10. Balance sheet audits or balance sheet audit contemplates a verification of the assets and liabilities and a sufficient examination of the profit-and-loss account to satisfy the auditor that each has been correctly stated. Inasmuch as this type of audit is limited in scope, the proprietor should be aware of the fact that fraudulent entries may be made which would remain undisclosed in a balance sheet audit. The greater the volume of the transactions the greater will be the opportunity for important er rors and fraudulent entries to be made and remain undetected. On the other hand, where the proprie tor's principal object is to obtain a certified state ment of his assets and liabilities which can be used as a basis for borrowing money from a bank or obtaining credit for merchandise, this type of audit is usually all that is necessary. Balance sheet audits can usually be safely employed where a highly organized system of internal checking has been adopted. They are be coming more and more common, but the business man should realize that they are attended with some degree of danger.
11. Investigations.—A great deal of the practice of the professional auditor consists of investigations for special purposes. Audits should be distinguished from investigations because the former include a more or less thoro review of all the accounting records, while an investigation is confined to securing certain specific information. Where work of this kind is to be done it is desirable to prepare a written memoran dum of the points to be covered so that the auditor will understand fully just what his client expects him to do, and the client will not be misled into thinking that a different kind of examination had been made. For example, an investigation might be made into the books of account of an undertaking to verify the statements made by the concern. This might be done solely from the concern's books without any attempt on the part of the auditor to verify from other rec ords the correctness of the entries in the books. Therefore the scope of the investigation will be de termined entirely by the nature of the information sought, and the circumstances which surround each individual case.
12. Investigations on behalf of a prospective pur chaser of a business.—Ordinary common-sense would dictate that anyone who intends to purchase a busi ness or an interest in a business should have an in vestigation made to verify the assets and liabilities as well as the income and expense of the undertaking. The author recalls the case of a prominent capitalist in the East who purchased for his son a small business which manufactured a patented specially. Accord
ing to the books, the concern with a very small equip ment, inadequate facilities and meager capital had succeeded in making a small profit, and it was be lieved that with the introduction of more capital and modern methods of management, the business could be made exceedingly profitable. The sum of $250, 000 was advanced by the capitalist, and at the end of the first year there was a loss from operation. The capitalist then employed a firm of auditors to instal a cost system which soon revealed the fact that the process was expensive and resulted in irrecoverable losses of considerable quantities of copper. The cost system proved that under the present methods of manufacture, the business could never be made to pay.
Notwithstanding the report of his auditors, the capitalist allowed himself to be persuaded by his en gineers that the cost system was wrong, and continued operations for another year, putting in additional capital, with the result that the operations at the end of the second year showed an increased loss. The business was finally wound up after the sum of $7.50,000 had been wasted. In order to satisfy him self further, the capitalist asked the auditors to'make an investigation of the affairs of the concern during its first year in business, for the purpose of learning why the profit which was earned in that year could not be realized in the later years. The investigation disclosed the fact that the concern at the outset of business had entered into an agreement with the owner of the factory property in which it was doing business whereby the property was leased for the sum of $18,000 per annum. The agreement further provided that if the property was subsequently pur chased, the amount paid in on rent would be applied on the purchase price. At the end of the first fiscal year, altho the option of purchase was not exercised, the managers of the concern had caused the amount paid for rent to be charged to a capital account called "factory improvement," thereby showing an item which was merely expense, as an asset and converting a deficit from operations into a small profit. Had the proper investigation been made by the capitalist be fore he invested the original $250,000, he would not have been deceived into believing that the business could be made profitable thru the introduction of ad ditional working capital. In the meantime the in ventor of the process, who was operating the con cern at the outset, had received a good cash price for his patent rights and had recovered the amount of money that he had originally invested in the business.