George Benton Renn.

Renn's practical auditing; a working manual for auditors, describing in complete detail the method of conducting a commercial audit, and indicating in proper order the successive steps of procedure, with a general treatise on auditing online

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Online LibraryGeorge Benton RennRenn's practical auditing; a working manual for auditors, describing in complete detail the method of conducting a commercial audit, and indicating in proper order the successive steps of procedure, with a general treatise on auditing → online text (page 1 of 8)
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Bus Admin.. Lit.

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5667



Bus. Admin
Lib.



RENN'S
PRACTICAL AUDITING




THE LIBRARY

OF

THE UNIVERSITY

OF CALIFORNIA

LOS ANGELES




This book is DUE on the last date stamped below



'



JUL 2 1 1943




PRIVATE L^



No. ...............

THOMAS KEPPEL,

ZEELAND, MICH.



yNlVERSHY OF CAUF9RNIA,



Library

Graduate ScV) iol of Business Administration,
University of California




-t^VT^A^^




Renn's Practical
Auditing

A Working Manual for Auditors



DESCRIBING IN COMPLETE DETAIL THE METHOD

OF CONDUCTING A COMMERCIAL AUDIT,

AND INDICATING IN PROPER ORDER

THE SUCCESSIVE STEPS OF

PROCEDURE,

WITH
A GENERAL TREATISE ON AUDITING



BY
GEORGE B. RENN

ACCOUNTANT AND AUDITOR



SECOND EDITION, REVISED AND ENLARGED



PRICE THREE DOLLARS



PUBLISHED BY

GEORGE B. RENN

1341 Dakin Street
CHICAGO, ILLINOIS

81831



Entered according to act of Congress, in the year 1905,

By GEORGE; B. RENN,

in the office of the Librarian of Congress, at Washington.

Entered according to act of Congress, in the year 1907,

By GEORGE B. RENN,

in the office of the Librarian of Congress, at Washington.
All rights reserved.



PRINTED AND BOUND BY
GEORGE SETON THOMPSON, CHICAGO, ILLINOIS



HF



\s

NL



PREFACE TO THE SECOND EDITION

^

\ The general commendation which the first edition of this

manual elicited from the accountancy profession, the press, and
discriminating students, proved that there is a demand for a
work which goes direct to the point on the subject of auditing.
This has encouraged the author to prepare a more extensive
treatise based upon the same plan.

In this edition, as in the first, one of the principal claims to
excellence lies in its distinctively practical treatment of the sub-
ject. This book aims to tell the student what to do and how to
do it, and it is written with the intention that its contents shall
be understood by the reader.

The Detailed Description of a Commercial Audit, presented in
the logical order of the procedure to be followed, which stamped
the first edition as unique in the literature on auditing, is re-
printed in its entirety in Part II of the present manual. That
<i

U> part has also been elaborated in order to clear up such points as

appeared from the inquiries of readers to be in the least doubtful ;
and an important feature has been added in the shape of an AUDI-
TOR'S REPORT in complete detail, made out according to standard
form.

}The whole work has been amplified by the addition of a
thorough exposition of the principles of auditing; with an elab-
orate treatise on EXAMINATIONS, INVESTIGATIONS, and PARTNER-
SHIP AUDITING; also the special considerations which govern
auditing in different lines of business; so that it is believed that
this new edition covers the subject adequately from every point of
view.

1341 DAKIN STREET, CHICAGO, JULY, 1907.



PREFACE TO THE FIRST EDITION

All the literature on auditing published heretofore presup-
poses familiarity with the rules of practice on the part of the
student; hence the information thus far obtainable upon this
subject is of too indefinite a character to be understood easily
by that large class of accountants who are otherwise excellently
equipped for auditing, but who are lacking in experience.

The purpose of this manual is, therefore, to set forth minute-
ly the details to be pursued in making a commercial audit, and to
indicate in proper order the procedure to be followed.

With this brief explanation the book is respectfully submitted
to ambitious accountants.



CONTENTS



INTRODUCTION Page 11

Definition of Auditing The benefit to the client from an in-
dependent audit To whom the work should be entrusted.

PART I

GENERAL CONSIDERATION OF PRINCIPLES AND
METHODS Page 13

Qualifications of an auditor The elemental aim in auditing
Rudimentary requirements of accountancy Special method for
checking the cash book The different kinds of errors in account-
ancy; characteristic examples of each kind; how brought to the
auditor's notice Some of the schemes employed for falsifying,
and methods for their detection Classification of various lines
of business according to their auditing features Different kinds
of audits The auditor's relation to his client His responsibil-
ity His attitude toward the office staff.

VOUCHERS. What constitutes a voucher; convenience of uni-
form vouchers ; what may be accepted as substitutes.

ANALYSIS OF ACCOUNTS. Purpose of analysis Proper ruling
of analysis paper Posting to analysis sheet Convenient time
for posting.

7



8 RENN'S PRACTICAL AUDITING

CONTROLLING ACCOUNT. Its purpose Method of conducting
the controlling account How it is used to prove the individual
accuracy of the personal accounts Illustrations of controlling ac-
counts.

AUDITOR'S WORKING SHEET. Its uses Illustration of a work-
ing sheet.

TURNOVER. Defined and illustrated.



PART II

PRACTICAL AUDITING Page 29

Description in complete detail of the method of conducting a
commercial audit, arranged to indicate in proper order the suc-
cessive steps of procedure, and concluding with an auditor's
report made out in standard form.

This division of the manual deals with the actual work of
auditing ; it tells at the beginning what to do first and how to do
it ; then the next step in order is similarly taken up and explained,
and in this manner the student is guided step by step through an
entire audit. Important principles involved in different features
of the audit are called to the student's attention at the points
where they apply. In conclusion, an extensive report is reprinted
exactly as it was rendered in practice.

PART III

SPECIAL AUDITS Page 101

FIRST AUDIT OF BOOKS OF CORPORATIONS. Precise directions
for auditing the corporation books as distinguished from the
trade books of account.



CONTENTS 9

PERIODICAL AUDIT. Definition Analogous to the audit
described in Part II.

CONTINUOUS AUDIT. Wherein it differs from the periodical
audit.

INVESTIGATION ON ACCOUNT OF SUSPECTED FRAUD. An elab-
orate article on this subject, treating the question from various
standpoints according to the department under suspicion.
Exactly what steps to take in case of a suspected cashier, conceal-
ment of sales, shipment of goods without entry, outright theft
of merchandise, fraud in the purchasing department, or merely a
suspicion that "something is wrong."

EXAMINATION ON BEHALF OF AN INTENDING PURCHASER.
The subject is treated in a very comprehensive manner. Some
features of this section are : Purpose of the examination Inspec-
tion of the statistical accounts Period to be covered Speculative
considerations The examination in detail Accounts receivable
and bills receivable Stock of merchandise Real estate, build-
ings and personal property Good will Patents Copyrights A
condensed outline of an examination Special directions in regard
to construction of the Trading account and the Profit & Loss
account How to ascertain the amount of working capital em-
ployed Estimating the inventory Liabilities not necessarily any
concern of the purchaser Their significance in relation to the
prosperity of the business.

EXAMINATION ON BEHALF OF A CREDITOR, ACTUAL OR PROS-
PECTIVE. This section covers the subject thoroughly, in reference
to either secured or unsecured loans. The points towards which
the examination should be directed are clearly indicated, and
detailed instructions follow.

FINAL AUDIT FOR ADJUSTMENT OF PARTNERSHIP IN CASE OF
DECEASED OR RETIRING PARTNER. Complete directions are given



10 RENN'S PRACTICAL AUDITING

for conducting this kind of an audit with due regard to the rights
of each partner.

DIFFERING FEATURES IN AUDITS OF VARIOUS LINES OF BUSI-
NESS. This section directs attention to features of special impor-
tance in auditing particular lines of business. Under this head
are treated Trading, Manufacturing, Mining and Banking con-
cerns.

INDEX Page 128



INTRODUCTION

By the term "Auditing" is meant the intelligent inspection of
books of account and subsidiary records and papers, for the pur-
pose of determining whether they are correct and complete.

The advantages of an independent audit may be summarized
as affording a client the means for detecting any dishonesty there
may be on the part of his employes, and, on the other hand, if
none is found, he will learn from a disinterested source that his
books are being kept correctly. Where inspection proves that
improvements in the methods of accounting would be desirable,
he will also be given expert suggestion along those lines.

In addition to the tangible benefits outlined above, it may be
mentioned that knowledge of an intention to have the books
audited at some time tends to discourage fraudulent practices an
effect which is not to be overlooked. Aside from any question of
dishonesty, the anticipation of an audit inspires also a desire that
the books shall be found technically correct, which prompts a
degree of care in their preparation that would often be lacking
were no inspection looked for.

In order to derive the best results from an audit, it should be
entrusted to a professional auditor, for he will be independent of
local influences and may therefore be relied on to treat matters
in a disinterested manner.



n



PART I

GENERAL CONSIDERATION OF PRINCIPLES AND

METHODS

The auditor should possess a thorough working knowledge of
accountancy, in order to qualify him for interpreting correctly the
work of others and for making intelligent criticism when neces-
sary.

The elemental aim in auditing is to safeguard the income and
to keep watch on the expenditures of the business. To that end
the auditor must ascertain whether the following rudimentary
requirements of accountancy have been complied with:

First. That charges have been made to the proper parties
upon the regular books of account for everything of value which
has passed to them.

Second. That all money received has been entered in the
cash book, and that it was entered at the time when it was
received.

Third. That no credit has been given to any one not entitled
to it.

Fourth. That no money has been paid out without proper
authority, and that no fabricated payments have been entered in
the cash book.

Fifth. That the proper amount of money called for by the
cash book balance is actually on hand either in bank, or in the

cash drawer.
is



14 RENN'S PRACTICAL AUDITING

Sixth. That the open Accounts Receivable (debtors' ac-
counts) and Bills Receivable, represent correctly the difference
between the charges for sales, etc., on the one hand, less the
credits through the cash book and other authorized mediums, on
the other hand.

Seventh. That all other assets acquired through the business
are correctly recorded, and that they exist in fact. This includes
inventories.

Eighth. That Accounts Payable (creditors' accounts) and
Bills Payable are correctly and fully stated, and that they were
incurred in the interest of the business. In the case of bills
payable discounted, it must be ascertained whether the proceeds
were entered in the cash book.

It will be observed that the trend of the foregoing is con-
stantly to force the entry of cash receipts into the cash book, and
to provide for the proper recording of values parted with.

Usually there is not much attempt to defraud by direct theft
of merchandise, although the conscientious auditor will satisfy
himself that proper safeguards are in force to prevent it. The
principal efforts of an embezzler, however, are directed toward
the abstraction of cash, and for that reason a special method for
checking the cash book is suggested in this manual, viz. : that the
cash book shall be checked inversely from the ledgers. This
process will determine positively that the items entered in the
ledgers as "cash" are so in fact if they are found in the cash
book, because they will then have to be accounted for. Other-
wise, if the auditor should remain content with checking the
cash book into the ledgers, it might happen that all items tested
in this way would check correctly, while still others would remain
unchecked in the ledgers, falsely stated as "cash," but originating
elsewhere, probably in the journal. This leads to a detailed con-
sideration of the subject of correctness of the books, as indicated
by their freedom from errors.



PRINCIPLES AND METHODS 15

ERRORS IN ACCOUNTANCY

There are three kinds of errors which may find their way into
books of account, and it is the duty of the auditor to detect them
when present, or to prove their absence. They are:

ERRORS OF PRINCIPLE.
TECHNICAL ERRORS.
FRAUD.

Errors of Principle.

This kind of errors divides into two minor classes those of
omission and those of commission. One of the most serious is
the omission to provide proper reserves for depreciation of assets
subject to wear and tear, or for shrinkage in values. Sometimes
this results in the payment of dividends out of capital, a pro-
ceeding which has been construed by courts as criminal; and in
one instance, at least, it has called forth an order from the court
compelling the directors who voted the dividend to make resti-
tution to the treasury of the corporation.

As an example of errors of principle through commission, we
may cite the incorrect distribution of purchase invoices or of
expense outlays, resulting in the loading of capital accounts with
charges which should be placed to expense, or vice versa.

The question of provision for reserves will come to the audi-
tor's notice through inspection of the balance sheet, and the point
in respect to proper distribution is disposed of through analysis
of the capital accounts and the various expense accounts.

Technical Errors.

These are the innocent mistakes committed in the mechanical
details of bookkeeping such as posting to wrong accounts, unin-
tentional errors in footings or in carrying them forward, in trans-
ferring accounts, etc. The auditor will detect such errors through



16 RENN'S PRACTICAL AUDITING

the detail work of checking postings, verifying footings, and
general inspection of the books.

Fraud.

Under this head come the numerous schemes employed to
falsify the books of account for the purpose of stealing cash or
merchandise.

It would be impossible to describe all the expedients which
may be used to accomplish theft, but among them are the with-
holding outright of cash received from cash sales or through
remittances from customers; the "kiting" of such remittances;
the falsification of cash book footings ; the introduction of fictitious
bills receivable; the manipulation of purchase invoices; the
clandestine disposal of merchandise, and so forth indefinitely.

The withholding of cash from customers' remittances is usually
concealed on the books by crediting the customers fictitiously with
an equal amount through the journal, or the "merchandise
returned" book, thus balancing the account and withdrawing it
from observation.

"Kiting" begins with pocketing remittances when they are
received and withholding credit for them until a later date; then
other remittances will be held out and credit will be entered for
those first withheld. Industrious embezzlers have been known to
carry this process to great lengths, until an auditor appeared and
exposed the trick by means of verification statements sent out
privately to the book debtors.

As regards the other methods for defrauding referred to in
this article, an exact observance of the rules for auditing set forth
in this manual will circumvent them also.

CLASSIFICATION OF DIFFERENT LINES OF
BUSINESS

Although the general principles of auditing are the same for
all lines of business, the methods to be followed in different audits



PRINCIPLES AND METHODS 17

vary somewhat according to the classification of the enterprise.
From their auditing features the various kinds of business may
be classified as follows:

TRADING.

MANUFACTURING.

MINING.

BANKING.

The auditor should always have a fair knowledge of the work-
ing details of the business which he undertakes to audit. Where
he is lacking in this respect he may acquire such knowledge by
studying a text-book on accounting in that particular line.

DIFFERENT KINDS OF AUDITS

Audits differ according to the immediate objects for which
they are undertaken; the following are regarded as the principal
kinds :

The Periodical Audit, to determine the general accuracy of
the books.

Investigation, on account of suspected fraud.

Examination, on behalf of an intending purchaser, to deter-
mine the earning capacity of a business ; or for a creditor, actual
or prospective, to establish the correctness of the balance sheet.

The Final Audit, for the purpose of partnership adjustment
in the case of a retiring or deceased partner.

There are other conditions that call for audits, but those above
mentioned are the more usual cases.

A complete description of all the various kinds of audits,
together with their possible ramifications, would prove entirely
too complex and confusing to the student. For that reason, and
because the greater number of audits are made merely for the
purpose of ascertaining the general correctness of books of ac-
count, it is believed by the author that a detailed description of



18 RENN'S PRACTICAL AUDITING

THE PERIODICAL, AUDIT will serve best to familiarize the
student with the principles and methods of auditing. In accord-
ance with this idea the detailed instructions in this manual are
limited in the first instance to a specimen audit of that kind.
However, to make the manual complete, there have been added
supplementary instructions in regard to other kinds of audits,
which, considered in connection with the detailed directions pre-
ceding them, will qualify the student to carry out any one of the
audits mentioned.

In concluding this chapter a few words in regard to the
auditor himself will be in order.

THE AUDITOR'S RELATION TO HIS CLIENT

The auditor's relation to his client is of an extremely confi-
dential nature, and all information obtained by him through that
relation must be held inviolate. Nothing can be more out of place
than a garrulous auditor.

Sometimes there is a disposition on the part of young auditors
to make impetuous criticisms and suggestions. They should
defer all comments until the audit is completed, for something
may develop meanwhile to modify their hastily formed opinions.

THE AUDITOR'S RESPONSIBILITY

There is no record of any legal decision in this country fixing
liability upon auditors for certifying to inaccurate or untruthful
statements. Where deliberate mendacity could be proven there
would probably be ground for action, but manifestly it would be a
hard matter to establish the "intent" in such a case.

Virtually this makes the public dependent upon the personal
integrity of the auditor for the truthfulness of statements con-
tained in his report, which imposes a moral responsibility that
he should not attempt to evade in any particular. His reports
should be complete, definite and absolutely correct. Only a high



PRINCIPLES AND METHODS 19

professional standard will bring him business of the desirable
kind, as no auditor can hope to be permanently successful unless
he commands a reputation for perfect reliability in his profes-
sional capacity.

THE AUDITOR'S ATTITUDE TOWARD THE OFFICE

STAFF

The auditor should conduct himself courteously toward the
office force, so far and so long as they enable him to do so con-
sistently. While it is true that his position is sometimes made
unpleasant through the boorish attitude of some of the staff, it
does not help matters to be openly resentful; and, in passing, it
may be remarked that sometimes auditors are the authors of their
own misfortunes in this respect, through an assumption of superi-
ority which engenders antagonism.

A great deal may be accomplished in this direction by the
auditor himself setting an example of gentlemanly deportment.
This does not mean, however, that he should yield one iota of
his freedom to investigate to any extent any "lead" which he may
desire to follow; on the contrary, he must regard himself as an
independent agent, and proceed without fear or favor.



20 RENN'S PRACTICAL AUDITING

VOUCHERS

A great many business concerns use their own form of voucher
for disbursing cash, the same being approved and certified as cor-
rect by certain officials or authorized employes. While this is
convenient and desirable, it should be understood that an invoice
itself, if properly made out to your client and duly approved,
is equally competent as a voucher. Therefore, wherever this
manual calls for vouchers either in support of cash payments
or for journal entries, any memorandum which will establish
the validity of the transaction should be accepted as satisfactory.
Your report, however, should suggest the introduction of regula-
tion vouchers, if considered desirable.

ANALYSIS OF ACCOUNTS

For the purpose of analyzing the various expense accounts
and capital accounts, use paper ruled in a series of parallel debit
and credit columns. At the top of the sheet write the caption of
the account under analysis, and sub-head the classification col-
umns; then from the books of original entry post the items into
the proper columns of this analysis sheet; when completed, the
net balance of all the columns combined should equal the amount
of the account as shown in the ledger. This analysis may be
made at the time of checking the invoices against the particular
items in the books, or it may be made a detail by itself ; the former
is the preferred method when you have an assistant. Some audi-
tors advocate the above method of checking all the general ledger
accounts, but that is not necessary, inasmuch as the items in the
general ledger accounts, including expense and capital accounts,
should all be checked against the books of original entry, and this
would consequently be mere duplication of work. This analysis,
it should be understood, is chiefly for purposes of comparison;
the audit proper is accomplished on these accounts, as well as
on the others, by first verifying the correctness of the items in the
books of original entry and then checking them into the ledger.



PRINCIPLES AND METHODS 21

THE CONTROLLING ACCOUNT

The Controlling Account is used in auditing to prove up the
personal accounts by totals instead of checking them by indi-
vidual items. (Where it is practicable, there should be a separ-
ate controlling account for the personal accounts receivable,
and another for the personal accounts payable; but where the
books are not so arranged as to make this expedient, it will be
satisfactory to make one account answer for both.) Begin with
the total sum in the personal accounts as shown by the trial balance
of the initial date, then post to the respective sides of the account
the monthly footings, during the period under audit, of such books
and columns as are posted exclusively to personal accounts.
Should there be any book in use, however, that is not columnized
in such a manner as to keep the personal account items separate
from those relating to general ledger accounts, the personal
account items from that particular book must be posted indi-
vidually to the controlling account. After all postings have been
made in this manner, the net balance of the controlling account
should be in exact agreement with the total of this class of
accounts as shown by the trial balance of the terminating date.
If found so, it establishes the aggregate accuracy of the personal
accounts.

Now, to prove their individual accuracy, take off statements
of every open account embraced within this general sum-
mary, and mail them yourself to the various debtors, with the
request that they check them over and return them to you, either
endorsed "Correct," or with notation of any differences. To make
these statements effective they should be an exact transcript of
the face of the ledger, particularly so far as relates to credits to
customers; and the various classes of credits should be desig-
nated exactly as they are entered upon the ledger, i. e., cash
should be designated "Cash" and other credits by the name cred-
ited upon the ledger. This form of making up the statements will



22 RENN'S PRACTICAL AUDITING

not only serve to prove the correctness of the amount of the ac-
count, but will establish quite effectively the truth of the compo-
nent parts. In fact, this is the proper method for determining


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Online LibraryGeorge Benton RennRenn's practical auditing; a working manual for auditors, describing in complete detail the method of conducting a commercial audit, and indicating in proper order the successive steps of procedure, with a general treatise on auditing → online text (page 1 of 8)