UNIT 3

AUDIT OF ACCOUNTS AND NOTES PAYABLE

Estimated Time: 3.0 HOURS

Discussion Question 3-1: Nature of Liabilities

1. Define the following:
a. Legal Obligation
b. Constructive Obligation
c. Obligating event
2. What are the initial recognition criteria for financial liabilities? How are these
initially and subsequently measured?

Discussion Questions 3-2: Substantive Procedures for Liabilities

Prepare an audit work program for the audit of short-term liabilities.

Problem 3-1: Classification of Liabilities

On December 31, 2016, the bookkeeper of Manna Company provided the following
information:
Accounts payable (net of P20,000 debit balance in creditors account)
Notes Payable (including note payable to bank on Dec. 31, 2017 of P1,000,000)
Salaries payable
SSS payable
Pag-ibig payable
Medicare payable
Withholding tax payable
Vat payable
Customers account with credit balances
Stock dividends payable
Serial bonds (payable in semiannual installments P1,000,000)
Accrued interest on bonds payable
Contested BIR assessment
Unearned rent income

P 640,000
1,500,000
800,000
30,000
5,000
15,000
60,000
120,000
50,000
800,000
10,000,000
300,000
600,000
100,000

In the December 31, 2016 statement of financial position, how much current liabilities
should be reported?
Problem 3-2: Classification of Liabilities
At December 31, 2016, Expert Company had a note payable of P2,500,000, due on
April 15, 2017. Expert expects to retire this debt with proceeds from the sale of its
100,000 ordinary shares. The shares were sold for P15 per share on March 2, 2017
prior to the issuance of year-end financial statements.

In Experts December 31, 2016 statement of financial position, what amount of the
notes payable should be excluded from current liabilities?

Auditing Practice II
Workbook

Third Term, AY 2015-2016

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Problem 3-3: Various liabilities

Due to an unexpected typhoon the other day, one of your clients, Yogi Bear Company,
had its books of accounts mixed up. You are now trying to help them compute the
correct amount of liabilities as of December 31, 2016.
Notes payable
Arising from purchase of goods
Arising from 5-year bank loans, on which available-for-sale
securities valued at P600,000 have been pledged as security,
with P75,000 due on December 31, 2017
Arising from advances from officers, due June 30, 2017
Reserve for general contingencies
Employees income tax withheld
Advances received from customers on purchase orders
Containers deposit
Accounts payable arising from purchase of goods, net of debit
balances of P25,000
Accounts receivable, net of credit balances, P65,000
Cash dividends payable
Stock dividends payable
Dividend in arrears on preferred stock not yet declared
Convertible bonds, due January 31, 2018
First mortgage serial bonds, payable in semiannual installments of
P75,000 due April 1 and October 1 of each year
Overdraft with Jelly Stone Bank
Cash in bank related to overdraft
Estimated damages to be paid as a result of unsatisfactory
performance on a contract
Estimated expenses on meeting guarantee for service
requirements on merchandise sold
Estimated premiums payable
Deferred revenue
Accrued interest on bonds payable
Common stock warrants outstanding
Common stock options outstanding
Unused letters of credit
Deficiency VAT assessment being contested
Notes receivable discounted

310,000
475,000
150,000
600,000
80,000
84,000
75,000
200,000
420,000
95,000
125,000
185,000
1,400,000
2,250,000
78,000
490,000
220,000
135,000
90,000
125,000
330,000
120,000
210,000
400,000
500,000
180,000

On January 15, 2017, the BIR assessed Yogi Bear Company an additional income
tax of P300,000 for the 2009 tax year. Yogi Bears legal counsel stated that it is likely
that the BIR will agree on a P200,000 settlement. The 2016 Financial Statements are
expected to be issued on March 31, 2017.

Required - Determine the correct balance of the following:

1. Total current liabilities
2. Total long term liabilities
3. Total liabilities

Auditing Practice II
Workbook

Third Term, AY 2015-2016

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Problem 3-4: Accruals

Your client, Puscha Corporation gave you the following schedule of accrued
expenses as at December 31, 2016.
Nature
Electricity
Water
Repairs

Amount
P285,000
18,400
30,200

You went over all payments made by the corporation from January 2, 2017 until
March 15, 2017, the date of your last day of field work and you ascertained the
following data:
Date of
Supporting
Nature
Amount
Documents
2016
Professional fees (check was prepared in January, 2017)
P90,000
2016
Professional fees ( check was dated and recorded in
45,000
2016, but check was released in January, 2017)
2016
Electricity
350,000
2016
Water
150,000
2016
Repairs
30,200
2016
Various Expenses
3,000
2017
Salaries
480,000
2017
Repairs
50,000

Required:
1. Prepare the adjusting journal entries on December 31, 2016.
2. Compute for the correct balances of accrued expenses.
Problem 3-5: Non-interest bearing notes payable in installment
Sir Price, Inc. (SPI) bought an equipment costing P1.5 million on December 31, 2016
paying P500,000 down payment and the balance in four equal annual installments.
SPI can borrow funds from a bank with a 10% interest rate. SPI recorded that
equipment at P1,500,000 in December 31, 2016.

Required:
1. What is the equipments cost as of December 31, 2016?
2. By how much should the cost be decreased?
3. How much interest expense should be reported for the year 2018?
4. What is the carrying value of the note at December 31, 2019?
Problem 3-6: Notes Payable
You were able to obtain the following information from the accountant of Itchy and
Scratchy Corporation related to the companys liabilities as of December 31, 2016.
Accounts payable
Notes payable trade
Notes payable bank
Wages and salaries payable
Interest payable
Mortgage notes payable 10%
Mortgage notes payable 12%
Bonds payable

Auditing Practice II
Workbook

730,000
235,800
1,200,000
65,000
?
750,000
1,850,000
2,500,000

Third Term, AY 2015-2016

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Provided below are the additional information pertaining 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 Jetson Bank.
(1) A P400,000, 8% notes issued March 1, 2014, payable on demand. Interest is
payable every six months.
(2) A 1-year, P800,000, 11 % note issued January 2, 2016. On December 30,
2016, Itchy and Scratchy negotiated a written agreement with Jetson Bank to
replace the note with a 2-year, P800,000, 10% note to be issued January 2,
2017. The interest was paid on December 31, 2016.
c. The 10% mortgage note was issued October 1, 2013, 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, 2016, Itchy and Scratchy is three months
behind in paying its required interest payment.
d. The 12% mortgage was issued May 1, 2010, with a term of 20 years. The current
principal amount due is P1,850,000. Principal and interest payable annually on
April 30. A payment of P350,000 is due April 30, 2017. The payment includes
interest of P222,000.
e. The bonds payable is 10-year, 8% bonds, issued June 30, 2007. Interest is
payable semi-annually every June 30 and December 31.

Required: Based on the above and the result of your audit, compute the correct
balance of the following as of December 31, 2016:
1.
2.
3.
4.

Interest payable
Note payable bank to be reported under current liabilities
Total current liabilities
Total non-current liabilities

Problem 3-7: Current vs. Non-current

Included in Levans Corp.s liability account balances at December 31, 2016 were the
following:
14% note payable issued October 1, 2013, maturing September 30, 2017
16% note payable issued April 1, 2012 due on April 2017

P1,250,000
2,000,000

On December 31, 2016, Levan expects to refinance the P2,000,000 by the issuance
of a long-term note payable in lump-sum. The refinancing of the P2,000,000 is at the
discretion of Levan. Levans December 31, 2016 financial statements were issued on
March 31, 2017. On January 15, 2017, the entire P2,000,000 balance of the 16%
note was refinanced by issuance of a long-term obligation payable.

On the December 31, 2016 statement of financial position, what amount of the notes
payable should Levans classify as short-term obligation?

Auditing Practice II
Workbook

Third Term, AY 2015-2016

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