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Chapter10 - Answer
Chapter10 - Answer
10 SUBSTANTIVE TESTS OF
INVESTMENTS
10-1. The CPAs would accept a confirmation of the securities on hand from the
custodian in lieu of their personal inspection of the securities after they had
investigated and satisfied themselves as to the standing of the custodian. The
CPAs would probably be satisfied if they found the custodian to be a well-known,
reliable financial institution, completely independent of the client and with
resources substantially larger in amount than the securities of the CPAs’ client that
are on deposit.
10-2. The auditors can make an independent computations of dividends earned during
the year by reference to dividend record books published by investment advisory
services.
10-3. Securities owned by the client may not be on hand at the balance sheet date
because they are held by others for safekeeping, pledged as collateral for loans,
deposited as assurance of performance under contracts, or in the hands of brokers
or others for transfer.
10-4. When the inspection of securities cannot be made for two weeks after the balance
sheet date, the client at the auditors’ suggestion may instruct the bank that the safe
deposit box is not to be opened until the time of the auditors’ inspection. A letter
may be obtained from the bank stating that the box has not been opened between
the balance sheet date and the auditors’ arrival. If the securities are in the client’s
office, it will be necessary to verify any security transactions between the date of
inspection and the balance sheet date and to reconcile the results of the inspection
with the securities owned at the balance sheet date. The count of cash and other
negotiable assets should be coordinated with the inspection of securities.
10-6. (a) (4) Having the securities held in safekeeping by a bank provides strong
internal control because the bank has no direct contact with the
employees responsible for maintaining the accounting record of the
securities and that individual has no access to the securities. Thus the
separation of the custody of securities from the accounting function is
complete.
(b) (1) The investment committee of the board of directors is not involved in the
routine of making buy and sell decisions and can therefore review the
transactions objectively. On the other hand, the chief operating officer,
the controller, and the treasurer may be closely associated on a daily
10-4 Solutions Manual to Accompany Applied Auditing, 2006 Edition
Requirement (a)
COLOR COMPANY
Investment
12.31.06
I N V E S T M E N T
Per Books Adjustments As Adjustments to Other Accounts
Adjusted
Date Transactions Dr Cr Dr Cr Dr Name of Account Dr Cr
(Cr)
200
6
Jan. 3 Purchased 100 shares, National P P 4,500
Motors 4,500
5 Purchased 100 shares, Major 500 (13) - Loss on investment
Electronics 500 on Major (13)
Electronics 500
Mar.31 Cash dividend, National Motors P (1) - Dividend income (1)
50 50 50
Apr. 5 Sold 100 shares, National 4,800 (2) (4,500) Gain on sale of (2)
Motors 300 investment 300
6 Purchased 100 shares, Ace 2,300 2,300
Investment
6 Purchased 100 shares, General 2,400 (3) 2,280 Investment in (3)
Utility 120 rights issues 120
May 1 Received 100 rights issues, 100 (4) - Miscellaneous (4)
General Utility 100 income 100
July 2 Purchased 10 shares, General 130 (5) 190 Investment in (5)
Utility 60 rights issues 60
15 Purchased 50 shares, Acme 1,900 1,900
Laboratories
18 Purchased 20 shares, The 3,000 (6) - Treasury shares (6)
Kalayaan Corp. 3,000 3,000
Aug.15 Sold 10 shares, The Kalayaan 1,550 (7) - Treasury shares (7)
Corporation 1,550 1,500
Dec.8 Received 2 shares, Acme 80 (8) - Additional paid on
Laboratories 80 Capital - (7)
10-10 Solutions Manual to Accompany Applied Auditing, 2006 Edition
TS trans. 50
8 Cash dividend, Acme 20 (9) ( 18) Gain on sale of (9)
Laboratories 2 fractional shares 2
15 Cash dividend, Ace Investment 90 (10) ( 10) Dividend income (10)
80 80
31 Cash dividend, General Utility 12 (11) - Miscellaneous (11)
0 120 income 120
Dividends (12)
receivable 110
Dividend income (12)
110
Loss on expiration
of rights issues (14)
60
Investment in (14)
rights issues 60
_______ _______ _______ _______ ________
_ _
15,03 6,51 2, 3,920 Adjusting Journal
0 0 042 Entry
8,5 1, Unrealized holding
20 878 loss on
Balance P P P P P SAS (Equity) (15)
15,030 15,030 3,920 3,920 6,642 1,142
Securities Fair Value
Adjustment – SAS (15)
1,142
10-11 Solutions Manual to Accompany Applied Auditing, 2006 Edition
Cash 269.50
Requirement (2)
CANADA CORPORATION
Bank Reconciliation
March 31, 2005
Requirement (3)
2005
Mar. 31 Cash 1,600.00
Notes Receivable 1,500.00
Interest Revenue 100.00
c.
Belle Manufacturing Company
Investment in Laribee Industries
December 31, 2006
No. of Shares
12/31/06: Final balance - 1,000 shares P 50,000 < 1,000
1/2/07: Purchased 1,500 shares 75,000 * @ 1,500
12/31/07: Ledger balance 125,000 2,500
AJE No. 1 210,000 _____
12/31/07: Audited balance P335,000 2,500 &
To WP–H
10-14 Solutions Manual to Accompany Applied Auditing, 2006 Edition
AJE 1
Investment in Laribee Ordinary P210,000
Dividend Revenue 40,000
Equity in Income of Unconsolidated
Subsidiary P250,000
To adjust investment account for excess
of Belle’s share of Laribee income over
Laribee dividends.
Dividends:
4/1/07 (P 12,500) “ #
7/1/07 (P 12,500) “ #
10/1/07 (P 15,000) “ #
(P 40,000)
Income:
25% of P1 million P250,000 X
P210,000
Requirement (1)
Analen, Inc.
Income Before Income Taxes from Investment in Bel Company
For the Year Ended December 31, 2006
Requirement (2)
Analen, Inc.
Income Before Income Taxes From Investment in Bel Company
For the Years Ended December 31, 2007, and 2006, Restated
Requirement (1)
July 2005: purchase of investment in trading security:
Investment in trading security: Celebrity Corp. bonds
(P1,000 x 8 x 1.02)................................................. 8,160
Interest receivable (P8,000 x 9% x 2/12;
May 1 – July 1)....................................................... 120
Cash................................................................. 8,280
Requirement (2)
November 2005 - Interest collected:
Cash (P8,000 x 9% x 6/12)............................................ 360
Interest revenue...................................................... 240
Interest receivable................................................... 120
10-16 Solutions Manual to Accompany Applied Auditing, 2006 Edition
Requirement (3)
Dec. 31, 2005: accrue interest on the Celebrity Corp. bonds held
as a trading securities investment:
Interest receivable (P8,000 x 9% x 2/12, Nov. – Dec.). 120
Interest revenue...................................................... 120
* Investment in Bonds:
Original cost.............................................................. P8,000
Fair value................................................................... 7,760
Unrealized loss.......................................................... P 240
Previously recorded unrealized loss.......................... 0
DR<CR> to valuation allowance.............................. P 240
Requirement (4)
Income Statement for 2005:
Interest revenue (P200 + P100)..................................... P 300
Unrealized loss on investment in trading securities.... <240>
Computation:
(P220,000 – P200,000) = P20,000; (P20,000 x 0.30)
÷ 10 yrs. = P600
Computation:
[(P260,000 – P250,000) = P10,000] x 0.30 = P3,000
Requirement (2)
January 1, 2006 – To record sale of 500 shares of Zash shares:
Cash [(500 shares x P18), Zash Corp.......................... 9,000
Long-term investment in equity-basis company:
Zash Corp............................................................ 8,250
Gain on disposal of long-term securities................ 750
Computation:
Balance in investment account (P153,000 + P6,600 –
P2,400 – P600 – P3,000 – P1,500 – P3,000 – P600) ..
= P140,500.
P148,500 x 500/9,000 shares = P8,250
Requirement (3)
Balance sheet:
Investment in equity-basis company
(P153,000 + P6,600 – P2,400 (P153,600 – P1,500 – P3,000
- P600 – P3,000).................. – P600)...................
P153,600 P148,500
* Investment income for 2006 is not known, as no data are given for
this year.
Requirement (1)
Assuming “other income” is zero, then the entire P74 million for 2006 and the
P127 million for 2005 are equity in the income of affiliated companies:
2006 2005
Equity in income of affiliated companies...................................... P 74 P127
Less: Undistributed equity in income of affiliated companies...... 27 84
Maximum amount of dividends that could be received................. P 47 P 43
Substantive Tests of Investments 10-19
If dividends were zero, then all of the equity in income of affiliated companies
would be retained. Since the amount actually retained was P27 million, the
amount of other income is P74 million less P27 million, or P47 million.
Requirement (2)
Investment at December 31, 2006........................................... P1,456
Investment at December 31, 2005........................................... 1,332
Increase in investment in equity.............................................. P 124
Amount of increase resulting from undistributed equity
in income of affiliated companies.................................... 27
Amount of increase (decrease) in investment from other
sources P 97
It appears Del either increased its equity holdings in its affiliated companies, or
made “advances” which had been recorded in the Investments account.
Requirement (3)
Rate of return on average investment in equity-basis companies = P74 / ([P1,332
+ P1,456] / 2) = 0.053%
Requirement (4)
If the investment at equity represents a 50% owned joint venture with no goodwill
or adjustment for book value to fair value of net assets, the total shareholders’
equity (TSE) can be approximated as:
Investment in Affiliate, at equity = 50% x TSE of Affiliate Joint Venture
TSE of Affiliate = P1,456 / 0.50 = P2,912 million.
Knowing the percentage owned allows estimates of the net assets of the equity-
basis companies to be made, assuming there are no adjustments or goodwill
involved.
The unrealized gains and losses resulting from changes in the fair value of
available-for-sale securities are recorded in an unrealized holding gain or loss
account that is reported as other comprehensive income and as a separate
component of shareholders’ equity until realized. Therefore, the following
adjusting entry should be made at the year-end: