sheet from which any asset has been omitted entirely. The arguments in favor of an undervaluation are weak enough, supported as they are by the general assertion that the item speaks for itself in the balance sheet, but there can be no argument at all to support the complete omission from the asset side of the balance sheet of any item of property, tangible or intangible, which has or may have a market value.

The auditor who knowingly certifies to such a statement can be held responsible, and money damages recovered, by any stockholder parting with his stock on the basis of the balancesheet figures. Such an action would be founded on a charge of deceit or fraud depending upon the circumstances of each case. Ernest Reckitt, C. P. A., has said on this point:

The shareholders of a corporation have certainly a right to know the real value of the tangible assets, the estimated value of the good will, and how much "water" there is in the stock, and any statement which does not separate these items should be looked upon with suspicion. A shareholder is entitled to his pro rata share of the whole profit between regular fiscal periods during the time he is a shareholder. He may not receive his profit entirely in the form of dividends, but that portion of the corporation's profits which is not paid out in dividends, but left in surplus, should be so presented to the public that, other things being equal, the selling price of the stock will correspondingly increase, and the shareholder will receive the balance of his profits upon the sale of his stock. It is for these reasons that, in my opinion, the public accountant should refuse to countenance the "secret reserve" or any other action which makes it difficult for the layman to determine the true financial condition of the company in which his funds are invested.

The shareholder has too frequently been' considered as a child, from whom it might be advisable to keep certain facts. I believe this condition of affairs is fast disappearing, and that the best coöperation is attained by the directors taking their shareholders into their confidence, and if there is "water" in the stock, let them separate it from the rest of the assets, and then, at the close of the year, the total additions to the plant should be charged to plant account, and an entry of like amount could be made crediting good will or franchise account and charging surplus, instead of charging the additions of the year direct to surplus, and thus clouding the issue.

CHAPTER XI

BALANCE-SHEET AUDIT-LIABILITIES

IN a balance-sheet audit nothing is more important than to ascertain whether or not all the liabilities of any nature whatsoever appear and are properly stated.

At the outset of this chapter it may be proper to illustrate this point in order that the auditor will realize the importance of placing himself in the position of the one who will read the balance sheet later.

Bankers extend credit to trading concerns, not to furnish additional capital, but to assist them to carry stock-in-trade, or accounts receivable, at their busy season, and they expect to have the borrowings repaid or materially reduced during the dull season. Therefore the balance sheet of a trading concern is always scanned closely by the banker to determine the proportion of current assets to current liabilities, and he calculates the time within which the stock-in-trade should be realized upon. Now it may be that the concern has contracted to purchase large quantities of goods which have not been received, and these contracts may call for large cash payments within a comparatively short time. Furthermore, the contracts may have been made on a declining market, and the goods to arrive may cost more than would have been the case if not contracted for in advance. This information would not appear on the regular books of account, but is it not the kind of information which the banker requires to make up his mind in passing upon the desirability of the risk, and is it not the kind of information which an auditor should seek in order to be of substantial value to his client?

The auditor who limits himself to an examination of the formal books of account in making an audit is preventing himself, in many cases, from being of constructive value, and in other cases he is approaching the limits of liability in money damages for negligence in not doing all that a skillful and experienced auditor should do. It is conceded that when an auditor assumes to pass on matters which are not in the books he is

opening up a wide field, and perhaps a troublesome one to cover, but it may as well be admitted that the ordinary so-called checking of books, and the subsequent balance sheet prepared therefrom, are about as valuable to the banker or other creditor as the information which the borrower can and does furnish himself.

Accounts Payable: The ideal course by which to satisfy oneself that all obligations to trade creditors appear in the books at the balance sheet date would be to read all the incoming mail for some days before and after such date. The period prior would yield information as to the original invoices for purchases, and during the subsequent days ordinary monthly statements, followed later by polite requests to pay, would show practically all of the class of debts mentioned. The mail would likewise bring notices of maturities of promissory notes.

Unfortunately, the auditor rarely has an opportunity to open the mail of his clients, although it might shed light on more items than accounts and notes payable. In the absence of this short cut an auditor must first see to it that all the accounts payable shown on, or indicated by, the books are reflected in the balance sheet, and, second, he must conduct a proper investigation to ascertain whether any accounts payable actually due by the concern under audit, and not shown on the books, should be included among the liabilities.

The auditor cannot foresee the use to which a balance sheet may be put, so that it is always his duty to use plain terms and classify the liabilities so that any pertinent question which arises in the mind of an interested person may be answered without the necessity of a special examination for each question. It is not enough to state the aggregate of the debts of a firm or corporation, unless it is desired that it shall be understood that all consist of open accounts payable, incurred in the regular course of business, not due, and for which value has been received. If various classes of debts, incurred in other than the regular course of business, are included in one sum, it has been made impossible for anyone not familiar with the facts to express a reliable opinion upon the financial position of the concern.

For instance, it might appear that a firm had assets of $100,000, consisting chiefly of accounts and stock-in-trade, and

accounts payable of $25,000. If the latter were not due it would be a fair inference that the accounts receivable and merchandise stock would be liquidated quickly enough to pay the obligations as they matured. But suppose it were shown that some of the accounts payable were long overdue; that the accounts receivable were very slow; that the merchandise stock was selling poorly; and that cash receipts were being used to pay wages and similar expenses. Would this make a favorable showing in the eyes of a banker who might be considering the advisability of extending a line of credit?

Of course a firm in such a condition might deserve the confidence of a banker, and there might be ample security for a reasonable line of credit, but no auditor would be justified in merely stating the bald facts as shown. If the auditor does not feel warranted in adding a few words of comment to convey unequivocally that the assets were not readily realizable and that the accounts payable were long overdue, then his point of view is too far apart from the author's. The latter can be of but scant service to one whose conception of an auditor's duty is that it requires him to state so-called facts only. The principal reason why some business men feel that professional auditors cannot help them is that they have been unfortunate enough to hear the words and see the figures which emanated from an auditor who felt that he exceeded the limits of propriety if he ventured an opinion upon any important item of the balance sheet.

It is a reasonable assumption that no balance sheet prepared within, say, twenty days of a certain date, exhibits every liability. No exception is made for those concerns which maintain an inflexible order system and where the books are not closed until every order issued is represented by a purchase invoice. It is always found that some one has ignored the rules and ordered something for which a liability exists, or it may be for an expense which does not require an order, such as long distance telephone calls or lawyers' bills. Taxes of which little is known may be accruing, or goods may not have been delivered to a customer who has refused to accept them, and return freight charges and storage may have accrued. The best the auditor can do is to schedule all of the liabilities to which he can find the slightest clue.

So many balance sheets have been issued which have failed to include all of the liabilities that the author feels justified in discussing the matter fully, in order that the student may have the benefit of accumulated experience.

Trade Creditors: This may not be the largest item of the liabilities, but it is clearly the most important to verify. The notes payable outstanding may be larger in amount, but the proceeds thereof were presumably used to discharge trade debts, so that the latter item loses none of its importance because the balance is small.

As already stated, an auditor might ascertain the total amount of the debts by examining all of the mail over a sufficiently long period, but as this procedure is perhaps out of the question, he must do the next best thing.

Statements from creditors are valuable in verifying the amount due or claimed to be due, and if the time permitted (which it usually does not) the auditor could do no better than to request a statement from everyone with whom the concern might be expected to do business. Even then some one from whom a purchase had been made might be forgotten, the invoice. might be omitted from the books, and the fact concealed from the auditor.

Most concerns keep order and receiving records of some description. The auditor should compare the entries in this record during the period immediately preceding the balancesheet date with the purchase journal or voucher record to ascertain if the purchases indicated are entered. Every entry need not be checked. It is necessary to test only enough of the work to be satisfied that no invoices have knowingly or unknowingly been suppressed.

Where an audit is not completed until more than a month has elapsed after the closing date, the voucher record should be scrutinized to ascertain whether invoices entered subsequently belong to the prior period.

The open accounts on the ledger should be compared with the schedule of accounts payable. It should be ascertained that the balances represent specific and recent items only. If not, why not? Where any account does not look regular in every way the statement from the creditor should be asked for. If it