL L ed g er 24, , 58

Pos tin gs 23 ,

I mprest S ystem , 43 for , 1 80

208 IN D EX

S inkin g Funds 1 20 1 5 1 , , U NDERW RIT IN G C ommissions 1 38

U
,

S peci al T i ck for V ouch ers 29 , n di scovere d D ifferences 25

U
,

S p eci c Reserves 1 1 6 , npaid D iv idends 1 6 2 ,

S pli ttin g C h eq ues 34 ,

S ta temen ts C re ditors 48 54
,

, ,
V AL U ATI O N of A ssets 6 9 7 5 1 3 5 , , ,

D ebtors 51 Au ditor s Posi tion

, ,

S ta tu t e A ppo in t ed un d er 1 7
, , 73 , 75 ,

S ta tu tory B ooks 141 ,

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 BUS I N ES S
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To S I , ,

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