Why the increasing loss?;

              70 HASKINS & SELLS September
Why the Increasing Loss?
MODERN accounting literature has
much to say in advocation of more
lucid audit reports, and in disparagement
of auditors whose comments are little more
than a statement that, "we have counted
and verified." The value of such writings
may be appraised in the light of findings
in a recent engagement.
The engagement was the regular annual
audit for the year ended December 31,
1923, of a large wholesale dealer in woolens
and allied products. The comparative
statements prepared disclosed continually
increasing net losses year after year. For
the period under consideration the loss was
a formidable amount, and was more than
double the loss for the preceding period.
Reasons for such a condition would be of
utmost value to the client and should
therefore be sought out.
In the first place, unfortunate non-operating
transactions might have caused
the trouble. Both income credits and
charges, however, were normal in amount,
with non-operating income on the increase
and charges on the decline. The number
of unprofitable foreign exchange operations
had diminished. A reduction in reserves
for inventory fluctuations had resulted in
a credit to other income.
The source of the client's difficulties lay
therefore in his regular business operations.
The 1923 operating loss was $48,000, or
1 3½ per cent. of the year's net sales. The
1922 figure had been only $1,400, or 3/10
of 1 per cent. of net sales for that year.
Operating expenses were then scruti­nized.
They were found to contain a large
number of relatively fixed items, such as
rent and salaries, which were too heavy for
the volume of business to bear. These
items had remained practically stationery
during 1923, in the face of a large decline in
volume of business. They served, there­fore,
to augment considerably the operat­ing
deficit for the year.
Only a part of the increased loss, how­ever,
could be accounted for in this way.
The cost of sales, although having de­creased
in 1923, had not fallen off as
rapidly as the sales, and therefore repre­sented
a greater percentage of sales than
was the case in the preceding year. This
fact received rather careful attention.
The woolen department was chosen for
study, as being the most important as well
as the most representative of the business
as a whole. This department had started
out at January 1, with inventories of
$138,000; had made purchases during the
year of $98,000; and had wound up at
December 31 with inventories of $107,000.
The cost of sales was therefore $129,000.
On the basis of the 1922 ratio of cost of
sales to sales, this figure would have been
only $117,000, freight, drayage, and other
miscellaneous components of cost of sales
having been left out of consideration.
Considering the size of the inventories
involved, and the large difference between
the opening and closing inventories, inves­tigation
began there. Any one of several
irregularities might have caused adverse
results.
A mechanical mistake might have been
made in the computation of the inventory
figures, such as in extensions, footings, etc.
However, the calculations, which were
made by an inventory computing company,
were tested and found correct. The use of
erroneous prices in taking the inventory,
either at the beginning or at the end of the
year, or both, or a change in the basis used,
from a higher to a lower, might cause cost
of sales for 1923 to show a relative increase
over 1922. However, the accountants
tested the prices and found no mistakes.
And the inventories at both dates were
taken on the same basis—cost or current
market price, whichever was lower.
The January 1 inventory figures might
have been padded, through the inclusion
of worthless goods at inflated prices or
otherwise. In view of the size of the in­ventories
this point received particular
attention, but nothing came of it.