derived therefrom. On the other hand, he should also help to bear the burden of any losses sustained in carrying out contracts which were made prior to the dissolution of the partnership. There is no reason why the continuing partner should be called on to bear the burden alone, unless a specific agreement is reached under which the continuing partner takes over the contracts at specific values and assumes all further risk in connection with their completion. To do this it would, of course, be necessary to secure the consent of all other parties to the contracts, so that the retiring partner or his estate be released from all liability for the execution of the contracts.

Usually the most equitable method of valuing machinery and fixtures would seem to be cost less proper depreciation allowances. If this differs materially from the cost of reproduction at the present time (also making allowance in this case for accrued depreciation), the valuation will probably have to be made the subject of compromise between the parties.

While the correctness of the balance sheet is of preeminent importance in an investigation such as the one under consideration, the correctness of the income account is likewise of importance if the good will is to be valued on the basis of past earnings. It is also necessary to review the expenses entering into the income account for a period prior to the date of dissolution so as to see that no prepaid expenses which would apply subsequent to the date of dissolution have been absorbed by the old business. The retiring partner will, in due course, be debited with his proportion of all expenses chargeable to the old firm, even though they may not have appeared among the liabilities stated on the books at the time of his retirement. Prepaid expenses applying to the new business would not, however, be so likely to be brought into the liquidation account if they were absorbed in the operations of the old firm.

There are still other questions, such as partners' salaries and interest on partners' accounts, which will need to be carefully considered in the light of the partnership agreement.

(j) Investigation for Those in Charge of Reorganizations: There is an increasing demand for the services of accountants in connection with reorganizations. The special features of such examinations are admirably expressed by A. Lowes Dickinson,

C. P. A., in his paper "Accounting Practice and Procedure," which appears in the American Association Year Book for 1908:

The consideration of a plan for the reorganization of a property which has been reduced to a condition of insolvency requires a full and accurate knowledge of all the existing conditions with regard to the property and its past and probable future earning capacity. The elements to be investigated and determined will, therefore, be as follows:

(1) The sources and nature of the gross earnings and the prospects of any increase therein without further expenditures for development.

(2) The cost of operation, with particular reference to the effect thereon of bad management or bad organization, and to the possibility of remedying these conditions; and the proportion which the cost of operation has borne and may be expected to bear to the gross earnings.

(3) A comparison of the gross and net earnings and capitalization of the property, with some actual or desirable standard, so as to determine the proportion which one should bear to the other if the reorganization is to prove successful.

(4) Hence to arrive at the total interest-bearing and dividend-paying capital, which the reorganized property will stand on some fixed interest basis.

(5) The rank of the different classes of obligations having regard to the property pledged as security therefor; the margin of security; the rate of interest; the date of maturity; the equivalent par value on the basis of the standard rate of interest adopted for all classes; and, if practicable, the extent to which the properties specifically mortgaged show sufficient earnings to meet interest on the indebtedness secured thereon. This class of information will probably require a report from an engineer or other expert on the value and the condition of the physical property.

(6) Following upon the determination of these factors, a consideration of the various separately mortgaged divisions of the property, with a view to determining whether any should be abandoned to the bondholders, rather than be included in a reorganization. And here it is important to observe that the contribution of any specific piece of property to the general organization is not necessarily measured by its ability by itself to earn interest on the obligations secured thereon. Numerous other factors will enter into a consideration of this point, and it may easily appear that a property earning little or nothing toward payment of its obligations is sufficiently valuable to the organization, as a whole, to be retained, if possible.

(7) Another important factor is the amount of new money required to be introduced for the purpose of paying off the floating debt and rehabilitating the property, and the best method of raising such money, whether by the issue of new prior lien securities ranking in front of or on an equality with those issued in exchange for existing mortgages, or by assessments on junior classes of securities. In the latter case it is im

portant that sufficient inducement be given to the junior classes, in the proportion of new securities issued for old, to induce them to pay these assessments; while for the assessments themselves, the securities issued should represent the par value of the cash paid in on some reasonable market valuation.

(2) INVESTIGATION FOR CREDITORS, ETC.

Auditors are frequently called upon to make examinations the scope of which is practically limited to certain accounts about which the most complete detail is required. For instance, a manufacturer may desire to extend a large line of credit to a jobber or merchant, and before doing so wants to know the latter's capacity for handling his line, as well as to know that his financial condition and method of doing business are satisfactory.

Investigation on Behalf of a Present or Prospective Creditor: Examinations along these lines may be divided into two general classes:

For bankers or note brokers who propose to loan on the promissory notes of the borrower, or for bankers who propose to bring out bond or preferred stock issues.

For individuals or business concerns who propose to make advances for various purposes, or who have extended or who expect to extend credit on open account.

In the main, the points to be observed have been discussed in the chapters on the conduct of a balance-sheet audit, but there are certain special precautions which may, with propriety, be enlarged upon at this time.

(a) Examinations for Bankers

Extension of Business: The most important line of examination, after ascertaining the assets and liabilities and analyzing the profit and loss account, is an inquiry into the plans for the future which have been adopted or which are under consideration. The average business man is not content with a stationary business. He wishes to expand for the purpose of increasing his profits, decreasing his expense ratio, and perhaps the most compelling of all reasons is his ambition to outstrip his competitors.

If his floating debt has been burdensome, he may have been

obliged to keep within certain bounds as to capacity and production, but the moment he is financed it seems almost inevitable that new liabilities are incurred sufficient to use up the additional supply of credit almost before it is available.

Accountants do not always feel concerned with this phase of business life, but as the lender should have some means of determining the use to which his money is to be put other than that supplied or promised by the borrower, he naturally looks to the professional auditor. True, he has looked in vain in many cases, and this may explain the reason why so many banks, bankers, and financiers have secured the services of men who can secure and impart the information required, irrespective of the fact of whether or not they have the degree of Certified Public Account

ant.

Collateral v. Integrity: Which is better, to loan money to a dishonest man on ample security, or to a perfectly honest man who wishes to borrow on his own name and who cannot furnish collateral? The former may seem to be more advisable, but there are disadvantages in doing any business whatever with a man who cannot be trusted.

Therefore, no matter how good the collateral may be, the banker wants more information, and the auditor may be able to furnish it. Facts relative to previous business experiences, possible failures or embarrassments caused by speculation, etc., will be secured from the mercantile agencies, but inside information relative to the personnel of the organization can be furnished by the auditor.

Experience has demonstrated that where partners quarrel, or where one does all the work, trouble will follow. Large concerns, solvent so far as finances go, have been placed in the hands of receivers because of internal dissensions. A banker does not want to make a loan which may be paid off eventually by a receiver, even if the assets are double the liabilities.

Then one or more departments of the business may be weak. The sales force may be highly organized and efficient, but if the manufacturing department is poorly managed, or is not coördinated with the sales department, the results will not be satisfactory.

If no criticism is justified and a man's honesty is unques

tioned, a banker may prefer the risk to the apparent safety of a loan secured by collateral. It has been said that "a crooked borrower is always a wise window-dresser," and this observation may be enlarged to remind the banker that crooked borrowers when negotiating a loan sometimes offer collateral to which they do not have title.

Future Business: During the progress of any audit which comprehends a balance sheet, there should be available full data with respect to future business and the means whereby it is proposed to finance it.

Schedules of orders booked, the time estimated to complete same, the cost of the raw materials, labor, and other manufacturing expenses, the time within which the proceeds of sales will mature, the dates by which the liabilities for purchase will have to be discharged, and many other factors are all to be compiled and put into readable and dependable form.

If funds are to be furnished to meet pressing obligations, and if any increase in the business means the tying up of additional cash for a considerable period, then there may be a hesitancy about supplying the needs unless a stipulation is furnished that additional business will not be sought until the funds with which to finance it are in sight. The auditor who can secure information of this nature may be helpful to the banker and even more so to the borrower, for it is of no permanent advantage to the latter to be tided over one period of stringency merely to be plunged into another and more serious situation.

Bank Loans to be Repaid: The auditor must bear in mind that the banker whom he represents in these investigations is considering the investment of deposits which are chiefly payable on demand, therefore he is not contemplating the making of a permanent loan, but one which will be repaid within a comparatively short period of time. If a banker were looking purely for security, he would invest a large portion of his funds in real estate mortgages. The security might be better than commercial paper, but the maturities would be from one to three years, and hence entirely unsuitable for his purposes.

If the auditor ascertains that the prospective borrower does not expect to "clean up" at least once a year, he should so report to his client.