Internal Audit. By an internal audit or check is meant a continuous audit by someone within an organization, or by the system being so planned that no one employee has complete control of any part of the accounts. A properly planned internal check is important and when carried out satisfactorily, a Balance Sheet audit will be found sufficient, unless fraud or dishonesty is suspected.

While large firms usually employ someone who acts as auditor and who maintains a continuous audit, yet a large majority of firms do not employ such a person, but simply plan the office work in such a way as to secure the best internal check. The exact division of the work in an office so as to secure a satisfactory internal check would depend very largely upon the surrounding circumstances.

In planning a system of accounts for a jobbing house, wherein five persons kept the books, did the billing, made the city collections, handled the general and petty cash, and paid all the invoices, the following method was advocated and later found to be very satisfactory:

It was arranged for one person to keep the general ledger and record the invoices; a second to handle the cash; a third to keep the sales ledger; a fourth to do the billing; and a fifth to make collections, etc. The work may be still further subdivided, depending upon the volume of business. For instance, one man might handle only cash receipts and another man handle cash payments, or one man might handle cash receipts from customers keeping a special customers' cash book. All this subdivision of the work will depend upon the volume of business. The important feature is that the cash book and ledger be kept by different persons so that one person acts as a check upon the other. Some accountants recommend that persons in the office exchange duties at times, the theory being that in so doing one person might detect dishonesty on the part of another. From the standpoint of efficiency, this procedure might be argued as unwise.

Without a doubt, vacations should be insisted upon. The author recalls an experience of a teller in a bank who for a period of three years constantly embezzled the bank, and although the books had been audited periodically by bank examiners, he had been able to cover up the shortage so that it had not been detected, but finally, while away on a vacation, the bank examiner made an unexpected call and during the process of his investigation uncovered a shortage of $10,000 in the teller's accounts. This illustration is mentioned as one reason why vacations should be insisted upon from the standpoint of an internal check.

Cash Audit. The so-called cash audit is practically a balance sheet audit or partial audit, but it is difficult to understand how an audit of cash could be made without leading

to the consideration of many other accounts and records. Fraud and errors of principle are not necessarily confined to cash in any sense, and are far more likely to be uncovered somewhere else.

Balance Sheet Audit. A Balance Sheet audit is made with the view of preparing a correct Balance Sheet as at a certain date. It not only includes the verification of stated assets and liabilities but also the discovery of any unstated assets and liabilities. Furthermore, the auditor must ascertain if all the liabilities have been incurred with proper authority. In the case of a corporation it will be found frequently that certain liabilities were incurred without authority from the board of directors.

Detailed Audit. As stated above, the detailed audit is the ideal audit. It comprehends a complete audit of all income and expenditures during the period, including the checking of all records, vouchers, footings, postings, etc. The detailed audit is seldom carried out in full. A process called TESTING is resorted to quite often in both a Balance Sheet and a detailed audit. It consists in picking out the transactions for a certain period and if, after carefully vouching these transactions they are found to be correct, it is then assumed that the transactions for the whole period under audit are reasonably correct.

Contingent Fees. The question as to the advisability of an auditor accepting a contingent fee frequently comes up. While under certain circumstances it may be safe to accept a fee based upon the results of the audit, it is doubtful if the plan is to be encouraged. At any rate it is not considered good ethics by the American Institute of Accountants which has gone on record as opposed to the practice. To illustrate what is meant by a contingent fee, a client approaches an auditor stating that he desires an audit made with the view to obtaining a loan from his banker and states that the fee will be based upon the auditor's success in aiding him to secure the loan through the preparation of a Balance Sheet for credit purposes. The auditor who undertakes such an engagement would not be likely to prepare an impartial report.

Audit Program. At the beginning of the engagement the auditor should prepare a program. Naturally it will differ, depending upon the scope of the engagement, the nature of the business, and the purpose of the audit, but it usually will be along lines similar to the following:

1. Count the cash; verify bank balances; read minutes.

3.

ledger.

If a Trial Balance is furnished, check it with the general

4. Check list of accounts receivable and accounts payable with controlling accounts.

5. Check any other subsidiary lists of accounts with controlling accounts.

6. Check extensions and footings of inventories; test the inventory.

7. Verify outstanding capital stock by comparison of stock ledger accounts with stubs of stock certificate book.

8. Check all footings of books of account, both original and final; check all postings or transfers from one book to another. 9. Review cash disbursements; compare with cancelled checks.

IO.

Ascertain if proper provision has been made for

depreciation.

Legal Responsibility of Client. It is not out of place here to mention the fact that it is always advisable to determine the legal responsibility of a client before accepting an engagement. If someone within an organization seeks to have an audit made, it is necessary to ascertain whether or not he has any right to engage the services of an auditor, and also as to whether or not he is employing you personally, or is merely acting as an agent of the company.

CLASSIFICATION OF ACCOUNTS

It is important that an accountant or auditor should thoroughly understand a proper classification of accounts. In the next chapter there is to be taken up what is known as a Balance Sheet audit; therefore, it is necessary at this point to devote a brief discussion to the subdivisions of accounts. Since a Balance Sheet is made up of ASSETS and LIABILITIES, these will now be discussed and classified.

REAL ACCOUNTS

Accounts are divided into two general classes-REAL and NOMINAL. It is the real accounts that appear in the Balance Sheet and are classed as assets and liabilities; they may be either PERSONAL or IMPERSONAL. There are three classes of personal accounts: accounts with customers; accounts with creditors; and accounts with owners or proprietors. Accounts with customers are usually classed as CURRENT assets. There might be an exception to this in the case of an open account, the terms of which would indicate that it would not become due within a year. Some authorities hold that all current assets must be those which can be realized upon within the current fiscal period, or, at least, within a year. However, it is conceded good practice to class all accounts with customers as current assets as long as these accounts are collectible. Once an account is considered uncollectible, or its collection as being doubtful, it should immediately be charged off and should not be included as a current asset without the proper depreciation being set up.

Accounts with creditors are considered as CURRENT liabilities; like accounts with customers, they are usually due within a short time and, therefore, provision must be made. for their liquidation within the current fiscal period.

The accounts with the owners or proprietors of a business are classified on the liability side of the Balance Sheet, but are usually listed separate from the liabilities in a section devoted to proprietorship accounts. They may be in the form of an account with a single owner, accounts with partners, or accounts with capital stock, and SURPLUS or DEFICIENCY. In the case of a corporation, net profits are usually credited to a Surplus account or they might be credited to an Undivided Profits account, in which case this account would also appear among the proprietorship accounts. Net losses are debited to the Surplus account, but when a business becomes insolvent, it is then necessary to set up a Deficiency account debiting it with the net excess loss. A Deficiency account shows that the business has been conducted at a loss and that the value of the stock owned by stock-holders has decreased in value equal to the amount of the deficiency.

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