Since 1977

AUDITING PROBLEMS OCAMPO/CABARLES/SOLIMAN/OCAMPO

AP.2808 - Audit of Equity MAY 2020

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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EXCEL PROFESSIONAL SERVICES, INC.

PROBLEM NO. 1 REQUIRED:

With your representation, as Managing Partner of the Sy 1. Prepare adjusting entries as of December 31, 2020.
Pee Ey & Co., your firm was engaged in the audit of the 2. Based on the above and the result of your audit,
Fortitude Company at the close of the company’s first determine the adjusted balances of the following as of
year of operations on December 31, 2020. The company December 31, 2020.
closed its books prior to the time you began your year-end a. Share capital
fieldwork. b. Share premium
c. Total retained earnings
Your audit and review showed the following shareholders’ d. Total shareholders’ equity
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.
Retained Earnings c. Dividends during the year under audit were
12/29 J P545,000 12/01 CR P287,500 approved by the shareholders.
12/31 J 4,000,000 d. Changes in the accounts are verified by a bank
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?
Based on the other working papers submitted by your a. Owner’s equity c. Revenue
audit staff, the following additional information was b. Assets d. Liabilities
forwarded:
5. When a corporate client maintains its own stock
From the Articles of Incorporation of Fortitude Company: records, the auditor primarily will rely upon
a. Confirmation with the company secretary of shares
• Authorized share capital – 150,000 shares outstanding at year-end.
• Par value per share – P100 b. Review of the corporate minutes for data as to
shares outstanding.
From the board of directors’ minutes of meetings, the c. Confirmation of the number of shares outstanding
following resolutions were extracted: at year-end with the appropriate state official.
d. Inspection of the stock book at year-end and
• 01/02 – authorized the issuance of 50,000 shares at
accounting for all certificate numbers.
P120 per share.
• 08/30 – authorized the acquisition of 5,000 shares at
6. If the auditee has a material amount of treasury
P110 per share.
shares on hand at year-end, the auditor should
• 12/01 – authorized the re-issuance of 2,500 treasury
a. Count the certificates at the same time other
shares at P115 per share.
securities are counted.
• 12/29 – Declared a 10% share dividend, payable
b. Count the certificates only if the company had
January 31, 2021 to shareholders on record as of
treasury share transactions during the year.
January 15, 2021. The market value of the share on
c. Not count the certificates if treasury share is a
December 29, 2020 was P130 per share.
deduction from shareholders’ equity.
d. Count the certificates only if the company classifies
treasury shares with other assets.

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
(l) Gain on life insurance policy settlement 10,500 264,270

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EXCEL PROFESSIONAL SERVICES, INC.

RETAINED EARNINGS
Balance
Date Debit Credit Debit Credit
(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 January 1, 2018, and began operations immediately. Unfortunately, the
company hired an incompetent bookkeeper. For the years 2018 through 2020, the bookkeeper presented an annual
balance sheet that reported only one amount for shareholders' equity: 2018, P1,377,000; 2019, P1,566,000 and 2020,
P1,850,000. Also, the condensed income statement reported as follows: 2018, net loss, P175,000; 2019, net profit,
P220,000; and 2020, 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 January 2021. 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
2018 Share issue costs P 13,000 2018 Ordinary shares, par P5
2018 Net loss 175,000 200,000 shares issued P1,600,000
2019 Bought 1,000 shares from an unhappy 2019 Net profit (including P100,000
shareholder Ekis 7,000 land write-up based on
president’s estimate) 220,000
Depreciation expense* 2019 Ordinary shares, 2,000
(2018, P15,000; 2019, P17,000; 2020, shares issued 18,000
P23,000) 55,000
Miscellaneous expenses* 2020 Sold 300 of the Ekis shares 2,700
(2018, P20,000; 2019, P25,000; 2020,
P5,000) 50,000
2020 Cash loan to the company president 100,000 2020 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 December 31, 2020?
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 December 31, 2020?

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EXCEL PROFESSIONAL SERVICES, INC.

PROBLEM NO. 4
Hawks Corporation was incorporated in 2019. During During 2020 Hawks Corporation had a profit of P380,000.
2019, the company issued 100,000 shares of P1 par value
ordinary shares for P27 per share. During 2019, Hawks QUESTIONS:
Corporation had a profit of P250,000 and paid dividends of
Based on the above and the result of your audit, determine
P28,000.
the following:
During 2020, the company had the following transactions. 1. Total share premium as of December 31, 2020
a. P4,333,000 c. P4,337,000
1/2 Issued 10,000 shares of P100 par value b. P1,733,000 d. P4,348,000
cumulative preference shares at par. The
preference shares are convertible into five 2. Total retained earnings as of December 31, 2020
ordinary shares and had a dividend rate of 6%. a. P516,000 c. P602,000
b. P501,000 d. P279,000
3/1 Issued 3,000 ordinary shares for legal service 3. Total equity as of December 31, 2020
performed. The value of the legal services was a. P5,621,000 c. P5,535,000
P100,000. The shares are actively traded on a b. P5,539,000 d. P5,550,000
stock exchange and valued on 3/1 at P32 per
share. 4. Basic earnings per share for the year 2020
a. P2.11 c. P3.20
7/1 Issued 40,000 ordinary shares for P42 per b. P1.60 d. P2.69
share. 5. Diluted earnings per share for the year 2020
a. P1.90 c. P2.11
10/1 Repurchased 16,000 treasury shares for P34 per b. P1.48 d. P2.25
share.

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

12/30 Declared and paid a dividend of P0.20 per share - now do the DIY drill -
on ordinary shares and a 6% dividend on the
preference shares.

DO-IT-YOURSELF (DIY) DRILL

PROBLEM NO. 1 Your examination of the Preference Shares and Ordinary

Shares accounts reveals that the amounts shown correctly
You are engaged to perform the first audit of the Torrents
state the total par value of the issued share capital. The
Company for the year ended December 31, 2020. You
Retained Earnings account contains the accumulated
find the following account balances related to shareholders'
earnings of the company, with the exception of any items
equity:
of retained earnings that were inappropriately debited or
Preference shares, P100 par P 3,000,000 credited to the Surplus account.
Ordinary shares, P10 par 6,500,000
Capital surplus (1,640,000) QUESTIONS:
Retained earnings 15,000,000
Based on the above and the result of your audit, answer
Due to the antiquated terminology and negative balance, the following:
you examine the Capital Surplus account first and find in it 1. The compound adjusting entry to eliminate the Capital
the following entries: Surplus account will include a
Credit a. Debit to Treasury Shares of P750,000
(Debit) b. Debit to Capital Surplus of P1,640,000
Premium on ordinary shares P 2,710,000 c. Credit to Share Premium of P3,910,000
Capital from donated land 1,600,000 d. Credit to Retained Earnings of 1,640,000
Treasury shares (50,000 ordinary shares
2. The total appropriated retained earnings is
at cost) ( 750,000)
a. P2,500,000 c. P3,000,000
Premium on preference shares 300,000
b. P3,250,000 d. P 0
Appropriation for contingencies 2,500,000
Share dividend issued (50%) (2,000,000) 3. The unappropriated retained earnings is
Prior period adjustment (net of income a. P6,250,000 c. P3,750,000
taxes) (1,200,000) b. P7,000,000 d. P8,650,000
Loss from the fire (uninsured), 2020 (1,800,000)
4. The total share premium (additional paid in capital) is
Property dividend distributed ( 600,000)
a. P4,360,000 c. P4,610,000
Cash dividends declared to be paid in
b. P1,600,000 d. P3,860,000
2021 (2,400,000)
Balance (P1,640,000) 5. The total shareholders’ equity is
a. P23,610,000 c. P20,360,000
b. P25,260,000 d. P22,860,000

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EXCEL PROFESSIONAL SERVICES, INC.

PROBLEM NO. 2 PROBLEM NO. 3

Corsair Inc. was organized on January 2, 2019, with The year-end audit of the records of Stamina Farms
authorized share capital of 50,000 shares of 10%, P200 disclosed a shortage in cash amounting to P600,000. The
par value preference, and 200,000 shares of no-par, no treasurer had concealed the fraud by increasing
stated value ordinary. During the first 2 years of the inventories by P300,000, land by P100,000 and accounts
company's existence, the following selected transactions receivable by P200,000.
took place:
Faced with prosecution, the treasurer offered to surrender
2019
6,000 Stamina Farms shares owned by him. The board of
Jan. 2 Sold 10,000 ordinary shares at P16.
directors accepted the offer, with the agreement that the
2 Sold 3,000 preference shares at P216.
treasurer would pay any deficiency between the shortage
Mar. 2 Sold ordinary shares as follows: 10,800 shares
and the book value of the shares, after adjusting for the
at P22; 2,700 shares at P25.
fraud. The corporation would in turn pay the excess, if
Jul. 10 Acquired a nearby piece of land, appraised at
any, of the book value over the shortage.
P400,000, for 600 preference shares and
27,000 ordinary shares. (Preference share
As of December 31, 2020, there were 40,000 ordinary
capital was recorded at P216, the balance
shares issued and outstanding with a par value of P100;
being assigned to ordinary.)
Retained earnings as of January 1, 2020 was P1,600,000
Dec. 16 Declared the regular preference share dividend
and net income from 2020 operations was P1,400,000.
and a P1.50 ordinary share dividend.
28 Paid dividends declared on December 16.
QUESTIONS:
31 The Income Summary account showed a credit
balance of P450,000. Considering the above information, answer the following:
11. What would be the book value per share for purposes
2020
of the agreement?
Feb. 27 Reacquired 12,000 ordinary shares at P19.
a. P175 c. P206
Jun. 17 Resold 10,000 treasury shares at P23.
b. P150 d. None of these
Jul. 31 Resold all of the remaining treasury shares at
P18. 12. How much would the company pay the treasurer, if
Sep. 30 Sold 11,000 additional ordinary shares at P21. any?
Dec. 16 Declared the regular preference share dividend a. P450,000 c. P300,000
and a P0.80 ordinary share dividend. b. P636,000 d. None of these
28 Dividends declared on December 16 were paid.
31 The income summary account showed a credit 13. Assuming further the company distributes the 6,000
balance of P425,000. shares as dividend to the remaining shareholders,
what would be the balance of the Retained earnings as
QUESTIONS: of December 31, 2020?
a. P1,950,000 c. P2,100,000
Based on the above and the result of your audit, answer b. P1,764,000 d. None of these
the following
14. An auditor usually obtains evidence of shareholders’
6. Share capital – ordinary as of December 31, 2020 is equity transactions by reviewing the entity’s
a. P720,000 c. P965,600 a. Canceled stock certificates.
b. P P735,500 d. P966,500 b. Transfer agent’s records.
c. Treasury stock certificate book.
7. Total share premium as of December 31, 2020 is
d. Minutes of board of directors meetings.
a. P38,000 c. P93,600
b. P57,600 d. P95,600 15. The auditor would not expect the client to debit retained
earnings for which of the following transactions?
8. Total retained earnings as of December 31, 2020 is
a. A 4-for 1 share split.
a. P302,250 c. P606,050
b. "Loss" resulting from disposition of treasury shares.
b. P320,250 d. P660,050
c. A 1-for 10 share dividend.
9. Total equity as of December 31, 2020 is d. Correction of error affecting prior year's earnings.
a. P2,498,150 c. P1,892,100
b. P2,388,150 d. P2,376,630 J - end of AP.2808 - J
10. When a client company does not maintain its own
stock records, the auditor most likely will
a. Obtain written confirmation from the transfer
agent and registrar concerning the number of
shares issued and outstanding.
b. Inspect the stock book at year-end and accounting
for all certificate numbers.
c. Review of the corporate minutes for information as
to shares outstanding.
d. Confirm the number of shares outstanding at year-
end with the appropriate state official.

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