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General. “These instructions cover audits of small or medium sized concerns. In large concerns having, for instance, tens of thousands of accounts or notes receivable, the detail procedure suggested would be impracticable, and internal check should make it unnecessary. In such cases only tests can be made, but the auditor must always be prepared to justify his departure from a complete program by showing that the purposes sought to be accomplished thereby have been adequately effected by his work.

“Any extensive clerical work, such as preparations of lists of notes receivable, etc., should be performed by the client's staff, so as to avoid unnecessary employment of professional staff in merely clerical work and consequent undue expense.

THE PROFIT AND LOSS STATEMENT A Profit and Loss statement should be submitted with the income and expenditures classified under appropriate captions, and, if possible, this statement should show the operations in comparative form. If comparative figures for several years are submitted, the accountant must satisfy himself that the figures for all periods are prepared on the same basis. Instances are frequent where concerns make a liberal provision for depreciation, etc., in prosperous years, and reduce, or even eliminate, all depreciation in years during which business is poor and profits small. Occasionally, a basis of inventory valuation is adopted differing materially from the basis used the year before, and some concerns show a tendency to charge to capital during lean years, items of a nature which are absorbed in operating expenses during prosperous years.

Since the Income and Excess Profits Tax Laws became effective, business men are liable to set up excessive depreciation and to charge to operating expense, expenditures which should have been capitalized. An instance recently came to the writer's attention wherein a concern charged to operating expenses, extensive improvements on grounds surrounding the plant, such as building of fences, driveways, sidewalks, parks, etc., costing thousands of dollars, not a cent having been capitalized. When the books of the company were audited by Income Tax inspectors the expenditures were analyzed, those representing improvements that increased the value of the property were charged to capital and not allowed as deductions from income; hence, the company was assessed for additional taxes.

Increases or decreases in the sales should be carefully scrutinized. A recent audit of a manufacturing concern disclosed a substantial increase in sales when compared with the operations of the preceding year, but a thorough investigation revealed the fact that the increase was due entirely to large orders having been received from two new customers. Had this new business not been obtained, the sales for the last year reported on would have shown an actual decrease.

The Profit and Loss statement should be so arranged as to reflect the actual results of the period, and the figures shown thereon should not need any explanation or qualification. The Model Statement of Profit and Loss, shown on page 214 of this Chapter, is a comparative statement for a period of three years. It would be quite impossible to show a form of statement that would fit every business. The form shown is general and at the same time is simple enough to be easily comprehended. It is based on Federal Reserve Board requirements.

In a manufacturing enterprise a special statement of factory operations showing cost of goods manufactured and sold should also be prepared. The cost of sales as arrived at from the statement of factory operations, may be used in arriving at the gross profit on sales in the Profit and Loss statement. A model statement showing cost of goods manufactured and sold is exhibited below.



Inventory, beginning of period. .....

$xxxxx. XX Material purchased..

$ XXXXX. XX Freight and cartage inward.

XXXXX. XX XXXXX. XX Cost of Accountable Material....

Deduct inventory, ending of period. .
Cost of Material Consumed...

Manufacturing expenses;

Depreciation on buildings .$ XXXXX. XX
Depreciation on machinery
Factory expense..
Insurance, bldgs. and machinery..
Repairs to building...
Repairs to machinery..
Taxes on real estate


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(Model Statement of Cost of Goods Manufactured and Sold)

Year ending19- 19


Gross sales...

Sxxxx. xx $xxxx. XX Sxxxx. XX Less outward freight,"allowances and returns xxxx. xx xXxx.xx xxxx xx

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Dividends paid ...
Surplus ending of period. ..

Sxxxx xx xxxx xx $xxxx. XX (Model Comparative Statement of Profit and Loss)


Completing an Audit. When an audit has been completed, the juniors should hand their working papers to the senior. The senior then assembles them and. before leaving the office of the client, he should check over the Trial Balance together with the various schedules, analyses and summaries supporting it, and prepare in journal form any correcting or adjusting entries that may be necessary. The reason for doing this work immediately and before leaving the place where the work has been carried on, is that if anything should develop which requires attention, access to the books is still possible. It is quite embarrassing to discover, perhaps several days after an audit has been completed, that certain information is needed and it is impractical to return to the office of the client. Satisfactory results in such cases often cannot be obtained by correspondence.

Correcting Entries. Journal entries should be made, together with full explanations, for all errors, whether mechanical or in principle, that have been discovered during the course of an audit. These errors will be shown by the working papers prepared by the persons engaged on an audit. A separate entry should be made for each error found. Usually, after discussing the matter of errors with the client, the bookkeepers will be instructed to make similar correcting entries on the books of account. If this is done the books will show the same results as the statements prepared by the auditor. If, for any reason, the books of the client are not corrected, the auditor should proceed with his working papers in the same manner as outlined, for his statements must show actual, financial conditions.

Adjusting Entries. There are certain facts which may not appear in the accounts at the close of the fiscal period and in order that the books may show true conditions on that date adjusting entries are required. Entries must be made for accrued assets, accrued liabilities, deferred charges to operation, deferred credits, depreciation, reserves, inventories, etc.

The Working Sheet. It is a comparatively simple matter to exhibit the results of an audit in a statement, commonly known as a Working Sheet. The purpose of the Working Sheet is frequently misunderstood. It is not a statement intended as a substitute for the financial statements, but is a summary of the accounts as they appear in the Trial Balance, adjusting data, and a classification of nominal and real accounts, and is prepared for the purpose of gathering together all the information needed from which an auditor may prepare formal financial statements and a formal report for the client.

The correcting and adjusting entries prepared by the auditor in connection with The Blank Manufacturing Company appear below. Each entry is followed by an appropriate explanation and needs no further comment, with the possible exception of the last entry (No. 8) which relates to the inventories. Some accountants do not set up an adjusting entry for the inventory. They simply enter the ending inventories in the Working Sheet arbitrarily and include them only in the "closing journal entries”. The entry shown will be found so simple and easily understood that it will be apparent at once that it is undoubtedly the best method for treating the subject.



Dec. 31, 1918 (1) Salaries of Salesmen

Salaries advanced to Salesmen

To correct an error of $30.00 in the footing of each of above accounts.

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$215.00 Tools and Implements

$215.00 To correct an item of $215.00 charged to Tools and Implements which should have been charged to Machinery as it represented the purchase of a new machine, July 1, 1918.

(3) Surplus

$22,500.00 Dividend

$22,500.00 To adjust account with Dividend authorized, July 1, 1918, but not charged to Surplus.


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Dec. 31, 1918
Factory Pay Roll, Labor
Surplus (Bond Interest Accrued)

Accrued Liabilities

To set up on the books the Accrued Liabilities as follows: (a) Factory pay roll accrued but not paid $2,875.00 (b) Accrued interest on first mortgage bonds $100,000.00 at 5%, July 15, 1918, to Dec. 31, 1918....

$2,315.07 This is charged to Surplus for the reason that no accrued interest on bonds was calculated at the end of the previous fiscal period, hence the present period should only be charged with bond interest amounting to $5,000.00. The Surplus account must be adjusted because of failure to charge Bond Interest account for accrued interest at end of the previous period.

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