The auditor is not justified in certifying to the balance-sheet item of notes receivable unless he believes that all of the notes will be paid when due, or unless a sufficient reserve is created to cover probable losses in realization.

Where notes have not been paid at maturity, they should, as stated above, be taken out of the notes receivable account, as the latter account should represent unmatured notes only. It might be feasible to carry dishonored notes in a separate account, but it is considered proper accounting practice to debit the personal account of the debtor with the amount of the note and the protest fees and include the debt among those of the class to which it belonged before it was converted from an account into a note receivable.

Thus if a grocer sold sugar to a customer, took a note for the amount of the sale, was unable to collect when due and charged the note and protest fees back to the customer's account, then he would include the new balance among other trade debtors. This is the proper way to handle the transaction. The auditor, in valuing the accounts, will estimate the actual worth of this account, taking into consideration the facts as shown on its face.

Protested notes are frequently paid thereafter, but they cannot be classed with accounts not due, nor with those overdue from chronic slow payers. The maker of a note who fails to meet his obligation at maturity is never a desirable customer, and in the long run subsequent credit extended to such customers invites ultimate loss.

There are exceptions to this rule in the case of such concerns as agricultural implement manufacturers where it is the custom to take notes for a large part of the sales, and many are not paid during years of crop failures. These overdue notes are considered almost as collectible (so far as ultimate realization is concerned) as the unmatured ones, and, as it is more convenient for the collection department to handle them as notes than as part of open accounts, they are not charged back to the customer's

accounts.

Under such circumstances in stating the item "Notes Receivable" in the balance sheet, the auditor. may not consider it necessary to separate the overdue and not due notes, but he

should be sure that one class is as good as the other, or that a sufficient reserve has been created for the probable loss.,

Stock Subscriptions: The uncollected balances due from stockholders in respect to their subscriptions to the capital stock of a corporation are undoubtedly accounts receivable, but it is not considered proper to include such balances with the receivables of any other class. The reason for this is obvious. If the subscriptions are overdue, the fact of their noncollection indicates poor management or undesirable stockholders. If not due, it affords those who use the balance sheet an opportunity to inquire into the financial standing of the debtors. If good, it not only means that a certain amount of liquid capital will be forthcoming at a certain date, but it furnishes evidence that the capital stock is being paid for in cash, and is reassuring as to the future, because the connection of financially responsible stockholders with a company usually means that they are prepared to stand by it and protect their interests.

Installment Contracts: In several lines of business sales are made or contracts are executed under conditions which require time to consummate, or which are payable in installments. It is customary to charge the total contract to the debtor and credit the collections on account as they are made. Experience has demonstrated that many of these contracts are not carried out, in which case balances due are uncollectible. If a business has been established for a number of years, past results can be used as a guide in valuing the outstandings, but where the business. has been recently established, great care must be taken. The first point to consider is the character of the contract and description of the subject matter.

In the case of piano contracts where a material first payment is collected, and where the piano can be taken back without excessive cost, the loss would be small; but the reverse is the case with the class of contracts for correspondence courses and books. It is not usually considered worth while to attempt to reclaim books and lesson papers, although title does not pass until the final payment is made, nor is it usually worth while to enter suit for collection of the balance due. Therefore, in all cases where this class of contracts is entered at the full purchase price, a considerable reserve must be provided for bad debts.

INVENTORIES

Raw Materials, and Stock Purchased to be Resold in the Same Form: Under this caption should be included only stocks of goods owned and under the control of the owner. Stocks are often hypothecated, and if this is the case, the fact should be stated on the face of the balance sheet.

The basis of value should be cost or market, whichever is the lower. If purchases have been made on a falling market, it is not conservative to place a higher value on an inventory item than the price at which the same thing can be duplicated in the open market. It deceives the banker, creditor, and stockholder, who have a right to believe that the values stated are real values as of the date of the balance sheet.

It may seem inconsistent to advocate a somewhat different principle when purchases have been made on a rising market and where the goods cannot be duplicated, except at a higher price. In this case, however, the conservative course is to carry the items at cost and thus do away with the objectionable practice of anticipating a profit.

In this connection raw materials are dealt with as being the first stage of a manufacturing process. If bought and sold without alteration in form, there is some merit in the contention that the difference between cost and market is a loss or gain properly applicable to the period preceding the closing of the books, but the fact, nevertheless, remains that the goods in the inventory have not been sold and no profit has been earned.

The safest rule is the better one to follow, and this is unquestionably cost or market, whichever is the lower, If the market is higher than cost, and cost is used, it is quite in order to indicate this fact (if it is important) in a footnote on the balance sheet, and no criticism will follow, whereas bankers are never pleased to learn that an inventory has been marked up and a profit taken which is not yet realized.

The physical condition and salability of the stock must also be considered. If there is deterioration or if part of the stock is out of date, or otherwise unsalable, the asset loses its most. important aspect, availability. This is a most difficult fact for the auditor to determine, but he must depend upon his own intuition and inquiries to determine whether or not the stock is in

good condition or merchantable, supplementing this, of course, by certificates from those in charge of the departments concerned covering this point fully.

The price placed upon raw materials can be checked in nearly all cases by recent purchase invoices, while with all staple goods reports as to current values are readily obtainable.

The extensions should be tested and all large items scrutinized. Exceptionally large quantities of particular items deserve special inquiry, and some general familiarity with the normal stock, which any well-conducted concern in the same line of business should carry, is very desirable.

The footings, too, should be verified, or at least be thoroughly tested. Many instances have been found where serious errors have existed in both calculations and footings, so that an auditor who fails to cover this point fully is open to criticism.

In a celebrated English case it was held by the Court that an auditor is not a valuer; that it is not his duty to take stock; that in the absence of suspicious circumstances he is entitled to rely upon the representations of responsible officials; and that he is not guilty of negligence if he accepts the certificate of such persons to the value of the stock-in-trade.

The auditor's course, therefore, is to secure all the evidence within his power to demand, and lacking any part of the proof which he deems necessary, his only course is to qualify his certificate accordingly.

The author thinks the accountants in England rely too much on the decision of a Lord Chief Justice that the auditor "is not called upon to be suspicious, nor even to make inquiry, provided that nothing comes to his notice to cause him to think that there is need." This may be law, but it is a poor rule to insert in an audit program.

It may be that the borrowers and debtors in the United States overstate their inventories and deceive their creditors to a greater extent than is the case in England, in which case an auditor there may be justified in accepting the certificate of some one else as the sole check on the stock, but the auditor here who would acquire a reputation for dependability will not be content with this measure of his duty.

Is it not true that the stockholder or banker is being taught

to look on the professional auditor as a sort of watchdog, one who will detect all irregularities, insist on businesslike methods, see that the accounts are stated clearly and correctly, and prevent unsatisfactory conditions generally?

Now what more important element of business is there than "stock-taking"? Is it not the most important of all? On it may depend financial success or failure; on it dividends may be paid or passed. Is it not then, in every sense of the word, a financial transaction to be audited?

The English law says that the auditor is using reasonable care and skill when he accepts the certificate of a responsible official. The profession will not advance in usefulness and standing if this is to be the standard on this side of the Atlantic.

The author differs from those who maintain that an auditor, not being a valuer, has no right to attempt to pass upon physical valuations, including stock-in-trade and plant; his opinion is that an auditor's duty is not properly performed unless he does all that his experience and skill enable him to do.

Numerous instances might be cited where professional auditors, without any special knowledge whatever in particular lines of business, have detected overvaluations, excessive statements of quantities, and misstatements as to the condition of the stocks, some of these discoveries being of sufficient importance to stop the sale of a business or the extension of a line of credit by a banker.

In many of these cases the inclusion in the certificate by the auditor of a statement to the effect that he has accepted the inventory valuations without verification would have been acceptable to his client at the time, but subsequent events would have demonstrated the worthlessness of the report from a practical point of view.

Looking at it from another angle, it may be asked: Why not as well accept a certificate from the cashier that the cash balance is duly accounted for as to accept the certificate of the stockkeeper that the materials and goods under his care are on hand?

The author has compiled some simple directions for use by those who desire to make a real test of what is frequently the largest item on a balance sheet. If these are followed with care,