One method is to charge the Tools and Implements account with the cost of all tools purchased and at the end of the year to take a physical inventory and make an adjusting entry crediting the asset account with the cost value of all tools used up or missing and charging the proper operating expense account. If this is done, no reserve for depreciation need be set up.

Another method is to charge the account with tools as above, but to issue all tools to the workmen and at certain times require them to submit all tools for inspection. At this time all tools worn out, broken, or worthless are charged to expense and new tools issued to the workmen. Any tools missing or otherwise unaccounted for are charged to the workmen and deducted from their wages. In either case the account with tools would be credited with the cost price of the tools worn out, broken, worthless, or missing and the balance of the account would show the cost of tools on hand and in use. No reserve for depreciation is necessary, but it is necessary to require the workmen to submit all tools for inspection before preparing the statements. At this time the account would be adjusted.

A third method is to charge all tools and implements to operating expense at the time of their purchase, and if there are any new tools on hand at the end of the fiscal period, their value at cost price is treated as a deferred expense. This method simply necessitates an inventory of new tools on hand undistributed.

Montgomery says:

"As a rule, the practice of depreciating small tools by way of a percentage cannot be followed satisfactorily. So many small tools are used up, or lost, or stolen, that an inventory should be made periodically and all tools on hand revalued. If this plan is followed for several years and a dependable rate of depreciation is secured, it may be feasible to omit the revaluation for a year or two, applying the rate previously ascertained." The Tax Commissioner of one of the states has adopted rates varying from 25 to 50 per cent, or as an alternative the entire cost of replacements.

Esquerre' says:

"The tools contained in this account are sometimes referred to as 'small equipment.' They comprise, saws, files, hammers, screwdrivers, etc., which on account of their fragility, their size, the manifold uses to which they are placed, and the facility with which they can be passed from hand to hand and from bench to bench, cannot be readily or accurately inventoried. They are generally kept under the custody of a storekeeper and charged to cost of manufacture when issued to the factory."

Greendlinger* says:

"Tools which are fixed and which in reality enter into the same category as machinery, should be valued in the same man

*Author of "Accountancy Problems with Solutions."

ner. Small tools, however, unless the aggregate is large, should be considered expenses. Where there are a great many it would be better to consider them as supplies and so list them in the inventory."

The Theory of the Account with Horses, Wagons and Harness. This account is rapidly being replaced with accounts with Auto Trucks or motorized delivery equipment. However, the theory of the account is the same. The items charged to it represent delivery equipment. The only difference is the amount of depreciation to be charged off or set up.

Some firms charge the account with the original cost and then charge all replacements and additions to expense. This is hardly to be commended because it does not show true facts at the end of the period. If the original value is increased or decreased by a conservative inventory or appraisement before preparing the statements, the difficulty may be overcome to some

extent.

A better practice would be to charge the account with the cost of all delivery equipment and then set up a reserve for depreciation that is estimated to be equal to the reduction in the value of the property. Under this plan, if losses occur by reason of accidents or other causes, the account is credited with the original cost. If the account had been credited direct with the amount of the estimated depreciation, then only the depreciated value would be credited to the account at the time of loss. It is advisable to set up special reserve accounts for each property account subject to depreciation. (Depreciation will be taken up in the Tenth Chapter and will be discussed in detail.)

The Federal Trade Commission, in a bulletin issued July 15, 1916, entitled "A System of Accounts for Retail Merchants,,' says, "Charge the account with Delivery Equipment with the cost of automobiles, wagons, horses, and harness. This account must not be charged with repairs to automobiles and wagons, horseshoeing or anything of this nature. A fair amount should be written off periodically for depreciation."

The Theory of the Office Furniture Account. In practice different methods will be found to exist in recording the value of office furniture or equipment. It will depend upon the policy of the concern. In many instances the account will include fixtures, partitions, etc. What was said with reference to the account with delivery equipment is applicable here. The important thing is to be conservative. If the account is charged with the cost of all office furniture purchased and a reserve account is set up crediting it with the estimated amount of the depreciation each year, it will represent sound accounting practice.

The Federal Trade Commission says in regard to the account with Office Furniture, "Charge this account with office furniture, desks, safe, and other office appliances. It should not be charged with the cost of typewriter supplies, account books, etc., as these are clearly items of expense. A fair amount should be written off periodically for depreciation."

AUDITING THEORY

Quoting from Federal Reserve Bulletin:

Schedules. "In preparing the leading schedules for the accounts grouped under this heading, such as real estate, buildings, plant, machinery, etc., the balances at the beginning of the period, the additions to or deductions from the accounts during the year, and the balances at the end of the period must be shown.

"The total of the balances at the beginning of the period must agree with the cost of property figures given in the Balance Sheet at that date, and the balances at the end of the period with the amount shown in the Balance Sheet that is being audited. The charges entering into the additions must be verified in detail, and in this connection the following notes are of value:

Authorizations for Expenditures. (1) "Authorizations for the expenditures made during the year should be examined, and where the costs of the additions have overrun the sums authorized, inquiries should be made in regard thereto. The authorizations should show the accounts to which the expenditures are chargeable, the amounts thereof, the approvals of the comptroller and manager, and descriptions of the jobs. When the authorizations are not specific as to the work done, the actual additions should, if possible, be inspected.

Additions. (2) "The auditor should satisfy himself before approving additions that they were made with the object of increasing the earning capacity of the plant, and that they are not of the nature of either renewals or improvements, and in this connection changes in the production and capacity of the plant should receive consideration.

Pay Roll and Store and Supply Charges. (3) "To verify the pay roll and store and supply charges to jobs, one or two pay roll distribution reports should be examined in detail, and also one or two storehouse reports. In cases where large purchases have been made from outside parties for capital construction work, the vouchers therefor should be examined and the usual precautions taken to see that they are properly approved for the the receipt of materials, prices, etc.

Real Estate Purchases. (4) "For purchases of real estate the title deeds should be examined, together with the vouchers, and it should be seen that the deeds have been properly recorded.

Factory Overhead Cost. (5) "While it may be considered permissible to make a charge for factory overhead cost to additions to property such as, e. g., time of superintendent and his clerical force employed on construction work, etc., it cannot be deemed conservative business practice, inasmuch as the probabilities are that the overhead charges of a plant will not be decreased to any extent even though additions are not under way, and, therefore, the absorption of part of these charges when additions are in progress, has the effect of reducing the operating costs, as compared with months in which no construction work is under way.

Construction Work in Progress. (6) "Construction work in progress at the end of the fiscal period should be shown in the Balance Sheet under the heading of fixed assets and not as part of the inventories. This is important to bear in mind because construction work is not an asset that can be quickly turned into money, while everything in the inventory is supposed to be realizable in cash within a reasonable short time.

Installments on Construction Work. (7) "The auditor should inquire as to whether any installments are due on account of construction work in progress which is being carried on by outside parties; and if so, the liabilities for these installments should be included in the Balance Sheet, as they may have a direct bearing on the amount of available cash on hand.

Leases. (8) "When a company uses leasehold properties the leases should be examined and notes made of the periods covered, so that it may be seen that improvements, etc., on such properties are written off over the periods covered by the leases.

Reserves for Depreciation. (9) "The auditor should satisfy himself that the reserves for depreciation of buildings, machinery, equipment, etc., are adequate to reflect the deterioration in the value of the fixed properties. If in his opinion the reserves shown on the Balance Sheet are insufficient, he should call attention to the matter in his certificate.

Property Destroyed by Fire. (10) "Care should be taken to insure that property destroyed by fire or otherwise prematurely put out of service is correctly treated in the books. Any portion of the original charge for such property which is not recoverable through insurance, as salvage or otherwise, and has not been provided for by the depreciation scheme should be written off.

"It is to be observed that the foregoing notes are to be applied only to cost of properties incurred during the period

under audit. In addition, information may usually be obtained on broader lines in regard to the composition of the Real Estate, Building, and Machinery accounts, and showing what principal property is represented thereby and how the accounts have been built up from year to year for a reasonable time past if not from the inception of the business. The information derived therefrom is valuable only in indicating the progressive policy of the concern, the extent to which it reinvests undivided surplus in its plan, etc. Beyond these facts the banker who is asked for ordinary discounts or short-term loans is not interested; he looks more to the quick assets for his security.

When an Appraisement is Necessary. "Optional.When the loan is greater than the quick assets seem to justify the auditor should suggest a reliable verification of the cost of property prior to the period under audit. Such action may become necessary even to the extent of calling for an appraisement by disinterested outside experts."

AUDITING PROCEDURE

Analyzing Fixed Assets. J. I. King, junior accountant, made an analysis of the fixed asset accounts. Inasmuch as all account footings had been carefully verified when the Trial Balance was vouched, it was only necessary to determine whether all charges to the asset accounts represented actual capital disbursements and that adequate reserves for depreciation had been set up.

The Land Account. The amount charged to this account, $100,000.00, represents the actual cost of the land at the time of its purchase. The deed was examined and found to be properly recorded.

The Buildings Account. Building operations were begun immediately after the purchase of the land and the book value as set up represents the actual contract price of the buildings when completed. A reserve for depreciation amounting to 22% has been set up annually. The Buildings account shows a debit of $150,000.00, and the Reserve for Depreciation on Buildings account shows a credit of $2,500.00. The buildings were completed May 1, 1917, and the Reserve, at the end of the year, was credited for depreciation on the basis of 2% of a

year.

A question might arise as to whether this represents a proper percentage of depreciation. Inasmuch as the buildings are of concrete and brick construction, it is considered adequate. (See discussion of Depreciation, Chapter Ten.)