In order to illustrate clearly this valuing of Work in Progress, a "Contracts" Profit and Loss Account of a builder and contractor is given (Form 3). The first column shows the prime cost of the Work in Progress at the commencement of the year. From the third column it will be seen that the "charges" (i.e. the general expenses) of the business amount to £1023. This is not the amount expended during the year, but includes the proportion of last year's charges applicable to the Work in Progress at the end of last year (viz. £3763-the total of the first column). The whole of this £1023 is apportioned over the jobs completed this year and those in progress at the close of the year. That is to say the turnover, or cost of work for the year, is not the basis on which the calculation is made, but it is on this turnover plus the work in hand at the commencement of the year (ie. on the items in both the first and second columns). Now, if the form is examined it will be seen that the unfinished work at the close of the year was in respect of contracts 46, 47, 49, 50, and 51 (vide seventh column). Excepting for these five jobs the amount of charges applicable to each contract is set out in the third column. Further, there has been a certain amount of jobbing work done, and this is debited with its ratio of charges (i.e. £45). The balance is the proportion of the charges applicable to the five unfinished contracts, and is set out last in the third column. It will be observed that the figure £79 bears the same ratio to the Work in Progress at 31st March, £1595, as do all or any of the detail amounts. debited to the finished contracts. At the same time the prime cost is kept distinct from the on-cost, and may be shown separately in the Balance Sheet if thought necessary, thus: Work in Progress (COST OF WORK TO DATE) Prime Cost £1595 £1674 Next year's debit to Charges Account will be in excess of the amount actually spent in the coming year by £79, as that sum is carried down from the year just ended. The remaining figures and columns in the form are not relevant to the subject at present under discussion. Stock taken at Selling Price as between Departments.-The correct mode of dealing with Work in Progress becomes more complicated when there are several and distinct processes involved in completing one article, and when each of these processes is performed in a separate and distinct department. The contention has been made that since the result of the manufacturing in each department must be shown, and since the sale of the completed article is credited to trading account in the period in which the sale is made, therefore each department ought to be credited with the market value of the work done in that department during the period, irrespective of whether the whole article has been finished and sold or whether it is in process of further manufacture in another department. In other words, this contention is that the department turning out that one section of the whole article is to be credited, and the next department receiving the material for the second process should be debited at market price as soon as the first process is completed. Now what is the effect of this? It is in direct opposition to the rule that stock (for the goods referred to are simply Work in Progress) must be valued at cost or market price, whichever is lower. Instead of this, however, the effect is to value the goods as turned out complete from the first (or subsequent) process at the current market price of such class of goods. That is to say, a paper profit is shown by means of the stock. The idea of showing the actual working of each department is correct, but in order to do that the effect under this system is to inflate the Work in Progress of the business as a whole. Provided a reserve is made for this inflation in the stock values, no objection can be found, but otherwise this departmental transferring at selling prices is to be deprecated. Even if the selling price of the completed article is not liable to violent fluctuation, and there is no difficulty in finding a market, this is no justification for the inflation of the stock above cost or market price-market price in this case being understood to be the present value of material plus present wages, etc. Stock brought into Accounts.-Having decided on the value of the stock, the next point is the manner in which to bring it into the accounts. Stock may be divided for this purpose into two classes. First the stock of goods in which the concern is trading; and next, stock on hand relating to expense accounts. The latter class of stock is not held for sale, but will be used in the course of manufacturing, etc., the articles which are for sale, and is dealt with in an entirely different manner to the ordinary stock of goods. The ordinary stock appears in the trading or manufacturing account, and may be shown in one of three ways— (a) The stock at the commencement of the period on the debit side, and the stock at the close on the credit side of the account. (b) The difference between the stocks at the commencement and end of the period as a debit or credit as the case may be. Should the stock at the beginning of the period be larger than that at the close, the difference will appear as a debit, and vice versa. (c) The difference between the stocks is added to the item "Purchases," appearing on the debit side if the opening stock is greater than the closing; in the contrary event the difference is deducted from the "Purchases." The Expense Accounts Stocks are deducted from the various items of expense, as illustrated by Form 4. The figures in this form are supposed to represent the working of a small concern where all expense items are posted to one account and analysed at the year's end in an Analysis Book. These figures, then, are the summary figures from such book, though the working of the principle of Expense Accounts Stocks would have been the same had separate accounts been opened for each heading. The first and fourth columns show the stocks at the commencement and end of the period; the second column gives the amount debited during the half-year; and the third the total debit. After deducting the stock on hand at the end of the half-year the net expense chargeable to the period is given in the fifth column. Of the expenses enumerated in Form 4, the first item (Manufacturing Wages) appears in the Manufacturing Account, the others in the Profit and Loss Account. Thus we see that the ordinary stock of a business is a Manufacturing or Trading Account item, while "expenses " stocks are generally adjusted in the Profit and Loss Account. It may happen, however, that some expense stocks are properly dealt with in the Manufacturing Account-coal stock in an engineering works, for instance. Auditor's Responsibilities. Having considered the subject of stocktaking generally, we will now proceed to deal with it from the accountant's point of view. Accountants rarely "take" stock as auditors. It is no part of an auditor's duty to take stock (Lindley, L. J., in the Kingston Cotton Mill case), and it is only when he is specially instructed, at an additional fee, that such work will be performed by the auditor. It will frequently happen, however, that accountants are called upon to take stock in other positions they may hold, such as liquidators, trustees, or receivers, or as directors or secretaries to public companies. In these cases the businesses will generally be carried on, at any rate for a time, and the accountant occupying one of these positions would be responsible for the valuation of the stock-in-trade, and the remarks in the preceding pages would directly apply to him. As auditor to a company, on the other hand, it cannot be too clearly emphasised that it is no part of his duty to take stock. A few accountants make a speciality of a particular trade, and undertake the work of stocktaking in that trade, but this is no part of the auditor's ordinary work. It would be impossible for an accountant to acquire the necessary knowledge to enable him to take stock in all the various classes of businesses he is called upon to audit. There are generally peculiarities and technicalities in each, and, moreover, it is more the work of a valuer to take stock than an accountant, who is only supposed to be an expert in accounts and matters appertaining thereto. The chief case dealing with the liability of an auditor for the value placed upon stock-in-trade is that of the Kingston Cotton Mills. In the lower court Vaughan Williams, J., had found the auditors liable, but this judgment was reversed on appeal. The facts of the case and the arguments will be seen best from the following extracts from Lindley, L. J.'s judgment: I pass now to consider the complaint made against the auditors in this particular case. The complaint is that they failed to detect certain frauds. There is no charge of dishonesty on the part of the auditors. They did not certify or pass anything which they did not honestly believe to be true. It is said, however, that they were culpably careless. The circumstances are as follows: For several years frauds were committed by the manager, who, in order to bolster up the company and make it appear flourishing when it was the reverse, deliberately exaggerated both the quantities and values of the cotton and yarn in the company's mills. He did this at the end of the years 1890, 1891, 1892, and 1893. There was no book or account (except the Stock Journal, to which I will refer presently) showing the quantity or value of the cotton or yarn in the mill at any one time. It would not be easy to keep such a book. Nor is it wanted for ordinary purposes. There is considerable waste (twenty or twentyfive per cent on the average) in the manufacture of yarn from cotton, and the market prices of both cotton and yarn are subject to great fluctuations. The Balance Sheets of each year contained on the asset side entries of the value of the stock-in-trade at the end of the year, and those entries were stated to be as per manager's certificate.' . . . The auditors took the entry of the stock-in-trade at the beginning of the year from the last preceding Balance Sheet, and they took the values of the stock-in-trade at the end of the year from the Stock Journal. This book contained a series of accounts under various heads purporting to show the quantities and values of the company's stock-in-trade at the end of each year, and a summary of all the accounts showing the total value of such stock-in-trade. The summary was signed by the manager, and the value as shown by it was adopted by the auditors and was inserted as an asset in the Balance Sheet, but as per manager's certificate.' The summary always corresponded with the accounts summarised, and the auditors ascertained that this was the case. But they did not examine further into the accuracy of the accounts summarised. The auditors did not profess to guarantee the correctness of this item. They assumed no responsibility for it. They took the item from the manager, and the entry in the Balance Sheet showed that they did so. I confess I cannot see that their omission to check his returns was a breach of their duty to the company. It is no part of an auditor's duty to take stock. No one contends that it is. He must rely on other people for details of the stock-in-trade in hand. In the case of a cotton-mill he must rely on some skilled person for the materials necessary to enable him to enter the stock-in-trade at its proper value in the Balance Sheet. In this case the auditors relied on the manager. He was a man of high character and of unquestioned competence. He was trusted by every one who knew him. The learned judge has held that the directors are not to be blamed for trusting him. The auditors had no suspicion that he was not to be trusted to give accurate information as to the stock-in-trade in hand, and they trusted him accordingly in that matter. But it is said they ought not to have done so, and for this reason. The Stock Journal showed the quantities that is, the weight in pounds-of the cotton and yarn at the end of each year. Other books showed the quantities of cotton bought during the year and the quantities of yarn sold during the year. If these books had been compared by the auditors they would have found that the quantity of cotton and yarn in hand at the end of the year ought to be much less than the quantity shown in the Stock Journal, and so much less that the value of the cotton and yarn entered in the Stock Journal could not be right, or, at all events, was so abnormally large as to excite suspicion and demand further inquiry. This is the view taken by the learned judge. But, although it is no doubt true that such a process might have been gone through, and that, if gone through, the fraud would have been discovered, can it be truly said that the auditors were wanting in reasonable care in not thinking it necessary to test the managing director's returns? I cannot bring myself to think they were, nor do I think that any jury of business men would take a different view. It is not sufficient to say that the frauds must have been detected if the entries in the books had been put together in a way which never occurred to any one before suspicion was aroused. The question is whether, no suspicion of anything wrong being entertained, there was a want of reasonable care on the part of the auditors in relying on the returns made by a competent and trusted expert relating to matters on which information from such a person was essential. I cannot think there was. The manager had no apparent conflict between his interest and his duty. His position was not similar to that of a cashier who has to account for the cash which he receives, and whose own account of his receipts and payments could not reasonably be taken by an auditor without further inquiry. The auditor's duty is not so onerous as the learned judge has held it to be. The order appealed from must be discharged with costs." Lopes, L. J., in the course of his judgment in the same case, made the following observations upon the duties of auditors: "It is the duty of an VOL. VI 12 |