Auditing Problems Usl PDF

Substantive Tests of Cash S.Y.
2013-2014
CHAPTER
1
SUBSTANTIVE
TESTS OF
cash
Assertions, Objectives and Procedures for Investments
Auditing Problems
1
Substantive Tests of Cash S.Y. 2013-2014
Assertions Audit Objectives Audit Procedures

Existence or To determine whether cash 1. Obtain analysis of cash balance
occurrence exists at year-end and cash and reconcile the general ledger.
related transactions occur 2. Confirm bank balances as of
within the year. balance sheet date.
3. Perform cash count procedures
To determine that all cash for cash on hand.
balances of the client are 4. Obtain (prepare) bank
reflected on the balance sheet reconciliations as of the balance
at year-end. sheet date.
5. Trace all transfers occurring
between banks near year-end.
Completeness To determine whether all cash 6. Obtain a cutoff bank statement
transactions are recorded in the containing transactions several
proper accounting period. days subsequent to the balance
sheet date. Examine items
returned with the cutoff bank
statements.
7. Prepare proof of cash and
reconcile cash transactions
occurring during a specified
period as they are recorded by
the bank and by the client.
8. Verify the client’s cutoff of cash
receipts and cash disbursements.
Rights and obligations To determine that cash 9. Review bank statements and the
balances are available for use bank replies to confirmation
without restrictions or if with letters.
restrictions, properly indicated
in the balance sheet.
Valuation or allocation To determine if cash is 10. Verify existence of cash in banks
recorded and presented at the under receivership, cash subject
proper amount. to court’s restraining order, in
foreign banks and in foreign
currency. This is in addition to
the foregoing procedures which
will enable the auditor to verify
proper valuation of cash.
Presentation and To determine whether cash is 11. Investigate any checks

disclosure presented in accordance with representing large or unusual
generally accepted accounting payments to related parties.
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principle. 12. Evaluate proper financial

statement presentation and
disclosure of cash.
The Relationships of Cash in the Bank to the various Transaction Cycles are presented below.
1. Capital Acquisition and Repayment Cycle:
Capital Stock- Common Dividends Payable

Redemption Issue of Payment of
of stock stock dividends
Paid-in Capital in Excess

of Par- Common Cash in Bank
Redemption Issue of
of stock stock
2. Acquisition and Payment cycle:
Accounts Payable
Payment
Cash in Bank
3. Sales and Collection Cycle:
Accounts Receivable Cash Discounts Taken

Cash
receipts
Gross Sales Cash in Bank

Cash
sales
4. Payroll and Personnel Cycle:
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Accrued Wages, Salaries, Accrued Payroll

Bonuses, and Commissions Tax Expense
Payment Payment
Withheld Income Taxes

and Other Deductions Cash in Bank
Payment
Types of Cash Accounts

➢ General cash account
➢Imprest accounts
➢ Branch bank account
➢Imprest petty cash fund
➢ Cash equivalents
Relationship of General Cash to Other Cash Accounts
Branch Bank Imprest Payroll

Account Account
General
Cash
Cash Imprest Petty

Equivalents Cash Fund
ILLUSTRATIVE AUDIT CASE 1.1-Composition of Cash and Cash Equivalents
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In connection with your audit of Papasakarin Corporation for the year ended December 30, 2013,
you gathered the following:
Current account at Metrobank 2,000,000

Current account at BPI (100,000)
Payroll Account 500,000
Foreign bank account- restricted (in equivalent pesos) 1,000,000
Postage stamps 1,000
Employee’s post dated check 4,000
IOU from controller’s sister 10,000
Credit memo from a vendor for a purchase return 20,000
Traveler’s check 50,000
Not- sufficient- funds check 15,000
Money order 30,000
Petty cash fund (P4,000 in currency and expense receipts for P6,000) 10,000
Treasury bills, due 3/30/14 (purchased 12/29/13) 200,000
Required:
Based on the above information and the result of your audit; compute for the cash and cash equivalents
that will be reported on the December 30, 2013 statement of financial position.
a. P2,784,000 c. P2,790,000
b. P3,084,000 d. P2,704,000
Answer: A
SOLUTION: Illustrative Audit Case 1.1
Current account at Metrobank P2,000,000

Payroll account 500,000
Traveler’s check 50,000
Money order 30,000
Petty cash fund (P4,000 in currency) 4,000
Total P2,784,000
PAS 7 paragraph 6 defines cash and cash equivalents as follows:
Cash- comprises cash on hand and demand deposits
Cash equivalents- short term, highly liquid investments that are readily convertible to known
amounts of cash and which are subject to an insignificant risk of changes in value. An investment
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normally qualifies as a cash equivalent only when it has a short maturity of, say, three months or
less from the date of acquisition.
Other items not included in cash and cash equivalents should be presented as follows:
• Current account at BPI- Current liabilities (Short term borrowings)
• Foreign bank account (restricted)- Other noncurrent assets
• Postage stamps- Other current assets (Supplies)
• Employee’s post-dated check- Trade and other receivables
• IOU from controller’s sister- Trade and other receivables
• Credit memo from a vendor for a purchase return – Deduction from Accounts payable and
included in the computation of Cost of sales
• Not- sufficient- funds check- Trade and other receivables
• Petty cash fund (expense receipts for P6,000)- Operating expenses
• Treasury bills, due 1/31/14 (purchased 2/1/13)- Other financial assets (Short term investments)
ILLUSTRATIVE AUDIT CASE 1.2- Computation of Unadjusted and Adjusted Balances
In the audit of Cagayan Company’s cash account, you obtained the following information:
The company’s bookkeeper prepared the following bank reconciliation as of November 30, 2013:
Bank balance- November 30, 2013 P90,800
Undeposited collections 5,000
Bank service charges 100
Bank collection of customer’s note (8,000)
Outstanding checks:
Number Amount
1159 P 3,000
1767 5,000
1915 2,000 (10,000)
Book balance- November 30, 2013 P77,900
Additional data are given as follows:

a. Company recordings for December:
Total collections from customers P165,000
Total checks drawn 98,000
b. Bank statement totals for December:

Charges P123,800
Credits 169,000
c. Check no. 1159 dated November 25, 2013 was entered as P3,000 in payment of a voucher for
P30,000. Upon examination of the checks returned by the bank, the actual amount of the check
was P30,000.
d. Check no. 2113 dated December 20, 2013 was issued to replace a mutilated check (no. 1767),
which was returned by the payee. Both checks were recorded in the amount drawn, P5,000, but
no entry was made to cancel check no. 1767.
e. The December bank statement included a check drawn by Isabela Company for P1,500.
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f. Undeposited collections on December 31, 2013- P8,000.
g. The service charge for December was P150 which was charged by the bank to another client.
h. The bank collected a note receivable of P7,000 on December 28, 2013, but the collection was not
received on time to be recorded by Cagayan.
i. The outstanding checks on December 31, 2013, were:

Check No. Amount Check No. Amount
1767 P5,000 2910 P2,300
2856 1,300 2925 4,100
Required:
Based on the above and the result of your audit, determine the following:
1. Unadjusted cash balance per books as of December 31, 2013

a. P152,800 c. P144,900
b. P152,750 d. P165,700
2. Adjusted cash balance as of November 30, 2013
a. P 85,800 c. P 63,800
b. P 58,800 d. P 90,800
3. Adjusted book receipts for December 2013

a. P170,500 c. P172,000
b. P182,000 d. P173,000
4. Adjusted bank disbursements for December 2013

a. P120,150 c. P125,150
b. P 76,150 d. P 98,150
5. Adjusted cash balance as of December 31, 2013

a. P132,650 c. P137,800
b. P137,650 d. P134,650
Answers: 1) A; 2) C; 3) C; 4) D; 5) B
Requirement 1
Unadjusted book balance, 11/30/13 P 77,900
Add unadjusted book receipts:
Collection from customers P165,000
Note collected by bank in Nov. presumed recorded in Dec 8,000 173,000
Total 250,900
Less unadjusted book disbursements:
Checks drawn 98,000
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Bank service charge for Nov. presumed recorded in Dec. 100 98,100
Unadjusted book balance, 12/31/13 P152,800
Requirements 2 to 5
To solve these questions in a structured form and in a lesser time, a Proof of Cash is
recommended.
A proof of cash is an expanded reconciliation in that it includes proof of receipts and disbursements.
Three forms are followed:
a. Adjusted balance method
b. Book to bank method
c. Bank to book method
Cagayan Company
Proof of Cash
For the month ended December 31, 2013
Beginning Receipts Disbursements Ending

Nov. 30 Dec. 31
Balance per bank
statement P90,800 P169,000 P123,800 P136,000
Deposits in transit:
November 30 5,000 (5,000)
December 31 8,000 8,000
Outstanding checks:
November 30 (32,000) (32,000)
December 31 7,700 (7,700)
Bank errors- Dec.
Check of Isabela Co. (1,500) 1,500
BSC charged to
another client 150 (150)
Adjusted bank balance P63,800 P172,000 P 98,150 P137,650
Balance per books P77,900 P173,000 P 98,100 P152,800

Customer’s note
collected by bank:
November 8,000 (8,000)
December 7,000 7,000
Bank service charge:
November (100) (100)
December 150 (150)
Book errors:
Check no. 1767
(mutilated check) 5,000 5,000
Adjusted book balance P63,800 P172,000 P 98,150 P137,650
Bank Reconciliation
A bank reconciliation is a statement which brings into agreement the cash balance per book and
cash balance per bank. It is usually prepared monthly because the bank provides the depositor with the
bank statement at the end of every month.
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Reconciling items
At the end of every month, comparison between the cash records of the depositor and the bank
statement received from the bank will yield the following reconciling items:
1. Book reconciling items:
a) Credit memos
b) Debit memos
c) Errors
2. Bank reconciling items
a) Deposits in transit
b) Outstanding checks
c) Errors
ILLUSTRATIVE AUDIT CASE 1.3- Computation of Unadjusted and Adjusted Balances
The following bank reconciliation is presented for Chris Company for the month of November of
the current year:
Balance per bank statement, November 30 3,600,000

Add: Deposit in transit 800,000
4,400,000
Less: Outstanding checks 1,200,000
Bank credit recorded in error 200,000 1,400,000
Balance per book, November 30 3,000,000
Data per bank statement for the month of December follow:

December deposits (including note collected of P1,000,000 for Chris) 5,500,000
December disbursements (including NSF, P350,000 and service charge, P50,000) 4,400,000
All items that were outstanding on November 30 cleared through the bank in December,
including the bank credit. In addition, checks amounting P500,000 were outstanding and deposits of
P700,000 were in transit on December 31.
Required:
1. What is the cash balance per ledger on December 31?

a. 4,100,000 c. 4,700,000
b. 4,900,000 d. 4,300,000
2. What is the amount of cash receipts per book in December?

a. 5,400,000 c. 5,500,000
b. 4,400,000 d. 6,400,000
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3. What is the amount of cash disbursements per book in December?

a. 3,700,000 c. 3,100,000
b. 3,300,000 d. 3,500,000
Answers: 1) D; 2) B; 3) C
Requirement 1
Balance per bank- November 30 3,600,000
December deposits 5,500,000
Total 9,100,000
December disbursements (4,400,000)
Balance per bank- December 31 4,700,000
Deposit in transit- December 700,000
Outstanding checks- December (500,000)
Adjusted bank balance- December 31 4,900,000
Balance per book- December 31 (SQUEEZE) 4,300,000
Note collected by bank 1,000,000
NSF check (350,000)
Service charge (50,000)
Adjusted book balance 4,900,000
Requirement 2
December bank deposits 5,500,000
Note collected by bank in December (1,00,000)
Deposit in transit- November 30 (800,000)
Deposit in transit- December 31 700,000
December book receipts 4,400,000
Requirement3
December bank disbursements 4,400,000
NSF check in December (350,000)
Service charge in December (50,000)
Outstanding checks- November 30 (1,200,000)
Erroneous bank credit in November (200,000)
Outstanding checks- December 31 500,000
December book disbursements 3,100,000
Proof of cash balance per book- December 31

Balance per book- November 30 3,000,000
December book receipts 4,400,000
December book disbursements (3,100,000)
Balance per book- December 31 4,300,000
ILLUSTRATIVE AUDIT CASE 1.4- Book to Bank Balances Format
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The following information was obtained in connection with the audit of BONUS COMPANY’s cash
account as of December 31, 2013.
Outstanding checks, 11/30/13 P 16,250

Outstanding checks, 12/31/13 12,500
Deposit in transit, 11/30/13 12,500
Cash balance per general ledger 12/31/13 37,500
Actual company collections from its customers during December 152,500
Company checks paid by bank in December 130,000
Bank service charges recorded on company books in December 2,500
Bank service charges per December bank statement 3,250
Deposits credited by bank during December 145,000
November bank service charges recorded on company books in December 1,500
The cash receipts book of December is under-footed by P2,500.
The bank erroneously charged the company’s account for a P3,750 check of another depositor. This
bank error was corrected in January 2014.
Required:
1. How much is the deposit in transit on December 31, 2013?

a. P 5,000 c. P22,500
b. P20,000 d. P17,500
2. The total unrecorded bank service charges as of December 31, 2013 is

a. P 750 c. P1,750
b. P2,250 d. P4,250
3. What is the total book receipts in December?

a. P150,000 c. P155,000
b. P152,500 d. P147,500
4. What is the total amount of company checks issued in December?

a. P130,000 c. P133,750
b. P123,000 d. P126,250
5. What is the total book disbursements in December?

a. P123,750 c. P126,250
b. P128,500 d. P128,750
6. What is the book balance on November 30, 2013?

a. P16,250 c. P37,500
b. P21,250 d. P35,000
7. What is the bank balance on November 30, 2013?
a. P23,000 c. P43,500
b. P18,500 d. P16,250
8. What is the total bank receipts in December?
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a. P120,000 c. P145,000
b. P140,000 d. P150,000
9. What is the total bank disbursements in December?

a. P154,500 c. P129,500
b. P132,500 d. P137,000
10. What is the bank balance on December 31, 2013?

a. P21,500 c. P31,000
b. P26,500 d. P33,250
Answers: 1) B; 2) B; 3) A; 4) D; 5) D; 6) A; 7) B; 8) C; 9) D; 10) B
Requirement 1
Deposit in transit, November 30 P12,500
Add: Company collections in December 152,500
Total 165,000
Less: Deposits credited by bank in December 145,000
Deposit in transit, December 31 P20,000
Requirement2
Bank service charges per December bank statement P 3,250
Less: December bank service charges recorded on company
books in December (P2,500 - P1,500) 1,000
Unrecorded December bank service charges P 2,250
Requirement3
Actual company collections in December P152,500
Less: Under-footing of December cash receipts book 2,500
Book receipts in December P150,000
Requirement4
Outstanding checks, December 31 P 12,500
Add: Checks paid by bank in December 130,000
Total 142,500
Less: Outstanding checks, November 30 16,250
Checks issued in December P126,250
Requirement 5
Checks issued in December (see no. 4) P126,250
Add: Bank service charges recorded in December 2,500
Book disbursements in December P128,750
Requirement6
Book balance, December 31 P 37,500
Add: Book disbursements in December (see no. 5) 128,750
Total 166,250
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Less: Book receipts in December (see no. 3) 150,000

Book balance, November 30 P 16,250
BONUS Company
Proof of Cash
For the month ended December 31, 2013

Nov. 30 Dec. 31
Book balances P16,250 P150,000 P128,750 P37,500
Outstanding checks:
November 30 16,250 16,250
December 31 (12,500) 12,500
November 30 (12,500) 12,500
December 31 (20,000) (20,000)
Bank service charges:
November 30 (1,500) (1,500)
December 31 2,250 (2,250)
Underfooting of December
book receipts 2,500 2,500
Erroneous bank charge in
December 3,750 (3,750)
Bank balances P18,500 P145,000 P137,000 P26,500
Requirements 7-10
7. Bank balance, November 30, 2013 P 18,500

8. Total bank receipts in December P145,000
9. Total bank disbursements in December P137,000
10. Bank balance, December 31 P 26,500
ILLUSTRATIVE AUDIT CASE 1.5-Bank to Book Balances Format
Shown below is the May 31, 2013, bank reconciliation prepared by your client’s staff.
RECONCILIATION
May 31, 2013
Bank balance P652,000
Add: Deposit in transit 10,000
Total P662,000
Less: Outstanding checks
No. 640 P 10,000
652 8,000
653 2,000 20,000
Adjusted bank balance P642,000
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Book balance
Add: Proceeds of note receivable
collected in May P 70,000
Deposit on May 31 not recorded
on books until June 2,000 72,000
Total P642,800
Less: Bank service charge 800
Adjusted book balance P642,000
The June 2012 bank statement is shown below:
Pasig Bank
Period covered: May 31, 2013-June 30, 2013
Account No.: 0096996
Date Checks Deposits

June 1 8,000 10,000
June 8 2,000
June 11 14,000 20,000
June 13 1,000 DM 1,000
June 16 4,000
June 21 12,000 56,000
June 27 18,000
June 29 1,000 EC 1,000 EC
June 30 200 SV
June 30 3,000 DM
SV- Service Charges DM- Debit Memo

EC- Error Corrected CM- Credit Memo
The paid checks accompanying this bank statement (all clearing in June) are the following:
No. 652 P8,000 No. 654 P14,000 No. 657 P12,000
No. 653 P2,000 No. 655 P 4,000 No. 658 P18,000
The checks register reveals that the last check issued in June is No. 659 for P5,000 and that check no.
656 is for P2,600.
Cash received for the period June 22 through June 30 of P70,000 was deposited in the bank on July 1.
The debit memos on June 13 and June 30 represent customer’s NSF checks returned by the bank. The
June 13 NSF was immediately re-deposited without entry. The June 30 NSF check was re-deposited on
July 1 without entry.
Required:
1. What is the total bank receipts in June?

a. P87,000 c. P77,000
b. P88,000 d. P78,000
2. What is the total bank disbursements in June?
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a. P59,200 c. P58,200
b. P58,000 d. P63,200
3. What is the balance per bank statement on June 30, 2013?

a. P676,800 c. P732,400
b. P627,200 d. P729,200
4. What is the total book receipts in June?

a. P88,000 c. P732,400
b. P220,000 d. P729,200
5. What is the total book disbursements in June?

a. P53,000 c. P56,400
b. P57,400 d. P63,200
6. What is the book balance on June 30, 2013?

a. P732,200 c. P732,400
b. P729,200 d. P676,800
Answers:1) B; 2) D; 3) A; 4) D; 5) C; 6) C
Requirement 1
Bank receipts in June (arrived at by footing the Deposits column of the
bank statement) P88,000
Requirement 2
Bank disbursements in June (arrived at by footing the Checks column of
the Bank statement) P63,200
Requirement 3
Bank balance, May 31 P652,000
Add: Bank receipts in June 88,000
Total 740,000
Less: Bank disbursements in June 63,200
Bank balance, June 30 P676,800
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Proof of Cash
For the month ended June 30, 2013

May 31 June 30
Bank balances P652,000 P88,000 P63,200 P676,800
May 31 10,000 (10,000)
June 30 70,000 70,000
Outstanding checks:
May 31 (20,000) (20,000)
June 30 17,600 (17,600)
Bank service charges:
May 31 800 800
June 30 (200) 200
Bank collection in May (70,000) 70,000
May deposit recorded by
the company in June (2,000) 2,000
NSF checks
Already redeposited ( 1,000) (1,000
Not yet redeposited (3,000) 3,000
Bank error corrected on
the same date (1,000)
Book balances P570,800 P218,000 P56,400 P732,400
Requirements 4-6
4. Total book receipts in June P218, 000

5. Total book disbursements in June P 56, 400
6. Book balance on June 30, 2013 P732, 400
ILLUSTRATIVE AUDIT CASE 1.6- Computation of Cash Shortage
The following table summarizes the cash receipts and disbursements of LOVE COMPANY for the last
six months of 2013:
Month Receipts Disbursements

July P102,000 P60,000
August 70,000 110,000
September 120,000 68,000
October 172,000 92,000
November 260,000 122,000
December 280,000 180,000
P964,000 P 668,000
Additional information:
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1. Bank balance, July 1, 2013 P200, 000

2. Bank balance, December 31, 2013 524,000
3. Outstanding checks, December 31, 2013 (No checks were outstanding on July 1) 42,000
4. Undeposited receipts, December 31, 2012 (included in the Dec. receipts) 24,000
5. Bank deposits, July 1 through December 31 914,000
Required:
What is the total shortage?
a. P0 c. P30, 000
b. P76, 000 d. P66,000
Answer: D

Book balance, July 1 (see note 1) P 200,000
Add: Total book receipts as corrected (see note 2) 1,004,000
Total 1,204,000
Less: Total book disbursements as corrected (see note 2) 632,000
Corrected book balance, December 31 P 572,000
Bank balance, December 31 P524, 000

Add: Undeposited receipts 24,000
Total P548,000
Less: Outstanding checks 42,000
Adjusted bank balance P506,000
Corrected book balance (accountability) (572,000)
Cash shortage P(66,000)
NOTES:
1. Because there were no book and bank reconciling items on July 1, the bank balance on that date
was also the cash balance per books.
2. The receipts column of the table of cash receipts and disbursements is underfooted by P40,000
(P1,004,000 correct total – P964,000) while the di8sbursements column is overfooted by P36,000
(P668,000 - P632,000 correct total).
ILLUSTRATIVE AUDIT CASE 1.7
The balance sheet for the IAM Corporation on December 31, 2012, includes the following cash
and receivables balances.
Cash-national security banks P45,000

Currency on hand 16,000
Petty cash fund 1,000
Cash in bond sinking fund 15,000
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Notes receivable (including notes discounted

with recourse,P15,500) 36,500
Accounts receivable P85, 600
Less: Allowance for bad debts 4,150 81,450
Interest receivable 525
Current liabilities reported in the December 3 1, 2012, balance sheet included:

Obligation of discounted notes receivable P15, 000
Transaction during 2013 included the following:
a. Sales on account were P767, 000.
b. Cash collected on accounts of including totaled P576, 500, including accounts of P93,
000 with cash discounts of 20%.
c. Notes received in settlement of accounts totaled P82,500.
d. Notes receivable discounted as of December 31, 2012 were paid at maturity with the
exception of one P3,000 note on which the company had to pay the bank P3,000 note on
which the company had to pay the bank P3,090, which included interest and protest fees.
It is expected that recovery will be made on this note early in 2014.
e. Customer notes of P58,500 were discounted with recourse during the year, proceeds from
their transfer being P58,500. (All discounting transactions were recorded as loans). Of
this total, P48,000 matured during the year without notice of protest.
f. Customer accounts of P8, 720 were written off the year as worthless.
g. Recovers of bad debts written off in prior years were P2,020.
h. Notes receivable collected during the year totaled P27,000 and interest collected was P2,
450.
i. On December 31, accrued interest on notes receivable was P630.
j. Uncollectible accounts are estimated to be 5% of the December 31, 2013, Accounts

Receivable balance.
k. Cash of P35, 000 was borrowed from National Security Bank with accounts receivable of
P40, 000 being pledged on the loan. Collections of P19, 500 had been made on these
receivables [included in the total given in transaction (b)], and this amount was applied
on December 31, 2011, to payment of accrued interest on the loan Of P600, and the
balance to partial payment of the loan.
l. The petty cash fund was reimbursed (meaning that cash was removed from the bank
account and placed in the petty cash fund) based on the following analysis of expenditure
vouchers:
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Travel expense P 112

Entertainment expense 78
Postage expense 93
Office supplies expense 173
Cash short and over (a revenue account) 6
m. Cash of P3, 000 was added to a bond retirement fund.
n. Currency on hand at December 31, 2013, was P12, 000.
o. Total cash payments for all expenses during the year were P680, 000. Charge to General
Expenses.
Required:
The total cash and cash equivalents to be shown in the Current Assets section of the balance sheet
as December 31, 2013 is
a. P45, 500.
b. P56, 000.
c. P57, 430.
d. P56, 430.
Answer: C
SOLUTION: Illustrative Audit Case 1.7-AM Corporation

Journal Entries:
a. Accounts Receivable 767,000
Sales 767,000
b. Cash 576, 500
Sales Discounts (P93, 000x0.02) 1,800
Accounts Receivable 578,360
c. Notes Receivable 82,500
d. Notes Receivable Discounted 15,500

Notes Receivable 15,500
Notes Receivable – Past Due 3, 090

Cash 3,090
e. Cash 58,500
Notes Receivable Discounted 58, 500
Notes Receivable Discounted 48,000

Notes Receivable 48, 000
f. Allowance for Bad Debts 8,720

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g. Accounts Receivable 2, 020

Allowance for Bad Debts 2, 020
Cash 2, 020
Accounts Receivable 2, 020
h. Cash 29,450
Notes Receivable 27,000
Interest Receivable 525
Interest Revenue 1,925
i. Interest Receivable 630

Interest Revenue 630
j. Bad Debt Expense 11,701

Allowance for Bad Debts 11,701
*Balance in Accounts Receivable, Dec. 31, 2011:
P85, 600 + P767, 000- P578,360 – P82, 500- P8,720 + P2, 020 – P2,020= P183,020
Required allowance:
(0.05 x P183, 020) P 9,151 (credit)
Balance in allowance:
(P4, 150 – P8, 720 + P2, 020) 2,550 (debit)
Required credit adjustment P11,701
k. Cash 35,000
Payable to National Security Bank 35, 000
Payable to National Security Bank 18, 900

Interest expense 600
Cash 19, 500
l. Travel Expense 112

Entertainment Expense 78
Postage Expense 93
Office Supplies Expense 173
Cash Short and Over 6
Cash 450
m. Cash in Bond Retirement Fund 3,000

Cash 3, 000
n. Cash 4,000
Currency on Hand
(P16, 000 – P12, 000) 4,000
Summary of Cash:
Cash-First Security Bank P44,430*
Auditing Problems
20
Currency on hand 12,000

Petty cash 1,000
Total cash P57,430
o. General Expenses 680,000

Cash 680,000
*Cash-National Security Bank, December 31, 2012

P45, 000 + P576, 500-P3, 000 + P2, 020 +P29, 459 +P35, 000- P19, 500 – P450-P3, 000+P4, 000
-P680, 000=P44, 430
ILLUSTRATIVE AUDIT CASE 1.8 -Computation of Cash Shortage
JVL COMPANY, organized on March 1, 2013, has a very poor internal control system. The
company’s cashier is also its accountant. After 9 months of operations, the company’s manager suspects
that the cashier-accountant has been misappropriating company collections. You have been engaged to
audit the company’s accounts to determine the extent of fraud, if any.
You started the audit in November 15. On that date, the cash on hand per your surprise count was
P5,140. Also on that date, the bank confirmed that the balance of the company’s current account was
P26,328. Your examination of the records reveals that a check for P1852 was outstanding on November
15. The company’s mark-up is 40% of sales.
Further examination of the company’s records reveals the following balances at November 15, 2013.
Ordinary share capital P 300,000

Share premium 20,000
Real property purchased for cash 200,000
Mortgage payable 80,000
Furniture and fixtures (of the acquisition cost, P6,000 remains unpaid
as of Nov. 15) 29,000
Notes payable-bank 32,000
Accounts payable-trade 46,284
Expenses paid (excluding purchases) 60,756
Merchandise inventory at cost 93,920
Accounts receivable-trade 85,380
Total sales 340,000
Required:
1. How much was paid for inventory purchases?

a. P157,716 c. P183,636
b. P293,716 d. P251,636
2. How much was collected from customers?
Auditing Problems
21
a. P118,620 c. P50,620
b. P254,620 d. P340,000
3. How much is the cashier’s accountability at November 15, 2013?

a. P131,228 c. P145,228
b. P 83,228 d. P151,228
4. What is the adjusted bank balance as of November 15, 2013?

a. P121,612 c. P127,612
b. P101,612 d. P206,992
Answers: 1) D; 2) B; 3) D; 4) C; 5) A
Requirement 1
Cost of sales (P340,000 total sales x 60%) P204,000
Add: Merchandise inventory, November 15 P 93,920
Purchases 297,920
Less: Accounts payable- trade, November 15 46,284
Payments for purchases P251,636
Requirement 2
Sales P340,000
Less: Accounts receivable –trade, November 15 85,380
Collection from sales P254,620
Requirement3
Cashier’s accountability:
Receipts:
Issuance of ordinary shares (P300,000+P20,000) P320,000
Mortgage payable 80,000
Note payable-bank 32,000
Collections from sales (see no. 2) 254,620
Total P686,620
Disbursements:
Real property P 200,000
Furniture and fixtures
(P29,000-P6,000) 23,000
Expenses 60,756
Purchases (see no. 1) 251,636 P532,392
Cash balance P151,228
Requirement 4
Bank balance, Nov. 15 P 26,328
Add: Undeposited collections 5,140
Total 31,468
Less: Outstanding checks 1,852
Adjusted bank balance, Nov. 15 P 29,616
Auditing Problems
22
Requirement 5
Cashier’s accountability (see no.3) P151,228
Cash accounted (see no. 4) (29,616)
Cash shortage as of Nov. 15, 2012 P121,612
ILLUSTRATIVE AUDIT CASE 1.9- Composition of Fund
A surprise count of the Salvatore Company’s imprest petty cash fund, carried on its records at
P5,000 was made on November 10, 2013.
The company acts as agent for an express company in the issuance and sale of money orders.
Blank money orders are held by the cashier for issuance upon payment of the designed amounts by
employees. Settlement with the express company is made weekly with its representative, who calls at the
Salvatore Co. office. At that time, he collects for orders issued, accounts for unissued orders, and leaves
additional blank money orders, serially numbered.
The count of the items presented by the cashier as composing the fund was as follows:
Currency (bills and coins) P 22,000

Cashed checks 5,000
Vouchers (made out in pencil and signed by recipients) 7,400
NSF checks (dated June 10 and 15, 2013) 2,600
Copy of petty cash receipt vouchers:
Return of expense advance P2,000
Sale of money orders (No. A11-20) 1,000 3,000
Blank money orders claimed to have been purchased for P100

each from the express company (No. A21-29) 6,000
At the time of the count, there were also on hand the following:
Unissued money orders, No. A30-40

Unclaimed wage envelopes (sealed and amounts not shown)
The following day, the custodian of the fund produced vouchers aggregating P4,000 and
explained that these vouchers had been temporarily misplaced the previous day. They were for wage
advances to employees.
Required:
1. Show the proper composition of the fund at November 10, 2013
Salvatore Company
Auditing Problems
23
Proper composition of the Fund, 11/10/13
Currency and coins P 22,000

Cashed checks 5,000
Vouchers 7,400
NSF checks 2,600
Total P37,000
Less: Petty cash receipt vouchers
Return of expense advance P2,000
Sale of money orders P1,000 P 3,000
Balance of Fund per count P 34,000
Balance of Fund per records 50,000
Shortage (P16,000)
The cashier attempted to conceal the shortage by:
1. Adding instead of deducting the cash received thereby overstating

the accounting of the fund by 6,000
2. Submitting blank money orders claimed to have been purchased 6,000
3. Submitting additional vouchers claimed to have been misplaced 4,000
ILLUSTRATIVE AUDIT CASE 1.10- Computation of Cash Shortage/ Overage
A count of the undeposited receipts under the custody of V. Vera, cashier of Pasado Company, on
October 1, 2013, 9:00 a.m., showed the following composition:
Currency and coins

Checks:
Date Payee Drawer Amount
2/28/13 Cash V. Vera P1,000
9/29/13 Pasado Co. Bagsac Co. 3,400
9/30/13 Pasado Co. C. Bill 2,500
9/30/13 Meralco Pasado Co. 1,900
Postage and documentary stamps
Paid vouchers covering transportation expenses
Customer’s check returned by bank, NSF
Money in envelop with list of contributors to Sweepstakes pool
IOUs from employees
Total
Required:
If the cashier’s accountability is P24,500, the amount of overage/shortage on October 1, 2013 was
a. P2,750 overage c. P3,850 shortage
b. P2,450 shortage d. None of these
Auditing Problems
24
Answer: D
Pasado Company
Currency and coins P14,750

Postage and documentary stamps 120
Checks:
Date Payee Drawer Amount
9/29/13 Pasado Co. Bagsac Co. P3,400
9/30/13 Pasado Co. C. Bill 2,500 P 5,900
Paid vouchers covering transportation expenses 1,200

IOU’s 500
Total per count P22,470
Accountability 24,500
Cash shortage (P2,030)
ILLUSTRATIVE AUDIT CASE 1.11– Cash Count
Mila Lim is the cashier of the Plaridel Glass Company. As representative of the
Reyes, Tan and Associates, CPAs, you were assigned to verify her cash hand in the morning
of January 4, 2012. You began to count at 9:00 A.M. in the presence of Miss Lim. In the
course of your counting you found currencies in paper bills and coins together with checks,
vouchers and other items, which are mentioned below:
Bills
2 fifties, 9 twenties, 13 tens
Coins
₱ 5.00 5 loose
1.00 - 5 rolls and 74 loose
0.25 - 10 rolls and 32 loose (50 pieces to a roll)
Checks
Maker Date Payee Amount
Jose Cruz, Asst. Manager 12/23/11 Plaridel Glass Co. ₱ 60.00

Mila Lim, Cashier 12/26/11 Plaridel Glass Co. 40.00
I.O.Us
A. David, janitor 12/20/11 ₱ 35.00

R. Tirao, clerk 12/22/11 25.00
Pedro Munar, bookkeeper 12/24/11 15.00
Auditing Problems
25
Petty Cash Vouchers for Replenishment
Payee Date Amount Charged Amount
L. Bilbao, messenger 12/16/11 Advance to Employee ₱ 10.00

Rosario & Co. 12/17/11 Supplies 14.50
Victory Liner 12/18/11 Freight-in 18.25
Bureau of Post (stamps) 12/18/11 Supplies 30.00
A. Vallo, carpenter 12/20/11 Repairs 45.00
B. Tello 12/21/11 Miscellaneous Exp. 15.40
Your investigation also disclosed the following:
1. The balance of the petty cash fund per books is ₱ 900.
2. Cash sales of January 2, 2012 amounted to ₱ 865 per sales record, while Cash Receipts Book
and deposit Slip showed that only ₱ 765 was deposited in the bank on January 3, 2012.
3. The following employees’ pay envelopes had been opened and the money removed. Each
envelope was marked “unclaimed.”
N. Roy ₱ 33.25
G. Gloria 24.75
Required:
1. Prepare working papers showing your cash count.

2. Prepare necessary adjusting journal entries without explanation in the books of the
company.
Requirement 1
Plaridel Glass Company

Cash Count Sheet
1-4-12
Bills Denomination Quality Amount Total

₱ 50 2 ₱ 100.00
20 9 180.00
10 13 130.00 ₱ 410.00
Fractional denominations
and coins
5.00 5 ₱ 25.00
1.00 74 7 4.00
0.25 282 70.50
0.10 515 51.50
0.05 649 32.45 253.45
Auditing Problems
26
Total Bills & Coins ₱ 663.45
Cash Items:
Check for deposit
Date Maker Payee
12/23/12 J. Cruz Plaridel Glass ₱ 60.00
Co.
12/26/12 M. lim Plaridel Glass 40.00 100.00
Co.
Unreplenished Voucher
Date Payee Particulars
12/19/12 Rosario & Co. Supplies ₱ 14.50
12/18/12 Victory Liner Freight-in 18.25
12/18/12 Bureau of Post Supplies 30.00
12/20/12 A. Vallo Repairs 45.00
12/21/12 B. Tello Miscellaneous 15.40 123.15
Advance or IOU’s
Date Payee
12/16/12 L. Bilbao ₱ 10.00
12/20/12 A. David 35.00
12/22/12 R. Tirao 25.00
12/24/12 Pedro Munar 15.00 85.00
Total Amount of fund per count ₱ 971.60
Total amount of fund per books or receipts:

Petty Cash Fund per ledger ₱ 900.00
Unclaimed Wages per opened envelops 58.00
Undeposited collections
Cash Sales 1/2/12 ₱ 865.00
Less: Amount deposited 765.00 100.00
₱1,056.00
Shortage ₱ (86.40)
I certify that the above fund of ₱ 971.60 was counted in my presence by (name of auditor) of
Reyes, Tan and Associate, CPAs on January 4, 2012 at 9:00 A.M. was returned to me intact.
MILA LIM
____________________
Cashier
Requirements 2
Adjusting Journal Entries:
1. Supplies expenses (₱ 14.50 + ₱ 30) ₱ 44.50

Freight-in 18.25
Repairs and maintenance 45.00
Petty Cash Fund 15.40
Auditing Problems
27
123.15
2. Advance to employees 85.00

Petty Cash 85.00
3. Cash in bank 58.00

Salaries payable 58.00
4. Accounts receivable-Cashier 86.40

Petty Cash Fund 86.40
ILLUSTRATIVE AUDIT CASE 1.12– Computation of Cash
The Silver Company’s internal control over its cash transactions is very weak. Actually, the
company’s cash position at December 31, 2012 were as follows:
The cash book showed a balance of ₱ 15,000, which include cash on hand. A credit of ₱ 150 on
the bank’s records did not appear on the company’s books. The bank statement showed a balance of
₱ 12,300; and the outstanding checks were: 0100 - ₱ 120; 0201 - ₱ 100; 0300 - ₱230; 1501 - ₱ 110;
1510 - ₱ 140 and 1515 - ₱ 150.
The cashier removed all of the cash on hand in excess of ₱ 3,000 and then prepared the following
reconciliation:
Balance per books, Dec. 21, 2012 ₱ 15,000

Add: Outstanding checks:
No. 1501 ₱ 110
1510 140
1515 150 300
Deduct – Cash on hand ₱ 15,300
Balance per bank, Dec. 31, 2012 3,000
Deduct – Unrecorded credit ₱ 12,300
True cash, Dec. 31, 2012 150
₱ 12,150
Required:
1. The cash shortage if any, is

a. ₱ 300. d. ₱ 700.
b. ₱ 400. e. None of the above
c. ₱ 500.
2. A correct reconciliation will show that the cahier’s accountability for cash on hand is
a. ₱ 3,300. d. ₱ 3,700.
b. ₱ 3,400. e. None of the above
c. ₱ 3,500.
Auditing Problems
28
3. The adjusted cash in bank balance for the balance sheet of December 31, 2012 is
a. ₱ 11,300. d. ₱ 11,850
b. ₱ 11450. e. None of the above
c. ₱ 11,600.
Answers:1)D; 2) D; 3)B
Unadjusted book balance ₱ 15,000

Add: Unrecorded bank credit 150
Total Accountability ₱ 15,150
Unadjusted bank balance ₱ 12,300
Less: Outstanding checks:
No. 0100 ₱ 120
0201 100
0300 230
1501 110
1510 140
1515 150 850
Adjusted bank balance (3) ₱ 11,450
Cash on Hand to be accounted for (2) ₱ 3,700

Actual Cash on Hand 3,000
Cash Shortage (1) ₱ 700
Auditing Problems
29
Substantive Tests of Receivables and Sales S.Y. 2013-2014
CHAPTER
SUBSTANTIVE
TESTS OF
receivables and
sales
Assertions, Objectives and Procedures for Receivables and Sales
Auditing Problems
30

Existence or occurrence To determine that receivables 1. Obtain schedule of aged trade
exist and represent bona fide accounts receivable and notes
Rights and obligations obligations owed to the receivable schedule and reconcile
company as of balance sheet to ledgers.
date. 2. Confirm receivables to debtors
3. Inspect notes on hand
4. Perform analytical procedures to
determine whether recorded sales
and receivables balances appear
reasonable.
Completeness To determine that all 5. Test cut-off of sales and sales
transactions relative to return to determine whether
receivables have been recorded receivables are recorded in the
in the proper accounting proper accounting period.
period.
I. Valuation To determine that receivables 6. Review collectability of
are recorded and presented at receivables and determine the
the proper accounts in adequacy of allowance for
accordance with PAS/PFRS. doubtful accounts.
7. Recalculate the interest income
from the notes receivable.
Presentation and To determine that receivables 8. Evaluate financial statement
disclosures are properly presented and presentation and disclosure of
classified in the balance sheet. receivables.
9. Obtain written client
representations regarding pledge,
discount or assignment of
receivable, and about receivables
from officers, directors, affiliates
or other related parties.
Existence or occurrence To determine that receivables 10. Obtain schedule of aged trade
exist and represent bona fide accounts receivable and notes
Rights and obligations obligations owed to the receivable schedule and reconcile
company as of balance sheet to ledgers.
date. 11. Confirm receivables to debtors
12. Inspect notes on hand
13. Perform analytical procedures to
determine whether recorded sales
and receivables balances appear
reasonable.
ILLUSTRATIVE AUDIT CASE 2.1 – Classification of Receivables
Auditing Problems
31
Your audit disclosed that on December 31, 2010, the accounts receivable control account of
Alilem Company had a balance of P2,865,000. An analysis of the accounts receivable account showed the
following:
Accounts known to be worthless P 37,500

Advance payments to creditors on purchase orders 150,000
Advances to affiliated companies 375,000
Customers’ account reporting credit balances arising from sales return (225,000)
Interest receivable on bonds 150,000
Other trade accounts receivable – unassigned 750,000
Subscription receivable due in 30 days 825,000
Trade accounts receivable – assigned (Alilem Company’s
equity in assigned accounts is 150,000) 375,000
Trade installment receivable due 1 – 18 months, including
unearned finance charges of 30,000 330,000
Trade receivables from officers due currently 22,500
Trade accounts on which post-dated checks are held (no entries
were made on receipts of checks) 75,000
Required:
1. The trade accounts receivable as of December 31, 2010 is

a. P1,147,500 c. P1,485,000
b. P1,522,500 d. P1,447,500
2. The net current trade and other receivables as of December 31, 2010 is
a. P2,647,500 c. P2,272,500
b. P2,610,000 d. P1,822.500
3. How much of the foregoing will be presented under noncurrent assets as of December 31, 2010.
a. P1,200,00 c. P525,000
b. P 375,000 d. P 0
Answers: 1) A; 2) A; 3) B
Current Receivables – measured at fair value (face value)

1. All trade receivables
➢ Accounts receivable (assigned/unassigned or pledged/not)
➢ Initially measured at face value
➢ Subsequent – net realizable value (net of allowance for freight, sales return, sales discount
and allowances, and bad debts)
➢ Credit balance – current liability (if not material=deduction to Account Receivable)
2. Notes receivable (customers’ note/traded)
3. Other trade receivables
Non-traded receivables that are collectible within one year after the balance sheet date
Auditing Problems
32
4. Advance payments to creditors on purchase order/supplies

5. Accrued interest receivable
6. Dishonored Note Receivable – matured and not paid (may also be included as part of Accounts
Receivable plus interest)
7. Other receivables that meet the criteria of current receivable
8. Subscription receivables that are collectible within 1year after the BSD
9. Current portion of long term receivables
Non-current receivables – measured at Fair value (present value)

1. Long term receivables
a. Interest bearing – face
b. Non-interest bearing
➢ initially at present value (discounted value)
➢ subsequent at amortized cost (effective interest method)
2. Loans Receivable
➢ Initially at fair value plus transaction cost
Transaction cost
• origination fee (deduct) – fee charged by the bank against borrower
–unearned interest income and over the term of the loan
• direct origination cost (add) – deferred and amortized over the term of the loan
➢ Subsequent at amortized cost (effective)
3. Other Noncurrent receivables such as:
a. advances to affiliates
b. advances to officers and employees
c. subscription receivable (silent)
Requirement 1
Other trade accounts receivable – unassigned P 750,000
Trade accounts receivable – assigned (Alilem Company’s
equity in assigned accounts is 150,000) 375,000
Trade installment receivable due 1 – 18 months, including
Unearned finance charges of 30,000 300,000*
Trade receivables from officers due currently 22,500
Trade accounts on which post-dated checks are held (no entries
were made on receipts of checks) 75,000
Trade accounts receivable P1,522,500
Requirement 2
Trade accounts receivable P1,522,500
Advance payments to creditors on purchase orders 150,000
Interest receivable on bonds 150,000
Subscription receivable due in 30 days 825,000
Current trade and other receivables P2,647,500
Requirement 3
Advances to affiliated companies P375,000
* Unearned finance charge should not be included in the receivables section (disclosure only)
Auditing Problems
33
ILLUSTRATIVE AUDIT CASE 2.2- Audit of Bad Debt Reporting
Cabugao Company provides for doubtful accounts based 3% of credit sales. The following data
are available for 2010.
Credit sales during 2010 P21,000,000

Allowance for doubtful accounts 1/1/10 170,000
Collection of accounts written-off in prior years
(customer credit was re-established) 80,000
Collection of accounts written-off as uncollectible during 2010 300,000
Required:
1. What is the balance in allowance for doubtful accounts at December 31, 2010?
a. P630,000 c. P500,000
b. P420,000 d. P580,000
Answer: D
Allowance for bad debts, beginning 170,000

Collection of accounts written-off in prior years 80,000
Collection of accounts written-off as uncollectible during 2010 (300,000)
Doubtful Account Expense (P12,000,000 x 3%) 630,000
Allowance for bad debts, end P580,000
METHODS OF ESTIMATING DOUBTFUL ACCOUNTS

✓ % of Accounts Receivable – the computed amount will be the ending balance of allowance for
doubtful accounts
(REQUIRED ALLOWANCE)
✓
✓ Aging of Accounts Receivable – required allowance
% of sales – provision or it is the amount to be expensed for the period
METHODS OF ACCOUNTING FOR BAD DEBTS

DIRECT WRITE-OFF ALLOWANCE METHOD
Requires recognition of bad debt loss only Requires recognition of bad debt loss if the
when the accounts are worthless accounts are doubtful of collection
(probable and can be estimated
Entry: Entry:
Doubtful Accounts Expense xx Doubtful Accounts Expense xx
Accounts Receivable xx Allowance for Bad Debts xx
NOTE:
Auditing Problems
34
DOUBTFUL ACCOUNT EXPENSE is considered as:

✓ Distribution cost –if granting of credit and collection is under the charge of the sales manager
✓ Administrative cost –if under the charged of officer other than sales manager
ILLUSTRATIVE AUDIT CASE 2.3 – Analysis of Accounts Receivable and Related Accounts
You were able to obtain the following information from your audit of Magsingal Corporation’s
accounts receivable and allowance for doubtful accounts:
From the general ledger you noted that the accounts receivable has a balance of P848,000 as of December
31, 2010. Below is a transcript of the allowance for doubtful accounts:
Debit Credit Balance
January 1 –balance P20,000
July 31 –write-off P16,000 4,000
December 31 –provision P48,000 52,000
The summary of the subsidiary ledger as of December 31, 2010 was totaled as follows:
Debit balances:
Under one month 360,000
1-6 months 368,000
Over 6 months 152,000
880,000
Credit balances:
Alien 8,000 - OK; additional billing in Jan., 1, 2011
T. Twister 14,000 - should have been credited to Apol*
Dee Lah 18,000 - advances on sales contract
40,000
*account is one to six months classification
The customers’ ledger is not in agreement with the accounts receivable control. The client
requested you to adjust the control account to the subsidiary ledger after corrections are made.
It is agreed that 1% is adequate for accounts under one month. Accounts 1-6 months are expected
to require a reserve of 2%. Accounts over six months are analyzed as follows:
Definitely bad 48,000

Doubtful (estimated to be 50% collectible) 24,000
Apparently good, but slow (estimated to be 90% collectible) 80,000
Total 152,000
Required:
1. How much is the adjusted balance of AR as of December 31, 2010?

a. 818,000 c. 832,000
b. 846,000 d. 826,000
2. How much is the adjusted balance of allowance for doubtful accounts as of December 31, 2010?
a. 30,680 c. 30,960
b. 31,240 d. 30,760
3. How much is the doubtful accounts expense for the year 2010?
Auditing Problems
35
a. 74,680 c. 74,960
b. 75,240 d. 74,760
Answers: 1) A; 2) A; 3) A

Requirement 1
GL SL
DEBIT CREDIT 0-1 1-6 OVER 6
Unadjusted balances 848,000 880,000 40,000 360,000 368,000 152,000
Add(deduct):
Accounts w/ credit balances 26,000 (14,000) (40,000) (14,000)
Definitely uncollectible accts (48,000) (48,000) (48,000)
Unallocated difference (8,000) ________ _______ _______ _______ _______
Adjusted balances 818,000 818,000 0 360,000 354,000 104,000
Requirement 2
Account classification Adjusted balance Rate Required allowance

0-1 mo. 360,000 1% 3,600
1-6 mos. 354,000 2% 7,080
Over 6 mos. 104,000 24,000-50% 12,000
80,000-10% 8,000
30,680
Requirement 3
ALLOWANCE FOR DOUBTFUL ACCOUNTS

Write off 16,000 Beg. Bal. 20,000
Provision 48,000
Adjustment 26,680 (squeezed)
Required allowance 30,680
Provision 48,000
Add: adjustment 26,680
Total bad debt expense 74,680
ILLUSTRATIVE AUDIT CASE 2.5- Analysis of Notes Receivable and Related Accounts;
Measurement of Notes Receivable
The statement of financial position of Santiago Corp. reported the following long-term
receivables as of December 31, 2010:
Notes receivable from sale of plant 9,000,000
Auditing Problems
36
Notes receivable from officer 2,400,000
In connection with your audit, you were able to gather the following transactions during 2010 and
other information pertaining to the company's long-term receivables:
a. The notes receivable from sale of plant bears interest at 12% per annum. The note is payable in 3
annual installments of 3,000,000 plus interest on the unpaid balance every April 1. The initial
principal and interest was payment was made on April 1, 2010.
b. The note receivable from officer is dated December 31, 2009, earns interest at 10% per annum,
and is due on December 31, 2012. The 2010 interest was received on December 31, 2010.
c. The corporation sold a piece of equipment to Yes, Inc. on April 1, 2010, in exchange for an
1,200,000 non-interest bearing note due on April 1, 2012. The note had no ready market, and
there was no established exchange price for the equipment. The prevailing interest rate for a note
of this type at April 1, 2010, was 12%. The present value factor of 1 for two periods at 12% is
0.797 while the present value factor of ordinary annuity of 1 for two periods at 12% is 1.690.
d. A track of land was sold by the corporation to No Co. on July 1, 2010, foe 6,000,000 under an
installment sale contract. No Co. signed a 4-year 11% note for 4,200,000 on July 1, 2010, in
addition to down payment of 1,800,000. The equal annual payments of principal and interest on
the note will be 1,353,750 payable on July 1, 2011, 2012, 2013, and 2014. The land had an
established cash price of 6,000,000, and its cost to the corporation was 4,500,000. The collection
of the installments on this note is reasonably assured.
Required:
1. Noncurrent notes receivable as of December 31, 2010

a. 13,556,400 c. 10,556,400
b. 9,664,650 d. 9,750,726
2. Current portion of long term notes receivable as of December 31, 2010

a. 3,891,750 c. 3,000,000
b. 4,353,750 d. 0
3. Accrued interest receivable as of December 31, 2010

a. 771,000 c. 540,000
b. 857,076 d. 1,011,000
4. Interest income for the year 2010

a. 1,281,000 c. 1,367,076
b. 1,637,076 d. 1,512,000
Answers: 1) D; 2) A; 3) A; 4) C

Journal Entries
a. Cash 4,080,000
Auditing Problems
37
Notes Receivable 3,000,000

Accrued Interest Receivable
(1,080,000/12x9) 510,000
Interest Income (1,080,000/12x3) 270,000
Accrued Interest Receivable (720,000/12x9) 540,000

Interest Income 540,000
b. Cash (2400x.1) 240,000

c. Notes Receivable 1,200,000

Equipment 956,400
Discount 243,980
Discount (956,400x.12/2) 86,076

d. Cash 1,800,000
Notes Receivable 4,200,000
Gain on sale 1,500,000
Land 4,500,000
Accrued Interest Receivable (462,000/2) 231,000

(1) (2) (3) (4)

a. 3,000,000 3,000,000 540,000 (540,000+270,000)
b. 2,400,000 0 2 40,000
c. 1,042,476 0 0 86,076
d. 3,308,250 * 891,750** 231,000 231,000
9750,726 3,891,750 771,000 1367,076
*{4,200,000-** [1353,750-(4,200,000x.11)]}
ILLUSTRATIVE AUDIT CASE 2.6- Measurement of Loans Receivable; Computation of Effective

Interest Rate
Sigay Bank granted a loan to a borrower in the amount of 5,000,000 on January 1, 2010. The
interest rate on the loan is 10% payable annually starting December 31, 2010. The loan matures 5 years
on December 31, 2014. Sigay Bank incurs 39,400 of direct loan origination cost and 10,000 of indirect
loan origination cost. In addition, Sigay Bank charges the borrower an 8-point nonrefundable loan
origination fee.
Required:
1. The carrying amount of the loan as of January 1, 2010 is
Auditing Problems
38
a. 5,000,000 c. 5,039,400
b. 4,639,400 d. 4,649,400
2. The effective interest rate of the loan is

a. 10% c. 12%
b. 11.94% d. 9.80%
3. The interest income to be recognized in 2010 is

a. 500,000 c. 493, 861
b. 555,138 d. 556,728
4. The carrying amount of the loan as of December 31, 2010

a. 5,000,000 c. 5,033,261
b. 4,696,128 d. 4,704,538
Answers: 1) B; 2) C; 3) D; 4) B

Requirement 1
Principal 5,000,000
Origination fee (5,000,000x.08) (400,000)
Direct loan organization cost 39,400
Carrying amount 4,639,400
Requirement 2
Interpolation 10%=5m
ER>10%=4,639,400
11%
Principal 5,000,000 x 1.11^ (-5)
Interest 5,000,000 x.1 x {[1-1.12^(-5)]/.12}
Total 4,639,522
12%
Principal 5,000,000 x 1.12^ (-5)
Interest 5,000,000 x.1 x {[1-1.11^ (-5)]/.11}
Total 4,815,205
Requirement 3
4,639,400 x .12 = 556,728
Requirement 4
4,639,400 x 1.12 - (5m x .1) = 4,696,128
**Impairment
» Directly Reduced Loan Receivable
Impairment Loss xx
Auditing Problems
39
Loan Receivable xx
» Allowance Account
Impairment Loss xx
Allowance for impairment xx
ILLUSTRATIVE AUDIT CASE 2.7-Imparment and Reversal of Impairment Loans Receivable
On January 1, 2008, Sinait Company loaned 3,000,000 to Ilocos Company. The terms of the loan
were payment in full on January 1, 2013, plus annual interest payment at 11%. The interest payment was
made as scheduled on January 1, 2009; however due to financial setbacks; Ilocos was unable to make its
2010 interest payment. Sinait considers the loan impaired and projects the following cash flows from the
loan as of December 31, 2010 and 2011. Assume that Sinait accrued the interest at December 31, 2009
but did not continue to accrue interest due to the impairment of the loan.
Amount Projected as of
Date of flow December 31, 2010 December 31, 2011
December 31, 2011 200,000 200,000
December 31, 2012 400,000 600,000
December 31, 2013 800,000 1,200,000
December 31, 2014 1,200,000 1,000,000
December 31, 2015 400,000
Required:
1. Loan impairment loss in 2010

a. 882,380 c. 1,212,380
b. 1,549,500 d. 1,542,380
2. Interest income for 2011 assuming the 200,000 was collected on December 31, 2011 as scheduled
a. 195,855 c. 200,000
b. 232,938 d. 66,000
3. Allowance for loan impairment as of December 31, 2011

a. 554,340 c. 649,442
b. 752,540 d. 776,900
4. Interest income in 2012 assuming the 600,000 was collected December 31, 2012 as scheduled
a. 225,210 c. 236,561
b. 247,023 d. 222,541
5. Carrying amount of loan receivable as of December 31, 2012

a. 1,672,570 c. 1,645,641
b. 2,150,558 d. 1,892,683
Answers: 1) C; 2) B; 3) A; 4) B; 5) D
Auditing Problems
40
Requirement 1
December 31, 2011 200,000 x 1.11^(-1)
December 31, 2012 400,000 x 1.11^(-2)
December 31, 2013 800,000 x 1.11^(-3)
December 31, 2014 1,200,000 x 1.11^(-2)
December 31, 2015 400,000 x 1.11^(-2)
PV of Projected Cash Flows 2,117,620
Principal (3,000,000)
Accrued Interest (3,000,000x.11) ( 330,000)
Impairment Loss 1,212,380
Loan Impairment Loss (Bad Debt Expense) 1,212,380

Interest Receivable 330,000
Allowance for Loan Impairment 882,380
Requirement2
2,117,620 x .11 = 232,938
Cash 200,000
Loan receivable 200,000
Allow for Loan Impairment 232,938
*Allow for Loan Impairment is Discount on Loans Receivable
Requirement3
December 31, 2012 600,000 x 1.11^(-1)
December 31, 2013 1,200,000 x 1.11^(-1)
December 31, 2014 1,000,000 x 1.11^(-1)
PV of Projected Cash Flows 2,245,660
Principal (3,000,000-200,000) 2,800,000
Allowance for Impairment 554,340
Allowance for impairment

Amortization 232,938 Beg 882,380
Reversal 95,102
End 554,340
Allowance for Impairment Loss 95,102

Reversal of Impairment Loss 95,102
Requirement 4
2,245,660 x .11 = 247,023
Requirement 5
Principal (2,800,000-600,000) 2,200,000
Allowance for Impairment Loss (554,340-247,023) 307,317
Auditing Problems
41
Carrying Amount 1,892,683
*Receivable financing
Common forms
1.) Pledge of Accounts Receivable - all Accounts Receivable serve as security for the loan (general)
Cash xx
Disc in Note Payable xx
Note Payable xx
Acquisition of Note Payable

Note Payable xx
Cash xx
Payment
NO ENTRY on Pledge Accounts Receivable
2.) Assignment -- specific Accounts Receivable serve as collateral

entry (refer to #1)
3.) Factoring -- sale of Accounts Receivable (without recourse, notification basis)
a) Casual
Cash xx
Sales discount xx
Commission xx
Receivable from factor xx ASSET account
Accounts Receivable xx
b) Continuing agreement
Cash ` xx
AFDA xx
loss on factoring xx
Accounts Receivable xx
4.) Discounting of Notes Receivable-> payee must endorse it (if silent- with recourse)
➢ without recourse (endorsers avoids future liability)
cash xx
loss on NR discounting xx
Note Receivable xx
Interest Receivable xx
Sale on note
➢ Endorsement with recourse

• endorser shall pay endorsee if the maker dishonors
• there is contingent liability of the endorser
• current liability shall only be disclosed
a.) conditional sale
Auditing Problems
42
cash xx
loss on NR discounting xx
NR-discounted xx deduction from Notes Receivable
Interest income xx
Incurrence of liability
NR xx
NR-discounted xx
Payment on liability
b.) secured borrowing – NR shouldn’t be derecognized unless the problem said so

cash xx
interest expense xx
liability for NR discounted xx
Interest Income xx
Incurrence of liability
Liability for NR discounted xx
Cash xx
ILLUSTRATIVE AUDIT CASE 2.8 – Receivable Financing
TAGUDIN Company required additional cash for its operation and used accounts receivable to raise
such needed cash, as follows:
• On December 1, 2010 Tagudin Co. Assigned on a non-notification basis AR of 5million pesos to

a bank in consideration for a loan of 90% of the accounts receivable less 5% service fee on the
accounts assigned. Tagudin signed a note for the bank loan. On December 31, 2010, Tagudin
collected assigned accounts of 3million pesos less discount of 200,000. Tagudin remitted the
collections to the bank in partial payment for the loan. The bank applied first the collection to the
interest and the balance to the principal. The agreed interest is 1% per month on the loan balance.
• Tagudin Co. Sold 1,550,000 of AR for 1,340,000. The receivables had a carrying amount of
1,470,000 and were sold outright on a non-recourse basis.
• Tagudin Co. Received an advance of 300,000 from Union bank by pledging 360,000 of accounts
receivable.
• On June 30 2010, Tagudin Co discounted at a bank a customer’s P600,000, 6-month, 10% note
receivable dated April 30, 2010. The bank discounted the note at 12% on the same date.
Required:
1. In its December 31,2010 statement of financial position, Tagudin should report note payable as a
current liability at
a. 1,745,000 b. 2,250,000 c. 1,545,000 d. 1,700,000
2. TagudinCo’s equity in the assigned accounts receivable as of December 31, 2010 is

a. 255,000 b. 300,000 c. 455,000 d. 0
Auditing Problems
43
3. The entry to record the sale of accounts receivable would include

a. A debit to finance charge of 210,000
b. A debit to allowance for doubtful accounts of 80,000
c. A credit to accounts receivable of 1,470,000
d. A credit to notes payable of 1,550,000
4. Account receivable pledge against borrowings , should be

a. Included in total receivables with disclosure
b. Included in total receivables without disclosure
c. Excluded from total receivables with disclosure
d. Excluded from total receivables without disclosure
5. The proceeds from notes receivable discounted on June 30,2010 is

a. 564,000 b. 617,400 c. 604,800 d. 576,000
Answers: 1) A; 2) A; 3) B; 4) A; 5) C
Journal Entries:
a. Cash(5,000,000 x .9) 4,250,000

Service fee (5,000,000x.05) 250,000
Notes payable 4,500,000
Cash 2,800,000
Discount 200,000
Accounts Receivable 3,000,000

Interest expense (4,500,000x.01) 45,000
Cash 2,800,000
b. Cash 1,340,000
Allowance for Doubtful Accounts 80,000
Loss on factoring 130,000
c. Cash 300,000
Notes Payable 300,000
*Pledge Accounts Receivable should be included in total receivables with disclosure
d. Cash 604,800
Loss on Discounting 5,200
Accrued Interest Income 10,000
Notes receivable 600,000
Auditing Problems
44
Requirement 1
Original Notes Payable 4,500,000
Payment 2,755,000
Notes Payable, end 1,745,000
Requirement 2
Accounts Receivable, end 2,000,000
Notes Payable (see no. 1) (1,745,000)
Equity in Accounts Receivable assigned 255,000
Requirement 3
(See b)
Requirement 4
(see c)
Requirement 4
(see d) 604,800
Auditing Problems
45
Substantive Tests of Inventories and Cost of Goods Sold S.Y. 2013-2014
CHAPTER
SUBSTANTIVE
TESTS OF
INVENTORIES AND
COST OF GOODS
SOLD
It is logical to consider the topics inventories and cost goods sold together because of their
interrelationship. The determination of inventory value therefore affects the cost of goods sold and has a
Auditing Problems
46
major impact on net income for the year. This is one of the reasons why special significance is attached to
inventories in both the accounting and auditing literature.
Assertions, Objectives and Procedures for Inventories and Cost of Goods Sold

Existence of occurrence To determine whether inventories 1. Obtain listings if inventory and
exist at year end and represents reconcile to ledgers.
items held for sale in the ordinary 2. Observe the taking of physical
items held for sale in the ordinary inventory and conduct test counts.
course of business. 3. Confirm inventories in public
warehouse and with consignees.
Completeness To determine whether all 4. Obtain a final inventory listing from
transactions related to inventory the client.
are recorded in proper accounting 5. Trace tests counts made during the
period. inventory observation into inventory
To determine that inventory listing.
listings are accurately compiled 6. Test the clerical accuracy the final
and inventory quantities include inventory listing.
all items on hand and in transit. 7. Review the year-end cutoff of
purchases and sales transactions.
8. Test numerical sequence of
inventory purchase requisition.
9. Review entire cost of goods sold
10. Perform analytical review related to
inventories and cost of goods sold.
Rights and Obligations To determine whether the 11. Make inquiries of management
company has a legal title or regarding inventory ownership and
ownership rights to inventory examine consignment agreement.
items and inventories exclude
items billed to customers or
owned by others.
Valuation or allocation To determine whether the 12. Evaluate the bases and methods of
inventories are properly stated inventory pricing.
with respect to: 13. Vouch and test inventory pricing.
Cost determined by acceptable Check inventory for quality and
method consistently applied. obsolescence.
Slow-moving, excess, defective,
and obsolete items identified and
reduced to replacement cost or net
realizable value if lower than
cost.
Presentation and To determine that the inventories 14. Determine the existence of pledged
disclosure and cost of goods sold are inventory.
presented and classified in the 15. Evaluate financial statement
financial statements in accordance presentation of inventories and cost
Auditing Problems
47
with PAS/PFRS. of goods sold, including the

adequacy of disclosures.
ILLUSTRATIVE AUDIT CASE 3.1-Items Considered Inventories
Presented below is a list of items that may or may not be reported as inventories in a company’s
December 31 statement of financial position.
1. Goods out of consignment at another company’s store P 800,000

2. Goods sold on installment basis 100,000
3. Goods purchased F.O.B shipping point that are in
transit at December 31 120,000
4. Goods purchased F.O.B destination that are in
transit at December 31 200,000
5. Goods sold to another company, for which our
company has signed an agreement to repurchase at
a set price that covers all costs related to the inventory 300,000
6. Goods sold where large returns are predictable 280,000
7. Goods sod F.O.B shipping point that are in transit
December 31 120,000
8. Freight charges on goods purchased 80,000
9. Factory labor cost incurred on goods still unsold 50,000
10. Interest cost incurred for inventories that are routinely
manufactured 40,000
11. Costs incurred to advertise goods held for resale 20,000
12. Materials on hand not yet placed into production 350,000
13. Office Supplies 10,000
14. Raw materials on which the company has started
Production, but which are not completely processed 280,000
15. Factory supplies 20,000
16. Goods held for consignment from another company 450,000
17. Costs identified with units completed but not yet sold 260,000
18. Goods sold F.O.B destination that are in transit at
December 31 40,000
19. Temporary investment in stocks and bonds that will be
Resold in the near future 500,000
Required:
How much of these items would typically be reported as inventory in the financial statements?
a. P2,300,000 c. P2,260,000
Auditing Problems
48
b. P2,000,000 d. P2,220,000
Answer: A
PAS 2 par. 6 defines “inventories” as assets
a. Held for sale in the ordinary course of business

b. In the process of production for such sale; or
c. In the form of materials or supplies to be consumed in the production process or in the
rendering o service
Par. 10 further provides that the cost of inventories shall comprise all costs of purchase, costs of
conversion and other costs incurred in bringing the inventories to their present location and condition.
Therefore, items 1, 3,5,8,9,12,15,17 and 18 would be reported as inventory in the financial statements.
The other items would be reported as follows:
Item 2- Cost of goods sold in profit or loss

Item 4-Not reported in the3 financial statements
Item 10- interest expense in the profit or loss
Item 11- advertising expense in the profit or loss
Item 13- Office supplies in the current asset section in the statement of financial position
Item 16- Not reported in the financial statements
Item 19- trading securities in the current asset section of the financial position
ILLUSTRATIVE AUDIT CASE 3.2 – Sales and Purchases Cutoff
The Anda Company is on a calendar year basis. The following data were found during your audit:
a. Goods in transit, shipped FOB destination by a supplier, in the amount of 100,000 had been
excluded from the inventory, and further testing revealed that the purchase had been recorded.
b. Goods costing 50,000 had been received, included in inventory, and recorded as a purchase.
However, upon your inspection the goods were found to be defective and would be immediately
returned.
c. Materials costing 250,000 and billed on December 30 at a selling price of 320,000, had been
segregated in the warehouse for shipment to a customer. The materials had been excluded from
inventory as a signed purchase order had been received from the customer. Terms, FOB
Destination.
Auditing Problems
49
d. Goods costing 70,000 was out on consignment with Hermie Company. Since the monthly
statement from Hermie Company listed those materials as on hand, the items had been excluded
from the final inventory and invoiced on December 31 at 80,000.
e. The sale of 150,000 worth of materials and costing 120,000 had been shipped FOB Point of
Shipment on December 31. However, this inventory was found to be included in the final
inventory. The sale was properly recorded in 2010.
f. Goods costing 100,000 and selling for 140,000 had been segregated, but not shipped at December
31, and were not included in the inventory. A review of the customer’s purchase order set forth
terms as FOB Destination. The sale had not been recorded.
g. Your client has an invoice from a supplier term FOB Shipping Point but the goods had not
arrived as yet. However, these materials costing 170,000 had been included in the inventory
count. But no entry had been made for their purchase.
h. Merchandise costing 200,000 had been recorded as a purchase but not included as inventory.
Terms of sale are FOB Shipping Point according to the supplier’s invoice which had arrived at
December 31.
Further inspection of the client’s records revealed the following December 31, 2013 balances:
Inventory, 1,100,000; Accounts Receivable, 580,000; Accounts Payable, 690,000; Net Sales, 5,050,000;
Net Purchases, 2,300,000; Net Income, 510,000.
Required:
Based on the above and the result of your audit, determine the adjusted balances of following as of
December 31, 2013.
1. Inventory
a. 1,230,000 c. 1,550,000
b. 1,650,000 d. 1,480,000
2. Accounts Payable
a. 710,000 c. 810,000
b. 540,000 d. 760,000
3. Net sales
a. 4,550,000 c. 4,730,000
b. 4,650,000 d. 4,970,000
4. Net Purchases
a. 2,370,000 c. 2,150,000
b. 2,420,000 d. 2,320,000
5. Net Income
a. 220,000 c. 540,000
Auditing Problems
50
b. 290,000 d. 550,000
Answers: 1) C; 2) A; 3) B; 4) D; 5) C
Inventory Accounts Net Sales Net Purchases Net Income

Payable
Unadjusted P1,100,000 P690,000 P5,050,000 P2,300,000 P510,000
balance
A (100,000) (100,000)
B (50,000) (50,000) (50,000)
C 250,000 (320,000) (70,000)
D 70,000 (80,000) (10,000)
E (120,000) (120,000)
F 100,000 100,000
G 170,000 170,000 (170,000)
H 200,000 200,000
Adjusted P1,550,000 P710,000 P4,650,000 P2,320,000 P540,000
Balances
ILLUSTRATIVE AUDIT CASE 3.3- Sales and Purchases Cutoff
You were engaged by Sheila Pams Corporation for the audit of the company’s financial
statements for the year ended December 31, 2013. The company is engaged in the wholesale business and
makes all sales at 25% over cost.
The following were gathered from the client’s accounting records.
SALES PURCHASES
DATE REFERENCE AMOUNT DATE REFERENCE AMOUNT
BALANCE FORWARDED 7,800,000 BALANCE FORWARDED 4,200,000
12/27 SI No. 865 60,000 12/28 RR #2059 36,000
12/28 SI No. 866 225,000 12/30 RR #2061 105,000
12/28 SI No. 867 15,000 12/31 RR #2062 63,000
12/31 SI No. 869 69,000 12/31 RR #2063 96,000
12/31 SI No. 870 102,000 12/31 Closing Entry (4,500,000)
12/31 SI No. 871 24,000
12/31 Closing Entry (8,295,000)
Note: SI= SALES INVOICE RR= RECEIVING REPORT
Accounts receivable 750,000
Auditing Problems
51
Inventory 900,000
Accounts Payable 600,000
You observed the physical inventory of goods in the warehouse on December 31 and were
satisfied that it was properly taken.
When performing sales and purchases cut-off tests, you found that at December 31, last Receiving
Report which had been used was No. 2063 and that no shipments had been made on any Sales Invoices
whose number is larger than No. 868. You also obtained the following additional information:
a. Included in the warehouse physical inventory at December 31 were goods which had been
purchased and received on Receiving Report No. 2060 but for which the invoice was not received
until the following year. Cost was 27,000.
b. On the evening of December 31, there were two trucks in the company siding:
• Truck no. XXX 888 was unloaded on January 22 of the following year and received on
receiving Report No. 2063. The freight was paid by the vendor.
• Truck No. MGM 357 was loaded and sealed on December 31 but leave the company
premises on January 2. This order was sold for 150,000 per Sales Invoice No. 868.
c. Temporary stranded at December 31 at the railroad siding were two delivery trucks enroute to
ABC Trading Corporation. ABC received the goods which were sold on Sales Invoice No. 866
terms FOB Destination, the next day.
d. Enroute to the client on December 31 was a truckload of goods, which was received on Receiving
Report No. 2064. The goods were shipped FOB Destination and freight of 2,000 was paid by the
client. However, the freight was deducted from the purchase price of 800,000.
Required:
1. Sales for the year December 31 2013

a. P8,100,000 c. P7,875,000
b. P7,725,000 d. P8,025,000
2. Purchases for the year ended December 31, 2013

a. P4,500,000 c. P5,631,000
b. P5,727,000 d. P4,527,000
3. Accounts receivable as of December 31, 2013

a. P330,000 c. P525,000
b. P555,000 d. P180,000
4. Inventory as of December 31, 2013

a. P1,452,000 c. P1,200,000
b. P1,221,000 d. P1,296,000
5. Accounts Payable as of December 31, 2013

a. P600,000 c. P 539,000
Auditing Problems
52
b. P627,000 d. P1,827,000
Answers: 1) C; 2) D; 3) A; 4) D; 5) B
Sales Purchases Accounts Inventory Accounts

Receivable Payable
Unadjusted P8,295,000 P4,500,000 P750,000 P 900,000 P600,000
Balances
Adjusting No. (195,000) (195,000)
1
Adjusting No. 27,000 27,000
2
Adjusting No. 96,000
3
4
Adjusting No. (225,000) (225,000)
5
6
Adjusted P7,875,000 P4,527,000 P330,000 P1,296,000 P627,000
balances
ILLUSTRATIVE AUDIT CASE 3.4-Correcting Inventory Errors: Perpetual Inventory System
KAILANMAN, INC. uses a perpetual inventory system and reports inventory at the lower of
FIFO or net realizable value. KAILANMAN’s inventory control account balance at June 30, 2013 was P
442,040. A physical count conducted on that day found inventory on hand worth P440,040. Net realizable
value for each item held for sale exceeded cost. An investigation of the following discrepancy disclosed
the following:
1. Goods worth P13,200 held on consignment for Bugok Co. had been included in the
physical count.
2. Goods costing P2,400 were purchased on credit from Amorseco Co. on June 27, 2013 on
FOB shipping point terms. The goods were shipped on June 28, 2013 but as they had not
arrived by June 30, 2013, were not included in the physical count. The purchase invoice
was received and processed on June 30, 2013.
3. Goods costing P4,800 were sold on credit to Acero Co. for P7,800 on June 28, 2013 on
FOB destination terms. The goods were still in transit on June 30, 2013. The sales invoice
was processed and recorded on June 29, 2013.
Auditing Problems
53
4. Goods costing P5,460 were purchased on credit (FOB destination) from San Pedro Co.
On June 28, 2013. The goods were received on June 29, 2013 and included in the
physical count. The Purchase invoice was received on July 2, 2013.
5. On June 30, 2013, KAILANMAN sold goods costing P12,000 on credit (FOB shipping
point) terms to Picasso Corp. for P19,200. The goods were dispatched from the
warehouse on June 30, 2013 but the sales invoice had not been processed at that date.
6. Damaged inventory items valued at P5,300 were discovered during the physical count.
These items were still recorded on June 30,2013 but were omitted from the physical
count records pending their write-off.
Required:
1. What is the adjusted inventory balance on June 30, 2013?

a. P424, 800 c. P445,000
b. P421, 200 d. P434,400
2. What adjustment should be made to KAILANMAN’s sales revenue for the year ended June 30,
2013?
a. Net increase of P11,400
b. Net decrease of P11,400
c. Increase of P19,200
d. Decrease of P7,800
3. KAILANMAN’s accounts payable at June 30, 2013, should be?

a. Decrease by P5,460
b. Increase by P5,460
c. Decrease by P5,300
d. Increase by P1600
4. The “unallocated difference” between the perpetual and the physical count amounts to?
a. P5,300 c. P1,640
b. P 160 d. P 0
Answers: 1) D; 2); 3); 4)
Perpetual Inventory Physical Count

Unadjusted Balances P442,040 P442,040
Goods held for consignment incorrectly ( 13,200)
counted
Goods in transit, purchased FOB shipping 2,400
point
Sales incorrectly recorded, FOB destination 4,800 4,800
Unrecorded purchase 5,460
Unrecorded sales (12,600)
Auditing Problems
54
Damaged inventory (5,300)

Adjusted balances P434,400 P434,400
ILLUSTRATIVE AUDIT CASE 3.5-Correcting Inventory Errors
Alligator Co.’s annual net income for the period 2009-2013 is as follows:
YEAR Net income (Loss)

2009 P150,000
2010 340,000
2011 645,000
2012 (100,000)
2013 250,000
A review of the company’s records reveals the following inventory errors:
2009 P3,000 overstatement, end of the year

2010 6,000 understatement, end of the year
Required:
1. What is the adjusted net income in 2009?

a. P150,000 c. P153,000
b. P159,000 d. P147,000

a. P331,000 c. P349,000
b. P337,000 d. P645,000

a. P651,000 c. P639,000
b. P648,000 d. P645,000
4. What is the adjusted net loss in 2012?

a. P 89,500 c. P100,000
b. P101,500 d. P 95,500

a. P250,000 c. P243,500
b. P234,500 d. P256,500
Answers: 1) D; 2) C; 3) C; 4) D; 5) D
Auditing Problems
55
Unadjusted net income or 2009 2010 2011 2012 2013

loss 150,000 340,000 645,000 (100,000) 250,000
2009 overstatement, end (3,000) 3,000
of the year
2010 understatement, end 6,000 (6,000)
of the year
2011 understatement, 4,500 (4,500)
end of the year
2012 understatement, 11,000
end of the year
Adjusted net income or P147,000 P349,000 P639,000 P(95,500) P256,500
loss
ILLUSTRATIVE AUDIT CASE 3.6- Income Effect of Inventory Errors
The ANACONDA, INC. reported income before taxes of P842,650 for 2012 and P965,350 for 2013.
The company takes its annual physical count of inventory every December 31. Your audit revealed the
following information:
a. The price used for 1,500 units included in the 2012 ending inventory was 109. The correct cost
was 190 per unit.
b. Goods costing P23,600 were received from a vendor on January 5, 2013. The shipment was made
on December 26, 2012, on FOB shipping point term. The purchase was recorded in 2012 but the
shipment was not included in the 2012, ending inventory.
c. Merchandise costing P64,750 was sold to a customer on December 29,2012.ANACONDA was

asked by the customer to keep the merchandise until January 3,2013, when the customer would
come and pick it up. Although the sale was properly recorded in 2012, the merchandise was
included in the ending inventory.
d. A supplier sold merchandise valued at P14,000 to ANACONDA, Inc. the merchandise was
shipped FOB shipping point on December 31,2012. The purchase was recorded in 2013 and the
merchandise was not included in the 2012 ending inventory.
Required:
1. What is the adjusted income before taxes for the year ended December 31, 2012?
a. P809,500 c. P875,800
b. P632,800 d. P923,000
2. What is the adjusted income before taxes for the year ended December 31,2013?
a. P877,000 c. P855,000
b. P932,200 d. P843,850
Answers: 1) D; 2) C
Auditing Problems
56
2012 2013
Reported income before taxes P842,650 P965,350
ADJUSTMENTS:
a. Transposition error in unit cost 121500 (121500)
b. Goods purchased FOB shipping point 23,600 ( 23,600)
c. Goods sold in 2012 (64750) 64750
d. Good purchased FOB shipping point - -
Adjusted income before taxes P923,000 P885,000
ILLUSTRATIVE AUDIT CASE 3.7-Correcting the Physical Inventory Count
In your audit of the RAKnaITU, INC. you find that a physical inventory count on December 31,
2013, showed merchandise costing P463,000 was on hand at that date. Your examination reveals the
following items were all excluded from the inventory per count.
1. Merchandise of P200,000 which was held on consignment.
2. Goods costing P39,500 that were shipped FOB shipping point on December 31,2013. These
goods were delivered to the customer on January 6, 2014.
3. Goods costing P16,800 that were shipped FOB destination to a customer on December 29, 2013.
The customer received these goods on January 2, 2014.
4. Merchandise costing P76,150 shipped by a seller FOB destination on December 28,2013, and
received by RAKnaITU, Inc on January 3, 2014.
5. Goods costing P16,500 shipped by a vendor FOB seller on December 31, 2012 and received by
RAKnaITU, Inc on January 4, 2014.
Required:
1. What is the amount that should appear in RAKnaITU, Inc’s statement of financial position as
inventory at December 31 2013?
a. P539,000 c. P535,800
b. P519,000 d.P496,300
Answer: 1) D
Inventory per physical count P463,000

Add: (3)Goods sold FOB Destination P16,800
(5) Goods purchased FOB seller 16,500 33,000
Adjusted Inventory P496,300
Auditing Problems
57
ILLUSTRATIVE AUDIT CASE 3.8-Correcting Inventory Errors
PIXMAS COMPANY is a manufacturer of small tools. The following information was obtained
from the company’s accounting records for the year then ended December 31, 2013:
Inventory at December 31,2013(based on physical count in PIXMAS’s P1,870,000

warehouse at cost on December 31, 2013)
Accounts payable at December 31, 2013 1,415,000
Net sales P9,693,400
Your audit reveals the following information:
1. The physical count included tools billed to a customer FOB shipping point on December 31,
2013. These tolls cost P64,000 and were billed at P78,500. They were in the shipping area
waiting to be picked up by the customers.
2. Goods shipped FOB shipping point by a vendor were in transit on December 31, 2013. These
goods with invoice cost of P93,000 were shipped on December 29, 2013.
3. Work in process inventory costing P27,000 was sent to a job contractor for further processing.
4. Not included in the physical count were goods returned by customers on December 31 2013.
These goods costing P49,000 were inspected and returned to inventory on January 7, 2014. Credit
memos for P67,800 were issued to the customer at that date.
5. In transit to a customer on December 31, 2013, were tools costing P17,000 shipped FOB shipping
point on December 26,2010. A sales invoice for P29,400 was issued on January 3, 2014, when
PIXMAS Company was notified by the customer that the tools had been received.
6. At exactly 5:00 pm on December 31, 2013, goods costing P31,200 were received from a vendor.
These were recorded on a receiving report dated January 2, 2014. The related Invoice was
recorded on December 31 2013, but the goods were not included in the physical count.
7. Included in the physical count were goods received from a vendor on December 27, 2013.
However the related invoice for P36,000 was not recorded because the accounting department’s
copy of the receiving report was lost.
8. A monthly Freight bill for P32,000 was received on January 3, 2014. It specifically related to
merchandise brought in December 2013, one-half of which was still in the inventory at December
31, 2013. The freight was not included in either the inventory or in the Accounts payable at
December 31, 2013.
Required:
1. PIXMAS’s December 31, 2013, inventory should be increased by

a. P216,200 c. P252,200
b. P233,200 d. P123,200
Auditing Problems
58
2. PIXMAS’s accounts payable balance at December 31, 2013, should be increased by

a. P68,000 c. P125,000
b. P145,000 d. P161,000
3. The amount of net sales to be reported on PIXMAS’s income statement for the year ended
December 31, 2013,should be
a. P9,547,100 c. P9,591,000
b. P9,576,500 d. P9,595,300
4. PIXMAS’s statement of financial position at December 31, 2013, should report accounts payable
of
a. P1,576,000 c. P1,540,000
b. P1,483,000 d. P1,432,000
5. The amount of inventory to be reported on PIXMAS’s December 31,2013,statement of financial

position should be
a. P2,103,200 c. P2,122,200
b. P2,086,200 d. P1,993,200
Answers: 1) A; 2) D; 3) B; 4) A; 5) B
Inventory Accounts Payable Net Sales

Unadjusted balances P1,870,000 P1,415,000 P9,693,400
ADJUSTMENTS:
1 (78,500)
2 93,000 93,000
3 27,000
4 49,000 (67,800)
5 29,400
6 31,200
7 36,000
8 16,000 32,000
Adjusted balances P2,086,200 P1,576,000 P9,576,500
ILLUSTRATIVE AUDIT CASE 3.9-Computation of Inventory loss
You are requested by a client on September 28 to prepare an insurance claim for a theft loss
which occurred on that day. An Inventory is immediately taken and the following data are available:
Inventory, September 1 P 38,000
Purchases received, September 1- September 28 19,000
Sales, September 1- September 28 52,000
Sales returns 1,000
Auditing Problems
59
The inventory on September 28 indicates t6hat an inventory of P15, 000 remains after the theft. During
the past year net sales have been made at 50% above cost of goods sold.
Required: Compute the inventory lost due to theft.
Beginning inventory P 38,000

Purchases 19,000
Cost of goods available for sale P 57,000
Cost of goods sold (net sales of P51,000  1.50) 34,000
Ending inventory before theft P 23,000
Ending inventory after theft 15,000
Inventory lost P 8,000
ILLUSTRATIVE AUDIT CASE 3.10-Computation of Inventory loss
On February 16, 2013, a flood destroyed the goods in process inventory and half the raw
materials inventory if the LRT Company. There was no damage to the finished goods inventory. The
Physical inventory taken after the flood indicated the following values:
Raw materials P35, 000
Finished goods 75, 000
A review of the accounting records indicated the following:
Inventories December 31, 2012:

Raw materials P65, 000
Goods in process 80, 000
Finished Goods 72, 000
Sales (to February 16) 40, 000
Raw materials purchases 20, 000
Direct labor cost 30, 000
Manufacturing overhead cost 15, 000
Gross profit rate (on sales) 40%
Required: Compute the value of the inventory destroyed by the Flood.
LRT Company
Computation of Value of Inventory Lost
February 16, 2013

Sales P 40,000
Less: Gross profit (40%) 16,000
Auditing Problems
60
Cost of goods sold P 24,000

Finished goods, February 16 75,000
Cost of goods available for sale P 99,000
Less: Finished goods, December 31, 2012 72,000
Cost of goods manufactured and completed P 27,000
Raw materials, December 31, 2012 P 65,000

Raw materials purchases 20,000
Raw materials available for production P 85,000
Raw materials before flood 70,000 (P35,000  1/2)
Raw materials used P 15,000
Direct labor 30,000
Manufacturing overhead cost 15,000
Goods in process, December 31, 2012 80,000
Cost of production P 140,000
Less: Cost of goods completed (from above) 27,000
Goods in process inventory lost in flood P 113,000
Total value of inventory =Raw materials lost + Goods in process lost destroyed by flood
P148,000 = (P70,000 - P35,000) + P113,000
ILLUSTRATIVE AUDIT CASE 3.11- Trade In and Repossessed Merchandise
The Cherry Company values its inventory at the lower of FIFO cost or net realizable value (NRV).
The inventory accounts at December 31, 2012, had the following balances.
Raw materials P 650,000
Work in process 1,200,000
Finished Goods 1,640,000
The following are some of the transactions that affected the inventory of Cherry Company during
2013.
January 8 Cherry purchased raw materials with a list price of P200,000 and was given a
trade discount of 20% and 10% terms 2/15,n/30. Cherry values inventory at the
net invoice price.
February 14 Cherry repossessed an inventory item from a customer who was overdue in
making payment. The unpaid balance on the sales is P15,200. The repossessed
merchandise is to be refinished and placed on sale. It is expected that the item
can be sold for P24,000 after estimated refinishing costs P6,800. The normal
profit for this item is considered to be P3,200.
March 1 Refinishing costs of P6,400 were incurred on the repossessed item.
April 3 The repossessed item was resold for P24,000 on account 20% down.
Auditing Problems
61
August 30 A sale on account was made of finished goods that have a list price of P59,200
and cost P38,400. A reduction of P8,000 off the list price was granted as a trade-
in allowance. The trade-in item is to be priced to sell at P6,400 as is. The normal
profit on this type of inventory is 25% of the sales price.
Required:
Based on the above and the result of your audit, answer the following:
(Assume the client is using perpetual inventory system)
1. The entry on January 8 will include a debit to Raw material inventory of

a. P200,000 c. P141,120
b. P144,000 d. P196,000
2. The repossessed inventory on February 14. Is most likely to be values at

a. P14,000 c. P17,200
b. P24,000 d. P14,400
3. The journal entries on April 3 will include a

a. Debit to Cash of P24,000
b. Debit to Cost of Repossessed Goods sold of P14,000
c. Credit to Profit on Sale of Repossessed Inventory of P3,600
d. Credit to Repossessed Inventory of P20,400
4. The trade in allowance on August 30 is most likely to be valued at

a. P8,000 c. P6,000
b. P4,800 d. P6,400
5. How much will be the recorded as Sales on August 30?

a. P51,200 c. P57.200
b. P56,000 d. P57,600
Answers: 1) C; 2) A; 3) D; 4) B; 5) B
Requirement 1
Amount to be debited to Raw Materials Inventory
(P200,000x.8x.9x.98) P141,120
Requirement 2
Estimated selling price P24,000
Less: refinishing costs 6,800
Net realizable value 17,200
Less: Normal Profit 3,200
Valuation of repossessed inventory P 14,000
Requirement 3
Journal Entry on April 3, 2013
Auditing Problems
62
Cash P 4,800
Sales P24,000
Cost of repossessed goods sold P20,400

Repossessed Inventory P20,400
Requirement 4
Estimated selling price P6,400
Less: normal profit 1,600
Valuation of trade-in inventory P 4,800
Requirement 5
Accounts Receivable P51,200
Trade-in inventory (see no. 4) 4,800
Amount to be recorded as sales P56,000
ILLUSTRATIVE AUDIT CASE 3.12- Sales and Purchases Cutoff; Window Dressing
The following accounts were included in the unadjusted trial balance of Pani Company as of
December 31, 2013:
Cash P 481,600
Inventory 3,025,000
Accounts payable 2,100,500
Accrued expenses 215,500
During your audit, you noted that Pani held its cash books open after the year end. In addition, your
audit revealed the following:
1. Receipts for January 2014 of P327,300 were recorded in the December 2013 cash receipts book.
The receipts of P180,050 represent cash sales and P147,250 represent collections from customers,
net of 5% cash discounts.
2. Accounts payable of P186,200 was paid in January 2014. The payments, on which discounts of
P6,200 were taken, were included in the December 2013 check register.
3. Merchandise inventory is valued at P3,025,000 prior to any adjustments. The following

information had been found relating to certain inventory transactions
a. Goods valued at P137,500 are on consignment with a customer. These goods are not included
in the inventory figure.
b. Goods costing P108,750 were received from a vendor on January 4, 2014. The related invoice
was received and recorded on January 6, 2014. The goods were shipped on December 31,
2013, terms FOB shipping point.
Auditing Problems
63
c. Goods costing P318,750 were shipped on December 31, 2013, and were delivered to the
customer on January 3, 2014. The terms of the invoice were FOB shipping point. The goods
were included in the 2013 ending inventory even though the sale was recorded in 2013.
d. A P91,000 shipment of goods to a customer on December 230,terms FOB destination are not
included in the year-end inventory. The goods cost P65,000 and were delivered to the
customer on January 3,2014. The sale was properly recorded in 2014.
e. The invoice for goods costing P87,500 was received and recorded as a purchase on December
31, 2013. The related goods, shipped FOB destination were received on January 4, 2014 and
thus were not included in the physical inventory.
f. Goods valued at P306,400 are on consignment from a vendor. These goods are not included
in the physical inventory.
Required:
Based on the above and the results of your audit, determine the adjusted balances of the following as
of December 31, 2013.
1. Cash
a. P481,600 c. P334,300
b. P340,500 d. P346,700
2. Accounts Receivable
a. P1,454,300 c. P1,127,000
b. P1,282,000 d. P1,274,250
3. Inventory
a. P3,017,500 c. P2,930,900
b. P3,040,000 d. P2,505,000
4. Accounts payable
a. P2,395,450 c. P2,286,500
b. P2,307,950 d. P2,301,750
5. Current Ratio
a. P2.00 c. P1.84
b. P1.83 d. P2.01
Answers: 1) C; 2) B; 3) A; 4) B; 5) C
Cash Accounts Inventory Accounts

receivable Payable
Unadjusted balances P481,600 P1,127,000 P3,025,000 P2,100,500
Add/(deduct):
Auditing Problems
64
Adjustment no. 1 (327,300) 155,000

Adjustment no. 2 180,000 186,200
Adjustment no. 3-a 137,500
Adjustment no. 3-b 108,750 108,750
Adjustment no. 3-c (318,750)
Adjustment no. 3-d 65,000
Adjustment no. 3-e (87,500)
Adjusted balances P334,300 P1,282,000 P3,017,500 P2,307,950
Requirement 5
Current Assets
Cash P 334,300
Accounts receivable 1,282,000
Inventory 3,017,500 P4,633,800
Divide by current liabilities
Accounts Payable P2,307,950
Accrued expenses 215,500 P 2,523,450
Current Ratio P1.84
ILLUSTRATIVE AUDIT CASE 3.13-Inventory Estimation- Gross Profit Rate Method; Theft of
Inventory
Calasiao Inc., owner of a trading company, engaged your services as auditor. There is a discrepancy
between the company’s income and the sales volume. The owner suspects that the staff is committing
theft. You are to determine whether or not this is true. Your investigations revealed the following:
1. Physical inventory, taken December 31, 2013 under your observation showed that cost was
265,000 and net realizable value (NRV), 244,000. The inventory on January 1, 2013 showed cost
of 390,000 and net realizable value of 375,000. It is the corporation’s practice to value inventory
at “lower of cost of NRV”. Any loss between cost and NRV is included in “Other expenses”.
2. The average gross profit rate was 40% of net sales.
3. The accounts receivable as of January 1, 2013 were 135,000. During 2013, accounts receivable
written off during the year amounted to 10,000. Accounts receivable as of December 31, 2013
were 375,000.
4. Outstanding purchase invoices amounted to 300,000 at the end of 2013. At the beginning of 2013
they were 375,000.
5. Receipts from customers during 2013 amounted to 3,000,000.
6. Disbursements to merchandise creditors amounted to 2,000,000.
Required:
Auditing Problems
65
1. The total sales in 2010 is

a. 3,240,000 c. 3,250,000
b. 3,230,000 d. 2,770,000
2. The total purchases in 2013 is

a. 2,000,000 c. 1,950,000
b. 2,075,000 d. 1,925,000
3. The amount of inventory shortage as of December 31, 2013 is

a. 106,000 c. 100,000
b. 175,000 d. 0
Answers: 1) C; 2) D; 3) C
Requirement 1
Accounts receivable, 12/31/13 375,000

Accounts written off 10,000
Collections 3,000,000
Accounts receivable, 1/1/13 (135,000)
Sales in 20130 3,250,000
Requirement 2
Accounts payable, 12/31/13 300,000

Payments 2,000,000
Accounts payable, 1/1/13 (375,000)
Purchases in 2013 1,925,000
Requirement 3
Inventory, 1/1/13(at cost) 390,000

Add purchases (see no. 2) 1,925,000
Total goods available for sale 2,315,000
Less cost of sales (3,250,000x60%) 1,950,000
Estimated inventory, 12/31/13 (at cost) 365,000
Inventory, 12/31/13 per physical count (at cost) 265,000
Estimated inventory shortage 100,000
Auditing Problems
66
ILLUSTRATIVE AUDIT CASE 3.14 -Inventory Estimation- Gross Profit Rate Method
In conducting your audit of Mangatarem Corporation, a company engaged in import and

wholesale business, for the fiscal year ended June 30, 2013, you determined that its internal control
system was good. Accordingly, you observed the physical inventory at an interim date, May 31, 2013
instead of at June 30, 2013.
You obtained the following information from the company’s general ledger.
Sales for eleven months ended May 31, 2013 1,344,000

Sales for the fiscal year ended June 30, 2013 1,536,000
Purchases for eleven months ended May 31, 2013
(before audit adjustments) 1,080,000
Purchases for the fiscal year ended June 30, 2013 1,280,000
Inventory, July 1, 2012 140,000
Physical Inventory, May 31, 2013 220,000
Your audit disclosed the following additional information.
1. Shipments costing 12,000 were received in May and included in the physical inventory but
recorded as June purchases.
2. Deposit of 4,000 made with vendor and charged to purchases in April 2013. Product was shipped
in July 2013.
3. A shipment in June was damaged through the carelessness of the receiving department. The
shipment was later sold in June at its cost of 16,000.
Required:
In your audit in which the interim physical inventories are observed, a frequently used auditing
procedure is to test the reasonableness of the year-end inventory by the application of gross profit ratio.
Based on the above and result of your audit, you are to provide the answers to the following:
1. The gross profit ratio for eleven months ended May 31, 2013 is
a. 20% c. 30%
b. 35% d. 25%
2. The cost of goods sold during the month of June 2013 using the gross profit ratio method is
a. 132,000 c. 148,000
b. 144,000 d. 160,000
3. The June 30, 2013 inventory using the gross profit ratio method is
a. 264,000 c. 268,000
b. 340,000 d. 260,000
Answers: 1) D; 2) C; 3) D
Auditing Problems
67
Requirement 1
Sales for 11 months

ended 5/31/2013 1,344,000
Less cost of Sales for 11
months ended 5/31/13:
Inventory, July 1, 2012 140,000
Add adjusted purchases:
Unadjusted 1,080,000
Item. No. 1 12,000
Item No. 2 (4,000) 1,088,000
Goods available for sale 1,288,000
Less inventory, 5/31/2013 220,000 1,008,000
Gross Profit 336,000
Divide by sales for 11 months
Ended 5/31/13 1,344,000
Gross profit rate for 11 months
Ended 5/31/13 25%
Requirement 2
Sales for the fiscal year ended June 30, 2013 1,536,000
Less sales for 11 months ended May 31, 2013 1,344,000
Sales for June, 2013 192,000
Less sales without profit 16,000
Sales with profit 176,000
Multiply by cost ratio (100%-25%) 75%
Cost of sales with profit 132,000
Add cost of sales without profit 16,000
Total cost of sales for June, 2013 148,000
Requirement 3
Inventory, 7/1/13 140,000

Add adjusted purchases:
Unadjusted 1,280,000
Item No. 2 (4,000) 1,276,000
Total goods available for sale 1,416,000
Less cost of sales:
Sales without profit 16,000
Sales with profit
[(1,536,000-16,000) x75%] 1,140,000 1,156,000
Inventory, 6/30/13 260,000
ILLUSTRATIVE AUDIT CASE 3.15- Inventory Estimation- Retail Inventory Method
You obtained the following information in connection with your audit of Villasis corporation:
Auditing Problems
68
Cost Retail
Beginning inventory 1,987,200 2,760,000
Sales 7,812,000
Purchases 4,688,640 6,512,000
Freight-in 94,560
Mark-ups 720,000
Mark-up cancellations 120,000
Markdown 240,000
Markdown cancellations 40,000
Villasis Corp. uses the retail inventory method in estimating the values of its inventories and cost
of goods sold.
Required:
1. The cost ratio to be used considering the provisions of PAS 2 is

a. 68.58 % c. 70%
b. 69.20% d. 75.78%
2. The estimated ending inventory at cost is

a. 2,300,000 c. 1,940,000
b. 2,060,000 d. 1,860,000

a. 1,412,786 c. 1,302,000
b. 1,275,588 d. 1,287,120
4. The estimated cost of goods sold is

a. 5,468,400 c. 5,357,614
b. 5,494,812 d. 4,685,117
Answers: 1) C; 2) D; 3) C; 4) A
Requirement 1
Cost Retail
Purchases 4,688,640 6,512,000
Freight in 94,560
Net mark up (720,000-120,000) 600,000
Net mark down (240,000-40,000) (200,000)
Goods available for sale 6,770,400 9,672,000
Cost ratio (6,770,400/9,672,000) 70%
Auditing Problems
69
PAS 2. Par. 22 states that the retail inventory method is often used in the retail industry for
measuring inventories of large numbers of rapidly changing items with similar margins for which it is
impracticable to use other costing methods. The cost of inventory is determined by reducing the sales
value of the inventory by the appropriate percentage gross margin. The percentage used takes into
consideration inventory that has been marked down to below its original selling price. An average
percentage for each retail department is often used.
Before PAS 2, the conventional approach (lower of average cost or market valuation) is often
used if the problem is silent. The conventional approach ignores markdown in the computation of cost
ratio. However, since PAS 2 specifically states that the percentage should take into consideration
inventory that has been marked down to below its original selling price; the cost ratio was computed
using the average method.
Requirement 2
Goods available for sale at retail 9,672,000

Less sales 7,812,000
Ending inventory 1,860,000
Requirement 3
Ending inventory, at cost (1,860,000X 70%) 1,302,000
Requirement 4
Goods available for sale at cost 6,770,400

Less ending inventory, at cost 1,302,000
Estimated cost of sales 5,468,400
ILLUSTRATIVE AUDIT CASE 3.16-Inventory Estimation- Retail Inventory Method
Lingayen Mart uses the average retail inventory method. The following information is available
for the current year:
Cost Retail
Beginning Inventory 1,100,000 2,200,000
Purchases 15,800,000 26,300,000
Freight In 400,000
Purchase returns 600,000 1,000,000
Purchase allowance 300,000
Departmental transfer in 400,000 800,000
Net mark-ups 600,000
Net markdowns 900,000
Sales 24,700,000
Sales returns 350,000
Auditing Problems
70
Sales discounts 200,000

Employee discounts 600,000
Loss from breakage 50,000
Required:
1. The cost ratio using the average retail inventory method is

a. 58.13% c. 62.00%
b. 61.07% d. 60.00%
2. The estimated ending inventory at retail is

a. 3,000,000 c. 2,800,000
b. 3,600,000 d. 3,650,000

a. 1,743,945 c. 1,832,143
b. 2,198,571 d. 1,800,000
4. The estimated cost of goods sold is

a. 15,267,857 c. 15,000,000
b. 14,901,429 d. 15,056,055
If the inventory at retail based on physical count at December 31, 2013 is 1,700,000, the estimated
inventory shortage is
a. 780,000 c. 755,709
b. 793,929 d. 0
Answers: 1) D; 2) A; 3) D; 4) C; 5) A
Requirement 1
Cost Retail
Purchases 15,800,000 26,300,000
Freight in 400,000
Purchase returns (600,000) (1,000,000)
Purchase allowances (300,000)
Departmental transfer in 400,000 800,000
Net markups 600,000
Net markdowns (900,000)
Cost ratio (16,800,000/28,000,000) 60%
Auditing Problems
71
Requirement 2

Less: Sales 24,700,000
Sales returns (350,000)
Employee discounts 600,000
Loss from breakage 50,000 25,000,000
Ending inventory 3,000,000
Requirement 3
Ending Inventory, at cost (3,000,000 x 60%) 1,800,000
Requirement 4
Goods available for sale, at cost 16,800,000

Less ending inventory, at cost (see no. 3) 1,800,000
Estimated cost of sales 15,000,000
Requirement 5
Ending inventory, at cost (see no. 3) 1,800,000

Physical inventory, at cost (1,700,000x60%) 1,020,000
Estimated inventory shortage 780,000
ILLUSTRATIVE AUDIT CASE 3.17-Inventory Estimation- Retail Inventory Method

You obtained the following information in connection with your audit of Labrador Corporation,
which uses FIFO retail inventory method:
Cost Retail
2012
Beginning inventory 835,200 1,392,000
Purchases 6,864,000 10,542,000
Mark up, net 63,000
Markdown, net 45,000
Sales 10,260,000
2013
Purchases 7,140,000 10,218,000
Mark up, net 84,000
Markdown, net 102,000
Sales 10,392,000
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Required:
1. The estimated inventory at cost on December 21, 2012 is

a. 1,095,062 c. 1,085,926
b. 1,099,800 d. 1,089,947
2. The estimated inventory at cost on December 31, 2013 is

a. 1,050,000 c. 1,038,086
b. 1,039,650 d. 1,028,550
Answers: 1) B; 2) A
Requirement 1
Cost Retail Ratio
Beginning inventory 835,200 1,392,000 60%
Purchases 6,864,000 10,542,000
Net mark up 63,000
Net markdown (45,000)
Net purchases 6,864,000 10,560,000 65%

Less sales 10,260,000
Inventory, 12/31/2012 at retail 1,692,000
Multiply cost ratio 65%
Inventory, 12/31/2012 at cost 1,099,800
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73
Substantive Tests of Investments S.Y. 2013-2014
CHAPTER
4
SUBSTANTIVE
TESTS OF
INVESTMENTS
Assertions, Objectives and Procedures for Investments
Auditing Problems
74

Existence or Occurrence To determine that investments in 1. Obtain or prepare a listing of
securities (shares, bonds, notes) securities and investments owned by
physically exist and in loans and the company and related revenue
advances exist. accounts
2. Inspect securities on hand.
3. Obtain confirmation of securities
held by others.
Completeness To determine that investments are 4. In addition to audit procedures 2 and
all included in the statement of 3, vouch selected purchases and
financial position. sales transactions of securities
during the year.
Rights and Obligations To determine that the company 5. In addition to audit procedures 2 and
owns or has ownership rights to all 3, verify the clients’ cutoff of
investments included in the securities transactions
statement of financial position. 6. Perform analytical procedures.
7. Compute independently revenue
from securities
Valuation To determine that investments are 8. Determine market value of
valued properly in accordance with securities at the balance sheet date.
generally accepted accounting 9. Evaluate the method of accounting
principles. for securities.
Presentation and Investments are properly described 10. Evaluate financial statement
Disclosure and classified in the statement of presentation and related revenue or
financial position and related loss accounts
disclosures are adequate.
ILLUSTRATIVE AUDIT CASE 4.1-Acquisition, Disposal and Measurement of Trading Securities
Auditing Problems
75
You were engaged by Baltazar Company to audit its financial statements for the year 2013.
During the course of the audit, you noted that the following trading securities were properly reported as
current assets at December 31, 2012:
Cost Fair Value
France Corporation, 5,000 shares,
convertible preference shares P 450,000 P 487,500
Ces, Inc., 30,000 ordinary shares 675,000 742,500
Coo Co., 10,000 ordinary shares 618,750 450,000
The following sale and conversion transactions transpired during 2013:
March 1 Sold 12,500 shares of Ces for P33.75 per share.

April 1 Sold 2,500 shares of Coo for P45 per share.
September 21 Converted 2,500 shares of France’s preference shares into 7,500 ordinary shares
of France, when the market price was P80.25 per share for the preference shares
and P40.50 per share for the ordinary shares.
The following 2013 dividend information pertains to shares owned by Baltazar:
January 2 Coo issued a 10% share dividend when the market price of Coo’s ordinary share
was P49.50 per share.
March 31 France paid dividends of P2.50 per share on its preference shares, to shareholders
And Sept 30 of record on March 15 and September 15, respectively. France did not pay
dividends on its ordinary shares during 2013.
July 1 Ces paid a P2.25 per share dividend on its ordinary shares
Market prices per share of the securities were as follows:

12/31/2013 12/31/2012
France Corp., preference 92.25 97.50
France Corp., ordinary 42.75 38.25
Ces Inc., ordinary 22.50 24.75
Coo Co., ordinary 40.50 45.00
All the foregoing shares are listed in the Philippine Stock Exchange. Declines in market value from cost
would not be considered permanent.
Required:
1. How much is the gain on sale of 12,500 Ces shares?

a. P112,500 c. P140,625
b. P281,250 d. P 0
2. How much is the gain on sale of 2,500 Coo shares?
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76
a. P 28,125 gain c. P28,125 loss

b. P10,227 gain d. P 0
3. How much is the gain or loss on conversion of 2,500 France preference shares into 15,000
ordinary shares?
a. P 43,125 loss c. P60,000 gain
b. P78,750 gain d. P 0
4. How much is the total dividend income for the year ended 2013?
a. P 64,375 c. P 51,875
b. P101,375 d. P364,375
Answers: 1) A; 2) B; 3) C; 4) A
Requirement 1
Sales proceeds (12,500 shares x P33.75) P 421,875

Less: Carrying amount of Ces shares sold
(12.5/3 x P742,500) 309,375
Gain on sale P 112,500
Requirement 2
Sales proceeds (2,500 shares x P45) P112,500
Less: Carrying amount of Coo shares sold
(P450,000x2,500/11,000*) 102,273
Gain on sale P 10,227
*total number of shares after 10% share dividend
Requirement 3
Fair value of ordinary shares received

(7,500 shares x P40.50) P303,750
Less: Carrying amount of preference shares converted
(P487,500 x 2.5/5) 243,750
Gain on conversion P 60,000
PAS 39 par. 43 requires that financial assets should be measured on initial recognition at its fair
value. Application guidance par. 64 of PAS 39 states that the fair value of a financial instrument on
initial recognition is normally the transaction price (i.e. the fair value of the consideration given or
Auditing Problems
77
received). However, both the fair value of the consideration given and received are available. Therefore,
the question now is what fair value should be used?
Actually, the conversion of the preference shares into ordinary shares involves derecognition (the
preference shares) and the recognition (the ordinary shares) of financial assets at the holder’s point of
view. PAS 39 par. 25 provides that if, as a result of a transfer, a financial asset is derecognized in its
entirety but the transfer results in the entity obtaining a new financial asset or assuming a new financial
liability, or a servicing liability, the entity shall recognize the new financial asset, financial liability or
servicing liability at fair value.
Therefore, the ordinary shares received in exchange for the preference shares should be
measured at the fair value of the ordinary shares received.
Requirement 4
From France (5,000 shares x P2.50x2) P 25,000

From Ces {(30,000-12,500) x P2.25} 39,375
Total dividend income in 2013 P 64,375
ILLUSTRATIVE AUDIT CASE 4.2-Regular Way Purchase of Financial Asset-Held for Trading
On December 28,2013, Hagibis Company commits itself to purchase a financial asset as held for
trading for P 1,000,000, its fair value on commitment (trade) date. This security has a fair value of
P1,002,000 and P1,005,000 on December 31, 2013(Hagibis’ financial year-end), and January 5, 2014
(settlement date), respectively.
Required:
1. If Hagibis applies the trade date accounting method to account for regular way purchases of its
securities, how much should be recognized as trading securities on December 31, 2013?
a. P 1,000,000 c. P1,005,000
b. P 1,002,000 d. P 0
2. If Hagibis applies the trade date accounting method to account for regular way purchases of its
securities, how much should be recognized as unrealized gain on trading securities in its 2013
profit or loss?
a. P 2,000 c. P3,000
b. P 4,000 d. P 0
3. If Hagibis applies the settlement date accounting method to account for regular way purchases of
its securities, how much should be recognized as trading securities on December 31, 2013?
a. P 1,000,000 c. P 1,005,000
b. P 1,002,000 d. P 0
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78
4. If Hagibis applies the settlement date accounting method to account for regular way purchases of
its securities, how much should be recognized as unrealized gain on trading securities in its 2013
profit or loss?
a. P 2,000 c. P3,000
b. P 4,000 d. P 0
Answers: 1) B; 2) A; 3) D; 4) A
A regular way purchase or sale is a purchase or sale of a financial asset under a contract whose
terms require delivery of the asset within the time frame established generally by regulation or
convention in the marketplace concerned.
A regular way purchase on sale of financial assets shall be recognized and derecognized, as
applicable, using the trade date accounting or settlement date accounting. (PAS 39 par. 38)
Requirements 1 & 2
The trade date is the date that an entity commits itself to purchase or sell an asset. Trade date
accounting refers to (a) the recognition of an asset to be received and the liability to pay for it on the
trade date, and (b) derecognition of an asset that is sold, recognition of any gain or loss on disposal and
the recognition of a receivable from the buyer for payment on the trade date. Generally, interest does not
start to accrue on the asset and corresponding liability until the settlement date when title passes.
Trade Date( 12/28/2013)
Trading Securities P1,000,000

Due to Broker P1,000,000
End of reporting period date (12/31/2013)
Trading Securities P2,000

Unrealized gain on Trading Securities P2,000
Settlement date (01/05/2014)
Trading Securities P3,000

Due to Broker P1,000,000

Cash P1,000,000
Requirement 3 & 4
The settlement date is the date that an asset is delivered to or by an entity. Settlement date
accounting refers to (a) the recognition of an asset on the day it is received by the entity, and (b) the
Auditing Problems
79
derecognition of an asset and recognition of any gain or loss on disposal on the day that it is delivered by
the entity. When settlement date accounting is applied, an entity accounts for any change in the fair value
of the asset to be received during the period between the trade date and the settlement date in the same
way as it accounts for the acquired asset. In other words, the change in value is not recognized for assets
carried at cost or amortized cost; it is recognized in profit or loss for assets classified as financial assets
at fair value through profit or loss.
Trade date (12/28/2013)
No Journal Entry
End of reporting period date (12/31/2013)
Due from broker P2,000

Settlement date (01/05/2014)
Trading Securities P1,005,000

Cash P1,000,000
Due from broker 2,000
Unrealized gain on Trading Securities 3,000
ILLUSTRATIVE AUDIT CASE 4.3-Investment in Financial Asset at Amortized Cost
On June 1, 2012, Panday Corporation purchased as a long term investment 4, 000 of the P 1,000
face value, 8% bonds of Purple Corporation. The bonds were purchased to yield 10% interest. Interest is
payable semi-annually on December 1 and June 1. The bonds mature on June 1, 2018. Panday uses the
effective interest method of amortization. On November 1, 2013, Panday sold the bonds for a total
consideration of P 3,925,000. Panday intended to hold these bonds until they mature, so year-to-year
market fluctuations were ignored in accounting for bonds.
Required:
1. The purchase price of the bonds on June 1, 2012 is

a. P 3,645,328 c. P 3,696,736
b. P 3,691,132 d. P 3,624,596
2. The interest income for the year 2012 is

a. P 215,850 c. P 212,829
b. P 215,521 d. P 211,612
3. The carrying amount of the investment in bonds as of December 31, 2012 is

a. P 3,725,919 c. P 3,719,986
Auditing Problems
80
b. P 3,649,541 d. P 3,671,491
4. The interest income for the year 2013 is

a. P 306,608 c. P 311,218
b. P 310,715 d. P 304,748
5. The gain on sale of investment in bonds on November 1, 2013 is

a. P 21,196 c. P 27,632
b. P 80,235 d. P 104,045
Answers: 1) A; 2) C; 3) D; 4) A; 5) B
Requirement 1
PV of principal (P 4,000,000 x 0.5568) 2,227,200

PV of interest [(P4,000,000 x 4%) x 8.8633] 1,418,128
Purchase price P3,645,328
Requirement 2
Amortization schedule:
Effective Nominal Discount
Date interest (5%) interest (4%) Amortization Amortized Cost
6/01/2012 3,645,328
12/01/2012 182, 266 160, 000 22,266 3,667,594
6/01/2013 183, 380 160, 000 23,380 3,690,974
12/01/2013 184, 549 160, 000 24,549 3,715,523
6/01/2012 to 11/30/2012 (see schedule) P 182, 266

12/01/2012 to 12/31/2012 (P183,380 x 1/6) 30,563
Total interest income for 2012 P 212,829
Requirement 3
Carrying amount, 12/01/2012 (see schedule) P 3,667,594

Add: Discount amortization, 12/01/2012 to
12/31/2012 (P23,370 x 1/6) 3,897
Carrying amount, 12/31/2012 P 3,671,491
Requirement 4
Auditing Problems
81
1/01/2013 to 5/31/2013 (P 183,380 x 5/6) P 152,817

6/01/2013 to 11/01/2013 (P 184,549 x 5/6) 153,791
Total interest income for 2013 P 306,608
Requirement 5
Total proceeds P 3,925,000

Accrued interest (P160,000 x 5/6) 133,333
Net proceeds 3,791,667
Less: Carrying amount, 11/01/2013 (see below) 3,711,432
Gain on sale of investment in bonds P 80,235
ILLUSTRATIVE AUDIT CASE 4.4-Investment in Financial Asset at Amortized Cost
On January 1, 2013, Geronimo Company acquired the entire issue of Tarmad’s P6,000,000 12%
serial bonds. The bonds were purchased to yield 10%. Bonds of P2,000,000 mature at annual intervals
beginning December 31,2013. Interest is payable annually on December 31. Geronimo intends and is able
to hold the bonds until maturity.
Required:
1. Purchase price of the bonds on January 1, 2013 is

a. P 6,000,000 c. P 6,298,368
b. P 6,746,368 d. P 6,205,136
2. Interest income to be recognized in 2013 is

a. P 620,514 c. P 676,437
b. P 629,837 d. P 720,000
3. Carrying amount of the investment in bonds on December 31, 2014 is

a. P 2,036,215 c. P 2,149,026
b. P 2,721,886 d. P 2,000,000
Answers: 1) D; 2) A; 3)A
Requirement 1
Date Principal Interest Total PVF PV

12/31/13 2,000,000 720,000 2,720,000 0.9091 2,472,752
12/31/14 2,000,000 480,000 2,480,000 0.8264 2,049,472
12/31/15 2,000,000 240,000 2,240,000 0.7513 1,682,912
Auditing Problems
82
6,000,000 6,205,136
Requirement 2 & 3
Nominal Effective Premium Principal Amortized

Date Interest (12%) interest (10%) Amortization Collection Cost
1/01/13 6,205,136
12/31/13 720,000 620,514 99,486 2,000,000 4,105,650
12/31/14 480,000 410,565 69,435 2,000,000 2,036,215
12/31/15 240,000 203,785 36,215 2,000,000 -
ILLUSTRATIVE AUDIT CASE 4.5- Impairment of Investment in Bonds
Purita Company purchased investment in bonds on January 1, 2012. At this date, the cost and fair
value is P 1,000,000. The bonds are classified as financial assets at fair value. On December 31, 2012, the
bonds were selling at 90. Because of the significant financial difficulty of the issuer, the bonds are
considered impaired on December 31, 2013 when the bonds are quoted at 70. On December 31, 2014, the
bonds are quoted at 95. The increase in the fair value of the bonds on December 31, 2014 is due to the
improvement of the issuer’s credit rating.
Required:
1. How much should be recognized as impairment loss in the year 2013?

a. P 300,000 c. P 100,000
b. P 200,000 d. P 0
Answer: D
SOLUTION: Illustrative Audit Case 5
IMPAIRMENT- FINANCIAL ASSET AT FAIR VALUE
For financial assets measured at fair value, all gains and losses are either presented in profit or
loss or in other comprehensive income depending on whether the election to present gains and losses on
equity investments in other comprehensive income is taken or not.
Therefore, it is not necessary to assess financial assets measured at fair value for impairment.
In other words, under PFRS 9, there is no more impairment loss on financial asset measured at
fair value, whether through profit or loss, or through other comprehensive income.
Auditing Problems
83
Accordingly, if the decline in value of financial asset measured at fair value through
comprehensive income is judged to be nontemporary, the unrealized loss will continue to be reported as
component of other comprehensive income rather than as an impairment loss.
ILLUSTRATIVE AUDIT CASE 4.6-Impairment of Investment in Equity Securities
On January 1, 2012, Manila Company purchased 200,000 ordinary shares of Poor Corporation at
P100 per share. The shares do not qualify as financial assets held for trading. The following table sets out
the changes in the fair value of the shares and the nature of the change in each year:
Year Fair Value Change Nature of Change

2012 (P 200,000) No objective evidence of impairment
2013 ( 400,000) objective evidence of impairment
2014 500,000 objective evidence of reversal of impairment
Required:
1. The amount to be recognized in 2013 profit or loss as a result of the fair value changes is
a. P 600,000 c. P 200,000
b. P 400,000 d. P 0
Answer: A
IMPAIRMENT- FINANCIAL ASSET AT AMORTIZED COST
Under PFRS 9, there is now only one impairment method for financial assets measured at
amortized cost.
Paragraph 58 of PAS 39 as consequently amended by PFRS 9 provides that an entity shall assess
at the end of the reporting period whether there is any objective evidence that a financial asset or group
of financial assets measured at amortized cost is impaired.
Paragraph 63 of PAS 39 further provides that if there is objective evidence that an impairment
loss on financial assets measured at amortized cost has been incurred, the amount of the loss is measured
as the difference between the carrying amount and the present value of estimated future cash flows
discounted at the original effective interest rate.
The carrying amount of the asset shall be reduced either directly or through the use of an
allowance account. The amount of the loss shall be recognized in profit or loss.
Incidentally, the journal entry to record the impairment of the investment on December 31, 2013
is:
Impairment loss (P/L) P 600,000

Investment in Equity Securities P 400,000
Auditing Problems
84
Unrealized loss- OCI 200,000
ILLUSTRATIVE AUDIT CASE 4.7- Investment in Associate; Excess of Cost Over Fair Value
On July 1, 2013, San Pedro Company acquired 25% of the outstanding ordinary shares of San
Pablo Corporation at a total of P7,000,000. The underlying equity of shares acquired by San Pedro was
only P6,000,000. San Pedro is willing to pay more than book value for the following reasons:
a. San Pablo owned depreciable plant assets (10-year remaining economic life) with a current fair
value of P600,000 more than its carrying amount.
b. San Pablo owned land with current fair value of P3,000,000 more than its carrying amount.
c. There are no other identifiable tangible or intangible assets with fair value in excess of book
value. Accordingly, the remaining excess, if any, is to be allocated to goodwill.
San Pablo earned net income of P5,400,000 evenly over the year ended December 31,2013. On
December 31, San Pablo declared and paid a cash dividend of P1,050,000 to ordinary shareholders.
Market value of San Pedro’s shares at December 31, 2013 is P7,500,000. Both companies close their
accounting records on December 31.
Required:
1. Total amount of goodwill of San Pablo Corporation based on the price paid by San Pedro is
a. P 4,000,000 c. P 400,000
b. P 1,000,000 d. P 100,000
2. Net investment income from Investment in San Pablo Corporation is

a. P 675,000 c. P 667,500
b. P 1,335,000 d. P 662,500
3. Carrying amount of Investment in San Pablo Corporation as of December 31, 2013 is

a. P 7,412,500 c. P 7,667,500
b. P 7,405,000 d. P 7,662,500
Answers: 1) C; 2) C; 3) A
SOLUTION: Illustrative Audit Case 4. 7
Requirement 1
Acquisition cost P7,000,000

Less: Carrying amount of net assets acquired 6,000,000
Excess 1,000,000
Attributed to:
Auditing Problems
85
Undervalued plant asset (P600,000 x 25%) (150,000)

Undervalued land (P3,000,000 x 25%) (750,000)
Goodwill 100,000
Divided by % of interest 25%
Goodwill of San Pablo P 400,000
Requirement 2
Share in net income (P 5,400,000 x 6/12 x 25%) P 675,000
Amortization of excess- plant asset
(P150,000/10 x 6/12) ( 7,500)
Net investment income P 667,500
An investment in associate is accounted for using the equity method from the date on which it
becomes an associate. Goodwill relating to an associate is included in the carrying amount of the
investment. However, amortization of that goodwill is not permitted and is therefore not included in the
determination of the investor’s share of the associate’s profits and losses.
Appropriate adjustments to the investor’s share of the associate’s profits or losses after acquisition
are also made to account, for example, for depreciation of the depreciable assets based on their fair
values at the acquisition date. Similarly, appropriate adjustments to the investor’s share of the
associate’s profits and losses after acquisition are made for impairment losses recognized by the
associate, such as for goodwill or property, plant and equipment.
Requirement 3
Acquisition cost P 7,000,000

Net investment income 667,500
Dividends received (P 1,050,000 x 25%) ( 262,500)
ILLUSTRATIVE AUDIT CASE 4. 8- Investment in Associate; Investee with Heavy Losses
On July 1,2009, Camias Corporation acquired 25% of the shares of Ling Company. At that date,
the equity of Ling was P4,000,000 with all the identifiable assets and liabilities being measured at
amounts equal to fair value. The table below shows the profits and losses made by Ling during 2009 to
2013:
YEAR Profit (Loss)

2009 P 200, 000
2010 (2,000,000)
2011 (2,500,000)
2012 160,000
2013 300,000
Auditing Problems
86
Required:
1. The carrying amount of the investment in Ling Company as of December 31, 2010 is
a. P 1,000,000 c. P 550,000
b. P 1,050,000 d. P 525,000
2. The amount to be recognized in 2011 profit and loss related to the Ling Company is
a. P 550,000 c. P 625,000
b. P 525,000 d. P 0
a. P 40,000 c. P 100,000
b. P 60,000 d. P 0
a. P 75,000 c. P 15,000
b. P 40,000 d. P 0
5. The carrying amount of the investment in Ling Company as of December 31, 2013 is
a. P 40,000 c. P 75,000
b. P 15,000 d. P 0
Answers: 1) D; 2) B; 3) D; 4) C: 5) B
SOLUTION: Illustrative Audit Case4. 8
Requirement 1
Acquisition cost P 1,000,000
Share of profit for 2009 (P200,000 x 6/12 x 25%) 25,000
Carrying amount, 12/31/2009 1,025,000
Share of loss for 2010 ( 500,000)
Carrying amount,12/31/2010 P 525,000
Requirement 2
Share of loss for 2011 (P2,500,000 x 25%) P 625,000
Carrying amount of investment, 12/31/2010 P 525,000
Amount to be recognized in 2011 profit or loss

(limited to the carrying amount of investment) P 525,000
Auditing Problems
87
If an investor’s share of losses of an associate equals or exceeds its interest in the associate, the
investor discontinues recognizing its share of further losses. The interest in an associate is the carrying
amount of the investment in the associate under the equity method together with any long-term interests
that, in substance, form part of the investor’s net investment in the associate. (PAS 28 par. 29)
After the investor’s interest is reduced to zero, additional losses are provided for, and a liability
is recognized, only to the extent that the investor has incurred legal or constructive obligations or made
payments on behalf of the associate. (PAS 28 par. 30)
Requirement 3
Share of profit for 2012 (P160,000 x 25%) P 40,000
Unrecognized share of loss for 2011

(P 625,000 – P 525,000) P 100, 000
Amount to be recognized in 2012 profit or loss P 0
If an associate subsequently reports profits, the investor resumes recognizing its share of those
profits only after its share of the profits equals the share of losses not recognized. (PAS 28 par. 30)
Requirement 4
Share of profit for 2012 (P 300,000 x 25%) P 75,000
Unrecognized share of loss for 2010

(P100,000 – P 40,000) P 60,000
Amount to be recognized in 2012 profit or loss P 15,000
Requirement 5
Carrying amount, 12/31/2010 (see no. 1) P 525,000

Recognized share of loss for 2011 (see no. 2) (525,000)
Recognized share of loss for 2013 (see no. 4) 15,000
Carrying amount, 12/31/2013 P 15,000
ILLUSTRATIVE AUDIT CASE 4.9-Fair Value and Equity Method
Malabon Company acquired 50,000 shares of AAA Co. for P5 per share and 125,000 ordinary
shares of BBB Co. for P10 per share on January 2, 2012. Both AAA Co. and BBB Co. have 500,000
ordinary shares outstanding. Both securities are being held as long term investments. Changes in retained
earnings for AAA and BBB for 2012 and 2013 are as follows:
AAA Co. BBB Co.
Auditing Problems
88
Retained earnings (deficit), 1/01/12 P 1,000,000 (P175,000)

Cash dividends, 2012 (125,000) -
Profit for 2012 200,000 325,000
Retained earnings (deficit), 12/31/12 P 1,075,000 P 150,000
AAA Co. BBB Co.

Retained earnings, 12/31/12 P 1,075,000 P 150,000
Cash dividends, 2013 (150,000) ( 50,000)
Profit for 2013 300,000 125,000
Retained earnings, 12/31/13 P 1,225,000 P 225,000
Market value of share: 12/31/12 P 7.00 P 12.00

12/31/13 6.50 15.00
Required:
1. The income from investment in AAA Co in 2013 is

a. P 15,000 c. P 12,500
b. P 1,000 d. P 0
2. The income from investment in BBB Co in 2012 is

a. P 31,250 c. P 2,500
b. P 81,250 d. P 0
3. Carrying amount of Investment in AAA Co. as of December 31,2013 is

a. P 250,000 c. P 325,000
b. P 350,000 d. P 252,500
4. Carrying amount of Investment in BBB Co. as of December 31,2013 is

a. P 1,250,000 c. P 1,875,000
b. P 1,268,750 d. P 1,350,000
Answers: 1) A; 2) B; 3) C: 4) D
Requirement 1
Malabon Co. owns 10% (50,000/500,000) of AAA Co. shares; therefore, the fair value method is
used and the dividend income is computed as follows:
Dividends paid by AAA Co. in 2013 P 150,000

Multiply by % ownership 10%
Income from Investment in AAA Co in 2013 P 15,000
Auditing Problems
89
If the investor holds, directly or indirectly (eg through subsidiaries), less than 20% of the voting
power of the investee, it is presumed that the investor does not have significant influence, unless such
influence can be clearly demonstrated. (PAS 28 par. 6)
Requirement 2
Malabon Co. owns 25% (125,000/500,000) of BBB Co. shares; therefore, the equity method is
used to record the income earned.
BBB Co. profit for 2012 P 325,000

Multiply by % ownership 25%
Income from Investment in BBB Co in 2012 P 81,250
If the investor holds, directly or indirectly (eg through subsidiaries), 20% or more of the voting
power of the investee, it is presumed that the investor has significant influence, unless it can be clearly
demonstrated that this is not the case. (PAS 28 par. 6)
Requirement 3
Investment in AAA Co. shares will be classified as a financial asset measured at fair value since
the shares are held as long term investment and there is reliable fair value. Therefore, the carrying
amount as of 12/31/2013 is P 325,000 (50,000 shares x P 6.50).
Requirement 4
Acquisition cost (P125,000x P10) P 1,250,000

Share of profit for 2012 ( P325,000 x 25%) 81,250
Carrying amount, 12/31/12 1,331,250
Dividends received in 2013 ( P50,000 x 25%) ( 12,500)
Share of profit for 2013 ( P125,000 x 25%) 31,250
ILLUSTRATIVE AUDIT CASE 4.10- Change from Fair Value Method to Equity Method
On January 3, 2011, San Mateo Company purchased for P 1,500,000 cash a 10% interest in San
Juan Corp. On that date, the net assets of San Juan had a book value of P 11,250,000. The excess of cost
over the underlying equity in net assets is attributable to undervalued depreciable assets having a
remaining life of ten years from the date of San Mateo’s purchase. The investment in San Juan Corp. is
not intended for trading.
The fair value of San Mateo’s investment in San Juan securities is as follows: December 31,
2011, P1,710,000; December 31,2012, P1, 575,000; and December 31, 2013, P6,600,00.
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On January 2, 2013, San Mateo purchased an additional 30% of San Juan’s stock for P4,525,000
cash when the carrying amount of San Juan’s net assets was P12,450,000. The excess was attributable to
depreciable assets having a remaining life of 8 years.
During 2011, 2012, and 2013, the following occurred:
San Juan Profit Dividends Paid by San Juan to San Mateo

2011 P 1,050,000 P 45,000
2012 1,200,000 60,000
2013 1,650,000 210,000
Required:
1. The adjustment to retained earnings as of January 1, 2013 as a result of the acquisition of the
additional 30% interest in San Juan Corp. is
a. P 120,000 c. P 45,000
b. P 75,000 d. Nil
2. Income from investment in San Juan Corp. to be recognized in 2013 profit or loss is
a. P 660,000 c. P 520,000
b. P 510,000 d. P 547,500
3. Carrying amount of the Investment in San Juan Corp. as of December 31,2013 is

a. P 6,410,000 c. P 6,480,000
b. P 6,720,000 d. P 6,510,000
Answers: 1) D; 2) C; 3) A
The problem actually involves investing in an associate in stages, the accounting for which is not
covered in PAS 28. However, PAS 28 par. 20 states that many of the procedures appropriate for the
application of the equity method are similar to the consolidation procedures described in PAS 27.
Furthermore, the concepts underlying the procedures used in accounting for the acquisition of a
subsidiary are also adopted in accounting for the acquisition of an investment in associate. Therefore,
because of the lack of accounting guidance in PAS28, we can refer to PFRS 3 in accounting for business
combinations achieved in stages.
PFRS 3, par. 42, provides that in a business combination achieved in stages, the acquirer shall
remeasure the previously held equity interest at fair value and recognize the resulting gain or loss in
profit or loss.
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By inference, the investor shall remeasure the previously held interest in an investee using the
equity method. The difference between the remeasured equity amount and the carrying amount of the
investment shall be recognized in profit or loss.
Actually, the difference between the remeasured equity amount and the carrying amount of the
investment is the same as the difference between the income previously reported and the income that
would have been reported under the equity method.
Requirement 1
Based on the above explanation, there is no necessary adjustment to retained earnings as of

January 1, 2013.
Requirement 2
Share of profit for 2013 (P1,650,000 x 40%) P 660,000

Amortization of excess (see computation below) (140,000)
Net investment income P 520,000
Computation of excess amortization:
Fair value of investment-2011 (10%) P 1,575,000

Acquisition cost- 2013 (30%) 4,525,000
Total cost P 6,100,000
Less: CA of net assets acquired, 1/02/13
(P12,450,000 x 40%) 4,980,000
Excess attributable to depreciable assets P 1,120,000
Amortization of excess (P1,120,000/8) P 140,000
Requirement 3
Total cost (see no.2) P 6,100,000

Net investment income- 2013 (see no.2) 520,000
Dividends received in 2013 ( 210,000)
ILLUSTRATIVE AUDIT CASE 4.11-Change from Equity Method to Fair Value Method
On January 2, 2011, Norway Company acquired 20% of the 400,000 ordinary shares of Mamao
Corporation for P30 per share. The purchase price was equal to Mamao’s underlying book value. Norway
plans to hold this stock to influence the activities of Mamao.
The following data are applicable for 2011 and 2012:
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2011 2012
Mamao dividends (paid Oct. 31) P 40,000 P 48,000
Mamao profit 140,000 160,000
Mamao share market price at year-end 32 31
On January 2, 2013, Norway Company sold 20,000 shares of Mamao at their quoted price of P31
per share. During 2013, Mamao reported profit of P120,000, and on October 31,2013, Mamao paid
dividends of P20,000. At December 31, 2013, after a significant stock decline, which is expected to be
temporary, Mamao’s stock was selling for P22 per share. After selling the 20,000 shares, Norway does
not expect to exercise significant influence over Mamao, and shares are classified as not held for trading.
Required:
1. Carrying amount of Investment in Mamao as of December 31,2011 is

a. P 12,020,000 c. P 2,420,000
b. P 2,500,000 d. P 2,388,000
2. Carrying amount of Investment in Mamao as of December 31,2012 is

a. P 2,442,400 c. P 12,042,400
b. P 2,612,000 d. P 2,372,000
3. Total amount to be recognized in profit or loss on January 2, 2013 is

a. P 9,400 c. P 33,000
b. P 37,600 d. P 27,000
4. The income investment in Mamao in 2013 is

a. P 3,000 c. P 4,000
b. P 24,000 d. P 0
Answers: 1) C; 2) A; 3) B; 4) A
Requirement 1
Acquisition cost (400,000 x 20% x P30) P 2,400,000

Dividends received in 2011 (P 40,000 x 20%) ( 8,000)
Share of profit (P140,000 x 20%) 28,000
Requirement 2
Carrying amount, 12/31/2011 (see no. 1) P 2,420,000

Dividends received in 2012 (P 48,000 x 20%) ( 9,600)
Share of profit (P160,000 x 20%) 32,000
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Requirement 3
Fair value and sales proceeds (80,000 x P31) P 2,480,000

Less: CA of investment, 1/02/2013 (see no.2) 2,442,400
Amount to be recognized in profit or loss P 37,600
An investor shall discontinue the use of the equity method from the date when it ceases to have
significant influence over an associate and shall account for the investment in accordance with PAS 39
from that date, provided the associate does not become a subsidiary or a joint venture. On the loss of
significant influence, the investor shall measure at fair value any investment the investor retains in the
former associate. The investor shall recognize in profit or loss any difference between:
a. The fair value of any retained investment and any proceeds from disposing of the part interest in
the associate; and
b. The carrying amount of the investment at the date when significant influence was lost. (PAS 28
par. 18)
Requirement 4
Dividend income (P 20,000 x 15%*) P 3,000
*[20% - (20,000/400,000 x 100%)]
ILLUSTRATIVE AUDIT CASE 4.12-Interest Rate Swap- Cash Flow Hedge
On January 1, 2013, Vigan Company received a 2-year, P33,000,000 loan, with interest payments
occurring at the end of each year and the principal to be repaid on December 31, 2014. The interest rate
for the first year is the prevailing market rate of 8%, and the rate in 2014 will be equal to the market
interest rate on January 1, 2014. In conjunction with this loan, Vigan enters into an interest rate swap
agreement to receive a swap payment (based on P33, 000, 000) if the January 1, 2014 interest rate is
greater than 8% and will make a swap payment if the rate is less than 8%. The interest swap payment
will be made on December 31, 2014. On January 1, 2014, the interest rate is 7%. Assume that all
conditions for hedge accounting are met.
Required:
1. What is the net amount that Vigan will pay or receive as a result of the interest rate swap?
a. P 308,418 payment c. P 330,000 payment
b. P 305,547 payment d. P 330,000 receipt
2. How much should be recognized on Vigan’s December 31, 2013 Statement of Financial Position
in relation to the interest rate swap?
a. P 308,418 payable c. P 330,000 payable
b. P 305,547 payable d. P 330,000 receivable
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3. How much is the net interest expense in 2014?

a. P 2,640,000 c. P 2,331,582
b. P 2,310,000 d. P 2,618,418
Answers: 1) C; 2) A; 3) A

Requirement 1
Payment ( P33,000,000 x 8%) P 2,640,000
Receipt (P33,000,000 x 7%) 2,310,000
Net Payment P 330 000
The computation means that under the interest rate swap agreement, Vigan Company shall pay
P330,000 on December 31, 2014 by reason of a lower interest rate.
Requirement 2
Derivative Liability – interest rate swap payable,

December 31, 2013 (P330,000 x . 9346) P308, 418
The “unrealized loss” on the interest rate swap is a component of other comprehensive income
because the derivative is designated as a cash flow hedge.
Incidentally, the journal entry to recognize the change in fair value of the interest rate swap
follows:
Unrealized loss on interest rate swap (OCI) P 308, 418

Interest rate swap payable P 308, 418
Requirement 3
Interest paid (P33,000,000 x 7%) P 2,310,000

Loss on interest rate swap 330,000
Total interest expense P 2, 640,000
ILLUSTRATIVE AUDIT CASE 4.13-Interest Rate Swap- Fair Value Hedge
On January 1, 2013, Cauayan Corporation purchased a five-year bonds that has a principal
amount of P1,000,000 and pays annually fixed interest rate of 12% per year. Cauayan Corporation
classified the bond as financial asset at fair value. Current market interest rates for similar five- year
bonds are also 12%.
Because the interest rate is fixed, Cauayan Corporation is exposed to the risk of declines in fair
value of the bond. To eliminate the risk of declines in fair value due to increases in market interest rates,
Cauayan Corporation enters into an interest rate swap on January 1, 2013 to exchange the fixed interest
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payments it receives on the bond for floating interest rate payments. Cauayan Corporation designated and
documented the swap as hedging instrument of the bond.
On December 31, 2013, market interest rates have increased to 14%.
Required:
1. The carrying amount of the investment in bonds on December 31,2013 is

a. P 1,000,000 c. P 956,600
b. P 941,700 d. P 931,300
2. The amount to be recognized in 2013 profit or loss due to change in fair value of the investment
is
a. P 58,300 c. P 43,400
b. P 68,700 d. P 0
3. The amount to be recognized as derivative asset on December 31,2013 is

a. P 68,700 c. P 58,000
b. P 60,700 d. P 0
Answers: 1) B; 2) A; 3) C
Requirement 1
Present value of principal (P1,000,000 x 0.5921) P 592,100

Present value of the interest (P1,00,000 x 12% x 2.9137) 349,644
Fair value, 12/31/2013 P 941,744
On every year-end, the bonds payable is measured at fair value. The fair value is equal to the
present value of the principal plus the present value of the interest payments at the “market rate of
interest”.
Requirement 2
Fair value, 12/31/2013 P 941,744

Cost 1,000,000
Unrealized loss to be recognized in profit or loss P 58,256
Since the investment is designated as a hedged item, the hedge accounting of PAS 39 should be
applied.
A fair value hedge is a hedge of the exposure to changes in fair value of a recognized asset or
liability or a previously unrecognized firm commitment to buy or sell an asset at a fixed price or an
identified portion of such asset, liability or firm commitment, that is attributable to a particular risk and
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96
could affect profit or loss. The gain or loss from the change in fair value of the hedging instrument is
recognized immediately in profit or loss. At the same time, the carrying amount of the hedged item is
adjusted for the corresponding gain or loss with respect to the hedged risk, which is also recognized
immediately in profit or loss.
Requirement 3
Payment (P1,000,000x12%) P 120,000

Receipt (P1,000,000x14%) 40,000
Net Receipt 20,000
PV of ordinary annuity of 1 at 14% for 4 periods 2.9137
Interest rate swap receivable P 58,274
ILLUSTRATIVE AUDIT CASE 14-Forward- Cash Flow Hedge
Santiago Company operates a chain of exotic restaurants. On January 1, 2013, Santiago

determined that it will need to purchase 2,000 kilos of an exotic fish on January 1, 2014. On January 1,
2013, because of the volatile fluctuation in the price of exotic fish, Santiago negotiated a forward contract
with Pay It Bank to purchase 2,000 kilos of exotic fish on January 1, 2013 at a price of P800 per kilo or
1,600,000. On December 31, 2013, and January 1, 2014, the prevailing market price for fish is P820 per
kilo. Santiago purchases the exotic fish and settles the forward contract on January 1, 2014. Assume that
all conditions for the hedge accounting are met and the appropriate discount rate is 12%.
Required:
1. The amount that should be recognized as derivative asset/liability on December 31, 2013 is
a. P 40,000 asset c. P 35,714 asset
b. P 40,000 liability d. P 0
2. The amount to be recognized in 2013 profit or loss that is related to the forward contract is
a. P 40,000 loss c. P 35,714 gain
b. P 40,000 gain d. P 0
Answers: 1) A; 2) D
Requirement 1
Derivative asset- Forward contract receivable
{2,000 kilos x (P820-800)} P 40,000
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97
Forward is another example of a derivative. Forward is a contract to purchase or sell a specific

quantity of a financial instrument, a commodity, or a foreign currency at a specified price determined at
the outset, with delivery or settlement at a specified future date. Settlement is at maturity by actual
delivery of the item specified in the contract, or by a net cash settlement.
Requirement 2
The forward contract is a cash flow hedge since it is a hedge of the exposure to variability in cash
flows. Again, the portion of the gain or loss on the hedging instrument that is determined to be an
effective hedge is recognized in the other comprehensive income and reclassified to profit or loss when
the hedged cash transaction affects it. Therefore, there would be no amount to be recognized in the 2013
profit or loss.
ILLUSTRATIVE AUDIT CASE 4.15-Options- Cash Flow Hedge
Gapan Fitness Enterprises uses soybeans to make one of their nutritional supplement products.
Gapan anticipates a need of 25,000 pounds of soybeans in January of 2014. On October 1, 2013, Gapan
purchased a call option for 25,000 pounds of soybeans on January 1, 2014, at a price of P20 per pound,
which is the market price on October 1. Gapan paid P60,000 for the call option and designated this option
as a hedge against price fluctuations for their January purchase of soybeans. On December 31, 2013 and
January 1, 2014, the prevailing market price for soybeans is P23 per pound.
Required:
1. The unrealized gain or loss to be recognized in the comprehensive income for the year ended
December 31,2013 is
a. P 75,000 gain c. P 15,000 gain
b. P 75,000 loss d. P 15,000 loss
2. The unrealized gain or loss to be recognized in the comprehensive income for the year ended
December 31,2013 if the prevailing market price is P18 per pound on December 31,2013 is
a. P 50,000 gain c. P 60,000 loss
b. P 50,000 loss d. P 60,000 gain
Answers: 1) C; 2) C
Option is another example of a derivative options are contracts that give the purchaser the right,
but not the obligation, to buy(call option) or sell(put option) a specified quantity of a particular financial
instrument, commodity, or foreign currency, at a specified price(strike price), during or at a specified
period of time. These can be individually written or exchange-traded. The purchaser of the option pays
the seller (writer) of the option a fee (premium) to compensate the seller for the risk of payments under
the option.
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Requirement 1
Intrinsic value of call option {25,000x (P23-20)} P 75,000
Carrying amount of call option (option premium) 60,000
Unrealized gain on call option P 15,000
If the market price is greater than the strike price or exercise price, the call option is said to be
“in the money”.
The unrealized gain on call option is recognized as a component of other comprehensive income.
Requirement 2
Intrinsic value of call option P 0
Carrying amount of call option (option premium) 60,000
Unrealized loss on call option P 60,000
If the market price is lower than the strike price or exercise price, the call option is said to be
“out of the money”.
ILLUSTRATIVE AUDIT CASE 4.16-Embedded Derivative
Olongapo Company invests P2,000,000 in a convertible debt instrument issued by Subic

Corporation that pays fixed interest of 10% and that can be converted into 2,000 shares in Subic
Corporation in 5 years at Olongapo’s option. Otherwise, the bond will pay P2,000,000 at maturity. The
estimated fair value of the conversion option at initial recognition is P260,000.
Required:
1. The amount to be recognized as a derivative asset assuming that the investment is classified as
held for trading is
a. P 2,000,000 c. P 260,000
b. P 1,740,000 d. P 0
2. The amount to be recognized as a derivative asset assuming that the investment is classified as a
financial asset at amortized cost is
a. P 2,000,000 c. P 260,000
b. P 1,740,000 d. P 0
3. The amount to be recognized as a derivative asset assuming that the investment is classified as
financial asset at fair value through OCI is
a. P 2,000,000 c. P 260,000
b. P 1,740,000 d. P 0
Answers: 1) D; 2) C; 3) C
The equity conversion option in the convertible debt is an example of an embedded derivative
from the perspective of the holder.
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99
An embedded derivative is a component of a hybrid (combined) instrument that also includes a

non-derivative host contract- with the effect that some of the cash flows of the combined instrument vary
in a way similar to a stand-alone derivative.
An embedded derivative shall be separated from the host contract and accounted for as a
derivative under PAS 39 if, and only if:
a. The economic characteristics and risks of the embedded derivative are not closely related to the
economic characteristics and risks of the host contract;
b. A separate instrument with the same terms as the embedded derivative would meet the definition
of a derivative; and
c. The hybrid (combined) instrument is not measured at fair value with changes in fair value
recognized in profit or loss.
Requirement 1
An equity conversion feature embedded in a convertible debt instrument is not closely related to
the host debt instrument from the perspective of the holder of the instrument. An equity conversion option
would also meet the definition of a derivative. However, since the investment is classified as held for
trading, the embedded derivative is not required to be separated.
Requirement 2
Since the investment is not classified as held for trading, the embedded derivative is required to
be separated from its host contract. The embedded derivative should be measured at fair value with
changes recognized in profit or loss while the host contract shall be measured at fair value with changes
recognized in other comprehensive income.
Requirement 3
Since the investment is classified as financial asset at amortized cost, the embedded derivative is
required to be separated from its host contract. The embedded derivative should be measured at fair
value with changes recognized in profit or loss while the host contract shall be measured at amortized
cost.
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100
Substantive Tests of Intangibles S.Y. 2013-2014
CHAPTER
SUBSTANTIVE
TESTS OF
intangibles
Assertions, Objectives and Procedures for Intangibles

Auditing Problems
101

Existence of occurrence To determine that intangibles 1. Obtain an analysis of ledger
exist and are represented by accounts for intangibles.
contractual rights, privileges or 2. Examine documentation
earning power owned by the supporting intangibles.
company.
Completeness To determine that all 3. Vouch additions to or
transactions relating to acquisitions during the year.
intangibles have been properly 4. Evaluate dispositions and write
recorded. offs during the year.
Rights and Obligations To determine that the 5. In addition to audit procedure no.
intangibles are owned by the 2, perform analytical procedures.
company.
Valuation or allocation To determine that intangibles 6. In addition to audit procedures
are stated at cost less nos. 3 and 4, evaluate
amortization. amortization policy and verify
computation of amortization.
Presentation and To determine whether 7. Evaluate financial statement
disclosure presentation and disclosures presentation and disclosure for
concerning intangibles are intangibles.
adequate and in accordance
with PAS/PFRS.
Definition
• An intangible asset is an identifiable nonmonetary asset without physical substance.
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102
• Three essential criteria:

o Identifiability
o Control
o Future economic benefits
• An intangible asset shall be recognized if the following conditions are present:
o It is probable that economic benefits attributable to the asset will flow to the entity.
o The cost of intangible asset can be measured reliably.
Initial Measurement
I. Separate Acquisition - purchase price, including any import duties and
nonrefundable purchase taxes after deducting trade discounts
and rebates and any directly attributable cost of preparing the
asset for its intended use.
- if the payment for an intangible asset is deferred beyond
normal credit terms, its cost is the cash price equivalent. The
difference between the cash equivalent and the total payments
is recognized as interest expense over its credit period.
II. Acquisition as part of a business - If acquired in a business combination, its cost is based on its
combination fair value on the date of acquisition.
III. Acquisition by way of a - Fair value; or
government grant - Nominal amount or zero, plus any expenditure that is directly
attributable to preparing the asset for its intended use.
(Accounting for government grants)
IV. Acquisition by exchange - Measured at its fair value.
- If the exchange transaction lacks commercial substance, it is
measured at the carrying amount of the asset given up.
V. Acquisition by self-creation or - All directly attributable costs necessary to create produce and
internal generation prepare the asset to be capable of operating it in the manner
intended by management.
ILLUSTRATIVE AUDIT CASE 5.1- Comprehensive
Information concerning Tippy Corporation’s intangible assets is as follows:
a. On January 1, 2012, Tippy signed an agreement to operate as franchisee of Roulette Copy Services,
Inc., for an initial franchise fee of P85,000. Of this amount, P25,000 was paid when the agreement
was signed, and the balance is payable of four annual payments of P15,000 each beginning January 1,
2013. The agreement provides that the down payment is not refundable and no future services are
required of the franchisor. The present value at January 2, 2012 of the four payments discounted at
14% (the implicit rate for a loan of this type) is P43,700. The agreement also provides that 5% of the
revenue from the franchise must be paid to the franchisor annually. Tippy’s revenue from the
franchise for 2013 was P900,000. Tippy estimates the useful life of the franchise to be 10 years
.
b. Tippy incurred P78,000 of experimental and development costs in its laboratory to develop a patent,
which was granted on January 2, 2012. Legal fees and other costs associated with registration of the
patent totaled P16,400. Tippy estimates that the useful life of the patent will be 8 years.
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c. A trademark was purchased from West Company for P40,000 on July 1, 2009. Expenditures for
successful litigation in defense of the trademark totaled P10,000 was paid on July 1, 2012. Tippy
estimates that the useful life of the trademark will be 20 years from the date of acquisition.
Required:
1. The audited balance as of December 31, 2012 of the franchise from Roulette Copy Service (net of
Accumulated Amortization) is
a. P61,830
b. P68,700
c. P25,000
d. P68,130
2. The purchase of average excess earnings over the next four years is
a. P14,350
b. P16,400
c. P94,400
d. P78,000
3. The audited balance as of December 31, 2012 of trademark, net of Accumulated Amortization is
a. P42,706
b. P50,000
c. P33,000
d. P40,000
4. The total Intangible Assets-net as of December 31, 2012 is

a. P109,180
b. P118,886
c. P101,980
d. P100,180
5. The expenses resulting from intangibles transactions for 2012 amounted to

a. P72,038
b. P62,332
c. P62,308
d. P70,038
Answers:
1) A; 2) A; 3) C; 4) A; 5) A
Requirement 1
Schedule
Franchise from Roulette Copy Service, Inc.
Cost of franchise at January 1, 2012
Down payment P25,000
Present value of installments 43,700
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Initial amount capitalized 68,700

Amortization of franchise for 2012 (68,700/10years) (6,870)
Franchise balance, December 31, 2012 P61,830
Requirement 2
Schedule 2
Patent
Capitalized cost of patent at January 2, 2012 P16,400
Amortization for 2012 (P16,400/8 years) (2,050)
Patent balance, December 31, 2012 P14,350
Requirement 3
Schedule 3
Trademark
Cost Accumulated Amortization
Cost of trademark, July 1, 2009 P40,000
Amortization through December 31, 2011
(P40,000/20years = P2,000 x 2 ½ years) P5,000
Amortization for 2012 2,000
Balance, December 31, 2012 40,000 7,000
Accumulated amortization (7,000)
Trademark balance, December 31, 2012 P33,000
Requirement 4
Schedule 4
Intangibles Section of Balance Sheet
December 31, 2012
Franchise from Roulette Copy Service, Inc.,

net of accumulated amortization of P6,870 (schedule 1) P61,830
Patent, net of accumulated amortization of P2,050 (schedule 2) 14,350
Trademark, net of accumulated amortization of P7,000 (schedule 3) 33,000
Total Intangibles P109,180
Requirement 5
Expenses resulting from Intangibles Transactions
For the year ended December 31, 2012
Franchise from Roulette Copy Service, Inc.,

Amortization of franchise P6,780
Franchise fee on revenues from
operations (P900,000 x 5%) P45,000
Imputed interest expense on unpaid balance
of initial franchise fee (P43,700 x 14%) 6,118 51,118
57,988
Litigation expense 10,000
Amortization of patent 2,050
Amortization of trademark 2,000
Total expenses P72, 038
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Transactions during 2005 of the newly organized Pink Corporation included the following:
Jan. 2 Paid legal fees of P150,000 and stock certificate costs of P83,000 to complete
organization of the corporation.
Jan. 15 Hired a clown to stand in front of the corporate office for 2 weeks and hound out
pamphlets and candy to create goodwill for the new enterprise. Clown cost, P10,000;
pamphlets and candy, P5,000.
April 1 Patented a newly developed process with costs as follows:

Legal fees to obtain patent P 429,000
Patent application and licensing fees 63,500
Total P 492,500
It is estimated that in 6 years other companies will have developed improved processes,
making the Pink Corporation process obsolete.
May 1 Acquired both a license to use a special type of container and a distinctive trademark to
be printed on the container in exchange for 6,000 shares of Pink’s no-par common
stock selling for P50 per share. The license is worth twice as much as the trademark, both
of which may be used for 6 years.
July 1 Constructed a shed for P1,310,000 to house prototypes of experimental models to be

developed in future research projects.
Dec. 31 Incurred salaries for an engineer and chemist involved in product development totaling
P1,750,000 in 2005.
Required:
1. Cost of patent
a. P492,500 b. P429,000 c. P63,500 d. P0
2. Cost of licenses
a. P150,000 b. P200,000 c. P100,000 d. P0
3. Cost of trademark
a. P150,000 b. P200,000 c. P100,000 d. P0
4. Carrying amount of Intangible Assets

a. P712,604 b. P2,477,604 c. P697,604 d. P0
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5. Total amount resulting from the foregoing transactions that should be expensed when incurred
a. P4,100,500 b. P1,983,000 c. P1,998,000 d. P0
Journal entries for 2005:
1/2 Organization expenses 233,000

Cash 233,000
1/15 Advertising expense 15,000
Cash 15,000
4/1 Patents 492,500
Cash 492,500
5/1 Licences (P300,000 x 2/3) 200,000
Trademark 100,000
Common stock (6,000 x P50) 300,000
7/1 Building 1,310,000
Cash 1,310,000
12/31 Research and Development expense 1,750,000
Cash 1,750,000
Requirement 1- A
See journal entry for April 1.
Note: Cost of internally developed patent includes only the licensing and other related legal fees
in securing the patent rights.
Requirement2 - B
See journal entry for May 1.
Requirement3 - C
See journal entry for May 1.
Requirement 4 - C
Cost
Patent 492,500
Licenses 200,000
Trademark 100,000 792,500
Less amortization
Patent (P492,500/6 x 9/12) 61,563
Licenses (P200,000/6 x 8/12) 22,222
Trademark (P100,000/6 x 8/12) 11,111 94,896
Carrying value, 12/31/04 697,604
Requirement5 - C
Organization expenses (Jan. 2 transaction) 233,000
Advertising expense (Jan. 15 transaction) 15,000
R and D expense (Dec. 31 transaction) 1,750,000
Total 1,998,000
Auditing Problems
107
ILLUSTRATIVE AUDIT CASE 5.3- Customer list
Cavinti Company purchased a customer list and a formula for a total of P2,000,000. Cavinti uses
the expected cash flow approach for estimating the fair value of these two intangibles. The appropriate
interest rate is 8%. The potential 'future cash flows from the two intangibles, and their associated
probabilities, are as follows:
Customer List
Outcome 1 - 20% probability of cash flows of P250,000 at the end of each year for 5 years.
Formula
Outcome 1 - 10% probability of cash flows of P1,500,000 at the end of each year for 10 years.
Required:
1. The estimated fair value of the customer list is

a. P413,110 c. P106,697
b. P 86,951 d. P541,284
2. The estimated fair value of the formula is
a. P4,164,771 c. P309,687
b. P1,878,915 d. P433,485
3. The cost to be allocated to the customer list is

a. P360,476 c. P230.037
b. P438,440 d. P395,042
4. The cost to be allocated to the formula

a. P1,769,963 c. P1,561,560
b. P1,604,958 d. P1,639,524
Answers: 1) A; 2) B; 3) A; 4) D
Requirement 1
Outcome Present value Probability Probability weighted present value
1 998,178 20% 199,636
2 496,819 30% 149,046
3 128,855 50% 64,428
413 110
Auditing Problems
108
Requirement 2
Outcome Present value Probability Probability weighted present value
1 10,065,122 10% 1,006,512
2 1,656,063 20% 331,213
3 773,129 70% 541,190
1,878,915
Requirements 3 & 4
Fair value Fraction Allocation
Customer list 413,110 413,110/2,292,025 360,476
Formula 1,878,915 1,878,915/2,292,025 1,639,524
2,292,025 2,000,000
ILLUSTRATIVE AUDIT CASE 5.4- Research and development
Pagsanjan Softbytes Corporation is engaged in developing computer software for the small
business at home computer market. Most of the computer programmers are involved in developmental
work designed to produce software that will perform fairly specific tasks in a user-friendly manner.
Extensive testing of the working model is performed before it is released to production for preparation of
masters and further testing. As a result of careful preparation, Pagsanjan has produced several products
that have been very successful in the market place. The following costs were incurred during 2010:
Salaries and wages of programmers doing research P 940,000

Expenses related to projects prior to establishment of
technological feasibility 313,600
Expenses related to projects after technological
feasibility has been established but before software
is available for production 198,000
Amortization of capitalized software development cost
from current and prior years 107,000
Costs to produce and prepare software for sale 225,200
Additional data for 2010:

Sales of products for the year P2,060,000
Beginning inventory 568,000
Portion of goods available for sale sold during the year. 60%
Required:
1. Amount to be capitalized as software development cost subject to amortization

a. P1,451,600 c. P736,800
b. P 198,000 d. P 0
2. Cost of ending inventory

a. P270,000 c. P439 280
Auditing Problems
109
b. P317,280 d. P160,080
3. Total amount related to the development of computer software that should be expensed when
incurred
a. P1,253,600 c. P1,451,600
b. P 940,000 d. P 0
Answers: 1) B; 2) D; 3) A
Requirement 1
Amount to be capitalized as software development cost P198,000
Expenses incurred after technological feasibility has been established but before software is
available for production would be capitalized and its amortization included in the cost of inventories.
Requirement 2
Beginning inventory P568,000
Costs of produce and prepare software for sale 225,200
Amortization of software development cost 107.000
Total cost of goods available for sale 900,200
Percentage of ending inventory (100%-60%) 40%
Ending inventory P360,080
Requirement 3
Salaries and wages of programmers doing research P940,000
Expenses related to projects prior to establishment
of technological feasibility 313,600
Total P1,253,600
ILLUSTRATIVE AUDIT CASE 5.5- Patent
Sim Laboratories holds a valuable patent (No. 125-1977-1E) on a precipitator that prevents
certain types of air pollution. Sim does not manufacture or sell the products and processes it develops.
Instead, it conducts research and develops products and processes which it patents, and then assigns the
patents to manufacturers on a royalty basis. Occasionally, it sells a patent. The history of Sim patent
number 125- 1977-1E is as follows:
Date Activity Cost

2002-2003 Research conducted to develop precipitator P 384.000
Jan. 2004 Design and construction of a prototype 87,600
Mar. 2004 Testing of models 42,000
Jan. 2005 Fees paid to engineers and lawyers to prepare a patent
application; patent granted June 30, 2005 62,050
Auditing Problems
110
Nov. 2006 Engineering activity necessary to advance the

design of the precipitator to the manufacturing
stage 81,500
Dec. 2007 Legal fees paid to successfully defend precipitator
patent 35,700
Apr. 2008 Research aimed at modifying the design of the
patented precipitator 43,000
July 2012 Legal fees paid in unsuccessful patent infringement
suit against a competitor 34,000
Sim assumed a useful life of 17 years when it received the initial precipitator patent. On January
1, 2010, it revised its useful life estimate downward to 5 remaining years. Amortization is computed for a
full year if the cost is incurred prior to July 1 and no amortization for the year if the cost is incurred after
June 30. The company's year ends December 31.
Required:
Compute the carrying value of patent No. 125-1977-1E on each of the following dates:
(a) December 31, 2005.
(b) December 31, 2009.
(c) December 31, 2012.
Requirement (a)
Costs to obtain patent Jan. 2005 P62,050
2005 amortization (P62,050 ÷ 17) (3,650)
Carrying value, 12/31/2005 P58,400
All costs incurred prior to January 2005 are related to research and development activities and were
expensed as incurred.
Requirement (b)
1/1/06 carrying value of patent P58,400
2006 amortization (P62,050 ÷ 17) P3,650
2007 amortization 3,650 (7,300)
51,100
Legal fees to defend patent 12/07 35,700
2008 amortization (P86,800 ÷ 14) 6,200
2009 amortization 6,200 (12,400)
The costs incurred in 2006 and 2008 are related to research and development activities and are
expensed as incurred. Legal fees in successful defense of the patent in 2007 could be capitalized and
considered GAAP.
Auditing Problems
111
Requirement (c)
1/1/10 carrying value P74,400
2010 amortization (P74.400 ÷ 5) P14,880
2011 amortization 14,880
2012 amortization 14.880 (44.640)
The legal costs in 2012 were expensed because the suit was unsuccessful. Even if the lawsuit was
successful, the legal fees would be likewise charged to expense. This is in accordance with PAS 38,
Intangibles which was made effective in 2010.
Jo Tan Company has provided information on intangible assets follows:
A patent was purchased from Francis Argante Company for P2,000,000 on January 1. 2011. Tan
estimates the remaining useful life of the patent to be 10 years. The patent was carried in Argante's
accounting records at a net book value of P2,000,000 when Argante sold it to Tan.
During 2012, a franchise was purchased from JC Company P480,000. In addition, 5% of revenue
from the franchise must be paid JC.
Revenue from the franchise for 2012 was P2,500,000. Tan estimates useful life of the franchise to
be 10 years and takes a full year amortization in the year of purchase.
Tan incurred research and development costs in 2012 as follows:

Materials and equipment P142,000
Personnel 189,000
Indirect costs 102,000
P433,000
Tan estimates that these costs will be recouped by December 31, 2015. The materials and
equipment purchased have no alternative uses.
On January 1, 2012, because of recent events in the field, Tan estimates that the remaining life of
the patent purchased on January 1, 2012, only 5 years from January 1, 2012.
Required:
(a) Total amount of Intangibles that should be shown in Tan’s balance sheet at December 31, 2012.
(b) Total expenses that should be charged against Tan’s income as a result of the facts above.
Auditing Problems
112
Requirement (a)
Jo Tan Company
INTANGIBLES SECTION OF BALANCE SHEET
December 31, 2012
Patent from Francis Argante Company, net of accumulated

amortization of P560,000 (Schedule 1) P1,440,000
Franchise from JC Company, net of accumulated
amortization of P48,000 (Schedule 2) 432,000
Total intangibles P1,872,000
Schedule 1: Computation of Patent from Francis Argante Company
Cost of patent at date of purchase P2,000,000

Amortization of patent for 2011 (P2,000,000 ÷ 10 years) (200,000)
1,800,000
Amortization of patent for 2012 (P1,800,000 ÷ 5 years) (360,000)
Patent balance P1,440,000
Schedule 2: Computation of Franchise from JC Company
Cost of franchise at date of purchase P480,000

Amortization of franchise for 2012 (P480,000 ÷ 10) (48,000)
Franchise balance P 432,000
Requirement (b)
Amortization of patent for 2012 P360,000
Amortization of franchise for 2012 48,000
Payment to Reagan Company (P2,500,000 X 5%) 125,000
Research and development costs 433,000
Total charged against income P966,000
ILLUSTRATIVE AUDIT CASE 5.7- Patent
YOLING INDUSTRIES reports the following patents on its December 31, 2012 statement of
financial position.
Initial Cost Date of Acquisition Useful life (at date of acquisition)

Patent A P1,224,000 March 1, 2009 17 years
Patent B 450,000 July 1, 2010 10 years
Patent C 432,000 Sep. 1, 2011 4 years
The following events occurred during the year ended December 31, 2013.
1. Research and development costs of P737,100 were incurred during the year. These costs were
incurred prior to projects achieving economic viability.
Auditing Problems
113
2. Patent D was purchased on July 1 for P855,000. It has a remaining life of 9 ½ years.
3. A possible impairment of Patent B's value may have occurred at December 31, 2013. This is due
to a significant reduction in the demands for certain products protected by Patent B. The
company's controller estimates the following future cash flows from Patent B.
December 31, 2014 P60,000
December 31, 2015 60,000
December 31, 2016 60,000
The appropriate discount rate to be used for these cash flows is 8%.
1. What is the total carrying value of Yoling's patents on December 31, 2012?
A. P2,383,500 C. P2,106,000
B. P1,390,620 D. P1,573,500
2. What amount of impairment loss should be reported by Yoling for the year ended December 31,
2013?
A. P137,880 C. P337,500
B. P292,500 D. P154,620
3. What is the total carrying value of Yoling's patents on December 31, 2013?
A. P1,969,080 C. P2,158,590
B. P2,020,620 D. P2,203,500
Answers: 1) D; 2) A; 3) B
Requirement 1
Patent A
Initial cost P1,224,000
Amortization:
2009 (P1,224,000/17 x 10/12) P 60,000
2010-2012 (P1,224,000 x 3/17) 216,000 (276,000) P948,000
Patent B
Initial cost P450,000
Amortization:
2010 (P450,000/10 x 6/12) P22,500
2011-2012 (P450,000 x 2/10) 90,000 (112500) 337,500
Patent C
Amortization:
2011 (P432,000/4 x 4/12) P36,000
2012 (P432,000 x ¼ ) 108,000 (144,000) 288,000
Total carrying value of patents, Dec. 31, 2012 P1,573.500
Requirement 2
Auditing Problems
114
Patent B
Carrying value, Dec. 31, 2012 P337,500
Less: 2013 amortization (450,000 x1/10) 45,000
Carrying value, Dec. 31, 2013 292,500
Present value of future cash flows (P60,000 x 2.5770) 154,620
Impairment loss P137,880
Requirement 3
Patent A
Less: 2013 amortization (P1,224,000 x 1/17) 72.000 P876,000
Patent B 154,620
Patent C
Less: 2013 amortization (P432,000 x ¼ ) 108,000 180,000
Patent D
Less: 2013 amortization (P855,000/9.5 x 6/12) 45,000 810,000
Total carrying value of patents, Dec. 31, 2013 P2,020,620
ILLUSTRATIVE AUDIT CASE 5.8- Research and Development
In your audit of the books of DIEHARD CORP. for the year ended December 31, 2013, you
found the following items in connection with the company's patents account.
a. Diehard had spent P360,000 during the year ended December 31, 2012, for research and
development costs. This amount was debited to its patents account. The company's cost
records discloses that it had spent a total of P424,500 for the research and development of its
patents, of which P64,500 spent in 2012 had been debited to Research and Development Expense.
b. The patents were issued on July 1, 2012. In connection with the issuance of the patents, the
company incurred legal expenses of P42,840, which were debited to Legal and Professional Fees
Expense.
c. On January 5, 2013, Diehard paid a retainer of P45,000 for legal services in connection with a
patent infringement suit brought against it. Deferred Costs was charged for the amount.
d. In reply to your inquiry about the company's liabilities as of December 31, 2013, you received a
letter from the company's legal counsel dated January 20, 2014, which indicated that a
settlement of the patent infringement suit had been arranged. The plaintiff will drop the suit and
release the company from all future liabilities in exchange for P60,000. Additional lawyer's fees
were incurred amounting to P3,780.
Required:
Auditing Problems
115
1. The correcting journal entries (excluding amortization) on December 31, 2013 would include net
debit (credit) to
Patents Legal and Professional Fees Expense
A. (317,160) P108,780
B. (208,380) 0
C. (272,160) 63,780
D. (253,380) 45,000
Answer: A

Adjusting journal Entries December 31, 2013
a) Retained earnings 360,000

Patents 360,000
b) Patents 42,840
Retained earnings 42,840
c) Legal and professional fees expense 45,000
Deferred costs 45,000
d) Legal and professional fees expense 63,780
Liability for settlement of patent
Infringement suit 60,000
Accrued attorney's fees 3,780
As the recently appointed auditor for SUPERPOWER COMPANY, you have been asked to
examine selected accounts. Your audit client, organized in 2012, has setup a single account for all
intangible assets. The following summary shows the debit entries that have been recorded during 2013.
Jan. 2 Purchased patent (8-year life) P870,000
April 5 Goodwill 720,000
June 30 Payment of 12 months' rent on property
leased by Superpower 182,000
July 1 Purchased franchise with 10-year life;
expiration date, July 1, 2023 900,000
Aug. 3 Payment for copyright (5-year life) 312,000
Sep. 1 Research and development costs related to patent
(incurred prior to achieving economic viability) 320,000
P3,304,000
1. What is the total carrying value of Superpower's intangible assets as of December 31, 2013?
A. P2,928,917 C. P2,927,705
B. P2,622,250 D. P2,713,250
Answer: B
Auditing Problems
116

Patent P870,000
Less: Amortization (P870,000/8) 108,750 P761,250
Goodwill 720,000
Franchise 900,000
Less: Amortization (900,000/10 x 6/12) 45,000 855,000
Copyright 312,000
Less: Amortization (312,000/5 x 5/12) 26,000 286,000
Total carrying value, Dec. 31, 2013 P2,622,250
ILLUSTRATIVE AUDIT CASE 5.10- Recognition of Intangible Assets
The following amounts are included in the general ledger of MARGHERITA PEAK
CORPORATION at December 31, 2012:
Organization costs P 72,000
Trademarks 45,000
Patents 225,000
Discount on bonds payable 105,000
Deposits with advertising agency for ads to promote
goodwill of company 30,000
Cost of equipment acquired for various research and
development projects 320,000
Costs of developing a secret formula for a product that
is expected to be marketed for at least 20 years 240,000
On the basis of the information above, what is the total amount of intangible assets to be reported
by Margherita Peak in its statement of financial position at December 31, 2012?
A. P342,000 C. P510,000
B. P270,000 D. P830,000
Answer: B

Trademarks P 45,000
Patents 225,000
Total intangible assets P270.000
• Organization cost should be recognized as expense in the period it is incurred.

• Discount on bonds payable should be reported as a contra account to bonds payable.
• Cost of equipment acquired for various research and development projects should be included in
the property, plant, and equipment section.
• Deposits with advertising agency for ads to promote goodwill of the company should be reported
as prepaid advertising in the current assets section. PAS 38 does not preclude recognizing a
prepayment as an asset when payment for the delivery of goods or services has been made in
advance of the delivery of goods or rendering of the services.
Auditing Problems
117
ILLUSTRATIVE AUDIT CASE 5.11- Organization costs
As a member of the audit team for the audit of RAS DASHEN COMPANY's financial statements
for the year ended December 31, 2012, you have been asked to examine selected accounts. The controller
for Ras Dashen mentions that there is only one account (shown below) kept for intangible assets.
INTANGIBLE ASSETS
Debit Credit
Feb. 1 Stock issue costs P 72,000 P 72,000
Mar. 15 Research and development costs 1,880,000 1,952,000
April 3 Legal costs to obtain patent 150,000 2,102,000
May 1 Payment of 12 months' rent
on property leased by Ras
Dashen 240,000 2,342,000
June 15 Promotional expenses related
to start-up of business 414,000 2,756,000
Dec. 31 Unamortized bond discount
on bonds due Dec. 31, 2032 168,000 2,924,000
Dec. 31 Operating losses for first year 482,000 3,406,000
Required:
1. The amount of organization expenses to be reported in Ras Dashen's income statement for the
year ended December 31, 2012, is
A. P2,348,000 C. P582,000
B. P486,000 D. P240,000
2. What is the carrying value of the patent at December 31, 2012, assuming that its useful life is 10
years?
A. P150,000 C. P135,000
B. P138,750 D. P 0
3. The prepaid rent to be shown on Ras Dashen's statement of financial position at December 31,
2012, is
A. P160,000 C. P80,000
B. P240,000 D. P 0
Answer: 1) B; 2) B; 3) C
Requirement 1
Stock issue costs P 72,000
Promotional expenses related to start-up of business 414,000
Auditing Problems
118
Total organization expenses P486,000
Requirement 2
Legal cost to obtain patent P150,000
Less: Amortization, April 3 - Dec. 31
(P150,000/10 x 9/12) 11,250
Balance, Dec. 31, 2012 P138,750
Requirement 3
Prepaid rent, Dec. 31, 2012 (P240,000 x 4*/12) P80,000
* Jan. 1, 2013 - May 1, 2013
ILLUSTRATIVE AUDIT CASE 5.12- Lease improvements
MERU, INC. leases an old building which it intends to improve and use for administrative
purposes. The company pays a bonus of P100,000 to obtain the lease. Annual rental for the 10-year lease
period is P160,000. No option to renew the lease or right to purchase the property is given by the lessor.
After obtaining the lease, improvements on the leased building are made costing P400,000. The building
has an estimated remaining useful life of 19 years.
Required:
1. What is the annual cost (excluding depreciation) of this lease to Meru?

A. P210,000 C. P160,000
B. P200,000 D. P170,000
2. What is the amount of annual depreciation (straight-line), if any, should Meru, Inc. record?
A. P40,000 C. P50,000
B. P30,000 D. P 0
3. What is the entry to record the lease bonus paid at the inception of the lease?
A. Rent expense 100,000
Cash 100,000
B. Prepaid rent 100,000
Cash 100,000
C. Prepaid rent 90,000
Rent expense 10,000
Cash 100,000
D. Rent expense 90,000
Prepaid rent 10,000
Cash 100,000
Answer: 1) D; 2) A; 3) B

1. Annual rental P160,000
Auditing Problems
119
Amortization of lease bonus 10,000

Annual cost of lease 170.000
2. Annual depreciation on leasehold improvements

(P400,000/10 years) P40.000
3. Prepaid rent 100,000

Cash 100,000
ILLUSTRATIVE AUDIT CASE 5.13- Organization costs
ELGON COMPANY was organized in 2011 and began operations at the beginning of 2012. The
company provides landscaping services. The following costs were incurred prior to the start of operations:
Legal fees in connection with organization of the company P135,000

Improvements to leased office space prior to occupancy 225,000
Fees paid to underwriters for handling stock issue 36,000
Costs of meetings of incorporators to discuss
organizational activities 63,000
Filing fee to incorporate 9,000
P468.000
What is the total amount of organization costs that should be reported in Elgon's income statement?
A. P243,000 C. P180,000
B. P468,000 D. P207,000
Answer: A
Legal fees in connection with organization of the company P135,000

Fees to underwriters for handling stock issue 36,000
Costs of meetings of incorporators to discuss organizational activities 63,000
Filing fee to incorporate 9,000
Total organizational expenses P243,000
Improvements to leased office space prior to occupancy of P225,000 should be classified as

leasehold improvements.
CAMEROON CORP. has provided information on intangible assets as follows:

• A patent was purchased from Patintero Company for P6,000,000 on January 1, 2011. On the
acquisition date, the patent was estimated to have a useful life of 10 years. The patent had a net book
value of P6,000,000 when Patintero sold it to Cameroon.
Auditing Problems
120
• On February 1, 2012, a franchise was purchased from the Franchisor Company for P1,440,000. The
contract which runs for 20 years provides that 5% of revenue from the franchise must be paid to
Franchisor. Revenue from the franchise for 2012 was P7,500,000.
• The following research and development costs were incurred by Cameroon in 2012:
Materials and equipment P 426,000
Personnel 567,000
Indirect costs 306,000
Total P1,299,000
Because of recent events, Cameroon, on January 1, 2012, estimates that the remaining useful life
of the patent purchased on January 1, 2011, is only 5 years from January 1, 2012.
1. On December 31, 2012, the carrying value of the patent should be

A. P4,320,000 C. P1,680,000
B. P6,000,000 D. P0
2. The unamortized cost of the franchise at December 31, 2012, should be

A. P999,000 C. P1,440,000
B. P1,356,250 D. P1,374,000
3. How much should be charged against Cameroon’s income for the year ended December 31,
2012?
A. P2,280,000 C. P2,820,000
B. P2,826,000 D. P1,725,000
4. An auditor will most likely obtain evidence regarding the continuing validity and existence of the
patent by obtaining a written representation from
A. The Securities and Exchange Commission (SEC)
B. A patent attorney
C. The patent inventor
D. The patent owner
Answers: 1) A; 2) D; 3) C; 4) B
Requirement 1
Acquisition cost of patent purchased Jan. 1, 2011 P6,000,000
Less: Amortization:
2011 (P6,000,000/10 years) P 600,000
2012 (P6,000,000 - P600,000=
P5,400,000/5 years) 1,089,000 1,680,000
Carrying value of patent, Dec. 31, 2012 P4,320,000
Requirement 2
Acquisition cost of franchise
- purchased Feb. 1, 2012 P6,000,000
Less: Amortization
Auditing Problems
121
(P1,440,000/20 years x 11/12) 66,000

Carrying value of franchise, Dec. 31, 2012 P1,374,000
PAS 38 provides that the depreciable amount of an intangible asset that has a finite life should be
allocated (amortized) on a systematic basis over its useful life. Amortization begins when the asset is
available for use, i.e., when it is in the location and condition necessary for it to be capable of operating
in the manner intended by management. On the other hand, an intangible asset with an indefinite useful
life should not be amortized but should be tested for impairment by comparing its recoverable amount
with its carrying amount at least annually, and whenever there is an indication that the intangible asset
may be impaired.
Requirement 3
Charges against 2012 income:
Amortization of patent (see no. 1) P1,080,000
Amortization of franchise (see no. 2) 66.000
Payment to franchisor (P7,500,000 x 5%) 375.000
Research and development costs 1,299,000
Total P2,820,000
Requirement 4 A patent attorney
ILLUSTRATIVE AUDIT CASE 5.15- Patents
EMI KOUSSI CORP. has its own research department. However, the company purchases patents
from time to time. The following is a summary of transactions involving patents now owned by the
company.
•During 2006 and 2007, Emi Koussi spent a total of P459,000 in developing a new process that
was patented (Patent A) on April 1, 2008; additional legal and other costs of P50,000 were
incurred.
• A patent (Patent B) developed by Nonoy Inventor, an inventor, was purchased for P187,500 on
December 1, 2009, on which date it had an estimated useful life of 12 ½ years.
• During 2008, 2009, and 2010, research and development activities cost P510,000. No additional
patents resulted from these activities.
• A patent infringement suit brought by the company against a competitor because of the
manufacture of articles infringing on Patent B was successfully prosecuted at a cost of P42,600.
A decision in the case was rendered in June 2010.
• On July 1, 2011, Patent C was purchased for P172,800. This patent had 16 years yet to run.
• During 2012, Emi Koussi expended P180,000 on patent development. However, the company is
still undecided as to how the patent, if approved by the Bureau of Patents, will generate probable
future economic benefits.
Assume that the legal life of each patent is also its useful life.
1. What is Patent A's carrying value on December 31, 2012?

A. P120,888 C. P 38,125
B. P497,125 D. P388,113
Auditing Problems
122
2. What is Patent B's carrying value on December 31, 2012?

A. P141,250 C. P 32,092
B. P 28,906 D. P173,342
3. What is Patent C's carrying value on December 31, 2012?

A. P162,000 C. P159,840
B. P327,600 D. P156,600
4. What is the total patent amortization expense to be reported in Emi Koussi's income statement for
the year ended December 31, 2012?
A. P37,300 C. P74,325
B. P28,741 D. P28,300
Answer: 1) C; 2) A; 3) D; 4) D
Date Patent Cost Useful Life Annual Amortization

April 1, 2008 A P 50,000 20* years P 2,500
Dec. 1, 2009 B 187,500 12.5 years 15,000
July 1, 2011 C 172,800 16 years 10,800
P410,300 P28,300
* In accordance with RA 8293, the intellectual Property Code of the Philippines, the term (legal
life) of patent is 20 years from the date of filing the application.
Requirement 1
Cost of Patent A P 50,000
Less: Amortization, April 1, 2008 - Dec. 31, 2012
(P2,500 x 4 9/12) 11,875
Requirement2
Cost of Patent B P187,500
Less: Amortization, Dec. 1, 2009- Dec. 31, 2012
(P15,000 x 3 1/12) 46,250
Requirement3
Cost of Patent C P172,800
Less: Amortization, July 1, 2011 - Dec. 31, 2012
(P10,800 x 1 6/12) 16,200
Requirement4. Amortization of patents for the year ended Dec. 31, 2012
(see schedule) P28,300
Auditing Problems
123
Legal costs incurred in prosecuting or defending a patent are subsequent costs of maintaining,
rather than enhancing the original future economic benefits that are expected to flow from the patent.
These subsequent legal costs should be expensed, not capitalized.
ILLUSTRATIVE AUDIT CASE 5.16- Research and Development
During 2010, APEX COMPANY purchased a building site for its proposed research and
development laboratory at a cost of P1,200,000. Construction of the building was started in 2010. The
building was completed on December 31, 2011, at a cost of P5,600,000 and was placed in service on
January 2, 2012. The estimated useful life of the building for depreciation purposes was 20 years; the
straight-line method of depreciation was to be employed and there was no estimated salvage value.
Management estimates that about 50% of the projects of the research and development group will
result in long-term benefits (i.e., at least 10 years) to the corporation. However, Apex fails to demonstrate
how such projects will generate probable future economic benefits. The remaining projects either benefit
the current period or are abandoned before completion. A summary of the number of projects and the
direct costs incurred in conjunction with the research and development activities for 2012 appears below.
Upon recommendation of the research and development group, Apex Company acquired a patent
for manufacturing rights at a cost of P1,600,000. The patent was acquired on April 1, 2011, and has an
economic life of 10 years.
Salaries and Other Expenses

Number Employee (excluding Building
of Projects Benefits Depreciation Charges)
Completed projects with
long-term benefits 30 P1,800,000 P1,000,000
Abandoned projects or
projects that benefit the
current period 20 1,300,000 300,000
Projects in process -
results indeterminate 10 800 000 240,000
Total 60 P3,900,000 P1,540,000
1. The total research and development expenses for 2012 should be

A. P2,920,000 C. P5,440,000
B. P5,880,000 D. P5,720,000
2. What is the amount of patent amortization for 2012?

A. P 80,000 C. P120,000
B. P160,000 D. P 0
3. What is the book value of the building on December 31, 2012?

A. P5,320,000 C. P5,040,000
B. P5,600,000 D. P6,460,000
Auditing Problems
124
4. What is the carrying value of the patent at December 31, 2012?

A. P1,280,000 C. P1,600,000
B. P1,320,000 D. P 0
Answer: 1) D; 2) B; 3) A; 4) B
Requirement 1
Salaries and employee benefits P3,900,000
Depreciation - building (P5,600,000/20 years) 280,000
Other expenses 1,540,000
Total research and development expenses P5.720.000
Requirement2
Patent amortization for 2012 (P1,600,000/10 years) P160.000
Requirement3
Cost of building P5,600,000
Less: Accumulated depreciation, Dec. 31, 2012
(P5,600,000/20 years) 280,000
Book value, Dec. 31, 2012 P5,320.000
Requirement4
Cost of patent purchased April 1, 2011 P1,600,000
Less: Amortization:
April 1 - Dec. 31, 2011
(P1,600,000/10 x 9/12) P120,000
Jan. 1 - Dec. 31, 2012
(P1,600,000/10) 160,000 280,000
Carrying value, Dec, 31, 2012 P1,320,000
Auditing Problems
125
Substantive Tests of Property, Plant and Equipment S.Y. 2013-2014
CHAPTER
SUBSTANTIVE
TESTS OF
property, plant
and equipment
Assertions, Objectives and Procedures for Property, Plant and Equipment
Auditing Problems
126

Existence and To determine whether property 1. Obtain or prepare a summary of
Occurrence and equipment included in the property and equipment
balance sheet physically exist. transactions and analysis of the
Additions include only the accumulated depreciation during
capitalizable cost of assets the year and reconcile to ledger.
purchased, constructed, or 2. Conduct physical inspection of
leased and retirements are major acquisition of plant and
removed. equipment.
Completeness To determine that property and 3. Vouch additions to property and
equipment include all equipment during the year.
capitalizable costs and 4. Investigate disposals and
capitalizable costs are not retirements of property and
expensed. equipment during the year.
Rights and Obligations To determine that has legal 5. Examine evidence of legal
title or equivalent ownership ownership of property and
rights to property and equipment.
equipment included in the 6. Examine lease agreement on
balance sheet and the related property and equipment leased to
lease obligation of capitalized and from others.
leased assets is recognized. 7. Review rental revenue from land,
buildings and equipment owned
by the client but leased to others
Valuation or Allocation To determine that property and 8. Analyze repair and maintenance
equipment is stated at cost and expense accounts.
allowances for depreciation 9. Investigate status of property and
and depletion are computed on equipment not in current use.
the basis of acceptable and 10. Test client’s computation of
consistent methods. depreciation.
11. Perform analytical procedures for
property and equipment.
Presentation and To determine that property and 12. Review financial statement
Disclosure equipment are properly presentation and disclosure for
described and classified in the property and equipment and for
balance sheet and related related revenue and expense.
disclosures are adequate.
Auditing Problems
127
Strathroy Manufacturing is in its sixth year of operations. The company had purchased all of its
manufacturing equipment when it started operations, but recently, it has been falling behind competitors
due to some outdated equipment. In response to this, the management of Strathroy has acquired a new
manufacturing machine, added to its computer facilities and moved into a new location. Information
regarding purchases and updates occurring on January 1, Year 7 for the three items are presented below:
1. An integrated computer system was purchased at a cost of $80,000, and is expected to last 4
years. The company expected that most of the benefits would come in the earlier years and
less in the later years, as the computer becomes outdated. It was expected to have a residual
value of $5,000 at the end of 4 years.
2. New manufacturing equipment was purchased at a cost of $280,000. The equipment is

expected to produce 600,000 units over the next 5 years with expected output of 100,000 in
year 1; 130,000 in years 2 and 3; and 120,000 in years 4 and 5. The equipment is expected to
have a residual value of $40,000 at the end of year 5.
3. A new building has been purchased at a cost of $800,000 and is expected to last the company
20 years, with an expected residual value of $250,000.
The company uses the most appropriate method available for the depreciation of its property,
plant, and equipment. For assets where the diminishing-balance method is appropriate, the company uses
double-the straight line rate.
Required:
Using the most appropriate method for the (1) computer system, (2) manufacturing equipment, and (3)
building, determine the amount of depreciation that would be recorded for each item in each of the first
two years.
Solution Step Progress Technique
1. Orientation: Read the problem quickly to get a feel for the type of problem and environment of
the problem. Identify that it is a manufacturing company, which has outdated equipment and is
looking to upgrade. The stakeholders are the managers and shareholders (or owners) as well as
government and employees. The problem deals with depreciation of property, plant, and
equipment. There are different acceptable methods to depreciate assets, based on the pattern of
the asset’s future economic benefits.
2. Analysis: Read the required and identify the type of problem that is being asked. This is a
depreciation calculation problem where you are also being asked to identify how each of the
newly acquired assets should be treated in regards to the appropriate method of depreciation,
given the choices available under GAAP. As discussed in the textbook, this is based on the pattern
of the asset’s future economic benefits (i.e., the way it is being used to generate revenues for the
Auditing Problems
128
company). Note that you are being asked for each of the first two years, not just the first year.
Look in the body of the chapter relating to depreciation and review the different methods and
formulas of depreciation and when each method should be used.
Straight-line: used when the economic benefits produced by the asset are relatively consistent
each period.
Formula: Depreciation Expense = [Cost – Residual Value] ÷ Estimated Useful Life
Diminishing Balance: used when the asset generates more economic benefits in the earlier
years, than in the later years.
Formula: Straight-line Depreciation Rate = 100% ÷ Estimated Useful Life

Double Diminishing balance Depreciation Rate = 2 × Straight-line Rate
Carrying Amount = Cost – Accumulated Depreciation
Depreciation Expense = Carrying Amount × Depreciation Rate
Note: Do not include residual value in initial calculation. However, note that you cannot
depreciate the asset below its residual value.
Units-of-productivity: Used when the economic benefits produced differ in each period.
Formula: Depreciable Amount Per Unit = [Cost – Residual Value] ÷ Total Estimated Units of
Activity
Depreciation Expense = Actual Units of Activity in Period × Depreciable Amount Per
Unit
3. Planning: Try to identify the specific situations with relation to each of the assets. It is clear from
the wording that each asset is to be treated differently.
a) A quick look at the descriptions of the assets should identify that the new computer
facilities will produce more economic benefits in the early years, thus requiring the
use of the diminishing-balance method. Note the specific wording in the problem
relating to the aging of the computer: The company expected that most of the benefits
would come in the earlier years and less in the later years as the computer becomes
outdated.
b) As shown by the differing levels of output, the new manufacturing equipment will be
utilized differently each period. The most appropriate method for this equipment is
the units-of-production method.
c) The building is to be used equally in each of the periods and thus it would be
appropriate to use the straight-line method.
4. Solve the Problem:

Computer: (Double-Diminishing-Balance Method)
Step 1: 100% ÷ 4 years = 25% per year × 2 = 50% Depreciation Rate
Beginning Accumulated
Auditing Problems
129
Period Carrying Rate Depreciation Depreciation Ending NBV

Amount
0
1 $80,000 50% $40,000 $40,000 $40,000
2 $40,000 50% $20,000 60,000 $20,000
Equipment: (Units-of-Production Method)

Step 1: Depreciable Amount = (Cost – Residual Value) / Estimated Total Units of Activity
= ($280,000 – $40,000) / 600,000 units
= $0.40 per unit
Step 2: Depreciation per year
Year 1 = $0.40/ unit × 100,000 units = $40,000
Year 2 = $0.40/ unit × 130,000 units = $52,000
Building: (Straight-Line Method)

Depreciation = (Cost – Residual Value) / Estimated Useful Life
Depreciation = ($800,000 – $250,000) / 20 years
= $27,500 per year in each of year 1 and 2
5. Evaluation: If you complete a depreciation schedule for the life of the asset, check that your final
carrying amount equals the residual value. Ask yourself if you have answered the required in the
manner in which you have been asked. Do your answers look reasonable? If so, you should feel
confident in the answer that you have provided. Is the solution in a clear, concise format that
would be easy for your instructor to follow and grade?
- Wiley lifted techniques
(Columnar method on solving) – faster, organize and convenient way to solve problems.
Aligaga Corporation was incorporated on January 2, 2010. The following items relate to the
Aligaga’s property and equipment transactions:
Cost of land, which included an old apartment building appraised at P3000,0000

P300,000
Apartment building mortgage assumed, including related interest due at the 80,000
time of purchase
Delinquent property taxes assumed by Aligaga 30,000
Payment to tenants to vacate the building 20,000
Cost of razing the apartment building 40,000
Proceeds from the sale of salvage materials 10,000
Architects fee for the new building 60,000
Building permit for new construction 40,000
Fee for title search 25,000
Survey before construction of new building 20,000
Auditing Problems
130
Excavation before construction of new building 100,000

Payment to building contractor 10,000,000
Assessment by city for drainage project 15,000
Cost of grading and leveling 50,000
Temporary quarters for construction crew 80,000
Temporary buildings to house tools and materials 50,000
Cost of charges during construction to make new building more energy 90,000
efficient
Interest cost on specific borrowing incurred during construction 360,000
Payment of medical bills of employees accidentally injured while inspecting 18,000
building construction
Cost of paving driveway and parking lot 60,000
Cost of installing lights in parking lot 12,000
Premium on insurance on building construction 30,000
Cost of open house party to celebrate opening of new building 50,000
Costs of windows broken by vandals distracted by the celebration 12,000
Required:
1. Cost of land
a. 3,250,000 b. 3,270,000 c. 3,280,000 d. 3,230,000
2. Cost of building
a. 10,810,000 b. 10,710,000 c. 10,510,000 d. 10,620,000
3. Cost of land improvements

a. 12,000 b. 60,000 c. 72,000 d. 82,000
4. Expensed-outright amount
a. 80,000 b. 50,000 c.18,000 d.12,000
5. Depreciable property and equipment.

a. 10,882,000 b. 10,682,000 c. 10,982,000 d. 10,782,000
Answers: 1) B; 2) A; 3) C; 4) A; 5) A
Land Building Land Amount should be Depreciable

Improvements expensed Property and
Equipment
3,000,000 60,000 60,000 18,000 10,810,000
80,000 40,000 12,000 50,000 72,000
Auditing Problems
131
30,000 100,000 12,000

20,000 10,000,000
40,000 80,000
(10,000) 50,000
25,000 90,000
20,000 360,000
15,000
50,000
3,270,000 10,810,000 72,000 80,000 10,882,000
The Blue Corporation was incorporated on January 2, 2005, but was unable to begin
manufacturing activities until July 1, 2005 because the new factory facilities were not completed until that
date.
The “Land and Building” account at December 31, 2005 follows:

Date Particulars Amount
- Jan. 31 Land and building P 1,098,000
- Feb. 28 Cost of removal of old building 60,000
- May 02 Partial payment on new construction 700,000
- 02 Legal fees paid 15,000
- June 01 Second payment on new construction 600,000
- July 01 Fire insurance premium – 1 year 26,000
- 01 Final payment on new construction 200,000
- Dec. 31 Asset write-up 500,000
P 3,199,000
Dec. 31 Depreciation – 2005, at 1% of account balance (31,990)
P 3,167,010
You were able to gather the following during your audit:
a. To acquire land and building, the company paid P98,000 cash and 10,000 shares of its 9%
cumulative preferred shares, P100 par value per share. The shares were then selling at P120.
b. Legal fees covered the following:

Cost of incorporation P 9,500
Examination of title covering purchase of the land 4,000
Legal work in connection with construction contract 1,500
P 15,000
c. Because of a general increase in construction costs after entering into the building contract, the
board of directors increased the value of the building by P500,000, believing such increase is
justified to reflect current market value at the time the building was completed. Retained earnings
was credited for this amount.
d. Estimated useful life of the building is 25 years.
Auditing Problems
132
Required:
1. Prepare the necessary adjusting journal entries as of December 31, 2005.
2. Determine the adjusted balances of the following as of December 31, 2005:
X. Land and building

a. -0- b. 1,362,000 c. 1,501,500 d. 2,836,500
Y. Land
a. -0- b. 1,362,000 c. 1,501,500 d. 2,836,500
Z. Carrying value of building

a. -0- b. 1,362,000 c. 1,501,500 d. 2,836,500
Answers: X) A; Y) B; Z) C
Journal entries:
1) Land [(10,000 shares x P120) +P98,000] 1,298,000

Land and building 1,098,000
Additional paid in capital 200,000
2) Land 60,000
Land and building 60,000
3) Organization expenses 9,500

Land 4,000
Building 1,500
4) Building 700,000
5) Building 600,000
6) Insurance expense (26,000 x 1/2) 13,000

Prepaid insurance 13,000
7) Building 200,000
8) Retained earnings 500,000

Auditing Problems
133
*Adjusted balances
Land Building
AJE no. 1 1,298,000 AJE no. 3 1,500
AJE no. 2 60,000 AJE no. 4 700,000
AJE no. 3 4,000 AJE no. 5 600,000
1,362,000 AJE no. 7 200,000
1,501,500
9) Land and building 31,990

Depreciation expense 1,960
Accumulated depreciation 30,030
Should be depreciation (1,501,500 / 25 x 6/12) 30,030

Recorded depreciation 31,990
Overstatement in depreciation expense 1,960
Land and building account

Unadjusted balance 3,167,010
AJE no. 1 (1,098,000)
AJE no. 2 (60,000)
AJE no. 3 (15,000)
AJE no. 4 (700,000)
AJE no. 5 (600,000)
AJE no. 6 (26,000)
AJE no. 7 (200,000)
AJE no. 8 (500,000)
AJE no. 9 31,990
-
On December 31, 2004, Silver Corporation acquired the following three intangible assets:
• A trademark for P300,000. The trademark has 7 years remaining legal life. It is anticipated that
the trademark will be renewed in the future, indefinitely, without problem.
• Goodwill for P1,500,000. The goodwill is associated with Silver’s Hayo Manufacturing
reporting unit.
• A customer list for P220,000. By contract, Silver has exclusive use of the list for 5 years.
Because of market conditions, it is expected that the list will have economic value for just 3
years.
On December 31, 2005, before any adjusting entries for the year were made, the following
information was assembled about each of the intangible assets:
a. Because of a decline in the economy, the trademark is now expected to generate cash
flows of just P10,000 per year. The useful life of trademark still extends beyond the
foreseeable horizon.
Auditing Problems
134
b. The cash flows expected to be generated by the Hayo Manufacturing reporting unit is
P250,000 per year for the next 22 years. Book values and fair values of the assets and
liabilities of the Hayo Manufacturing reporting unit are as follows:
Book values Fair values

Identifiable assets P2,700,000 P3,000,000
Goodwill 1,500,000 ?
Liabilities 1,800,000 1,800,000
c. The cash flows expected to be generated by the customer list are P120,000 in 2006 and
P80,000 in 2007.
REQUIRED:
Based on the above and the result of your audit, determine the following: (Assume that the
appropriate discount rate for all items is 6%):
1. Total amortization for the year 2005

a. -0- b. 73,333 c. 133,333 d. 166,667
2. Impairment loss for the year 2005

a. -0- b. 73,333 c. 133,333 d. 166,667
3. Carrying value of Trademark as of December 31, 2005

a. -0- b. 73,333 c. 133,333 d. 166,667
4. Carrying value of Goodwill as of December 31, 2005

a. -0- b. 1,500,000 c. 133,333 d. 166,667
5. Carrying value of Customer list as of December 31, 2005

a. -0- b. 73,333 c. 133,333 d. 46,667
Answers: 1) B; 2) C; 3) D; 4) B; 5) D
Requirement 1
Trademark* -
Goodwill* -
Customer list (P220,000/3) 73,333
Total amortization 73,333
*The useful life is indefinite, so no amortization expense is recognized.
Requirement 2
Trademark:
Carrying value 300,000
Recoverable amount (P10,000/0.06) (166,667) 133,333
Auditing Problems
135
Goodwill*:
Carrying value of Hayo Manufacturing unit
(P2,700,000 + P1,500,000 - P1,800,000) 2,400,000
Recoverable amount (P250,000 x 12.0416) 3,010,400 -
Customer list
Carrying value (P220,000 - P73,333) 146,667
Recoverable amount:
2006: (P120,000 x 0.9434) 113,208
2007: (P80,000 x 0.8900) 71,200 184,408 -
Total impairment loss 133,333
*Since goodwill does not generate cash flows independently from other assets or group of assets,
the recoverable amount of goodwill as an individual asset cannot be determined. Therefore, the
recoverable amount is determined for the cash generating unit to which goodwill belongs.
Requirement3
Cost 300,000
Less impairment loss (133,333)
Requirement4
*Since goodwill is not amortized and is not impaired as of 12/31/05, the carrying value is
P1,500,000.
Requirement5
Cost 220,000
Less amortization for 2005 (73,333)
Carrying value, 12/31/05 1 46,667
In connection with your audit of the Josef Mining Corporation for the year ended December 31,
2005, you noted that the company purchased for P10,400,000 mining property estimated to contain
8,000,000 tons of ore. The residual value of the property is P800,000.
Building used in mine operations costs P800,000 and have estimated life of fifteen years with no
residual value. Mine machinery costs P1,600,000 with an estimated residual value P320,000 after its
physical life of 4 years.
Following is the summary of the company’s operations for first year of operations.
Tons mined 800,000 tons
Tons sold 640,000 tons
Unit selling price per ton P4.40
Direct labor 640,000
Miscellaneous mining overhead 128,000
Operating expenses (excluding depreciation) 576,000
Auditing Problems
136
Inventories are valued on a first-in, first-out basis. Depreciation on the building is to be allocated
as follows: 20% to operating expenses, 80% to production. Depreciation on machinery is chargeable to
production.
Required:
Based on the above and the result of your audit, answer the following: (Disregard tax
implications)
1. How much is the depletion for 2005?

a. 800,000 b. 384,000 c. 960,000 d. 320,000
2. Total inventoriable depreciation for 2005?

a. 800,000 b. 384,000 c. 960,000 d. 320,000
3. How much is the Inventory as of December 31, 2005?

a. 800,000 b. 422,400 c. 460,000 d. 420,000
4. How much is the cost of sales for the year ended December 31, 2005?
a. 800,000 b. 384,000 c. 960,000 d. 1,689,600
5. How much is the maximum amount that may be declared as dividends at the end of the
company’s first year of operations?
a. 1,302,400 b. 1,384,000 c. 1,960,000 d. 1,320,000
Answers: 1) C; 2) B; 3) B; 4) D; 5) A
Requirement 1
Acquisition cost 10,400,000
Less residual value (800,000)
Depletable cost 9,600,000
Total estimated reserves 8,000,000
Depletion rate 1.20
Tons mined 800,000
Depletion for 2005 960,000
Requirement2
Depreciation - Building [(P800,000/8,000,000 tons) x 800,000 tons x 80%] 64,000
Depreciation - Machinery [(P1,600,000-P320,000/4] 320,000
Total 384,000
Requirement3
Depletion (see no. 1) 960,000
Direct labor 640,000
Depreciation (see no. 2) 384,000
Auditing Problems
137
Miscellaneous mining overhead 128,000

Total available for sale 2,112,000
Divide by tons mined 800,000
Cost per ton 2.64
Unsold tons (800,000 - 640,000) 160,000
Inventory, 12/31/05 422,400
Requirement4
Cost of sales (640,000 tons x P2.64) 1,689,600
Requirement5
Sales (640,000 x P4.4) 2,816,000
Less cost of sales (see no. 4) 1,689,600
Gross profit 1,126,400
Operating expenses (576,000)
Depreciation - Building [(P800,000/8,000,000 tons) x 800,000 tons x 20%] (16,000)
Net income 534,400
Realized depletion (640,000 tons x P1.2) 768,000
Maximum amount that may be declared as dividends 1,302,400
The property, plant and equipment section of White Corporation’s balance sheet at December 31,
2004 included the following items:
Land P 2,500,000
Land improvements 560,000
Building 3,600,000
Machinery and equipment 6,600,000
During 2005 the following data were available to you upon your analysis of the accounts:
Cash paid on purchase of land P10,000,000
Mortgage assumed on the land bought, including interest at 16% 16,000,000
Realtor’s commission 1,200,000
Legal fees, realty taxes and documentation expenses 200,000
Amount paid to relocate persons squatting on the property 400,000
Cost of tearing down an old building on the land 300,000
Amount recovered from the salvage of the building demolished 600,000
Cost of fencing the property 440,000
Amount paid to a contractor for the building erected 8,000,000
Building permit fees 50,000
Excavation expenses 250,000
Architect’s fee 100,000
Interest that would have been earned had the money used during
the period of construction been invested in the money market 600,000
Invoice cost of machinery acquired 8,000,000
Freight, unloading, and delivery charges 240,000
Customs duties and other charges 560,000
Auditing Problems
138
Allowances, hotel accommodations, etc., paid to foreign

technicians during instillation and test run of machines 1,600,000
Royalty payment on machines purchased (based on units
produced and sold) 480,000
REQUIRED:
Based on the above and the result of your audit, compute for the following as of December 31, 2005:
1. Land
a. 30,000,000 b. 1,000,000 c. 12,000,000 d. 17,000,000
2. Land improvements
a. 30,000,000 b. 1,000,000 c. 12,000,000 d. 17,000,000
3. Building
a. 30,000,000 b. 1,000,000 c. 12,000,000 d. 17,000,000
4. Machinery and equipment
a. 30,000,000 b. 1,000,000 c. 12,000,000 d. 17,000,000
5. Total depreciable property, plant and equipment

a. 30,000,000 b. 1,000,000 c. 12,000,000 d. 30,000,000
Answers: 1) A; 2) B; 3) C; 4) D; 5) D
Nondepreciable:
Land, 1/1/05 2,500,000
Cash paid on purchase of land 10,000,000
Mortgage assumed on the land bought, including interest at 16% 16,000,000
Realtor’s commission 1,200,000
Legal fees, realty taxes and documentation expenses 200,000
Amount paid to relocate persons squatting on the property 400,000
Cost of tearing down an old building on the land 300,000
Amount recovered from the salvage of the building demolished (600,000)
Land, 12/31/05 30,000,000 1
Depreciable:
Land improvements
Balance, 1/1/05 560,000
Cost of fencing the property 440,000 1,000,000 2
Building
Auditing Problems
139
Balance, 1/1/05 3,600,000

Amount paid to a contractor for the building erected 8,000,000
Building permit fees 50,000
Excavation expenses 250,000
Architect’s fee 100,000 12,000,000 3
Machinery and equipment

Balance, 1/1/05 6,600,000
Invoice cost of machinery acquired 8,000,000
Freight, unloading, and delivery charges 240,000
Customs duties and other charges 560,000
1,600,000 17,000,000 4
Total depreciable PPE, 12/31/05 30,000,000 5
In the audit of the books of Green Company for the year 2005, the following items and
information appeared in the Production Machines account of the auditee:
Date Particulars Debit Credit

2005
Jan. 01 Balance–Machines 1, 2, 3, and 4 at P90,000 each P 360,000
Aug 31 Machine 5 198,000
Machine 1 P 3,000
Sept 30 Machine 6 96,000
Dec 01 Machines 7 and 8 at P216,000 each 432,000
Dec 01 Machine 2 21,000
31 Balance . 1,062,000
P1,086,000 P1,086,000
The Accumulated Depreciation account contained no entries for the year 2005. The balance on
January 1, 2005 per your audit was as follows:
Machine 1 P 84,375
Machine 2 39,375
Machine 3 33,750
Machine 4 22,500
Total P 180,000
Based on your further inquiry and verification, you noted the following:
• Machine 5 was purchased for cash; it replaced Machine 1, which was sold on this date for P3,000.
• Machine 2 was destroyed by the thickness of engine oil used leading to explosion on December 1,
2005. Insurance of P21,000 was recovered. Machine 7 was to replace Machine 2.
• Machine 3 was traded in for Machine 6 at an allowance of P12,000; the difference was paid in
cash and charged to Production Machine account.
• Depreciation rate is recognized at 25% per annum.
Auditing Problems
140
REQUIRED:
1. Determine the adjusted balance of the Production Machine as of December 31, 2005
a.828,000 b. 97,875 c. 216,000 d. 432,000
2. Depreciation Expense for the year 2005.

a.828,000 b. 97,875 c. 216,000 d. 432,000
Answers: 1) A; 2) B;
Adjusted bal. Orig. cost Months

Depreciation remaining
Machine 1 - sold 8/31 - 90,000 5,625
Machine 2 - destroyed 12/1 - 90,000 11 20,625
Machine 3 - traded in 9/30 - 90,000 9 16,875
Machine 4 90,000 90,000 12 22,500
Machine 5 198,000 198,000 4 16,500
Machine 6 108,000 108,000 3 6,750
Machine 7 216,000 216,000 1 4,500
Machine 8 216,000 216,000 1 4,500
Total 828,000 97,875
Transactions during 2005 of the newly organized Pink Corporation included the following:
Jan. 2 Paid legal fees of P150,000 and stock certificate costs of P83,000 to complete
organization of the corporation.
15 Hired a clown to stand in front of the corporate office for 2 weeks and hound out
pamphlets and candy to create goodwill for the new enterprise. Clown cost, P10,000;
pamphlets and candy, P5,000.
Apr. 1 Patented a newly developed process with costs as follows:

Legal fees to obtain patent P 429,000
Patent application and licensing fees 63,500
Total P 492,500
It is estimated that in 6 years other companies will have developed improved processes,
making the Pink Corporation process obsolete.
May 1 Acquired both a license to use a special type of container and a distinctive trademark to
be printed on the container in exchange for 6,000 shares of Pink’s no-par common stock
selling for P50 per share. The license is worth twice as much as the trademark, both of
which may be used for 6 years.
Auditing Problems
141
July 1 Constructed a shed for P1,310,000 to house prototypes of experimental models to be

developed in future research projects.
Dec. 31 Incurred salaries for an engineer and chemist involved in product development totaling
P1,750,000 in 2005.
REQUIRED:
1. Cost of patent
a. 492,500 b. 200,000 c. 100,000 d. 697,604
2. Cost of licenses
a. 492,500 b. 200,000 c. 100,000 d. 697,604
3. Cost of trademark
a. 492,500 b. 200,000 c. 100,000 d. 697,604
4. Carrying amount of Intangible Assets

a. 492,500 b. 200,000 c. 100,000 d. 697,604
5. Total amount resulting from the foregoing transactions that should be expensed when incurred
a. 492,500 b. 200,000 c. 100,000 d. 1,998,000
Answers: 1) A; 2) B; 3) C; 4) D; 5) D
Journal entries for 2005:

1/2 Organization expenses 233,000
Cash 233,000
1/15 Advertising expense 15,000

Cash 15,000
4/1 Patents 492,500

Cash 492,500
5/1 Licenses (P300,000 x 2/3) 200,000

Trademark 100,000
Common stock (6,000 x P50) 300,000
7/1 Building 1,310,000

Cash 1,310,000
Auditing Problems
142
12/31 Research and Development expense 1,750,000

Cash 1,750,000
Requirement 1
See journal entry for April 1. Note: Cost of internally developed patent includes only the licensing
and other related legal fees in securing the patent rights. 492,500
Requirement2
See journal entry for May 1. 200,000
Requirement3
See journal entry for May 1. 100,000
Requirement 4
Cost
Patent 492,500
Licenses 200,000
Trademark 100,000 792,500
Less amortization
Patent (P492,500/6 x 9/12) 61,563
Licenses (P200,000/6 x 8/12) 22,222
Trademark (P100,000/6 x 8/12) 11,111 94,896
Requirement 5
Organization expenses (Jan. 2 transaction) 233,000
Advertising expense (Jan. 15 transaction) 15,000
R and D expense (Dec. 31 transaction) 1,750,000
Total 1,998,000
On January 1, 2009, Cabiao Corporation purchased a tract of land (site number 10) with a
building for P1,800,000. Additionally, Cabiao paid a real broker’s commission of P108,000, legal fees of
P18,000 and title guarantee insurance of P54,000. The closing statement indicated that the land value was
P1,500,000 and the building was for P300,000. Shortly after the acquisition, the building was razed at a
cost of P225,000.
Cabiao entered into a P9,000,000 fixed-priced contract with Cabanatuan Builders, Inc. on March
1, 2009 for construction of an office building on the land site 10. The building was completed and
occupied on September 30, 2010. Additional construction costs were incurred as follows.
Plans, specifications and blueprints P 36,000

Architect’s fees for design and supervision 285,000
The building is estimated to have a forty year life from the date of completion and will be
depreciated using a 150%-declining balance method.
Auditing Problems
143
To finance the construction cost, Cabiao borrowed P9,000,000 on March 1, 2009. The loan is
payable in 10 annual installments of P900,000 plus interest a rate of 14%. Cabiao used part of the loan
proceeds for working capital requirements. Cabiao’s average amounts of accumulated building
construction expenditures were as follows:
For the period March 1 to December 31, 2009 P2,700,000

For the period January 1 to September 30, 2010 6,900,000
Cabiao is using the allowed alternative treatment for borrowing cost.
Required:
1. Compute for cost of land site number 10

a. 2,205,000 b. 10,360,500 c.97,130 d. 1,800,000
2. Cost of building
a. 2,205,000 b. 10,360,500 c.97,130 d. 1,800,000
3. Depreciation of office building for 2010

a. 2,205,000 b. 10,360,500 c.97,130 d. 1,800,000
Answers: 1) A; 2) B; 3) C
Cost of Land Site number 10

Acquisition Cost P1,800,000
Real estate broker’s commission 108,000
Legal fee 18,000
Title guarantee insurance 54,000
Cost of razing the existing building 225,000
Total P2,205,000
Cost of Building
Fixed priced contract cost P9,000,000
Plans, specifications and blueprints 36,000
Architect’s fees and design supervision 285,000
Capitalizable borrowing cost:
Mar. 1 to Dec 32, 2009
(P2,700,000 x 14% x 10/12) 315,000
Jan. 1 to Sep. 30, 2010
(P6,900,000 x 14% x 10/12) 724,500 1 ,039,500
Total P10,360,500
Depreciation Expense [P10,360,500 x (1/40x1.5) x 3/12] P97,130
Auditing Problems
144
On June 1, 2010, Natividad Mining Corp. acquired the rights to a coal mine containing estimated
reserves of 2,000,000 tons of coal. The company estimated that 25,000 tons of coal would be extracted
and sold each month. Cost allocable to coal was P7,000,000.
Also on June 1, 2010, the company purchased an equipment to be used in production, costing
P190,000 which has an estimated useful life of 10 years. The equipment ws expected to become obsolete
after all the coal deposits had been extracted from the mine and only P10,000 selling price of the
equipment could be expected. Production was in full blast since June 2, 2010
Required:
1. Compute for depletion expense for year ended December 31, 2010
a.612,500 b. 600,000 c. 512,500 d. 15,750
2. Depreciation expense on the new equipment for the year ended December 31, 2010.
a.612,500 b. 600,000 c. 512,500 d. 15,750
Answer: 1) A; 2) D
Depletion expense for 2010 [25,000 x 7 3.5(P7,000,000/2,000,000)] P612,500
Depreciation expense for 2010 {25,000 x 7 x P0.09 [P190,000-10,000)/2,000,000]} P 15,750
Auditing Problems
145
Substantive Tests of Liabilities S.Y. 2013-2014
CHAPTER
7
SUBSTANTIVE
TESTS OF
LIABILITIES
Auditing Problems
146
Assertions, Objectives and Procedures for Liabilities

Existence of To determine that payables exist 1. Obtain from the client a listing of
occurrence as of the balance sheet date. accounts and notes payable as of year-
end and reconcile to the general ledger.
2. Vouch recorded liabilities to vendor‘s
statement.
3. Confirm recorded liabilities directly
with suppliers and creditors. Investigate
differences in liabilities reported in the
confirmations with the recorded book
amounts.
4. Examine bank confirmations for loans.
Completeness To determine that all transactions 5. Perform purchase cut off examination.
relating to payables have been 6. Test for unrecorded liabilities.
properly recorded. 7. Perform analytical procedures.
Rights and To determine that payables 8. In addition to audit procedures no. 3,

Obligations represent valid and legal claims of review documentation in client‘s files.
third parties from the client. 9. Examine subsequent payments to
creditors.
Valuation or To determine that payables are 10. Vouch accounts payable schedule
allocation recorded at the proper amount. 11. Test computation of accrued or prepaid
interest.
Presentation and To determine that payables are 12. Scan list of payables to determine that
disclosure presented and disclosed according each major type of obligation is properly
to PAS/PFRS. described and classified. Determine that
contingent liabilities are properly
disclosed.
13. Obtain client‘s representation letter.
ILLUSTRATIVE AUDIT CASE 7.1- Current and Non-Current Liabilities
Auditing Problems
147
You were able to obtain the following from the accountant for Emorej Corp. related to the
company's liabilities as of December 31, 2013.
Accounts payable P 650,000.00

Notes payable- trade 190,000.00
Notes payable- bank 800,000.00
Wages and salaries payable 15,000.00
Interest payable ?
Mortgage Notes payable-10% 600,000.00
Mortgage Notes payable- 12% 1,500,000.00
Bonds payable 2,000,000.00
The following additional formation pertains to these liabilities.
A. All trade notes payable are due within six months from the end of the reporting period.
B. Bank notes payable include two separate notes payable to Allied bank.
1. A P300,000, 8% note issued March 1, 2011, payable on demand. Interest is payable every
six months.
2. A 1-year, P500,000, 11.5% note issued January 2, 2013. On December 30, 2013, Emorej
negotiated a written agreement with Allied bank to replace the note with a 2-year, P500,000,
10% note to be issued January 2, 2014. The Interest was paid on December 31, 2013.
C. The 10% mortgage note was issued October 1, 2010, with a term of 10 years. Terms of the note
give the holder the right to demand immediate payment if the company fails to make a monthly
Interest payment within 10 days of the date the payment is due. As of December 31, 2013,
Emorej is three months behind in paying its required Interest payment.
D. The 12% mortgage note was issued May 1, 2007, with a term of 20 years. The current principal
amount due isP1,500,000. Principal and interest payable annually on April 30. A payment of
P220,000 is due April 30,2014. The payment includes Interest of P180,000.
E. The bonds payable is 10-year, 8% bonds, issued June 30, 2004. Interest is payable semi-annually
every June 30 and December 31.
Required:
1. Interest payable as of December 31, 2013 is

a. P155,000 c. P143,000
b. P203,000 d. P215,000
2. The portion of the notes payable-bank to be reported under current liabilities as of December
31,2013 is
a. P300,000 c. P500,000
b. P800,000 d. P 0
3. Total current liabilities as of December 31, 2013 is
Auditing Problems
148
a. P3,950,000 c. P4,138,000
b. P3,938,000 d. P3,998,000
4. Total non-current liabilities as of December 31, 2013 is

a. P1,760,000 c. P2,560,000
b. P3,960,000 d. P1,960,000
Answers: 1) C; 2) A; 3) B; 4) D
Requirement 1
P300,000 note payable to bank (P300,00*8%*4/12) P 8,000

Mortgage note payable-10% (P600,000*10%3/12) 15,000
Mortgage note payable-12% (P1,500,000*12%*8/12) 120,000
Total Interest payable, 12/31,2013 P143,000
Requirement 2
Note payable to bank-payable on demand P300,000
The P500,000 note payable to bank will be classified as noncurrent because it was refinanced on
a long term basis as of December 31, 2013.
Requirement 3
Accounts payable P 650,000

Notes payable- trade 190,000
Notes payable-bank(see no.2) 300,000
Wages and salaries payable 15 ,000
Interest payable (see no.1) 143,000
Mortgage notes payable-10%
(with breach of Loan covenant) 600,000
Mortgage notes payable-12% (P220,000-P180,000) 40,000
Bonds payable, due 7/1/14 2,000,000
Total current liabilities, 12/31/2013 P3,938,000
In accordance with the revised PAS 1 par. 69, an entity shall classify a liability as current when:
a. It expects to settle the liability in its normal operating cycle
b. It holds the liability primarily for the purpose of trading
c. The liability is due to be settled within twelve months after the reporting period or
d. The entity does not have an unconditional right to defer settlement of the liability for at least
twelve months after the reporting period.
An entity shall classify all other liabilities as noncurrent.
Auditing Problems
149
When an entity breaches an undertaking under a long term loan agreement on or before the end of
the reporting period with the effect that the liability becomes payable on demand, the liability is classified
as current, even if the lender has agreed, after the reporting period and before the authorization of the
financial statements for issue, not to demand payment as a consequence of the breach. The liability is
current, because at the end of the reporting period, the entity does not have an unconditional right to
defer its settlement for at least twelve months after that date. (PAS 1, par. 74)
However, the liability is classified as noncurrent if the lender agreed by the end of the reporting
period to provide a period of grace ending at least twelve months after the reporting period, within which
the entity can rectify the breach and during which the lender cannot demand immediate repayment. (PAS
1, par.75)
Requirement 4
Notes payable-bank (see no.2) P 500,000
Mortgage notes payable-12%
(P1,500,000-P 40,000) 1,460,000
Total noncurrent liabilities, 12/31/2013 P1,960,000
ILLUSTRATIVE AUDIT CASE 7.2-Provisions, Contingent Liabilities, and Contingent Assets

Divine Corporation, a listed company, is a manufacturer of confectionary and biscuits. Its end of
reporting period is December 31. Relevant extracts from its financial statements at 31, December 2012
are as follows:
Current liabilities Provision
Provision for warranties P 270,000
Noncurrent liabilities Provision
Provision for warranties 180,000
Note- Contingent liabilities

Divine is engaged in litigation with various parties in relation to allergic reactions to traces of
peanuts alleged to have been found in packets of fruit gums. Divine strenuously denies the allegations
and, as at the date of authorizing the financial statements for issue, is unable to estimate the financial
effect, if any, of any costs or damages that may be payable to the plaintiffs.
The Provision for warranties at December 31, 2012 was calculated using the following
assumptions: There was no balance carried forward from the prior year.
Estimated costs of repairs-products with minor defects P1,000,000

Estimated costs of repairs-products with major defects P5,000,000
Expected % of products sold during 2013 having no defects in 2013 85%
Expected % of products sold during 2013 having minor defects in 2013 13%
Expected % of products sold during 2013 having major defects in 2013 2%
Expected timing of settlement of warranty payments
-those with minor defects all in 2014
Expected timing of settlement of warranty payments 20% in 2014
-those with major defects 60% in 2014
During the year ended December 31, 2013 the following occurred:
Auditing Problems
150
1. In relation to the warranty Provision of P450,000 at December 31, 2012, P200,000 was
paid out of the Provision. Of the amount paid, P150,000 was for products with minor
defects and P50,000 was for products with major defects, all of which related to amounts
that have been expected to be paid in 2013.
2. In calculating its warranty provision for December 31, 2013, Divine made the following
adjustments to the assumption used for the prior year:
Estimated costs of repairs-products with minor defects P1,000,000

Estimated costs of repairs-products with major defects P6,000,000
Expected % of products sold during 2012 having no defects in 2013 80%
Expected % of products sold during 2012 having minor defects in 2013 15%
Expected % of products sold during 2012 having major defects in 2013 5%
Expected timing of settlement of warranty payments
-those with minor defects all in 2013
Expected timing of settlement of warranty payments 40% in 2013
-those with major defects 80% in 2015
3. Divine determined that part of its plant and equipment needed an overhaul - the conveyer
belt on one of its machines would need to be replaced in about December 2014 at an
estimated cost of P250,000. The carrying amount of the conveyer belt at December 31,
2012 was P140,000. Its original cost was P200,000.
4. Divine was unsuccessful in its defense of the peanut allergy case and was ordered to pay
P1,500,000 to the plaintiffs. As at December 31, 2013 Divine has paid P800,000.
5. Divine commenced litigation against one of its advisers for negligent advice given on the
original installation of the conveyers belt referred to in (4) above. In October 2013 the
court found in favor of Divine. The hearing for damages had not been scheduled as at the
date the financial statements for 2013 are authorized for issue. Divine estimated that it
would receive about P425,000 .
6. Divine signed an agreement with Craft bank. Divine would guarantee a loan made by
Craft bank to subsidiary, Divina Ltd. Divina's loan with Craft bank P3,200,000 as at
December 31, 2013. Divina was in financial position at December 31, 2013.
Required:
1. The warranty expenses in 2013 is

a. P100,000 c.P400,000
b. P160,000 d. P230,000
2. The provision for warranties as of December 31, 2013 is

a. P580,000 c. P230,000
b. P480,000 d. P410,000
3. The provision for warranties o be reported as current liability as of December 31, 2013 is
Auditing Problems
151
a. P220,000 c. P150,000
b. P400,000 d. P330,000
4. The provision for warranties to be reported as noncurrent as of December 31, 2013 is

a. P 80,000 c. P260,000
b. P150,000 d. P330,000
5. Total provisions to be reported in the statement of financial position as of December 31, 2013 is
a. P 480,000 c. P 410,000
b. P1,180,000 d. P1,360,000
Answers: 1) B; 2) D; 3) D; 4) A; 5) C
Requirement 1
No defects - 85% P 0
Minor defects (P1,000,000*13%) 130,000
Major defects (5,000,000*2%) 100,000
Increase in provision in 2013 230,000
Unused amounts reversed in 2013
(P270,000-P200,000) (70,000)
Warranty expense n 2013 P160,000
Where the provision being measured involves a large population of items, the obligation is
estimated by weighting all possible outcomes by their associated probabilities. The name for this
statistical method of estimation is expected value.
Requirement 2
Balance, 1/1/13 (P270,000+180,000) P450,000
Amounts used in 2013 (200,000)
Increase in provision in 2013 230,000
Unused amounts reversed in 2013 ( 70,000)
Balance, December 31, 2013 P410,000
Alternative computation:
Increase in provision in 2013 P230,000
Balance of provision from 2012
payable in 2014 180,000
Balance, 12/31/13 P410,000
A provision shall be used only for expenditures for which the provision was originally
recognized.
Provisions shall be reviewed at the end of each reporting period and adjusted to reflect the
current best estimate. If it is no longer probable that an outflow of resources embodying economic
benefits will be required to settle the obligation, the provision shall be reversed.
Auditing Problems
152
Requirement 3
Balance of provision from 2012 payable in 2014 P180,000
Increase in provision in 2013
Minor defects 130,000
Major defects (P100,000*20%) 20,000
Provision for warranties-current P330,000
Requirement 4
Provision for warranties, 12/31/13 P410,000
Less: current provisions for warranties 330,000
Noncurrent provisions for warranties P 80,000
Requirement 5
Provision for warranties, 12/31/13 P410,000
Under PAS 37: Provisions, Contingent liabilities and Contingent assets, a provision shall be
recognized when:
a. an entity has a present obligation (legal or constructive) as a result of past event;

b. it is probable that an outflow of resources embodying economic benefits will be required to settle
the obligation; and
c. a reliable estimate can be made of the amount of the obligation.
The other items should be treated as follows:

Expected overhaul - not a provision; Divine has no present obligation to conduct the overhaul.
Rather, it is an evidence that the conveyer belts’ useful life has been shortened.
Unpaid amount of P700,000 (peanut allergy case) - not a provision; there is no uncertainty
regarding timing or amount of settlement. The amount should be included as part of trade and other
payables.
Claim for damages against the entity's advisers - Contingent asset
Guarantee - not a provision; although the entity has a present obligation under the guarantee, it
is not probable that an outflow of economic benefits will be required to settle the obligation since Divina
was in a strong financial position at December 31, 2013. The guarantee would be disclosed as a
Contingent liability.
ILLUSTRATIVE AUDIT CASE 7.3- Currently Maturing Debt Expected to be Refinanced
Miles Company has the following three loans payable scheduled to be repaid in February of next
year. The company's accounting year ends on December 31.
a. The company intends to repay Loan 1 for P100,000 when it comes due in February. In
the following October, the company intends to get a new loan for P80,000 from the same
bank.
Auditing Problems
153
b. The company intends to refinance Loan 2 forcP150,000 when it comes due in February.
The refinancing agreement, for P180,000, will be signed n April, after the financial
statements for this year have been authorized for issue.
c. The company intends to refinance Loan 3 for P200,000 before it comes due in February.
The actual refinancing, for P175,000, took place in January, before the financial
statements for this year have been authorized for issue.
Required:
1. As of December 31 of this year, the Total non-current liabilities to be reported in the company's
statement of financial position should be
a. P250,000 c. P170,000
b. P 0 d. P125,000
2. As of December 31 of this year, the Total current liabilities to be reported in the company's
statement of financial position should be
a. P100,000 c. P450,000
b. P250,000 d. P125,000
Answers: 1) B; 2) C
Requirement 1
Noncurrent liabilities P0
Requirement 2
Loan 1 P100,000
Loan 2 150,000
Loan 3 200,000
Total current liabilities P450,000
Under PAS 1: Presentation of financial statements an entity classifies its financial liabilities as
current when they are due to be settled within 12 months after the end of the reporting period, even if:
a. the original term was for a period longer than 12 months; and
b. an agreement to refinance, or to reschedule payments, on a long-term basis is completed
after the end of the reporting period and before the financial statements are authorize
for issue.
PAS 1 further provides that if the refinancing on a long-term basis occurs between the end of the
reporting period and before the financial statements are authorized for issue, such event in accordance
with PAS 10.
Auditing Problems
154
ILLUSTRATIVE AUDIT CASE 7.4- Bonds Payable
In your audit of Jebie Co., you find the following ledger account balances.
Debit Credit
12%, 25-year bonds payable, 2009 issue
01/1/2009 P6,400,000
Treasury bonds
10/01/2013 P864,000
Bond premium
01/01/2009 320,000
Bond Interest expense

01/01/2013 P384,000
07/01/2013 P384,000
The bonds were redeemed for permanent cancellation on October 1, 2013 at 105 plus accrued
interest.
Use straight line method to amortize premium or discount.
1. The adjusted balance of bonds payable as of December 31, 2013 is

a. P5,536,000 c. P5,600,000
b. P6,400,000 d. P4,000,000
2. The unamortized bond premium on December 31, 2013

a. P320,000 c. P256,000
b. P224,000 d. P235,200
3. The total bond Interest expense for the year 2013

a. P756,400 c. P731,600
b. P755,200 d. P731,200
4. The gain or loss on partial bond redemption is

a. P 7,600 loss c. P 7,600 gain
b. P72,400 loss d. P72,400 gain
Answers: 1) C; 2) B; 3) C; 4) A
Requirement 1
Total bonds issued P6,400,000
Face value of bonds retired
{P864,000/[1.05+(.12*3/12)]} 800,000
Adjusted balance of bonds payable 12/31/13 P5,600,000
Auditing Problems
155
Requirement 2
Unamortized bond premium, 12/31/13
(P320,000*8/64*20/25) P 224,000
Requirement 3
Nominal Interest:
Remaining bonds (P5,600,000*12%) P672,000
Bonds retired (P800,000*12%*9/12) 72,000 P744,000
Less premium amortization:
Remaining bonds (P320,000/25*14/16) 11,200
Bonds retired (P320,000/25*2/16*9/12) 1,200 12,400
Bond Interest expense P731,600
Requirement 4
Face value of bonds redeemed P800,000
Unamortized bond premium
(P320,000*8/64*20.25/25) 32,400
Carrying amount of bonds redeemed 832,400
Less retirement price (P800,000*1.05) 840,000
Loss on bond redemption P 7,600
ILLUSTRATIVE AUDIT CASE 7.5- Bonds Payable
In connection with the audit of the company's financial statements for the year ended December
31, 2013, the Ace Corporation presented to you their records. This is the first time the company has been
audited. The company issued serial bonds on April 1, 2010. Your audit showed the following details of
the issue and the accounts as of December 31, 2013:
Total face value P2,000,000

Date of bond March 1,2010
Total proceeds P2,656,000
Interest rate 12% per annum
Interest payment date March 1
Date of maturity Amount

March 1, 2013 P 500,000
March 1, 2014 500,000
March 1, 2015 500,000
March 1, 2016 500,000
P2,000,000
Since the Corporation had excess cash, bonds of P500,000 scheduled to be retired on March
1,2015 were retired on April 1, 2013. The total amount paid was charged to serial bonds payable account.
SERIAL BONDS PAYABLE

3/01/2013 VR P500,000 4/01/2010 CR P2,656,000
Auditing Problems
156
4/01/2013 VR P495,000
ACCRUED INTEREST PAYABLE
01/01/2013 GJ P200,000
INTEREST EXPENSE
03/01/2013 VR P240,000
Use bond outstanding method to amortize premium or discount.
Required:
1. The adjusted balance of the bonds payable account as of December 31,2013 is

a. P2,000,000 c. P1,500,000
b. P1,084,000 d. P1,000,000
2. The Unamortized bond premium as of December 31, 2013 should be

a. P66,642 c. P 84,000
b. P82,444 d. P104,000
3. The accrued Interest payable as of December 31,2013 is

a. P150,000 c. P100,000
b. P120,000 d. P200,000
4. The bond Interest expense that should be reported by the Corporation for the year 2013 is
a. P55,264 c. P63,801
b. P58,000 d. P59,61
5. The gain on early retirement of bonds is

a. P79,000 c. P81,170
b. P77,722 d. P 0
Answers: 1) D; 2) C; 3) C; 4) B; 5) A
Requirement 1
Total bonds issued P2,000,000
Bonds retired, 3/1/13 (500,000)
Bonds retired, 4/1/13 (500,000)
Adjusted bal. of bonds payable, 12/31/13 P1,000,000
Requirement 2
Total proceeds P2,656,000
Less: Accrued Interest Payable
(P2,000,000×12%×1/12) 20,000
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157
Issue price 2,636,000

Less: Face value 2,000,000
Total Bond Premium 636,000
Less: Amortization
Prior years (2010-2012) P396,000
Current years (2013):
Bonds retired on maturity
(P500,000×.006×3 mos.) P6,000
Bonds retired prior to
maturity
(P500,000×.006×2mos.) 9,000
Remaining bonds
(P1M×.006×12mos.) 72,000 87,000 483,000
Unamortized premium
cancelled on bonds retired
prior to maturity
(P500,000×.006×23mos) 69,000
Unamortized bond premium, 12/31/13 P 84,000
Computation of amortization rate:

Period covered Bonds outstanding Mos. Peso months
4/1/10-2/28/13 P2,000,000 35 P 70,000,000
3/1/13-2/28/14 1,500,000 12 18,000,000
3/1/14-2/28/15 1,000,000 12 12,000,000
3/1/15-2/28/16 500,000 12 6,000,000
Total P106,000,000
Amortization rate = P636,000/P106,000,000=.006
Requirement 3
Accrued Interest payable, 12/31/13
(P1,000,000×12%×10/12) P100,000
Requirement 4
Nominal interest:
Remaining bonds ( P1,000,000×12%) P120,000
Bonds retired on maturity (P500,000×12%×2/12) 10,000
Bonds retired prior maturity (P500,000×12%×3/12) 15,000
Less: Premium amortization for 2013 (see no.2) 87,000
Interest expense for 2013 P 58,000
Requirement 5
Face value P500,000
Add unamortized bond premium
(P500,000×.006×23 mos.) 69,000
Carrying amount of bonds retired P569,000
Less: Retirement price (P500,000×.98) 490,000
Gain on early retirement of bonds P 79,000
Auditing Problems
158
ILLUSTRATIVE AUDIT CASE 7.6- Convertible Debt Issue
On January 1, 2013, Masagca Company issued 3-year, 4,000 convertible bonds at face value of
P1,000 per bond. Interest is to be paid annually in arrears at the stated coupon rate of 6%. Each bond is
convertible, at the holder's option, into 200 P2 par value ordinary shares at any time up to maturity. On
the date or issuance, the prevailing market Interest rate for similar debt without the conversion privilege
was 9%. On the same date, the market price of one ordinary share was P3. The bonds were converted on
December 31, 2014.
The following present value factors are obtained from the present value tables:
6% 9%
Present value of 1 for 3 periods 0.83962 0.77218
Present value of an ordinary
Annuity of 1 for 3 periods 2.67301 2.53130
Present value of an annuity
due of 1 for 3 periods 2.83339 2.75911
Required:
1. The liability component of the Convertible debt is

a. P4,000,000 c. P1,600,000
b. P3,696,232 d. P3,730,242
2. The Equity component of the Convertible debt is

a. P 303,768 c. P1,600,000
b. P1,973,621 d. P2,400,000
3. The Interest expense to be reported on Masagca Company's income statement for the year ended
December 31, 2014 is
a. P101,000 c. P240,000
b. P110,107 d. P341,000
4. The entry to record the bond conversion on December 31, 2014, should include a credit to share
premium - issuance of
a. P2,289,893 c. P2,593,661
b. P2,400,000 d. P 0
Answers: 1) B; 2) A; 3) D; 4) C;
Requirement 1
Present value of principal (P4,000,000*0.77218) P3,088,720

Present value of Interest payments
(P4,000,000*6%=P240,000*2.53130) 607,512
Liability component of Convertible debt P3,696,232
Auditing Problems
159
Requirement 2
Proceeds P4,000,000
Less: Liability component (see no. 1) 3,696,232
Equity component of Convertible debt P 303,768
Requirement 3
AMORTIZATION SCHEDULE
Date Interest Interest Discount Carrying Value
paid expense Amortization
01/01/13 ----------- ----------- ---------- P3,696,232

12/31/2013 P240,000 P332,661 P 92,661 3,788,893
12/31/2014 240,000 341,000 101,000 3,889,893
12/31/2015 240,000 350,107 110,107 4,000,000
Requirement4
Carrying value of bonds, December 31, 2014

(See Amortization schedule) P3,889,903
Add: Share premium- conversion privilege 303,768
Total consideration 4,193,661
Par value of ordinary shares (P2*(4,000*200)) 1,600,000
Share premium - issuance P2,593,661
*The entry to record the bond conversion is:

Bonds payable 4,000,000
Share premium-conversion privilege 303,768
Bond Discount (P4,000,000-P3,889,893) 110,107
Ordinary shares (P2*800,000 shares) 1,600,000
Share premium-issuance 2,593,661
Under PAS 32: Financial instruments: Disclosure and Presentation, a Convertible bond is a
compound financial instrument that contains both a liability component and an Equity component. Such
components should be classified separately on an entity's statement of financial position. The separation
of components is made at the time the instrument is issued and is not subsequently revised.
An Equity instrument evidences a residual Interest in the assets of an entity after deducting all its
liabilities. Thus, when the initial Carrying amount of a compound financial instrument is allocated to its
Equity and liability components, the equity component is assigned the residual amount after deducting
from the fair value of the instrument as a whole the amount separately determined for the liability
component.
In the case of Convertible bonds, the amount allocated to the liability component s the fair value without
the conversion privilege, the sum of the present value of the face amount of the bonds and the present
Auditing Problems
160
value of the future Interest payments discounted using the effective Interest rate is assigned to the liability
component.
On the conversion date, the carrying value of the bonds converted is used to measure the
ordinary shares issued. No gain or loss is recognized.
ILLUSTRATIVE AUDIT CASE 7.7- Pension
The following information relates to the defined benefit pension plan of the Marquez Corporation
for the year ended December 31, 2013:
Projected benefit obligation, January 1 P13,800,000

Projected benefit obligation, December 31 13,150,000
Fair value of plan assets, January 1 11,500,000
Fair value of plan assets, December 31 13,600,000
Unrecognized past service cost, January 1 500,000
Unrecognized net actuarial loss, January 1 1,300,000
Contributions to the plan 2,000,000
Benefits paid to retirees 1,800,000
Amortization of past service cost, January 1 100,000
Actuarial change decreasing PBO 906,000
Present value of available refunds and reductions in
future Contributions to the plan 250,000
Expected return on plan assets 14%
Settlement rate 12%
Expected average remaining working lives of
the employees participating in the plan 10 years
Required:
1) Current service cost for 1013

a. P 400,000 c. P506,000
b. P1,778,000 d. P656,000
2) Actual return on plan assets in 2013

a. P 100,000 c. P1,900,000
b. P1,610,000 d. P2,100,000
3) Unrecognized net actuarial loss as of December 31 , 2013

a. P104,000 c. P 954,000
b. P 96,000 d. P1,010,000
4) Amount to be recognized in the statement of financial position as of December 31, 2013

a. P650,000 c. P954,000
b. P754,000 d. P504,000
5) Net amount to be recognized in 2013 profit or loss

a. P761,000 c. P996,000
Auditing Problems
161
b. P546,000 d. P746,000
Answers: 1) A; 2) C; 3) A; 4) B; 5) D
Requirement 1
Projected benefit obligation, 1/1/13 P13,800,000
Current service cost (squeeze) 400,000
Interest cost (P13,800,000*12%) 1,656,000
Actuarial change decreasing PBO ( 906,000)
Benefits paid to retirees (1,800,000)
Projected benefit obligation, 12/31/13 P13,150,000
Requirement 2
Fair value of Plan Assets, 01/01/13 P11,500,000

Actual return on plan assets (squeeze) 1,900,000
Contribution to the plan 2,000,000
Benefits paid to retirees (1,800,000)
Fair value of plan assets, 12/31/13 P13,600,000
Requirement 3
Unrecognized net actuarial loss, 1/1/13 P 1,300,000

Actuarial change decreasing PBO (906,000)
Difference between actual and expected return
on plan assets (P1,900,000-(P11,500,000*14%)) (290,000)
Unrecognized net actuarial loss, 12/31/13 P 104,000
Requirement 4
DEBITS
Fair value of plan assets, 12/31/13 P13,600,000
Unrecognized past service cost, 12/31/13
(P500,000- P100,000) 400,000
Unrecognized net actuarial loss, 12/31/13 ( 290,000)
Unrecognized net actuarial loss, 12/31/13 P 104,000
CREDIT
Present value of obligation, 12/31/13 P13,150,000
Prepaid (Accrued) pension Expense, 01/01/13 P 954,000
The amount recognized as a defined benefit liability shall be the net Total of the following
amounts: (PAS 19 par. 54)
a. The present value of the defined benefit obligation at the end of the reporting period;
b. Plus any actuarial gains ( less any actuarial losses) not recognized;
Auditing Problems
162
c. Minus any past service cost not yet recognized;

d. Minus the fair value at the end if the reporting period of plan assets (if any) out of which the
obligations are to be settled directly.
If the calculation of the statement of financial position amount as setout above results in an asset, the
amount recognized should be limited to the net total of Unrecognized actuarial losses and past service
cost, plus the present value of available refunds and reductions in future Contributions to the plan. (PAS
19 par 58)
The asset ceiling is computed below:
Unrecognized net actuarial loss, 12/31/13 P104,000

Unrecognized past service cost, 12/31/13 400,000
Present value of available refunds and
reductions in future Contributions to the plan 250,000
Limit on the amount that may be recognized as asset P754,000
Since the amount computed based on PAS 19 par. 58b is lower than the amount computed based
on PAS 19 par. 54, the amount to be recognized in the statement of financial position should be limited to
P754,000. The excess of P200,000 is recognized in accordance with the entity's accounting policy.
Requirement 5
Current service cost (see no. 1 ) P 400,000

Interest cost (P13,800,000*12%) 1,656,000
Expected return on plan assets (P11,500,000*14%) (1,610,000)
Actuarial loss recognized (see below) -
Past service cost Amortization 100,000
Excess over limit on recognized asset (see no.4) 200,000
Net pension expense P 746,000
Unrecognized net actuarial loss, 1/1/13 P1,300,000

Less corridor (P13,800,000*10%) 1,380,000
Excess P0
ILLUSTRATIVE AUDIT CASE 7.8- Deferred Income Tax Asset and Liability: Single Tax Rate for
all Periods
At December 31, 2012, Keithryn Corporation had a temporary difference (related to depreciation)
and reported a related deferred tax liability of P70,000 on its statement of financial position. At December
31, 2013, Keithryn has four temporary differences. An analysis of these reveals the following:
Temporary Difference Future( Deductible) amounts
2014 2015 Later Year

1. Use of straight line depreciation for accounting purpose 160,000 220,000 760,000
Auditing Problems
163
and accelerated depreciation for tax purposes

2. Rent collected in advance; recognized when earned for (380,000)
accounting purposes and when received for tax purposes
3. Various expenses accrued when incurred for accounting
purposes; recognized for tax purposes when paid ( 90,000)
4. Recognition of gain on installment sales for accounting 276,000 210,000

purposes and during the period of collection for tax
purpose
(34,000) 430,000 760,000
Assume that the company has income taxes of P507,500 due per the tax return for 2013. The
installment receivable collectible in 2015 is classified as noncurrent. The enacted tax rate is 35% for all
periods.
Required:
1. What amount of deferred tax asset should be shown on Keithryn statement of financial position at
December 31, 2013?
a. P303,100 c. P164,500
b. P133,000 d. P569,000
2. What amount of deferred tax liability should be shown on Keithryn's statement of financial
position at December 31, 2013?
a. P399,000 c. P450,000
b. P430,500 d. P569,100
3. How much is Keithryn's pretax accounting income for 2013?

a. P1,563,900 c. P1,450,000
b. P2,406,000 d. P2,606,000
4. How much is Keithryn's net income for 2013?

a. P 607,900 c. P1,898,500
b. P1,563,900 d. P2,233,100
Answers: 1) C; 2) D; 3) B; 4) B
Requirement 1
Deferred tax liability, December 31, 2013
(See computation below) P164,500
Requirement 2
Deferred tax asset, December 31, 2013
(See computation below) P569,100
Auditing Problems
164
Computation of deferred tax asset and liability

Future taxable Tax Deferred tax
Temporary Difference (Deductible) amounts Rate Asset Liability
Depreciation P 1,140,000 35% P399,000
Unearned rent (380,000) 35% P133,000
Accrued expenses (90,000) 35% 31,500
Installment sale 486,000 35% 170,100
Totals P164,500 P569,100
Requirement 3
Taxable income (P507,500/35%) P1,450,000
Excess depreciation for tax
(P160,000+P220,000+P760,000-P200,000*) 940,000
Excess rent income per tax (380,000)
Excess expenses per books ( 90,000)
Excess income per book for installment sale
(P276,000+P210,000) 486,000
Pretax accounting income P2,406,000
*beginning cumulative temporary Difference related to depreciation (P200,000=P70,000/35%
Requirement 4
Pretax accounting income P2,406,000
Less: Income tax (P2,406,000*35%) 842,100
Net income P1,563,900
ILLUSTRATIVE AUDIT CASE 7.9 - Deferred Income Tax Asset and Liability: Carrying Value and
Tax Base; Multiple Tax Rates
Markcon Inc., in its first year of operation, has the following differences between the Carrying
value and tax base of its assets and liabilities at the end of 2013:
Carrying value Tax base

Equipment (net) P800,000 P680,000
Estimated warranty liability 400,000 0
Markcon estimates that the warranty liability will be settled in 2014. The Difference in equipment
(net) will result in taxable amounts as shown below:
Year Amount
2014 P40,000
2015 60,000
2016 20,000
The company has taxable income of P1,040,000 for 2013. As of the beginning 2013, the enacted
tax rates are as follows:
2013 and 2014 35%
Auditing Problems
165
2015 and later 30%
Required:
1. What amount of deferred tax liability should be reported on Markcon's statement of financial
a. P36,000 c. P38,000
b. P42,000 d. P39,000
2. What amount of deferred tax asset should be reported on Markcon's statement of financial
a. P102,000 c. P120,000
b. P140,000 d. P130,000
3. What is the amount of income tax payable (current) to be reported on Markcon's statement of
financial position at December 31, 2013?
a. P462,000 c. P312,000
b. P335,300 d. P364,000
4. What is the total income tax expense for 2010?

a. P262,000 c. P364,000
b. P466,000 d. P298,000
Answers: 1) C; 2) B; 3) D; 4) A
Requirement 1
Deferred tax liability, December 31, 2013 P38,000
2013 2014 2015 Total

Future taxable
amount - depreciation P40,000 P60,000 P20,000 P120,000
Enacted tax rate 35% 30% 30%
Deferred tax liability P14,000 P18,000 P 6,000 P 38,000
Requirement 2
Future tax Deductible amount - warranty P 400,000
Enacted tax rate 35%
Deferred tax asset, December 31, 2013 P 140,000
Requirement 3
Taxable amount for 2013 P1,040,000
Tax rate 35%
Income tax payable for 2013 P 364,000
Requirement 4
Current tax expense for 2013(see no.3) P 364,000
Auditing Problems
166
Deferred tax expense for 2013 38,000

Deferred tax benefit for 2013 ( 140,000)
Income tax expense for 2013 P 262,000
ILLUSTRATIVE AUDIT CASE 7.10- Finance lease - Direct financing
Jebie Corporation is in the business of leasing new sophisticated computer systems. As a lessor of
computers, Jebie purchased a new system on December 31, 2012. The system was delivered the same day
(by prior arrangement) to General Investment Company, a lessee. The Corporation accountant revealed
the following information relating to the lease transaction:
Cost of system to Jebie P550,000

Estimated useful life and lease term 8 years
Expected residual value (unguaranteed) P 40,000
Jebie's implicit rate of Interest 12%
General's incremental borrowing rate 14%
Date of first lease payment Dec. 31, 2012
Additional information is as follows:

a. At the end of the lease, the system will revert to Jebie.
b. General is aware of Jebie's rate of implicit Interest.
c. The lease rental consists of equal annual payments.
Required:
1. The annual lease payment under the lease is

a. P110,717 c. P102,665
b. P 95,950 d. P 91,664
2. The Total financial revenue to be earned by the lessor over the lease term is
a. P257,600 c. P271,320
b. P183,312 d. P335,736
3. The Interest income to be recognized by the lessor in 2013 is

a. P53,680 c. P54,486
b. P52,714 d. P52,547
4. The Total expenses related to the lease that will be recognized by the lessee in 2013
a. P121,464 c. P112,630
b. P130,792 d. P119,278
5. The amount to be reported under current liabilities as liability under finance lease as of December
31, 2013 is
a. P60,239 c. P35,715
b. P48,611 d. P64,963
Auditing Problems
167
Answers: 1) B; 2) A; 3) C; 4) D; 5) B
Requirement 1
Cost of system P550,000
Less: Present value of unguaranteed residual
Value (P40,000*0.4039) 16,156
Net investment to be recovered 533,844
Divide by the present value of annuity due
at 12% for 8 periods 5.5638
Annual lease payment P 95,950
Requirement 2
Gross investment in the lease:
Minimum lease payments (P95,950*8) P767,600
Unguaranteed residual value 40,000 P807,600
Net investment in the lease:
PV of minimum lease payments 533,844
PV of unguaranteed residual value 16,156 550,000
Total Unearned Interest income P257,600
A lease is classified as a finance lease if it transfers substantially all the risks and rewards
incidental to ownership. A lease is classified as an operating lease if it does not transfer substantially all
the risks and rewards incidental to ownership. (PAS 17 par 8)
Whether a lease is a finance lease or an operating lease depends on the substance of the
transaction rather than the form. Situations that would normally lead to a lease being classified as a
finance lease include the following:
°the lease transfers ownership of the asset to the lessee by the end of the lease term;
°the lessee has the option to purchase the asset at a price which is expected to be sufficiently
lower than fair value at the date the option becomes exercisable that, at the inception of the lease, it is
reasonably certain that the option will be exercised;
° the lease term is for the major part of the economic life of the asset, even if title is not
transferred;
°at the inception of the lease, the present value of the Minimum lease payments amounts to at
least substantially all of the fair value of the leased asset; and
°the lease assets are of a specialized nature such that only the lessee can use them without
major modifications being made. (PAS 17 par 10)
PAS 17 paragraph 4 defines Unearned finance income as the Difference between:

a. The gross investment in the lease, and
b. The net investment in the lease.
Gross investment in the lease is the aggregate of:

a. The minimum lease payments receivable by the lessor under a finance lease, and
b. Any unguaranteed residual value accruing to the lessor.
Auditing Problems
168
Net investment in the lease is the gross investment in the lease discounted at the Interest rate
implicit in the lease.
Requirement 3
Interest income in 2013 [ (P550,000 - P95,950) * 12%] P54,480
Requirement 4
Interest expense [(P533,844-P95,950) * 12%] P 52,547
Depreciation expense (P533,844/8) 66731
Total P119,278
Requirement 5
Finance lease liability, 12/31/12 P533,844
Less lease payment, 12/31/12 95,950
Balance, 12/31/12 437,894
Less principal payment on 12/31/13:
Total payment in 2013 P95,950
Less Interest expense (P437,894*12%) 52,547 43,403
Balance, 12/31/13 P394,491
Total payment in 2014 P95,950

Less interest (P394,491*12%) 47,339
Current portion of finance lease liability P48,611
Auditing Problems
169
Substantive Tests of Owners’ Equity Accounts S.Y. 2013-2014
CHAPTER
SUBSTANTIVE
TESTS OF
owners’ equity
accounts
Auditing Problems
170
Assertions, Objectives and Procedures for Owners’ Equity Accounts

Existence of occurrence To determine the validity of 1. Obtain schedules of shareholders’
recorded shareholders’ equity equity accounts and reconcile to the
balances and whether the general ledger balances.
transactions actually occurred. 2. Review authorizations and terms
of share issues.
3. Confirm shares outstanding with
registrar on share and transfer agent.
4. Inspect share certificate book
5. Inspect certificate of shares held
in treasury.
Completeness To determine whether recorded 6. In addition to the above
shareholders’ equity accounts mentioned procedures, perform
reflect all data that should be analytical review procedures.
recorded.
Rights and Obligations To determine whether the 7. Review articles of incorporation
entity has the authority and and by-laws.
execute the shareholders’ 8. Make inquiries of legal counsel.
equity transactions, e.g.,
whether share capital was
legally issued and shareholders
have a legal claim on corporate
assets at the balance sheet date.
Valuation or allocation To determine whether the 9. Vouch share capital entries,
shareholders’ equity balances dividend entries and entries to
are shown in the proper retained earnings.
statements amounts in
accordance with PAS/PFRS.
Presentation and To determine that the 10. Review minutes of board
disclosure shareholders’ equity accounts directors’ and shareholders’
are properly presented in the meetings for share options and
statement of financial position dividend restrictions.
11. Evaluate financial statement
presentation and disclosure for
shareholders’ equity accounts.
Auditing Problems
171
ILLUSTRATIVE AUDIT CASE 8.1 – Various Equity Transactions
In connection with your audit of the Kalan Corporation, you were able to obtain the following
information pertaining to the corporation’s equity accounts
.
Kalan Corporation has 32,000, P2 par value, ordinary shares authorized. Only 75% of these
shares have been issued, and of the shares issued, only 22,000 are outstanding. On December 31, 2013,
the equity section revealed that the balance in Share Premium- Ordinary was P832,000, and the Retained
Earnings balance was P220,000. The Treasury shares were purchased at an average price of P37.50 per
share.
During 2014, Kalan had the following transactions:
Jan. 15 Kalan issued, at P55 per share, 1600 shares of P50 par, 5% cumulative
preference shares, 4,000 shares are authorized.
Feb. 01 Kalan sold 3,000 newly issued ordinary shares at P42 per share.
Mar. 15 Kalan declared a cash dividend on ordinary shares of P0.15 per share, payable
on April 30 to all shareholders of record on April 1.
Apr. 15 Kalan reacquired 400 ordinary shares for P43 per share.
Employees exercised 2,000 share options granted in 2008. When the options
were granted, each option entitled the employees to purchase 1 ordinary share for
P50 per share. The share price on the date of grant was also P50 per share. Kalan
issued new shares to the employees.
May 01 Kalan declared a 10% share dividend to be distributed on June 01 to

Shareholders of record on May 07. The market price of the ordinary share was
P50 per share on May 01.
May 31 Kalan sold 300 treasury shares reacquired on April 15 and an additional 400
shares costing P15,000 that had been on hand since the beginning of the year.
The selling price was P57 per share.
Sept. 15 The semiannual cash dividend on ordinary shares was declared, amounting to
P0.15 per share. Kalan also declared the yearly dividend on preference shares.
Both are payable on October 15 to shareholders of record on October 01.
Profit for 2014 was P100,000.
Required:
Based on the above and the result of your audit, determine the balances of the following as of December
31, 2010:
Auditing Problems
172
1. Preference Share Capital (PSC)

A. P70,000 B. P50,000
C. P80,000 D. P40,000
2. Ordinary Share Capital(OSC)

A. P53,320 B. P73,320
C. P63,320 D. P83,320
3. Share Premium (SP)

A. P2,000,500 B. P1,898,500
C. P1,915,860 D. P1,195,680
4. Treasury Shares (TS)

A. P64,300 B. P42,300
C. P54,300 D. P55,500
5. Total Retained Earnings (TRE)

A. P134,567 B. P164,576
C. P174,756 D. P174,765
Answers: 1. C; 2. C; 3. D; 4. A; 5. C

PSC OSC SP TS TRE
Unadjusted Balance - P48,000 P832,000 P75,000 P220,000
Jan.15 P80,000 - 8,000 - -
Feb.01 - 6,000 120,000 - -
Mar.15 - - - - (3,750)
Apr.15 - - - 17,200 -
- 4,000 96,000 - -
May.01 - - 127,680 - (133,000)
May.31 - - 12,000 (27,900) -
June.01 - 5,320 - - -
Sept.15 - - - - (8494)
Dec.31 - - - - 100,000
Adjusted Balance P80,000 P63,320 P1,195,680 P64,300 P174,756
(1) (2) (3) (4) (5)
The Columnar method is recommended in solving this kind of problem. Although, preparing
journal entries and T-accounts are also useful, the columnar method presents a simpler solution and
helps improve speed in solving such problem.
Alternative solution: Prepare T-accounts for each component of Equity. Place the balances as of
January 1, 2014, journalize the transactions affecting the equity accounts, post the entries to the affected
accounts, then extract the balances.
Auditing Problems
173
Journal Entries:
1/15 Cash (1,600 shares x P55) P 88,000
Preference Share Capital (1,600 x P50) P80,000
Share Premium-preference 8,000
2/1 Cash (3,000 shares x P42) P 126,000

Ordinary Share Capital (3,000 x P2) P6,000
Share Premium-ordinary 120,000
3/15 Retained Earnings [(22,000+3,000) x P0.15] P 3,750

Dividends Payable P 3,750
4/15 Treasury Shares P 17,200

Cash (400shares x P43) P 17200
4/15 Cash (2,000shares x 50) P100,000

Ordinary Share Capital (2,000xP2) P 4,000
Share Premium-Ordinary 96,000
5/1 Retained earnings (26,600x10%xP50) P133,000

Share Dividends Payable (26,600x10%xP2) P 5,320
Share Premium-Ordinary 127,680
5/31 Cash (700shares x P57) P 39,900

Treasury Shares [(300shares x P43) +15,000] P27,900
Share Premium-treasury shares 12,000
6/1 Share dividends payable-ordinary P 5,320

Ordinary Share Capital P 5,320
9/15 Retained Earnings P 8,494
Dividends Payable-preference (80,000x5%) P 4,000
Dividends Payable-ordinary (29,960xP15) 4,494
12/31 Profit or loss summary P100,000

Retained Earnings P100,000
ILLUSTRATIVE AUDIT CASE 8.2 - Analysis of Share and Dividend Transactions
In connection with your audit of the Puru Company, you were asked to prepare comparative data
from the company’s inception to the present. The following were gathered during your audit:
a. Puru Company’s charter became effective on January 2, 2010, when 80,000, P10 par value,
ordinary shares and 40,000, 5% cumulative nonparticipating, preference shares were issued. The
ordinary share was sold at P12 per share and the preference share was sold at its par value of
P100 per share.
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b. Puru was unable to pay preference dividends at the end of its first year. The owners of the
preference shares agreed to accept 2 ordinary shares for every 50 shares of preference shares
owned in discharge of the preference share dividends due on December 31, 2010. The shares
were issued on January 2, 2011. The fair value was P30 per share for the ordinary on the date of
issue.
c. Puru Company acquired all outstanding shares of Putu Corporation on May 1, 2012, in exchange
for 40,000 ordinary shares of Puru.
d. Puru split its ordinary shares 3 for 2 on January 1, 2013 and 2 for 1 on January 1, 2014.
e. Puru offered to convert 20% of the preference shares to ordinary on the basis of 2 ordinary shares
for 1 preference share. The offer was accepted, and the conversion was made on July 1, 2014.
f. No cash dividends were declared on ordinary shares until December 31, 2012. Cash dividends per
ordinary share were declare and paid as follows:
December 31 June 30
2012 P4.00 -
2013 5.00 P3.00
2.00 2.50
Required:
1. Outstanding number of Ordinary shares(OS) as of December 31,2014

A. P200,000 B. P380,900
C. P400,000 D. P380,800
2. Outstanding number of Preference shares(PS) as of December 31,2014

A. P50,500 B. P42,000
C. P62,000 D. P32,000
3. Amount of cash dividends declared and paid to ordinary shareholders for the year 2013
A. P1,673,600 B. P1,500,500
C. P1,700,000 D. P1,459,200
4. Amount of cash dividends declared and paid to ordinary shareholders for the year 2014
A. P1,459,200 B. P1,700,000
C. P1,500,500 D. P1,673,600
Answers: 1) D; 2) D; 3) D; 4) D

Transactions OS PS
a. 80,000 40,000
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b. [2 OS x (40,000 PS / 50)] 1,600

c. 40,000
121,600 40,000
d. share split (3:2)
[(121,600x3/2)-121,600] 60,800
December 31,2013 182,400 40,000
Share split (2:1)
[(182,400x2)-182400] 182,400
June 30, 2014 364,800 40,000
e. Conversion of PS
(40,000x20%x2) 16,000 (8,000)
December 31, 2014 380,800 32,000
(1) (2)
Dividends declared 7/1/13(182,400xP3.00) P 547,200

Dividends declared 12/31/13(182,400xP5.00) 912,000
Cash dividends to Ordinary shareholders in 2013 P1,459,200
(3)
Dividends declared 7/1/14(364,800xP2.50) P 912,000

Dividends declared 12/31/14(380,800xP2.00) 761,600
Cash dividends to Ordinary shareholders 2014 P1,673,600 (4)
Again, Columnar method is recommended in solving this problem.
Recognition of dividend
Under IFRIC 17 “Distribution of noncash assets to owners” paragraph 10, the liability to pay
dividend shall be recognized when the dividend is appropriately authorized and is no longer at the
discretion of the entity, which is the date:
a. When the dividend is declared by management or the board of directors if the local jurisdiction
does not require further approval.
b. When the declaration of the dividend by management or the board of directors is approved by the
relevant authority, for example the shareholders, if the local jurisdiction requires such approval.
c. Simply stated, the liability for dividend must be recognized on the date of declaration.
ILLUSTRATIVE AUDIT CASE 8.3- Share Options
At the beginning of 2014, Santa grants share options to each of its 100 employees working in the
sales department. The share options will vest at the end of 2016, provided that the employees remain in
the entity’s employ, and provided that the volume of sales of a particular product increases by at least an
average of 5 per cent per year. If the volume of sales of the product increases by an average of between 5
per cent 10 per cent per year, each employee will receive 100 share options. If the volume of sales
increases by an average of between 10 per cent and 15 per cent each year, each employee will receive 200
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share options. If the volume of sales increases by an average of 15 per cent or more, each employee will
receive 300 share options.
On grant date, Santa estimates that the share options have a fair value of P20 per option. Santa
also estimates that the volume of sales of the product will increase by an average between 10 per cent and
15 per cent per year. The entity also estimates, on the basis of weighted average probability that 19
percent of the employees will leave before the end of 2016.
By the end of 2014, seven employees have left and the entity still expects that a total of 19
employees will leave by the end of 2016. Product sales have increased by 12 per cent and the entity
expects this rate of increase to continue over the next 2 years.
By the end of 2015, a further six employees have left. The entity now expects only three more
employees will leave during 2016. Product sales have increased by 18 per cent. The entity now expects
that sales will average 15 per cent or more over the three-year period.
By the end of 2016, a further two employees have left. The entity’s sales have increased by an average of
16 percent over the three years.
Required:
Based on the above and the result of the audit, determine the following:
1. Compensation expense in 2014
A. P108,000 B. P 80,000
C. P100,000 D. P140,000
2. Share Premium-share options at the end of 2015

A. P336,000 B. P 80,000
C. P 70,000 D. P300,000

A. P300,000 B. P228,000
C. P338,000 D. P500,000

A. P274,000 B. P174,000
C. P200,000 D. P100,000
Answers: 1) A; 2) A; 3) B; 4) B
Compensation expense in: 2014 2015 2016

No. of employees 81 84 85
No. of share options x 200 x 300 x 300
Fair value of option x P20 x P20 x P20
x 1/3 x 2/3 x 3/3
P108,000(1) P336,000(2) P 510,000
(108,000) (336,000)
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P228,000(3) P 174,000(4)
Share Options are granted to officers and key employees to enable them to acquire shares of the
entity during a specified period upon fulfillment of certain conditions at a specified price.
Measurement of Compensation:
The compensation resulting from share options is measured following two methods namely:
1. Fair value method – This means that the compensation is equal to the fair value of the share
options on the date of grant.
a. This is the method mandated by PFRS 2.
2. Intrinsic value method – This means that the compensation is equal to the intrinsic value of the
share options. This intrinsic value is the “excess of the market value of the share over the option
price.”
Paragraph 24 of PFRS 2 provides that the intrinsic value method can be used only if the fair value of
the share option cannot be estimated reliably.
ILLUSTRATIVE AUDIT CASE 8.4- Share Options
An entity grants an employee the right to choose either 1,000 phantom shares (i.e., a right to a
cash payment equal to the value of 1,000 shares) or 1,200 shares with par value of P10 per share. The
grant is conditional upon the completion of three years’ service. If the employee chooses the share
alternative, the shares must be held for three years after vesting date.
At the grant date, the entity’s share price is P50 per share. At the end of years 1, 2 and 3, the share
price is P52, P55, and P60, respectively. The entity does not expect to pay dividends in the next three
years. After taking into account the effects of the post-vesting transfer restrictions, the entity estimates
that the grant date fair value of the share alternative is P48 per share.
At the end of year 3, the employee chooses:

Scenario 1: The cash alternative
Scenario 2: The share alternative
Required:
1. The total fair value of the equity component as a result of the share based payment transaction
with settlement alternatives.
A. P57,600 B. P66,000
C. P60,000 D. P 7,600
2. Compensation expense in year 1

A. P19,866 B. P20,000
C. P15,000 D. P 7,600

A. P21,866 B. P30,000
C. P20,000 D. P 7,600
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A. P25,868 B. P25,000
C. P20,000 D. P30,000
5. If the employee has chosen the cash alternative, the amount to be paid at the end of year 3 should
be
A. P60,000 B. P20,000
C. P57,600 D. P 7,600
6. If the employee has chosen the share alternative, the amount of share premium to be recognized is
A. P55,600 B. P30,000
C. P60,000 D. P40,000
Answers: 1) D; 2) A; 3) A; 4) A; 5) A; 6) A
Fair value of equity alternative (P48x1,200 shares) P57,600

Fair value of cash alternative (P50x1,000 phantom shares) (50,000)
Fair value of equity component P 7,600 (1)
For share-based payment transactions in which the terms of the arrangement provide either the
entity or the counterparty with the choice of whether the entity settles the transaction in cash (or other
assets) or by issuing equity instruments, the entity shall account for that transaction, or the components of
that transaction, as a cash-settled share-based payment transaction if, and to the extent that, the entity
has incurred a liability to settle in cash or other assets, or as an equity settled share-based payment
transaction if, and to the extent that, no such liability has been incurred. (PFRS 2 par. 34)
If an entity has granted the counterparty the right to choose whether to a share-based payment
transaction is settled in cash or by issuing equity instruments, the entity has granted a compound
financial instrument, which includes a debt component and an equity component (PFRS 2 par. 35)
The entity shall account separately for the goods or services received or acquired in respect of
each component of the compound financial instrument. For the debt component, the entity shall
recognized the goods or services acquired, and a liability to pay for those goods or services, as the
counterparty supplies goods or render service, in accordance with the requirements applying to cash
settled share based payment transactions. For the equity component, the entity shall recognize the goods
or services received, and an increase in equity, as the counterparty supplies goods or renders service, in
accordance with the requirements applying to equity-settled share-based payment transactions. (PFRS 2
par. 38)
Year Liability Equity Compensation Equity Liability

Expense
1 (P52x1,000x1/3) P 17,333 P - P17,333
(P7,600x1/3) 2,533 2,533 -
P 19,866 (2) P2,533 P17,333
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2 [(P55x1,000x2/3)
-P17,333] P 19,333 P - P19,333
(P7,600x1/3) 2,533 2,533 -
P 21,866 (3) P5,066 P36,666
3 [(P60x1,000)
-P36,666] P 23,334 P - P23,334
(P7,600x1/3) 2,534 2,534 -
P 25,868 (4) P7,600 P60,000
End of year 3:
Scenario 1 – Cash of P60,000 paid - - (60,000)
Totals P67,600 P 7,600 P 0
Scenario 2- 1200 shares issued - 60,000 (60,000)

Totals P67,600 P67,600 P 0
Final accounting:
Scenario 1 – Cash of P60,000 paid

Accrued Salaries Payable 60,000
Share options Outstanding 7,600
Cash 60,000 (5)
Share Premium 7,600
Scenario 2 – 1,200 shares issued

Accrued Salaries Payable 60,000
Shares Options Outstanding 7,600
Share Capital 12,000
Share Premium 55,600 (6)
ILLUSTRATIVE AUDIT CASE 8.5– Quasi Reorganization
Yaman Corporation has incurred losses from operations for many years. At the recommendation
of the newly hired president, the board of directors voted to implement a quasi-reorganization, subject to
shareholders’ and creditors’ approval. Immediately, prior to the quasi-reorganization, on June 30, 2014,
Yaman’s statement of financial position was as follows:
ASSETS
Current Assets P1,375,000
Property, plant and equipment (net) 3,375,000
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Other noncurrent assets 500,000

Total assets P5,250,000
LIABILITIES & SHAREHOLDERS’ EQUITY

Total Liabilities P1,500,000
Ordinary shares, P10 par 4,000,000
Retained Earnings (1,000,000)
Total liabilities & shareholders’ equity P5,250,000
The Shareholders and the creditors approved the quasi reorganization effective July 1,2014, to be
accomplished by a reduction in Property, plant and equipment (net) of P875,000, a reduction in other
noncurrent assets of P375,000, and a reduction in par value from P10 to P5.
Required:
1. Yaman’s July 1, 2014, statement of financial position after the quasi reorganization should show
total assets of
A. P4,000,000 B. P4,500,000
C. P3,000,000 D. P3,500,000
2. The balance in the share premium account after the quasi reorganization on July 1,2014, should
be
A. P1,000,000 B. P500,000
C. P1,500,000 D. P200,000
3. Yaman’s deficit after the quasi reorganization on July 1,2014, should be

A. P200,000 B. P50,000
C. P550,000 D. P 0
Answers: 1) A; 2) B; 3) D
Journal Entries:
1. Retained Earnings 1,250,000
Other noncurrent assets 375,000
Property, plant and equipment 875,000
2. Ordinary Shares 2,000,000

Share Premium 2,000,000
3. Share Premium 2,250,000

Retained Earnings 2,250,000
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Current Assets P1,375,000

Property, plant and equipment (net)
( P3,375,000 – P875,000) 2,500,000
Other noncurrent assets (P500,000 – 375,000) 125,000
Total assets P4,000,000 (1)
Share Premium, July 1, 2014

(P750,000 + P2,000,000 – P2,250,000) P500,000 (2)
*An Entity undergoes a quasi-reorganization primarily to eliminate its deficit.

Deficit after quasi reorganization = Zero/none (3)
A Quasi-reorganization is a permissive but not mandatory procedure under which a financially

troubled entity restates its accounts and establishes a “fresh start” in accounting sense. It is also called
Corporate readjustment.
ILLUSTRATIVE AUDIT CASE 8.6– Quasi Reorganization
Shown below are Alba Company’s condensed statements of financial position immediately
before and one year after it had completed a quasi-reorganization.
Dec. 31, 2014 Dec. 31, 2015

(Before quasi)
Current assets P 900,000 P1,350,000

Property, plant and equipment 5,100,000 3,870,000
Total Assets P 6,000,000 P5,220,000
Ordinary Shares P7,200,000 P4,650,000

Share Premium 660,000 90,000
Retained Earnings 1,860,000) 480,000
Total Shareholders’ Equity P6,000,000 P5,220,000
In 2015, Alba reported Net income of P480,000 and Depreciation expense of P330,000. The quasi
reorganization on December 31, 2014, included the write down of the company’s inventories by
P360,000. No purchases or sales of property, plant and equipment items and no share transactions
occurred in 2015.
Required:
Prepare Journal entries made at the time of the quasi-reorganization.
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Journal Entries:
December 31, 2014
1. Retained Earnings 1,260,000

Inventories 360,000
Property, plant and equipment *900,000
*P5,100,000 - (P3,870,000 + P330,000) = 900,000
2. Ordinary Shares 2,550,000
Share premium *2,550,000
(*P7,200,000 – P4,650,000)
3. Share Premium 3,120,000

Retained Earnings *3,120,000
(*P1,860,000 + P1,260,000)
ILLUSTRATIVE AUDIT CASE 8.7– Computation of Book Value Per Share
Farah, Inc. began operations in January 2013, and reported the following results for each of its
three years of operations.
2013 P300,000 net loss

2014 30,000 net loss
2015 3,950,000 net income
At December 31, 2014, the company’s capital accounts were as follows:
5% cumulative preference shares, par value P100;

Authorized, 100,000 shares; issued and outstanding,
60,000 shares P6,000,000
Ordinary shares, par value P1; authorized, 1,000,000

Shares issued and outstanding, 800,000 shares 8,000,000
Farah, Inc. has never paid a cash or stock dividend and there has been no change in the capital
accounts since it began operations.
Required:
1. Book Value Per preference share on December 31,2014

A. P120 B. P145
C. P155 D. P115
2. Book Value Per ordinary share on December 31, 2014

A. P13.40 B. P14.00
C. P14.50 D. P15.00
Assume that the preference shares have a liquidation value of P105 per share.
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3. What is the book value of the preference shares on December 31, 2014?
A. P120 B. P110
C. P130 D. P140
4. What is the book value of the ordinary shares on December 31, 2014?
A. P13.03 B. P14.04
C. P13.70 D. P14.09
Answers: 1) D; 2) A; 3) A; 4) A
Excess
Over Par Preference Ordinary
Balance P3,620,000 P6,000,000 P 8,000,000
Dividend on
Preference shares
(5% xP6,000,000x 3yrs) (900,000) 900,000
Balance to Ordinary P2,720,000 2,720,000
Shares
Total SHE P6,900,000 P 10,720,000
Shares Outstanding / 60,000 / 800,000
Book value per share (1) P 115 (2)P 13.40
Excess
Over Par Preference Ordinary
Balance P3,620,000 P6,000,000 P 8,000,000
Liquidation
Premium (5x60,000) (300,000) 300,000
Preference Dividend
(5%xP6,000,000x3yrs) (900,000) 900,000
Balance to Ordinary P2,420,000 2,420,000
Shares
Total SHE P7,200,000 P10,420,000
Shares Outstanding / 60,000 / 800,000
Book value per share (3) P 120 (4) P 13.02
Book value per share is the amount that would be paid on each share assuming the entity is
liquidated and the amount available to shareholders is exactly the amount reported as shareholders’
equity.
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The liquidation value is the amount which the preference shareholders normally receive upon the
liquidation of the corporation. The liquidation value may be more than the par value.
In the absence of a liquidation value, the preference shareholders shall receive an amount equal
to the par or stated value, unless there is a deficit in which case the preference shareholders would share
on pro rata basis with the ordinary shareholders.
The preference share may have a call price or redemption price but this is ignored for book value
computation.
The call price is the amount paid to preference shareholders upon the redemption of preference
share during the lifetime of the corporation.
ILLUSTRATIVE AUDIT CASE 8.8– Retained Earnings
The following information has been taken from the ledger account of Thailand Corporation:
Total Net Income since incorporation P3,200,000

Total Cash dividends paid 150,000
Carrying Value of the company’s investment
in Sakura Company declared as property dividend 600,000
Proceeds from sale of donated shares 150,500
Total value of stock dividends distributed 420,000
Gains on treasury share transactions 375,000
Unamortized premium on bonds payable 413,200
Appropriated for contingencies 700,000
Required:
The Current balance of unappropriated retained earnings is

A. P2,030,000 B. P1,330,000
C. P3,200,000 D. P1,930,000
Answer: B
Total Net Income since incorporation P3,200,000

Total Cash dividends paid (150,000)
Carrying Value of the company’s investment
in Yogi Company declared as property dividend (600,000)
Total value of stock dividends distributed (420,000)
Appropriated for contingencies (700,000)
Current balance of unappropriated retained earnings P1,330,000
Retained earnings represent the cumulative balance of periodic net income or loss, dividend
distributions, prior period errors, changes in accounting policy and other capital adjustments.
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The IAS term for retained earnings is “Accumulated Profits”. However, the retained earnings
account is used. The illustrative statement of financial position and statement of changes in equity in IAS
1 and IAS 8 still maintain the title “Retained Earnings”
Retained earnings are of two kinds, namely, unappropriated retained earnings and appropriated
retained earnings.
Unappropriated Retained Earnings represent the portion which is free and can be declared as
dividends to shareholders.
Appropriated Retained Earnings represent that portion which has been restricted and therefore
is not available for any dividend declaration.
When the retained earnings account has a debit balance, it is called a “deficit”. A deficit is not an asset
but a deduction from shareholders’ equity. The IAS term for deficit is “accumulated losses”.
Daka Company’s December 31, 2014, audited statement of Financial position reported retained
earnings of P150,000. Net income for 2014 was P85,000, and dividends of P60,000 were declared and
paid in 2014. Daka’s accountant discovered that net income for 2013 had been understated by P25,000
due to an error in recording depreciation expense in 2013.
Required:
The amount of Retained Earnings per books as of December 31, 2013 was
A. P150,000 B. P125,000
C. P200,000 D. P100,000
Answer: D
Retained Earnings per books, Dec. 31, 2013(Squeeze) P100,000

Adjustment for depreciation error in 2013 25,000
Retained Earnings adjusted, Dec. 31, 2013 P125,000
Net income for 2014 85,000
Dividends Declared and paid in 2014 (60,000)
Retained Earnings per audit, Dec. 31, 2014 P150,000
ChangChang has been employed as an accountant by Iraq, Inc. for number of years. She handles all
accounting duties, including the preparation of financial statements. The following is a statement of
earned surplus prepared by ChangChang for 2014.
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Iraq, Inc.
STATEMENT OF EARNED SURPLUS FOR 2014
Balance at January 1, 2014 P365,000
Additions:
Change in estimate of 2013 amortization P5,000
Gain on sale of trading securities 3,000
Interest revenue 2,000
Net Income for 2014 150,000
Decreased depreciation due to
Change in estimated life 13,000 173,000
P538,000
Deductions:
Dividends declared and paid P100,000
Loss on sale of Equipment 2,500
Loss on Earthquake 83,000 185,500
Balance at December 31, 2014 P352,500
Required:
1. What is the correct net income of Iraq for 2014?

A. P 87,500 B. P84,500
C. P173,000 D. P82,500
2. What is the correct retained earnings balance as of December 31, 2014?

A. P349,500 B. P438,000
C. P347,500 D. P352,500
Answers: 1) A; 2) D
(1) Reported Net Income P150,000

Add: Change in estimate of 2013 amortization P 5,000
Gain on sale of trading securities 3,000
Interest revenue 2,000
Decreased depreciation due to
Change in estimated life 13,000 23,000
P173,000
Deduct: Loss on sale of Equipment 2,500
Loss on Earthquake 83,000 85,500
Corrected Net Income for 2014 P 87,500
(2) Retained earnings, Jan.1, 2014 P365,000

Net Income for 2014 (see no. 1) 87,500
Dividends declared ( 100,000)
Retained Earnings, Dec. 31,2014 P352,500
Auditing Problems
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Cash to Accrual Basis, Single Entry and Correction of Errors S.Y. 2013-2014
CHAPTER
9
Cash to Accrual
Basis,
Single Entry and
correction of
errors
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ILLUSTRATIVE AUDIT CASE 9.1 – Cash to Accrual Basis
You were able to gather the following in connection with your audit of Bahay Company for the
year ended December 31, 2013:
01/01/2013 12/31/2013
Accounts receivable 6,400,000 4,000,000
Unpaid merchandise invoices ? 2,621,000
Accrued wages 85,000 125,000
Advertising supplies inventory 35,000 75,000
Accrued advertising 14,250 40,000
Prepaid insurance 25,000 -
Unexpired insurance - 41,000
During the year:

Amount collected from customers 10,000,000
Total payments to suppliers of merchandise 13,618,000
Total payments to suppliers of merchandise of prior years 4,632,000
Wages paid 3,050,000
Advertising paid which includes P40,000 applicable in 2014 300,000
Insurance premium paid 125,000
Required:
1. Net sales for 2013

a. P 6,400,000 c. P 7,600,000
b. P 12,400,000 d. P 14,000,000
2. Net purchases for 2013

a. P 11,607,000 c. P 13,618,000
b. P 15,629,000 d. P 16,239,000
3. Wages expense for 2013

a. P 3,010,000 c. P 3,050,000
b. P3,090,000 d. P 3,100,000
4. Advertising expense for 2013

a. P 245,750 c. P 260,000
b. P 285,750 d. P 300,000
5. Insurance expense for 2013

a. P 84,000 c. P 100,000
b. P 109,000 d. P 141,000
Answers: 1) C; 2) A; 3) B; 4) A; 5) B
Auditing Problems
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Cash Basis Versus Accrual Basis

Item Cash Basis Accrual Basis
Sales Cash sales plus collection of trade receivables Cash sales plus sales on account.
Purchases Cash purchases plus payment to trade creditors. Cash purchases plus purchases on
account.
Income other than Items received are considered as income Items earned are considered as
sales regardless of when earned. income regardless of when
received.
Expenses, in Items paid are treated as expenses regardless of Items incurred are treated as
general when incurred. expenses regardless of when paid.
Depreciation Depreciation is provided normally. Depreciation is provided normally.
Bad debts No bad debts are recorded because trade Doubtful accounts are treated as
receivables are not recognized. bad debts.
Requirement 1
Accounts Receivable, 12/31/13 P 4,000,000
Add: collections from customers 10,000,000
Total 14,000,000
Less: accounts receivable, 1/1/13 6,400,000
Net sales for 2013 P 7,600,000
Requirement 2
Unpaid merchandise invoices, 12/31/13 P 2,621,000
Add: Payments to suppliers of 2013:
Total payments to suppliers in 2013 P 13,618,000
Less: Payments in 2013 to
suppliers of prior years 4,632,000 8,986,000
Net purchases for 2013 P 1,607,000
Requirement 3
Accrued wages, 12/31/13 P 125,000
Add: wages paid in 2013 3,050,000
Total 3,175,000
Less: accrued wages, 01/01/13 85,000
Wages expense for 2013 P 3,090,000
Requirement 4
Accrued advertising, 12/31/13 P 40,000
Advertising supplies inventory, 01/01/13 35,000
Advertising paid in 2013 300,000
Total 375,000
Less: accrued advertising, 01/01/13 P 14,250
Advertising supplies inventory, 12/31/13 75,000
Advertising paid applicable to 2013 40,000 129,250
Advertising expense for 2013 P 245,750
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Requirement 5
Prepaid insurance, 1/1/13 P 25,000
Add: insurance premium paid in 2013 125,000
Total 150,000
Less: prepaid insurance, 12/31/13 41,000
Insurance expense in 2013 P 109,000
The income statement of Cagayan Company for 2013 included the following items:
Interest income P 2,101,000

Salaries expense 1,650,000
Insurance expense 227,200
The following balances have been excerpted from Cagayan Company’s statement of financial
position:
12/31/12 12/31/13
Accrued interest receivable 165,000 200,200
Accrued salaries payable 92,400 195,800
Prepaid insurance 33,000 24,200
Required:
1. The cash received for interest during 2013 was

a. P 1,900,800 c. P 2,065,800
b. P 2,101,000 d. P 2,136,200
2. The cash paid for salaries during 2013 was

a. P 1,753,400 c. P 1,546,600
b. P 1,557,600 d. P 1,845,800
3. The cash paid for insurance premiums during 2013 was

a. P 253,000 c. P 244,200
b. P 286,000 d. P 268,400
Answers: 1) C; 2) C; 3) D
Requirement 1
Interest income P 2,101,000
Accrued interest receivable, 12/31/12 165,000
Accrued interest receivable, 12/31/13 ( 200,200)
Cash received for interest during 2013 P 2,065,800
Auditing Problems
191
Requirement 2
Salaries Expense P 1,650,000
Accrued salaries payable, 12/31/12 92,400
Accrued salaries payable, 12/31/13 ( 195,800)
Cash received for salaries during 2013 P 1,546,600
Requirement 3
Insurance expense P 277,200
Prepaid insurance, 12/31/12 ( 33,000)
Prepaid insurance, 12/31/13 24,200
Cash received for insurance premiums during 2013 P 268,400
Presented below is information pertaining to PRTC Stationery Supply, a calendar- year sole
proprietorship owned by Mr. Word. The business maintains its books on the cash basis except that, at
year-end, the closing inventory and depreciation are recorded. On December 31, 2013, after recording the
ending inventory and depreciation, and closing the nominal accounts, Mr. Word had the following general
ledger trial balance:
PRTC Stationery Supply

Trial Balance
December 31,2013
DEBIT CREDIT
Cash 165,000
Merchandise inventory 390,000
Equipment 525,000
Accumulated depreciation 205,000
Note payable, bank 100,000
Withholding tax payable 13,000
Word, Capital 762,000
1,080,000 1,080,000
During the last quarter of 2013, Mr. Word and Ms. Me, an outside investor, agreed to incorporate
the business under the name of Me Word Stationers, Inc. Word will receive 10,000 shares for hid business,
and Me will pay P 860,000 cash for her 10,000 shares. On January 1, 2014, they received the certificate of
incorporation for Me Word Stationers, Inc., and the corporation issued 10,000 ordinary shares each to
Word and Me for the above consideration. The agreement between Word and Me requires that the
December 31, 2013 statement of financial position of the proprietorship should be converted to the
accrual basis, with all assets and liabilities stated at current fair values, including Word’s goodwill
implicit in the terms of the ordinary shares issuance.
Additional information is as follows:

1. Amounts due from customers totaled P235,000 at December 31,2013. A review of collectability
disclosed that an allowance for doubtful accounts of P 33,000 is required.
Auditing Problems
192
2. The P 390,000 merchandise inventory is based on a physical count of goods priced at cost.
Unsalable damaged goods costing P25,000 are included in the count. The current fair value of thr
total merchandise inventory is P450,000.
3. On July 1, 2013, Word paid P38,000 to renew comprehensive insurance coverage for one year.
4. The P100,000 note payable is dated July 1,2013, bears interest at 12%, and is due July 1, 2014,
5. Unpaid vendors’ invoices totaled P305,000 at December 31,2013.
6. During January 2014, final payroll tax returns filed for PRTC Stationery Supply required
remittances totaling P 21,000.
7. Not included in the trial balance is the P 35,000 principal balance at December 31, 2013 of the
three-year loan to purchase a delivery van on December 31, 2011. The debt was assumed by the
corporation on January 1, 2014. The current fair value of the used equipment is P400,000,
including the delivery van.
8. Me Word Stationers, Inc. has 75,000, P50 par, authorized ordinary shares.
Required:
1. Word’s goodwill implicit in the issuance of 10,000 ordinary shares for his business is
a. P 116,000 c. P 85,000
b. P 91,000 d. P 50,000
2. The share premium on the issuance of the 20,000 ordinary shares is

a. P 635,000 c. P 670,000
b. P 720,000 d. P 664,000
3. The total assets of Me Word Stationers, Inc. on January 1,2014 is

a. P 2,181,000 c. P 2,187,000
b. P 2,146,000 d. P 2,162,000
4. The total liabilities of Me Word Stationers, Inc. on January 1,2014 is

a. P 467,000 c. P 462,000
b. P 461,000 d. P 432,000
5. The total equity of Me Word Stationers, Inc. on January 1,2014 is

a. P 1,720,000 c. P 1,635,000
b. P 1,000,000 d. P 1,670,000
Answers: 1) B; 2) B; 3) C; 4) A; 5) A
Auditing Problems
193
Requirement 1
Fair value of 10,000 shares issued
(equal to the cash paid by Ms. Me) P 860,000
Less: Fair value of identifiable of Mr. Word’s net assets:
Fair value of identifiable assets transferred:
Cash P 165,000
Accounts Receivable, net
(P 235,000- P33,000) 202,000
Merchandise Inventory 450,000
Prepaid Insurance (P38,000 x6/12) 19,000
Equipment 400,000 1,236,000
Less: FV of liabilities assumed:
Note payable, bank P100,000
Withholding Tax Payable 21,000
Loan payable (delivery van) 35,000
Interest payable (P100,000 x 12% x6/12) 6,000 467,000
769,000
Goodwill P 91,000
Requirement 2
Cash paid by Ms. Me P 860,000
Fair value of net assets of Mr. Word, including goodwill 860,000
Total consideration received 1,720,000
Less: Par value of shares issued (20,000 shares x P50) 1,000,000
Share Premium P 720,000
Requirement 3
Cash (P 165,000 + P860,000) P1,025,000
Accounts receivable, net (P235,000 – P 33,000) 202,000
Prepaid Insurance (P38,000 x6/12) 19,000
Equipment 400,000
Goodwill 91,000
Total assets, 1/1/14 P2,187,000
Requirement 4
Note payable, bank P 100,000
Withholding Tax Payable 21,000
Loan payable (delivery van) 35,000
Interest payable ( P100,000 x 12% x6/12) 6,000
Total liabilities, 1/1/14 P 467,000
Requirement 5
Share capital P 1,000,000
Auditing Problems
194

Total equity,1/1/14 P 1,720,000
ILLUSTRATIVE AUDIT CASE 9.4- Single Entry
Your audit of Caya Company disclosed that your client kept very limited records. Purchases of
merchandise were paid by check, but most other items were out of cash receipts. The company’s
collections were deposited weekly. No record was kept of cash in bank, nor was a record kept of sales.
Accounts receivable were recorded only by keeping a copy of the ticket, and this copy was given to the
customer when he paid his account.
On January 2, 2013, Caya started business and issued 108,000 ordinary shares with P 100 par, for
the following considerations.
Cash P 900,000
Building (useful life, 15 years) 8,100,000
Land 2,700,000
P 11,700,000
An analysis of the bank statements showed total deposits, including the original cash investment
of P 6,300,000. The balance in the bank statement on December 31, 2013 was P 450,000 but there were
checks amounting to P 90,000 dated in December but not paid by the bank until January 2014. Cash on
hand on December 31, 2013 was P225,000 including customers’ deposit of P135,000.
During the year, Caya Company borrowed P900,000 from the bank and repaid P225,000 and
P45,000 interest.
Disbursements paid in cash during the year were as follows:
Utilities P 180,000
Salaries 180,000
Supplies 360,000
Dividends 270,000
P 990,000
An inventory of merchandise taken on December 31, 2013 showed P 1,359,000 of merchandise.

Tickets for accounts receivable totaled P 1,620,000 but P90, 000 of that amount may prove uncollectible.
Unpaid suppliers invoices for merchandise amounted to P630,000.
Equipment with a cash price of P720,000 was purchased in early January on a one-year
installment basis. During the year, checks for the down payment and all maturing installments totaled
P801,000. The equipment has a useful life of 5 years.
Required:
1. Payment for merchandise purchases in 2013
Auditing Problems
195
a. P 4,689,000 c. P 3,654,000
b. P 3,879,000 d. P 3,969,000
2. Collections from sales in 2013

a. P 6,480,000 c. P 5,580,000
b. P 7,380,000 d. P 4,500,000
3. Net income for the year ended December 31,2013

a. P 2,430,000 c. P 2,655,000
b. P 1,440,000 d. P 2,340,000
4. Equity as of December 31,2013

a. P 13,860,000 c. P 14,085,000
b. P 12,870,000 d. P 13,770,000
5. Total assets as of December 31,2013

a. P 14,175,000 c. P 14,374,800
b. P 14,085,000 d. P 14,310,000
Answers: 1) A; 2) C; 3) B; 4) B; 5) D
Requirement 1
Total deposits P 6,300,000
Less: adjusted cash in bank:
Balance per bank statement P 450,000
Less: outstanding checks 90,000 360,000
Total outstanding checks 5,940,000
Less: other check disbursements
Payment of loan 225,000
Payment of interest in loan 45,000
Payment for equipment 801,000 1, 071,000
Payments for merchandise purchases P 4,869,000
Requirement 2
Total deposits P 6,300,000
Less: deposits other than collections:
Cash investment P 900,000
Proceeds from bank loan 900,000 1,800,000
Collections deposited in the bank P 4,500,000
Add: collections not deposited:
Cash on hand, 12/31/13 225,000
Add: disbursements in cash 990,000
Total 1,215,000
Less: customers’ deposit 135,000 1,080,000
Total collections from sales P 5,580,000
Auditing Problems
196
Requirement 3
Sales (P5,580,000 + P1,620,000) P 7,200,000
Less: cost of sales:
Purchases (P 4,869,999 + P630,000) P 5,499,000
Less: inventory, 12/31/13 1,359,000 4,140,000
Gross profit 3,060,000
Less: expenses:
Utilities 180,000
Salaries 180,000
Supplies 360,000
Doubtful accounts 90,000
Depreciation-building (P8,100,000/15) 540,000
Depreciation-equipment (P720,000/5) 144,000
Interest expense
[P45,000 + (801,000-720,000)] 126,000 1,620,000
Net income P 1,440,000
Requirement 4
Share capital (108,000 shares x P100) P10,800,000
Share premium (P 11,700,000 - P 10,80,000) 900,000
Retained earnings (P 1,440,000 – P270,000) 1,170,000
Total equity P12,870,000
Requirement 5
Current assets:
Cash (P360,000 + P225,000) P 585,000
Accounts Receivable- net
(P 1,620,000 – P90,000) 1,530,000
Inventory 1,359,000 P 3,474,000
Non-current assets:
Land 2,700,000
Building- net (P8,100,000 – P 540,000) 7,560,000
Equipment- net (P720,000- P 144,000) 576,000 10,836,000
ILLUSTRATIVE AUDIT CASE 9.5- Correction of Errors
Misamis Company’s December 31 year-end financial statement contained the following errors:
12/31/2012 12/31/2013
Ending inventory P 100,000 understated P 90,000 overstated
Depreciation expense 20,000 understated
Auditing Problems
197
An insurance premium of P 75,000 was prepaid in 2012 covering the years 2012, 2013, and 2014.
The same was charged to expense in full in 2012. In addition, on December 31, 2013, a fully depreciated
machinery was sold for P160,000 cash, but the sale was not recorded until 2014. There were no other
errors during 2012, 2013 and 2014 and no corrections have been made for any of the errors. Ignore
income tax considerations.
Required:
1. What is the net effect of the errors on the 2012 profit?

a. Understated by P130,000 c. Overstated by P70,000
b. Understated by P155,000 d. No effect
2. What is the net effect of the errors on the 2013 profit?

a. Overstated by P55,000 c. Overstated by P215,000
b. Overstated by P30,000 d. Understated by P45,000
3. What is the net effect of the errors on the company’s working capital at December 31, 2013?
4. What is the net effect of the errors on the balance of the company’s retained earnings at
December 31, 2013?
5. What is the net effect of the errors on the company’s working capital at December 31, 2014?
a. Overstated by P 65,000 c. Understated by P160,000
Answers: 1) A; 2) A; 3) A; 4) A; 5) D
Non-counterbalancing errors are errors which, if not detected, are not automatically
counterbalanced or corrected in the next accounting period. In other words, if the net income of one year
is understated or overstated, the net income of subsequent year is not affected. The effects of these errors
are:
a. The income statement of the period in which the error is committed is incorrect but the
succeeding income statement is not affected.
b. The statement of financial position of the year of error and succeeding statement of financial
position are incorrect until the error is corrected.
The best example of a non-counterbalancing error is the misstatement of depreciation.

PROFIT WC
PROFIT 2012 2013 WC 12/31/13 RE 12/31/13 12/31/11
12/31/12
Auditing Problems
198
Inventory understated (100,000) 100,000 - - -

12/31/13
inventory overstated - 90,000 90,000 90,000 -
2012 depreciation
understated 20,000 - - 20,000 -
Insurance paid in
2012 for 3 years (50,000) 25,000 (25,000) (25,000) -
Sale of fully
depreciated
machinery in 2013
recorded in 2014 - (160,000) (160,000) (160,000) -
Over (under) (130,000) 55,000 (95,000) (75,000) -
ILLUSTRATIVE AUDIT CASE 9.6- Correction of Errors
Cotabato Company’s current assets and liabilities section of the statement of financial position as
of December 31, 2013 appear as follows:
Current Assets
Cash P 1,200,000
Accounts receivable P 2,670,000
Less: allowance for doubtful accounts 210,000 2,460,000
Inventories 5,130,000
Prepaid insurance 270,000
Total current assets P 9,060,000
Current liabilities
Accounts payable P 1,830,000
Total current liabilities P 3,840,000
The following errors in the company’s accounting have been discovered:
a. January 2014 cash disbursements earned as of December 2013 included payment of accounts
payable in the amount of P1,170,000, on which a cash discount of 2% was taken.
b. The inventory included P 810,000 of merchandise that have been received at December 31 but for
which no purchase invoices have been received or rendered. Of this amount, P360,000 had been
received on consignment; the remainder was purchased F.O.B destination, terms 2/10, n/30.
c. Sales for the first four days in January 2014 in the amount of P900,000 were entered in the sales
book as of December 31,2013. Of these, P645,000 were sales on account and the remainder were
cash sales.
Auditing Problems
199
d. Cash, not including cash sales, collected in January 2014 and entered as of December 31, 2013,
totaled P 1,059,720. Of this amount, P699,720 was received on account after cash discounts of
2% had been deducted; the remainder represented the proceeds of a bank loan.
Required:
1. Adjusted cash balance as of December 31,2013

a. P 1,031,880 c. P 1,055,280
b. P 641,880 d. P 1,286,880
2. Adjusted accounts receivable balance as of December 31,2013

a. P 2,739,000 c. P 2,724,720
b. P 2,529,000 d. P 3,129,000
3. Adjusted accounts payable balance as of December 31, 2013

a. P 3,000,000 c. P 2,976,600
b. P 2,190,000 d. P 3,450,000
4. Adjusted working capital as of December 31, 2013

a. P 4,160,880 c. P 3,950,880
b. P 3,500,880 d. P 3,524,280
5. Net misstatement in the reported profit for the year ended December 31,2013 as a result of the
errors
a. P 1,269,120 c. P 1,719,120
b. P 1,700,880 d. P 1,250,880
Answers: 1) A; 2) A; 3) D; 4) B; 5) C
Requirement 1
Unadjusted cash balance P 1,200,000
January cash payments (P 1,170,000 x .98) 1,146,600
January cash sales (P900,000 – P645,000) ( 255,000)
January cash collections and loans proceeds (1,059,720)
Adjusted cash balance P 1,031,880
Requirement 2
Unadjusted accounts receivable P 2,670,000
January sales on account ( 645,000)
January collections on AR (P699,720/.98) 714,000
Adjusted accounts receivable P 2,739,000
Requirement 3
Unadjusted accounts payable P 1,830,000
January payments on accounts payable 1,170,000
Auditing Problems
200
Unrecorded purchases (P 810,000 – P360,000) 450,000

Adjusted accounts payable P 3,450,000
Requirement 4
Current Assets:
Cash (see no. 1) P 1,031,880
Accounts receivable (see no. 2) 2,739,000
Allowance for DA (210,000)
Inventories (5,130,000-360,000) 4,770,000
Prepaid expense 270,000 P 8,600,880
Less: Current liabilities
Accounts payable (see no.3) 3,450,000
Notes payable [210,000-
(1,059,720-699,720)] 1,650,000 5,100,000
Working capital P 3,500,880
Requirement 5
Over (under)
January purchase discounts (P 1,170,000 x .02) P 23,400
Goods held on consignment 360,000
Unrecorded purchases (P810,000- P360,000) 450,000
January sales 900,000
January sales discounts [(699,720/.98) x .02] ( 14,280)
Net misstatement P 1,719,120
Auditing Problems
201
Substantive Tests of Financial Statements S.Y. 2013-2014
CHAPTER
10
Substantive
tests of
financial
statements
ILLUSTRATIVE AUDIT CASE 10.1 ─ Income Statement
Auditing Problems
202
The bookkeeper for the Davao Company prepared the following income statement and retained
earnings statement for the year ended December 31, 2013:
Davao Company
December 31, 2013
Expense and Profits
Sales ( net ) ₱ 1,568,000

Less: Selling expenses ( 156,800)
Net sales 1,411,200
Add: Interest revenue 18,400
Add: Gain on sale of equipment 25,600
Gross sales revenue ₱ 1,455,200
Less: Costs of operations
Cost of goods sold ₱ 960,800
Correction of overstatement in last
year’s income due to error (net of ₱ 13,200
income tax credit) 30,800
Dividends costs (₱ 4 per share for 8,000
ordinary shares) 32,000
Loss due to earthquake 33,600 (1,057,200)
Taxable revenues 398,000
Less: Income tax on income from
continuing operations ( 99,840)
Net income 298,160
Miscellaneous deductions
Loss from operations of discontinued
Segment X44 (net of ₱7,200 income
tax credit) 16,800
Administrative expenses 134,400 ( 151,200)
Net revenues ₱ 146,960
Davao Company
Retained Revenue Statement
For the Year Ended December 31, 2013
Beginning retained earnings P 474,400

Add: Gain on sale of Segment X44 (net
of P 10,800 income taxes) 25,200
Recalculated retained earnings 499,600
Add: Net revenues 146,960
646,560
Less: Interest expense ( 27,200)
Ending: retained earnings P 619,360
Required:
Based on the above and the result of the audit, answer the following:
Auditing Problems
203
1. The income from continuing operations for the year ended December 31, 2013 is
a. P207,760 c. P299,200
b. P199,360 d. P226,560
2. The income (loss) from discontinued operations for the year ended December 31, 2013 is
a. P 8,400 c. P 25,000
b. P 10,800 d. P 0
3. The profit for the year ended December 31, 2013 is

a. P234,960 c. P209,760
b. P307,600 d. P207,760
4. The balance of retained earnings as of December 31, 2013 should be

a. P619,360 c. P650,160
b. P646,560 d. P709,360
Answers: 1) B; 2) A; 3) D; 4) A
Requirement 1
Sales (net) P 1,568,000
Less cost of goods sold 960,800
Gross profit 607,200
Less operating expenses:
Selling expenses P 156,800
Administrative expenses 134,400 291,200
Operating income 316,000
Other items:
Interest income 18,400
Gain on sale of equipment 25,600
Interest expense ( 27,200)
Loss due to earthquake ( 33,600) ( 16,800)
Pretax income from continuing operations 299,200
Less income tax expense 99,840
Income from continuing operations P 199,360
Requirement 2
Loss from operations of discontinued Segment X44
(net of P7,200 income tax credit) (P 16,800)
Gain on sale of Segment X44 (net of P10,800
income taxes) 25,000
Income from discontinued operations P 8,400
Requirement 3
Auditing Problems
204
Income from continuing operations P 199,360

Income from discontinued operations 8,400
Profit P 207,760
Requirement 4
Retained earnings, 1/1/2013 P 474,400
Prior period adjustment, correction of
Overstatement is last year’s income
(net- P13,200 income tax credit) (P 30,800)
Adjusted retained earnings, 1/1/2013 443,600
Add profit 207,760
Total 651,360
Less cash dividends (P4 per ordinary share) 32,000
Retained earnings, 12/31/2013 P 619,360
ILLUSTRATIVE AUDIT CASE 10.2 ─ Statement of Cash Flows
Tagurong Corporation has recently decided to go public and has hired you as an independent
CPA. One statement that the entity is anxious to have is a statement of cash flows. Financial statements of
Tagurong Corporation for 2013 and 2012 are provided below.
Statements of Financial Position
12/31/13 12/31/12
Cash P 153,000 P 72,000
Accounts receivable 135,000 81,000
Merchandise inventory 144,000 180,000
Property, plant and equipment (net of accumulated
Depreciation of P 120,000 and P 114,000 as
of 12/31/13 and 12/31/12 respectively) 108,000 246,000
P 540,000 P 579,000
Accounts payable P 66,000 P 36,000

Income taxes payable 132,000 147,000
Bonds payable 135,000 225,000
Share capital 81,000 81,000
Retained earnings 126,000 90,000
P 540,000 P 579,000
Income Statement
For the Year Ended December 31, 2013
Sales P 3,150,000
Cost of sales 2,682,000
Gross profit P 468,000
Auditing Problems
205

Administrative expenses 72,000 297,000
Income from operations 171,000
Interest expense 27,000
Profit before taxes 144,000
Income taxes 36,000
Profit P108,000
The following additional data were provided:
1. Dividends for the year 2013 were P 72,000.
2. During the year, equipment was sold for P 90,000. This equipment cost P 132,000 originally and had
a book value of P 108,000 at the time of sale. The loss on sale was incorrectly charged to cost of
sales.
3. All depreciations expense is in the selling expense category.
Required:
Based on the above and the result of your engagement, you are asked to provide the following
information for the year ended December 31, 2013, for Tagurong Corporation:
1. The net cash provided by the opening activities is

a. P 153,000 c. P 108,000
b. P 90,000 d. P 75,000
2. The net cash provided (used) by investing activities is

a. (P 132,000) c. P 18,000
b. P 90,000 d. P (108,000)
3. Under the direct method, the cash received from the costumers is
a. P 3,204,000 c. P 3,096,000
b. P 3,150,000 d. P 3,165,000
4. Under the direct method, the total taxes paid is

a. P 36,000 c. P 15,000
b. P 21,000 d. P 51,000
5. The net cash provided (used) by financial activities is

a. (P 90,000) c. P 18,000
b. (P162,000) d. P 72,000
Answers: 1) A; 2) B; 3) C; 4) D; 5) B
Auditing Problems
206
Requirement 1
Profit P 108,000
Loss on sale equipment (P90,000 – P108,000) 18,000
Depreciation expense
[P120,000 + (P132,000 - P108,000) – P114,000] 30,000
Increase in accounts receivable (P135,000 - P81,000) ( 54,000)
Decrease in merchandise inventory (P144,000-P 180,000) 36,000
Increase in accounts payable (P66,000 – P36,000) 30,000
Decrease in income tax payable (P132,000 – P147,000) ( 15,000)
Net cash provided by operating activities P 153,000
Key principles for the preparation of statement of cash flows:
● operating activities are the main revenue-producing activities of the enterprise that are not
investing or financial activities, so operating cash flows include cash received from costumers
and cash paid to suppliers and employees.
● investing activities are the acquisition and disposal of long-term assets and other investments that
are not considered to be cash equivalents
● financial activities are the activities that alter the equity capital and borrowing structure of the
enterprise
● interest and dividends received and paid may be classified as operating, investing, or financial
cash flows, provide that they are classified consistently from period to period
Interest paid – usually operating; alternatively financing
Interest received – usually operating; alternatively investing
Dividends received – usually operating; alternatively investing
Dividends paid – usually financing; alternatively operating
● cash flows arising from taxes on income are normally classified as operating, unless they can be
specifically identified with financing or investing activities
● for operating cash flows, the direct method of the presentation is encouraged, but the indirect
method is acceptable
The direct method shows each major class of gross cash receipts and gross cash payments.
The indirect method adjusts accrual basis net profit or loss for the effects og non-cash
transactions.
● investing and financing transactions which do not require the use of cash should be excluded
from the cash flow statement, but they should be separately disclosed elsewhere in the financial
statement
● the components of cash and cash equivalents should be disclosed, and a reconciliation presented
to amounts reported in the statement of financial position
Auditing Problems
207
● the amount of cash and cash equivalents held by the enterprise that is not available for use by the
group should be disclosed, together with the commentary by management
Requirement 2
Net cash provided by investing activities
(proceeds from sale of equipment) P 90,000
Requirement 3
Credit sales P 3,150,000
Accounts receivable, 12/31/12 81,000
Accounts receivable, 12/31/13 ( 135,000)
Cash received from costumers P 3,096,000
Requirement 4
Income taxes P 36,000
Income tax payable, 12/31/12 147,000
Income tax payable, 12/31/13 ( 132,000)
Cash paid for income taxes P 51,000
Requirement 5
Payment of dividends (P 72,000)
Payments of bonds payable (P135,000-P225,000) ( 90,000)
Net cash by financing activities (P 162,000)
ILLUSTRATIVE AUDIT CASE 10.3-Cash Flows From Operating Activities: Indirect Method
BURUNDI COMPANY’s Income statement for the year ended December 31, 2013, reported net
income of P478,800. In preparing the statement of cash flows, the accountant noted the following
transactions during 2013 that might affect cash flow from operating activities:
1. Burundi purchased 300 treasury shares at a cost of P20 per share. These shares were then resold
at P25 per share.
2. Burundi sold 300 of Loleng ordinary shares at P200 per share. The acquisition of these shares
was P145 per share. The investment was shown as an available-for-sale security on Burundi’s
statement of financial position at December 31, 2012.
3. Burundi changed from the straight-line method to the double declining-balance method of
depreciation for its machinery. The cumulative effect of the change was P43,800.
4. Burundi revised its estimate for bad debts. Prior to 2013, Burundi’s bad debt expense was 1% of
its net sales. In 2013, this rate was increased to 2%. Net sales for 2013 were P1,500,000 and net
accounts receivable decreased by P36,000 during 2013.
5. Burundi issued 1,500 ordinary shares of its P10 par ordinary shares for a patent. The ordinary
shares had a market value of P23 per share on the transaction date.
Auditing Problems
208
6. Depreciation expense amounted to P117,000.
7. Burundi Company holds 40% of the Sioning Corp.’s ordinary shares as a long-term investment.
Sioning Corp. reported net income of P81,000 for 2013.
8. Sioning Corp. paid a total cash dividends of P6,000 to all investees in 2013.
9. Burundi declared a 10% stock dividend. Three thousand of P10 par ordinary shares were
distributed. The market price on the date of declaration of the stock dividend was P20 per share.
Required:
What is the amount of net cash provided by operating activities?

a. P585,300 c. P555,300
b. P586,800 d. P587,700
Answer: A
Net income P478,800

Depreciation expense 117,000
Gain on sale of investment (16,500)
Decrease in accounts receivable 36,000
Income from investment-equity method (32,400)
Dividends from equity investments 2,400
Net cash provided by the operating activities P585,300
COMMENTS ON OTHER ITEMS:
ITEM No.
1 The purchase and resale of treasury shares are both financing activities.
2 The amount received from the sale of investment (P200 x 300= P60,000) shall be shown
as cash inflow from investing activities.
4 Bad debt expense, a noncash expense, is not shown separately under the indirect method.
It is part of the change in net accounts receivable.
5 the acquisition of patent in exchange for the company’s ordinary shares is a noncash
transaction and shall not be shown under any of the three activities on the face of the
statement of cash flows.
ILLUSTRATIVE AUDIT CASE 10.4 -Cash Flows From Operating Activities: Direct Method
AWTSU COMPANY uses the direct method to prepare its statement of cash flows. Awtsu‘s trial
balances at December 31, 2013 and 2012, are shown below:
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December 31
2013 2012
DEBITS
Cash P 105,000 P 96,000
Accounts receivable 99,000 90,000
Inventory 93,000 141,000
Property, plant and equipment 300,000 285,000
Unamortized bond discount 13,500 15,000
Cost of goods sold 750,000 1,140,000
Selling expenses 424,500 516,000
General and administrative expenses 411,000 453,900
Interest expense 12,900 7,800
Income tax expense 61,200 183,600
P 2,270,100 P2,928,300
CREDITS
Allowance for bad debts P 3,900 P 3,300
Accumulated depreciation 49,500 45,000
Accounts payable-trade 75,000 46,500
Income taxes payable 63,000 87,300
Deferred income taxes payable 15,900 13,800
8% Bonds payable 135,000 60,000
Ordinary share capital 150,000 120,000
Share premium 27,300 22,500
Retained earnings 134,100 193,800
Sales 1,616,400 2,336,100
P2,270,100 P2,928,300
Additional data are as follows:
1. Awtsu purchased P15,000 in equipment during 2013.
2. One-third of Awtsu’s depreciation expense is allocated to selling expenses and the remainder to
general and administrative expenses.
3. Bad debt expense for 2013 was P15,000. During the year, uncollectible accounts totaling P14,400
were written off. The company reports bad debts as selling expense.
Required:
Based on the preceding data, determine the amounts that should be reported on Awtsu’s statement of cash
flows for the year ended December 31, 2013, for the following:
1. Cash collected from customers

a. P1,593,000 c. P1,607,000
b. P1,578,000 d. P1,639,800
2. Cash paid to suppliers

a. P769,500 c. P673,500
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b. P826,500 d. P730,500
3. Cash paid for interest

a. P14,400 c. P 600
b. P22,200 d. P11,400
4. Cash paid for income taxes

a. P39,000 c. P87,400
b. P83,400 d. P34,800
5. Cash paid for selling expenses

a. P408,000 c. P405,000
b. P423,000 d. P409,500
Answers:1)A; 2)C; 3)D; 4)B; 5)A
Requirement 1
Sales P1,616,400
Less: increase in accounts receivable, net of write offs (P9,000+P14,400) 23,400
Cash collected from customers P1,593,000
Requirement 2
Cost of goods sold P 750,000
Less: Decrease in inventory 48,000
Purchases P 702,000
Less: Increase in Accounts payable 28,500
Cash payments to suppliers P 673,500
Requirement 3
Interest expense P 12,900
Less: Decrease in unamortized bond discount 1,500
Cash paid for interest P 11,400
Requirement 4
Income tax expense P 61,200
Decrease in income taxes payable 24,300
Increase in deferred tax liability (2,100)
Cash paid for income taxes P 83,400
Requirement 5
Depreciation (P4,500*x 1/3) (1,500)
Bad debt expense (15,00)
Cash paid for selling expenses P408,000
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ILLUSTRATIVE AUDIT CASE 10.5 – Hyperinflation
Awanenah Corporation operates in hyperinflationary economy. Its statement of financial position on

December 31, 2013, follows:
Cash ` P3,500,000
Inventory 27,000,000
Property, plant and equipment 9,000,000
Current liabilities 7,000,000
Noncurrent liabilities 5,000,000
Share capital 4,000,000
Retained earnings 23,500,000
The general price index at December 31 had moved in this way: 2009-100; 2010-130; 2011-150; 2012-
240; 2013-300.
The property, plant and equipment was purchased on December 31, 2011, and there is six month’s
inventory held. The noncurrent liabilities were a loan raised on March 31, 2013.
Required:
1. The total assets on December 31, 2013 after adjusting for hyperinflation is
a. P51,500,000 c. P48,500,000
b. P39,500,000 d. P55,250,000
2. The retained earnings balance on December 31, 2013 after adjusting for hyperinflation is
a. P35,500,000 c. P31,250,000
b. P27,500,000 d. P23,500,000
Answers: 1) A; 2) B

Requirement 1
Cash P 3,500,000
Inventory (P27,000,000 x 300/270) 30,000,000
Property, plant and equipment (9,000,000 x 300/150) 18,000,000
PAS 29 Financial Reporting in Hyperinflationary Economies does not establish an absolute at

which hyperinflation is deemed to arise. It is a matter of judgment when restatement of financial
statements in accordance with PAS 29 becomes necessary. Hyperinflation is indicated by characteristics
of the economic environment of a country which include, but are not limited to, the following:
(a) the general population prefers to keep its wealth in non-monetary assets or in a relatively stable
foreign currency. Amounts of local currency held are immediately invested to maintain
purchasing power;
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(b) the general population regards monetary amounts not in terms of the local currency but in terms
of a relatively foreign currency. Prices may be quoted in that currency;
(c) sales and purchases on credit take place at prices that compensate for the expected loss of
purchasing power during the credit period, even if the period is short;
(d) interest rates, wages and prices are linked to a price index; and
(e) the cumulative inflation rate over three years is approaching, or exceeds, 100%.
Restatement of financial statements
Statement of financial position amounts not already expressed in terms of the measuring unit
current at the end of the reporting period are restated by applying a general price index.
Monetary items are not restated because they are already expressed in terms of the monetary unit
current at the end of the reporting period.
Some non-monetary items are carried at amounts current at the end of the reporting period, such
as net realizable value and fair value, so they are not restated. All other non-monetary assets and
liabilities are restated.
Most non-monetary items are carried at cost or cost less depreciation; hence they are expressed
at amounts current at their date of acquisition. The restated cost, or cost less depreciation, of each item is
determined by applying to its historical cost and accumulated depreciation the change in a general price
index from the date of acquisition to the end of the reporting period. Hence, property, plant and
equipment, investments, inventories of raw materials and merchandise, goodwill, patents, trademarks and
similar assets are restated from the dates of their purchase. Inventories of partly-finished and finished
goods are restated from the dates on which the costs of purchase and conversion were incurred.
At the beginning of the first period of application of PAS 29, the components of owner’s equity,
except retained earnings and any revaluation surplus that arose in previous periods is eliminated.
Restated retained earnings are derived from all the other amounts in the restated statement of financial
position.
Requirement 2
Total assets after restatement P51,500,000
Current liabilities ( 7,500,000)
Noncurrent liabilities ( 5,000,000)
Share capital (P4,000,000 x 300/100) (12,000,000)
Retained earnings P27,500,000
ILLUSTRATIVE AUDIT CASE 10.6- Statement of Financial Position
The summarized general ledger trial balance of garceron corporation, an investment company
includes the following accounts at december 21 2013:
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Debit Credit
Cash P 7,000
Deposits, at call 112,869
Diviodends Receivable 15,693
Interest Receivable 478
Outstanding settlements receivable 4,900
Trading security 68,455
Listed Securities (available for sale) 1,880,472
Deffered tax 655
Oustanding Settlements Payable P 10,253
Interest Payable 280
Other payable 83
Current tax payable 242
Provision for employee benefits 752
Deferred tax 56,414
Share capital 1,368,024
Revaluation reserve- investments 376,090
Retained earnings 278,384
P2,090,522 P2,090,522
Note: Provision for employee benefits includes P525 payable within one year.
Required:
Based on the babove information. Calculate the amount that should appear, on Garceron’s statement of
financial position at December 31, 2010 for the following:
1. Current assets
a. P 96,526 c. P 209,395
b. P204,495 d. P2,089,867
2. Non current assets

a. P 655 c. P1,866,027
b. P1,881,127 d. P 605
3. Current liabilities
a. P 11,383 c. P10, 858
b. P 1, 130 d. P 605
4. Non Current liabilities

a. P56,641 c. P57,166
b. P67,419 d. P66,894
Answers: 1) C; 2) B; 3) A; 4) A

Cash P 7,000
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Deposits, at call 112,869

Dividend receivable 15,693
Interest receivable 478
Outstanding settlements receivable 4,900
Trading securities 68,455
Current assets P209, 395
An entity must normally present a classified statement of financial position, separating current and
noncurrent assets and liabilities. Only if a presentation based on liquidity provides information that is
reliable and more relevant may the current/noncurrent split be omitted.
In accordance with the revised PAS 1 par. 66, an entity shall classify an asset as current when:
(a) It expects to realize the asset, or intends to sell or consume it in its normal operating cycle;
(b) It holds the assets primarily for the purpose of trading;
(c) It expects to realize the asset within twelve months after the reporting period; or
(d) The asset is cash or cash equivalent (as defined in PAS 7) unless the asset is restricted from
being exchanged or used to settle a liability for at least twelve months after the reporting
period.
An entity shall classify other assets as non-current.
Par. 54 further requires that as minimum, the statement of financial position shall include line items that
present the following amounts:
(a) Property, plant and equipment;

(b) Investment property
(c) Intangible Assets;
(d) Financial assets (Excluding Amounts shown under (e), (h) and (i);
(e) Investment accounted for using the equity method;
(f) Biological assets;
(g) Inventories;
(h) Trade and other receivables;
(i) Cash and cash equivalents;
(j) The total of assets classified as held for sale and assets included in disposal groups classified as
held for sale in accordance with PFRS 5;
(k) Trade and other payables;
(l) Provisions;
(m) Financial liabilities(excluding amounts shown under (k) and (l));
(n) Liabilities and assets for current tax, as defined in PAS 12;
(o) Deferred tax liabilities and deferred tax assets, as defined in PAS 12;
(p) Liabilities included in disposal groups classified as held for sale in accordance with PRFS 5;
(q) Non-controlling interests, presented within equity; ad
(r) Issued capital and reserves attributable to owners of the parent.
Additional line items may be needed to fairly present the entity’s financial position. [PAS 1 par. 55]
Requirement 2
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Listed Securities (available for sale) P1,880,472

Deferred tax 655
Noncurrent assets P1,881,127
Requirement 3
Outstanding settlements payable P 10,253

Interest Payable 280
Other Payables 83
Current tax payable 242
Provision for employee benefits 525
Current Liabilities P 11,383
In accordance with the revised PAS 1 par. 69, an entity shall classify a liability as current when:
(a) It expects to settle the liability in its normal operating cycle;

(b) It holds the liability primarily for the purpose of trading;
(c) The liability is due to be settled within twelve months after the reporting period; or
(d) The entity does not have an unconditional right to defer settlement of the liability for at least
twelve months after the reporting period.
An entity shall classify all other liabilities as noncurrent.

When an entity presents current and noncurrent assets and liabilities as separate classifications on the
face of the statement of financial position, it shall not classify deferred tax assets (liabilities) as current
assets (liabilities)
Requirement 4
Provision for employee benefits (P752-525) P 227
Deferred tax 56,414
Noncurrent liabilities P56,641
ILLUSTRATIVE AUDIT CASE 10.7- Statement of Financial Position
The following unadjusted sections of the Statement of Financial Position of the Dipolog Inc. as at
December 31, 2013 were presented to you.
Cash P 85,000
Accounts receivable 282,400
Deferred charges 8,600
Currents assets P468,000
Trade accounts payable, net of 5,000 debit balance P125,000
Interest payable 3,000
Income tax payable 12,000
Money claims of Union pending final decision ` 45,000
Mortgage payable due in four annual installments 100,000
Current liabilities P285,000
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A review of the above indicate that the Cash account of P85,000 included a customer’s checked
returned by the bank marked NSF amounting to P1250; and employee’s of P2,000; and P10,000 deposited
with the courts for a case under litigation.
Accounts receivable totaling P282,400 is composed of: Customers, debit balances- P181,400;
Advances to subsidiaries- P20,000; Advances to suppliers- P15,000; Receivables from Dipolog officers-
P18,000; Allowance for Bad Debts- (P8,000); and selling price of merchandise invoiced at 140% of cost
but not yet delivered- P56,000 (The goods were not included in Merchandise Inventory).
Required:
1. The correct total of Current Assets on December 31, 2013 is

a. P410,150 c. P413,400
b. P415,150 d. P418,400
2. The correct total of Current Liabilities on December 31, 2013 is

a. P170,000 c. P145,000
b. P160,000 d. P215,000
Answers: 1) D; 2) A
Requirement 1
Cash (P85,000-P1,250-P2,000-P10,000) P 71,750
Trade and other receivables
(P282,400+ P1,250+P2,000-P20,000-P56,000+P5,000) P214,650
Merchandise Inventory [P92,000+ (P56,000/1.4)] P132,000
Total current assets P418,400
Requirement 2
Accounts payable (P125,000+P5,000) P130,000
Interest Payable 3,000
Income tax payable P 12,000
Mortgage payable- current portion (P100,000/4) P 25,000
Total current liabilities P170,000
ILLUSTRATIVE AUDIT CASE 10.8- Statement of Comprehensive Income
In your audit of Sapping Company’s statement of comprehensive income for the year ended
December 31, 2013, you noted that company reported profit of P10,000,000. You raised questions about
the following amounts that had been included in profit:
Unrealized loss on decline in value of available for sale securities P 500,000

Loss on write-off of inventory due to a government ban net of tax 1,500,000
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Adjustment of profit of prior year net-debit 2,000,000

Loss from expropriation of property, net of tax 3,500,000
Exchange differences gain on translating foreign operations 4,500,000
Realized revaluation surplus 1,000,000
The loss from expropriation was unusual in occurrence in Sapping’s line of business.
Required:
1. Sapping’s Company’s 2013 statement of comprehensive income should report profit at

a. P9,600,000 c. P7,000,000
b. P6,500,000 d. P8,500,000
2. Sapping Company’s 2013 statement of comprehensive income should total comprehensive income at
a. P12,000,000 c. P5,000,000
b. P11,000,000 d. P4,000,000
Answers: 1) C; 2) B
Requirement 1
Reported profit P10,000,000
Unrealized loss on decline in value of available for sale securities 500,000
Adjustment of profit of prior year net-debit 2,000,000
Exchange differences gain on translating foreign operations ( 4,500,000)
Realized revaluation surplus 1,000,000)
Adjusted profit P 7,000,000
Requirement 2
Unrealized loss on decline in value of available for sale securities (P500,000)
Exchange differences gain on translating foreign operations 4,500,000
Other comprehensive income 4,000,000
Adjusted profit 7,000,000
Total comprehensive income 11,000,000
PAS 16 par. 41 states that transfers from revaluation surplus to retained earnings are not made
through profit or loss. Therefore the realized surplus is not a reclassification adjustment since it will be
credited directly to retained earnings and therefore not a component of other comprehensive income.
ILLUSTRATIVE AUDIT CASE 10.9 – Computation of Respective Accounts
Auditing Problems
218
The following accounts were included in the unadjusted trial balance of Charm Company as of
December 31, 2012:
Cash P 481,600
Inventory 3,025,000
Accounts payable 2,100,500
Accrued expenses 215,500
During your audit, you noted that Charm held its cash books open after year-end. In addition,
your audit revealed the following:
1. Receipts for January 2013 of P 327,300 were recorded in the December 2012 cash receipts
book. The receipts of P 180,050 represent cash sales and P 147,250 represent collections from
customer, net of 5% cash discounts.
2. Accounts payable of P 186,200 was paid in January 2013. The payments, on which discounts
of P 6,200 were taken, were included in the December 2009 check register.
3. Merchandise inventory is valued at P 3,025,000 prior to any adjustments. The following

information has been found relating to certain inventory transactions.
a. The invoice for goods costing P 87,500 was received and recorded as a purchase on
December 31, 2012. The related goods, shipped Fob destination were received on
January 4, 2013, and thus were not included in the physical inventory.
b. A P 91,000 shipment of goods to a customer on December 30, terms FOB destination are
not included in the year-end inventory. The goods cost P 65,000 and were delivered to
the customer on January 3, 2012. The sale was properly recorded in 2012.
c. Goods costing P 318,750 were shipped on December 31, 2012, and were delivered to
the customer on January 3, 2013. The terms of the invoice were FOB shipping point. The
goods were included in the 2009 ending inventory even though the sale was recorded in
2012.
d. Goods costing P 108,750 were received from a vendor on January 4, 2013. The related
invoice was received and recorded on January 6, 2013. The goods were shipped on
December 31, 2012, terms FOB shipping point.
e. Goods valued at P 137,500 are on consignment with a customer. These goods are not
included in the inventory figure.
f. Goods valued at P 306,400 are on consignment with a vendor. These goods are not
included in the physical inventory.
Based on the above and the result of your audit, determine the adjusted balance of the following as of
December 31, 2012.
Auditing Problems
219
Required:
1. Cash
a. P 841,600
b. P 340,500
c. P 334,300
d. P 346,700
2. Accounts receivable
a. P 1,454,300
b. P 1,282,000
c. P 1,127,000
d. P 1,274,250
3. Inventory
a. P 3,017,500
b. P 3,040,000
c. P 2,930,000
d. P 2,505,000
4. Accounts payable
a. P 2,395,450
b. P 2,307,950
c. P 2,286,500
d. P 2,301,750
5. Current ratio
a. 2.00
b. 1.83
c. 1.84
d. 2.01
Answers: 1) C; 2) B; 3) A; 4) B; 5) C
Accounts Accounts
Cash Receivable Inventory Payable
Unadjusted balances P 841,600 P 1,127,000 P 3,025,000 P 2,100,500
Add (deduct):
AJE No. 1 (327,500) 155,000 - -
AJE No. 2 180,000 - - 186,200
AJE No. 3.a - - 137,500 -
AJE No. 3.b - - 108,750 108,750
AJE No. 3.c - - (318,750) -
AJE No. 3.d - - 65,000 -
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AJE No. 3.e - - (87,500)

P 334,300 P 1,282,000 P 3,017,500 P 2,307,950
(1) (2) (3) (4)
General Comment:
* With regards to this problem, the columnar method is encouraged in solving it since it would facilitate
understanding of the effects in different accounts simultaneously, thereby reducing the time allotted.
Adjusting Entries:
1) Accounts receivable (P 147,250/0.95) P 155,000

Sales 180,050
Cash P 327,300
Sales discount
(P 147,250/0.95 x 0.05) 7,750
2) Cash 180,000
Purchases discount 6,200
Accounts payable 186,200
3) a) Inventory 137,500
Cost of sales 137,500
b) Inventory 108,750
Accounts payable 108,750
c) Cost of sales 318,750

Inventory 318,750
d) Inventory 65,000
Cost of Sales 65,000
e) Accounts payable 87,500

Cost of sales 87,500
f) No adjusting entry
Current assets
Cash P 334,300
Inventory 3,017,500 P 4,633,800
Divide by current liabilities
Accounts payable P 2,307,950
Accrued expenses 215,500 2,523,450
1.84 (5)
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ILLUSTRATIVE AUDIT CASE 10.10 – Computation of Respective Accounts
You have been appointed as auditor of Makulay Corporation, an SME. Presented below is the
balance sheet of Makulay Corporation as of December 31, 2012.
Makulay Corporation
Balance Sheet
December 31, 2012
Assets
Goodwill (Note2) P 1,200,000
Building (Note 1) 16,400,000
Land 7,500,000
Treasury shares (50,000 shares) 870,000
Cash on hand 1,759,000
Assets allocated to trustee for plant expansion
Cash in bank 700,000
BSP Treasury notes, at cost and fair value 1,380,000
P 34,630,000
Equities
Note payable ( Note 3) P 6,000,000

Share capital – Ordinary, authorized and issued,
1,000,000 shares, nor par 11,500,000
Appreciation capital (Note 1) 5,700,000
Income taxes payable 750,000
Reserve for depreciation recorded to date on the building 4,100,000
P 34,630,000
Note 1: Building is stated at revalued amount. The excess of revalued amount over cost was
P 5,700,000. Depreciation has been recorded based on revalued amount.
Note 2: Goodwill in the amount of P 1,200,000 was recognized because the company
believed that book was not an accurate representation of the fair market value of the
company. The gain of P 1,200,000 was credited to Retained Earnings.
Note 3: Notes payable are long-term expect for the current installment due of P 1,000,000.
Required:
1. The audited total current assets as of December 31, 2012 would amount to
a. P 6,580,000
b. P 6,850,000
c. P 8,660,000
d. P 6,880,000
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222
2. The net carrying value of property, plant and equipment would amount to
a. P 19,800,000
b. P 14,100,000
c. P 18,900,000
d. P 19,900,000
3. Total shareholders’ equity as adjusted would amount to

a. P 28,460,000
b. P 21,710,000
c. P 16,010,000
d. P 27,110,000
4. Total assets as adjusted would amount to

a. P 22,760,000
b. P 28,460,000
c. P 24,860,000
d. P 27,260,000
5. Total liabilities as adjusted would amount to

a. P 6,750,000
b. P 6,570,000
c. P 7,650,000
d. P 5,000,000
Answers: 1) A; 2) A; 3) B; 4) B; 5) A
MAKULAY CORPORATION
Balance Sheet
December 31, 2012
Assets
Currents Assets
Cash P 1,759,000
Account receivable 1,700,000
Total current assets P 6,850,000
Long-term Investment
Assets allocated to trustee for expansion:
Cash in bank 700,000
Treasury notes, at fair value 1,380,000 2,080,000
Property, Plant and Equipment

Land 7,500,000
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223
Building P 10,700,000 a
Less: Accumulated depreciation 4,100,000 6,600,000 14,100,000
Total assets P 22,760,000
Liabilities and Shareholders’ Equity
Current Liabilities
Notes payable – current installment P 1,000,000
Income taxes payable 750,000
Total current liabilities 1,750,000
Long-term Liabilities
Notes payable 5,000,000 b
Total liabilities 6,750,000
Shareholders’ Equity
Common stock, no par; 1,000,000
Share authorized and issued;
950,000 shares outstanding P 11,500,000
16,880,000
Less: Treasury stock, at cost
(50,000 shares) 870,000
Total stockholders’ equity 16,101,000
Total liabilities and stockholders’ equity P 22,760,000
a
P 16,400,000 – P 5,700,000 (To eliminate the excess of appraisal value over cost from the Building
account. Note that the appreciate capital account is also deleted.)
b
P 6,000,000 – P 1,000,000 (To reclassify the currently maturing portion of the notes payable as a
current liability.)
c
P 6,580,000 – P 1,200,000 (to remove the value of goodwill from retained earnings. Note 2 indicates that
retained was earning was credited. Note that the goodwill account is also deleted.)
Note: As an alternate presentation, the cash restricted for plant expansion would be added to the general
cash account and then subtracted. The amount reported in the investments section would not change.
Auditing Problems
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Substantive Tests of Cash S.Y.

Assertions, Objectives and Procedures for Investments

Assertions Audit Objectives Audit Procedures

Presentation and To determine whether cash is 11. Investigate any checks

principle. 12. Evaluate proper financial

1. Capital Acquisition and Repayment Cycle:

Capital Stock- Common Dividends Payable

Paid-in Capital in Excess

2. Acquisition and Payment cycle:

3. Sales and Collection Cycle:

Accounts Receivable Cash Discounts Taken

Gross Sales Cash in Bank

4. Payroll and Personnel Cycle:

Accrued Wages, Salaries, Accrued Payroll

Withheld Income Taxes

Types of Cash Accounts

Relationship of General Cash to Other Cash Accounts

Branch Bank Imprest Payroll

Cash Imprest Petty

ILLUSTRATIVE AUDIT CASE 1.1-Composition of Cash and Cash Equivalents

Current account at Metrobank 2,000,000

SOLUTION: Illustrative Audit Case 1.1

Current account at Metrobank P2,000,000

PAS 7 paragraph 6 defines cash and cash equivalents as follows:

Cash- comprises cash on hand and demand deposits

ILLUSTRATIVE AUDIT CASE 1.2- Computation of Unadjusted and Adjusted Balances

Additional data are given as follows:

b. Bank statement totals for December:

f. Undeposited collections on December 31, 2013- P8,000.

i. The outstanding checks on December 31, 2013, were:

1. Unadjusted cash balance per books as of December 31, 2013

3. Adjusted book receipts for December 2013

4. Adjusted bank disbursements for December 2013

5. Adjusted cash balance as of December 31, 2013

SOLUTION: Illustrative Audit Case 1.2

Beginning Receipts Disbursements Ending

Balance per books P77,900 P173,000 P 98,100 P152,800

1. Book reconciling items:

2. Bank reconciling items

ILLUSTRATIVE AUDIT CASE 1.3- Computation of Unadjusted and Adjusted Balances

Balance per bank statement, November 30 3,600,000

Data per bank statement for the month of December follow:

1. What is the cash balance per ledger on December 31?

2. What is the amount of cash receipts per book in December?

3. What is the amount of cash disbursements per book in December?

SOLUTION: Illustrative Audit Case 1.3

Proof of cash balance per book- December 31

ILLUSTRATIVE AUDIT CASE 1.4- Book to Bank Balances Format

Outstanding checks, 11/30/13 P 16,250

The cash receipts book of December is under-footed by P2,500.

1. How much is the deposit in transit on December 31, 2013?

2. The total unrecorded bank service charges as of December 31, 2013 is

3. What is the total book receipts in December?

4. What is the total amount of company checks issued in December?

5. What is the total book disbursements in December?

6. What is the book balance on November 30, 2013?

8. What is the total bank receipts in December?

9. What is the total bank disbursements in December?

10. What is the bank balance on December 31, 2013?

SOLUTION: Illustrative Audit Case 1.4

Less: Book receipts in December (see no. 3) 150,000

Beginning Receipts Disbursements Ending

7. Bank balance, November 30, 2013 P 18,500