8. Value of auditor's services to promoters.— Again, the auditor can be of service to the promoter in gathering facts which the latter may submit in his prospectus, and which shall not be made a part of the auditor's report. The investor himself will thus be left to determine whether or not the anticipated re sults are likely to be achieved. Take, for example, the case of a factory that has not been able to operate at full capacity owing to a lack of working capital. It may be true that with additional working capital the output can be greatly increased, and if the addi tional products manufactured can-be sold as profitably as the output in the past, the return will undoubtedly justify the investment of additional funds. But it may also happen that the additional cost of marketing the increased output will cut into the profits to such an extent as to reduce the average return on the turn over. It may be also that difficulties will be encoun tered in securing the additional raw material, or that a sufficient supply of labor cannot be secured at the preseirt average price.
9. Value of auditor's services in the case of fire losses.—In cases of loss by fire, poorly kept financial records practically place a merchant at the mercy of the adjuster for the insurance company, while on the other hand, a certified balance sheet of the business at the end of the last fiscal period, supported by a proper system of internal records, aids the insured in secur ing a proper indemnity. The writer's attention was recently called to a case in which the adjuster's figures in a loss involving $50,000 were $3,000 too low, due to an improper basis of calculation on the part of the adjusters. In preparing a proof of loss, the services of a reliable auditor may prevent the business man from making an understatement of the loss he has sustained. Furthermore, if he 'has a fully 'authenti cated balance sheet at the close of the previous fiscal period, certifying to the valuation of the inventory and property at that time, he is in an excellent position to insist upon receiving the full amount of his claim.
10. Importance of audits of the accounts of em ployes under financial bond.—When application is made to a bonding company for a fidelity bond, the company usually asks whether or not the accounts of the employe are periodically audited. If an affirma tive answer is given, the bonding company may as sume that this practice would be continued and would therefore enter into the contract. Neglect on the part of the insured to continue the periodical audit of the accounts of the trusted employe might be used by the insurance company as a defense against the payment of the policy in the event of a claim for indemnity.
Where the accounts of employes are periodically audited, there is usually no difficulty in securing a fidelity bond from any reliable bonding company.
11. Proprietor requires an impartial review of busi ness conditions.—Many business men are unfamiliar with accounts altho they may have a capacity both for organization and for money-making. There are other instances of men who are in such close touch with all the activities of their businesses that they are able to determine almost to the dollar, the amount of profit or loss that has been sustained during the period.
It is a well-known practice of credit men to "dress up" the accounts receivable at the end of a fiscal pe riod. In some cases where a debtor has not been prompt in making remittances, the credit man will secure a note from the customer for the amount of the debt past due. There is of course a certain ad vantage in having the note instead of an open account because the note is a confession of judgment and the claim against the debtor may be more easily proved on a note than an open account.
The bookkeeping entry upon the receipt of a note would be a debit to notes receivable account and a credit to the open account of the individual customer. An entry of this kind resulted once in deceiving an experienced executive. A customer who owed the firm $40,000 on open account was persuaded by the credit man to send in notes to the amount of $35,000; these notes were debited to the notes receivable ac count and credited to the open account of the cus tomer, thus reducing the balance in his open account to $5,000. When the executive received a statement from the bookkeeper showing the open balances in customer's accounts at the end of the period, the ac count of this particular debtor was shown as $5,000. The fact that there was in the safe $35,000 of notes from the debtor was not disclosed.
A short time afterward the debtor was forced into the hands of a receiver and the executive learned to his dismay, that the firm in question owed $40,000 instead of $5,000. His experience in learning the bookkeeping effect of the receipt of a note upon the open account of a customer proved costly.
In this instance, had an audit of the accounts been made, the auditor would undoubtedly have called at tention to the fact that the real standing of the debtor must be determined by considering not only the amount which he owes on open account but also the amount of notes which he has given and which are not as yet due, including also any notes received from the debtor which have been discounted by the proprietor and which have not as yet matured. The advantage of a financial statement prepared by a disinterested outsider is self-evident.