in that they are larger, have coupons attached, are sealed, and are also less valuable because they do not fall due for a considerable period. From the auditor's point of view the security is important because of its bearing on other obligations and the equity, if any, which may exist for a subsequent lender or creditor.

Balance sheets are, as a rule, deficient in the information which they impart with reference to the real estate or personal property which is pledged with an issue of bonds. Sometimes a bond is a first lien on certain assets and a second lien on others. When considering the matter of liens it should be noted that interest unpaid is a lien as well as unpaid principal.

If it is feasible to have a balance sheet disclose the position which a bond bears to the assets, it is the auditor's duty so to state it. In any event he should determine as nearly as possible the position, if it is not so disclosed.

The corporation which issues bonds should, and in most cases does, keep a copy or sample thereof. The auditor should read this carefully in connection with the mortgage or deed of trust, make an abstract of these documents, and note all references to interest rate (or rates, as changes are sometimes made), due date or dates (installments of principal are frequently provided for), property pledged, sinking fund or similar provisions, and in fact anything which relates to the accounts or financial transactions of the maker.

Judgments: It frequently happens that a prosperous concern will dispute a claim, litigate it, and have judgment entered against them. If the case is appealed the judgment may be allowed to stand or a bond may be given pending a final decision. In rare instances are these debts entered on the books. Most business men consider that the entry of an invoice is an admission of liability, and, of course, will not permit the entry of a claim which they propose to fight.

What position must the auditor take? If a balance sheet is being constructed, the amount of the judgment should be included as a liability or a reserve set up to cover the estimated liability under the claim. If a balance sheet has been completed, the auditor should call attention thereto in a footnote.

How is the auditor to be informed as to the existence of

judgments? As mentioned under mortgages (page 155), he should be able to examine the public record himself. If he is not willing to do this, he should make such inquiry or investigation as is feasible. An inspection of lawyers' bills is a good way to secure a clue. If a concern is able to pay, but does not do so on principle, the auditor will have no difficulty in learning the facts. If a concern is obviously hard up, the auditor is charged with constructive knowledge that judgments have been obtained, and he is not safe unless he secures a report based on a search. Even if the search costs a few dollars the expense will be well worth while. If the audit is made for a banker, the latter may have had a search made, or, if not, will do so through his own attorney.

Interest Payable: Many of the liabilities which appear on a balance sheet carry interest, therefore the calculation of accrued interest to the date of the balance sheet is an important matter. The auditor should consider the possibility of an accrual upon the accounts as well as notes payable, bonds, etc. Enough book accounts bear interest to warrant an inquiry being made into its possibility.

Loan accounts of partners and officers of corporations almost invariably bear interest, but it is not always calculated up to the date of closing the books. Judgments, overdue taxes, and other liens, bear interest sometimes at an extremely high rate.

Legally, the interest on a bond is secured by the same property as the principal and in effect becomes part of the principal, but the latter is a long-term obligation, while interest is payable at frequent intervals and should therefore appear as a current liability.

Taxes: The balance sheet of a commercial enterprise not owning real estate rarely shows a liability for accrued taxes, yet probably ninety-nine out of every one hundred are liable therefor. Under the Federal Corporation Tax Law a tax of one per cent is imposed upon the net profits of a corporation in excess of five thousand dollars. This tax must be paid even if a corporation is dissolved before the end of the year during which the tax is imposed. As the tax is specifically based on the net profits of a particular period, although payable some months thereafter, the tax accrues throughout the specified period, and if a net

profit in excess of five thousand dollars is disclosed upon the closing of the books, a reserve of one per cent thereof should be made.

Bond interest which accrues from July 1st to December 31st, and which is payable on January 1st, always appears among the liabilities on December 31st, assuming, of course, that a proper system of accounts is in force. The Federal tax has accrued, and is payable thereafter, just as surely as any other item.

The uncertainty as to the constitutionality of the law may have justified the omission of this liability from balance sheets prior to 1911, but there is no longer any doubt about the necessity for a strict compliance, and auditors cannot certify to the balance sheet of a prosperous corporation which has not given proper consideration to this subject.

A corporation which had made a large temporary profit was dissolved in July. A balance sheet was prepared and on its showing, a distribution of capital and profits was made. In the following February the government demanded a report and one per cent of the profit realized. One of the directors had to pay the assessment.

The matter of taxes is of extreme importance in all audits of public service corporations, but the auditor should consider the possible liability for taxes before finally passing upon any

balance sheet.

Water Rates, etc.: There are certain expenses, such as gas and water, the bills for which are frequently rendered at long intervals. The auditor should provide for all accrued expenses of this class.

Wages: The date of the balance sheet does not always coincide with the date to which a payroll has been calculated. Unless the amount is trifling the amount accrued should be ascertained and entered as a liability.

Where there is little fluctuation in the number of men employed, it will be sufficient to take the proportion of the full week's payroll; i. e., if the next succeeding payroll amounts to $1,000, and three days accrue in each period, the liability can be stated as $500, although each day's total might vary a few dollars from the others. The difference would not be large enough to pay for the work involved in making the calculations.

Rent: Rent is usually payable in advance, but this is not always the case. If any is accrued and not paid, it should be shown.

Freight: Sales are frequently made on a basis of free delivery to destination, and current freight bills are sometimes permitted to run, if the concern is well known.

An allowance of freight to a customer should be treated as a deduction from amounts due from trade debtors.

Goods may have been shipped, refused, and returned, in which case freight charges will have accrued.

Traveling Expenses and Commissions: It is important to note whether the accounts of all traveling salesmen have been received and entered before the books are closed. The auditor should secure a list and, if any report was not so entered, provision therefor should be made.

Ample provision should be made for all commissions eventually payable on sales which have been billed to customers. As commissions are frequently not payable to salesmen until the sales have been collected from the customers, accrued commissions are often omitted from the books. As they must, however, be paid out of the proceeds of the sales on which the full profit has already been taken into the accounts, they should clearly be set up as a liability.

Legal Expenses: All concerns have more or less litigation. Lawyers are usually expensive, but they have the merit, if it can be so termed, of waiting for their money. Before the books are closed the lawyers should be requested to send in a bill. If one is not found, the auditor should ascertain the amount due, if any.

Audit Fees: In line with the theory that all accrued expenses must be included among the liabilities, it might be assumed that the expense incurred for an audit to, say, June 30th, would be a proper charge to the period prior thereto. In practice, however, it is not usual to include the audit fee as an outstanding liability as of the date of the balance sheet. If the auditor has not performed any work on the accounts until after the closing date, it is certain that no legal liability exists at that time.

Under ordinary conditions the amount of the fee is not

known until after the report is written and submitted, so that no more than an estimate could be included.

Ordinarily the fee is not such a liability as should be provided for, provided that the audit commences after the closing date. An exception should be made, however, in the case of a partnership or a close corporation where a partner or stockholder is about to retire. The audit being partly for the benefit of the retiring party, and he being entitled to a copy of the report, it is proper that a sufficient reserve should be set aside, prior to the closing of the books, to provide therefor.

Damages: It is customary to insure against liability for damages claimed by employees or the public, but few insurance policies, if any, assume an unlimited liability. Then all concerns do not carry such insurance, although it is a reflection on a man's business ability to omit such protection. Furthermore, claims for damages may arise out of alleged breach of contract, or failure to deliver goods, or for any one of many other

reasons.

The auditor should inquire as to this possible liability and should also request that a letter be procured from the concern's attorneys stating any pending claims or suits.

It may be that claims have arisen which have not been referred to the attorney. It often happens that a salesman claims commissions in excess of those paid to him, or an employee who has been dismissed claims salary or other compensation for an uncompleted term of service, or claim is made for a part of profits, which has not been paid. It is true that these are unusual items, but it is equally true that tens of thousands of dollars have been paid out in liquidation of disputed claims.

If an auditor finds any evidence which leads him to suspect that there may be a possible liability of this nature, he should insist on being informed as to all of the facts. He can then form an opinion as to the reserve, if any, which should be made on the books and balance sheet to provide therefor.

Coupons, Unused Tickets, etc.: The auditor of a railway company will expect to (but may not) find a reserve account for the outstanding liability in respect to unused tickets, but the point receives little or no attention in other cases. Many kinds