Property may be situated in or near a city and as time goes on may appreciate greatly in value based on transfers or appraisements of land similarly located. It must be remembered, however, that it is a fallacy to assume that the value of land available for any kind of improvement can be directly compared with the value of land upon which a manufacturing plant has been erected. The value of the plant cannot be separated from the value of the land itself, because, based upon the assumption that the land could be sold for general purposes, in ninety-nine cases out of one hundred the buildings (being adapted for one purpose only) would have to be demolished and the capital loss thus sustained would more than offset the appreciation in the value of the land.

Therefore an apparent rise in the value of the land is not the equivalent of an increase in assets unless the proportion the improvements bear to the entire investment is a small one. The auditor can readily test the propriety of such a statement of increased land value by asking the question: Is the land available for sale aside from the improvements?

Bankers are strangely negligent in accepting such statements, when they could without cost just as well have the facts. No borrower could afford to refuse to furnish a certified statement when called upon to do so by the lender.

(2) Buildings: The valuation of buildings opens up the question of depreciation, which is discussed fully in Chapter XXI. Following the suggestions there made, buildings should appear on the balance sheet at cost and a reserve should be created sufficient to cover the wear and tear and obsolescence thereof, accrued to the date of the balance sheet.

As an aid to forming an opinion upon the value of buildings, the auditor should personally inspect the plant and note whether it appears to be in good condition.

Leaseholds: Very few manufacturing plants in the United States are built on leased premises, but inquiry as to this should be made, however, in every audit where real estate appears as an asset. In a surprisingly large number of cases hotels, theaters, office and "loft" skyscrapers, and other business buildings are erected on land which is leased for a definite term of years.

So far as the author has been able to discover, it is not cus

tomary for the owners of such buildings to provide a sinking fund to take care of the diminishing value of their property, nor even to charge depreciation as one of their expenses. There are two reasons for this: first, the term is usually a long one, running from twenty-one to ninety-nine years. In this age of startling changes such a long term, or one of sixty-three or eightyfour years the latter being the most popular in New York City —is equivalent in the minds of real estate operators, to a freehold, and no provision for the far distant future seems necessary. The second reason is that in the great majority of cases land has appreciated in value faster than the buildings thereon have depreciated. For instance, a building on upper Fifth Avenue, New York, built twenty years ago on leased ground, with, say forty-three years to run before the lease expires, could be demolished and the vacant land sub-let for a great deal more than the building was worth, in addition to the rental under the original lease. With similar experiences in other cities it is difficult to persuade the builder that a sinking fund should be created, although he will probably admit that the building is depreciating in value.

The auditor should use this admission as a basis for the argument that the depreciation in value of a building, computed on its life and on the expiration of the lease, is an annual charge against the revenue which the building produces; that, unless and until the leasehold is sold or parted with, the only facts at hand are that the building is diminishing in value, slowly but surely, from the two causes stated.

An auditor should not set off one against the other without so stating the fact in his certificate or showing it on the balance sheet, otherwise he is guilty of conniving at a practice shunned by all conservative men, viz., taking credit in a current period for a prospective profit. Nevertheless, he must not ignore the question of a rise in value, as it may have an important bearing on the borrowing capacity of the concern. Therefore, whenever an auditor is met with a claim that the unexpired portion of a leasehold is of great value, he should secure an appraisal thereof from a reliable and disinterested real estate agent.

If a lease has been purchased, and the purchase price appears on the books as an asset, the expired portion should be written

off periodically. If an appraisal should establish the fact that the price paid was too high, it would be wise and conservative to increase the installments to such an extent that the cost would be written off before the expiration of the lease. But if this is not satisfactory to the lessee, the auditor would not be justified in insisting upon it any more than he would be in requiring a tenant who, under a long lease, is paying more rent than similar space could be secured for later, to set up a reserve for excessive rent.

Machinery and Equipment: As with buildings, machinery should be valued at cost and a sufficient reserve provided to cover depreciation. In determining the sufficiency of the machinery reserve, consideration should be given to the question of obsolescence. No general rule can be found which will govern the rates of depreciation applicable to any particular plant. Much depends upon the way the machinery is used and cared for. The life of a lathe in one plant may be twenty years; in another the same lathe will be out of commission in ten years.

The auditor must apply the general principles of depreciation to the item of machinery and then bring to bear the special knowledge he has gained of the plant under review before expressing his opinion as to the accuracy, or otherwise, of the book values.

The auditor should not fail to inquire whether a detailed record is available showing the particulars of the cost, etc., of the machinery. In many factories such a record exists, being kept for insurance purposes or as a check on depreciation charges. This record is found usually on cards or in a loose-leaf book, and as it is not considered one of the regular books of account, it will not be submitted to the auditor unless he asks for it. If accurate, it is an invaluable aid in determining the value of the machinery. The record should show how and when acquired; cost, including installation; amount reserved each year for depreciation; position in factory, etc.

Strange as it may seem, there is a tendency towards excessive depreciation reserves, particularly with respect to certain machinery the important parts of which can be and are renewed from time to time and where the cost of such renewal is not charged to the reserve. A manufacturer who wants to be con

servative will allow, say, fifteen per cent per annum on machinery. He may set aside this rate for three or four years and make no charges for renewals against it. Now when it is applied to any particular machine it will be apparent at once that it is impossible for the machine, so long as it is not obsolete, to depreciate more than, say, thirty per cent. In other words, the machine could not be operated properly if it were allowed to deteriorate below seventy per cent of its normal condition. There is a standard below which it cannot go or it could not be operated at all.

There is some basis of reason in a factory manager's contention that his plant is as good as new. He knows that every machine is working to its effective capacity, and that any considerable depreciation thereof is a physical impossibility or he could not produce a normal output.

There is, of course, accrued depreciation on every machine, and this is usually admitted, sometimes after a strenuous argument, but the auditor who argues that a five-year-old plant has depreciated, say, fifty per cent, fails to obtain a respectful hearing, because, if it were true, the plant could not be running, and that fact is stronger than his theories.

The real point at issue is that a considerable reserve for obsolescence is necessary in every plant where machine tools and similar equipment are used. Depreciation, as such, cannot exceed a definite limit, but a machine which would never require more than thirty per cent or forty per cent reserve for depreciation, no matter what its age may be, should have an obsolescence reserve of perhaps as much or more.

Constant changes are being made in factories and mills. Machinery which is comparatively new is set aside or discarded for improved models, and this possibility should influence the auditor who passes upon the value of such assets.

In some cases the argument is advanced that the superseded machinery is as good as ever and is always available in case of emergency or a sudden demand for an increased output. This sounds plausible, but does not work out well in practice. The proper value to place upon such discarded machinery, designated as "reserve plant," is the nominal sum of $1.

Small Tools; As a rule the practice of depreciating this item

by way of a percentage cannot be followed satisfactorily. So many small tools are used up, or lost, or stolen, that an inventory should be made at periodical intervals and all the tools on hand revalued for balance-sheet purposes.

If this has not been done, the auditor can fix his valuation only from the best evidence available, but he should insist on a material writing-off from the book values unless liberal depreciation has been provided for.

Furniture and Fixtures: This is an asset which has little residual value, and conservative concerns charge off the larger proportion of the cost.

In most establishments many items, such as partitions, special shelving, etc., are charged to the fixture account, and frequent alterations and changes are made. For this reason most of such expenditure is in the nature of repairs and should be charged off at the time. If charged to an asset account, it should be distributed ratably over one or more years' operations.

Where alterations are made in leased premises, the auditor must be careful to see that if the lease is about to expire nothing is carried as an asset except movable fittings, etc., and that if removable, ample allowance is made for deterioration.

The auditor should not pass the item of furniture and fixtures without giving some thought to its physical condition. His experience should furnish data as to the actual value of this item and it should be impossible to induce him to certify to an overvaluation.

Packages: In certain lines of business, such as breweries, milk depots, spring-water dealers, bakers, etc., a considerable number of packages, such as casks, kegs, bottles, cases, cracker tins, etc., are owned, which are used for convenience of transportation only and are supposed to be returned when empty. At balancing time an accurate inventory should be taken, if possible, but if not practicable, the auditor will be under the necessity of making his own calculations as to the number required for the normal operation of the business. He should then inspect the reserve supply and decline to certify to a greater number than is thus disclosed, unless furnished with unquestioned proof as to such larger quantity.

In many cases concerns go on the assumption that all such