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Chapter Two
BEGINNING AN AUDIT

Engagement Blank. Accountants as a rule have a form known as an engagement blank. This is carefully filled in at the time the agreement is made or as soon thereafter as is convenient. The form of engagement blank used by the author is illustrated on page 18. The form may vary, but should show all the facts in connection with the agreement made with the client. It is important that an auditor should have with him a copy of the engagement blank for convenient reference.

Letter of Introduction. In starting out on an engagement one is sure to come in contact with a number of different persons. Naturally he will go first to the client. He will also need to meet heads of departments and others in arranging to begin the work. It is, therefore, important that he have a letter of introduction. Remember an auditor is engaged in professional work and the nature of his work and the liberties extended him are such that he should be properly introduced.

Equipment. In the way of equipment, an auditor will need journal, ledger, and analysis paper. Analysis paper may be secured with almost any number of columns. Fourteen columns is well adapted to the use of the Working Sheet and is therefore preferable. He will also need black, blue and red pencils, an eraser, a ruler, bank certificates in blank, time and expense report blanks, and a memorandum book.

NATURE OF ENGAGEMENT

The first thing of importance at this point is to know in your own mind exactly what you are going to do. Heretofore the business public has depended upon the auditor and accountant as to the scope of the work and in many cases the work has been started without knowing in advance exactly the nature and scope of the engagement. There should be a clear understanding reached with the client by the accounting firm, and this in turn should be conveyed to the senior in charge of the audit. The junior should understand definitely just what part of the audit he is to be responsible for and should proceed accordingly. Of course, it is needless to say that he will get his information direct from the senior and not from the client.

(Continued on page 19)

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2. Official position...Board of Directors. . . . . . . . . . 3. Address.... Indianapolis, Indiana ... . . . . . . . . 4. Conference. ... C. H. Becker, Chairman....... 5. File No.....A245 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6. Telephone No..... Main 24 . . . . . . . . . . . . . . . . . . . . . . . . 7. Report to be addressed to. Mr. Becker. . . . . . . . . . . . . . 8. Account to be opened with. The Blank Mfg. Co... 9. Nature of engagement...Balance Sheet Audit.... for credit purposes. . . . . . . . . . . . . . . . . . . . . . . . . Io. Work to be done at... their office. . . . . . . . . . . . . . . . II. Nature of the business. manufacturing............. 12. When to be commenced. Jan. 15, 1919 . . . . . . . . . . . 13. Probable time required... two weeks. . . . . . . . . . . . . . . . . 14. Accountants required one senior; two juniors 15. Rates... regular.................................. 16. Additional information...No previous audit has ever been made but an internal check is maintained. Mr. Becker called at our office Dec. 20, 1918. . . . . . . . . . . . . . . . . Engagement No. . . . . . . One... Date completed. . . . . . . . . . .

Assigned to staff. . . . . . A...... Report mailed. . . . . . . . . . . .

THE VALUE OF AN AUDIT I9

In determining the nature of the engagement and making arrangements for the audit with the client, naturally it is frequently necessary to explain the different classes of audits. The client is likely to state that he wants a complete audit when, as a matter of fact, he wants only a Balance Sheet audit. It is of the utmost importance that there be no misunderstanding on the auditor and his client as to the exact scope of the audit.

THE WALUE OF AN AUDIT

The value of an audit will naturally depend upon each individual instance. Business men have been somewhat slow to realize the actual benefits to be derived from periodical audits by professional accountants, but today the importance of an audit is generally recognized by the business community. It is not infrequent, however, that we still hear business men say that in their particular case an audit is unnecessary. They say that they have absolute confidence in their bookkeeper or accountant and that he is able to prepare annual statements that are just as accurate as anyone could prepare. Others say that they know exactly where they stand in the financial sense and do not need an outsider to point out defects, or to plan improvements in the accounting system in use.

Questions such as the following should cause business men, stockholders, directors, investors and others to realize that such arguments as the above are groundless: Are you certain that your bookkeeper is competent to furnish an accurate statement of financial condition or of earnings? Has your general manager had sufficient accounting training and experience to judge of the correctness of the reports which he submits periodically? Do you know that corporations frequently pay dividends which have not been earned, though it is illegal to do so? Is your general manager competent to prepare for the United States Government, returns for Income and Excess-Profits Taxes? ‘Even though your attorney is consulted with regard to these returns, are you sure that he fully comprehends the application of the Income Tax Law and all the regulations of the Treasury Department? Is he able to interpret your accounts and determine the accuracy of your returns? It is such questions as these that only a professional accountant with wide training and experience is competent to pass upon.

A bookkeeper may perform his detail work so accurately that for years his books are always in balance and errors in posting or in footing the accounts are unknown, yet the statements which he presents are not only in such form as to convey little information of value, but the figures which he shows as earnings may never be correct. An audit of his books may disclose the fact that accounts receivable, amounting to thousands of dollars, have been carried at full value though known to be uncollectible. He may not have made provision for depreciation of plant and machinery. Equipment which has become worthless because of depreciation or obsolescence may be shown in the statements at its original cost.

These are some of the things which an average bookkeeper, even one whose services command a big salary, knows but little or nothing about. If he does know something of the necessity for adjustments of this kind, his lack of experience and theoretical knowledge is a dangerous thing, and his attempt to put this theory into practice is likely to mar the result.

Don't think for a moment that the present day work of an auditor is merely a checking of the footings and postings. This part of his work requires the least amount of ability and experience. It is an auditor's duty to go much further—to determine the accuracy of the figures stated on the books of account; to distinguish between capital and revenue expenditures; to determine the actual value of accounts with customers through a process of testing, or, if necessary, to correspond with each customer to secure a verification of the account; to determine a conservative and sound basis for the estimation of depreciation on all assets; and to secure authority for making all necessary adjustments. These things can be brought about through courteous cooperation between the officers and employees of the company and the accountants.

The professional accountant's work would not be satisfactory if he were to submit statements of financial condition which are simply in accord with the books of account. He must determine that none of the assets are overvalued and that all liabilities are stated. The latter may mean the determining of liabilities on account of accommodation endorsements of notes and other negotiable instruments, guaranties, warranties, etc. The head bookkeeper of a concern, in preparing statements of financial condition, is certain to be influenced by the wishes of the management, but an accountant must of necessity prepare his statements so as to show the absolute facts; he must be impartial. To fail in this is to become morally and legally liable for having failed to use the skill of a professional accountant.

Periodical audits by professional accountants are necessary in hard times when competition is keen and profits small, because in such times operating cost must be carefully analyzed and reduced to a minimum. The auditor must determine where the expenditures have been made, why they were made and what the results were. He must find out if there are any leaks and suggest a way to stop them.

An auditor's report may disclose that during a period when sales were abnormally large, the results show a loss as compared

THE VALUE OF AN AUDIT 2I

with previous periods when sales were considerably less. His report may show that one department is suffering a loss, yet the entire business shows a gain. His report may show that operating expenses in one department are abnormally high and he may be able to show how they could be lowered.

In many instances, it has been found profitable to secure an accountant to install a system of accounting and to make arrangements for the accounting to be done under his supervision. When this is done, the work of the bookkeeper is performed and statements are prepared under the oversight of a highly trained and widely experienced professional accountant, and usually at a very reasonable cost as compared with the value of the accountant's services if confined to the individual firm; yet with such arrangements the accountant may be consulted any time, even over the telephone. Unusual and difficult problems may be placed before him before the bookkeeper has recorded them, thus avoiding errors and misstatements.

There is not the slightest doubt as to the value of an audit when performed by a skilled professional accountant or auditor, and it is exceedingly doubtful if any corporation or business firm can afford to do without an audit.

The professional accountant is an efficiency engineer in times of prosperity. He sets the signals which, unless they are disregarded, keep the business train running without accident. He is the wreckmaster who gathers up the pieces, sets them on the track and starts them going—if possible—after a concern has been ditched.

When a rich man dies, the public accountant examines and appraises his estate. His range of activities covers the whole field of business existence, from birth to death, and the interval between.

KINDS OF AUDITS

Audits may be either complete or partial. A complete audit is known as a DETAILED audit; a partial audit is usually known as a BALANCE SHEET audit. Since the average business man has no idea of the difference in the two main classes of audits, a careful explanation must be made so that he will know in advance just what kind of an audit he is getting. He will frequently ask the auditor to make a recommendation in the matter. It is quite impossible and inadvisable to do so without a preliminary inspection of the books and conditions existing. The detailed audit is the ideal audit but the time and expense of such an audit is not always advisable nor is it always necessary. In determining this matter much will depend upon whether a satisfactory internal check has been maintained.

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