CHAPTER XIX.

THE AUDITOR'S REPORT.

§ 195.

General.

It is customary for the by-laws of corporations to provide for periodical audits of the books of account, either by committees consisting of directors or by professional accountants.

In the larger corporations an audit by the directors is practically impossible. In the smaller corporations it is ordinarily inadvisable. If properly conducted an audit is a laborious process, requiring painstaking accuracy and an amount of time that the directors of a corporation are not usually disposed to give it, and demanding a technical knowledge of accountancy that they do not usually possess.

In practice directors' audits do not ordinarily discover the true conditions of the corporate business nor the real results of its operations, and the report of such an audit is not only of no material value but is at times absolutely misleading. For this reason, even when the audit is entrusted to a committee of directors, the actual accounting work should be delegated by them to some independent and capable accountant who is able to perform it properly without fear or favor. The object contemplated by the by-laws is undoubtedly a competent and thorough investigation and an adequate report, and this cannot be attained by the unaided efforts of the ordinary committee of directors.

§ 196. The Objects of an Audit.

Stated briefly, the more important objects of the usual audit examination are to determine,-(1) whether the books have been kept honestly and efficiently; (2) the true condition of the corporate business as expressed by the balance sheet; (3) the results from the business operations logically arranged in the form of a profit and loss statement; (4) any deductions or suggestions of importance arising from the facts discovered by the auditor in the course of his examination.

The audit report shows the true results from the operations of the business and thereby reflects with accuracy the efficiency of the management. It also supplies the most authentic possible statement of past results and present conditions and thus affords a safe basis for plans of future operations. If profits have been decreasing; if production costs have fluctuated widely; if certain departments have made abnormal showings without apparent cause, a proper audit discovers the reasons, and if faults exist, enables their correction.

An important incidental advantage of periodical audits. is found in the direct and material benefits which inure to the accounting department. A competent auditor must of necessity be a past master in the science of accountancy. His examination of the records will therefore inevitably discover any defects which may exist in the methods or general system employed in the accounting department of the corporation under examination. He will, then, either in the course of his audit or in his report, suggest any changes or additions that may seem to him desirable. These suggestions, based as they are on an extended study and experience of accounting methods, are usually practical and valuable, and when put into effect, not only curtail clerical labor but also increase the accuracy and general efficiency of the system.

Also the mere knowledge that a competent and exhaustive investigation of the corporate records and accounts will be made periodically, tends directly to remove temptation and

prevent dishonesty, and to maintain a high condition of efficiency in the accounting department.

In some cases the auditor is called upon to make special examinations and reports, as for instance where a corporation is to be organized to take over some existing business, or when a combination or consolidation of existing industries is to be effected. In such cases thorough and extended investigations of the corporations and properties involved are essential. Such audits frequently exhibit the results of the operations of the investigated industries for terms of years, including in their scope every phase of organization, operation and condition.

§ 197. What an Audit Comprises.

A complete audit embraces the verification of all existing assets and liabilities as of a certain date, requires that all cash receipts and disbursements for the period under review be verified, that all accounts shown in the general ledger be analysed for the term covered by the audit, and, in many cases, that inventories be taken in order to ascertain the true quantity of goods on hand and in process of manufacture. The audit may also require a verification of all open accounts receivable, statements showing the balance due as of the date of the audit being sent to each debtor, with a request that any difference be reported directly to the auditor in charge. The audit should not, however, extend to such detail as checking all items from the books of original entry to the subsidiary ledgers. This merely verifies the clerical accuracy of the bookkeeper's work, requires no special skill and is ordinarily a waste of the auditor's time.

There are two general classes of audit reports, viz., (a) the unqualified report and (b) the qualified report.

(a) Unqualified Reports. An unqualified report is one showing the general condition of the affairs of the business

and the results of its operations, the accuracy of which is certified to without qualification or reservation by the auditor.

If an unqualified report is to be made, the accountants in charge should be permitted to verify every asset and liability. This means that they should supervise the taking of a physical inventory of all raw materials, supplies, finished products, etc.; that they should satisfy themselves as to the existence and value of all fixed assets; that they should verify all accounts receivable by sending statements to customers showing the balances due and requesting them to report any differences; that they examine all securities owned, and in short conduct such an investigation as will justify them in rendering an unqualified report.

A report full of qualifications is of little or no value, and a certificate which reads "We hereby certify that the balance sheet agrees with the books" means very little. A report is supposed to show facts, regardless of the books. If, however, it is understood by clients that only certain assets and liabilities will be examined, or that a partial audit only will be made, a qualified report follows as a matter of course and is perfectly proper.

(b) Qualified Reports. A qualified report is one which falls short of the unqualified report. If an audit has been made but this has not been extended to the verification of all existing assets and liabilities, it is not complete and an unqualified report cannot be made. A qualified report should show particularly in its comments what has not been done. The results themselves will show what has been done. A skeleton report (balance sheet and Profit and Loss Statement) is not a complete report. The complete report should embody comments bearing upon the items shown in the balance sheet and accompanying exhibits, so clearly stated that a person unfamiliar with the business can readily understand every detail.

Pursuant to your request we have examined the books and accounts of The J. B. Matthews Company, at both the Hartford and New York offices, for the year ended December 31, 1906. The results of this examination are presented in the accompanying comments, and in the exhibits and schedules designated as follows; viz.,