POLYTECHNIC UNIVERSITY OF THE PHILIPPINES

COLLEGE OF ACCOUNTANCY AND FINANCE

Manila

P R A C T I C E E X A M I N A T I O N I N
A U D I T I N G P R O B L E M S

Look not at your best friend’s answer but for the best answer

CASH

In connection with the audit of the financial statement of White Mocha Company for the year ended
December 31, 2018, you performed a surprise count of the petty cash fund and undeposited collections
under the custody of Mr. Frappuccino at exactly 8:15 in the morning of January 3, 2019. Your count disclosed
the following:

Bills and coins

Bills Coins
P100 100 pieces P1.00 2,000 pieces
50 300 pieces 0.50 5,000 pieces
20 1,000 pieces 0.25 10,000 pieces

Checks

Date Payee Drawer Amount

Dec 30 Mr. Frappuccino White Mocha P9,200
Dec 30 White Mocha Caffe 36,000
Dec 31 White Mocha Latte, sales manager 2,500
Dec 31 White Mocha Caramel 25,000
Dec 31 White Mocha Chocolate 13,000
Dec 31 White Mocha Dark Mocha 27,000
Dec 31 Teavana Corp White Mocha 39,000
Dec 31 Chai Tea Corp White Mocha 11,000

Expense Vouchers

Date Payee Description Amount

Dec 17 Starbucks Kopi Coffee in Meeting P2,300
Dec 18 Golden Arches Corp Meals during meeting 5,200
Dec 20 CBTL Merchandise Bond paper and scissors 1,700
Dec 23 Latte, sales manager Cash advance for business trip 15,000
Dec 29 Messengers Transportation 1,700
Dec 29 Mac express Machinery repair 2,500

Other items found in the cash box

a. A pay envelope which had been opened and the contents aggregating P5,000 representing unclaimed
salaries had been found inside the envelope.
b. Collection for an employee who was hospitalized due to sickness was inside the cashier’s box at the time
of count. A bunch of bills with list of employees who contributed amounting to P12,000 was found
wrapped with bond paper, the list showed total collection of P12,600

c. Sales manager liquidation report for his Davao trip.

Hotel Accommodation P6,500

Meals during Travel 2,000
Taxi Fare 500
Air Fare 2,500

Additional information:

1. The custodian is not authorized to issue nor encash checks.

2. The last official receipt included in the deposit on December 30 is No. 5062 and the last official receipt
issued for the current year is No. 5065. The following official receipts are all dated December 31, 2018.

O.R. No. Amount Form of payment

5062 P45,500 Cash
5063 36,000 Check
5064 25,000 Check
5065 27,000 Check

It was noted that check of P27,000 collected with OR 5065 was dated January 4, 2019.

3. The petty cash balance per general ledger is P30,000. The last replenishment of the fund was made on
December 20, 2018.

1. Determine the amount of cash shortage or overage, if any.

2. How much is the adjusted balance of petty cash fund?
3. Total Cash Balance in the financial statement of financial position

RECEIVABLE

You are auditing the accounts receivable and the related allowance for bad debts account of CAMPUSWISE. The
control account of the aforementioned accounts had the following balances:

Accounts receivable P 1,270,000

Allowance for bad debts (78,000)
Net book value P 1,192,000

Upon your investigation, you found out the following information:

a. The company’s normal sales term is n/30

b. The allowance for bad debt account had the following details in the general ledger

Allowance for bad debts

July 31 Write off P24,000 Jan. 1 Balance 30,000
Dec. 31 72,000
 Provision, per
books
Dec 31 Balance 78,000

c. The subsidiary ledger balances of the company’s accounts receivable as of December 31, 2018 contained
the following information:

Debit Balances Credit Balances

Under One month P540,000 ABC Co. P12,000
One to Six Months 552,000 DEF 21,000
Over Six months 228,000 GHI 27,000
P1,320,000 P60,000

Additional information

 The credit balance with ABC was for an overpayment from the customer. The Company delivered
additional merchandise to ABC on January 3, 2019 to cover such overstatement
 The credit balance of DEF was due to error to a posting error. The amount should have been credited
to ZYA for a 60 day outstanding receivable.
 The credit balance from GHI was a cash receivable for a delivery to be made on January 15, 2019.

d. It was estimated that 1 percent of accounts under one month is doubtful of collection while 2 percent of
accounts one to six months are expected to require an allowance for doubtful of collection. The accounts
over six months are analyzed as follows.

Definitely uncollectible P72,000

Doubtful (estimated to be 50% collectible) 36,000
Apparently good, but slow (estimated to be 90% collectible) 120,000

4. The adjusted accounts receivable balance on December 2018 should be:

5. The required balance of the allowance for bad debts account on December 2018 is
6. The correct bad debt expense is
7. The net book value of the accounts receivable as of December 2018 should be

INVENTORY

You were assigned to do a substantive test procedure merchandise inventories of your audit client,
CAMPUWISE.

As a result of your preliminary assessment of audit risk and the result of your test of controls over
inventory shipments and receipts, you decided to render a cut-off procedures on deliveries and receipts
of goods several days before and after the balance sheet date, December 31, 2018. The inventories
reported per books amounting to P234,500 was as a result of physical count conducted on the clients’
warehouse on December 30, 2018.

Audit Notes

a. All customers are within a 3-5 days delivery area. Gross profit on sales is at 50%. The last sales
invoice recorded sales in the December Sales Journal is SI NO. 20824. The Following is a
summary of the cut-off made on sales transaction.
 SI No. SI Date Shipment Date Amount Remarks
20821 Dec. 19 Dec. 20 P26,500 FOB Shipping Point
20822 Dec. 21 Dec. 21 30,900 FOB Destination (to consignee)
20823 Dec. 27 Dec. 29 40,500 FOB Destination (in transit)
20824 Dec. 29 Dec. 31 20,600 FOB Shipping Point (in transit)
20825 Dec. 31 Dec. 31 36,800 FOB Shipping Point (in transit)
20826 Dec. 30 Dec. 30 23,600 FOB Destination (in transit)
20827 Jan. 4 Jan. 5 20,500 FOB Shipping Point

b. All suppliers are within 3-5 days delivery area. The last receiving report recorded in the
December Purchase Journal was RR No. 68138. The following is a summary of the cut-off made
on purchase transactions:

RR No RR Date Amount Remarks

68135 Dec. 15 P16,000 FOB Shipping Point
68136 Dec. 26 20,500 FOB Destination (from consignor)
68137 Dec. 31 19,900 FOB Destination
68138 Jan. 2 20,800 FOB Destination (in transit)
68139 Jan. 2 25,500 FOB Destination (in transit)
68140 Jan. 3 22,500 FOB Shipping Point (in transit)
68141 Jan. 5 11,400 FOB Shipping Point

c. An excerpt of the company’s trial balance revealed the following selected account balances
relevant to your audit:

Sales P8,671,200
Purchases 4,167,900
Account Receivable 519,800
Accounts Payable 312,400
Net Income 1,290,300

8. What is the adjusted balance of inventories as of December 31, 2018?

9. What is the adjusted balance of accounts receivable as of December 31, 2018?
10. What is the adjusted balance of account payable as of December 31, 2018?
11. What is the adjusted income in 2018?

INVESTMENT

Universal Corp. had the following portfolio of financial instruments of the December 31, 2018. All
securities were acquired at the beginning of 2018.

Denomination/Face Recorded Acquisition

Security
Value Cost
Alpha Shares 100,000 shares P5,250,000
Beta Shares 40,000 2,350,000
10%, Delta Bonds, 3 years P2,000,000 par 1,951,126
Audit notes:

a. Alpha shares were acquired with an intention of generating short-term profits from fluctuation in
value. The shares were acquired at P52.50 per share which included a P2.50 per share transaction
cost. Half of the alpha shares were sold at P58 per share on July 1, 2019.

b. Beta shares were acquired with no intent of generating short-term profits. The company have
neither control nor significant influence over Beta. The shares were acquired at P60 per share which
included P1.25 per share transaction cost. 15,000 of these shares were sold on August 1, 2019 at
P59 per share.

c. The delta bonds were acquired when the prevailing market rate of interest at 11% interest are
collectible every December 31. Half of the Delta bonds were sold on June 30, 2019 at P1.1M.

d. Information on the securities as of December 2019 are as follows:

Fair Value Fair Value

Security
December 31, 2018 December 31, 2019
Alpha Shares P55/share P62/share
Beta Shares 57.50/share 64/share
9% yield 12% yield
10%, Delta Bonds, 3 years
P2,035,182 ?

12. What is the realized gain or loss on sale of Alpha shares in 2019?
13. What is the realized gain or loss on sale of Beta shares in 2019?
14. Assuming that the company’s business model has no objective of holding debt securities to collect
contractual cash flows, what is the realized gain on sale of the Delta Bonds in 2019?
15. Assuming that the company’s business model has objective of holding debt securities to collect
contractual cash flows, what is the realized gain on sale of the Delta Bonds in 2019?
16. Assuming that the company’s business model has objective of holding debt securities to collect
contractual cash flows, what is the total carrying value of investments that shall be presented as
financial asset at fair market value through profit or loss?
17. Assuming that the company’s business model has no objective of holding debt securities to collect
contractual cash flows, what is the total carrying value of investments that shall be presented as
financial asset at fair market value through profit or loss?
 PROPERTY, PLANT, AND EQUIPMENT

The following information were deemed relevant in line with your audit

Balances as of Accumulated
Cost
12/31/2018 Depreciation
Land 1,600,000
Building 4,800,000 1,650,720
Machinery and
2,400,000 864,000
Equipment
Automotive
1,600,000 1,371,429
Equipment

Audit notes

a. The company depreciates its asset using the following depreciation policies

Method Useful life Salvage Value

Double declining
Building 20 years 10% of cost
balance
Machinery and
Straight line 10 years 10% of cost
Equipment
Automotive Sum of years
6 years None
Equipment digits

b. The building expansion was completed at the beginning of the year. The total cost of the
expansion amounted to P850,000. The amount was recognized as outright repairs and
maintenance expense. You have ascertained per audit that the cost of the expansion should have
been capitalized and depreciated over the remaining useful life of the expanded building.

c. A four-year old car with an original cost of P500,000 was traded in for a new automotive
equipment having a cash price of P800,000 at the beginning of 2018. The company paid additional
cash of P650,000. The new automotive equipment was recorded by the company at the cash
payment made.

d. A machinery was acquired on September 1, 2018 on installment basis. The total installment price
is P959,264 and is payable five equal annual installments beginning September 1, 2018. The
company issued a non-interest bearing note in lieu of the machinery. There is no established price
for the machinery. The prevailing market rate of interest for similar securities on the transaction
date was at 10%. The new machinery has an estimated useful life of 10 years with an estimated
salvage value of 10% based on its cost.

e. The beginning balance of the automotive equipment would have been deprecated at total of
P152,381 for the year.

f. Salvage value of the assets are considered immaterial.

18. What is the correct depreciation expense on the building for 2018?
19. What is the gain or loss from the trade in transaction at the beginning of 2018?
20. What is the correct depreciation expense on machinery and equipment for 2018?
21. What is the correct depreciation expense on automotive equipment for 2018?

TRADE AND OTHER PAYABLES

The following schedule was presented to you by SEDA’s bookkeeper:

Accounts payable P225,000

Estimated premiums liability ?
Estimated warranties payable 320,750
Accrued salaries 240,400
Deferred tax liability ?
Notes payable, 20% due 4/1/19 500,000
Serial bonds payable, 12% 1,000,000
Total ?

Audit notes

a. The accounts payable balance is net of a P35,000 advance made to a supplier for merchandise to
be delivered in 2018.

b. The company started a promotional program in 2018 whereby for every five product labels
customer surrenders with P25 cash, a customer shall receive an especially designed t-shirt. The
company sold 40,000 units of the product covered by the said promotional program and
purchased 4,500 t-shirts in anticipation of the premium’s redemption which the company
appropriately debited to premiums inventory account upon purchase. Each t-shirt costs P95. The
company estimates that 60% of the product labels accompanying sales shall ultimately be
presented for the redemption of premiums. 1,200 t-shirts remained on hand as of December 31,
2018. Actual redemptions during the year were appropriately recorded, while accrual at year end
is yet to be made.

c. The company has also a two-year warranty on its products. The warranty estimate is at 8% of the
peso sales, two thirds of which is expected to be incurred during the year of sale and one-third on
the year following the year of sale. The summary of the company’s total sales and actual warranty
costs incurred for the past three years are presented below (assume sales were made evenly
throughout the year):

2016 2017 2018

Net Sales P4,000,000 4,525,000 5,275,000
Actual costs paid 127,500 233,750 285,250

The company is yet to update its warranty liabilities as of December 31, 2018.

d. Apart from the estimated premiums liability and the estimated warranties payable, you have
ascertained that another temporary difference creating deferred tax was the excess tax
depreciation over financial depreciation which amounted to P250,000. The income tax rate is at
30% and is not expected to change in the future. There were no other temporary or permanent
difference.
 e. The 20% notes payable was to a bank and was originally dated April 1, 2016 with a 3 year term
with interest payable annually every April 1. On December 31, 2018, the company entered into
an agreement with the bank to refinance the notes payable by issuing another 5 year notes
payable, the proceeds of which shall be used to refinance the obligation maturing currently. As
part of the agreement, the company is to offer an asset as a security/collateral on the loan and
that the loan amount will be set at 75% of the fair market value of the asset being offered as
collateral. As of December 31, 2018 the asset offered as collateral had a fair market value of
P600,000. Due to the nature of the asset, its fair market value is not expected to materlally change
at any time up to the execution of the refinancing agreement.

f. The 12% bonds payable matures at the rate of P200,000 annually every December 31. Interests
are also payable every December 31. The last P200,000 bonds will be paid on December 31, 2024.

Requirements:

22. What is the correct estimated premiums liability as of December 31, 2018?
23. What is the correct estimated warranties payable as of December 31, 2018?
24. What is the correct deferred tax liability as of December 31, 2018?
25. What is the total current liabilities that will appear in the statement of financial position as of
December 31, 2018?
26. What is the total non-current liabilities that will appear in the statement of financial position as of
December 31, 2018?

LEASE LIABILITY

Rocks corp is asset rich but cash poor. In an attempt to alleviate its liquidity problems, it entered into an
agreement on 1 January 2018 to sell its processing plant to Ahjussi corp. for P467,100. At the date of sale,
the plant had a carrying amount of P400,000 and a future useful life of five years. Ahjussi Corp.
immediately leased the processing plant back to Rocks Corp. The terms of the lease agreement were:

Lease term 3 years

Economic life of plant 5 years
Annual rental payment, in arrears
(commencing 31 Dec. 2018) P165,000
Residual value of plant at end of lease term P90,000
Residual value of guaranteed by Rocks Corp 60,000
Interest rate implicit in the lease ?

The lease is cancellable, but only with the permission of the lessor. At the end of the lease term, the plan
is to be returned to Ahjussi Corp. in settling up the lease agreement Ahjussi Corp incurred P9,414 of initial
direct costs. The annual rental payment includes P15,000 to reimburse the lessor for maintenance costs
incurred on behalf of the lessee.

Requirements

27. The interest income to be recognized by the lessor for the year ended 31 December 2018 is
28. The carrying amount of the finance lease receivable to be reported by the lessor as of 31 december
2018 is
29. The total lease-related expense to be recognized by the lessee for the year ended 31 December
2018 is
30. The amount to be reported by the lessee under current liabilities as liability under finance lease as
of 31 December 2018 is

DEFINED BENEFIT OBLIGATION

Myko will be paid an annual pension equivalent of 0.5% of the final year’s salary for every year of service
which is payable at the end of each year after retirement. His retirement is expected to span 10 years.

As of January 1, 2017, the following information relates to Myko’s employment:

a. He has rendered service for 15 years each

b. His current salary is P1,000,000 and is expected to increase by 8% annually
c. He is expected to retire after another 20 years

The interest on high quality corporate bonds is 7% for 2018.

31. How much is the projected benefit obligation as of January 1, 2018?

32. How much is the pension cost for the year?
33. How much is the projected benefit obligation as of December 31, 2018?

SHAREHOLDERS’ EQUITY

The shareholders’ equity section of MORNING RUSH’s statement of financial position as of December 31,
2017 is as follows:

Ordinary shares, P100, par value; authorized, 200,000

P4,000,000
shares; issued 40,000 shares
Preference shares, P50 par value; authorized, 100
1,000,000
shares; 20,000
Share premium – Ordinary shares 1,800,000
Share premium – Preference shares 600,000
Retained earnings 6,000,000
Total P13,400,000

The following transactions occurred during 2018:

The company issued P2,350,000 of 10,000 ordinary shared and 5,000 preference shares.
Jan 5 The company incurred share issue cost at P150,000. The ordinary shares were currently
selling at P140 per share while the preference shares at 120.

Feb 16 5,000 preference shares were subscribed at P120 per share

2,000 previously unissued ordinary shared were issued in exchange of an equipment

Mar 25
having a fair market value of P500,000.

Apr 20 Reacquired 4,000 ordinary shares as treasury shares at P720,000

 The company declared and paid P5 cash dividends to ordinary shares and P10 per share
Jun 30
cash dividends to preference share

Jul 30 Reissued half of the treasury shares at P155 per share

A 15% ordinary stock dividend was declared and issued to ordinary shares. Market value
Aug 30
is current at P159 per share.

Sep 16 Collected full payments on 80% of the preference shares subscribed on Feb 16.

The company declared and paid P5 cash dividends to ordinary shares and P10 per share
Dec 31
cash dividends to preference shares

Dec 31 Adjusted net income for the year is at P3,510,000

34. What is the amount credited to the share premium – preference shares account as a result of the
share issuance on January 5?
35. The entry to record cash dividends on June 30 requires a debit to retained earnings at
36. The entry to record the reissue treasury shares on July 30 requires a debit to
37. The entry to record the stock dividends on August 30 requires a credit to share premium at
38. The entry to record cash dividends on December 31 requires a debit to retained earnings at

SHARE-BASED PAYMENT

CAMP Corporation grants 100 share options to each of its 500 employees. Each grant is conditional upon
the employee working for CAMP Corporation over the next three years. CAMP Corporation estimates that
the fair value of each share option is P15.

On the basis of weighted average probability, CAMP Corporation estimates that 20 percent of the
employees will leave during the three year period and therefore forfeit their rights to the share options.

During year 1, 20 employees leave. CAMP revises its estimate of total employee departures over three
year period from 20 percent (100 employees) to 15 percent ( 75 employees ).

During year 2, a further 22 employees leave. CAMP revises its estimate of total employee departures over
the three year period from 15% to 12% (60 employees).

During year 3, a further 15 employees leave. Hence, a total of 57 employees forfeited their rights to the
share options during the three year period, and a total of 44,300 share options vested at the end of year
3.

39. Compensation expense in year 1

40. Compensation expense in year 2
41. Compensation expense in year 3
42. Share Premium recognized upon exercise of the option
 CORRECTION OF ERRORS

You have been engaged to audit the accounts of PRINSIPIO for the first time in 2018. The Company
started operations in 2016. During the audit you discovered the following information:
Year ended December 31
2016 2017 2018
a. Unadjusted net income P520,000 P580,000 P710,000
b. Ending inventory overstated as a result of over
50,000 40,000
counting items at year-end
c. Ending inventory understated as a result of wrong
14,000 8,000
pricing and computational errors
d. Delivery of merchandise to customers t year-end
recorded as sales only upon collection the 25,000 22,000
following year
e. Receipt of merchandise from suppliers at year-end
recorded as purchases only upon payment the 12,000 10,000
following year
f. Major repairs on equipment at the beginning of
each year, charged to repairs expense but should 240,000
have been capitalized. Annual depre. Is 10%

Additional information:

 An equipment with an original cost of P200,000 and an accumulated depreciation of P120,000

as of December 31, 2018 was sold for P100,000 on December 31, 2018. The amount collected
was credited to miscellaneous income.

 A 10%, P1,000,000, 5 year bonds payable was issued on January 1, 2018. Interest on the bonds is
payable annually. The yield rate on the bonds on the issuance date was at 8%. The company
recorded the transaction as a debit to cash (based on the 8% yield rate) a credit to bonds
payable at face value with the difference being charged against the interest expense account.
The only other charged against the interest expense account. The only other entry made by the
client was the payment of the interest at year-end.

 Dividends declared by the company at each year end but were recorded only upon payment the
following year were P90,000, P120,000, and P150,000 for 2016, 2017, and 2018, respectively.

Determine the adjusted balances of

43. 2016 net income

44. 2017 net income
45. 2018 net income
46. Retroactive adjustment to the retained earning beginning 2018?
47. What is the correct carrying value of the bonds payable as of December 31, 2018?