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(3) The Petty Cash fund is kept on the imprest system. On December 31, 1915, a voucher covering expenditures to date was passed and entered in the Voucher Register. The check in payment thereof was not entered in the cash book until January 3, 1916. (4) A building had been destroyed by fire, and the insurance recovered had been credited to the asset account and the cost of replacement had been debited thereto. (5) An item was posted to the debit of the Interest account in the general ledger from the journal as $3.03. It should have been $303.00. (6) Sales aggregating $25,000.00 were entered on the books as at December 31, 1915, but the goods were not all delivered until January 25, 1916. Indicate what adjustments you would make of the books or of the accounts for the purpose of statement on the Balance Sheet. Give journal entries. C. P. A. Ill. 5. It is generally conceded that merchandise inventories should be calculated on “cost” prices, but in practice there are found many differences in the method of determining the cost price. State whether or not the following items should be regarded in arriving at this cost, giving your reason in each case: Cash discounts. Trade discounts. Freight inward (on goods bought). Freight outward (on goods sold). Rebates and premiums, such as are found in connection with the tobacco business. Drayage and handling (inward). Packing and draying (outward). C. P. A. Fla.
C. INCOME TAX QUESTION
Should an individual who conducts a grocery, dry goods, clothing, or farm implement business, or any other business which requires that a stock be carried, take an inventory at the close of each taxable year and take such inventories into consideration in arriving at his net income from business? Explain.
In Chapter Three there was a discussion of the general ledger showing its control in an accounting system, also a discussion of the Trial Balance. The discussion there, however, was quite brief. It is intended here to show how an auditor would proceed to verify all the items in the Trial Balance.
The Bookkeeper's Trial Balance. There is no reason why an auditor should not accept a Trial Balance offered him by the head bookkeeper at the beginning of the audit, but that does not mean that he need not verify the items listed thereon. If he were to refuse the Trial Balance offered him, the chances are the bookkeeper would be offended and it might lead to his opposition instead of his cooperation during the audit. It would seem to be better practice, however, to prepare your own Trial Balance even though you have been furnished with one by the head bookkeeper or someone else in the employ of the client. Trial Balances may be made of the subsidiary ledgers as well as of the general ledger, provided summary or adjustment accounts are maintained in the subsidiary ledgers.” Usually, however, no such accounts are maintained in the subsidiary ledger, therefore, the only way a Trial Balance can be taken is to check the list of accounts taken from the subsidiary ledger with the controlling account in the general ledger.
Advantages of an Auditor Preparing His Own Trial Balance. The auditor will find that he has a splendid opportunity to become familiar with the details of the accounting system while preparing his Trial Balance. He cannot help, in going over all the accounts, thinking about them and while making the necessary calculations to determine the correct balances, build up in his mind as he goes along a general knowledge of the organization as a whole.
*Any subsidiary ledger may be made self-balancing by means of a summary or adjustment account. This account is set up in the subsidiary ledger and is an exact duplicate of the controlling account in the general ledger except that the sides of the account are reversed so that the subsidiary ledger account has for its debits the credits of the general ledger account, and for its credits the debits of the general ledger account.
There is no theory or principle of debit and credit involved in this, the device is simply introduced in order that the ledger may provide an internal proof of its correctness. Therefore, the total .# the balances of the individual accounts in the subsidiary ledger will be offset exactly by the opposite balance of the one additional account, and the ledger then is said to be self-balancing.
This is not often carried out for the reason that it is considered better
practice and more desirable for the controlling account to be in the hands of another person who thus has a check upon the bookkeeper's work.
A Set of Books is not Ready to be Audited Until in Balance. Some bookkeepers and business men think that an auditor by some sort of magic should be able to detect all mechanical errors in bookkeeping and arrive at a correct Trial Balance in a few minutes time. However, the fact is that it is no part of an auditor's duty to locate an error or errors in a Trial Balance unless he has been employed specifically to do so. An auditor who accepts an engagement to perform an audit, and who on beginning his work finds that the books are not in balance, should report the matter to his client and lay the facts before him. He can, of course, undertake to do the necessary clerical work in order to locate the errors in the accounts so as to obtain a Trial Balance, but to do so without previous arrangement with the client is liable to result in difficulties when the bill for services is presented. Anyone who spends his time in ordinary clerical work is hardly to be considered a professional auditor and it would seem to be better to permit the bookkeeper to locate his own errors and obtain a Trial Balance before beginning the audit.
Remuneration Basis. In this connection it is well to point out that audits are made under two classes of remuneration: those in which the remuneration is based on a per diem basis; and those in which it is being done under a contract specifying a certain sum. If the work is being done under a contract and the time necessary to do the work has been previously estimated, it would certainly be foolish to put in a lot of time finding ordinary clerical mistakes in bookkeeping, and to do so may result in a loss on the engagement. If the work is being done on a per diem basis, the auditor is apt to become involved in disagreeable discussions with the client because of the length of time spent in performing the ordinary clerical work of the bookkeeper. Consequently, let us point out again that the books should be in balance before the auditor begins his work, and if they are not in balance, the bookkeeper should be given an opportunity to locate his own errors and obtain a Trial Balance, after which, the auditor may proceed with his work in accordance with the instructions given hereinbefore and hereinafter.
The Trial Balance as a Part of the Working Sheet. The Trial Balance is not a financial statement, neither is it a test as to the accuracy of the bookkeeping work. It is merely a list of the balances of the accounts remaining open in the ledger. Therefore, it is nothing more than a surface indication that the books are in balance and that an equilibrium has been maintained between the debits and credits. The professional auditor usually prepares what is known as a “Working Sheet”, the Trial Balance simply being a part and is represented by the first two columns. The Working Sheet, in addition to containing
THE TRIAL BALANCE I 15
columns for a Trial Balance, should provide columns for adjustments, columns for the nominal accounts only, and columns for the real accounts only. The first two columns show the Trial Balance taken at the close of the period, but before the adjustments have been made. The adjustment columns show all the adjustments and corrections made after the Trial Balance is taken and before the statements and report are prepared. The columns for nominal accounts show the profits and losses for the period. The columns for real accounts show the assets and liabilities as at the end of the period under audit.
The accounts should be arranged on the Working Sheet in such a manner as to provide the most information and so as to make it most convenient for the preparation of the report for the client at the completion of the audit. The accounts need not, therefore, be arranged in the same order as the arrangement of the accounts in the ledger. (The Working Sheet will be explained in detail in a later chapter.)
Procedure in Taking a Trial Balance. First, prove each account by footing both sides of the account and substracting the two footings so as to verify the balance. It does not matter whether this has been done by the bookkeeper previously or not. The auditor should make his own verification independent of that of the bookkeeper.
Second, every page in the ledger should be examined. Experience will prove that some bookkeepers have peculiar ideas with regard to the arrangement of their accounts, consequently blank pages will be found here and there throughout the ledger and if every page isn't examined, accounts might be omitted.
Third, subsidiary and memorandum accounts may be found in the general ledger. For instance, one ledger may be used. It may be divided into sections; the first section may contain all the assets and liabilities together with controlling accounts for customers and creditors; the second section of the ledger may contain accounts with customers; and the third section, accounts with creditors. On the other hand, it is not infrequently found that subsidiary ledgers are kept, but no controlling accounts maintained in the general ledger. The bookkeeper when preparing his Trial Balance simply makes a schedule from the subsidiary ledgers and uses the total amount in his Trial Balance.
Fourth, some bookkeepers seem to have the idea that a Cash account need not be kept in the general ledger simply because a cash book is kept. While it is certainly poor practice to eliminate the Cash account in the ledger, yet such will often be the case, consequently a Trial Balance cannot be obtained unless the cash balance is first obtained from the cash book and included in the Trial Balance. The only sound accounting theory is that a general ledger should balance independently of all the other books of account. Any argument contrary to these principles is certainly contrary to good accounting practice. Fifth, the first Trial Balance is usually taken after the posting has been done at the end of the period and before any adjustments have been made. The auditor will have to be on the lookout for items posted to the accounts after the bookkeeper completed his Trial Balance. This is sure to happen when an audit is made at a date later than the end of the period under audit.
Quoting From The Federal Reserve Bulletin:
“Trial Balances of the general ledger, both at the beginning and end of the period under review, should be prepared in comparative form and checked with the ledger. The items in the Trial Balances should be traced into the Balance Sheets before the assets and liabilities are verified, to prove, among other things, that no ‘contra' asset or liability has been omitted from the accounts, that the assets and liabilities have been grouped in the same manner at the beginning and at the end of the period, and also that the Balance Sheets are in accordance with the books. The disposition of any general ledger assets and liabilities that may have been scrapped, sold, written off, or liquidated during the period under review should be traced and noted in the working papers. Furthermore, a general scrutiny of the general ledger should be made to see that the accounts, if any, that have been opened and closed during the year have no bearing on the company's financial position at the close of the fiscal period.”
ITEMS NOT ON TRIAL BALANCES
The following quotation is taken from “Duties of the Junior Accountant” by Reynolds and Thornton, published by the American Institute of Accountants: “Among the items which must be taken into account, but may not be on the books, are some which the junior should detect and take up in every instance. These are omissions from interdepartmental balances and balances between subsidiary companies, goods in transit and cash in transit. “It is quite common to find Trial Balances, apparently in order, which contain among ‘accounts receivable' amounts due from subsidiary companies or from departments of the same company, and among ‘accounts payable' corresponding entries, but for differing amounts. Wherever a Trial Balance shows any balance due from one department to another, from one subsidiary to another or from either to the principal company the auditor must see that the entry is exactly offset by a corresponding item in the accounts of the subsidiary or department concerned. If a department carry as an asset an amount due from another department and the