As a rule, the auditor Will not be present when the inventory is taken, and the character of the mer chandise stocks may have changed to a considerable extent between the time when the inventories were taken and the date of the auditor's investigation. Thus, an auditor is often obliged to accept the valu ation placed upon inventories submitted to him by the managers. Not only has he to accept the certifica tion of the management as to quantities, but often as to prices.
However, even tho the auditor accepts the valu ation and the quantities reported by the management and so states in his certificate, he is not relieved from the responsibility of assuring himself that the persons' who took the stock were competent to do so and that they fully appreciated the importance of their re sponsibility. He will, as a rule, make some investiga tion into the accuracy of the method and system em ployed in ascertaining the value, and the correctness of the pricing and of the mathematical work so as to satisfy himself that the results are worthy of accept ance.
5. Procedure where inventories may not be relied the inventories have been taken by per sons incompetent to do so; by those on whose judg ment the auditor does not rely ; or where, by reason of other circumstances, the auditor may not feel justi fied in accepting the statements handed to him, he will state in his certificate that the inventory has been entered at the values assigned to it, subject to what ever qualification he deems it necessary to append. The use of the phrase "subject to" implies that the auditor himself is not willing to assume the respon sibility for the quantities or the valuation and one who reads the report must be governed accordingly. In some instances the auditor will certify as to the ac curacy of the extensions and footings and thus assume responsibility solely for this part of the inventory.
6. An auditor is not entirely absolved by qualifica tions from responsibility.—Even here the auditor is not absolved from all responsibility for, if anything arises during the course of his investigation which would lead him to believe that the officers were at tempting to commit fraud in respect of the inventory or any other asset, it is clearly his duty to decline to give even a qualified certificate. Inasmuch as an auditor cannot control the use of his report after it leaves his hands, it is questionable whether or not he has relieved himself of his moral responsibility even tho he may have absolved himself from all legal re sponsibility by adroitly wording his qualifying cer tificate. An auditor should certainly refuse his cer
tificate in cases where fraud has been attempted by the management for the reason that while the firm may agree to re-state values in those cases in which the auditor has discovered inflation, he will not always be able to ferret out all ingeniously laid schemes of fraud and he may thus pass over other frauds.
7. Examples of attempted fraud.—Not long ago, in the city of New York, the management of an American branch of a European concern was sued by a salesman for breach of contract. The verdict of the court was in favor of the salesman and judgment was given to the amount of $13,000. The local man agement paid the amount of the damages but charged the amount thereof to a personal account in the name of the salesman. In the trial balance submitted each month to /the European headquarters, the amount paid out was reported as an account receivable. A firm of auditors, upon being called to investigate, was requested to certify to the balance sheet and when this item was discovered very properly declined to give a certificate. It subsequently developed that the management of the branch had also grossly over valued the inventory, thereby concealing operating losses in the year under investigation amounting to $178,000.
In one of the recent consolidations underwritten by a firm of Eastern bankers, a firm of auditors was in trusted with the duty of preparing balance sheets of the various concerns to be amalgamated for the pur pose of determining the basis upon which each con cern was to be taken into the consolidation. While auditing the accounts of one of the concerns, the firm of auditors was obliged to transfer the principal in charge of the engagement to another station and his successor accepted the valuation of the inventory without sufficient investigation. When the consolida tion finally took place, inventory values to the ex tent of $1,000,000 could not be located and the bankers underwriting the consolidation were com pelled to put into the business an equivalent amount of cash to protect their own reputation as well as to protect clients who purchased securities upon their solicitation.