Manila * Cavite * Laguna * Cebu * Cagayan De Oro * Davao

Since 1977

AUDITING PRACTICE OCAMPO/OCAMPO

AP.01-Audit of Inventories

INTERNAL CONTROL MEASURES

1. Authority and responsibility for controlling the 6. Deliveries of materials, finished stock and merchandise
inventories should be centralized management and in should be made only upon specific authorizations
one person. emanating at authorized levels.
2. There should be careful selection of inventory 7. Slow-moving, obsolete and damaged stock should be
personnel and intensive training of such personnel in identified and reported following periodic reviews of
policies, objectives and system of inventory control. physical and book records by qualified employees.
Valuation on the basis of approved cost-mark-down
3. Adequate physical facilities for handling and storage of
methods should be reviewed.
inventory should be provided.
8. Safeguards against that action of the element and
4. Adequate system of procedures, forms and reports
inaccuracies in recording receipts and issues should be
related to the management of inventories should be
adopted. Example – Maintaining adequate insurance
developed and implemented.
coverage.
5. Quantitative controls through perpetual inventory
records; book quantities verified with physical counts
at least once a year and differences being investigated,
promptly adjusted and reported to higher authority
should be implemented.

SUBSTANTIVE AUDIT OF INVENTORIES

Inventory Balances

Existence: Recorded inventory exist 11. Verify computations in the inventory listing.
1. Before the client takes the physical inventory, review 12. Review the obsolescence of the inventory by:
and approve the client’s written plan for taking it. a. being alert while observing inventory being taken
2. Observe the client personnel physically counting for damaged, slow-moving, or scrap inventory.
inventory. b. Scanning perpetual records for slow-moving items
and discussing their valuation with client.
3. Confirm inventories on consignment and held in public
warehouses.
Presentation and disclosure: Inventory is classified and
disclosed in accordance with GAAP
Completeness: All inventory of the entity recorded
13. Determine whether accounts are classified and
4. Obtain a copy of prenumbered inventory tags used by
disclosed in the financial statements in accordance
the client in taking inventory and reconcile the tags to
with GAAP.
the listing.
5. For selected items, trace from tags to listing.
6. Perform cutoff procedures. Obtain the receiving report Purchases
number for the last shipment received prior to year-
end and determine that the item is included in Completeness: Purchases that occurred are recorded
inventory. Also, identify the last shipping document Trace a sequence of receiving reports to entries in the
and determine, based on shipping terms, whether the voucher register. Test cutoff. Account for a sequence of
item was properly recorded in sales or inventory. entries in the voucher register.
7. Perform analytical procedures.
Occurrence: Recorded purchases are for items that were
Rights and obligations: Inventory is owned by the entity acquired
8. Determine that consigned inventory has been excluded Examine underlying documents for authenticity and
from inventory and that inventory pledged has been reasonableness. Scan voucher register for large or
properly disclosed. Examine confirmations from unusual items. Trace inventory purchased to perpetual
financial institutions and read minutes of the board of records. Scan voucher register for duplicate payments.
directors’ meetings.
Classification: Purchase transactions have been recorded in
Valuation and allocation: Recorded inventory is valued in the proper accounts
accordance with GAAP
For a sample of entries in the purchases journal, verify the
9. Considering the method the client uses for inventory accuracy of account coding.
valuation, examine invoices for inventory on hand or
trace prior year’s inventory listing to verify cost. Accuracy (Valuation): Purchases are recorded at proper
10. For selected items, determine net realizable value amounts
(NRV) of the inventory and apply the lower of cost or Recompute invoices and compare invoice price to purchase
NRV. order.

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Production
Classification: Production transactions have been recorded
Completeness: All production transactions that occurred in the proper accounts
are recorded
For a sample of entries, verify the accuracy of account
Account for a sequence for production reports. coding.

Occurrence: Recorded production transactions occurred Accuracy (Valuation): Production transactions are
recorded at proper amounts
For selected transactions, examine signed materials
requisitions, approved labor tickets, and allocation of Test cost records by tracing to underlying documents, such
overhead. as bill of materials, labor tickets, authorized labor rates,
and standard overhead rates. Review variances.

- end -

PROBLEM NO. 1
b) On the evening of Dec. 31, there were two trucks in
You were engaged by Quezon Corporation for the audit the company siding:
of the company’s financial statements for the current year • Truck No. CPA 123 was unloaded on January 2 of
ended. The company is engaged in the wholesale business the following year and received on Receiving
and makes all sales at 25% over cost. Report No. 1063. The freight was paid by the
vendor.
The following were gathered from the client’s accounting • Truck No. ILU 143 was loaded and sealed on
records: December 31 but leave the company premises on
January 2. This order was sold for P100,000 per
SALES PURCHASES
Sales Invoice No. 968.
Date Ref. Amount Date Ref. Amount
Balance Balance c) Temporarily stranded at Dec. 31 at the railroad siding
forwarded P5,200,000 forwarded P2,700,000 were two delivery trucks en route to Brooks Trading
Dec. SI No. Dec. RR No. Corporation. Brooks received the goods, which were
27 965 40,000 27 1057 35,000 sold on Sales Invoice No. 966 terms FOB Destination,
Dec. SI No. Dec. RR No. the next day.
28 966 150,000 28 1058 65,000
Dec. SI No. Dec. RR No. d) En route to the client on Dec. 31 was a truckload of
28 967 10,000 29 1059 24,000 goods, which was received on Receiving Report No.
Dec. SI No. Dec. RR No. 1064. The goods were shipped FOB Destination, and
31 969 46,000 30 1061 70,000 freight of P2,000 was paid by the client. However, the
Dec. SI No. Dec. RR No. freight was deducted from the purchase price of
31 970 68,000 31 1062 42,000 P800,000.
Dec. SI No. Dec. RR No.
31 971 16,000 31 1063 64,000 QUESTIONS:
Dec. Closing Dec. Closing
31 entry (5,530,000) 31 entry (3,000,000) 1. When inventory is material to the financial statements,
P - P - the auditor shall obtain sufficient appropriate audit
evidence regarding the existence and condition of
Note: SI = Sales Invoice RR = Receiving Report
inventory by:
a. Attendance at physical inventory counting, unless
Inventory P600,000 impracticable.
Accounts receivable 500,000 b. Performing audit procedures over the entity’s final
Accounts payable 400,000 inventory records to determine whether they
accurately reflect actual inventory count results.
You observed the physical inventory of goods in the c. Both a and b.
warehouse on Dec. 31 and were satisfied that it was d. Neither a nor b.
properly taken.
2. Attendance at physical inventory counting involves:
When performing sales and purchases cut-off tests, you a. Inspecting the inventory to ascertain its existence
found that at Dec. 31, the last Receiving Report which had and evaluate its condition, and performing test
been used was No. 1063 and that no shipments had been counts.
made on any Sales Invoices whose number is larger than b. Observing compliance with management’s
No. 968. You also obtained the following additional instructions and the performance of procedures for
information: recording and controlling the results of the physical
inventory count.
a) Included in the warehouse physical inventory at
c. Obtaining audit evidence as to the reliability of
December 31 were goods which had been purchased
management’s count procedures.
and received on Receiving Report No. 1060 but for
d. All of these.
which the invoice was not received until the following
year. Cost was P18,000.
3. The procedures involve in the attendance at physical
inventory counting
a. Serve as risk assessment procedures.
b. Serve as test of controls.
c. Serve as substantive procedures.

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d. May serve as test of controls or substantive 10. An auditor selected items for test counts while
procedures depending on the auditor’s risk observing a client’s physical inventory. The auditor
assessment, planned approach and the specific then traced the test counts to the client’s inventory
procedures carried out. listing. This procedure most likely obtained evidence
concerning
4. In which of the following cases is attendance at a. Existence. c. Rights.
physical inventory counting impracticable? b. Completeness. d. Valuation.
a. Where inventory is held in a location that may
pose threats to the safety of the auditor. Based on the given information and the result of your
b. Where the auditor will be inconvenienced because audit, determine the adjusted amount for the following:
of the difficulty, time and cost involved in doing
the procedures. 11. Sales
c. Both a and b. a. P5,150,000 c. P5,350,000
d. Neither a nor b. b. P5,250,000 d. P5,400,000
12. Purchases
5. If attendance at physical inventory counting is
a. P3,000,000 c. P3,754,000
impracticable, the auditor shall
b. P3,018,000 d. P3,818,000
a. Perform alternative audit procedures to obtain
sufficient appropriate audit evidence regarding the 13. Inventory
existence and condition of inventory. a. P800,000 c. P864,000
b. Modify the opinion in the auditor’s report. b. P814,000 d. P968,000
c. Make or observe some physical counts on an
14. Accounts receivable
alternative date, and perform audit procedures on
a. P120,000 c. P350,000
intervening transactions.
b. P220,000 d. P370,000
d. Do nothing and just rely on the result of physical
inventory counting conducted by the client. 15. Accounts payable
a. P354,000 c. P 418,000
6. Which of the following may provide sufficient b. P400,000 d. P1,218,000
appropriate audit evidence about the existence and
condition of inventory if attendance at physical
inventory counting is impracticable? PROBLEM NO. 2
a. Inspection of documentation of the subsequent
sale of specific inventory items purchased prior to During your audit of the Makati Corporation for the current
the physical inventory counting. year ended, you found the following information relating to
b. Inspection of documentation of the subsequent certain inventory transactions from your observation of the
sale of specific inventory items purchased after the client’s physical count and review of sales and purchases
physical inventory counting. cutoff:
c. Both a and b. a. Goods costing P180,000 were received from a vendor
d. Neither a nor b. on Jan. 3. The goods were not included in the physical
count. The related invoice was received and recorded
7. When inventory under the custody and control of a
on Dec. 30. The goods were shipped on Dec. 31, terms
third party is material to the financial statements, the
FOB shipping point.
auditor shall obtain sufficient appropriate audit
evidence regarding the existence and condition of that b. Goods costing P200,000, sold for P300,000, were
inventory by shipped on Dec. 31, and were received by the
a. Requesting confirmation from the third party as to customer on Jan. 2. The terms of the invoice were FOB
the quantities and condition of inventory held on shipping point. The goods were included in the ending
behalf of the entity. inventory for the current year and the sale was
b. Performing inspection or other audit procedures recorded in the subsequent year.
appropriate in the circumstances.
c. Performing one or both of the procedures in (a) c. The invoice for goods costing P150,000 was received
and (b). and recorded as a purchase on Dec. 31. The related
d. Relying only on the written representations made goods, shipped FOB destination were received on Jan.
by the client’s management. 2, but were included in the physical inventory as goods
in transit.
8. Which of the following is not one of the independent d. A P600,000 shipment of goods to a customer on Dec.
auditor's objectives regarding the audit of inventories? 30, terms FOB destination, was recorded as a sale
a. Verifying that inventory counted is owned by the upon shipment. The goods, costing P400,000 and
client. delivered to the customer on Jan. 6, were not included
b. Verifying that the client has used proper inventory in the current year ending inventory.
pricing.
c. Ascertaining the physical quantities of inventory on e. Goods valued at P250,000 are on consignment from a
hand. vendor. These goods are included in the physical
d. Verifying that all inventory owned by the client is inventory.
on hand at the time of the count. f. Goods valued at P160,000 are on consignment with a
customer. These goods are not included in the physical
9. An auditor is most likely to inspect loan agreements
inventory.
under which an entity’s inventories are pledged to
support management’s financial statement assertion of
QUESTIONS:
a. Existence or occurrence.
b. Completeness. Based on the given information and the result of your
c. Presentation and disclosure. audit, answer the following:
d. Valuation or allocation.

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1. The inventory as of Dec. 31 is understated by

a. P140,000 c. P230,000 SOLUTION GUIDE (Question No. 1 to 4)
b. P190,000 d. P290,000
Over (Under)
2. The cost of sales for the current year ended is Inventory COS Profit WC
overstated by a
a. P110,000 c. P380,000 b
b. P290,000 d. P440,000 c
3. The profit for the current year ended is misstated by d
a. P 10,000 over c. P190,000 over e
b. P140,000 under d. P290,000 under f

4. The working capital as of Dec. 31 is misstated by

a. P 10,000 over c. P190,000 over
b. P140,000 under d. P290,000 under PROBLEM NO. 3
5. Purchase cut-off procedures should be designed to test Your client, Mandaluyong Company, is an importer and
whether all inventory wholesaler. Its merchandise is purchased from several
a. Owned by the company is in the possession of the suppliers and is warehoused until sold to customers.
company at year-end.
b. Ordered before year-end was received. In conducting your audit for the current year ended, you
c. Purchased and received before year-end was paid were satisfied that the system of internal control was
for. good. Accordingly, you observed the physical inventory at
d. Purchased and received before year-end was an interim date, Nov. 30, instead of at year end. You
recorded. obtained the following information from your client’s
6. The audit of year-end inventories should include steps general ledger:
to verify that the client’s purchases and sales cutoffs Inventory, Jan. 1 P 1,312,500
were adequate. These audit steps should be designed Physical inventory, Nov. 30 1,425,000
to detect whether merchandise included in the physical Sales for 11 months ended Nov. 30 12,600,000
count at year-end was not recorded as a Sales for the year ended Dec. 31 14,400,000
a. Sale in the subsequent period Purchases for 11 months ended Nov. 30
b. Purchase in the current period (before audit adjustments) 10,125,000
c. Sale in the current period Purchases for the year ended Dec. 31
d. Purchase in the subsequent period (before audit adjustments) 12,000,000
7. An auditor usually examines receiving reports to Your audit disclosed the following information:
support entries in the
a. Voucher register and sales returns journal. a) Shipments received in Nov. and
b. Sales journal and sales returns journal. included in the physical inventory but
c. Voucher register and sales journal. recorded as Dec. purchases. P 112,500
d. Check register and sales journal. b) Shipments received in unsalable
condition and excluded from physical
8. The authority to accept incoming goods in receiving inventory. Credit memos had not
should be based on a (an) been received nor chargebacks to
a. Vendor’s invoice. vendors been recorded:
b. Bill of lading. Total at Nov. 30 15,000
c. Materials requisition. Total at Dec. 31
d. Approved purchase order. (including the November
9. For effective internal control, the accounts payable unrecorded chargebacks) 22,500
department generally should c) Deposit made with vendor and charged
a. Ascertain that each requisition is approved as to to purchases in Oct. Product was
price, quantity, and quality by an authorized shipped in Jan. 30,000
employee. d) Deposit made with vendor and charged
b. Stamp, perforate, or otherwise cancel supporting to purchases in Nov. Product was
documentation after payment is mailed. shipped FOB destination on Nov. 29
c. Establish the agreement of the vendor’s invoice and was included in Nov. 30 physical
with the receiving report and purchase order. inventory as goods in transit. 82,500
d. Remove the quantity ordered on the receiving e) Through the carelessness of the
department copy of the purchase order. receiving department shipment in
early Dec. was damaged by rain. This
10. A client's purchasing system ends with the assumption shipment was later sold in the last
of a liability and the eventual payment of the liability. week of Dec. at cost. 150,000
Which of the following best describes the auditor's
primary concern with respect to liabilities resulting QUESTIONS:
from the purchasing system?
a. Commitments for all purchases are made only after Based on the given information and the result of your
established competitive bidding procedures are audit, answer the following:
followed.
b. Accounts payable are not materially understated.
c. Authority to incur liabilities is restricted to one
designated person.
d. Acquisition of materials is not made from one
vendor or one group of vendors.

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1. Which statement is correct regarding physical Question No. 4

inventory counting conducted other than at the date of
Sales, up to 12/31 P14,400,000
the financial statements?
Less sales, up to 11/30 12,600,000
a. For practical reasons, the physical inventory
Sales - December 1,800,000
counting may be conducted at a date, or dates,
Sales without profit ( 150,000)
other than the date of the financial statements.
Sales with profit 1,650,000
b. This may be done irrespective of whether
x Cost ratio
management determines inventory quantities by
COS with profit
an annual physical inventory counting or maintains
COS without profit
a perpetual inventory system.
Total
c. The effectiveness of the design, implementation
and maintenance of controls over changes in
Question No. 5
inventory determines whether the conduct of
physical inventory counting at a date, or dates, Inventory, 1/1 P 1,312,500
other than the date of the financial statements is Net purchases, 12/31
appropriate for audit purposes. Cost of sales
d. All of these. Estimated inventory, 12/31
2. A client maintains perpetual inventory records in both
quantities and pesos. If the assessed level of control
PROBLEM NO. 4
risk is high an auditor will probably
a. Request the client to schedule the physical On April 21 of the current year, a fire damaged the office
inventory count at the end of the year. and warehouse of Muntinlupa Company. The only
b. Apply gross profit tests to ascertain the accounting record saved was the general ledger, from
reasonableness of the physical counts. which the trial balance below was prepared.
c. Increase the extent of tests of controls relevant to
the inventory cycle. Muntinlupa Company
d. Insist that the client perform physical counts of Trial Balance
inventory items several times during the year. March 31
DEBIT CREDIT
3. Gross profit rate for 11 months ended Nov. 30 is
a. 19% c. 21% Cash P 180,000
b. 20% d. 22% Accounts receivable 400,000
4. Cost of goods sold during the month of Dec. using the Inventory, Jan. 1 750,000
gross profit method is Land 350,000
a. P1,290,000 c. P1,440,000 Building 1,100,000
b. P1,320,000 d. P1,470,000
Acc. depreciation P 413,000
5. Estimated inventory at Dec. 31 is
Other assets 56,000
a. P1,710,000 c. P1,740,000
b. P1,725,000 d. P1,860,000 Accounts payable 237,000
Accrued expenses 180,000
SOLUTION GUIDE: Share capital, P100 par 1,000,000
Question No. 3 Retained earnings 520,000
Sales, up to 11/30 P12,600,000 Sales 1,350,000
Less COS, up to 11/30: Purchases 520,000
Inventory, 1/1 P 1,312,500
Operating expenses 344,000 .
Net purchases, 11/30
TGAS Totals P3,700,000 P3,700,000
Inventory, 11/30
Gross profit The following data and information have been gathered:
a. The company’s year-end is Dec. 31.
Computation of adjusted amounts:
b. An examination of the April bank statement and
Inventory, N.P.,11/30 N.P.,12/31 cancelled checks revealed that checks written during
11/30 (11 mos.) (12 mos.) the period April 1 to 21 totaled P130,000: P57,000
paid to accounts payable as of March 31, P34,000 for
Unadjusted 1,425,000 10,125,000 12,000,000 April merchandise purchases, and P39,000 paid for
other expenses. Deposits during the same period
a
amounted to P129,500, which consisted of receipts on
b account from customers with the exception of a P9,500
refund from a vendor for merchandise returned in
c April.
d c. Correspondence with suppliers revealed unpaid
obligations at April 21 of P106,000 for April
e merchandise purchases, including P23,000 for
Adjusted shipments in transit on that date.

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d. Customers acknowledged indebtedness of P360,000 at 10. Which of the following controls most likely addresses
April 21. It was also estimated that customers owed the completeness assertion for inventory?
another P80,000 that will never be acknowledged or a. Receiving reports are prenumbered and
recovered. Of the acknowledged indebtedness, P6,000 periodically reconciled.
will probably be uncollectible. b. Work in process account is periodically reconciled
with subsidiary records.
e. The insurance company agreed that the fire loss claim
c. Employees responsible for custody of finished
should be based on the assumption that the overall
goods do not perform the receiving function.
gross profit ratio for the past two years was in effect
d. There is a separation of duties between payroll
during the current year. The company’s audited
department and inventory accounting personnel.
financial statements disclosed the following
information:
Prior year Two-year prior
PROBLEM NO. 5
Net sales P5,300,000 P3,900,000
Net purchases 2,800,000 2,350,000 You are engaged in the regular annual examination of the
Beginning inventory 500,000 660,000 accounts and records of Valenzuela Manufacturing Co.
Ending inventory 750,000 500,000 for the current year ended. To reduce the workload at year
end, the company, upon your recommendation, took its
f. Inventory with a cost of P70,000 was salvaged and
annual physical inventory on Nov. 30. You observed the
sold for P35,000. The balance of the inventory was a
taking of the inventory and made tests of the inventory
total loss.
count and the inventory records.
QUESTIONS:
The company’s inventory account, which includes raw
Based on given information and the result of your audit, materials and work-in-process is on perpetual basis.
answer the following: Inventories are valued at cost, first-in, first-out method.
1. How much is the adjusted balance of Accounts Payable There is no finished goods inventory.
as of Apr. 21?
The company’s physical inventory revealed that the book
a. P106,000 c. P286,000
inventory of P1,695,960 was understated by P84,000. To
b. P237,000 d. P343,000
avoid delay in completing its monthly financial statements,
2. How much is the net purchases for the period Jan. 1 to the company decided not to adjust the book inventory until
Apr. 21? year-end except for obsolete inventory items.
a. P650,500 c. P673,500
b. P660,000 d. P683,000 Your examination disclosed the following information
regarding the November 30 inventory:
3. How much is the adjusted balance of Accounts a. Pricing tests showed that the physical inventory was
Receivable as of Apr. 21? overstated by P61,600.
a. P354,000 c. P400,000
b. P360,000 d. P440,000 b. An understatement of the physical inventory by P4,200
due to errors in footings and extensions.
4. How much is the sales for the period Jan. 1 to Apr. 21?
c. Direct labor included in the inventory amounted to
a. P1,430,000 c. P1,510,000
P280,000. Overhead was included at the rate of 200%
b. P1,506,000 d. P1,519,500
of direct labor. You have ascertained that the amount
5. How much is the cost of sales for the period Jan. 1 to of direct labor was correct and that the overhead rate
Apr. 21? was proper.
a. P786,500 c. P830,500 d. The physical inventory included obsolete materials with
b. P828,300 d. P835,725 a total cost of P7,000. During December, the obsolete
6. How much is the estimated inventory on Apr. 21? materials were written off by a charge to cost of sales.
a. P570,000 c. P587,775
b. P579,500 d. P623,500 Your audit also disclosed the following information about
the Dec. 31 inventory:
7. How much is the estimated inventory fire loss? a. Total debits to the following accounts during December
a. P477,000 c. P535,000 were:
b. P512,000 d. P579,500 Cost of sales P1,920,800
8. To determine whether accounts payable are complete, Direct labor 338,800
an auditor performs a test to verify that all Purchases 691,600
merchandise received is recorded. The population of b. The cost of sales of P1,920,800 included direct labor of
documents for this test consists of all P386,400.
a. Payment vouchers.
b. Purchase requisitions. QUESTIONS:
c. Receiving reports.
Based on the above and the result of your audit, answer
d. Vendor’s invoices.
the following:
9. What is the reason for ensuring that every copy of a
1. Adjusted amount of physical inventory at Nov. 30
vendor’s invoice has a receiving report?
a. P1,631,560 c. P1,722,560
a. To ascertain that merchandise received by the
b. P1,715,560 d. P1,845,760
company was billed by the vendor.
b. To ascertain that the invoice was correctly 2. Adjusted amount of inventory at Dec. 31
prepared. a. P1,425,760 c. P1,509,760
c. To ascertain that a check was prepared for every b. P1,502,760 d. P1,516,760
invoice.
d. To ascertain that merchandise billed by the vendor
was received by the company.

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3. Cost of materials on hand, and materials included in 8. What form of analytical review might uncover the
work in process as of Nov. 30 existence of obsolete merchandise?
a. P791,560 c. P 882,560 a. Inventory turnover rates.
b. P875,560 d. P1,005,760 b. Decrease in the ratio of gross profit to sales.
c. Ratio of inventory to accounts payable.
4. Cost of materials on hand, and materials included in
d. Comparison of inventory values to purchase
work in process as of Dec. 31
invoices.
a. P728,560 c. P819,560
b. P812,560 d. P942,760
9. An auditor is most likely to learn of slow-moving
5. The amount of direct labor included in work in process inventory through
as of Dec. 31 a. Inquiry of sales personnel
a. P232,400 c. P386,400 b. Inquiry of warehouse personnel
b. P338,800 d. P618,800 c. Physical observation of inventory
d. Review of perpetual inventory records.
6. Which of the following auditing procedures most likely
would provide assurance about a manufacturing 10. The auditor tests the quantity of materials charged to
entity’s inventory valuation? work in process by tracing these quantities to
a. Tracing test counts to the entity’s inventory listing. a. Cost ledgers.
b. Obtaining confirmation of inventories pledged b. Perpetual inventory records.
under loan agreements. c. Receiving reports.
c. Reviewing shipping and receiving cutoff procedures d. Material requisitions.
for inventories.
d. Testing the entity’s computation of standard
overhead rates. SOLUTION GUIDE (Question No. 3 and 4)

7. The physical count of inventory of a retailer was higher Inventory,11/30

than shown by the perpetual records. Which of the Direct labor, 11/30 ( 280,000)
following could explain the difference? Factory overhead, 11/30
a. Inventory item has been counted but the tags Materials, 11/30
placed on the items had not been taken off the Purchases - December 691,600
items and added to the inventory accumulation Total
sheets. Less materials in COS:
b. An item purchased “FOB shipping point” had not Adj. COS – Dec.
arrived at the date of the inventory count and had Direct labor ( 386,400)
not been reflected in the perpetual records. Factory overhead
c. No journal entry had been made on the retailer’s Materials on hand and
books for several items returned to its suppliers. included in WIP
d. Credit memos for several items returned by
customers had not been recorded. J - end of AP.01 - J

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 Manila * Cavite * Laguna * Cebu * Cagayan De Oro * Davao
Since 1977

AUDITING PRACTICE OCAMPO/OCAMPO

AP.02 - Audit of Property, Plant and Equipment

INTERNAL CONTROL MEASURES

1. Additions and dispositions of fixed assets should be properly authorized and approved by the board of directors or
executive committee or person to whom authority has been delegated.

2. A clearly defined and sound policy for differentiation of capital and revenue expenditures should be established.

3. Cost of constructed fixed assets should be controlled through work orders.

4. Fixed assets controlling account should be supported by detailed plant records.

5. Physical inspection of fixed assets should be conducted and investigated.

SUBSTANTIVE AUDIT OF PROPERTY, PLANT AND EQUIPMENT

Existence: Recorded property, plant and equipment exist Rights and obligations: Property, plant and equipment are
owned by the entity
1. Physically inspect the assets for a sample of property,
plant and equipment recorded in the plant ledger. 7. Determine whether liens or mortgages have been
placed on property, plant and equipment by examining
2. Physically inspect the assets and examine supporting bank confirmations and reading minutes of the board
documentation for additions to property, plant and of directors’ meetings.
equipment.
Valuation and allocation: Property, plant and equipment
3. Verify that existing retirements and disposals are are valued in accordance with GAAP
recorded and properly valued.
8. Verify accuracy of recorded property, plant and
equipment.
Completeness: All property, plant and equipment are
recorded 9. Verify depreciation.

4. Perform analytical procedures.

Presentation and disclosure: Property, plant and
5. Analyze repairs and maintenance for expenditures that equipment are classified and disclosed in accordance with
should have been capitalized. GAAP

6. Examine lease and loan agreements to identify any 10. Review financial statements and perform analytical
liabilities that should be recorded. procedures to determine whether accounts are
classified and disclosed in the financial statements in
accordance with GAAP.

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PROBLEM NO. 1 Payment for safety equipment surrounding

equipment 110,000
An entity provided the following inflows and outflows
Payment for removal of safety fence 20,000
regarding its property, plant and equipment:
Payment for new fence surrounding the
While searching for a suitable block of land, factory 80,000
the entity placed an option to buy with Payment for advertisements in the local
three real estate agents at a cost of paper about the forthcoming factory and
P10,000 each. One of these blocks of its benefits to the local community 5,000
land was later acquired. Payment for opening ceremony 60,000
Payment of option fees P 30,000
Receipt of loan from bank 4,000,000 QUESTIONS:
Payment to settlement agent for title
Determine the cost of the following:
search, stamp duties and settlement
fees 100,000 1. Land
Payment for property taxes in arrears on a. P1,160,000 c. P1,700,000
building and land 50,000 b. P1,180,000 d. P1,800,000
Payment for land 1,000,000
2. Land improvements
Payment for demolition of current building
a. Nil c. P620,000
on land 120,000
b. P540,000 d. P674,000
Proceeds from sale of material from old
building 55,000 3. Building
Payment to architect 230,000 a. P2,845,000 c. P3,439,000
Payment to council for approval of building b. P2,899,000 d. P3,519,000
construction 120,000
Payment for safety fence around 4. Equipment
construction site 34,000 a. P760,000 c. P870,000
Payment to construction contractor for b. P816,000 d. P926,000
factory building 2,400,000 5. When auditing property, plant and equipment, an
Payment for external driveways, parking auditor would least likely verify that
bays and safety lighting 540,000 a. The financial statement presentation of property,
Payment for safety inspection on building 30,000 plant and equipment is appropriate.
Payment for equipment 640,000 b. The client has used proper depreciation method.
Payment of freight and insurance costs on c. Impaired items have been properly accounted for.
delivery of equipment 56,000 d. Items used as collateral are derecognized.
Payment of installation costs on equipment 120,000

PROBLEM NO. 2
You were engaged in making your second annual examination of Indigo Company. The Machinery and Accumulated
Depreciation accounts are shown below:
Machinery
01/01 Balance P 500,000 09/01 Sale of machine
No. 3 P 10,000
06/01 Machine No. 23 150,000 12/31 Balance 644,000
09/01 Dismantling of
Machine No. 3 4,000 .
P 654,000 P 654,000

Accumulated Depreciation
12/31 Balance P 344,400 01/01 Balance P 280,000
. 12/31 Depreciation 64,400
P 344,400 P 344,400

Your examination disclosed the following information: d. Machine No. 3, which was purchased on Mar. 1, Year
3, at a cost of P80,000, was sold on Sept. 1, Year 7 for
a. The following adjusted balances appeared on Dec. 31,
P10,000 cash.
Year 6 working papers: Machinery – P500,000;
Accumulated Depreciation –P 280,000. e. Included in charges to Repairs and Maintenance
account was an invoice for installation of Machine No.
b. The company has depreciated all items of machinery at
23, in the amount of P35,000.
10% per annum. The oldest item owned is seven years
old as of Dec. 31, Year 7.
QUESTIONS:
c. It is the company’s policy to take full year’s
Based on the information presented above and the result
depreciation in the year of acquisition and none in the
of your audit, answer the following:
year of disposition.

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1. How much is the loss on the sale of Machine no. 3? PROBLEM NO. 3
a. Nil c. P38,000
In the audit of the books of Yellow Corporation for the
b. P37,333 d. P42,000
current year ended, the following items and information
2. The adjusting entry to correct the entry made in appeared in the Production Machine account of the client:
recording sale of Machine no. 3 will include a debit to
Date Particulars Debit Credit
a. Loss on sale of machinery P42,000
01/01 Balance–Machine 1, 2,
b. Accumulated depreciation P32,000
3, and 4 at P180,000 P 720,000
c. Both a and b
each
d. No adjusting entry is necessary.
02/28 Machine 5 396,000
3. How much is the adjusted balance of the Machinery Machine 1 P 6,000
account as of Dec. 31, Year 7? 09/01 Machine 6 192,000
a. P296,500 c. P609,000 12/01 Machine 7 432,000
b. P605,000 d. P644,000
The Accumulated Depreciation account contained no
4. How much is the total depreciation expense on
entries for the current year. The balance on Jan. 1 of the
machinery for Year 7?
current year, per your audit, was as follows:
a. P50,000 c. P60,500
b. P58,125 d. P64,400 Machine 1 P168,750
Machine 2 78,750
5. How much is the balance of the Accumulated Machine 3 67,500
Depreciation account as of Dec. 31, Year 7? Machine 4 45,000
a. P301,458 c. P340,500
b. P308,500 d. P344,000 Based on your further inquiry and verification, you noted
6. Property, plant and equipment is typically judged to be the following:
one of the accounts least susceptible to fraud because 1. Machine 5 was purchased for cash; it replaced Machine
a. The amounts recorded on the balance sheet for 1, which was sold on this date for P6,000.
most companies are immaterial. 2. Machine 2 was destroyed by the thickness of engine oil
b. The depreciated values are always smaller than used leading to explosion on Dec. 1. Machine 7 was to
cost. replace Machine 2.
c. Internal control is inherently effective regarding 3. Machine 3 was traded in for Machine 6 at an allowance
this account. of P24,000; the difference was paid in cash and
d. The inherent risk is usually low. charged to Production Machine account.
4. Depreciation rate is recognized at 25% per annum.
7. When few property and equipment transactions occur
during the year the continuing auditor usually obtains QUESTIONS:
an understanding of internal control and performs
a. Tests of controls Based on the above and the result of your audit, answer
b. Analytical procedures to verify current year the following:
additions to property and equipment 1. The adjusting entry to correct the entry made on the
c. A thorough examination of the balances at the sale of Machine 1 will include a
beginning of the year. a. Debit to Accumulated Depreciation P176,250
d. Extensive tests of current year property and b. Debit to Cash P6,000
equipment transactions. c. Credit to Production Machine P180,000
8. Which of the following combinations of procedures is d. Credit to Gain on Sale of Machine P5,250
an auditor most likely to perform to obtain evidence 2. The adjusting entry to correct the entry made on the
about fixed asset addition? destruction of Machine 2 will include a
a. Inspecting documents and physically examining a. Debit to Accumulated Depreciation P120,000
assets. b. Debit to Loss on Destruction of Machine P101,250
b. Recomputing calculations and obtaining written c. Credit to Production Machine P101,250
management representations. d. Credit to Cash P432,000
c. Observing operating activities and comparing
balances to prior period balances. 3. The adjusting entry to correct the entry made on
d. Confirming ownership and corroborating trade-in of Machine 3 will include a
transactions through inquiries of client personnel. a. Debit to Accumulated Depreciation P67,500
b. Debit to Loss on Exchange P58,500
9. Additions to equipment are sometimes understated. c. Credit to Production Machine P67,500
Which of the following accounts would be reviewed by d. Credit to Cash P192,000
the auditor to gain reasonable assurance that additions
are not understated? 4. The total depreciation for the year is
a. Accounts payable a. P232,500 c. P236,250
b. Depreciation expense b. P233,250 d. P237,000
c. Gain on disposal of equipment 5. The carrying amount of production machine as of Dec.
d. Repairs and maintenance expense 31 is
10. In violation of policy, Coat Company erroneously a. P 990,750 c. P1,029,000
capitalized the cost of painting its warehouse. An b. P1,024,500 d. P1,069,500
auditor would most likely detect this when 6. Determining that proper amounts of depreciation are
a. Discussing capitalization policies with controller. expensed provides assurance about management’s
b. Examining maintenance expense accounts. assertions of valuation and
c. Observing that the warehouse had been painted. a. Presentation and disclosure. c. Completeness.
d. Examining construction work orders that support b. Rights and obligations. d. Existence.
items capitalized during the year.

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7. The auditor may conclude that depreciation charges 10. The auditor is least likely to learn of retirements of
are insufficient by noting equipment through which of the following?
a. Insured values greatly in excess of book values. a. Review of the purchase return and allowance
b. Large numbers of fully depreciated assets. account.
c. Continuous trade-in of relatively new assets. b. Review of depreciation.
d. Excessive recurring losses on assets retired. c. Analysis of the debits to the accumulated
depreciation account.
8. In testing for unrecorded retirements of equipment, an
d. Review of insurance policy.
auditor is most likely to
a. Select items of equipment from the accounting
records and then locate them during the plant tour.
SOLUTION GUIDE (Questions 4 and 5):
b. Compare depreciation journal entries with similar
prior-year entries in search of fully depreciated 12/31
equipment. No Remarks Cost Acc. Dep. Dep.
c. Inspect items of equipment observed during the 1
plant tour and then trace them to the equipment 2
subsidiary ledger. 3
d. Scan the general journal for unusual equipment 4
additions and excessive debits to repairs and 5
maintenance expense. 6
9. A weakness in internal control over recording of 7
acquisitions of equipment may cause an auditor to
a. Select certain items of equipment from the
accounting records and locate them in the plant.
b. Inspect certain items of equipment in the plant
and trace those items to the accounting records.
c. Review the subsidiary ledger to ascertain whether
depreciation was taken on each item of
equipment during the year.
d. Trace additions to the “other assets” account to
search for equipment that is still on hand but no
longer being used.

PROBLEM NO. 4
Survive, Inc.’s property, plant and equipment at Dec. 31, Year 6:
P R T C
Original cost P175,000 P255,000 P400,000 P400,000
Year Purchased Year 1 Year 2 Year 3 Year 5
Useful life 10 years 75,000 hours 15 years 10 years
Salvage value P15,500 P15,000 P25,000 P25,000
Depreciation method SYD Activity Straight-line Double-declining
balance
Note: In the year an asset is purchased, Survive, Inc. does not record any depreciation expense on the asset.
In the year an asset is retired or traded in, Survive, Inc. takes full year depreciation on the asset.

The following transactions occurred during Year 7: 1. How much is the gain or loss on sale of Asset P?
a. P20,500 gain c. P32,100 gain
1. On May 5, Asset P was sold for P65,000 cash.
b. P20,500 loss d. P32,100 loss
2. Asset R was used for 10,500 hours during Year 7.
Accumulated usage as of Dec. 31, Year 6 is 40,800 2. How much is the depreciation of Asset T for Year 7?
hours. a. P30,000 c. P42,858
3. On Dec. 31, before computing depreciation expense on b. P32,500 d. P46,428
Asset T, the management of Survive, Inc. determined
3. How much is the total depreciation expense for Year 7?
that the useful life remaining from Jan. 1, Year 7 is
a. P161,200 c. P166,600
only 10 years.
b. P164,100 d. P177,498
4. On Dec. 31, it was discovered that a plant asset
purchased in Year 6 had been expensed completely in 4. How much is the adjusted cost of property, plant and
that year. This asset costs P110,000 and has useful life equipment as of Dec. 31, Year 7?
of 10 years and no salvage value. Management has a. P1,055,000 c. P1,230,000
decided to use the double-declining balance for this b. P1,165,000 d. P1,340,000
asset, which can be referred to as “Asset I.”
5. How much is the carrying amount of property, plant
QUESTIONS: and equipment as of Dec. 31, Year 7?
a. P435,160 c. P763,440
Based on the above and the result of your audit, answer b. P729,840 d. P860,400
the following: (Disregard tax implications)

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PROBLEM NO. 5 1. The carrying amount of the new warehouse as of Dec.

31, Year 4 is
The draft statement of financial position of Four
a. P869,250 c. P 987,500
Corporation as of Dec. 31, Year 4 reported the net
b. P950,000 d. P1,000,000
property, plant and equipment at P6,270,000. Details of
the amount follow: 2. The adjusting entry to correct the entry made on the
Land at cost P1,000,000 disposal of plant will include a
Building at cost P4,000,000 a. Debit to Depreciation P33,750
Less accumulated b. Debit to Accumulated depreciation P630,000
depreciation at 12/31/Y3 ( 800,000) 3,200,000 c. Credit to Gain on sale of plant P63,750
Plant at cost 5,200,000 d. All of these
Less accumulated 3. The carrying amount of plant as of Dec. 31, Year 4 is
depreciation at 12/31/Y3 (3,130,000) 2,070,000 a. P1,282,500 c. P1,375,310
P6,270,000 b. P1,350,000 d. P1,710,000

The following matters are relevant 4. The total depreciation for the year ended Dec. 31, Year
4 is
(a) The company policy for all depreciation is that a full a. P380,000 c. P736,250
year’s charge is made in the year of acquisition or b. P735,750 d. P740,000
completion and none in the year of disposal.
5. The revaluation surplus as of Dec. 31, Year 4 is
(b) Included in the sales revenue is P300,000 being the a. P 960,000 c. P1,720,000
sales proceeds of an item of plant that was sold on b. P1,710,000 d. P1,800,000
June 30, Year 4. The plant had originally cost P900,000
and had been depreciated by P630,000 as of Dec. 31,
Year 3. Other than recording the proceeds in sales and PROBLEM NO. 6
cash, no other accounting entries for the disposal of
the plant have been made. All plant is depreciated at On Jan. 2, Year 1, Calamba Company purchased land for
25% per annum on the reducing balance basis. P450,000, from which it is estimated that 400,000 tons of
ore could be extracted. It estimates that it will cost
(c) On Sept. 30, Year 4, the company completed the P80,000 to restore the land, after which it could be sold for
construction of a new warehouse. The construction was P30,000.
achieved using the company’s own resources as
follows: During Year 1, the company mined 80,000 tons and sold
Purchased materials P150,000 50,000 tons. During Year 2, the company mined 100,000
Direct labor 800,000 tons and sold 120,000 tons. At the beginning of Year 3,
Supervision 65,000 the company spent an additional P100,000, which
Design and planning costs 20,000 increased the reserves by 60,000 tons. In Year 3, the
Included in the above figures are P10,000 for materials company mined 140,000 tons and sold 130,000 tons. The
and P25,000 for labor costs that were effectively lost company uses a FIFO cost flow assumption.
due to the foundations being too close to a neighboring
property. All the above costs are included in cost of QUESTIONS:
sales. The building was brought into immediate use Based on the above and the result of your audit, answer
upon completion and has an estimated useful life of 20 the following: (Round depletion rate to two decimal places)
years (straight-line depreciation).
1. The depletion for Year 2 is
(d) At the beginning of Year 4, the company had an open a. P 80,000 c. P125,000
market basis valuation of its properties (excluding the b. P107,200 d. P134,000
newly constructed warehouse). Land was valued at 2. The depletion for Year 3 is
P1.2 million and the property at P4.8 million. The a. P114,800 c. P175,000
directors wish these values to be incorporated into the b. P145,600 d. P187,600
financial statements. The properties had an estimated
remaining life of 20 years at the date of the valuation 3. The carrying amount of the natural resources as of
(straight-line depreciation is used). The company Dec. 31, Year 3 is
makes a transfer to retained earnings in respect of the a. P217,400 c. P290,200
excess depreciation on revalued assets. b. P259,400 d. P317,400
4. The depletion included in cost of sales for the year
(e) Depreciation for Year 4 has not yet been accounted for
ended Dec. 31, Year 3 is
the in the draft financial statements.
a. P110,900 c. P168,350
b. P137,300 d. P173,300
QUESTIONS:
5. Which method might an auditor utilize in testing
Based on the given information and the result of your
depletion expense?
audit, answer the following:
a. Estimating the useful life of the natural resource.
b. Observation of the physical count.
c. Obtaining management representation.
d. Using analytical procedures.

J - end of AP.02 - J

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AUDITING PRACTICE OCAMPO/OCAMPO

AP.03 - Audit of Intangible Assets

SUBSTANTIVE AUDIT OF INTANGIBLE ASSETS

Existence: Recorded intangible assets exist Valuation and allocation: Intangible assets are valued in
accordance with GAAP
1. Obtain an analysis of ledger accounts for intangible
assets. 6. Vouch additions to or acquisitions during the year.

2. Examine documentation supporting intangible assets. 7. Evaluate dispositions and write offs during the year.

8. Evaluate amortization policy and verify computation of

Completeness: All intangible assets are recorded amortization.

3. Vouch additions to or acquisitions during the year.

Presentation and disclosure: Intangible assets are
4. Evaluate dispositions and write offs during the year. classified and disclosed in accordance with GAAP

9. Review financial statements and perform analytical

Rights and obligations: Intangible assets are owned by procedures to determine whether accounts are
the entity classified and disclosed in the financial statements in
accordance with GAAP.
5. Examine documentation supporting intangible assets.

INTERNAL CONTROL MEASURES

1. Acquisitions, dispositions and write offs of intangible assets should be properly authorized.

2. Adequacy and consistency of accounting policies governing intangible assets should be reviewed periodically.

3. General ledger account should be supported by adequate detailed records and they should be periodically reconciled.

4. Schedules of intangibles showing their cost and basis of amortization should be prepared periodically and reviewed by
a responsible official.

- end -

PROBLEM NO. 1
Apr.1 Patented a newly developed process with costs as
The accountant of the newly organized Zerg Corporation
follows:
provided to you the details of the company’s Intangible
Assets account as follows: Legal fees to obtain patent P429,000
Patent application and licensing fees 61,000
Intangible Assets
Total P490,000
Date Description Amount
01/02 Organization costs P 233,000 It is estimated that in 5 years other companies
01/15 Goodwill 15,000 will have developed improved processes, making
04/01 Patent 490,000 the Zerg Corporation process obsolete.
05/01 License and trademark 300,000
May1 Acquired both a license to use a special type of
07/01 R & D laboratory 1,310,000
container and a distinctive trademark to be
12/31 Product development costs 1,750,000
printed on the container in exchange for 6,000,
P4,098,000
no-par, ordinary shares of Zerg selling for P50
per share. The license is worth twice as much as
Transactions during current year included the following:
the trademark, both of which may be used for 5
Jan.2 Paid legal fees of P150,000 and other costs of years.
P83,000 to complete organization of the
Jul. 1 Constructed a shed for P1,310,000 to house
corporation.
prototypes of experimental models to be
15 Hired a clown to stand in front of the corporate developed in future research projects.
office for 2 weeks and hand out pamphlets and
Dec. Paid salaries for an engineer and chemist involved
candy to create goodwill for the new enterprise.
31 in research and development totaling P1,750,000.
Clown cost, P10,000; pamphlets and candy,
P5,000.
It is the company’s policy to take full year amortization in
the year of acquisition.

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REQUIRED: QUESTIONS:
1. Prepare the necessary adjusting journal entries as of Based on the above and the result of your audit, determine
Dec. 31. the following: (Assume that the appropriate discount rate
for all items is 5%)
2. Compute the carrying amount of the Intangible assets
as of Dec. 31. 1. Total amortization of intangible assets in Year 2
a. P20,000 c. P 88,750
3. Compute the total amount resulting from the foregoing
b. P70,000 d. P107,500
transactions that should be expensed when incurred.
2. Total loss on impairment in Year 2
4. The most effective means for the auditor to determine
a. P433,720 c. P471,220
whether a recorded intangible asset possesses the
b. P452,470 d. P530,280
characteristics of an asset is to
a. Evaluate the future revenue-producing capacity of 3. Carrying amount of goodwill on Dec. 31, Year 2
the intangible asset. a. P659,720 c. P855,000
b. Vouch the purchase by reference to underlying b. P718,780 d. P900,000
documentation.
4. Carrying amount of other intangible assets on Dec. 31,
c. Inquire as to the status of patent applications.
Year 2
d. Analyze research and development expenditures to
a. P640,000 c. P706,667
determine that only those expenditures possessing
b. P690,000 d. P980,000
future economic benefit have been capitalized.
5. Which statement is incorrect regarding audit of
5. Assuming the company has capitalized all research and
intangible assets?
development costs associated with patent. The auditor
a. Accounting principles allow goodwill to be held on
will probably
the books of a company indefinitely and not
a. Confer with management regarding transfer of the
amortized over time.
amount from the balance sheet to the income
b. Patents are amortized over the remaining legal life
statement.
or their useful life.
b. Confirm that the patent is registered and on file
c. When testing a client's additions to an asset for
with the intellectual property office.
research and development, the auditor must
c. Confer with management regarding a change in
remember that such costs should be amortized
the title of the account to "goodwill."
over the lesser of their legal lives or useful lives.
d. Confer with management regarding ownership of
d. All the statements are correct.
the patent.

PROBLEM NO. 3
PROBLEM NO. 2
The statement of financial position of Walsh Corporation as
The Terran Company acquired several small companies
of Dec. 31, Year 4 reported the Intangible Assets, net as
at the end of Year 1 and, based on the acquisitions,
follows:
reported the following intangibles in its Dec. 31, Year 1
statement of financial position: Patent A P1,680,000
Patent B 2,450,000
Patent P200,000
P4,130,000
Copyright 400,000
Tradename 350,000
During the course of your audit, you noted the following.
Computer software 100,000
Goodwill 900,000 a. Patent A was purchased for P1,920,000 on Jan. 1, Year
3, at which date the remaining legal life was sixteen
The company's accountant determines the patent has an years. On Jan. 1, Year 5, Walsh determined that the
expected life of 10 years and no expected residual value, useful life of the patent was only eight years from the
and that it will generate approximately equal benefits each date of acquisition.
year. The company expects to use the copyright and
tradename for the foreseeable future. The accountant b. On May 1, Year 5, Walsh sold Patent B in exchange for
knows that the computer software is used in the a P5,000,000 non-interest-bearing note due on May 1,
company's 120 sales offices. The company has replaced Year 8. There was no established exchange price for the
the software in 60 offices in Year 2, and expects to replace patent, and the note had no ready market. The
the software in 40 more offices in Year 3 and the prevailing rate of interest for a note of this type at May
remainder in Year 4. 1, Year 5 was 14%. The patent was purchased for
P3,150,000 on Sept. 1, Year 1. On that date, the
On Dec. 31, Year 2, there are no indications of impairment remaining legal life was fifteen years, which was also
of patent and computer software. The following determined to be the useful life.
information relate to the other intangible assets: c. On Jan. 3, Year 5, in connection with the purchase of a
a) Because of the rampant piracy, the copyright is trademark from Joe Corporation, the parties entered
expected to generate cash flows of just P8,000 per into a noncompetition agreement and a consulting
year. contract. Walsh paid Joe P8,000,000, of which three-
quarters was for the trademark and one-quarter was for
b) The tradename is expected to generate cash flows of Joe’s agreement not to compete for a five-year period
P15,000 per year. in the line of business covered by the trademark. Walsh
considers the life of the trademark to be indefinite.
c) The goodwill is associated with Terran’s SCV
Under the consulting contract, Walsh agreed to pay Joe
Manufacturing reporting unit. The cash flows expected
P500,000 annually on Jan. 3 for five years. The first
to be generated by the SCV Manufacturing reporting
payment was made on Jan. 3, Year 5.
unit is P200,000 per year for the next 25 years. The
reporting unit has a carrying amount of P2,100,000.

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d. At Dec. 31, Year 5, Walsh determined the recoverable Item 2:

amount of the intangible assets as follows: On Jan. 3, Year 1, Summer purchased two licensing
Patent A P1,350,000 agreements; at that time, they were believed to have
Trademark 5,500,000 unlimited useful lives. The balance in the Licensing
Noncompetition agreement 1,800,000 Agreement – A account included its purchase price of
P48,000 and P2,000 in acquisition expenses. Licensing
agreement – B also was purchased on Jan. 3, Year 1 for
QUESTIONS: P50,000.

Based on the above and the result of your audit, determine Item 3:
the following: In Dec. Year 1, an explosion caused a permanent 60
percent reduction in the expected revenue-producing value
1. Gain on sale of Patent B
of Licensing Agreement – A, and in Jan. Year 3, a flood
a. P995,000 c. P1,012,500
caused additional damage, which rendered the agreement
b. P977,500 d. P2,620,000
worthless.
2. Total amortization to be recognized in Year 5
a. P680,000 c. P 767,500 Item 4:
b. P750,000 d. P1,950,000 A study of Licensing Agreement – B made by Summer in
Jan. Year 2 revealed that its estimated remaining life
3. Total impairment loss to be recognized in Year 5
expectancy was only 10 years as of Jan. 1, Year 2.
a. P 50,000 c. P620,000
b. P550,000 d. P750,000
Item 5:
4. Intangible assets to be recognized in the statement of The balance in the Goodwill account includes P24,000 paid
financial position as of Dec. 31, Year 5 Dec. 30, Year 1, for an advertising program, which it is
a. P7,750,000 c. P8,450,000 estimated will assist in increasing Summer’s sales over a
b. P7,950,000 d. P8,850,000 period of four years following the disbursement.

5. In auditing intangible assets, an auditor most likely Item 6:

would review or recompute amortization and The Leasehold Improvement account includes (a) the
determine whether the amortization period is P15,000 cost of improvements with a total estimated
reasonable in support of management’s financial useful life of 12 years, which Summer, as tenant made to
statement assertion of leased premises in Jan. Year 1; (b) movable assembly-line
a. Valuation. c. Existence equipment costing P8,500, which was installed in the
b. Completeness. d. Rights leased premises in Dec. Year 2; and (c) real estate taxes
of P2,500 paid by Summer, which under the terms of the
lease, should have been paid by the landlord. Summer
PROBLEM NO. 4 paid its rent in full during Year 2. A 10-year nonrenewable
Summer Manufacturing Corporation was incorporated on lease was signed Jan. 3, Year 1, for the leased building
Jan. 3, Year 1. The corporation’s financial statements for that Summer used in manufacturing operations.
its first year’s operations were not examined by a CPA. You
have been engaged to audit the financial statements for Item 7:
the year ended Dec. 31, Year 2, and your work is The balance in the Organization Expenses account includes
substantially completed. A partial trial balance of the pre-operating costs incurred during the organizational
company’s accounts follows: period.

Account Title Debit Credit QUESTIONS:

Cash P11,000
Accounts receivable 42,500 1. The carrying amount of Patents as of Dec. 31, Year 2 is
Allowance for doubtful accounts P 500 a. P46,000 c. P66,000
Inventories 38,500 b. P64,000 d. P85,000
Machinery 75,000 2. The carrying amount of Licensing Agreement – A as of
Equipment 29,000 Dec. 31, Year 2 is
Accumulated depreciation 10,000 a. Nil c. P20,000
Patents (Item 1) 85,000 b. P10,000 d. P50,000
Leasehold improvements (Item 6) 26,000
Prepaid expenses 10,500 3. The carrying amount of Licensing Agreement – B as of
Organization expenses (Item 7) 29,000 Dec. 31, Year 2 is
Goodwill (Item 5) 24,000 a. P45,000 c. P66,000
Licensing Agreement – A b. P64,000 d. P85,000
(Item 2 & 3) 50,000
4. The carrying amount of Leasehold Improvements as of
Licensing Agreement – B
Dec. 31, Year 2 is
(Item 2 & 4) 50,000
a. P12,000 c. P15,000
b. P13,500 d. P26,000
Additional information:
5. The net adjustment to Retained earnings to reflect all
Item 1: the necessary corrections from Item 1 to 7 will amount
Patents for Summer’s manufacturing process were to
purchased Jan. 2, Year 2, at a cost of P68,000. An a. P55,400 debit c. P84,500 debit
additional P17,000 was spent in Dec. Year 2 to improve b. P83,000 debit d. P84,500 credit
machinery covered by the patents and charged to the
Patents account. The patents had a remaining legal term of J - end of AP.03 - J
17 years.

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Since 1977

AUDITING PRACTICE OCAMPO/OCAMPO

AP.04-Audit of Cash and Cash Equivalents

INTERNAL CONTROL MEASURES FOR CASH

1. Cash receipts should be deposited intact – that is, in 5. Bank reconciliation statement should be prepared
the same amount and form as they are received. monthly.
2. All disbursements should be authorized and made by 6. Provide physical protection for cash.
check except those involving small amounts which
7. Minimize cash on hand in the office.
should be paid from petty cash fund.
8. Cash actually present in the office – petty cash,
3. Both receipts and disbursements should be properly
change fund and undeposited receipts can be
accounted for in the records.
periodically counted and compared with the company
4. There should be separation of personnel duties for records.
a. receiving cash
9. Adopt imprest fund system for petty cash.
b. recording receipts
c. depositing cash collections
d. reconciling bank account
e. authorizing disbursement
f. disbursing cash

SUBSTANTIVE AUDIT PROCEDURES FOR CASH

Cash Balances Occurrence: Recorded receipts represent actual collections

of cash from customers
Existence: Cash recorded on the books exist
For a sample of entries in cash receipts journal, trace to
1. Count cash on hand. the prelisting of cash receipts and to remittance advice.
2. Confirm bank balances. For a sample of entries, reconcile daily deposit to validated
3. Examine interbank transfers. deposit ticket.
4. Perform analytical procedures.
Classification: Cash receipts transactions have been
Completeness: All of the entity’s cash is included recorded in the proper accounts
5. Perform cash cutoff test. Review account coding for a sample of entries in the cash
6. Prepare proof of cash. receipts journal.

Accuracy (Valuation): Debits to cash and credits to

Rights and obligations: Any restrictions on cash have been accounts receivable are valued at amounts received
identified
For a sample of entries in cash receipts journal, examine
7. Examine standard bank confirmations and read the remittance advice and verify that discount taken was
minutes of the board of directors’ meetings to appropriate. Foot accounts receivable subsidiary ledger
determine whether any restrictions have been placed and reconcile to general ledger.
on cash.

Valuation and allocation: Cash is correctly valued. Cash Payments

8. Obtain bank cutoff statements directly from the bank
Completeness: All cash payments made are recorded
and use them to test the bank reconciliation as of the
balance sheet date. Reconcile cash payments per books with cash payments
per bank. Prepare or test bank reconciliation.

Occurrence: Recorded cash payments occurred

Presentation and disclosure: Cash is presented and
Examine paid checks for appropriate endorsements.
disclosed properly.
Examine documents underlying payments.
9. Review financial statements and perform analytical
procedures to determine whether accounts are Classification: Cash payments transactions have been
classified and disclosed in accordance with GAAP. recorded in the proper accounts
Check accuracy of accounts on invoices by reference to
chart of accounts.
Cash Collections
Accuracy (Valuation): Debits to various accounts and
Completeness: All receipts of cash and checks are
credits to cash are valued at proper amounts
recorded
Recalculate invoices paid.
For a sample of days, verify that all cash receipts are
recorded by reconciling daily listing(s) of cash receipts and
- end -
validated deposit ticket to cash receipts journal.

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PROBLEM NO. 1 5. Which of the following balance-related audit objectives

typically is assessed as having high inherent risk for
In connection with your audit of the company, you were
cash?
able to gather the following from the Dec. 31 current year
a. Existence c. Detail tie-in
trial balance of Peso Corporation:
b. Cutoff d. Presentation and disclosure
Cash on hand P 372,000
6. The general cash account is considered a significant
Petty cash fund 10,000
account in almost all audits:
BPI current account 950,000
a. Where the ending balance is material.
Security Bank current account No. 01 1,280,000
b. Even when the ending balance is immaterial.
Security Bank current account No. 02 (40,000)
c. Except those of not-for-profit organizations.
PNB savings account 500,000
d. Where either the beginning or ending balance is
PNB time deposit 300,000
material.
Cash on hand includes the following items:
a. Customer’s check for P60,000 returned by bank on PROBLEM NO. 2
Dec. 26 due to insufficient fund but subsequently
In connection with the audit of the financial statements of
redeposited and cleared by the bank on Jan. 8.
Rupee Company for the current year, you performed a
b. Customer’s check for P30,000 dated Jan. 2, received
surprise count of the petty cash fund and undeposited
on Dec. 29.
collections under the custody of Ms. Jessie at 8:15 a.m. on
c. Postal money orders received from customers,
Jan. 2. Your count disclosed the following:
P36,000.
Bills and Coins
Bills Coins
The petty cash fund consisted of the following items as of
P100 10 pieces P1.00 410 pieces
Dec. 31.
50 80 pieces 0.50 324 pieces
Bills and coins P 2,100 20 70 pieces 0.25 64 pieces
Employees’ vales 1,600 10 54 pieces
Currency in an envelope marked “collections
Unused postage stamps – P730
for charity” with names attached 1,200
Unreplenished petty cash vouchers 800 Checks
Check drawn by Peso Corporation, payable Date Payee Drawer Amount
to the petty cashier 4,600 Dec. 30 Cash Ms. Jessie P 2,400
P10,300 Dec. 30 Rupee Company Robert 28,000
Dec. 31 Rupee Company Jay Ar, sales
Included among the checks drawn by Peso Corporation manager 3,360
against the BPI current account and recorded in Dec. are Dec. 31 Rupee Company Francis 35,600
the following: Dec. 31 Rupee Company Ryan 16,600
Dec. 31 German Corp. Rupee
a. Check written and dated Dec. 29 and delivered to
(not endorsed) Company 54,000
payee on Jan. 2, P50,000.
b. Check written on Dec. 27, dated Jan. 2, delivered to
Expense Vouchers
payee on Dec. 29, P86,000.
Date Payee Description Amount
Dec. 23 Jay Ar, Cash advance for
The credit balance in the Security Bank current account
sales manager trip to Baguio
No. 2 represents checks drawn in excess of the deposit
City P14,000
balance. These checks were still outstanding at Dec. 31.
Dec. 27 Central Post Postage stamps
Office 3,240
The savings account deposit in PNB has been set aside by
Dec. 29 Messengers Transportation 300
the board of directors for acquisition of new equipment.
Dec. 29 PC Express Computer repair 1,600
This account is expected to be disbursed in the next 3
months from the end of the reporting period.
Other items found inside the cash box:
QUESTIONS: a) Two pay envelopes which had been opened and the
contents aggregating P15,000 representing unclaimed
Based on the above and the result of your audit, compute
salaries had been removed.
for the adjusted balances of following:
b) The sales manager’s liquidation report for his Baguio
1. Cash on hand
trip:
a. P246,000 c. P342,000
b. P282,000 d. P408,000 Cash advance received on
Dec. 23 P14,000
2. Petty cash fund Less: Hotel accommodation P9,000
a. P2,100 c. P 9,100 Bus fare for two 800
b. P6,700 d. P10,000 Cash given to Roy,
3. BPI current account salesman 600 10,400
a. P914,000 c. P1,000,000 Balance P 3,600
b. P950,000 d. P1,086,000 Accounted for as follows:
Cash returned by Roy to the sales
4. Cash and cash equivalents
manager P 240
a. P2,614,700 c. P2,954,700
Personal check of sales
b. P2,914,700 d. P3,414,700
manager 3,360
Total P 3,600

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Additional information: • Included in the list of outstanding checks were the

following:
a) The custodian is not authorized to cash checks.
a. A check payable to a supplier, dated Dec. 29, in
b) The last official receipt included in the deposit on Dec. the amount of P14,750, released on Jan. 5.
30 is No. 351 and the last official receipt issued for the b. A check representing advance payment to a
current year is No. 355. The following official receipts supplier in the amount of P37,210, the date of
are all dated Dec. 31. which is Jan. 4, and released in Dec.
O.R. No. Amount Form of payment • On Dec. 31, the company received and recorded
352 P27,200 Cash customer’s postdated check amounting to P50,000.
353 35,600 Check
354 7,200 Cash QUESTIONS:
355 16,600 Check Based on the given information and the result of your
audit, answer the following:
c) The Petty Cash balance per general ledger is P20,000.
1. The adjusted deposit in transit as at Dec. 31 is
The last replenishment of the fund was made on Dec.
a. P125,000 c. P175,250
22.
b. P125,250 d. P225,250
REQUIRED: 2. The adjusted outstanding checks as at Dec. 31 is
a. P194,790 c. P232,000
1. Computation of shortage or overage, if any
b. P209,540 d. P298,710
2. Adjusting entries as of Dec. 31
3. The adjusted cash to be presented in the statement of
3. Who is responsible, at all times, for the amount of the financial position at Dec. 31 is
petty cash fund? a. P235,460 c. P265,460
a. General cashier b. P250,460 d. P310,460
b. President of the company
c. Petty cash custodian 4. The cash shortage as of Dec. 31 is
d. Chairman of the Board of Directors a. P 8,040 c. P58,040
b. P45,000 d. P60,000
4. What is the effect of not replenishing the petty cash
fund at year-end and not making the appropriate 5. The starting point for the verification of the balance in
adjusting entry? the general bank account is to obtain:
a. A detailed audit is necessary. a. A bank reconciliation from the client.
b. The petty cash custodian should turn over the b. The client's cash account from the general ledger.
petty cash to the general cashier. c. A cutoff bank statement directly from the bank.
c. Cash will be overstated and expenses understated. d. The client's year-end bank statement.
d. Expenses will be overstated and cash will be
6. Which of the following substantive audit procedures is
understated.
most likely to be performed by the auditor to gather
5. An imprest petty cash fund would least likely be used evidence in support of the balance per bank?
to pay for which of the following items? a. Confirm directly with bank
a. Minor office supplies b. Compare to general ledger.
b. Monthly interest expense c. Trace to cash receipts journal.
c. Stamps for small mailings d. Trace items on the cutoff bank statement to bank
d. Small contributions to a local charity reconciliation.
7. Which of the following substantive audit procedures is
least likely to be performed by the auditor to gather
PROBLEM NO. 3
evidence in support of the deposits in transit?
You are conducting an audit of the Swerte Company for a. Inspect supporting documents for reconciling item
the current year ended. The internal control procedures not appearing on cutoff bank statement.
surrounding cash transactions were not adequate. The b. Trace items on the bank reconciliation to cutoff
bookkeeper-cashier handles cash receipts, maintains bank statement.
accounting records, and prepares the monthly bank c. Trace to cash receipts journal.
reconciliations. d. Inspect bank credit memo.

The bookkeeper-cashier prepared the following 8. Which of the following substantive audit procedures is
reconciliation at the end of the year: least likely to be performed by the auditor to gather
evidence in support of the outstanding checks?
Balance per bank statement P350,000
a. Confirm directly with bank.
Add: Deposit in transit P175,250
b. Trace to cash disbursements journal.
Note collected by bank 15,000 190,250
c. Ascertain reason for unusual delay.
Total 540,250
d. Trace items on the bank reconciliation to cutoff
Less outstanding checks 246,750
bank statement.
Balance per general ledger P293,500

In the process of your audit, you gathered the following:

• At Dec. 31, the bank statement and general ledger
showed balances of P350,000 and P293,500,
respectively.
• The cut-off bank statement showed a bank charge on
Jan. 2 for P30,000 representing correction of an
erroneous bank credit.

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9. A partial-period bank statement and the related 2. Cash balance per books as of Dec. 31 is
canceled checks, duplicate deposit slips, and other a. P122,000 c. P133,000
documents included in bank statements, mailed by the b. P127,000 d. P138,000
bank directly to the CPA firm's office, is called:
3. The cash shortage as of Dec. 31 is
a. A four-column proof of cash.
a. P30,000 c. P41,000
b. A year-end bank statement.
b. P35,000 d. P46,000
c. A cutoff bank statement.
d. A short-period bank statement. 4. The primary purpose of sending a standard
confirmation request to financial institutions with which
10. An auditor who is engaged to examine the financial
the client has done business during the year is to
statements of a business enterprise will request cutoff
a. Detect kiting activities that may otherwise not be
bank statement primarily in order to
discovered.
a. Verify the cash balance reported on the bank
b. Corroborate information regarding deposit and loan
confirmation inquiry form.
balances.
b. Verify reconciling items on the client’s bank
c. Provide the data necessary to prepare a proof of
reconciliation.
cash.
c. Detect lapping.
d. Request information about contingent liabilities and
d. Detect kiting.
secured transactions.
5. The auditor should ordinarily mail confirmation
PROBLEM NO. 4 requests to all banks with which the client has
conducted any business during the year, regardless of
You were engaged to audit the books of Davao Company.
the year-end balance, since
From the records of the company, you gathered the
a. The confirmation form also seeks information
following information:
about indebtedness to the bank.
b. This procedure will detect kiting activities which
Davao Company started operations in the current year
otherwise not be detected.
with the owners investing P150,000 cash. Monthly bank
c. The mailing of confirmation forms to all such banks
reconciliation statements have not been prepared;
is required by GAAS.
however, bank statements for Oct., Nov., and Dec. were
d. This procedure relieves the auditor of any
made available to you. Your analysis of these bank
responsibility with respect to non-detection of
statements showed total bank credits (deposits) of
forged checks.
P575,000 including the owners’ initial investment and a
bank loan, details of which are in additional data. The bank
statement in Dec. showed an ending balance of P91,500.
PROBLEM NO. 5
Examination of the paid checks disclosed that checks You were able to obtain the following information during
totaling P4,500 were issued by the company in Dec. and your audit of Euro Company:
were presented for payment only in Jan. Cash count of the
cashier’s accountability amounted to P5,000. You were told Reconciling items:
by the cashier that these were collections from credit sales
Nov. 30 Dec. 31
on Dec. 30 deposited on Jan. 2.
Undeposited collections P200,000 P120,000
Outstanding checks 80,000 60,000
Additional information are as follows:
Customer’s notes collected by
a. Accounts receivable subsidiary ledgers had a total
bank 100,000 120,000
balance of P70,000 at Dec. 31. P5,000 of this was
Bank service charges 2,000 3,000
ascertained to be uncollectible.
Erroneous bank debits 10,000 20,000
b. Suppliers’ unpaid invoices for merchandise totaled
Erroneous bank credits 40,000 30,000
P15,000; while an account for store fixtures bought for
NSF checks not redeposited 5,000 7,000
P50,000 had an unpaid balance of P5,000.
Customer's check deposited
c. Merchandise inventory at Dec. 31 amounted to
December 10, returned by
P30,000 but P5,000 of these were spoiled with no
bank on December 16
resale value.
marked NSF, and
d. The bank statement in Oct. showed a bank credit for
redeposited immediately;
P98,000, dated Oct. 2. Inquiry from the cashier
no entry made on books for
disclosed that the amount represents proceeds of a 90-
return or redeposit 10,000
day, discounted bank note. P80,000 of this loan was
paid by check in Dec.
Unadjusted balances:
e. Operating expenses paid during the period totaled
P180,000; while merchandise purchases amounted to Books ? 90,000
P250,000. Bank 230,000 ?
f. The gross profit rate is 120% of cost.
December Transactions:
QUESTIONS:
Bank Books
Based on the above and the result of your audit, answer Receipts P420,000 P270,000
the following: Disbursements 500,000 407,000

1. Total collections from sales for the year is REQUIRED:

a. P414,000 c. P425,000
b. P419,000 d. P430,000 1. Prepare a 4-column bank reconciliation for the month
of December, using the form that reconciles both the
book and bank balances to a correct cash amount.
2. Adjusting entries as of Dec. 31.

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QUESTIONS:
SOLUTION GUIDE:
Based on the above and the result of your audit, answer
the following:
Bank
1. How much is the unadjusted cash balance per books as
(B) (R) (D) (E)
of November 30?
11/30 Dec. Dec. 12/31
a. P11,190 c. P12,490
Unadjusted bal.
b. P11,690 d. P13,290
DIT – 11/30
- 12/31 2. How much is the unadjusted book receipts for
OC – 11/30 December?
- 12/31 a. P279,540 c. P282,190
Error, Dr.–11/30 b. P281,640 d. P284,840
- 12/31 3. How much is the unadjusted book disbursements for
Error, Cr.–11/30 December?
- 12/31 a. P271,565 c. P274,635
NSF check red. b. P273,100 d. P275,335
Adjusted bal.
4. How much is the unadjusted cash balance as of
Books December 31?
a. P17,495 c. P21,580
(B) (R) (D) (E) b. P18,195 d. P24,965
11/30 Dec. Dec. 12/31
5. Auditors are likely to prepare a proof of cash when the
Unadjusted bal.
client has:
Note coll.– 11/30
a. Material control weaknesses in cash receipts and
- 12/31
cash disbursements.
BSC – 11/30 b. Material control weaknesses in accounts receivable
- 12/31 and revenue.
NSF check–11/30 c. Material control weaknesses in accounts payable
- 12/31 and inventory.
NSF check red. d. Material control weaknesses in payroll.
Adjusted bal.
6. A proof of cash represents:
a. A test of controls and substantive test of
PROBLEM NO. 6 transactions.
b. A substantive test of transactions.
In your audit of the cash account of Cebu Company, you c. A substantive test of transactions and test of
were requested by the client to prepare a four-column details of balances.
reconciliation of receipts, disbursements, and balances to d. A test of details of balances.
reconstruct the balances per books.
Nov. 30 Dec. 31
a) Balances per bank P14,010 P19,630 SOLUTION GUIDE (Questions 1 to 4):
b) Deposits in transit 2,740 3,110 (B) (R) (D) (E)
c) Outstanding checks 4,260 3,870 11/30 Dec. Dec. 12/31
d) Bank collections not in Unadj. bank bal.
books 1,200 1,600 DIT – 11/30
e) Bank charges not in - 12/31
books 950 640 OC – 11/30
f. Of the checks outstanding on December 31, one check
- 12/31
for P700 was certified at the request of the payee.
CM-coll.– 11/30
g. Receipts for December, per bank statement –
- 12/31
P281,070.
DM-BSC – 11/30
h. DAIF check from customer was charged by the bank on
December 28, and has not been recorded – P800. - 12/31
i. DAIF check returned in November and recorded in DAIF checks: (h)
December, P1,050. (i)
j. DAIF check returned and recorded in December, P900. (j)
k. Check of Cibo Company charged by the bank in error, Bank error, Dr.
P2,010. Receipts used for
l. Receipt on December 6 paid out in cash for travel payments
expenses, P750. Recorded as receipts and Book errors: (m)
disbursements per books. (n)
m. Error in recording customer’s check on December 20, Unadj. book bal.
P165 instead of P465.
n. Error in disbursements journal for December, P3,250
instead of P325. J - end of AP.04 - J

You noted in your audit that the DAIF checks returned by

the bank are recorded as a reduction on the cash receipts
journal instead of recording it at cash disbursements
journal; redeposits are recorded as regular cash receipts.

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Since 1977

AUDITING PRACTICE OCAMPO/OCAMPO

AP.05-Audit of Receivables

INTERNAL CONTROL MEASURES

1. Proper internal control over receivables should observe 2. Notes receivable custodian should not have access to
the following: cash or to the accounting record.
a. Sales must be separated from the accounting for
them. 3. A responsible official who does not have access to the
b. Accounting for sales must be separated from the notes should approve note renewals as well as charge-
receipt of cash arising from the receivables. offs of defaulted notes in writing.
c. Returns, allowances, discounts, and uncollectible
charge-offs must be properly approved and 4. Proper procedures should be adopted for the follow-up
separated from the cash receipts function. of defaulted notes.
d. Periodically, receivables should be aged in order to
determine the actions and efficiency of the credit
department.

SUBSTANTIVE AUDIT OF RECEIVABLES

Sales and Accounts Receivable Balances Sales Transactions

Existence or occurrence: Sales and accounts receivable Completeness: Sales transactions that occurred are
are for shipments made to customers recorded
1. Confirm accounts receivable and perform procedures For a sample of shipping documents, trace sales invoice
for confirmations not returned. and entry into sales journal and accounts receivable
2. Perform analytical procedures to test sales and subsidiary ledger. Perform cutoff tests.
accounts receivable.
Occurrence: Recorded sales are for shipments actually
Completeness: Sales transactions that occurred and made to customers
existing receivables are recorded
For a sample of entries in the sales journal, compare sales
3. Perform a test of sales cutoff. invoice copy, customer order, and sales invoice.

Rights and obligations: Accounts receivable are owned by Classification: Sales and accounts receivable transactions
the client have been recorded in the proper accounts
4. Review minutes of the board of directors’ meetings, For a sample of entries in the sales journal, verify the
inquire of the client personnel, read contracts and accuracy of account coding.
agreements, and confirm with lenders any indications
that accounts have been assigned, sold, or pledged. Accuracy (Valuation): Sales are correctly billed and
recorded
Valuation and allocation: Accounts receivable are properly
For a sample of entries in the sales journal, (a) examine
valued
sales invoice, shipping document, and customer for
5. Verify mathematical accuracy of the accounts consistency of descriptions and quantities; (b) examine
receivable aging schedule and trace it to the accounts sales orders for credit approval; and (c) check prices and
receivable subsidiary ledger. extensions. Foot sales journal and general ledger account.
6. Test the adequacy of the allowance for uncollectible
accounts.

Presentation and disclosure: Sales and accounts

receivable are properly presented and disclosed in
accordance with GAAP.
7. Review financial statements and perform analytical
procedures to determine whether accounts are
classified and disclosed in accordance with GAAP.

- end -

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PROBLEM NO. 1 PROBLEM NO. 2

The Dec. 31 prior year statement of financial position of In connection with the audit of the financial statements of
Help Company included the following information: Praktis Corporation, your audit senior instructed you to
Notes receivable P 598,000 examine the company’s accounts receivable.
Less: NR discounted (380,000) P 218,000
From the schedule of accounts receivable as of Dec. 31
Accounts receivable P2,240,000 current year, you determined that this account includes
Less: Allow. for D.A. ( 141,000) 2,099,000 the following:
Total receivables P2,317,000
Accounts with debit balances P 441,100
Advances to officers 16,400
The following transactions occurred during the current Accounts with credit balance (15,000)
year: Accounts receivable per GL P 442,500
1. Sales on account P8,812,000
2. Collections on accounts 8,410,000 The credit balance in customer’s account represents
3. Accounts receivable written off as collection from a customer whose account had been
uncollectible 138,000 written-off as uncollectible in prior year.
4. Notes receivable collected 290,000
5. Customer notes received in payment Accounts receivable for more than a year totaling P21,000
of accounts receivable 740,000 should be written off.
6. Notes receivable discounted paid at
maturity 360,000 Confirmation replies received directly from customers
7. Notes receivable discounted disclosed the following exceptions:
defaulted, including interest of Customer’s
P200 and a P100 fee. This amount Customer Comments Audit Findings
is not expected to be collected Jessie The goods sold on The client failed to
within the next twelve months 20,300 Dec. 1 were returned record credit memo
8. Proceeds from customer notes on Dec. 16. no. 23 for P12,000.
discounted (face value P450,000, The merchandise
accrued interest income, P2,000) 448,500 was included in the
9. Collections on accounts previously ending inventory at
written off 5,000 cost.
10. Sales returns and allowances 20,000
11. Required allowance for doubtful Robert We do not owe this Investigation
accounts based on impairment amount *%#@ (bad revealed that goods
assessment at year end 12,000 word). We did not sold for P16,000
receive any were shipped to
QUESTIONS: merchandise from Robert on Dec. 29,
your company. terms FOB shipping
Based on the above and the result of your audit, answer point. The goods
the following: were lost in transit
and the shipping
1. The loss from discounting of notes receivable is
company has
a. Nil c. P2,000
acknowledged its
b. P1,500 d. P3,500
responsibility for the
2. The adjusted balance of Accounts Receivable as of loss of the
Dec. 31 current year is merchandise.
a. P1,729,000 c. P1,744,000
Anne I am entitled to a Anne is an employee
b. P1,739,000 d. P2,479,000
10% employee of Praktis. Starting
3. The adjusted balance of Notes Receivable as of Dec. 31 discount. Your bill Nov., all company
current year is should be reduced employees were
a. P238,000 c. P688,000 by P1,200. entitled to a special
b. P668,000 d. P688,300 discount.
4. The amount to be reported as trade and other Jay-ar We have not yet sold Merchandise billed
receivables in the entity’s statement of financial the goods. We will for P18,000 were
position as of Dec. 31 current year is remit the proceeds consigned to Jay-ar
a. P1,945,000 c. P1,965,300 as soon as the goods on Dec. 30. The
b. P1,950,000 d. P1,970,300 are sold. goods cost P13,000.
5. Which of the following may be considered to be a Roy We do not owe you The sale of
primary objective of the auditor in the examination of P20,000. We already merchandise on Dec.
accounts receivable? paid our accounts as 18 was paid by Roy
a. Determine approximate time of collectability of evidenced by OR # on Jan. 6.
receivables. 1234.
b. Determine the relationship of receivables to sales.
Roldan Reduce your bill by This amount
c. Determine the reasonableness of the sales figure.
P1,500 represents freight
d. Establish validity and collectability of receivables.
paid by the customer
for the merchandise
shipped on Dec. 17,
terms, FOB
destination-collect.

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TEAM PRTC

REQUIRED: c. Collectability of the receivables is in doubt.

d. Pledging of the receivables is probable.
1. Adjusting entries as of Dec. 31.
2. Adjusted balance of Accounts Receivable as of Dec. 31. 9. Which of the following procedures would an auditor
most likely perform for year-end accounts receivable
3. Confirmation, which is a specific type of inquiry, is the
confirmations when the auditor did not receive replies
process of obtaining a representation of information or
to second requests?
of an existing condition directly from a third party.
a. Review the cash receipts journal for the month
Two assertions for which confirmation of accounts
prior to year-end.
receivable balances provides primary evidence are
b. Intensify the study of internal control concerning
a. Completeness and valuation
the revenue cycle.
b. Rights and obligations and existence
c. Increase the assessed level of detection risk for the
c. Valuation and rights and obligations
existence assertion
d. Existence and completeness
d. Inspect the shipping records documenting the
4. Which of the following statements is correct concerning merchandise sold to the debtors.
the use of negative confirmation requests?
10. If management refuses to allow the auditor to send a
a. Unreturned negative confirmation requests indicate
confirmation request, the auditor shall:
that alternative procedures are necessary.
a. Inquire as to management’s reasons for the
b. Negative confirmation requests are effective when
refusal, and seek audit evidence as to their validity
detection risk is low.
and reasonableness.
c. Negative confirmation requests are effective when
b. Evaluate the implications of management’s refusal
understatements of account balances are
on the auditor’s assessment of the relevant risks of
suspected.
material misstatement, including the risk of fraud,
d. Unreturned negative confirmation requests rarely
and on the nature, timing and extent of other audit
provide significant explicit evidence.
procedures.
5. The negative request form of accounts receivable c. Perform alternative audit procedures designed to
confirmation may be used when the obtain relevant and reliable audit evidence.
Combined d. All of these.
Assessed Level
Of Inherent Number of Consideration
and Control Small by the PROBLEM NO. 3
Risk Is Balances is Recipient is
In connection with your examination of the financial
a. Low Many Likely
statements of Ringo, Inc. for the year current year
b. Low Few Unlikely
ended, you were able to obtain certain information during
c. High Few Likely
your audit of the accounts receivable and related accounts.
d. High Many Likely
• The Dec. 31 balance in the Accounts Receivable control
6. Which of the following statements would an auditor
account is P837,900.
most likely add to the negative form of confirmations
of accounts receivable to encourage timely
• An aging schedule of the accounts receivable as of
consideration by the recipients?
Dec. 31 is presented below:
a. “This is not a request for payment; remittances
should not be sent to our auditors in the enclosed Percentage to be applied
envelope.” Net debit after corrections have
b. “Report any differences on the enclosed statement Age balance been made
directly to our auditors; no reply is necessary if 60 days &
this amount agrees with your records.” under P387,800 1 percent
c. “If you do not report any differences within fifteen 61 to 90
days, it will be assumed that this statement is days 307,100 2 percent
correct.” 91 to 120
d. “The following invoices have been selected for days 89,800 5 percent
confirmation and represent amounts that are Over 120 Definitely uncollectible,
overdue.” days 53,200 P9,000; the remainder is
estimated to be 25%
7. When an auditor does not receive replies to positive P837,900 uncollectible.
requests for year-end accounts receivable
confirmations, the auditor most likely would • The Allowance for Doubtful Accounts schedule is
a. Ask the client to contact the customers to request presented below:
that the confirmations be returned.
Debit Credit Balance
b. Inspect the allowance account to verify whether
Jan. 1, P19,700
the accounts were subsequently written off.
Nov. 30 P6,100 13,600
c. Increase the assessed level of detection risk for the
Dec. 31
valuation and completeness assertions.
(P837,900 x 5%) P41,895 P55,495
d. Increase the assessed level of inherent risk for the
revenue cycle.
• Entries made in the Doubtful Accounts Expense
8. An auditor should perform alternative procedures to account were:
substantiate the existence of accounts receivable when 1. A credit for P6,100 on Nov. 30, and a debit to
a. No reply to a positive confirmation request is Allowance for Doubtful Accounts because of a
received. bankruptcy. The related sales took place on Oct. 1.
b. No reply to a negative confirmation request is 2. A debit on Dec. 31 for the amount of the credit to
received. the Allowance for Doubtful Accounts.

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• There is a credit balance in one account receivable (61 As a result of your examination, the correct data shown
to 90 days) of P11,000; it represents an advance on a below are available:
sales contract. 12/31/Y2 12/31/Y5
Accounts receivable balances:
QUESTIONS: Less than one year old P61,600 P112,800
One to two years old 4,800 7,200
Based on the given information and the result of your
Two to three years old - 3,200
audit, answer the following:
Over three years old - 8,800
1. How much is the adjusted balance of Accounts P66,400 P132,000
Receivable as of Dec. 31?
Inventories 146,400 124,160
a. P822,800 c. P837,900
b. P833,800 d. P839,900 Accounts payable for inventory
purchased 20,000 44,000
2. How much is the adjusted balance of the Allowance for
Doubtful Accounts as of Dec. 31?
Cash received on
a. P25,255 c. P25,780
AR in: Year 3 Year 4 Year 5
b. P25,475 d. P41,895
Applied to:
3. How much is the net adjustment to the Doubtful Current year
Accounts expense account? sales P595,200 P647,200 P835,200
a. P14,615 credit c. P15,140 debit Accounts of the
b. P14,920 credit d. P20,875 credit prior year 53,600 60,000 67,200
Accounts of two
4. All of the following are examples of substantive tests year prior 2,400 1,600 8,000
to verify valuation of net accounts receivable except Total P651,200 P708,800 P910,400
the
a. Re-computation of the allowance for bad debts. Cash sales 68,000 104,000 124,800
b. Inspection of the aging schedule and credit records
of past due accounts. Cash disbursements
c. Comparison of the allowance for bad debts with for inventory
past records. purchased 750,000 728,400 581,600
d. Inspection of accounts for current versus non-
current status in the statement of financial REQUIRED:
position.
Based on the given information and the result of your
5. When designing audit procedures, tracing of source audit, compute for the gross profit for the years ended
documents to the customers subsidiary ledger and Dec. 31, Year 3, Year 4 and Year 5.
subsequently to the general ledger is done to satisfy
what assertion? SOLUTION GUIDE:
a. Valuation c. Completeness
b. Cutoff d. Classification Year 3 Year 4 Year 5 Total
Sales – Cash 68,000 104,000 124,800 296,800
Sales - Credit
SOLUTION GUIDE #2: Total
Less COS
Category Balance Rate Allowance Gross profit
60 days and under 1%
Computation of Credit Sales
61 - 90 days 2%
Year 3 Year 4 Year 5
91 - 120 days 5% Balance, 12/31/Y5
Add collections:
Over 120 days 25% Year 3
Total Year 4
Year 5
Total

PROBLEM NO. 4
The following information is based on the first audit of PROBLEM NO. 5
Paul Company. The balance sheet of Yoko Corporation reported the
following long-term receivables as of Dec. 31, Year 1:
The client has not prepared financial statements for Year
3, Year 4, or Year 5. During these years, no accounts have Note receivable from sale of plant P6,000,000
been written off as uncollectible, and the rate of gross Note receivable from officer 1,600,000
profit on sales has remained constant for each of the three
years. In connection with your audit, you were able to gather the
following transactions during Year 2 and other information
Prior to Jan. 1, Year 3, the client used the accrual method pertaining to the company’s long-term receivables:
of accounting. From Jan. 1, Year 3 to Dec. 31, Year 5, only
a. The note receivable from sale of plant bears interest at
cash receipts and disbursements records were maintained.
12% per annum. The note is payable in 3 annual
When sales on account were made, they were entered in
installments of P2,000,000 plus interest on the unpaid
the subsidiary accounts receivable ledger. No general
balance every Apr. 1. The initial principal and interest
ledger postings have been made since Dec. 31, Year 3.
payment was made on Apr. 1, Year 2.

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TEAM PRTC

b. The note receivable from officer is dated Dec. 31, Year PROBLEM NO. 6
1, earns interest at 10% per annum, and is due on
On Jan. 1, Year 1, Pedro Company sold land that
Dec. 31, Year 5. The Year 2 interest was received on
originally cost P400,000 to Buyer Company. As payment,
Dec. 31, Year 2.
Buyer gave Pedro Company a P600,000 note. The note
c. The corporation sold a piece of equipment to Yes, Inc. bears an interest rate of 4% and is to be repaid in three
on Apr. 1, Year 2, in exchange for an P800,000 non- annual installments of P200,000 (plus interest on the
interest-bearing note due on Apr. 1, Year 4. The note outstanding balance). The first payment is due on Dec. 31,
had no ready market, and there was no established Year 1. The market price of the land is not reliably
exchange price for the equipment. The prevailing determinable. The prevailing rate of interest for notes of
interest rate for a note of this type at Apr. 1, Year 2, this type is 14% on Jan. 1, Year 1 and 15% on Dec. 31,
was 12%. The present value factor of 1 for two periods Year 1.
at 12% is 0.797.
Pedro made the following journal entries in relation to the
d. A tract of land was sold by the corporation to No Co.
sale of land and the related note receivable:
on July 1, Year 2, for P4,000,000 under an installment
sale contract. No Co. signed a 4-year 11% note for
Jan. 1, Year 1
P2,800,000 on July 1, Year 2, in addition to the down
payment of P1,200,000. The equal annual payments of Notes receivable P600,000
principal and interest on the note will be P902,500 Land P400,000
payable starting July 1, Year 3. The land had an Gain on sale of land 200,000
established cash price of P4,000,000, and its cost to
the corporation was P3,000,000. Dec. 31, Year 1
Cash P224,000
QUESTIONS:
Notes receivable P200,000
Based on the given information and the result of your Interest income 24,000
audit, determine the following:
Pedro reported the notes receivable in its statement of
1. Noncurrent receivables as of Dec. 31, Year 2
financial position at Dec. 31, Year 1 as part of trade and
a. P6,443,100 c. P7,037,600
other receivables.
b. P6,500,484 d. P9,037,600
2. Current portion of long-term receivables as of Dec. 31, QUESTIONS:
Year 2
Based on the above and the result of your audit, answer
a. Nil c. P2,594,500
the following:
b. P2,000,000 d. P2,902,500
1. The correct gain on sale of land is
3. Interest income for Year 2
a. P 94,868 c. P120,061
a. P854,000 c. P1,008,000
b. P103,105 d. P200,000
b. P911,384 d. P1,091,384
2. The correct interest income for Year 1 is
4. Accrued interest receivable as of Dec. 31, Year 2
a. P24,000 c. P72,809
a. P360,000 c. P571,384
b. P70,435 d. P74,230
b. P514,000 d. P674,000
3. Profit for Year 1 is overstated by
5. Which of the following pairs of accounts would an
a. Nil c. P50,460
auditor most likely analyze on the same working
b. P31,130 d. P54,902
paper?
a. Notes receivable and interest income. 4. The correct carrying amount of the notes receivable at
b. Interest receivable and interest payable. Dec. 31, Year 1 is
c. Notes payable and notes receivable. a. P345,098 c. P368,870
d. Interest income and interest expense. b. P349,540 d. P400,000
5. The entity’s working capital at Dec. 31, Year 1 is
SOLUTION GUIDE #1&2:
overstated by
Non- a. Nil c. P232,936
current b. P182,476 d. P235,765

NR-sale of plant:
CA, 12/31/Y2 SOLUTION GUIDE #1:
Less principal inst. due, 4/1/Y3
PVF @ PV,
NR-officer Date P I (4%) Total 14% 1/1/Y1
NR-sale of equipment: 12/31/Y1 200T 24T 224T 0.8772 196,493
CA, 4/1/Y2
Discount amort. 12/31/Y2 200T 16T 216T 0.7695 166,212

12/31/Y3 200T 8T 208T 0.6750 140,400

NR-sale of land: 600T 503,105
CA, 12/31/Y2
Less principal inst. due, 7/1/Y3
Total
Interest J - end of AP.05 - J

Total

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 Manila * Cavite * Laguna * Cebu * Cagayan De Oro * Davao
Since 1977

AUDITING PRACTICE OCAMPO/OCAMPO

AP.06 - Audit of Investments

SUBSTANTIVE AUDIT OF INVESTMENTS

Investments and Investment Income

Existence or occurrence: Recorded investments and Valuation and allocation: Investments are valued in
investment exist accordance with GAAP and investments and investment
income are mathematically accurate
1. Inspect securities on hand and trace to list.
6. Reconcile the investment list to the subsidiary ledger
2. Confirm securities held by others. and general ledger account.

7. Recalculate interest income and verify dividend income

Completeness: All investments and investment income are by reference to published reports of dividends.
recorded

3. Apply analytical procedures. Presentation and disclosure: Investments and investment

income are presented and disclosed in accordance with
GAAP
Rights and obligations: Investments and investment
income are owned by the entity 8. Review financial statements and perform analytical
procedures to whether accounts are classified and
4. Examine supporting brokers’ advices and paid checks disclosed in the financial statements in accordance
for investments acquired during the period. with GAAP.

5. Examine remittance advices for dividends, interest and

disposals of investments.

INTERNAL CONTROL MEASURES

1. Purchases and sales of investments should be properly authorized (normally by the board of directors or investment
committee of the board of directors).

2. Access to securities should not be vested in one person only.

3. Custodianship of investment securities and the accounting for them should be segregated.

4. Securities must be physically controlled in order to prevent unauthorized usage and they must be registered in the
name of the entity.

5. Income received from investments should be reconciled periodically with amounts that should be received.

- end -

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TEAM PRTC

PROBLEM NO. 1 5. How much is the net amount to be recognized in BFF

Corp.’s profit or loss related to these investments?
You were able to obtain the following ledger details of
a. P 48,000 c. P204,000
Equity investment-FVTPL in connection with your audit of
b. P198,000 d. P246,000
the BFF Corp. for the current year ended:
Date Particulars DR CR 6. Which of the following is not one of the auditor’s
Jan. 10 Purchase of Rian Co. primary objectives in an audit of trading securities?
– 6,000 shares P1,440,000 a. To determine whether securities are authentic.
Feb. 20 Purchase of Bryan b. To determine whether securities are the property
Co. – 7,200 shares 1,800,000 of the client.
Mar. 1 Sale of Bryan Co. – c. To determine whether securities actually exist.
2,400 shares 540,000 d. To determine whether securities are properly
May 31 Receipt of Rian share classified on the statement of financial position.
dividend–
Offsetting Credit to 132,000 7. A client has a large and active investment portfolio
retained earnings that is kept in a bank safe-deposit box. If the auditor
Aug. 15 Sale of Rian – is unable to count the securities at the end of the
4,800 shares 1,176,000 reporting period, the auditor most likely will
Sept. 1 Sale of Rian – a. Request the bank to confirm to the auditor the
1,200 shares 276,000 contents of the safe deposit box at the end of the
reporting period.
The following information was obtained during your b. Examine supporting evidence for transactions
examination: occurring during the year.
c. Count the securities at a subsequent date and
• From independent sources, you determine the following confirm with bank whether securities were added
dividend information for the current year: or removed since the end of the reporting period.
Nature Declared Record Payment Rate d. Request the client to have a bank seal the safe-
Cash 01/02 01/15 01/31 P20/share deposit box until the auditor can count the
Share 05/02 05/15 05/31 10% securities at a subsequent date.
Cash 08/01 08/30 09/15 P30/share
8. In establishing the existence and ownership of an
• Closing market quotation as at Dec. 31: investment held by a corporation in the form of
publicly traded shares an auditor should inspect the
Bid Ask
securities or
Rian shares P210 P220
a. Obtain written representations from management
Bryan shares 240 250
confirming that the securities are properly
classified as trading securities.
QUESTIONS:
b. Inspect the audited financial statements of the
Based on the above and the result of your audit, answer investee company.
the following: c. Confirm the number of shares held by an
independent custodian.
1. In relation to Mar. 1 transaction, the necessary
d. Determine that the investment is carried at the
adjusting journal entry includes
lower of cost or market.
a. A debit to Loss of P60,000
b. A credit to Equity investment-FVTPL of P600,000 9. Which of the following is the least effective audit
c. Both a and b procedure regarding the existence assertion for the
d. Neither a nor b securities held by the auditee?
2. In relation to Aug. 15 transaction, the necessary a. Examination of paid checks issued in payment of
adjusting journal entry includes securities purchased.
a. A debit to Equity investment-FVTPL of P216,000 b. Vouching all changes during the year to supporting
b. A debit to Loss of P15,300 documents.
c. A credit to Gain of P216,000 c. Simultaneous count of liquid assets.
d. A credit to Equity investment-FVTPL of P15,300 d. Confirmation from the custodian.

3. In relation to Sept. 1 transaction, the necessary 10. In performing tests of the carrying amount of trading
adjusting journal entry includes securities, the auditor would usually:
a. A debit to Equity investment-FVTPL of P36,000 a. Ask management to estimate the market value of
b. A credit to Gain of P36,000 the securities.
c. Both a and b b. Refer to the quoted market prices of the securities.
d. Neither a nor b c. Value the securities at cost regardless of their
market prices.
4. The carrying amount of Equity investment-FVTPL as of
d. Count the securities.
Dec. 31 is overstated by
a. Nil c. P102,000
b. P60,000 d. P228,000

PROBLEM NO. 2
The LEE BUYS COMPANY had acquired interest in a promising local company, the Silver Tab Company. During your
audit of the company’s accounts for Year 3, which was a first audit, you obtained the following:

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TEAM PRTC

Investment in Silver Tab Company

Year 1–Jan. 2 30,000 sh @35 P1,050,000 Year 3–Jul. 15 50,000 sh @40 P2,000,000
Year 2–Jul. 2 90,000 sh @60 5,400,000
Year 3–Mar. 2 30,000 sh @70 2,100,000
Investment in Red Tab Company
Year 3–Aug. 10 P10,000

Dividend Income
Year 3 Jan. 2 P120,000
Apr. 1 150,000
Aug. 10 10,000
Dec. 20 100,000

The transactions pertaining to the foregoing for Year 3 SOLUTION GUIDE:

were as follows:
Jan. 2 Received cash dividend (declared on Dec. 1) of
P1 per share.
Mar. 2 Bought 30,000 shares at P70 per share.
Apr. 1 Received cash dividend (declared on Mar. 1 to
shareholders of record as of Mar. 10) of P1 per
share.
July 15 Sold 50,000 shares at P40 per share.
Aug. 10 Received an “extra” dividend in shares of one
share of Red Tab Company for every ten shares
of Silver Tab Company. The share dividend had
a market value of P3 per share and its book
value on the ledger of Silver Tab Company was
P1 per share.
Dec.20 Received cash dividend of P1 per share,
declared December 1, out of Silver Tab
Company’s “Reserve for Depletion”.
29 Sold 10,000 Silver Tab Company shares at P90.
Cash was received on Jan. 5, Year 4.
QUESTIONS:
Based on the above and the result of your audit, determine
the following:
1. Loss on sale of 50,000 Silver Tab Company shares on PROBLEM NO. 3
July 15 Your audit of the Norte Corp. disclosed that the company
a. Nil c. P 850,000 owned the following securities on Dec. 31, Year 1:
b. P250,000 d. P1,300,000
FA at FVTPL
2. Gain on sale of 10,000 Silver Tab Company shares on Security Shares Cost Fair value
Dec. 29 Vigan, Inc. 9,600 P144,000 P184,000
a. Nil c. P310,000 Laoag, Inc. 16,000 432,000 288,000
b. P300,000 d. P330,000 10% , P200,000 face
value , Santiago
3. Adjusted balance of Investment in Silver Tab Company
bonds (interest
as of Dec. 31, Year 3
payable every
a. P5,130,000 c. P5,580,000
b. P5,570,000 d. P5,640,000 Jan. 1 and Jul. 1) 158,400 163,440
Total P734,400 P635,440
4. Dividend income for the year ended Dec. 31, Year 3
a. P150,000 c. P180,000 FA at FVTOCI
b. P160,000 d. P280,000 Security Shares Cost Fair value
Candon Products 32,000 P1,376,000 P1,540,000
5. Which of the following is the most effective audit
Pagudpud, Inc. 240,000 6,240,000 5,840,000
procedure for verification of dividends earned on
Batac, Inc. 80,000 960,000 1,280,000
investments in equity securities?
Total P8,576,000 P8,660,000
a. Tracing deposited dividend checks to the cash
receipts book.
FA at AC
b. Reconciling amount received with published
Amortized
dividend records.
Cost Fair value
c. Comparing the amounts received with preceding
12%, 2,000,000 face
year dividends received.
value, Ilocos bonds
d. Recomputing selected extensions and footings of
(interest payable
dividend schedules and comparing totals to the
annually every Dec. 31) P1,926,000 P1,900,000
general ledger.

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TEAM PRTC

During Year 2, the following transactions occurred: PROBLEM NO. 4

Jan. 1 Receive interest on the Santiago bonds. Assassin Corp.’s accounting records included the
following investments:
Mar. 1 Sold 8,000 shares of Laoag Inc. for
P152,000, net of transaction cost of P7,600. Investment in Ordinary Shares
1/1/Y1 P1,000,000 7/1/Y3 P800,000
May 15 Sold 3,200 shares of Batac, Inc. at fair value 12/31/Y1 200,000
of P17 per share. The entity paid transaction 12/31/Y2 300,000
cost of P2,400.
July 1 Received interest on the Santiago bonds. Investment in Bonds
Dec. 31 Received interest on the Ilocos bonds. 1/1/Y3 P1,051,510

31 Because of the change in business model,

the entity transferred the Ilocos bonds to FA During the course of your audit, you noted the following.
at FVTOCI. The bonds were selling at 101 on
this date. The bonds were originally Investment in Ordinary Shares
purchased at an effective rate of 14%. • The investment is not designated at FVTOCI.
• Acquired on Jan. 1, Year 1 at P950,000 plus
The fair values of the shares and bonds on Dec. 31, Year transaction costs of P50,000.
2, are as follows: • On July 1, Year 3, the entity sold half of the
Vigan, Inc. P22 per share investment for its fair value of P800,000.
Laoag, Inc. P15 per share • Fair value of the investment: Dec. 31, Year 1,
10% Santiago bonds P151,200 P1,200,000; Dec. 31, Year 2, P1,500,000; Dec. 31,
Candon Products P42 per share Year 3, P900,000.
Pagudpud, Inc. P28 per share
Batac, Inc. P18 per share Investment in Bonds
• The entity uses the ‘held for collection’ business model
The company’s accounting policy is that when an equity for acquired and originated debt instruments.
investment classified as FVTOCI is sold, the accumulated • P1,000,000, 10% bonds, purchased for P1,051,510
OCI amount is transferred to retained earnings. including transaction costs of P20,000. Interest is
payable annually every Dec. 31. The bonds mature on
QUESTIONS: Dec. 31, Year 5. The effective interest rate is 8%.
• The prevailing market rate for the bonds is 9% at
Based on the above and the result of your audit, determine Dec. 31, Year 3.
the following:
QUESTIONS:
1. Total interest income for Year 2
a. P251,120 c. P286,000 Based on the above and the result of your audit, answer
b. P260,000 d. P289,640 the following:
2. On ‘reclassification date’, the amount to be recognized
1. The carrying amount of Investment in Ordinary Shares
in other comprehensive income on the reclassification
as of Dec. 31, Year 3 is misstated by
of Ilocos bonds
a. P50,000 over c. P200,000 over
a. Nil c. P 94,000
b. P50,000 under d. P200,000 under
b. P64,360 d. P123,640
2. The carrying amount of Investment in Bonds as of Dec.
3. Gain or loss on sale of 8,000 Laoag, Inc. shares on
31, Year 3 is overstated by
Mar. 1
a. P13,900 c. P18,020
a. P8,000 gain c. P64,000 loss
b. P15,880 d. P33,900
b. P8,000 loss d. P64,000 gain
3. The net amount to be recognized in Year 3 profit or
4. In relation to the sale of 3,200 Batac, Inc. shares on
loss related to these investments is
May 15, the net amount to be recognized in profit or
a. P114,121 c. P284,121
loss
b. P134,121 d. P384,121
a. Nil c. P 2,400
b. P800 d. P13,600 4. If the investment in bonds is FVTOCI, the carrying
amount as of Dec. 31, Year 3 is overstated by
5. Adjusted carrying amount of investments as of Dec.
a. P15,880 c. P33,900
31, Year 2
b. P18,020 d. P38,020
FA at FVTPL FA at FVTOCI
a. P482,400 P 9,446,400 5. An auditor who physically examines securities should
b. P482,400 P11,466,400 insist that a client representative be present in order to
c. P602,400 P 9,446,400 a. Detect fraudulent securities.
d. P602,400 P11,466,400 b. Lend authority to the auditor’s directives.
c. Acknowledge the receipt of securities returned.
6. The accumulated OCI to be reported as separate
d. Coordinate the return of securities to the proper
component of equity at Dec. 31, Year 2
locations.
a. P840,800 c. P908,800
b. P892,800 d. P924,800
7. The amount to be recognized in Year 2 OCI
a. P840,800 c. P908,800
b. P892,800 d. P924,800

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PROBLEM NO. 5
On Jan. 3, Year 1, JR Company purchased for P500,000
cash a 10% interest in Judi Corp. On that date the net
assets of Judi had a book value of P3,750,000. The excess
of cost over the underlying equity in net assets is
attributable to undervalued depreciable assets having a
remaining life of 10 years from the date of JR's purchase.
The investment in Judi Corp. was designated as FVTOCI.

The fair value of JR's investment in Judi securities is as

follows: Dec. 31, Year 1, P570,000; Dec. 31, Year 2,
P525,000; Dec. 31, Year 3, P2,200,000.

On Jan. 2, Year 3, JR purchased an additional 30% of

Judi's stock for P1,575,000 cash when the book value of
Judi's net assets was P4,150,000. The excess was
attributable to depreciable assets having a remaining life of
8 years.

During Year 1, Year 2, and Year 3 the following occurred:

Judi Dividends Paid by
Net Income Judi to JR
Year 1 P350,000 P15,000
Year 2 400,000 20,000
Year 3 550,000 70,000

QUESTIONS:
Based on the above and the result of your audit, answer
the following:
1. The net amount to be recognized in Year 1
comprehensive income related to this investment?
a. P15,000 c. P 85,000
b. P70,000 d. P120,000
2. The net amount to be recognized in Year 2
comprehensive income related to this investment?
a. P15,000 c. P(25,000)
b. P20,000 d. P(45,000)
3. If the entity used the ‘fair value as deemed cost
approach’ in accordance with PIC Q&A No. 2019-06,
the carrying amount of the investment in Judi Corp. as
of Dec. 31, Year 3 is
a. P2,100,000 c. P2,195,000
b. P2,190,000 d. P2,200,000
4. If the entity used the ‘accumulated cost approach’ in
accordance with PIC Q&A No. 2019-06, the carrying
amount of the investment in Judi Corp. as of Dec. 31,
Year 3 is
a. P2,173,125 c. P2,198,125
b. P2,195,000 d. P2,200,000
5. Which of the following provides the best form of
evidence pertaining to the annual valuation of an
investment in which the independent auditor’s client
owns a 30% voting interest?
a. Market quotations of the investee company’s stock.
b. Current fair value of the investee company’s
assets.
c. Historical cost of the investee company’s assets.
d. Audited financial statements of the investee
company.

J - end of AP.06 - J

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 Manila * Cavite * Laguna * Cebu * Cagayan De Oro * Davao
Since 1977

AUDITING PRACTICE OCAMPO/OCAMPO

AP.07 - Audit of Liabilities

SUBSTANTIVE AUDIT OF LIABILITIES

Existence: Recorded liabilities exist Rights and obligations: Liabilities are owed by the entity
1. Obtain from the client a listing of accounts and notes 8. Confirm recorded liabilities directly with suppliers and
payable as of year-end and reconcile to the general creditors.
ledger.
9. Review documentation in client’s files.
2. Vouch recorded liabilities to the suppliers’ statements.
10. Examine subsequent payments to credits.
3. Confirm recorded liabilities directly with suppliers and
creditors. Investigate differences in liabilities reported
in the confirmations with the recorded book amounts. Valuation and allocation: Liabilities are valued in
accordance with GAAP
4. Examine bank confirmations for loans.
11. Vouch accounts payable schedule.

12. Test computation of accrued or prepaid interest.

Completeness: All liabilities are recorded
5. Perform purchases cutoff examination.
Presentation and disclosure: Liabilities are classified and
6. Test for unrecorded liabilities. disclosed in accordance with GAAP
13. Review financial statements and perform analytical
7. Perform analytical procedures.
procedures to determine whether accounts are
classified and disclosed in the financial statements in
accordance with GAAP.

INTERNAL CONTROL MEASURES

Current Liabilities
Accounts payable
1. A proper system of requisitioning, purchase order placement and approval, receiving, invoice approval, and approval
for payment should be well-defined and established.
2. Subsidiary accounts payable records or unpaid vouchers should be reconciled with controlling account at frequent
intervals.
3. Check mathematical accuracy of suppliers’ invoices prior to recording.
4. Adjustments to accounts payable should be properly approved.
5. Debit balances in accounts payable should be reviewed and resolved.

Notes payable
1. Borrowings on notes payable should be properly authorized. (Specify the institutions from which money may be
borrowed and designate the officers authorized to sign notes)
2. Unissued notes should be properly safeguarded.
3. Adequate and well organized records for notes specifying the details should be maintained.
4. Subsidiary notes payable records should be reconciled with controlling account at frequent intervals.
5. Paid notes should be properly cancelled and preserved.

Long-Term Liabilities
1. Long-term obligation should be properly authorized by the board of directors or by a required majority of the
shareholders.
2. There should be proper control over issued and unissued obligations as in bonds, by an independent bond trustee or
transfer agent.
3. Redeemed bonds should be cancelled, property mutilated and retained for audit in order to prevent the unauthorized
issuance.
4. Bond ledger should be used in which details of bonds issued, cancelled and outstanding are shown. A subsidiary
bondholders’ ledger should also be maintained by the issuing corporation or the bond trustee for bonds registered, as
to principal and interest.
5. Proper control should be exercised over the payment of interest on long-term liabilities. Payment may be done by an
independently engaged interest-paying agent.

- end -

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PROBLEM NO. 1 5. In auditing accounts payable, an auditor’s procedures

most likely will focus primarily on management’s
Dallas Corporation is selling audio and video appliances.
assertion of
The company’s fiscal year ends on Mar. 31. The following
a. Existence c. Completeness
information relates to the obligations of the company as of
b. Presentation and disclosure d. Valuation
Mar. 31, Year 7:
6. When using confirmations to provide evidence about
Notes payable the completeness assertion for accounts payable, the
Dallas has signed several notes with financial institutions. appropriate population most likely would be
The maturities of these notes are given below. The total a. Vendors with whom the entity has previously done
unpaid interest for all of these notes amounts to P340,000 business.
on Mar. 31, Year 7. b. Amounts recorded in the accounts payable
Due date Amount subsidiary ledger.
Apr. 31, Year 7 P 700,000 c. Payees of checks drawn in the month after the
July 31, Year 7 900,000 year-end.
Feb. 1, Year 8 800,000 d. Invoices filed in the entity’s open invoice file.
Apr. 30, Year 8 1,200,000 7. Which of the following procedures is least likely to be
June 30, Year 8 1,500,000 performed before the balance sheet date?
P 5,100,000 a. Observation of inventory
b. Testing of internal control over cash
Estimated warranties
c. Search for unrecorded liabilities
Dallas has a one-year product warranty on some selected
d. Confirmation of receivables
items. The estimated warranty liability on sales made
during the previous fiscal year and still outstanding as of 8. Which of the following procedures would an auditor
Mar. 31, Year 6, amounted to P252,000. The warranty most likely perform in searching for unrecorded
costs on sales made from Apr. 1, Year 6 to Mar. 31, Year liabilities?
7, are estimated at P630,000. The actual warranty costs a. Trace a sample of accounts payable entries
incurred during the current fiscal year are as follows: recorded just before year-end to the unmatched
Warranty claims honored on receiving report file.
Year 5 – Year 6 sales P 252,000 b. Compare a sample of purchase orders issued just
Warranty claims honored on after year-end with the year-end accounts payable
Year 6 – Year 7 sales 285,000 trial balance.
Total P 537,000 c. Vouch a sample of cash disbursements recorded
just after year-end to receiving reports and vendor
Trade payables invoices.
Payables for purchases of inventory on open account d. Scan the cash disbursements entries recorded just
amount to P560,000 as of Mar. 31, Year 7. be- fore year-end for indications of unusual
transactions.
Dividends
9. Unrecorded liabilities are most likely to be found during
On Mar. 10, Year 7, Dallas’ board of directors declared a
the review of which of the following documents?
cash dividend of P0.30 per ordinary share and a 10%
a. Unpaid bills c. Shipping records
ordinary share dividend. Both dividends were to be
b. Unmatched sales invoices d. Bills of lading
distributed on Apr. 5, Year 7 to ordinary shareholders on
record at the close of business on Mar. 31, Year 7. As of 10. An auditor’s purpose in reviewing the renewal of a note
Mar. 31, Year 7, Dallas has 5 million, P2 par value, payable shortly after the balance sheet date most
ordinary shares issued and outstanding. likely is to obtain evidence concerning management’s
assertions about
Bonds payable a. Existence or occurrence
Dallas issued P5,000,000, 12% bonds, on Oct. 1, Year 1 at b. Presentation and disclosure
96. The bonds will mature on Oct. 1, Year 11. Interest is c. Valuation or allocation
paid semi-annually on Oct. 1 and Apr. 1. Dallas uses the d. Completeness
straight-line method to amortize bond discount.

QUESTIONS: PROBLEM NO. 2

Based on the given information and the result of your Relevant extracts from Magic Corporation’s financial
audit, determine the adjusted balances of the following as statements at Dec. 31, Year 1 are as follows:
of Mar. 31, Year 7:
Current liabilities
1. Estimated warranty payable Provision for warranties P405,000
a. P252,000 c. P630,000
b. P345,000 d. P882,000 Non-current liabilities
Provision for warranties 270,000
2. Total current liabilities
a. P3,945,000 c. P5,445,000 Note 10 - Contingent liabilities
b. P5,105,000 d. P6,445,000
Magic is engaged in litigation with various parties
3. Trade and other payables in relation to allergic reactions to traces of peanuts
a. P2,700,000 c. P5,100,000 alleged to have been found in packets of fruit
b. P3,045,000 d. P5,445,000 gums. Magic strenuously denies the allegations
and, as at the date of authorizing the financial
4. Total noncurrent liabilities
statements for issue, is unable to estimate the
a. P7,500,000 c. P7,610,000
financial effect, if any, of any costs or damages
b. P7,590,000 d. P7,700,000
that may be payable to the plaintiffs.

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The provision for warranties at Dec. 31, Year 1 was 6. Magic signed an agreement with a bank to the effect
calculated using the following assumptions: that Magic would guarantee a loan of P3,000,000 made
by the bank to Magic's subsidiary. The subsidiary was
Estimated costs of repairs - products with
in a strong financial position at Dec. 31, Year 2.
minor defects P1,500,000
Estimated cost of repairs - products with
QUESTIONS:
major defects P9,000,000
Expected % of products sold during Year Based on the given information and the result of your
1 having no defects in Year 2 80% audit, answer the following:
Expected % of products sold during Year
1. The warranty expense in Year 2 is
1 having minor defects in Year 2 15%
a. P150,000 c. P345,000
Expected % of products sold during Year
b. P240,000 d. P600,000
1 having major defects in Year 2 5%
Expected timing of settlement of 2. The provision for warranties as of December 31, Year 2
warranty payments - those with is
minor defects All in Year 2 a. P345,000 c. P720,000
Expected timing of settlement of b. P615,000 d. P870,000
warranty payments - those with 40% in Year 2,
major defects 60% in Year 3 3. The provision for warranties to be reported as current
liability as of Dec. 31, Year 2 is
During the year ended Dec. 31, Year 2 the following a. P225,000 c. P495,000
occurred: b. P330,000 d. P600,000

1. In relation to the warranty provision of P675,000 at 4. The provision for warranties to be reported as
Dec. 31, Year 1, P300,000 was paid out of the noncurrent liability as of Dec. 31, Year 2 is
provision. Of the amount paid, P225,000 was for a. P120,000 c. P390,000
products with minor defects and P75,000 was for b. P225,000 d. P495,000
products with major defects, all of which related to 5. Total provisions to be reported in the statement of
amounts that had been expected to be paid in Year 2. financial position as of Dec. 31, Year 2 is
2. In calculating its warranty provision for Dec. 31, Year a. P615,000 c. P1,770,000
2, Magic made the following adjustments to the b. P720,000 d. P2,040,000
assumptions used for the prior year: 6. In evaluating an entity’s accounting estimates, one of
Estimated cost of repairs - products with an auditor’s objectives is to determine whether the
minor defects No change estimates are
Estimated cost of repairs - products with a. Not subject to bias.
major defects P7,500,000 b. Consistent with industry guidelines.
Expected % of products sold during Year c. Based on objective assumptions.
2 having no defects in Year 3 85% d. Reasonable in the circumstances.
Expected % of products sold during Year
7. Which of the following is not an audit procedure that
2 having minor defects in Year 3 13%
the independent auditor would perform concerning
Expected % of products sold during Year
litigation, claims, and assessments?
2 having major defects in Year 3 2%
a. Obtain assurance from management that it has
Expected timing of settlement of
disclosed all unasserted claims that the lawyer has
warranty payments - those with minor All in
advised are probable of assertion and must be
defects Year 3
disclosed.
Expected timing of settlement of
b. Inquire of and discuss with management the
warranty payments - those with major 20% in Year 3,
policies and procedures adopted for identifying,
defects 80% in Year 4
evaluating, and accounting for litigation, claims,
3. Magic determined that part of its plant and equipment and assessments.
needed an overhaul – the conveyer belt on one of its c. Obtain from management a description and
machines would need to be replaced in about Dec. evaluation of litigation, claims, and assessments
Year 3 at an estimated cost of P500,000. The carrying existing at the balance sheet date.
amount of the conveyer belt at Dec. 31, Year 2 was d. Confirm directly with the client’s lawyer that all
P280,000. Its original cost was P400,000. claims have been recorded in the financial
statements.
4. Magic was unsuccessful in its defense of the peanut
allergy case and was ordered to pay P2,000,000 to the 8. A lawyer’s response to an auditor’s inquiry concerning
plaintiffs. As at Dec. 31, Year 2 Magic had paid litigation, claims, and assessments may be limited to
P1,500,000. matters that are considered individually or collectively
material to the client’s financial statements. Which
5. Magic commenced litigation against one of its advisers parties should reach an understanding on the limits of
for negligent advice given on the original installation of materiality for this purpose?
the conveyers’ belt referred to in (4) above. In Oct. a. The auditor and the client’s management.
Year 2 the court found in favor of Magic. The hearing b. The client’s audit committee and the lawyer.
for damages had not been scheduled as at the date the c. The client’s management and the lawyer.
financial statements for Year 2 were authorized for d. The lawyer and the auditor.
issue. Magic estimated that it would receive about
P500,000.

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TEAM PRTC

9. Which of the following statements extracted from a 6. In an audit of bonds payable, an auditor expects the
client’s lawyer’s letter concerning litigation, claims, and trust indenture to include the
assessments most likely would cause the auditor to a. Auditee’s debt-to-equity ratio at the time of
request clarification? issuance.
a. “I believe that the possible liability to the company b. Effective yield of the bonds issued.
is nominal in amount.” c. Subscription list.
b. “I believe that the action can be settled for less d. Description of the collateral
than the damages claimed.”
7. In auditing long-term bonds payable, an auditor most
c. “I believe that the plaintiff’s case against the
likely will
company is without merit.”
a. Perform analytical procedures on the bond
d. “I believe that the company will be able to defend
premium and discount accounts.
this action successfully.”
b. Examine documentation of assets purchased with
10. The refusal of a client’s attorney to provide information bond proceeds or liens
requested in an inquiry letter generally is considered c. Compare interest with the bond payable amount
a. Grounds for an adverse opinion. for reasonableness.
b. A limitation on the scope of the audit. d. Confirm the existence of individual bondholders at
c. Reason to withdraw from the engagement. year-end.
d. Equivalent to a significant deficiency.
8. When an auditor observes that the recorded interest
expense seems to be excessive in relation to the
balance in the bonds payable account, the auditor
PROBLEM NO. 3
might suspect that
In your initial audit of Bulls Co., you find the following a. Discount on bonds payable is understated.
ledger account balances. b. Bonds payable are understated.
c. Bonds payable are overstated.
12%, 25-year Bonds Payable, Year 1 issue
d. Premium on bonds payable is overstated.
01/01/Y1 CR P 1,600,000
9. Which of the following audit procedures is least likely
to detect an unrecorded liability?
Treasury Bonds a. Analysis and recomputation of interest expense.
10/01/Y5 CD P 216,000 b. Mailing of standard bank confirmation forms.
c. Reading of the minutes of meetings of the board
Bond Premium directors.
01/01/Y1 CR P 80,000 d. Analysis and recomputation of depreciation
expense.
Bond Interest Expense 10. The auditor can best verify a client’s bond sinking fund
01/01/Y5 CD P 96,000 transactions and year-end balance by
07/01/Y5 CD 96,000 a. Confirmation with individual holders of retired
bonds.
The bonds were redeemed for permanent cancellation on b. Confirmation with the bond trustee.
Oct. 1, Year 5 at 105 plus accrued interest. c. Recomputation of interest expense, interest
payable, and amortization of bond discount or
QUESTIONS: premium.
d. Examination and count of the bonds retired during
Based on the above and the result of your audit, answer the year.
the following: (Use straight line amortization method)
1. The adjusted balance of bonds payable as of Dec. 31,
PROBLEM NO. 4
Year 5 is
a. P1,000,000 c. P1,400,000 On Jan. 1, Year 1, Thunder Corporation issued 2,000 of
b. P1,384,000 d. P1,600,000 its 5-year, P1,000 face value, 11% bonds dated Jan. 1 at
2. The unamortized bond premium on Dec. 31, Year 5 is an effective annual interest rate (yield) of 9%. Interest is
a. P56,000 c. P64,000 payable each Dec. 31. Thunder uses the effective interest
b. P58,800 d. P80,000 method of amortization. On Dec. 31, Year 2, the 2,000
bonds were extinguished early through acquisition in the
3. The total bond interest expense for Year 5 is open market by Thunder for P1,980,000 plus accrued
a. P182,800 c. P188,800 interest.
b. P182,900 d. P189,100
On July 1, Year 1, Thunder issued 5,000 of its 6-year,
4. The gain or loss on partial bond redemption is
P1,000 face value, 10% convertible bonds at par. Interest
a. P1,900 loss c. P18,100 loss
is payable every June 30 and Dec. 31. On the date of
b. P1,900 gain d. P18,100 gain
issue, the prevailing market interest rate for similar debt
5. An auditor’s program to audit long term debt should without the conversion option is 12%. On July 1, Year 2,
include steps that require an investor in Thunder’s convertible bonds tendered 1,500
a. Examining bond trust indentures bonds for conversion into 15,000 ordinary shares of
b. Inspecting the accounts payable subsidiary ledger. Thunder, which had a fair value of P105 and a par value of
c. Investigating credits to the bond interest income P1 at the date of conversion.
account.
d. Verifying the existence of the bondholders. QUESTIONS:
Based on the above and the result of your audit, determine
the following: (Round off present value factors to four
decimal places.)

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4. The amount of depreciation to be recognized by Lessee

1. The issue price of the 2,000 5-year, P1,000 face value
Corp. for the year ended Dec. 31, Year 1 is
bonds on Jan. 1, Year 1 is
a. P 97,243 c. P147,588
a. P1,844,434 c. P2,147,800
b. P125,588 d. P155,588
b. P2,000,000 d. P2,155,534
5. Ignoring income taxes, if Lessee Corp. erroneously
2. The carrying amount of the 2,000 5-year, P1,000 face
accounted for the transaction as an operating lease, its
value bonds on Dec. 31, Year 1 is
profit for Year 1 would be misstated by
a. P1,898,434 c. P2,121,100
a. P 4,397 under c. P32,743 under
b. P2,000,000 d. P2,129,534
b. P25,603 over d. P34,376 over
3. The gain on early retirement of bonds on Dec. 31, Year
2 is SOLUTION GUIDE #1:
a. Nil c. P112,000
The interest rate implicit in the lease is the discount rate
b. P20,000 d. P121,286
that, at the inception of the lease, causes the aggregate
4. The issuance of the 6-year, P1,000 face value bonds present value of
on July 1, Year 1 increased equity by (a) the lease payments and
a. Nil c. P411,300 (b) the unguaranteed residual value
b. P371,050 d. P419,050 to be equal to the sum of
(i) the fair value of the underlying asset and
5. The conversion of the 1,500 6-year, P1,000 face value (ii) any initial direct costs of the lessor.
bonds on July 1, Year 2 increased share premium by
a. P1,374,608 c. P1,415,054 SOLUTION GUIDE #3:
b. P1,377,697 d. P1,485,000
Amortization schedule - Lessee:
Lease Lease
PROBLEM NO. 5 Date Payment Interest Principal Liability
Lessor Corp. has entered into an agreement to lease a 1/1/Y1 777,940
machine to a Lessee Corp. The lease agreement details are
12/31/Y1 200,000 70,015 129,985 647,955
as follows:
12/31/Y2 200,000 58,316 141,684 506,271
Length of lease 5 years
Commencement date Jan. 1, Year 1
Annual lease payment payable Dec.
PROBLEM NO. 6
31 each year commencing Dec.
31, Year 1 P200,000 Denver Corp. has determined its accounting profit before
Fair value of the machine at Jan. 1, tax for the current year to be P256,700. Included in this
Year 1 P845,425 profit are the items of income and expense shown below.
Estimated economic life of the Royalty revenue (exempt from taxation) P 8,000
machine 8 years Gain on sale of building 5,000
Estimated residual value of the asset Entertainment expense (non deductible) 1,700
at the end of its economic life P40,000 Depreciation expense - buildings 7,600
Residual value at the end of the lease Depreciation expense - plant 22,500
term P150,000 Doubtful debts expense 4,100
Interest rate implicit in the lease ? Annual leave expense 46,000
Insurance expense 4,200
Lessee Corp. does not intend to buy the machine at the Development expense 15,000
end of the lease term. Lessor Corp. incurred P30,000 to
negotiate and execute the lease agreement. Lessor Corp. The company's draft statement of financial position at the
purchased the machine for P845,425 just before the end of the current year showed the following assets and
inception of the lease. liabilities:
QUESTIONS: Assets
Cash P 2,500
Based on the above and the result of your audit, answer Accounts receivable 21,500
the following: (Round off present value factors to four Allowance for doubtful debts (4,100) P 17,400
decimal places) Inventory 31,600
Prepaid insurance 4,500
1. The interest rate implicit in the lease is
Land 75,000
a. 6% c. 8%
Buildings 170,000
b. 7% d. 9%
Accumulated depreciation (59,500) 110,500
2. Ignoring income taxes, if Lessor Corp. erroneously
accounted for the transaction as an operating lease, its Plant 150,000
profit for Year 1 would be overstated by Accumulated depreciation (67,500) 82,500
a. P14,534 c. P 23,307 Deferred tax asset, (opening
b. P20,534 d. P121,212 balance) 9,600
333,600
3. The amount to be reported by Lessee Corp. as lease
Liabilities
liability under current liabilities as of Dec. 31, Year 1 is
Accounts payable 25,000
a. P129,985 c. P154,436
Provision for annual leave 10,000
b. P141,684 d. P183,486
Deferred tax liability (opening
balance) 27,270
Loan 140,000
202,270

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TEAM PRTC

Additional information PROBLEM NO. 7

a. Quarterly income tax installments paid during the year You gathered the following information related to Hanep
were: Company’s the defined benefit plan for the current year:
First P18,000 • Fair value of plan assets: P2,100 million at Jan. 1, and
Second 17,500 P2,340 million at Dec. 31
Third 18,000 • Present value of obligation to provide benefits: P2,200
with the final balance due on April 15 next year. million at Jan. 1, and P2,600 million at Dec. 31
• Current service cost of providing benefits for the year:
b. The tax depreciation rate for plant (which cost P30 million
P150,000 three years ago) is 20%. Depreciation on • Past service cost: P115 million. All of these benefits
buildings is not deductible for taxation purposes. have vested.
c. The building sold during the year had cost P100,000 • Discount rate and expected rate of return on plan
when acquired six years ago. The company depreciates assets:
buildings at 5% p.a., straight-line. Discount rate 5%
Expected rate of return on plan assets 7%
d. During the year, the following cash amounts were
• Average remaining working life of employees: 10 years
paid:
• Contributions paid to the fund: P20 million
Annual leave P52,000 • Benefits paid to retired employees: P30 million
Insurance 3,700
e. Bad debts of P3,500 were written off against the QUESTIONS:
allowance for doubtful debts during the year. 1. The amount to be recognized in the statement of
f. The P15,000 spent (and expensed) on development financial position as of Jan. 1 is
during the year is not deductible for tax purposes until a. P100M surplus c. P400M deficit
next year. b. P100M deficit d. P400M surplus

g. Denver Corp. has tax losses amounting to P12,500 2. The amount to be recognized in the statement of
carried forward from prior years. financial position as of Dec. 31 is
a. P260M surplus c. P400M deficit
h. The company tax rate is 35%. b. P260M deficit d. P400M surplus

REQUIRED: 3. The net amount to be recognized in profit or loss.

a. P 35M c. P150M
Compute for the following as of and for the current year b. P145M d. P180M
ended Dec. 31:
4. The actual return on plan asset is
1. Current tax expense a. P 40M c. P145M
a. P77,210 c. P85,085 b. P105M d. P250M
b. P81,585 d. P89,460
5. The net amount to be recognized in OCI is
2. Current tax payable a. P30M c. P145M
a. P23,710 c. P31,585 b. P35M d. P180M
b. P28,025 d. P35,960
3. Deferred tax liability
a. P1,575 c. P 9,450
b. P7,875 d. P48,125
4. Deferred tax asset
a. P 9,310 c. P11,760
b. P10,185 d. P14,560
5. Deferred tax expense (benefit)
a. P(18,405) c. P20,270
b. P(19,980) d. P(22,780)

PROBLEM NO. 7 SOLUTION GUIDE:

P/L OCI SFP Debit Credit

Debit (Credit) Debit (Credit) Debit (Credit) Plan Asset DBO
Jan. 1 2,100 2,200
Service cost - Current
Service cost - Past
Interest – DBO
Interest – Plan asset
Remeasurement - DBO
Remeasurement – Plan asset

Contribution
Payment
Dec. 31 2,340 2,600

J - end of AP.07 - J

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 Manila * Cavite * Laguna * Cebu * Cagayan De Oro * Davao
Since 1977

AUDITING PRACTICE OCAMPO/OCAMPO

AP.08 - Audit of Equity

SUBSTANTIVE AUDIT OF EQUITY

Existence: Recorded equity accounts exist Valuation and allocation: Shareholders’ equity balances
are shown at appropriate amounts.
1. Obtain schedules of shareholders’ equity accounts and
reconcile to the general ledger balances. 9. Vouch share capital entries, dividend entries and
entries to retained earnings.
2. Review authorization and terms of share issues.

3. Confirm shares outstanding with registrar on share and Presentation and disclosure: Shareholders’ equity
transfer agent. accounts are properly presented and adequately disclosed
in the financial statements.
4. Inspect share certificate book.
10. Review financial statements and perform analytical
procedures to determine whether accounts are
5. Inspect certificates of shares held in treasury.
classified and disclosed in the financial statements in
accordance with GAAP.
Completeness: All equity accounts are recorded
11. Review minutes of board of directors’ and
6. In addition to the above-mentioned procedures, shareholders’ meetings for share options and dividend
perform analytical review procedures. restrictions.

Rights and obligations: the entity has the authority to

execute the shareholders’ equity transactions
7. Review articles of incorporation and by laws.

8. Make inquiries of legal counsel.

INTERNAL CONTROL MEASURES

1. Internal control measures regarding the issuance of share certificates and proper accounting for transfers and
registration of shares should be established. One of these measures is the appointment of a share and transfer agent
or an independent registrar.

2. Share certificates should be serially prenumbered by the printer and that the authority for signing and issuing the
certificates be designated by the board of directors.

3. As individual certificates are issued, corresponding records of the certificates should be prepared containing the name
and address of the shareholders and the number of shares issued to each.

4. Cancelled certificates should be mutilated and any necessary documentary stamps should be attached to the
cancelled certificates.

5. Entries for the share issuances and transfers should be made by a person who does not have authority to sign and
issue certificates.

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TEAM PRTC

PROBLEM NO. 1 1. Prepare adjusting entries as of Dec. 31.

2. Based on the above and the result of your audit,
With your representation, as Managing Partner of the Sy
determine the adjusted balances of the following as of
Pee Ey & Co., your firm was engaged in the audit of the
Dec. 31.
Fortitude Company at the close of the company’s first
a. Share capital
year of operations on Dec. 31. The company closed its
b. Share premium
books prior to the time you began your year-end fieldwork.
c. Total retained earnings
d. Total shareholders’ equity
Your audit and review showed the following shareholders’
equity accounts in the general ledger:
3. In an examination of shareholder’s equity, an auditor
Share Capital is most concerned that
08/30 CD P550,000 01/02 CR P6,000,000 a. Capital stock transactions are properly authorized.
12/29 J 545,000 b. Stock splits are capitalized at par or stated value
on the dividend declaration date.
c. Dividends during the year under audit were
Retained Earnings approved by the shareholders.
12/29 J P545,000 12/01 CR P287,500 d. Changes in the accounts are verified by a bank
12/31 J 4,000,000 serving as a registrar and stock transfer agent.

P/L Summary 4. In audit of a medium-sized manufacturing concern,

12/31 J P26,000,000 12/31 J P30,000,000 which one of the following areas can be expected to
12/31 J 4,000,000 require the least amount of audit time?
a. Owner’s equity c. Revenue
Based on the other working papers submitted by your b. Assets d. Liabilities
audit staff, the following additional information was
forwarded: 5. When a corporate client maintains its own stock
records, the auditor primarily will rely upon
From the Articles of Incorporation of Fortitude Company: a. Confirmation with the company secretary of shares
outstanding at year-end.
• Authorized share capital – 150,000 shares b. Review of the corporate minutes for data as to
• Par value per share – P100 shares outstanding.
c. Confirmation of the number of shares outstanding
From the board of directors’ minutes of meetings, the at year-end with the appropriate state official.
following resolutions were extracted: d. Inspection of the stock book at year-end and
accounting for all certificate numbers.
• 01/02 – authorized the issuance of 50,000 shares at
P120 per share.
6. If the auditee has a material amount of treasury
• 08/30 – authorized the acquisition of 5,000 shares at
shares on hand at year-end, the auditor should
P110 per share.
a. Count the certificates at the same time other
• 12/01 – authorized the re-issuance of 2,500 treasury
securities are counted.
shares at P115 per share.
b. Count the certificates only if the company had
• 12/29 – Declared a 10% share dividend, payable Jan.
treasury share transactions during the year.
31 to shareholders on record as of Jan. 15. The market
c. Not count the certificates if treasury share is a
value of the share on Dec. 29 was P130 per share.
deduction from shareholders’ equity.
d. Count the certificates only if the company classifies
treasury shares with other assets.

REQUIRED:

PROBLEM NO. 2
The Retained Earnings account of Endurance Company shows the following debits and credits for the current year:
RETAINED EARNINGS
Balance
Date Debit Credit Debit Credit
Jan. 1 Balance 726,400
(a) Loss from fire 5,250 721,150
(b) Write-off of goodwill 52,500 668,650
(c) Share dividends distributed 140,000 528,650
(d) Loss on sale of equipment 48,300 480,350
(e) Officers’ compensation related to income of prior
periods – accrual overlooked 325,500 154,850
(f) Loss on retirement of preference shares at more
than issue price 70,000 84,850
(g) Paid in capital in excess of par 129,500 214,350
(h) Share issuance expenses (related to letter g) 10,000 204,350
(i) Share subscription defaults 8,470 212,820
(j) Gain on retirement of preference shares at less than
issue price 25,900 238,720
(k) Gain on early retirement of bonds 15,050 253,770

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TEAM PRTC

RETAINED EARNINGS
Balance
Date Debit Credit Debit Credit
(l) Gain on life insurance policy settlement 10,500 264,270
(m) Correction of a fundamental error 50,050 314,320
(n) Effect of change in accounting principle from FIFO to
weighted average 100,000 414,320
(o) Dividends payable 25,000 389,320
(p) Loss on sale of treasury shares 20,000 369,320
(q) Proceeds from sale of donated shares 40,000 409,320
(r) Appraisal increase in land 250,000 659,320
(s) Appropriated for property acquisition 100,000 559,320

REQUIRED:
1. Prepare adjusting journal entries to correct the 4. The auditor is concerned with establishing that
Retained Earnings account. dividends are paid to client corporation shareholders
owning shares as of the
2. Determine the correct amount of Retained Earnings a. Issue date c. Declaration date
account before closing profit or loss for the period. b. Record date d. Payment date

3. An audit program for the retained earnings account 5. During an audit of an entity’s shareholders’ equity
should include a step that requires verification of the accounts, the auditor determines whether there are
a. Fair value used to charge retained earnings to restrictions on retained earnings resulting from loans,
account for a two-for-one-share split. agreements, or law. This audit procedure most likely
b. Approval of the adjustment to the beginning is intended to verify management’s assertion of
balance as a result of a write-down of an account a. Existence
receivable. b. Valuation
c. Authorization for both cash and share dividends. c. Completeness
d. Gain or loss resulting from disposition of treasury d. Presentation and disclosure
shares.

PROBLEM NO. 3
Resilience Corporation was organized on Jan. 1, Year 1, and began operations immediately. Unfortunately, the
company hired an incompetent bookkeeper. For the Year 1 through Year 3, the bookkeeper presented an annual balance
sheet that reported only one amount for shareholders' equity: Year 1, P1,377,000; Year 2, P1,566,000 and Year 3,
P1,850,000. Also, the condensed income statement reported as follows: Year 1, net loss, P175,000; Year 2, net profit,
P220,000; and Year 3, net profit, P409,300 (cumulative earnings of P454,300). Based on the P454,300, the president
has recommended to the board of directors that a cash dividend of P450,000 be declared and paid during Jan. Year 4.
The outside director on the board has objected on the basis that the company's financial statements contain major errors
(there has never been an audit). You have been engaged to clarify the situation. The single shareholders' equity account,
provided by the bookkeeper, appeared as follows:
Shareholders' Equity
Year 1 Share issue costs P 13,000 Year 1 Ordinary shares, par P5
Year 1 Net loss 175,000 200,000 shares issued P1,600,000
Year 2 Bought 1,000 shares from an unhappy Year 2 Net profit (including P100,000
shareholder Ekis 7,000 land write-up based on
president’s estimate) 220,000
Depreciation expense* Year 2 Ordinary shares, 2,000
(Year 1, P15,000; Year 2, P17,000; shares issued 18,000
Year 3, P23,000) 55,000
Miscellaneous expenses* Year 3 Sold 300 of the Ekis shares 2,700
(Year 1, P20,000; Year 2, P25,000;
Year 3, P5,000) 50,000
Year 3 Cash loan to the company president 100,000 Year 3 Net profit 409,300
P400,000 P2,250,000
* Recorded as expense but not shown on the income statement.

QUESTIONS:
Based on the concerns of the outside director, you must address the following questions:
1. What is the adjusted balance of retained earnings as of Dec. 31, Year 3?
2. What entry is necessary (a) to close the above single shareholders' equity account and (b) to record the various
components of shareholders' equity in separate accounts?
3. What is the adjusted total equity as of Dec. 31, Year 3?

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PROBLEM NO. 4
Hawks Corporation was incorporated in Year 1. During
Year 1, the company issued 100,000 shares of P1 par
value ordinary shares for P27 per share. During Year 1,
Hawks Corporation had a profit of P250,000 and paid
dividends of P28,000.

During Year 2, the company had the following

transactions.

1/2 Issued 10,000 shares of P100 par value

cumulative preference shares at par. The
preference shares are convertible into five
ordinary shares and had a dividend rate of 6%.

3/1 Issued 3,000 ordinary shares for legal service

performed. The value of the legal services was
P100,000. The shares are actively traded on a
stock exchange and valued on 3/1 at P32 per
share.

7/1 Issued 40,000 ordinary shares for P42 per

share.

10/1 Repurchased 16,000 treasury shares for P34 per

share.

12/1 Sold 3,000 treasury shares for P29 per share.

12/30 Declared and paid a dividend of P0.20 per share

on ordinary shares and a 6% dividend on the
preference shares.

During Year 2 Hawks Corporation had a profit of P380,000.

QUESTIONS:
Based on the above and the result of your audit, determine
the following:
1. Total share premium as of Dec. 31, Year 2
a. P4,333,000 c. P4,337,000
b. P1,733,000 d. P4,348,000
2. Total retained earnings as of Dec. 31, Year 2
a. P516,000 c. P602,000
b. P501,000 d. P279,000
3. Total equity as of Dec. 31, Year 2
a. P5,621,000 c. P5,535,000
b. P5,539,000 d. P5,550,000
4. Basic earnings per share for Year 2
a. P2.11 c. P3.20
b. P1.60 d. P2.69
5. Diluted earnings per share for Year 2
a. P1.90 c. P2.11
b. P1.48 d. P2.25

J - end of AP.08 - J

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