Audt3 - Applied Auditing Complete Module

APPLIED AUDITING
TABLE OF CONTENTS
CHAPTER 1 AUDIT OF CASH AND CASH EQUIVALENTS
CHAPTER 2 AUDIT OF RECEIVABLES
CHAPTER 3 AUDIT OF INVENTORIES
CHAPTER 4 AUDIT OF INVESTMENTS
CHAPTER 5 AUDIT OF PROPERTY, PLANT AND

EQUIPMENT
CHAPTER 6 AUDIT OF INTANGIBLE ASSETS
CHAPTER 7 AUDIT OF LIABILITIES
CHAPTER 8 AUDIT OF STOCKHOLDERS’ EQUITY
CHAPTER 9 CASH TO ACCRUAL BASIS, SINGLE ENTRY

AND CORRECTION OF ERRORS
CHAPTER 10 AUDIT REPORTS

APPLIED AUDITING
CHAPTER 1
AUDIT OF CASH AND CASH EQUIVALENTS
Objective
1. Solving Audit of Cash and Cash Equivalent Problems
2. Theory of Audit of Cash and Cash Equivalents.
PROBLEM NO. 1
In connection with your audit of Caloocan Corporation for the year ended
December 31, 2006, you gathered the following:
1. Current account at Metrobank P2,000,000

2. Current account at BPI (100,000)
3. Payroll account 500,000
4. Foreign bank account – restricted (in equivalent 1,000,000
pesos)
5. Postage stamps 1,000
6. Employee’s post dated check 4,000
7. IOU from controller’s sister 10,000
8. Credit memo from a vendor for a purchase 20,000
return
9. Traveler’s check 50,000
10. Not-sufficient-funds check 15,000
11. Money order 30,000
12. Petty cash fund (P4,000 in currency and
expense receipts for P6,000) 10,000
13. Treasury bills, due 3/31/07 (purchased 200,000
12/31/06)
14. Treasury bills, due 1/31/07 (purchased 1/1/06) 300,000
APPLIED AUDITING
Question:
Based on the above information and the result of your audit, compute for the
cash and cash equivalent that would be reported on the December 31, 2006
balance sheet.
a. P2,784,000 c. P2,790,000
b. P3,084,000 d. P2,704,000
Suggested Solution:
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
Treasury bills, due 3/31/07 (purchased 12/31/06)
200,000
Total P2,784,000
Answer: A
PROBLEM NO. 2
In the course of your audit of the Las Piñas Corporation, its controller is
attempting to determine the amount of cash to be reported on its December 31,
2006 balance sheet. The following information is provided:
1. Commercial savings account of P1,200,000 and a commercial checking

account balance of P1,800,000 are held at PS Bank.
2. Travel advances of P360,000 for executive travel for the first quarter of the
next year (employee to reimburse through salary deduction).
3. A separate cash fund in the amount of P3,000,000 is restricted for the
retirement of a long term debt.
4. Petty cash fund of P10,000.
5. An I.O.U. from a company officer in the amount of P40,000.
6. A bank overdraft of P250,000 has occurred at one of the banks the
company uses to deposit its cash receipts. At the present time, the
company has no deposits at this bank.
7. The company has two certificates of deposit, each totaling P1,000,000.
These certificates of deposit have maturity of 120 days.
8. Las Piñas has received a check dated January 2, 2007 in the amount of
P150,000.
9. Las Piñas has agreed to maintain a cash balance of P200,000 at all times
at PS Bank to ensure future credit availability.
10. Currency and coin on hand amounted to P15,000.
Question:
APPLIED AUDITING
Based on the above and the result of your audit, how much will be reported as
cash and cash equivalent at December 31, 2006?
a. P3,025,000 c. P2,575,000
b. P2,825,000 d. P5,025,000
Suggested Solution:
Savings account at PS Bank P1,200,000

Checking account at PS Bank 1,800,000
Petty cash fund 10,000
Currency and coin
15,000
Total P3,025,000
Answer: A
PROBLEM NO. 3
The cash account of the Makati Corporation as of December 31, 2006 consists
of the following:
On deposit in current account with Real Bank P 900,000

Cash collection not yet deposited to the bank 350,000
A customer’s check returned by the bank for 150,000
insufficient fund
A check drawn by the Vice-President of the
Corporation dated January 15, 2007 70,000
A check drawn by a supplier dated December 28,
2006 for goods returned by the Corporation 60,000
A check dated May 31,2006 drawn by the
Corporation against the Piggy Bank in payment of
customs duties. Since the importation did not
materialize, the check was returned by the
customs broker. This check was an outstanding
check in the reconciliation of the Piggy Bank 410,000
account
Petty Cash fund of which P5,000 is in currency;
P3,600 in form of employees’ I.O.U. s; and
P1,400 is supported by approved petty cash
vouchers for expenses all dated prior to closing of
the books on December 31, 2006 10,000
Total 1,950,000
Less: Overdraft with Piggy Bank secured by a
Chattel mortgage on the inventories
300,000
Balance per ledger P1,650,000
Question:
APPLIED AUDITING
At what amount will the account “Cash” appear on the December 31, 2006
balance sheet?
a. P1,315,000 c. P1,495,000
b. P1,425,000 d. P1,725,000
Suggested Solution:
Current account with Real Bank P 900,000

Undeposited collection 350,000
Supplier's check for goods returned by the Corporation 60,000
Unexpended petty cash 5,000
Current account with Piggy Bank (P410,000 - P300,000)
110,000
Total
P1,425,000
Answer: B
PROBLEM NO. 4
You noted the following composition of Malabon Company’s “cash account” as

of December 31, 2006 in connection with your audit:
Demand deposit account P2,000,000

Time deposit – 30 days 1,000,000
NSF check of customer 40,000
Money market placement (due June 30, 1,500,000
2007)
Savings deposit in a closed bank 100,000
IOU from employee 20,000
Pension fund 3,000,000
Customer’s check dated January 1, 2007 50,000
Customer’s check outstanding for 18
months 40,000
Total P7,760,000
Additional information follows:

a) Check of P200,000 in payment of accounts payable was recorded on
December 31, 2006 but mailed to suppliers on January 5, 2007.
b) Check of P100,000 dated January 15, 2007 in payment of accounts
payable was recorded and mailed on December 31, 2006.
c) The company uses the calendar year. The cash receipts journal was held
open until January 15, 2007, during which time P400,000 was collected
and recorded on December 31, 2006.
Question:
APPLIED AUDITING
The cash and cash equivalents to be shown on the December 31, 2006
balance sheet is
a. P3,310,000 c. P2,910,000
b. P1,910,000 d. P4,410,000
Suggested Solution:
Demand deposit account as adjusted:

Demand deposit account per books P2,000,000
Undelivered check 200,000
Postdated check issued 100,000
Window dressing of collection (400,000) P1,900,000

Time deposit - 30 days 1,000,000

Cash and cash equivalents
P2,910,000
Answer: C
PROBLEM NO. 6
The books of Manila's Service, Inc. disclosed a cash balance of P687,570 on

December 31, 2006. The bank statement as of December 31 showed a
balance of P547,800. Additional information that might be useful in
reconciling the two balances follows:
(a) Check number 748 for P30,000 was originally recorded on the books as
P45,000.
(b) A customer's note dated September 25 was discounted on October 12.
The note was dishonored on December 29 (maturity date). The bank
charged Manila's account for P142,650, including a protest fee of P2,650.
(c) The deposit of December 24 was recorded on the books as P28,950, but it
was actually a deposit of P27,000.
(d) Outstanding checks totaled P98,850 as of December 31.
(e) There were bank service charges for December of P2,100 not yet recorded
on the books.
(f) Manila's account had been charged on December 26 for a customer's NSF
check for P12,960.
(g) Manila properly deposited P6,000 on December 3 that was not recorded by
the bank.
(h) Receipts of December 31 for P134,250 were recorded by the bank on
January 2.
(i) A bank memo stated that a customer's note for P45,000 and interest of
P1,650 had been collected on December 27, and the bank charged a P360
collection fee.
Questions:
Based on the above and the result of your audit, determine the following:
APPLIED AUDITING
1. Adjusted cash in bank balance

a. P583,200 c. P589,200
b. P577,200 d. P512,400
2. Net adjustment to cash as of December 31, 2006

a. P104,370 c. P 98,370
b. P110,370 d. P175,170
Suggested Solution:
Question No. 1
Balance per bank statement, P547,800

12/31/06
Add: Deposits in transit P134,250
Bank error-deposit not recorded 6,000 140,250

Total 688,050
Less: Outstanding checks 98,850
Adjusted bank balance, 12/31/06 P589,200
Balance per books, 12/31/06 P687,570

Add: Book error - Check No. 748 P15,000
Customer note collected by 46,290
bank 61,290
Total 748,860
Less: Dishonored note 142,650
Book error-improperly recorded 1,950
deposit
NSF check 12,960
Bank service charges 2,100 159,660

Adjusted book balance, 12/31/06 P589,200
Question No. 2
Unadjusted balance per books, 12/31/06 P687,570

Adjusted book balance, 12/31/06 589,200
Net adjustment to cash – credit P 98,370
Answers: 1) C; 2) C
PROBLEM NO. 6
Shown below is the bank reconciliation for Marikina Company for November
2006:
APPLIED AUDITING
Balance per bank, Nov. 30, 2006 P150,000

Add: Deposits in transit
24,000
Total 174,000
Less: Outstanding checks P28,000
Bank credit recorded in
error 10,000 38,000
Cash balance per books, Nov. 30, P136,000
2006
The bank statement for December 2006 contains the following data:
Total deposits P110,000

Total charges, including an NSF check of P8,000
and a service charge of P400 96,000
All outstanding checks on November 30, 2006, including the bank credit, were
cleared in the bank 1n December 2006.
There were outstanding checks of P30,000 and deposits in transit of P38,000

on December 31, 2006.
Questions:
Based on the above and the result of your audit, answer the following:
1. How much is the cash balance per bank on December 31, 2006?
a. P154,000 c. P164,000
b. P150,000 d. P172,400
2. How much is the December receipts per books?

a. P124,000 c. P110,000
b. P 96,000 d. P148,000
3. How much is the December disbursements per books?

a. P96,000 c. P89,600
b. P79,600 d. P98,000
4. How much is the cash balance per books on December 31, 2006?
a. P150,000 c. P180,400
b. P170,400 d. P162,000
5. The adjusted cash in bank balance as of December 31, 2006 is

a. P141,600 c. P172,000
b. P162,000 d. P196,000
Suggested Solution:
APPLIED AUDITING
Question No. 1
Balance per bank, Nov. 30, 2006 P150,000

Add: Total deposits per bank statement 110,000
Total 260,000
Less: Total charges per bank statement 96,000
Balance per bank, Dec. 31, 2006 P164,000
Question No. 2
Total deposits per bank statement P110,000

Less deposits in transit, Nov. 30 24,000
Dec. receipts cleared through the bank 86,000
Add deposits in transit, Dec. 31 38,000
December receipts per books P124,000
Question No. 3
Total charges per bank statement P96,000

Less: Outstanding checks, Nov. 30 P28,000
Correction of erroneous 10,000
bank credit
December NSF check 8,000
December bank service 46,400
charge 400
Dec. disb. cleared through the bank 49,600
Add outstanding checks, Dec. 31 30,000
P79,600
December disbursements per books
Question No. 4
Balance per books, Nov. 30, 2006 P136,000

Add December receipts per books 124,000
Total 260,000
Less December disbursements per books 79,600
Balance per books, Dec. 31, 2006 P180,400
Question No. 5
Balance per bank statement, 12/31/06 P164,000

Deposits in transit 38,000
Outstanding checks ( 30,000)
Adjusted bank balance, 12/31/06 P172,000
Balance per books, 12/31/06 P180,400

NSF check ( 8,000)
Bank service charges ( 400)
Adjusted book balance, 12/31/06 P172,000
APPLIED AUDITING
Answers: 1) C; 2) A; 3) B; 4) C; 5) C
PROBLEM NO. 7
The accountant for the Muntinlupa Company assembled the following data:
June 30 July 31
Cash account balance P P
15,822 39,745
Bank statement balance
107,082 137,817
Deposits in transit
8,201 12,880
Outstanding checks
27,718 30,112
Bank service charge
72 60
Customer's check deposited July 10,
returned by bank on July 16 marked 8,250
NSF, and redeposited immediately; no
entry made on books for return or
redeposit
Collection by bank of company's 71,815 80,900
notes receivable
The bank statements and the company's cash records show these totals:
Disbursements in July per bank statement P218,373

Cash receipts in July per Muntinlupa's 236,452
books
QUESTIONS:
Based on the application of the necessary audit procedures and appreciation

of the above data, you are to provide the answers to the following:
1. How much is the adjusted cash balance as of June 30?

a. P87,565 c. P107,082
b. (P3,695) d. P15,822
2. How much is the adjusted bank receipts for July?

a. P253,787 c. P245,537
b. P214,802 d. P232,881
3. How much is the adjusted book disbursements for July?

a. P220,767 c. P181,782
b. P212,517 d. P206,673
APPLIED AUDITING
4. How much is the adjusted cash balance as of July 31?

a. P137,817 c. P22,513
b. P112,335 d. P120,585
5. How much is the cash shortage as of July 31?

a. P8,250 c. P196,144
b. P71,815 d. P0
Suggested Solution:
Muntinlupa Company
Reconciliation of Receipts, Disbursements, and Bank Balance
For the month ended July 31
Beginning Ending
June 30 Receipts Disb. July 31
Balance per bank

P249,108
statement P107,082 a P218,373 P137,817
Deposits in
transit:
June 30 8,201 (8,201)
July 31 12,880 12,880
Outstanding
checks:
June 30
(27,718) (27,718)
July 31 30,112
(30,112)
NSF check
redeposited
(8,250) (8,250)
Adjusted bank
balance P 87,565 P245,537 P212,517 P120,585
Balance per P212,529

P 15,822 P236,452 P 39,745
books b
Bank service
charge:
June
(72) (72)
July 60
(60)
Collection of
notes
receivable:
June 71,815 (71,815)
80,90
July
0 80,900
APPLIED AUDITING
Adjusted book
balance P 87,565 P245,537 P212,517 P120,585
a
(P137,817 + P218,373 – P107,082)
b
(P15,822 + 236,452 – P39,745)
Answers: 1) A; 2) C; 3) B; 4) D; 5) D
PROBLEM NO. 8
In the audit of Pasig Company’s cash account, you obtained the following
information:
The company’s bookkeeper prepared the following bank reconciliation as of

November 30, 2006:
Bank balance – November 30, P90,800

2006
Undeposited collections 5,000
Bank service charges 100
Bank collection of customer’s (8,000)
note
Outstanding checks:
Number Amount
7159 P3,000
7767 5,000
7915 2,000
(10,000)
Book balance – November 30, P77,900
2006
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. 7159 dated November 25, 2006, 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. 8113 dated December 20, 2006 was issued to replace a
mutilated check (no.7767), 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. 7767.
APPLIED AUDITING
e. The December bank statement included a check drawn by Sipag Company

for P1,500.
f. Undeposited collections on December 31, 2006 - 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, 2006, but
the collection was not received on time to be recorded by Pasig.
i. The outstanding checks on December 31, 2006, were:
Check No. Amount Check No. Amount

7767 P5,000 8910 P2,300
8856 1,300 8925 4,100
QUESTIONS:
1. Unadjusted cash balance per books as of December 31, 2006

a. P152,800 c. P144,900
b. P152,750 d. P165,700
2. Adjusted cash balance as of November 30, 2006

a. P85,800 c. P63,800
b. P58,800 d. P90,800
3. Adjusted book receipts for December 2006

a. P170,500 c. P172,000
b. P182,000 d. P173,000
4. Adjusted bank disbursement for December 2006

a. P120,150 c. P125,150
b. P 76,150 d. P 98,150
5. Adjusted cash balance as of December 31, 2006

a. P132,650 c. P137,800
b. P137,650 d. P134,650
Suggested Solution:
Question No. 1
Unadjusted book balance, 11/30/06 P77,900

Add unadjusted book receipts:
Collection from customers P165,000
Note collected by bank in Nov.
APPLIED AUDITING
presumed recorded in Dec. 173,000

8,000
Total 250,900
Less unadjusted book disbursements:
Checks drawn 98,000
BSC for Nov. presumed 98,100
recorded in Dec. 100
P152,800
Unadjusted book balance, 12/31/06
Question Nos. 2 to 5
Pasig Company
Proof of Cash
For the month ended December 31, 2006
Beginning Ending
Nov. 30 Receipts Disb. Dec. 31
Balance per bank

P136,000
statement P90,800 P169,000 P123,800 a
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 Sipag
(1,500) 1,500
Co.
BSC charged to
another client
150 (150)
Adjusted bank
balance P63,800 P172,000 P 98,150 P137,650
Balance per
P77,900 P173,000 P98,100 P152,800
books
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)
APPLIED AUDITING
Beginning Ending
Book errors:
Check no. 7159
(P30,000-P3,
(27,000) (27,000)
000)
Check no. 7767
(mutilated
check) 5,000 5,000
Adjusted book
balance P63,800 P172,000 P 98,150 P137,650
a
(P90,800 + P169,000 – P123,800)
Answers: 1) A; 2) C; 3) C; 4) D; 5) B
PROBLEM NO. 9
You obtained the following information on the current account of Parañaque

Company during your examination of its financial statements for the year
ended December 31, 2006.
The bank statement on November 30, 2006 showed a balance of P306,000.

Among the bank credits in November was customer’s note for P100,000
collected for the account of the company which the company recognized in
December among its receipts. Included in the bank debits were cost of
checkbooks amounting to P1,200 and a P40,000 check which was charged by
the bank in error against Parañaque Co. account. Also in November you
ascertained that there were deposits in transit amounting to P80,000 and
outstanding checks totaling P170,000.
The bank statement for the month of December showed total credits of
P416,000 and total charges of P204,000. The company’s books for
December showed total debits of P735,600, total credits of P407,200 and a
balance of P485,600. Bank debit memos for December were: No. 121 for
service charges, P1,600 and No. 122 on a customer’s returned check marked
“Refer to Drawer” for P24,000.
On December 31, 2006 the company placed with the bank a customer’s
promissory note with a face value of P120,000 for collection. The company
treated this note as part of its receipts although the bank was able to collect on
the note only in January, 2007.
A check for P3,960 was recorded in the company cash payments books in
December as P39,600.
APPLIED AUDITING
QUESTIONS:
Based on the application of the necessary audit procedures and appreciation

of the above data, you are to provide the answers to the following:
1. How much is the undeposited collections as of December 31, 2006?

a. P339,600 c. P219,600
b. P179,600 d. P139,600
2. How much is the outstanding checks as of December 31, 2006?

a. P191,960 c. P361,960
b. P397,600 d. P363,160
3. How much is the adjusted cash balance as of November 30, 2006?

a. P216,000 c. P176,000
b. P256,000 d. P157,200
4. How much is the adjusted bank receipts for December?

a. P635,600 c. P475,600
b. P515,600 d. P435,600
5. How much is the adjusted book disbursements for December?

a. P395,960 c. P225,960
b. P431,600 d. P397,160
6. How much is the adjusted cash balance as of December 31, 2006?

a. P625,640 c. P220,000
b. P195,640 d. P375,640
Suggested Solution:
Question No. 1
Deposits in transit, 11/30/06 P80,000

Add collections in December:
December book receipts P735,600
Less receipts not representing
collections in December:
Customer’s note collected by
bank in Nov. recorded in P100,000
Dec.
Uncollected customer's note 220,000

treated as receipts 120,000 515,600
Total 595,600
Less deposits credited by the bank

in December:
December bank receipts P416,000
APPLIED AUDITING
Less receipts not representing

deposits:
Erroneous bank debit, Nov.;

corrected Dec. 40,000 376,000
Deposits in transit, 12/31/06 P219,600
Question No. 2
Outstanding checks, 11/30/06 P170,000

Add checks issued in December:
December book disbursements P407,200
Less disbursements not
representing checks issued in
December:
Bank service charge, Nov.;
recorded Dec. P1,200
Error in recording a check

(should be P3,960, 35,640
recorded as P39,600) 36,840 370,360
Total 540,360
Less checks paid by the bank in
December:
December bank disbursements P204,000
Less disbursements not
representing checks:
Bank service charge, Dec. P1,600
24,000
NSF check, Dec. 25,600 178,400
Outstanding checks, 12/31/06 P361,960
Parañaque Company
Proof of Cash
Beginning Ending
Balance per bank

P518,000
statement P306,000 P416,000 P204,000 a
Deposits in
transit:
November 30 80,000 (80,000)
December 31 219,600 219,600
APPLIED AUDITING
Beginning Ending
Outstanding
checks:
November 30 (170,000)
(170,000)
December 31 361,960 (361,960)
Erroneous bank
debit-Novembe
(40,000)
r 40,000
Adjusted bank
balance P256,000 P515,600 P395,960 P375,640

P735,600 P407,200 P485,600
books b
Customer's note
collected by
bank -
100,000 (100,000)
November
Bank service
charge:
November (1,200) (1,200)
December 1,600 (1,600)
NSF check -
December 24,000 (24,000)
Book errors -
December
Uncollected
customer's
note treated
as receipts (120,000) (120,000)
Error in
recording a
check (should
be P3,960,
recorded as
(35,640)
P39,600) 35,640
Adjusted book
balance P256,000 P515,600 P395,960 P375,640
a
(P306,000 + P416,000 – P204,000)
b
(P485,600 + 407,200 – P735,600)
Answers: 1) C; 2) C; 3) B; 4) B; 5) A; 6) D
PROBLEM NO. 10
APPLIED AUDITING
You were able to obtain the following information in connection with your audit
of the Cash account of the Pasay Company as of December 31, 2006:
November 30 December
31
a. Balances per bank P480,000 P420,000
b. Balances per books 504,000 539,000
c. Undeposited collections 244,000 300,000
d. Outstanding checks 150,000 120,000
e. The bank statement for the month of December showed total credits of
P240,000 while the debits per books totaled P735,000.
f. NSF checks are recorded as a reduction of cash receipts. NSF checks

which are later redeposited are then recorded as regular receipts. Data
regarding NSF checks are as follows:
1. Returned by the bank in Nov. and recorded by the company in Dec.,
P10,000.
2. Returned by the bank in Dec. and recorded by the company in Dec.,
P25,000.
3. Returned by the bank in Dec. and recorded by the company in Jan.,
P29,000.
g. Check of Pasaway Company amounting to P90,000 was charged to the

company’s account by the bank in error on December 31.
h. A bank memo stated that the company’s account was credited for the net
proceeds of Anito’s note for P106,000.
i. The company has hypothecated its accounts receivable with the bank
under an agreement whereby the bank lends the company 80% of the
hypothecated accounts receivable. The company performs accounting
and collection of the accounts. Adjustments of the loan are made from
daily sales reports and deposits.
j. The bank credits the company account and increases the amount of the
loan for 80% of the reported sales. The loan agreement states specifically
that the sales report must be accepted by the bank before the company is
credited. Sales reports are forwarded by the company to the bank on the
first day following the date of sale. The bank allocates each deposit 80%
to the payment of the loan, and 20% to the company account. Thus, only
80% of each day’s sales and 20% of each collection deposits are entered
on the bank statement. The company accountant records the
hypothecation of new accounts receivable (80% of sales) as a debit to
Cash and a credit to the bank loan as of the date of sales. One hundred
percent of the collection on accounts receivable is recorded as a cash
receipt; 80% of the collection is recorded in the cash disbursements books
as a payment on the loan. In connection with the hypothecation, the
following facts were determined:
APPLIED AUDITING
 Included in the undeposited collections is cash from the hypothecation

of accounts receivable. Sales were P180,000 on November 30, and
P200,000 at December 31. The balance was made up from
collections which were entered on the books in the manner indicated
above.
 Collections on accounts receivable deposited in December, other than

deposits in transit, totaled P725,000.
k. Interest on the bank loan for the month of December charged by the bank
but not recorded in the books, amounted to P38,000.
QUESTIONS:
1. How much is the adjusted cash balance as of November 30, 2006?

a. P574,000 c. P430,000
b. P394,000 d. P350,000
2. How much is the adjusted book receipts for December, 2006?

a. P860,000 c. P876,000
b. P280,000 d. P296,000
3. How much is the adjusted book disbursements for December, 2006?

a. P180,000 c. P180,000
b. P905,000 d. P760,000

a. P690,000 c. P440,000
b. P530,000 d. P490,000
5. How much is the cash shortage as of December 31, 2006?

a. P32,000 c. P8,000
b. P90,000 d. P0
Suggested Solution:
Pasay Company
Proof of Cash
Beginning Ending
Balance per bank

P300,000
statement P480,000 P240,000 a P420,000
Deposits in
APPLIED AUDITING
Beginning Ending
transit:
November 30 100,000c
(100,000)
December 31 140,000d 140,000
Outstanding
checks:
November 30 (150,000)
(150,000)
December 31 120,000 (120,000)
Erroneous bank
debit-Decembe
r (90,000) 90,000
Deposits with
loan payment
(P725,000 x
580,000
80%) 580,000
Adjusted bank
balance P430,000 P860,000 P760,000 P530,000

P504,000 P735,000 P539,000
books b
NSF checks:
Returned in
Nov.,
recorded in (10,000) 10,000
Dec.
Returned and
recorded in
25,000 25,000
Dec.
Returned in
Dec.,
recorded in 29,000 (29,000)
Jan.
Customer's note
collected by
bank -
106,000 106,000
December
Anticipated loan
proceeds from
AR
hypothecation:
Nov. 30 sales
(P180,000 x
(144,000) 144,000
80%)
Dec. 31 sales
(160,000)
(P200,000 x (160,000)
APPLIED AUDITING
Beginning Ending
80%)
Anticipated loan
payment from
undeposited
collections:
Nov. 30
(P100,000 x
80,000 80,000
80%)
Dec. 31
(P140,000 x
(112,000) 112,000
80%)
Interest charge
for bank loan in
Dec. 38,000 (38,000)
Adjusted book
balance P430,000 P860,000 P760,000 P530,000
a
(P480,000 + P240,000 – P420,000)
b
(P504,000 + 735,000 – P539,000)
c[
P244,000 – (P180,000 x 80%)]
d[
P300,000 – (P200,000 x 80%)]
Answers: 1) C; 2) A; 3) D; 4) B; 5) D
PROBLEM NO. 11
In connection with your audit, Quezon Metals Company presented to you the
following information:
Quezon Metals Company

Comparative Balance Sheets
December 31, 2006 and 2005
2006 2005
Assets
Current Assets:
Cash P 476,000 P 392,000
Available for sale securities 236,000 -
Accounts Receivable 1,248,000 1,016,000
Inventory 1,112,000 956,000
Prepaid expenses 140,000 84,000

Total Current Assets 3,212,000 2,448,000
APPLIED AUDITING
Property, plant, and equipment 2,144,000 1,636,000

Accumulated depreciation (304,000) (212,000)
1,840,000 1,424,000
Total Assets P5,052,000 P3,872,000
Liabilities and Stockholders' Equity
Current Liabilities:
Accounts Payable P 848,000 P 792,000
Accrued expenses 392,000 304,000
Dividends Payable 160,000 -

Total Current Liabilities 1,400,000 1,096,000
Notes Payable - due 2008 500,000 -

Total Liabilities 1,900,000 1,096,000
Stockholders' Equity:
Common Stock 2,400,000 2,200,000
Retained earnings 752,000 576,000
Total Stockholders' Equity 3,152,000 2,776,000
Total Liabilities and Stockholders'
Equity P5,052,000 P3,872,000
Quezon Metals Company

Condensed Comparative Income Statements
For the Years Ended December 31, 2006 and 2005
2006 2005
Net sales P14,244,000 P13,016,000
Cost of Goods Sold 11,156,000 10,272,000
Gross Profit 3,088,000 2,744,000
Expenses 2,084,000 1,944,000

Net Income P 1,004,000 P 800,000
Additional information for Quezon:

(a) All accounts receivable and accounts payable relate to trade merchandise.
(b) The proceeds from the notes payable were used to finance plant
expansion.
(c) Capital stock was sold to provide additional working capital.
QUESTIONS:
Based on the above and the result of your audit, compute the following for
2006:
1. Cash collected from accounts receivable, assuming all sales are on

account.
a. P14,012,000 c. P14,476,000
b. P 796,000 d. P16,508,000
APPLIED AUDITING
2. Cash payments made on accounts payable to suppliers, assuming that all

purchases of inventory are on account.
a. P11,368,000 c. P10,944,000
b. P11,212,000 d. P11,256,000
3. Cash payments for dividends.

a. P 828,000 c. P 668,000
b. P1,020,000 d. P1,180,000
4. Cash receipts that were not provided by operations.

a. P192,000 c. P700,000
b. P500,000 d. P 0
5. Cash payments for assets that were not reflected in operations.

a. P1,412,000 c. P 508,000
b. P 744,000 d. P1,176,000
Suggested Solution:
Question No. 1
Accounts receivable, 1/1/06 P 1,016,000

Add sales for 2006 14,244,000
Total collectible accounts 15,260,000
Less accounts receivable, 12/31/06 1,248,000
Cash collected from accounts receivable P14,012,000
Question No. 2
Accounts payable, 1/1/06 P 792,000

Add purchases for 2006:
Cost of goods sold for 2006 P11,156,000
Add Inventory, 12/31/06 1,112,000

Total goods available for 12,268,000
sale
11,312,000
Less Inventory, 1/1/06 956,000
Total accounts to be paid 12,104,000
Less accounts payable, 12/31/06 848,000
P11,256,000
Cash payments made on AP
Question No. 3
Retained earnings, 1/1/06 P 576,000

Add net income for 2006 1,004,000
Total 1,580,000
Less retained earnings, 12/31/06 752,000

APPLIED AUDITING
Total dividends declared 828,000
Less increase in dividends payable 160,000

Cash payments for dividends P 668,000
Question No. 4
Proceeds from notes payable P500,000

Proceeds from issuance of common stock
(P2,400,000 - P2,200,000) 200,000
Cash receipts not provided by operations
(cash provided from financing) P700,000
Question No. 5
Purchase of available for sale securities P236,000

Purchase of PPE (P2,144,000 - 508,000
P1,636,000)
Cash payments for assets that were not
reflected in operations P744,000
Answers: 1) A; 2) D; 3) C; 4) C; 5) B
PROBLEM NO. 12
The Valenzuela Corporation was organized on January 15, 2006 and started
operation soon thereafter. The Company cashier who acted also as the
bookkeeper had kept the accounting records very haphazardly. The
manager suspects him of defalcation and engaged you to audit his account to
find out the extent of the fraud, if there is any.
On November 15, when you started the examination of the accounts, you find
the cash on hand to be P25,700. From inquiry at the bank, it was ascertained
that the balance of the Company’s bank deposit in current account on the
same date was P131,640. Verification revealed that the check issued for
P9,260 is not yet paid by the bank. The corporation sells at 40% above cost.
Your examination of the available records disclosed the following information:
Capital stock issued at par for cash P1,600,000

Real state purchased and paid in full 1,000,000
Mortgage liability secured by real state 400,000
Furniture and fixtures (gross) bought on which
there is still balance unpaid of P30,000 145,000
Outstanding notes due to bank 160,000
Total amount owed to creditors on open 231,420
account
Total sales 1,615,040
Total amount still due from customers 426,900
APPLIED AUDITING
Inventory of merchandise on November 15 at 469,600

cost
Expenses paid excluding purchases 303,780
QUESTIONS:
Based on the above and the result of your audit, compute for the following as
of November 15, 2006:
1. Collections from sales

a. P1,188,140 c. P1,615,040
b. P1,153,600 d. P2,041,940
2. Payments for purchases

a. P1,854,620 c. P1,207,204
b. P1,391,780 d. P 922,180
3. Total cash disbursements

a. P2,340,960 c. P2,810,560
b. P3,273,400 d. P2,625,984
4. Unadjusted cash balance

a. P 74,740 c. P1,007,180
b. P722,156 d. P 537,580
5. Cash shortage
a. P574,076 c. P859,100
b. P389,500 d. P 0
Suggested Solution:
Question No. 1
Sales P1,615,040
Less accounts receivable, 11/15 426,900

P1,188,140
Collections from sales
Question No. 2
Cost of sales (P1,615,040/1.4) P1,153,600
Add Merchandise inventory, 11/15 469,600

Purchases 1,623,200
Less Accounts payable, 11/15 231,420

Payments for purchases P1,391,780
APPLIED AUDITING
Question No. 3
Purchase of real estate P1,000,000

Payment for furniture and fixtures
(P145,000 - P30,000) 115,000
Expenses paid 303,780
Payments for purchases (see no. 2) 1,391,780

P2,810,560
Total cash disbursements
Question No. 4
Proceeds from issuance of common stock P1,600,000

Proceeds from mortgage note payable 400,000
Proceeds from notes payable - bank 160,000
Collections from sales (see no. 1) 1,188,140

Total cash receipts 3,348,140
Less cash disbursements (see no. 3) 2,810,560

P
Unadjusted cash balance 537,580
Question No. 5
Cash accountability P537,580

Less cash accounted (Adjusted
cash balance):
Unadjusted bank balance P131,640
Deposit in transit 25,700
Outstanding checks (9,260) 148,080

Cash shortage P389,500
Answers: 1) A; 2) B; 3) C; 4) D; 5) B
PROBLEM NO. 13
You were engaged to audit the accounts of Taguig Corporation for the year
ended December 31, 2006. In your examination, you determined that the
Cash account represents both cash on hand and cash in bank. You further
noted that the company’s internal control over cash is very poor.
You started the audit on January 15, 2007. Based on your cash count on this
date, cash on hand amounted to P19,200. Examination of the cash book and
other evidence of transactions disclosed the following:
a. January collections per duplicate receipts, P75,200.

APPLIED AUDITING
b. Total duplicate deposit slips, all dated January, P44,000. This amount
includes a deposit representing collections on December 31.
c. Cash book balance at December 31, 2006 amounted to P186,000,

representing both cash on hand and cash in bank.
d. Bank statement for December showed a balance of P170,400.
e. Outstanding checks at December 31:
November checks December checks

No. 280 P1,800 No. 331 P2,400
6,600 1,600
290 339
20,000
345
3,600
353
10,000
364
f. Undeposited collections at December 31, 2006 amounted to P20,000.
g. An amount of P4,400 representing proceeds of a clean draft on a customer

was credited by bank, but is not yet taken up in the company’s books.
h. Bank service charges for December, P400.
The company cashier presented to you the following reconciliation statement

for December, 2006, which he has prepared:
Balance per books, December 31, P180,600

2006
Add outstanding checks:
No. 331 P2,400
339 1,600
345 2,000
353 3,600
364 1,000 10,600
Total 191,200
Bank service charge (400)
Undeposited collections (20,400)
Balance per bank, December 31, P170,400
2006
QUESTIONS:
APPLIED AUDITING

a. P152,800 c. P180,200
b. P144,400 d. P 0
2. How much is the cash shortage as of December 31, 2006?

a. P45,600 c. P37,200
b. P 4,400 d. P41,200
3. How much is the cash shortage for the period January 1 to 15, 2007?
a. P30,800 c. P31,200
b. P32,400 d. P32,000
4. Which of the following is not a method used by the cashier to cover-up the
shortage as of December 31, 2006?
a. Understating outstanding checks by P27,000.
b. Not recording the bank collection of P4,400.
c. Understating the book balance by P5,400.
d. Overstatement of undeposited collections by P400.
Suggested Solution:
Questions No. 1 and 2
Bank Books
Unadjusted balances P170,400 P186,000
Add (deduct) adjustments:
Outstanding checks: (46,000)
Undeposited collections 20,000
Unrecorded bank collection 4,400
Bank service charge
(400)
Balances 144,400 190,000
Shortage
(45,600)
Adjusted balances P144,400 P144,400
Question No. 3
Collections per records P75,200

Add undeposited collections, Dec. 31 20,000
Total cash that should be deposited in 95,200
January
Less January deposits 44,000
Undeposited collections, Jan. 15 51,200
Less undeposited collections per cash 19,200
count
Shortage, Jan. 1 to 15, 2007 P32,000
Question No. 4
APPLIED AUDITING
Cover-up for the December 31, 2006

shortage:
Non-recording of bank collection P 4,400
Understatement of book balance
(P186,000 - P180,600) 5,400
Understatement of outstanding checks
(P46,000 - P10,600) 35,400
Overstatement of undeposited
collections (P20,400 - P20,000)
400
Total shortage, December 31, 2006 P45,600
Answers: 1) B; 2) A; 3) D; 4) A
PROBLEM NO. 14
Select the best answer for each of the following:
1. An auditor would consider a cashier’s job description to contain compatible

duties if the cashier receives remittance from the mailroom and also
prepares the
a. Daily deposit slip. c. Remittance advices.
b. Prelist of individual checks. d. Monthly bank reconciliation.
2. Which of the following internal control procedures will most likely prevent
the concealment of a cash shortage resulting from improper write-off of a
trade account receivable?
a. Write-offs must be supported by an aging schedule showing that only
receivables overdue for several months have been written off.
b. Write-offs must be approved by the cashier who is in a position to know
if the receivables have, in fact, been collected.
c. Write-offs must be approved by a responsible officer after review of
credit department recommendations and supporting evidence.
d. Write-offs must be authorized by company field sales employees who
are in a position to determine the financial standing of the customers.
3. An entity’s internal control structure requires every check request that there
be an approved voucher, supported by a prenumbered purchase order and
a prenumbered receiving report. To determine whether checks are being
issued for unauthorized expenditures, an auditor most likely would select
items for testing from the population of all
a. Cancelled checks. c. Purchase orders.
b. Approved vouchers. d. Receiving reports.
4. Which of the following auditing procedures would the auditor not apply to a
cutoff bank statement?
a. Trace year end outstanding checks and deposits in transit to the cutoff
bank statement.
b. Reconcile the bank account as of the end of the cutoff period.
APPLIED AUDITING
c. Compare dates, payees and endorsements on returned checks with the

cash disbursements record.
d. Determine that the year end deposit in transit was credited by the bank
on the first working day of the following accounting period.
5. A client maintains two bank accounts. One of the accounts, Bank A, has
an overdraft of P100,000. The other account, Bank B, has a positive
balance of P50,000. To conceal the overdraft from the auditor, the client
may decide to
a. Draw a check for at least P100,000 on Bank A for deposit in Bank B.
Record the receipt but not the disbursement and list the receipt as a
deposit in transit. Record the disbursement at the beginning of the
following year.
b. Draw a check for at least P100,000 on Bank B for deposit in Bank A.
Record the receipt but not the disbursement and list the receipt as a
deposit in transit. Record the disbursement at the beginning of the
following year.
c. Draw a check for P100,000 on Bank B for deposit in Bank A. Record
the disbursement but not the receipt. List the disbursement as an
outstanding check, but do not list the receipt as a deposit in transit.
Record the receipt at the beginning of the following period.
d. Draw a check for at least P100,000 on Bank A for deposit in Bank B.
Record the disbursement but not the receipt and list the disbursement
as an outstanding check. Record the receipt at the beginning of the
following year.
Answers: 1) A; 2) C; 3) A; 4) B, 5) B;
Reference:
Compilation of lecture notes by
Dean Rene Boy R. Bacay , CPA, CrFA, CMC, MBA, FRIAcc
APPLIED AUDITING
CHAPTER 2
AUDIT OF RECEIVABLES
Objective
1. Solving Audit of Receivables Problem
2. Theory of Audit of Receivables
PROBLEM NO. 1
Your audit disclosed that on December 31, 2006, 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’ accounts reporting credit balances arising
from sales return (225,000)
Interest receivable on bonds 150,000
Other trade accounts receivable – unassigned 750,000
Subscriptions receivable for common stock due in 30 825,000
days
Trade accounts receivable - assigned (Finance
company’s equity in assigned accounts is P150,000) 375,000
Trade installment receivable due 1 – 18 months,
including unearned finance charges of P30,000 330,000
Trade receivables from officers due currently 22,500
Trade accounts on which post-dated checks are held
APPLIED AUDITING
(no entries were made on receipts of checks) 75,000

P2,865,000
Questions:
Based on the above and the result of your audit, determine the adjusted
balance of following:
1. The trade accounts receivable as of December 31, 2006 is

a. P1,147,500 c. P1,485,000
b. P1,522,500 d. P1,447,500
2. The current trade and other receivables net as of December 31, 2006 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, 2006?
a. P1,200,000 c. P525,000
b. P 375,000 d. P 0
Suggested Solution:
Question No. 1
Other trade accounts receivable – unassigned P 750,000

Trade accounts receivable - assigned 375,000
Trade installment receivable due 1 – 18 months,
net of unearned finance charges of P30,000 300,000
Trade receivables from officers due currently 22,500
Trade accounts on which post-dated checks are 75,000
held
Trade accounts receivable P1,522,500
Question No. 2
Trade accounts receivable (see no. 1) P1,522,500

Advance payments to creditors on purchase 150,000
orders
Interest receivable on bonds 150,000
Subscriptions receivable, due in 30 days
825,000
Current trade and other receivables P2,647,500
Question No. 3
Advances to affiliated companies P375,000

APPLIED AUDITING
Note: Advances to affiliated companies are normally presented under

noncurrent assets.
Answers: 1) B; 2) A; 3) B
PROBLEM NO. 2
Presented below are a series of unrelated situations. Answer the following

questions relating to each of the independent situations as requested.
1. Bantay Company’s unadjusted trial balance at December 31, 2006,

included the following accounts:
Debit Credit
Accounts receivable P1,000,000
Allowance for doubtful accounts 40,000
Sales P15,000,000
Sales returns and allowances 700,000
Bantay Company estimates its bad debt expense to be 1 1/2% of net sales.
Determine its bad debt expense for 2006.
a. P225,000 c. P214,500
b. P254,500 d. P 55,000
2. An analysis and aging of Burgos Corp. accounts receivable at December

31, 2006, disclosed the following:
Amounts estimated to be uncollectible P 1,800,000

Accounts receivable 17,500,000
Allowance for doubtful accounts (per 1,250,000
books)
What is the net realizable value of Burgos’ receivables at December 31,

2006?
a. P15,700,000 c. P16,250,000
b. P17,500,000 d. P14,450,000
3. Cabugao Company provides for doubtful accounts based 3% of credit

sales. The following data are available for 2006.
Credit sales during 2006 P21,000,000

Allowance for doubtful accounts 1/1/06 170,000
Collection of accounts written off in prior years
(Customer credit was reestablished) 80,000
Customer accounts written off as uncollectible
during 2006 300,000
What is the balance in allowance for doubtful accounts at December 31,

2006?
a. P630,000 c. P500,000
APPLIED AUDITING
b. P420,000 d. P580,000
4. At the end of its first year of operations, December 31, 2006, Caoayan, Inc.
reported the following information:
Accounts receivable, net of allowance for

doubtful accounts P9,500,000
during 2006 240,000
Bad debts expense for 2006 840,000
What should be the balance in accounts receivable at December 31, 2006,

before subtracting the allowance for doubtful accounts?
a. P10,100,000 c. P 9,740,000
b. P10,340,000 d. P10,580,000
5. The following accounts were taken from Cervantes Inc.’s balance sheet at
December 31, 2006.
Debit Credit
Net credit sales P7,500,000
If doubtful accounts are 3% of accounts receivable, determine the bad debt

expense to be reported for 2006.
a. P123,000 c. P223,000
b. P 23,000 d. P225,000
Suggested Solution:
Question No. 1
Sales P15,000,000
Less sales returns and
allowances 700,000
Net sales 14,300,000
Multiply by bad debt rate 1
1/2%
Bad debt expense P 214,500
Question No. 2

Amount estimated to be (1,800,000)
uncollectible
Net realizable value P15,700,000
Question No. 3
APPLIED AUDITING
Allowance for doubtful accounts 1/1/06 P170,000

Establishment of accounts written off in prior 80,000
years
Customer accounts written off in 2006 (300,000)
Bad debt expense for 2006 (P21,000,000 X 630,000
3%)
Allowance for doubtful accounts 12/31/06 P580,000
Question No. 4
Bad debt expense for 2006 P840,000

during 2006 (240,000)
Allowance for doubtful accounts, 12/31/06 P600,000
Accounts receivable, net of allowance for

doubtful accounts P 9,500,000
Allowance for doubtful accounts, 12/31/06
600,000
Accounts receivable, before deducting
allowance for P10,100,000
doubtful accounts
Question No. 5

Percentage
3%
Bad debt expense, before adjustment 123,000
Allowance for doubtful accounts (debit
balance) 100,000
Bad debt expense for 2006 P 223,000
Answers: 1) C; 2) A; 3) D; 4) A, 5) C
PROBLEM NO. 3
The adjusted trial balance of Galimuyod Company as of December 31, 2005

shows the following:
Debit Credit
Allowance for bad debts P40,000
Additional information:
APPLIED AUDITING
 Cash sales of the company represents 10% of gross sales.

 90% of the credit sales customers do not take advantage of the 2/10, n/30
terms.
 It is expected that cash discount of P6,000 will be taken on accounts
receivable outstanding at December 31, 2006.
 Sales returns in 2006 amounted to P400,000. All returns were from
charge sales.
 During 2006, accounts totaling to P44,000 were written off as uncollectible;
bad debt recoveries during the year amounted to P3,000.
 The allowance for bad debts is adjusted so that it represents certain
percentage of the outstanding accounts receivable at year end. The
required percentage at December 31, 2006 is 150% of the rate used on
December 31, 2005.
Questions:
1. The accounts receivable as of December 31, 2006 is

a. P3,000,000 c. P 333,333
b. P 300,000 d. P2,444,000
2. The allowance for doubtful accounts as of December 31, 2006 is

a. P 20,000 c. P180,000
b. P120,000 d. P146,640
3. The net realizable value of accounts receivable as of December 31, 2006 is

a. P 307,340 c. P2,874,000
b. P2,814,000 d. P2,291,360
4. The doubtful account expense for the year 2006 is

a. P181,000 c. P 21,000
b. P121,000 d. P147,640
Suggested Solution:
Question No. 1
Expected cash discounts P 6,000

Divide by percentage of cash discount
0.02
Portion of AR that will be granted cash 300,000
discounts
Divide by percentage of total AR estimated to
take advantage of the discount
0.10
Accounts receivable, 12/31/06 P3,000,000
Question No. 2

APPLIED AUDITING
Multiply by bad debt rate

[(P40,000/P1,000,000) x 1.5]
0.06
Allowance for doubtful accounts, 12/31/06 P 180,000
Question No. 3

Less: Allowance for doubtful P180,000
accounts
Allowance for sales
discounts 6,000 186,000
Net realizable value, 12/31/06 P2,814,000
Question No. 4
Allow. for doubtful accounts, 12/31/06 P180,000
Add accounts written off 44,000

Total 224,000
Less: Allow. for doubtful accounts, P40,000
12/31/05
Bad debt recoveries 3,000 43,000

P181,000
Doubtful accounts expense for 2006
Answers: 1) A; 2) C; 3) B; 4) A
PROBLEM NO. 4
In your audit of Lidlidda Plastic Products Co., you noted that the company’s
balance sheet shows the accounts receivable balance at December 31, 2005
as follows:

Allowance for doubtful 72,000
accounts
P3,528,000
During 2006, transactions relating to the accounts were as follows:
 Sales on account, P38,400,000.

 Cash received from collection of current receivable totaled P31,360,000,
after discount of P640,000 were allowed for prompt payment.
 Customers’ accounts of P160,000 were ascertained to be worthless and
were written off.
APPLIED AUDITING
 Bad accounts previously written off prior to 2005 amounting to P40,000

were recovered.
 The company decided to provide P184,000 for doubtful accounts by journal
entry at the end of the year.
 Accounts receivable of P5,600,000 have been pledged to a local bank on a
loan of P3,200,000. Collections of P1,200,000 were made on these
receivables (not included in the collections previously given) and applied as
partial payment to the loan.
Questions:
1. The accounts receivable as of December 31, 2006 is

a. P8,680,000 c. P4,240,000
b. P9,840,000 d. P8,640,000
2. The allowance for doubtful accounts as of December 31, 2006 is

a. P 8,000 c. P184,000
b. P136,000 d. P176,000
3. The net realizable value of accounts receivable as of December 31, 2006 is

a. P8,544,000 c. P8,504,000
b. P8,456,000 d. P4,104,000
4. If receivables are hypothecated against borrowings, the amount of

receivables involved should be
a. Disclosed in the statements or notes
b. Excluded from the total receivables, with disclosure
c. Excluded from the total receivables, with no disclosure
d. Excluded from the total receivables and a gain or loss is recognized
between the face value and the amount of borrowings
Suggested Solution:
Question No. 1
Accounts receivable, 12/31/05 P 3,600,000

Add: Sales on account 38,400,000
Bad debt recoveries 40,000

Total 42,040,000
Less: Current receivables
collected, before cash
discounts P32,000,000
(P31,360,000 +
P640,000)
Accounts written off 160,000
Bad debt recoveries 40,000
Collections made on AR
APPLIED AUDITING
pledged as collateral 33,400,000

1,200,000
P 8,640,000
Accounts receivable, 12/31/06
Question No. 2
Allowance for doubtful accounts, 12/31/05 P 72,000

Add: Bad debt recoveries 40,000
Provision for doubtful accounts 184,000
Total 296,000
Less: Accounts written off 160,000
Allowance for doubtful accounts, 12/31/06 P136,000
Question No. 3

Less allowance for doubtful accounts,
12/31/06 136,000
Question No. 4
Receivables hypothecated or pledged against borrowings should be disclosed.
Answers: 1) D; 2) B; 3) C; 4) A
PROBLEM NO. 5
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, 2006. 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- P48,000 P52,000
Provision
 The summary of the subsidiary ledger as of December 31, 2006 was

totaled as follows:
Debit balances:
Under one month P360,000
One to six months 368,000
APPLIED AUDITING
Over six months 152,000

P880,000
Credit balances:
Alien P 8,000 - OK; additional billing in January, 2006
T. Twister 14,000 - Should have been credited to Apol*
Dee Lah 18,000 - Advances on sales contract
P40,000
*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 percent is adequate for accounts under one month.

Accounts one to six months are expected to require a reserve of 2 percent.
Accounts over six months are analyzed as follows:
Definitely bad
P 48,000
Doubtful (estimated to be 50% collectible)
24,000
Apparently good, but slow (estimated to be 90% collectible) 80,000
Total
P152,000
QUESTIONS:
1. How much is the adjusted balance of Accounts Receivable as of December

31, 2006?
a. P818,000 c. P832,000
b. P846,000 d. P826,000
2. How much is the adjusted balance of the Allowance for Doubtful Accounts
as of December 31, 2006?
a. P30,680 c. P30,960
b. P31,240 d. P30,760
3. How much the Doubtful Accounts expense for the year 2006?
a. P74,680 c. P74,960
b. P75,240 d. P74,760
Suggested Solution:
APPLIED AUDITING
Question No. 1
SL
GL Debit Credit 0 to 1 1 to 6 Over 6
Unadjusted 848,000 880,000 40,000 360,000 368,000 152,000
balances
Add (deduct):
Accounts w/
credit 26,000 (14,000) (40,000) (14,000)
balances
Definitely
uncollectibl
e accounts (48,000) (48,000) (48,000)
Unlocated
difference (8,000)
Adjusted 818,000 818,000 360,000 354,000 104,000
balances 0
Question No. 2
Account Adjusted Required

classification balance Rate Allowance
0 to 1 month P360,000 1% P 3,600
1 to 6 months 354,000 2% 7,080
Over 6 months 104,000 P24,000 – 12,000
50%
P80,000 – 8,000
10%
P30,680
Question No. 3
Doubtful account expense, per P48,000

books
Add adjustment to allowance:
Required allowance P30,680
Less balance before required
allowance (P52,000 – 26,680
P48,000) 4,000
Doubtful Accounts expense for P74,680
2006
Answers: 1) A; 2) A; 3) A
PROBLEM NO. 6
APPLIED AUDITING
In connection with your examination of the financial statements of Nagbukel,

Inc. for the year ended December 31, 2006, you were able to obtain certain
information during your audit of the accounts receivable and related accounts.
The December 31, 2006 balance in the Accounts Receivable control accounts
is P788,000.
The only entries in the Doubtful Accounts Expense account were:

 A credit for P1,296 on December 2, 2006 because Company A remitted
in full for the accounts charged off on October 31, 2006; and
 A debit on December 31 for the amount of the credit to the Allowance
for Doubtful Accounts.
The Allowance for Doubtful Accounts schedule is presented below:
Debit Credit Balance

January 1, 2006 P14,632
October 31, 2006
Uncollectible
accounts:
Company A –
P1,296 P6,032 8,600
Company B –
P3,280
Company C –
P2,256
December 31, 2006 P39,400 P48,000
An aging schedule of the accounts receivable as of December 31, 2006 is

presented below:
Amount to which the

Net debit Allowance is to be adjusted
Age balance after adjustments and
corrections have been made
0 to 1 month P372,960 1 percent
1 to 3 months 307,280 2 percent
3 to 6 months 88,720 3 percent
Over 6 months 24,000 Definitely uncollectible,
P4,000; P8,000 is considered
50% uncollectible; the
remainder is estimated to be
80% collectible.
There is a credit balance in one account receivable (0 to 1 month) of P8,000; it

represents an advance on a sales contract. Also, there is a credit balance in
one of the 1 to 3 months account receivable of P2,000 for which merchandise
will be accepted by the customer.
APPLIED AUDITING
The ledger accounts have not been closed as of December 31, 2006. The
Accounts Receivable control account is not in agreement with the subsidiary
ledger. The difference cannot be located, and you decided to adjust the
control account to the sum of the subsidiaries after corrections are made.
QUESTIONS:
1. How much is the adjusted balance of Accounts Receivable as of December

31, 2006?
a. P794,000 c. P798,960
b. P793,200 d. P802,960
2. How much is the adjusted balance of the Allowance for Doubtful Accounts
a. P63,552 c. P18,937
b. P23,057 d. P19,057
3. How much is the net adjustment to the Allowance for Doubtful Accounts?
a. P24,493 debit c. P28,943 debit
b. P15,552 credit d. P29,063 debit
4. How much is the Doubtful Accounts expense for the year 2006?
a. P13,961 b. P18,411 c. P58,456 d. P13,841
5. How much is the net adjustment to the Doubtful Accounts expense

account?
a. P20,352 debit c. P24,143 credit
b. P24,263 credit d. P19,693 credit
Suggested Solution:
Question No. 1
GL SL 0 to 1 1 to 3 3 to 6 Over 6
Unadjusted 788,000 792,960 372,960 307,280 88,720 24,000
balances
Add (deduct):
Understatement
of accounts
written off (800)
(P6,832-P6,03
2)
Definitely
uncollectible (4,000) (4,000) (4,000)
accounts
Advances from
APPLIED AUDITING
customers 8,000 8,000 8,000

Accounts w/
credit 2,000 2,000 2,000
balances
Unlocated 5,760
difference
Adjusted 798,960 798,960 380,960 309,280 88,720 20,000
balances
Question No. 2
Account Adjusted Required

classification balance Rate Allowance
0 to 1 month P380,960 1% P 3,809.60
1 to 3 months 309,280 2% 6,185.60
3 to 6 months 88,720 3% 2,661.60
Over 6 months 20,000 P8,000 – 50% 4,000.00
P12,000 – 2,400.00
20%
P19,056.80
Question No. 3
Balance per books P48,000

AJE No. 1 P1,296
AJE No. 2 ( 800)
AJE No. 3 (4,000)
AJE No. 4 (25,439) (28,943)
Required allowance (See No. 2) P19,057
Adjusting entries affecting Allowance for Doubtful Accounts and Doubtful

Accounts Expense
1) Doubtful account expense P1,296

Allowance for doubtful accounts P1,296
To correct entry made in recording recovery of account written off
2) Allowance for doubtful accounts P800

Accounts receivable P800
To correct understatement of accounts written off
3) Allowance for doubtful accounts P4,000

Accounts receivable P4,000
To write off definitely uncollectible accounts
4) Allowance for doubtful accounts P25,439

Doubtful account expense P25,439
To adjust allowance to required balance
APPLIED AUDITING
Questions No. 4 & 5
Balance per books P38,104

(P39,400-P1,296)
AJE No. 1 P1,296
AJE No. 4 (25,439) (24,143) (5)
Doubtful accounts expense per P13,961 (4)
audit
Answers: 1) C; 2) D; 3) C; 4) A, 5) C
PROBLEM NO. 7
During your examination of the 2006 financial statements of the Narvacan

Company you find that the company does not provide allowance for doubtful
accounts ever since it started operations in 2002. The company’s practice is
to directly write-off as expense doubtful accounts and credit recoveries to
income. The company’s contracts are generally for two years.
Upon your recommendation, the company agreed to change its accounts for
2006 to give effect to doubtful treatment on the allowance basis. The
allowance is to be based on a percentage of sales which is derived from the
experience of prior years. Statistics for 2002 to 2006 are shown as follows:
Year of 2002 2003 2004 2005 2006

Sale
Charge P2,400,000 P6,000,000 P7,200,000 P7,800,000 P6,600,000
Sales
Accounts
Written
off &
Year of
Sale
2002 13,200
2003 36,000 24,000
2004 12,000 96,000 31,200
2005 28,800 108,000 36,000
2006 64,800 120,000 33,600
Recoverie
s & Year
of Sale
2002
2003 2,400
2004 9,600
2005 12,000
2006 14,400
APPLIED AUDITING
Accounts receivable at December 31, 2006 were as follows:
From 2005 sales P 360,000

From 2006 sales 3,240,000
Total P3,600,000
QUESTIONS:
Based on the above and the result of your audit, you are to provide the
answers to the following:
1. The average percentage of net doubtful accounts to charge sales that

should be used in setting up the 2006 allowance is
a. 2.50% c. 2.05%
b. 1.90% d. 1.77%
2. How much is the doubtful accounts expense for 2006?

a. P131,400 c. P165,000
b. P218,400 d. P175,200
3. The doubtful accounts expense for 2006 is over(under) stated by

a. P223,800 c. (P131,400)
b. P 53,400 d. (P165,000)
4. The net realizable value of accounts receivable as of December 31, 2006

balance sheet is
a. P3,415,200 c. P3,326,400
b. P3,474,600 d. P3,240,000
5. The adjusting journal entry necessary to set up the allowance for doubtful
accounts as of December 31, 2006 will include a debit to Retained
Earnings of
a. P223,800 c. P165,000
b. P184,800 d. P 0
Suggested Solution:
Question No. 1
Net AR
Year Charge AR Recoveries written-off
sales written-off
2002 P P 61,200 P 2,400 P 58,800
2,400,000
2003 6,000,000 148,800 9,600 139,200
2004 204,000 12,000 192,000
7,200,000
P15,600,000 P414,000 P24,000 P390,000
APPLIED AUDITING
Net AR written off P 390,000

Divide by charge sales P15,600,000
Percentage
2.50%
Question No. 2
Doubtful accounts expense for 2006 (P6,600,000 x P2.50%) P165,000
Question No. 3
Recorded doubtful accounts expense

(P64,800 + P120,000 + P33,600) P214,800
Should be doubtful accounts expense for 165,000
2006
Overstatement of doubtful accounts P 53,400
expense
Question No. 4

Required allowance for doubtful accounts
(see computation below) 184,800
(A) (B) (C) (D)

(A) x 2.5% AR (B)-(C)+(D)
Year Charge sales D/A expense written-off Recoveri Allowance
es
2005 P 7,800,000 P195,000 P156,000 P14,400 P 53,400
2006 6,600,000 165,000 33,600 131,400
-
P14,400,000 P360,000 P189,600 P14,400 P184,800
Question No. 5
Adjusting journal entry necessary to set up the allowance for doubtful

accounts as of December 31, 2006:
Bad debt recovery P 14,400

Retained earnings (see below) 223,800
Doubtful account expense P53,400
2002 2003 2004 2005 Total

APPLIED AUDITING
D/A exp P P P139,200 P172,800 P 385,200

provided 13,200 60,000
Less
recoveries - 2,400 9,600 12,000 24,000
Net 13,200 57,600 129,600 160,800 361,200
Should be
D/A exp
(Sales x 195,000
2.5%) 60,000 150,000 180,000 585,000
Over (P46,800) (P92,400) (P50,400) (P34,200) (P223,800)
(Under)
Answers: 1) A; 2) C; 3) B; 4) A, 5) A
PROBLEM NO. 8
Unless otherwise identified, the notes receivable of the Quirino Company on

December 31, 2006, were trade notes receivable. On this date the balance of
the account, P3,036,915, consisted of the following notes all received during
the calendar year under audit:
Maker Date Term Rate Amount Remarks

A Co. Oct. 6 mos. 18% P Four notes
1 12 mos. 18% 57,416 to settle
Oct. 18 mos. 18% 100,000 past due
1 24 mos. 18% 100,000 account.
Oct. 100,000 Current
1 billings are
Oct. on a 10 –
1 day credit
basis.
B Co. July 36 mos. 18% 500,000 This note is
1 for a cash
loan made
to this
customer.
No interest
has been
collected to
date.
C Co. Oct. 4 mos. 15% 251,636 All interest
1 collected
on Oct. 1.
Mr. Pogi Feb. Demand 18% 1,000,000 Loan
(Company 1 approved in
President) minutes
book, Jan.
20. On
APPLIED AUDITING
Maker Date Term Rate Amount Remarks

Aug. 1 this
note was
pledged as
collateral
for a bank
loan
P500,000.
D Co. Nov. 12 mos. 15% 546,387 Interest
1 payable at
maturity
E, Inc. Dec. 90 days 18% Interest
10 payable at
381,476 maturity
P3,036,915
All of the above notes are considered good except that of A Company which is
somewhat doubtful. An allowance of 25% should be established against the
notes receivable of this company.
QUESTIONS:
Based on the above and the result of your audit, compute the following:
1. Adjusted balance of Trade Notes Receivable as of December 31, 2006

a. P1,179,499 c. P2,036,915
b. P 927,863 d. P1,536,915
2. Net realizable value of Trade Notes Receivable as of December 31, 2006

a. P1,447,561 c. P1,090,145
b. P1,947,561 d. P 838,509
3. Interest income for the year ended December 31, 2006

a. P243,749 c. P208,185
b. P253,185 d. P 43,185
4. Accrued interest income as of December 31, 2006

a. P253,185 c. P243,749
b. P 78,749 d. P198,749
Suggested Solution:
Question No. 1
Unadjusted Trade Notes P3,036,915

Receivable
Less Non-Trade Notes
Receivable:
B Company (Cash Loan) P 500,000
APPLIED AUDITING
Mr. Pogi (Loan to officer) 1,000,000 1,500,000

Adjusted Trade Notes P1,536,915
Receivable
Question No. 2
Adjusted Trade Notes Receivable P1,536,915

Less allowance for doubtful accounts
(P357,416 x 25%)
89,354
Net realizable value P1,447,561
Questions No. 3 & 4
Interest
Maker Date Amount Rate Income AIR
A Co. Oct. 1 P 18% P P
57,416 2,584 2,584
Oct. 1 100,000 18% 4,500 4,500
Oct. 1 100,000 18% 4,500 4,500
Oct. 1 100,000 18% 4,500 4,500
B Co. Jul. 1 500,000 18% 45,000 45,000
C Co. Oct. 1 251,636 15% 9,436 -
Mr. Feb. 1,000,000 18% 165,000 165,000
Pogi 1
D Co. Nov. 546,387 15% 13,660 13,660
1
E, Inc. Dec. 381,476 18%
10 4,005 4,005
) P253,185 P243,749
Answers: 1) D; 2) A; 3) B; 4) C
PROBLEM NO. 9
In connection with your audit of the Salcedo Corporation, you noted that the
company’s Notes Receivable consists of the following:
a. A 4-month note dated November 30, 2006, from AA Company, P200,000;

interest rate, 16%; discounted on November 30, 2006 at 16%.
b. A draft drawn payable 30 days after for P900,000 by the BB Company on

the Charlie Company in favor of the Delta Company, endorsed to Salcedo
Corp. on December 2, 2006 and accepted on December 4, 2006.
APPLIED AUDITING
c. A 90-day note dated November 1, 2006 from E. Dy, P500,000; interest at

16%; the note is for subscription to 5,000 shares of the preferred stock of
Salcedo Corp. at P100 per share.
d. A 60-day note dated May 3, 2006, from CC Company, P600,000; interest

rate, 16%; dishonored at maturity; judgment obtained on October 10, 2006.
Collection within the next twelve months is doubtful.
e. A 90-day note dated January 4, 2006, from Apol Bobads, president of

Salcedo, P160,000; no interest; note not renewed; president confirmed.
f. A 120-day note dated September 14, 2006, from DD Company, P120,000;

interest rate, 16%; note is held by bank as collateral.
QUESTIONS:
1. The adjusted balance of Notes Receivable as of December 31, 2006 is

a. P2,480,000 c. P1,020,000
b. P1,220,000 d. P 900,000
2. How much of foregoing notes receivable will be reported in the current

assets section of the balance sheet?
a. P1,220,000 c. P1,680,000
b. P2,480,000 d. P1,520,000
3. How much is the net interest income from the foregoing notes receivable
for 2006?
a. P19,093 c. P166,613
b. P70,613 d. P 35,093
4. The adjusted balance of Interest Receivable as of December 31, 2006 is

a. P19,093 c. P70,613
b. P 5,760 d. P 0
Suggested Solution:
Question No. 1
AA Company P 200,000
BB Company 900,000
DD Company 120,000
Adjusted balance of Notes Receivable P1,220,000
Notes:
1) AA Company will still be included in the balance of “Notes Receivable”
since “Notes Receivable-Discounted” account will be credited upon
APPLIED AUDITING
discounting. If the question is Notes Receivable that will be reported in

the balance sheet, the Notes Receivable – Discounted will be excluded
from the total Notes Receivable with disclosure of contingent liability.
2) E. Dy note was excluded since that will be reclassified to Subscriptions
Receivable.
3) CC Company note was excluded because the note was dishonored. It
will be reclassified to Accounts Receivable, including the accrued
interest.
4) Apol Bobads note was excluded due to the fact that it will be reclassified
to Advances to Officers.
5) The fact that DD Company note is held by bank as collateral should be
disclosed but the note will still be included in the Notes Receivable.
Question No. 2
Notes receivable – trade (excluding note

discounted amounting to P200,000) P1,020,000
Subscriptions receivable 500,000
Advances to officers
160,000
Amount that will be reported in the current
assets section of the balance sheet P1,680,000
Questions No. 3 & 4
Interest
Maker Date Amount Rate Income AIR
E. Dy Nov. P500,000 16% P 13,333 P 13,333
1
CC May 3 600,000 16% 16,000 -
Com.
DD Co. Sep. 120,000 16% 5,760
14 5,760
) P35,093 P19,093
Answers: 1) B; 2) C; 3) D; 4) A
PROBLEM NO. 10
The balance sheet of Santiago Corporation reported the following long-term

receivables as of December 31, 2005:
Note receivable from sale of plant P9,000,000

Note receivable from officer 2,400,000
In connection with your audit, you were able to gather the following
transactions during 2006 and other information pertaining to the company’s
long-term receivables:
APPLIED AUDITING
a. The note receivable from sale of plant bears interest at 12% per annum.
The note is payable in 3 annual installments of P3,000,000 plus interest on
the unpaid balance every April 1. The initial principal and interest
payment was made on April 1, 2006.
b. The note receivable from officer is dated December 31, 2005, earns
interest at 10% per annum, and is due on December 31, 2008. The 2006
interest was received on December 31, 2006.
c. The corporation sold a piece of equipment to Yes, Inc. on April 1, 2006, in

exchange for an P1,200,000 non-interest bearing note due on April 1, 2008.
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, 2006, 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 tract of land was sold by the corporation to No Co. on July 1, 2006, for
P6,000,000 under an installment sale contract. No Co. signed a 4-year
11% note for P4,200,000 on July 1, 2006, in addition to the down payment
of P1,800,000. The equal annual payments of principal and interest on
the note will be P1,353,750 payable on July 1, 2007, 2008, 2009,and 2010.
The land had an established cash price of P6,000,000, and its cost to the
corporation was P4,500,000. The collection of the installments on this
note is reasonably assured.
QUESTIONS:
1. Noncurrent notes receivable as of December 31, 2006

a. P13,556,400 c. P10,556,400
b. P 9,664,650 d. P 9,750,726
2. Current portion of long-term notes receivable as of December 31, 2006

a. P3,891,750 c. P3,000,000
b. P4,353,750 d. P 0
3. Accrued interest receivable as of December 31, 2006

a. P771,000 c. P 540,000
b. P857,076 d. P1,011,000
4. Interest income for the year 2006

a. P1,281,000 c. P1,367,076
b. P1,637,076 d. P1,512,000
Suggested Solution:
Question No. 1
NR from sale of plant

APPLIED AUDITING
Balance, 12/31/06
(P9,000,000 - P6,000,000
P3,000,000)
Less inst. due on 3,000,000 P3,000,000
4/1/07
NR from officer, due 2,400,000
12/31/08
NR from sale of
equipment
Present value of note,
4/1/06 (P1,200,000 x 956,400
0.797)
Add interest earned for
2006 (P956,400 x 86,076 1,042,476
12% x 9/12)
NR from sale of land
Balance, 12/31/06 4,200,000
Less principal
installment due on
7/1/07
Total amount to be P1,353,750
received
Less interest
(P4,200,000 x 891,750
11%) 462,000 3,308,250
Total P9,750,726
Question No. 2
Note receivable from sale of plant due, 4/1/07 P3,000,000

Note receivable from sale of land (see no. 1)
891,750
Current portion of long-term notes receivable P3,891,750
Question No. 3
NR from sale of plant (P6,000,000 x 12% x P540,000

9/12)
NR from sale of land (P4,200,000 x 11% x 231,000
6/12)
Accrued interest receivable, 12/31/06 P771,000
Question No. 4
NR from sale of plant:

1/1 to 3/31 - P9,000,000 x 12% x 3/12 P 270,000
4/1 to 12/31 - P6,000,000 x 12% x 9/12 540,000
810,000
APPLIED AUDITING
NR from officer (P2,400,000 x 10%) 240,000

NR from sale of equipment (P956,400 x 12% 86,076
x 9/12)
NR from sale of land (P4,200,000 x 11% x 231,000
6/12)
Interest income for 2006 P1,367,076
Answers: 1) D; 2) A; 3) A; 4) C
PROBLEM NO. 11
Sigay Company has been using the cash method to account for income since
its first year of operation in 2005. All sales are made on credit with notes
receivable given by the customers. The income statements for 2005 and
2006 included the following amounts:
2005 2006
Revenues – collection on P1,600,000 P2,500,000
principal
Revenues – interest 180,000 275,000
Cost of goods purchased* 2,260,000 2,601,000
* Includes increase in inventory of goods on hand of P100,000 in 2005 and

P400,000 in 2006.
The balances due on the notes at the end of each year were as follows:
2005 2006
Notes receivable (gross) - 2005 P3,100,000 P1,800,000
Notes receivable (gross) – 2006 - 3,000,000
Unearned interest income – 358,350 278,950
2005
Unearned interest income – - 402,150
2006
QUESTIONS:
Your client requested you to compute for the following using the installment
sales method:
1. Installment sales for the year 2005

a. P4,700,000 c. P4,521,650
b. P4,341,650 d. P4,062,700
2. Realized gross profit in 2005

a. P804,000 c. P835,680
b. P864,640 d. P749,280
3. Installment sales for the year 2006

a. P4,200,000 c. P3,877,250
b. P3,797,850 d. P4,152,250
APPLIED AUDITING
4. Realized gross profit in 2006 on 2005 installment sales

a. P853,265 c. P637,519
b. P440,975 d. P613,352
5. Realized gross profit in 2006 on 2006 installment sales

a. P504,600 c. P653,250
b. P730,413 d. P553,085
Suggested Solution:
Question No. 1
Principal amount collected on 2005 note P1,600,000

Add uncollected 2005 note, net – 12/31/05
(P3,100,000-P358,350)
2,741,650
Installment sales for 2005 P4,341,650
Note: Installment sales is equal to the original amount of notes receivable,

net of unearned interest income.
Question No. 2
Principal amount collected on 2005 note P1,600,000

Multiply by gross profit rate in 2005
50.25%
Realized gross profit in 2005 on 2005 inst. sales P 804,000
Computation of gross profit rate in 2005:

Less cost of installment sales (P2,260,000 -
P100,000) 2,160,000
Gross profit for 2005 2,181,650
Divide by installment sales for 2005
4,341,650
Gross profit rate in 2005
50.25%
Question No. 3
Total principal amount collected in P2,500,000

2006
Principal amount collected in 2006 on
2005 note:
Uncollected 2005 note, net - P2,741,650
12/31/05
APPLIED AUDITING
Less uncollected 2005 note, net -

12/31/06 (P1,800,000-P278,950) 1,220,600
1,521,050
Principal amount collected on 2006 1,279,400
note
Uncollected 2006 note, net – 12/31/06
(P3,000,000-P402,150) 2,597,850
Question No. 4
Principal amount collected in 2006 on 2005 note P1,220,600

50.25%
Question No. 5
Principal amount collected in 2006 on 2006 note P1,279,400

43.23%
Computation of gross profit rate in 2006:

Less cost of installment sales (P2,601,000 -
P400,000) 2,201,000
Gross profit for 2006 1,676,250
Divide by installment sales for 2006
3,877,250
Gross profit rate in 2006
43.23%
Answers: 1) B; 2) A; 3) C; 4) D, 5) D
PROBLEM NO. 12
On January 1, 2004, Sinait Company loaned P3,000,000 to Ilocos Company.

The terms of the loan were payment in full on January 1, 2009, plus annual
interest payments at 11%. The interest payment was made as scheduled on
January 1, 2005; however, due to financial setbacks, Ilocos was unable to
make its 2006 interest payment. Sinait considers the loan impaired and
projects the following cash flows from the loan as of December 31, 2006 and
APPLIED AUDITING
2007. Assume that Sinait accrued the interest at December 31, 2005, but did
not continue to accrue interest due to the impairment of the loan.
Amount projected as of
Date of Flow Dec. 31, Dec. 31,
2006 2007
December 31, 2007 P 200,000 P 200,000
December 31, 2008 400,000 600,000
December 31, 2009 800,000 1,200,000
December 31, 2010 1,200,000 1,000,000
December 31, 2011 400,000
QUESTIONS:
Your client requested you to determine the following: (Round-off present value
factors to four decimal places)
1. Loan impairment (bad debt expense) for the year 2006

a. P 882,380 c. P1,212,380
b. P1,549,500 d. P1,542,380
2. Interest income for 2007 assuming the P200,000 was collected on

December 31, 2007 as scheduled
a. P195,855 c. P200,000
b. P232,938 d. P 66,000
3. Allowance for loan impairment as of December 31, 2007

a. P554,340 c. P649,442
b. P752,640 d. P776,900
4. Interest income for 2008 assuming the P600,000 was collected on

December 31, 2008 as scheduled
a. P225,210 c. P236,561
b. P247,023 d. P222,541
5. Carrying amount of loan receivable as of December 31, 2008

a. P1,672,570 c. P1,645,641
b. P2,150,558 d. P1,892,683
Suggested Solution:
Question No. 1
Principal P3,000,000
Add accrued interest in 2005 (P3,000,000 x
11%) 330,000
Carrying amount, 12/31/06 3,330,000
APPLIED AUDITING
Less PV of projected cash flows (see below)

2,117,620
Loan impairment (bad debt expense) P1,212,380
Date Collection Period PVF at Present value

11%
Dec. 31, P 200,000 1 year 0.9009 P 180,180
2007
Dec. 31, 400,000 2 years 0.8116 324,640
2008
Dec. 31, 800,000 3 years 0.7312 584,960
2009
Dec. 31, 1,200,000 4 years 0.6587 790,440
2010
Dec. 31, 5 years 0.5935 237,400
2011 400,000
P3,000,000 P2,117,620
Journal entry to record the loan impairment:

Bad debt expense P1,212,380
Interest receivable P 330,000
Allowance for loan impairment 882,380
Note: PAS 39 par. 63 states that the carrying amount of the asset shall be
reduced either directly or through the use of an allowance account. The
use of allowance account is preferable since this will inform the users of the
gross amount of the impaired loan receivable.
Question No. 2
Interest income for 2007 (P2,117,620 x 11%) P232,938
Incidentally, the following are the journal entries to record the collection:
Cash P200,000
Loan receivable P200,000
Allowance for loan impairment P232,938

Interest income P232,938
Question No. 3
Principal, 12/31/07 (P3,000,000 - P200,000) P2,800,000

Less PV of projected cash flows (see below) 2,245,660
Allowance for loan impairment, 12/31/07 P 554,340
Date Collection Period PVF at Present value

11%
Dec. 31, P 600,000 1 year 0.9009 P 540,540
2008
APPLIED AUDITING
Dec. 31, 1,200,000 2 0.8116 973,920

2009 years
Dec. 31, 1,000,000 3 0.7312 731,200
2010 years
P2,800,000 P2,245,660
Journal entry to adjust net loan receivable to present value of new cash
flow projections.
Allowance for loan impairment
(P882,380 - P232,938 - P554,340) P95,102
Bad debt expense P95,102
Question No. 4
Interest income for 2008 (P2,245,660 x 11%) P247,023
Question No. 5
Principal, 12/31/08 (P2,800,000 - P600,000) P2,200,000

Less allowance for loan impairment, 12/31/08
(P554,340 - P247,023)
307,317
Carrying value, 12/31/08 P1,892,683
Answers: 1) C; 2) B; 3) A; 4) B, 5) D
PROBLEM NO. 13
Tagudin Co. required additional cash for its operation and used accounts
receivable to raise such needed cash, as follows:
 On December 1, 2006 Tagudin Company assigned on a nonnotification

basis accounts receivable of P5,000,000 to a bank in consideration for a
loan of 90% of the receivables less a 5% service fee on the accounts
assigned. Tagudin signed a note for the bank loan. On December 31,
2006, Tagudin collected assigned accounts of P3,000,000 less discount of
P200,000. 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 P1,550,000 of accounts receivable for P1,340,000. The

receivables had a carrying amount of P1,470,000 and were sold outright on
a nonrecourse basis.
 Tagudin Co. received an advance of P300,000 from Union Bank by

pledging P360,000 of accounts receivable.
APPLIED AUDITING
 On June 30, 2006, Tagudin Co. discounted at a bank a customer’s

P600,000, 6-month, 10% note receivable dated April 30, 2006. The bank
discounted the note at 12% on the same date.
QUESTIONS:
1. In its December 31, 2006 balance sheet, Tagudin should report note
payable as a current liability at
a. P1,745,000 c. P1,545,000
b. P2,250,000 d. P1,700,000
2. Tagudin Company’s equity in the assigned accounts receivable as of

December 31, 2006 is
a. P255,000 c. P455,000
b. P300,000 d. P 0
3. The entry to record the sale of accounts receivable would include

a. A debit to Finance Charge of P210,000.
b. A debit to Allowance for Doubtful Accounts of P80,000.
c. A credit to Accounts Receivable of P1,470,000.
d. A credit to Notes Payable of P1,550,000.
4. Accounts receivable pledged 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 the note receivable discounted on June 30, 2006 is
a. P564,000 c. P604,800
b. P617,400 d. P576,000
Suggested Solution:
Question No. 1
Original note payable (P5,000,000 x P4,500,000

90%)
Less payment applied to principal:
Total payment (P3,000,000 - P2,800,000
P200,000)
Less payment applied to interest
(P4,500,000 x 1%) 2,755,000
45,000
Note payable, 12/31/06 P1,745,000
APPLIED AUDITING
Question No. 2
Total accounts receivable assigned P5,000,000

Less collections
3,000,000
Accounts receivable assigned, 12/31/06 2,000,000
Note payable, 12/31/06
1,745,000
Equity in accounts receivable assigned P
255,000
Question No. 3
Journal entry to record the sale (factoring) of accounts receivable:

Cash P1,340,000
Allowance for doubtful accounts
(P1,550,000-P1,470,000) 80,000
Loss on factoring (Finance Charge) 130,000
Question No. 4
Accounts receivable pledged against borrowings, should be Included in

total receivables with disclosure.
Question No. 5
Face value P600,000

Add interest up to maturity (P600,000 x 10% x
6/12) 30,000
Maturity value 630,000
Less discount (P630,000 x 12% x 4/12) 25
200
Proceeds from note receivable discounting P604,800
Answers: 1) A; 2) A; 3) B; 4) A, 5) C
PROBLEM NO. 14
1. An auditor is testing sales transactions. One step is to trace a sample of

debit entries from the accounts receivable subsidiary ledger back to the
supporting sales invoices. What would the auditor intend to establish by
this step?
a. Sales invoices represent bona fide sales.
b. Debit entries in the accounts receivable subsidiary ledger are properly
supported by sales invoices.
c. All sales invoices have been recorded.
APPLIED AUDITING
d. All sales invoices have been properly posted to customer accounts.
2. Tracing bills of lading to sales invoices provides evidence that

a. Shipments to customers were recorded as sales.
b. Shipments to customers were invoiced.
c. Recorded sales were shipped.
d. Invoiced sales were shipped.
3. Proper authorization procedures in the revenue/receipt cycle usually

provide for approval of write-offs by an employee in which of the following
departments?
a. Accounts receivable c. Billing
b. Treasurer d. Sales
4. To gather audit evidence about the proper credit approval of sales, the
auditor would select a sample of documents from the population
represented by the
a. Subsidiary customers' accounts ledger.
b. Sales invoice file.
c. Customer order file.
d. Bill of lading file.
5. In determining validity of accounts receivable, which of the following would

the auditor consider most reliable?
a. Direct telephone communication between auditor and debtor.
b. Documentary evidence that supports the accounts receivable balance.
c. Confirmation replies received directly from customers.
d. Credits to accounts receivable from the cash receipts book after the
close of business at year end.
Answers: 1) B; 2) B; 3) B; 4) C, 5) C;
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Reference:
APPLIED AUDITING
CHAPTER 3
AUDIT OF INVENTORIES
Objective
1. Solving Audit of Inventories Problems
2. Theory of Audit of Inventories
PROBLEM NO. 1
Presented below is a list of items that may or may not reported as inventory in
a company’s December 31 balance sheet.
1. Goods out on consignment at another company’s P800,000

store
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 300,000
inventory
6. Goods sold where large returns are predictable 280,000
7. Goods sold f.o.b. shipping point that are in transit
December 31 120,000
8. Freight charges on goods purchased 80,000
9. Factory labor costs 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
APPLIED AUDITING
13. Office supplies 10,000

14. Raw materials on which a the company has started
production, but which are not completely processed 280,000
15. Factory supplies 20,000
16. Goods held on consignment from another company 450,000
17. Costs identified with units completed but not yet 260,000
sold
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
Question:
How much of these items would typically be reported as inventory in the

financial statements?
a. P2,300,000 c. P2,260,000
b. P2,000,000 d. P2,220,000
Suggested Solution:
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 of services.
Par. 10 further states 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, 14, 15, 17 and 18 would be reported as

inventory in the financial statements.
The other items will be reported as follows:
Item 2 - Cost of goods sold in the income statement

Item 4 - Not reported in the financial statements
Item 10 - Interest expense in the income statement
Item 11 - Advertising expense in the income statement
Item 13 - Office supplies in the current asset section of the
balance sheet
Item 16 - Not reported in the financial statements
Item 19 - Trading securities in the current asset section of the
balance sheet
Answer: A
APPLIED AUDITING
PROBLEM NO. 2
In connection with your audit of the Alcala Manufacturing Company, you

reviewed its inventory as of December 31, 2006 and found the following items:
(a) A packing case containing a product costing P100,000 was standing in the
shipping room when the physical inventory was taken. It was not included
in the inventory because it was marked “Hold for shipping instructions.”
The customer’s order was dated December 18, but the case was shipped
and the costumer billed on January 10, 2007.
(b) Merchandise costing P600,000 was received on December 28, 2006, and
the invoice was recorded. The invoice was in the hands of the purchasing
agent; it was marked “On consignment”.
(c) Merchandise received on January 6, 2007, costing P700,000 was entered

in purchase register on January 7. The invoice showed shipment was
made FOB shipping point on December 31, 2006. Because it was not on
hand during the inventory count, it was not included.
(d) A special machine costing P200,000, fabricated to order for a particular

customer, was finished in the shipping room on December 30. The
customer was billed for P300,000 on that date and the machine was
excluded from inventory although it was shipped January 4, 2007.
(e) Merchandise costing P200,000 was received on January 6, 2007, and the
related purchase invoice was recorded January 5. The invoice showed
the shipment was made on December 29, 2006, FOB destination.
(f) Merchandise costing P150,000 was sold on an installment basis on

December 15. The customer took possession of the goods on that date.
The merchandise was included in inventory because Alcala still holds legal
title. Historical experience suggests that full payment on installment sale
is received approximately 99% of the time.
(g) Goods costing P500,000 were sold and delivered on December 20. The
goods were included in the inventory because the sale was accompanied
by a purchase agreement requiring Alcala to buy back the inventory in
February 2007.
Question:
Based on the above and the result of your audit, how much of these items
should be included in the inventory balance at December 31, 2006?
a. P1,300,000 c. P1,650,000
b. P 800,000 d. P1,050,000
APPLIED AUDITING
Suggested Solution:
Unshipped goods P 100,000

Purchased merchandise shipped
FOB shipping point 700,000
Goods used as collateral for a loan 500,000
Total P1,300,000
Reasons for including and excluding the items:
a) Included - Merchandise should be included in the inventory until shipped.

An exception would be special orders.
b) Excluded - Alcala Manufacturing has the merchandise on a consignment
basis and therefore does not possess legal title.
c) Included - The merchandise was shipped FOB shipping point and therefore
would be included in the inventory on the shipping date.
d) Excluded - Title may pass on special orders when segregated for shipment.
e) Excluded - The merchandise was shipped FOB destination and was not
received until January 3, 2006.
f) Excluded - Historical experience suggests that Alcala will collect the full
purchase price, so the sale is recognized even though legal title has not
passed.
g) Included - This is not a sale of inventory but instead is a loan with the
inventory as collateral.
Answer: A
PROBLEM NO. 3
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

P100,000, had been excluded from the inventory, and further testing
revealed that the purchase had been recorded.
b. Goods costing P50,000 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 P250,000 and billed on December 30 at a selling price of

P320,000, 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.
APPLIED AUDITING
d. Goods costing P70,000 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 P80,000.
e. The sale of P150,000 worth of materials and costing P120,000 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 2005.
f. Goods costing P100,000 and selling for P140,000 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, terms FOB shipping point but the
goods had not arrived as yet. However, these materials costing P170,000
had been included in the inventory count, but no entry had been made for
their purchase.
h. Merchandise costing P200,000 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,
2006 balances: Inventory, P1,100,000; Accounts receivable, P580,000;
Accounts payable, P690,000; Net sales, P5,050,000; Net purchases,
P2,300,000; Net income, P510,000.
QUESTIONS:
balances of following as of December 31, 2006:
1. Inventory
a. P1,230,000 c. P1,550,000
b. P1,650,000 d. P1,480,000
2. Accounts payable
a. P710,000 c. P810,000
b. P540,000 d. P760,000
3. Net sales
a. P4,550,000 c. P4,730,000
b. P4,650,000 d. P4,970,000
4. Net purchases
a. P2,370,000 c. P2,150,000
b. P2,420,000 d. P2,320,000
APPLIED AUDITING
5. Net income
a. P220,000 c. P540,000
b. P290,000 d. P550,000
Suggested Solution:
Questions No. 1 to 5
Accounts Net Net

Inventory Payable
Net Sales Purchases Income
Unadjusted
balances P1,100,000 P690,000 P5,050,000 P2,300,000 P510,000
(a) - (100,000) - (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
balances P1,550,000 P710,000 P4,650,000 P2,320,000 P540,000
Answers: 1) C; 2) A; 3) B; 4) D, 5) C
PROBLEM NO. 4
You were engaged by Asingan Corporation for the audit of the company’s
financial statements for the year ended December 31, 2006. 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 P7,800,000 Balance forwarded P4,200,000
12/27 SI No. 965 60,000 12/28 RR #1059 36,000
12/28 SI No. 966 225,000 12/30 RR #1061 105,000
12/28 SI No. 967 15,000 12/31 RR #1062 63,000
12/31 SI No. 969 69,000 12/31 RR #1063 96,000
12/31 SI No. 970 102,000 12/31 Closing
entry (4,500,000)
12/31 SI No. 971 24,000 P
-
12/31 Closing
entry (8,295,000)
P
-
APPLIED AUDITING
Note: SI = Sales Invoice RR = Receiving Report

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, the last Receiving Report which had been used was No. 1063
and that no shipments had been made on any Sales Invoices whose number is
larger than No. 968. 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. 1060 but
for which the invoice was not received until the following year. Cost was
P27,000.
b) On the evening of December 31, there were two trucks in the company
siding:
 Truck No. XXX 888 was unloaded on January 2 of the following year
and received on Receiving Report No. 1063. 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
P150,000 per Sales Invoice No. 968.
c) Temporarily 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. 966 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. 1064. The goods were shipped FOB
Destination, and freight of P2,000 was paid by the client. However, the
freight was deducted from the purchase price of P800,000.
QUESTIONS:
1. Sales for the year ended December 31, 2006

a. P8,100,000 c. P7,875,000
b. P7,725,000 d. P8,025,000
2. Purchases for the year ended December 31, 2006

a. P4,500,000 c. P5,631,000
b. P5,727,000 d. P4,527,000
APPLIED AUDITING
3. Accounts receivable as of December 31, 2006

a. P330,000 c. P525,000
b. P555,000 d. P180,000
4. Inventory as of December 31, 2006

a. P1,452,000 c. P1,200,000
b. P1,221,000 d. P1,296,000
5. Accounts payable as of December 31, 2006

a. P600,000 c. P 531,000
b. P627,000 d. P1,827,000
Suggested Solution:
Sales Purchases AR Inventory AP

Unadjusted
balances P8,295,000 P4,500,000 P750,000 P900,000 P600,000
AJE No. 1 (195,000) - (195,000) - -
AJE No. 2 - 27,000 - - 27,000
AJE No. 3 - - - 96,000 -
AJE No. 4 - - - 120,000 -
AJE No. 5 (225,000) - (225,000) - -
AJE No. 6
- - - 180,000 -
Adjusted
balances P7,875,000 P4,527,000 P330,000 P1,296,000 P627,000
Adjusting entries:
1) Sales (P69,000+P102,000+P24,000) P195,000

To adjust unshipped goods recorded as sales (SI No. 969, 970 and
971)
2) Purchases P27,000
Accounts payable P27,000
To take up unrecorded purchases (RR No. 1060)
3) Inventory P96,000
Cost of sales P96,000
To take up goods under RR No. 1063
4) Inventory (P150,000/1.25) P120,000

To take up unshipped goods under SI No. 968
APPLIED AUDITING
5) Sales P225,000
To reverse entry made to record SI No. 966
6) Inventory (P225,000/1.25) P180,000

To take up goods under SI No. 966
Answers: 1) C; 2) D; 3) A; 4) D, 5) B
PROBLEM NO. 5
The following accounts were included in the unadjusted trial balance of Bani
Company as of December 31, 2006:
Cash P 481,600
Inventory 3,025,000
Accounts payable 2,100,500
Accrued expenses 215,500
During your audit, you noted that Bani held its cash books open after year-end.
In addition, your audit revealed the following:
1. Receipts for January 2007 of P327,300 were recorded in the December

2006 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 2007. The payments,

on which discounts of P6,200 were taken, were included in the December
2006 check register.
3. Merchandise inventory is valued at P3,025,000 prior to any adjustments.

The following information has 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,

2007. The related invoice was received and recorded on January 6,
2007. The goods were shipped on December 31, 2006, terms FOB
shipping point.
c. Goods costing P318,750 were shipped on December 31, 2006, and

were delivered to the customer on January 3, 2007. The terms of the
APPLIED AUDITING
invoice were FOB shipping point. The goods were included in the
2006 ending inventory even though the sale was recorded in 2006.
d. A P91,000 shipment of goods to a customer on December 30, 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, 2007.
The sale was properly recorded in 2007.
e. The invoice for goods costing P87,500 was received and recorded as a
purchase on December 31, 2006. The related goods, shipped FOB
destination were received on January 4, 2007, 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.
QUESTIONS:
balances of the following as of December 31, 2006:
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. P2,930,000
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
Suggested Solution:
Accounts Accounts
Cash Receivable Inventory Payable
Unadjusted P481,600 P1,127,000 P3,025,000 P2,100,500
APPLIED AUDITING
balances
Add
(deduct):
AJE No. 1 (327,300) 155,000 - -
AJE No. 2 180,000 - - 186,200
AJE No. - - 137,500 -
3.a
AJE No. - - 108,750 108,750
3.b
AJE No. - - (318,750) -
3.c
AJE No. - - 65,000 -
3.d
AJE No.
3.e - - - (87,500)
Adjusted P334,300 P1,282,000 P3,017,500 P2,307,950
balances
Adjusting entries:
1) Accounts receivable (P147,250/.95) P155,000

Sales 180,050
Cash P327,300
Sales discount (P147,250/.95 x .05) 7,750
2) Cash P180,000
Purchase discount 6,200
3.a) Inventory P137,500

3.b) Inventory P108,750

3.c) Cost of sales P318,750

Inventory P318,750
3.d) Inventory P 65,000

Cost of sales P 65,000
3.e) Accounts payable P 87,500

Cost of sales P 87,500
3.f) No adjusting entry
Question No. 5
Current assets
APPLIED AUDITING
Cash P 334,300
Inventory 3,017,500 P4,633,800
Divide by current liabilities
Accounts payable 2,307,950
Accrued expenses 2,523,450
215,500
Current ratio
1.84
Answers: 1) C; 2) B; 3) A; 4) B, 5) C
PROBLEM NO. 6
The Bolinao Company values its inventory at the lower of FIFO cost or net
realizable value (NRV). The inventory accounts at December 31, 2005, 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 the
Bolinao Company during 2006.
Jan. Bolinao purchased raw materials with a list price of

8
P200,000 and was given a trade discount of 20% and
10%; terms 2/15, n/30. Bolinao values inventory at the
net invoice price
Feb. Bolinao repossessed an inventory item from a

14
customer who was overdue in making payment. The
unpaid balance on the sale 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 of

APPLIED AUDITING
P6,800. The normal profit for this item is considered
to be P3,200.
Mar. Refinishing costs of P6,400 were incurred on the

1
repossessed item.
Apr. The repossessed item was resold for P24,000 on

3
account, 20% down.
Aug. A sale on account was made of finished goods that

30
have a list price of P59,200 and a 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.
QUESTIONS:
(Assume the client is using perpetual inventory system)
1. The entry on Jan. 8 will include a debit to Raw Materials Inventory of

a. P200,000 c. P141,120
b. P144,000 d. P196,000
2. The repossessed inventory on Feb. 14 is most likely to be valued 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 inventory on Aug. 30 is most likely to be valued at

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

a. P51,200 c. P57,200
b. P56,000 d. P57,600
Suggested Solution:
Question No. 1
Amount to be debited to Raw Materials

Inventory P141,120
(P200,000 x .8 x .9 x .98)
Question No. 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 P14,000
Repossessed inventory is valued at fair value or best possible

approximation of fair value. Since fair value of the item is not given, the
item was valued at net realizable value less the normal profit. Incidentally,
this is the valuation of trade-in inventory.
Question No. 3
Journal entries on April 3, 2006:
Cash (P24,000 x 20%) P 4,800

Accounts receivable (P24,000 – P4,800) 19,200
Sales – Repossessed inventory P24,000
Cost of Repossessed Goods Sold (P14,000+P6,400) P20,400

Repossessed Inventory
P20,400
Question No. 4
Estimated selling price (net realizable P6,400

value)
Less normal profit (P6,400 x 25%) 1,600
Valuation of trade-in inventory P4,800
Question No. 5
APPLIED AUDITING
Accounts receivable (P59,200 - P51,200

P8,000)
Trade-in inventory (see no. 4) 4,800
Amount to be recorded as sales P56,000
Answers: 1) C; 2) A; 3) D; 4) B, 5) B
PROBLEM NO. 7
Calasiao Construction Corporation engaged you to advise it regarding the

proper accounting for a series of long-term contracts. Calasiao commenced
doing business on January 2, 2006. Construction activities for the first year of
operations are shown below. All contract costs are with different customers,
and any work remaining at December 31, 2006, is expected to be completed in
2007.
Contra
ct Estimated
Total Billings Collectio Costs Additional
Contract Throug ns Incurre Costs to
Project Price h Through d Complete
12/31/ 12/31/06 Throug
06 h
12/31/0
6
A P1,200,000 P P P P 268,000
800,000 720,000 992,000
B 1,400,000 440,000 420,000 271,200 1,084,800
C 1,120,000 1,120,0 1,020,000 744,000 -
00
D 800,000 140,000 100,000 492,000 348,000
E
960,000 820,000 800,000 740,000 60,000
P5,420,000 P3,320, P3,060,0 P3,239, P1,760,800
000 00 200
QUESTIONS:
Based on the above and the result of your engagement, determine the
following using the percentage-of-completion method:
1. Net realized gross profit for the year 2006

a. P462,133 c. P1,149,419
b. P432,800 d. P 276,000
2. Balance of Construction in Progress account as of December 31, 2006

APPLIED AUDITING
a. P2,552,000 c. P3,268,619
b. P2,581,333 d. P2,395,200
3. Amount to be reported in the current assets section of the balance sheet as

Inventories as of December 31, 2006
a. P541,333 c. P352,000
b. P512,000 d. P444,000
4. Amount to be reported in the current liabilities section of the balance sheet

as of December 31, 2006
a. P 56,960 c. P160,000
b. P248,800 d. P 0
5. Net realized gross profit for the year 2006 assuming the company used the
completed-contract method
a. P432,800 c. P376,000
b. P436,000 d. P276,000
Suggested Solution:
Question No. 1
Estimated
gross Percentage Realized
Project profit (loss)* of gross profit
completion** (loss)
A (P60,000) not (P60,000)
applicable
B 44,000 20.00% 8,800
C 376,000 100.00% 376,000
D (40,000) not (40,000)
applicable
E 160,000 92.50% 148,000
Total P432,800
* (Total contract price - Total estimated costs)

** (Costs incurred through Dec. 31, 2006 / Total estimated costs)
Question No. 2
Costs
incurred Realized Construction
Project through gross profit in Progress
12/31/06 (loss)
A P992,000 (P60,000) P 932,000
B 271,200 8,800 280,000
D 492,000 (40,000) 452,000
E 740,000 148,000
APPLIED AUDITING
Costs
incurred Realized Construction
Project through gross profit in Progress
12/31/06 (loss)
888,000
Total P2,552,000
Question No. 3
Construction Progress
Project in Progress Billings Net
A P 932,000 P 800,000 P132,000
D 452,000 140,000 312,000
E 68,000
888,000 820,000
Total P2,272,000 P1,760,000 P512,000
Question No. 4
Progress billings in excess of costs and

recognized profit – Project B (P440,000 - P280,000) P160,000
Question No. 5
Realized
Project gross profit
(loss)
A (P60,000)
B – not yet completed -
C 376,000
D – not yet completed -
E (40,000)
P276,000
Answers: 1) B; 2) A; 3) B; 4) C, 5) D
PROBLEM NO. 8
During your audit of the records of the Manaoag Corporation for the year
ended December 31, 2006, the following facts were disclosed:
Raw materials inventory, 1/1/2006 P 720,200

Raw materials purchases 5,232,800
Direct labor 4,900,000
Manufacturing overhead applied (150% of direct 7,350,000
labor)
Finished goods inventory, 1/1/2006 1,240,000
APPLIED AUDITING
Selling expenses 8,112,800

Administrative expenses 7,377,200
Your examination disclosed the following additional information:
a) Purchases of raw materials
Month Units Unit Price Amount

January – February 55,000 P17.76 P 976,800
March – April 45,000 20.00 900,000
May – June 25,000 19.60 490,000
July – August 35,000 20.00 700,000
September – October 45,000 20.40 918,000
November – 60,000 20.80 1,248,000
December
265,000 P5,232,800
b) Data with respect to quantities are as follows:
Units
Explanation 1/1/06 12/31/06
Raw materials 35,000 ?
Work in process (80% - 25,000
completed)
Finished goods 15,000 40,000
Sales, 200,000 units
c) Raw materials are issued at the beginning of the manufacturing process.

During the year, no returns, spoilage, or wastage occurred. Each unit of
finished goods contains one unit of raw materials.
d) Inventories are stated at cost as follows:

 Raw materials – according to the FIFO method
 Direct labor – at an average rate determined by correlating total direct
labor cost with effective production during the period
 Manufacturing overhead – at an applied rate of 150% of direct labor
cost
QUESTIONS:
1. The raw materials inventory as of December 31, 2006 is

a. P992,000 c. P 936,000
b. P888,000 d. P1,040,000
2. The work in process inventory as of December 31, 2006 is

a. P1,496,000 c. P1,746,000
APPLIED AUDITING
b. P1,514,000 d. P1,776,000
3. The finished goods inventory as of December 31, 2006 is

a. P2,793,600 c. P3,553,130
b. P3,334,000 d. P2,812,000
4. The cost of goods sold for the year ended December 31, 2006 is
a. P16,897,000 c. P14,077,000
b. P14,161,400 d. P13,911,400
Suggested Solution:
Question No. 1
Units
Raw materials, 1/1/06 35,000
Add Purchases 265,000
Raw materials available for use 300,000
Less raw materials, 12/31/06 (squeeze) 50,000
Goods placed in process 250,000
Less work-in-process, 12/31/06 25,000
Goods manufactured 225,000
Finished goods, 1/1/06 15,000
Total goods available for sale 240,000
Less finished goods, 12/31/06 40,000
Goods sold 200,000
Raw materials, 12/31/06 (50,000 units x P1,040,000

P20.80)
Question No. 2
Raw materials [(10,000 units x P20.80) +

(15,000 units x P20.40)] P 514,000
Direct labor (25,000 units x 80% x P20a) 400,000
Factory overhead (25,000 units x 80% x
P30b) 600,000
Work in process, 12/31/06 P1,514,000
Labor unit cost (P4,900,000/245,000* units) P20a
Overhead unit cost (P7,350,000/245,000* P30b

units)
*Equivalent production for labor and overhead

Started, finished and sold [(200,000 units -
15,000 units) x 100%] 185,000
Started, finished and on hand (40,000 units x 40,000
APPLIED AUDITING
100%)
Started, and in process (25,000 units x 80%)
20,000
Total 245,000
Question No. 3
Raw materials [(30,000 units x P20.40)

+(10,000 units x P20)] P 812,000
Direct labor (40,000 units x P20a) 800,000
Factory overhead (40,000 units x P30b) 1,200,000
Finished goods inventory, 12/31/06 P2,812,000
Question No. 4
Raw materials, 1/1/06 P 720,200

Add purchases 5,232,800
Raw materials available for use 5,953,000
Less raw materials, 12/31/06 (see no. 1) 1,040,000
Direct materials used 4,913,000
Direct labor 4,900,000
Factory overhead 7,350,000
Total manufacturing cost 17,163,000
Add work-in-process, 1/1/06
-
Total cost placed in process 17,163,000
Less work-in-process, 12/31/06 (see no. 1,514,000
2)
Cost of goods manufactured 15,649,000
Add finished goods, 1/1/06 1,240,000
Total goods available for sale 16,889,000
Less finished goods, 12/31/06 (see no. 3) 2,812,000
Cost of goods sold P14,077,000
Answers: 1) D; 2) B; 3) D; 4) C
PROBLEM NO. 9
The Mangaldan Merchandising Company is a leading distributor of kitchen

wares. The company uses the first-in, first-out method of calculating the cost
of goods sold. The following information concerning two of the company’s
products is taken from the month of May:
PANS KETTLES
No. of Unit No. of Unit
units cost units cost
May 1, beginning inventory 10,000 P 60 P 40
6,000
APPLIED AUDITING
Purchases:
May 15 14,000 P 42
65 9,000
May 25
6,000 75
Sales for the month 20,000 10,000

(@ (@
P80) P44)
On May 31, Mangaldan’s suppliers reduced their price from the last purchase
price by the following percentages:
Pans…………………..25% Kettles…………………20%
Accordingly, the company agreed to reduce selling prices by 15% on all items
beginning June 1.
Mangaldan Merchandising Company’s selling costs are calculated at 10% of

selling price. Both products have a normal profit of 30% on sales prices (after
selling costs).
QUESTIONS:
1. Total cost of Pans as of May 31 is

a. P710,000 c. P600,000
b. P653,300 d. P612,000
2. Total cost of Kettles as of May 31 is

a. P210,000 c. P200,000
b. P206,000 d. P168,300
3. The inventory at May 31 should be valued at

a. P768,300 c. P920,000
b. P780,300 d. P890,000
4. The loss on inventory write down for the month of May is

a. P139,700 c. P29,300
b. P137,300 d. P27,600
5. The cost of sales, before loss on inventory write down, for the month of
May is
a. P1,778,000 c. P1,797,700
b. P1,685,600 d. P1,658,000
Suggested Solution:
APPLIED AUDITING
Question No. 1
4,000 units @ P65 P260,000

6,000 units @ P75 450,000
Total cost of Pans P710,000
Question No. 2
Total cost of Kettles (5,000 units @ P210,000

P42)
Question No. 3
Inventory
Item Units Unit Cost NRV* Amount**
Pans 4,000 P65 P61.20 P244,800
6,000 75 61.20 367,200
Kettles 5,000 42 33.66 168,300
P780,300
* Estimated selling price – Estimated cost to sell

** Lower of cost or NRV
Question No. 4
Total cost of inventory (P710,000 + P920,000

P210,000)
Less inventory value (see no. 3) 780,300
Required allowance for inventory writedown 139,700
Less allowance, May 1 (6,000 x P0.40)
2,400
Loss on inventory writedown for May P137,300
Question No. 5
Pans:
10,000 units @ P60 P600,000
10,000 units @ P65 650,000 P1,250,000
Kettles:
6,000 units @ P40 240,000
4,000 units @ P42 168,000
408,000
Total cost of sales P1,658,000
Alternative computation:
Inventory, 5/1:
Pans (10,000 units x P60) P600,000
APPLIED AUDITING
Kettles (6,000 units x P40) P 840,000

240,000
Add purchases:
Pans [(14,000 units x P65)
+ (6,000 x P75)] 1,360,000
Kettles (9,000 units x P42) 1,738,000
378,000
Less inventory, 5/31 (at cost)
920,000
Cost of sales, before
inventory writedown P1,658,000
Answers: 1) A; 2) A; 3) B; 4) B, 5) D
PROBLEM NO. 10
In conducting your audit of Mangatarem Corporation, a company engaged in

import and wholesale business, for the fiscal year ended June 30, 2006, you
determined that its internal control system was good. Accordingly, you
observed the physical inventory at an interim date, May 31, 2006 instead of at
June 30, 2006.
You obtained the following information from the company’s general ledger.
Sales for eleven months ended May 31, 2006 P1,344,000

Sales for the fiscal year ended June 30, 2006 1,536,000
Purchases for eleven months ended May 31,
2006 (before audit adjustments) 1,080,000
Purchases for the fiscal year ended June 30, 1,280,000
2006
Inventory, July 1, 2005 140,000
Physical inventory, May 31, 2006 220,000
Your audit disclosed the following additional information.
(1) Shipments costing P12,000 were received in May and included in the
physical inventory but recorded as June purchases.
(2) Deposit of P4,000 made with vendor and charged to purchases in April
2006. Product was shipped in July 2006.
(3) A shipment in June was damaged through the carelessness of the

receiving department. This shipment was later sold in June at its cost of
P16,000.
QUESTIONS:
APPLIED AUDITING
In audit engagements in which 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 the result of your audit, you are to provide the answers to the
following:
1. The gross profit ratio for eleven months ended May 31, 2006 is
a. 20% c. 30%
b. 35% d. 25%
2. The cost of goods sold during the month of June, 2006 using the gross
profit ratio method is
a. P132,000 c. P148,000
b. P144,000 d. P160,000
3. The June 30, 2006 inventory using the gross profit method is
a. P264,000 c. P268,000
b. P340,000 d. P260,000
Suggested Solution:
Question No. 1
Sales for 11 months

ended 5/31/06 P1,344,000
Less cost of sales for 11
months ended
5/31/06:
Inventory, July 1, P 140,000
2005
Add adjusted
purchases:
Unadjusted P1,080,000
Item no. 1 12,000
Item no. 2 1,088,000
(4,000)
Goods available for 1,228,000
sale
Less inventory, 1,008,000
5/31/06 220,000
Gross profit 336,000
Divide by sales for 11
months ended 1,344,000
5/31/06
Gross profit rate for 11
months ended
5/31/06 25%
Question No. 2
APPLIED AUDITING
Sales for the fiscal year ended June 30, P1,536,000

2006
Less sales for 11 months ended May 31, 1,344,000
2006
Sales for June, 2006 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 132,0000
Add cost of sales without profit
16,000
Total cost of sales for June, 2006 P 148,000
Question No. 3
Inventory, 7/1/05 P 140,000

Add adjusted purchases:
Unadjusted P1,280,000
Item no. 2 1,276,000
(4,000)
Less cost of sales:
Sales without profit 16,000
Sales with profit
[(P1,536,000 - P16,000) x 1,140,000 1,156,000
75%]
Inventory, 6/30/06 P 260,000
Answers: 1) D; 2) C; 3) D
PROBLEM NO. 11
1. In auditing inventories, a major objective relates to the existence assertion.

Of the following audit procedures relating to inventories, which does not
support the existence assertion?
a. The auditor reviews the client's inventory-taking instructions for such
matters as proper arrangement of goods, separation of consigned
goods, and limits on movements of goods during inventory.
b. The auditor observes the client's inventory and performs test counts as
appropriate.
c. The auditor confirms inventories not on the premises.
APPLIED AUDITING
d. The auditor performs a lower of cost or market test for major categories
of inventory.
2. In a manufacturing company, which one of the following audit procedures

would give the least assurance of the valuation of inventory at the audit
date?
a. Obtaining confirmation of inventories pledged under loan agreements.
b. Testing the computation of standard overhead rates.
c. Examining paid vendors' invoices.
d. Reviewing direct labor rates.
3. When auditing merchandise inventory at year end, the auditor performs a

purchase cutoff test to obtain evidence that
a. No goods held on consignment for customers are included in the
inventory balance.
b. No goods observed during the physical count are pledged or sold.
c. All goods owned at year end are included in the inventory balance
d. All goods purchased before year end are received before the physical
inventory count.
4. Which of the following items should not be included in a physical inventory?

a. Materials in transit from vendors.
b. Goods in a private warehouse.
c. Goods received for repairs under warranty.
d. Consignment to an agent.
5. You were engaged to conduct an annual examination for the fiscal year
ended October 31, 2006. Because of the expected holiday, you were able
to convince your client to take a complete physical inventory, in which you
were present on October 15. Perpetual inventory records are kept and the
client considers a sale to be made in the period in which goods are shipped.
You had a sales cut-off test worksheet prepared. Which item among those
listed below will not require an adjusting entry to reconcile the client's
detailed inventory record with the physical inventory?
a. b. c. d.
Date Goods Shipped Oct Nov 2 Oct 14 Oct 10
31
Transaction Recorded as Nov 2 Oct Oct 16 Oct 19
Sale 31
Date Inventory Control Oct Oct Oct 16 Oct 12
Credited 31 31
Answers: 1) D; 2) A; 3) C; 4) C, 5) D;
APPLIED AUDITING
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Reference:
APPLIED AUDITING
CHAPTER 4
AUDIT OF INVESTMENTS
Objective
PROBLEM NO. 1
The following transactions of the Angat Company were completed during the
year 2006:
Jan. Purchased 20,000 shares of Bulacan Auto Co. for P40

2 per share plus brokerage costs of P4,500. These
shares were classified as trading securities.
Feb. Purchased 20,000 shares of Malolos Company

1 common stock at P125 per share plus brokerage fees
of P19,000. Angat classifies this stock as and
available-for-sale security.
Apr. Purchased P2,000,000 of RP Treasury 7% bonds,

1 paying 102.5 plus accrued interest of P35,000. In
addition, the company paid brokerage fees of P18,000.
Angat classified these bonds as a trading security.
Jul. 1 Received semiannual interest on the RP Treasury

Bonds.
Aug. 1 Sold P500,000 of RP Treasury 7% bonds at 103 plus

accrued interest.
Oct. Sold 3,000 shares of Malolos at P132 per share.

1
APPLIED AUDITING
The market values of the stocks and bonds on December 31, 2006, are as
follows:
Bulacan Auto Co. P45 per share

Malolos Company P130 per
share
RP Treasury 7% bonds 102
QUESTIONS:
1. Gain or loss on sale of P500,000 RP Treasury Bonds on August 1, 2006

a. P15,000 gain c. P2,000 loss
b. P 2,500 gain d. P7,500 loss
2. Gain or loss on sale of 3,000 Malolos shares on October 1, 2006

a. P18,150 loss c. P 2,000 gain
b. P18,150 gain d. P21,000 gain
3. What amount of unrealized gain should be shown as component of income

in 2006?
a. P92,500 c. P74,500
b. P97,000 d. P80,000
4. What amount of unrealized gain should be shown as component of equity

a. P68,850 c. P66,000
b. P85,000 d. P 0
Suggested Solution:
Question No. 1
Sales proceeds (P500,000 x 1.03) P515,000

Less cost of RP Treasury bonds sold (P500,000 x 512,500
1.025)*
Gain on sale of P500,000 RP Treasury Bonds P 2,500
* PAS 39 par. 43 states that when a financial asset or financial liability is

recognized initially, an entity shall measure it at its fair value plus, in the
case of a financial asset or financial liability not at fair value through profit
or loss, transaction costs that are directly attributable to the acquisition or
issue of financial asset or financial liability. Therefore, the transaction
costs (e.g. brokerage fees) should be expensed for trading securities.
Question No. 2
Sales proceeds (3,000 shares x P396,000

APPLIED AUDITING
P132)
Less cost of shares sold
{[(20,000 x P125) + P19,000] x 377,850
3/20}
Gain on sale of 3,000 Malolos P 18,150
shares
Question No. 3
Cost of Bulacan Auto Co. shares (20,000 x P 800,000

P40)
Cost of RP Treasury 7% bonds (P2,000,000 x 2,050,000
1.025)
Cost of P500,000 RP Treasury bonds sold (see ( 512,500)
no. 1)
Trading securities, 12/31/06 before 2,337,500
mark-to-market
Fair value of trading securities, 12/31/06 (see 2,430,000
below)
Unrealized gain on TS to be reported on the IS P 92,500
Bulacan Auto Co. (20,000 x P45) P 900,000

RP Treasury 7% bonds (P1,500,000 x 1.02) 1,530,200
Fair value of trading securities, 12/31/06 P2,430,000
Question No. 4
Cost of Malolos Company shares

[(20,000 x P125) + P19,000] P2,519,000
Cost of 3,000 shares sold (see no. 2) (377,850)
AFS, 12/31/06 before mark-to-market 2,141,150
Fair value of AFS, 12/31/06 [(20,000 - 3,000) x 2,210,000
P130]
Unrealized gain-AFS, 12/31/06 to be reported P 68,850
under SHE
Answers: 1) B; 2) B; 3) A; 4) A
PROBLEM NO. 2
You were engaged by Balagtas Company to audit its financial statements for
the year 2006. During the course of your audit, you noted that the following
trading securities were properly reported as current assets at December 31,
2005:
APPLIED AUDITING
Cost Market
France Corporation, 5,000 shares,
convertible preferred shares P 450,000 P 487,500
Ces, Inc., 30,000 shares of common 675,000 742,500
stock
Coo Co., 10,000 shares of common 618,750
stock 450,000
P1,743,750 P1,680,000
The following sale and conversion transactions transpired during 2006:
Mar. 1 Sold 12,500 shares of Ces for P33.75 per share.
April 1 Sold 2,500 shares of Coo for P45 per share.
Sept. 21 Converted 2,500 shares of France’s preferred

stock into 7,500 shares of France’s common stock,
when the market price was P78.75 per share for
the preferred stock and P47.25 per share for the
common stock.
The following 2006 dividend information pertains to stocks owned by Balagtas:
Jan. 2 Coo issued a 10% stock dividend when the market

price of Coo’s common stock was P49.50 per
share.
March 31 France paid dividends of P2.50 per share on its

and Sept. preferred stock, to stockholders of record on
30 March 15 and September 15, respectively.
France did not pay dividends on its common stock
during 2006.
July 1 Ces paid a P2.25 per share dividend on its

common stock.
Market prices per share of the securities were as follows:
12/31/2006 12/31/2005
France Corp., 92.25 97.50
preferred
France Corp., 42.75 38.25
common
Ces, Inc., common 22.50 24.75
Coo Co., common 40.50 45.00
All of the foregoing stocks are listed in the Philippine Stock Exchange.
Declines in market value from cost would not be considered permanent.
QUESTIONS:
APPLIED AUDITING
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 or loss on sale of 2,500 Coo shares?

a. P28,125 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 preferred

stock into 15,000 common stock?
a. P 28,125 loss c. P46,875 loss
b. P129,375 gain d. P 0
4. How much is the total dividend income for the year 2006?
a. P 64,375 c. P 51,875
b. P101,375 d. P364,375
5. How much should be reported as unrealized gain on trading securities in

the company’s income statement for the year 2006?
a. P 4,500 c. P59,250
b. P67,773 d. P 0
Suggested Solution:
Question No. 1
Sales proceeds (12,500 shares x P33.75) P421,875

Less CV of Ces shares sold (12.5/30 x 309,375
P742,500)
Gain on sale of 12,500 Ces shares P112,500
Question No. 2
Sales proceeds (2,500 shares x P45) P112,500

Less CV of Coo shares sold (P450,000 x 102,273
2,500/11,000*)
Gain on sale of 2,500 Coo shares P 10,227
* total number of shares after 10% stock dividends (10,000 x 1.1)

Question No. 3
Fair value of preferred stock (2,500 shares x P196,875

P78.75)
Less CV of shares converted (P487,500 x 2.5/5) 243,750
Loss on conversion of 2,500 France preferred P 46,875
shares
APPLIED AUDITING
Question No. 4
From France (5,000 shares x P2.50 x 2) P25,000

From Ces [(30,000 - 12,500) x P2.25) 39,375
Total dividend income in 2006 P64,375
Question No. 5
Trading securities, 1/1/06 P1,680,000

CV of Ces shares sold (see no. 1) (309,375)
CV of Coo shares sold (see no. 2) (102,273)
CV of France preferred shares converted (see (243,750)
no. 3)
Cost of 7,500 France common shares received 196,875
(see no. 3)
Trading securities, 12/31/06 before 1,221,477
mark-to-market
Fair value of trading securities, 12/31/06 (see 1,289,250
below)
Unrealized gain on trading securities P 67,773
France Corp., preferred [(5,000 - 2,500) x P

P92.25] 230,625
France Corp. – Common (7,500 x P42.75) 320,625
Ces, Inc., common [(30,000 - 12,500) x 393,750
P22.50]
Coo Co., common {[(10,000 x 1.1) - 2,500] x
P40.50} 344,250
Fair value of trading securities, 12/31/06 P1,289,250
Answers: 1) A; 2) B; 3) C; 4) A; 5) B
PROBLEM NO. 3
You were able to obtain the following ledger details of Trading Securities in
connection with your audit of the Bocaue Corporation for the year ended
December 31, 2006:
Particulars Date Ref. DR CR

Purchase of GOOD Co. – 1-14 CV P
4,000 shares 960,000
Purchase of LUCK Co. –

4,800 shares 2-20 CV 1,200,000
Sale of LUCK Co. – 1,600 3-01 CR 360,000

APPLIED AUDITING
shares
Receipt of GOOD Stock

Dividend – Offsetting Credit
to retained earnings 5-31 JV 88,000
Sale of GOOD Stocks –

3,200 shares 8-15 CR 784,000
Sale of GOOD Stocks –

800 shares 10-1 CR 184,000
From the Philippine Stock Exchange, the GOOD dividends were analyzed as
follows:
Kind Declared Record Payment Rate

Cash 01-02 01-15 01-31 P20/share
Stock 05-02 05-15 05-31 10%
Cash 08-01 08-30 09-15 P30/share
At December 31, 2006, GOOD and LUCK shares were selling at P210 and
P240 per share, respectively.
QUESTIONS:
1. Gain or loss on sale of 1,600 LUCK shares on March 1, 2006

a. P360,000 gain c. P40,000 loss
b. P200,000 loss d. P40,000 gain
2. Gain on sale of 3,200 GOOD shares on August 15, 2006

a. P 48,000 c. P16,000
b. P144,000 d. P 0
3. Gain or loss on sale of 800 GOOD shares on October 1, 2006

a. P 8,000 gain c. P 8,000 loss
b. P24,000 loss d. P24,000 gain
4. Dividend income for the year 2006

a. P132,000 c. P212,000
b. P300,000 d. P 0
5. Carrying value of Trading Securities as of December 31, 2006

a. P768,000 c. P880,000
b. P852,000 d. P768,000
Suggested Solution:
APPLIED AUDITING
Question No. 1
Sales proceeds P360,000

Less CV of shares sold (P1,200,000 x 400,000
1,600/4,800)
Loss on sale of 1,600 Luck shares on 3/1/06 P 40,000
Question No. 2
Total proceeds P784,000

Less dividends sold (3,200 shares x P30) 96,000
Sales proceeds 688,000
Less CV of investment sold
(P880,000* x 3,200/4,400**) 640,000
Gain on sale of 3,200 Good shares on P 48,000
9/15/06
Computation of adjusted cost of Good Co. shares
Total cash paid P960,000

Less purchased dividend (4,000 x P20) 80,000
Adjusted cost P880,000 *
**After 10% stock dividend
Question No. 3

Less CV of investment sold (P880,000 x 160,000
800/4,400)
Gain on sale of 800 Good shares on 10/1/06 P 24,000
Question No. 4
Dividend income - Declared Aug. 1 (4,400 shares x P30) P132,000
Question No. 5
Good Co. [(4,000 x 1.1) - 3,200 - 800] = 400 P 84,000

x P210
Luck Co. (4,800 - 1,600) = 3,200 x P240 768,000
Carrying value of trading securities, P852,000
12/31/06
Answers: 1) C; 2) A; 3) D; 4) A, 5) B
PROBLEM NO. 4
APPLIED AUDITING
In connection with your audit of the financial statements of the Guiguinto

Company for the year 2006, the following Available for Sale Securities and
Dividend Income accounts were presented to you:
Available for Sale Securities

Date Description Ref. Debit Credit
01/08 Purchased 20,000 shares
common, par value
P50, BUSTOS Co. VR-69 780,000
03/30 10,000 shares BUSTOS
Co. CJ-30 500,000
04/03 received as stock CR-44 250,000
12/02 dividend CR-65 240,000
Sold 10,000 shares @
P25
Sold 4,000 shares @ P60
Dividend Income
Date Description Ref. Debit Credit
03/30 Stock dividend SJ-8 500,000
08/30 BUSTOS Company CR-52 100,000
common
The following information was obtained during your examination:
1. From independent sources, you determine the following dividend

information:
Type of Date Date of Date of

Dividend Declared Record Payment Rate
Stock 02/14/2006 02/28/2006 03/30/2006 50%
Cash 08/01/2006 08/15/2006 08/30/2006 P5/share
Cash 12/01/2006 12/15/2006 01/02/2007 20%
2. Closing market quotation as at December 31, 2006:
Bid Asked
BUSTOS Company common 13-3/4 16-1/2
QUESTIONS:
1. How much is the gain or loss on the April 3, 2006 sale?

a. P10,000 loss c. P140,000 loss
b. P10,000 gain d. P 0
2. How much is the gain on the December 2, 2006 sale?

a. P136,000 c. P84,000
b. P 96,000 d. P 0
APPLIED AUDITING
3. How much is the total dividend income for the year 2006?
a. P600,000 c. P100,000
b. P800,000 d. P300,000
4. How much is the adjusted balance of Available for Sale Securities as of

December 31, 2006?
a. P290,000 c. P220,000
b. P264,000 d. P416,000
5. How much is the Unrealized Loss on AFS as of December 31, 2006?

a. P196,000 c. P152,000
b. P 70,000 d. P 0
Suggested Solution:
Question No. 1

10/30*)
Loss on sale of AFS on 4/3/06 P 10,000
*After 50% stock dividend
Question No. 2
Total proceeds (4,000 shares x P60) P240,000

Less dividends sold (4,000 shares x P50 x
20%) 40,000
Net sales proceeds 200,000
4/30)
Gain on sale of AFS on 12/2/06 P 96,000
Question No. 3
Cash dividends declared, 8/1/2006 P100,000

(20,000 shares x P5)
Cash dividends declared, 12/1/2006
(20,000 shares x P50 x 20%) 200,000
Total dividend income P300,000
Question No. 4
Shares purchased, 1/08 20,000

Shares received as stock dividend 10,000
Sold, 4/3 (10,000)
Sold, 12/2
(4,000)
APPLIED AUDITING
Balance, 12/31/06 16,000

Multiply by market value/share, 12/31/06
13.75
Carrying value of AFS, 12/31/06 P220,000
Note: Application guidance par. 72 of PAS 39 states that the appropriate

market price for an asset held or liability to be issued is usually the current
bid price and, for an asset to be acquired or liability held, the asking price.
Question No. 5
Acquisition cost P780,000

CV of 10,000 shares sold, 4/3 (see no. 1) (260,000)
CV of 4,000 shares sold, 12/2 (see no. 2) (104,000)
AFS, 12/31/06 before mark-to-market 416,000
Fair value of AFS, 12/31/06 220,000
Unrealized loss on AFS, 12/31/06 P196,000
Answers: 1) A; 2) B; 3) D; 4) C, 5) A
PROBLEM NO. 5
The Marilao Company has the following transactions in the stocks of the Sta.
Maria Corp.
a) On January 2, 1999, Marilao purchased 4,000 shares of P100 par value

common stock at P110 per share.
b) The Sta. Maria Corp. was expanding and on March 2, 2000, it issued stock
rights to its stockholders. The holder needs four rights to purchase one
share of common stock at par. The market value of the stock on that date
was P140 per share. There was no quoted price for the rights. No
journal entry was made to record the receipt of the rights.
c) On April 2, 2000, Marilao exercised all its stock rights. The Investment in
Stock account was charged for the amount paid.
d) Robinson, Marilao’s accountant, felt that the cash paid for the new shares
was merely an assessment since Marilao’s proportionate share in Sta.
Maria was not changed. Hence, he credited all dividends (5% in
December of each year) to the Investment in Stock account until the debit
was fully offset.
e) Marilao received a 50% stock dividend from Sta. Maria in December 2004.
Because the shares received were expected to be sold, the company’s
president instructed Robinson not to make any entry for this dividend.
The company did sell the dividend shares in January 2005 for P150 per
share. The proceeds from the sale were credited to income.
APPLIED AUDITING
f) In December 2005, Sta. Maria’ stocks were split on a two-for-one basis and
the new shares were issued as no par shares. Marilao found that each
new share was worth P10 more than the P110 per share original
acquisition cost. For this reason, Marilao decided to debit the Investment
in Stock account with the additional shares received at P110 per share and
credited revenue for it.
g) In August 2006, Marilao sold one half (½) of its holdings in Sta. Maria at
P120 per share. The proceeds were credited to the Investment in Stock
account.
Marilao uses the average method in recording the sale of its investment in
stock.
QUESTIONS:
1. The cost of investment to be allocated to stock rights received on March 2,

2000 is
a. P 0 c. P31,429
b. P29,333 d. P25,143
2. The unadjusted balance of Investment in Sta. Maria stock on December 31,

2006 is
a. P940,000 c. P390,000
b. P490,000 d. P430,000
3. The adjusted balance of Investment in Sta. Maria stock on December 31,

2006 is
a. P135,000 c. P180,000
b. P360,000 d. P270,000
4. The gain on the sale of stock dividend received in December 2004 is

a. P100,000 c. P 80,000
b. P105,000 d. P195,000
5. The gain on sale of the shares sold in August 2006 is

a. P240,000 c. P120,000
b. P420,000 d. P870,000
Suggested Solution:
Question No. 1
Cost allocated to stock rights (P10*/P150 x P440,000) P29,333
Since the MV of rights is not available we must compute for the theoretical
value of the stock rights. Since the market value of the stock given is on
the date of issuance of the stock rights, the market value is considered
“ex-rights”.
APPLIED AUDITING
Theoretical value of stock rights = MV of stock ex-rights – subs. price

Number of rights to purchase 1 share
= (P 140 - P100)/4
= P10*
Question No. 2
Debits to Investment account:

Purchase, 1/2/99 (4,000 shares x P440,000
P110)
Exercise of rights, 4/2/00 (4,000/4 x 100,000
P100)
Stock split, 12/2005 (5,000 x P110) P1,090,000
550,000
Less credits to Investment account:
Dividends received, 2000-2003
(5,000 x P100 x 5% x 4) 100,000
Sale, 8/2006 (5,000 shares x P120) 600,000
700,000
Balance, 12/31/06 per books P
390,000
Question No. 3
Cost/
Shares share Total cost
Purchase, 1/2/1999 4,000 P110 P440,000
Receipt of stock rights, 3/2/2000 (29,333)
Balance 4,000 103 410,667
Exercise of rights, 4/2/2000 1,000 129 129,333
(see below)
Balance 5,000 108 540,000
50% stock dividend, 12/2004 2,500
Balance 7,500 72 540,000
Sale of stock dividend, 1/2005 (2,500) (180,000)
72
Balance 5,000 72 360,000
Stock split, 12/2005
5,000
Balance 10,000 36 360,000
Sale, 8/2006 (5,000) (180,000)
36
Adjusted balance, 12/31/06 P180,000
5,000 36
Cash paid (4,000/5 x P100) P 80,000

APPLIED AUDITING
Cost of stock rights 29,333

Total cost P129,333
Question No. 4

Less cost of investment sold (see no. 3) 180,000
Gain on sale of stock dividend received P195,000
Question No. 5

Less cost of investment sold (see no. 3) 180,000
Gain on sale of investment in 8/2006 P420,000
Answers: 1) B; 2) C; 3) C; 4) D, 5) B
PROBLEM NO. 6
Meycauayan Inc. acquired 50,000 shares of AAA stock for P5 per share and
125,000 shares of BBB stock for P10 per share on January 2, 2005. Both
AAA Inc. and BBB Corp. have 500,000 shares of no-par common stock
outstanding. Both securities are being held as long term investments.
Changes in retained earnings for AAA and BBB for 2005 and 2006 are as
follows:
AAA, Inc. BBB Corp.

Retained earnings (deficit), 1/1/05 P1,000,000 (P175,000)
Cash dividends, 2005 (125,000) -
Net income, 2005 200,000
325,000
Retained earnings, December 31, 1,075,000 150,000
2005
Cash dividends, 2006 (150,000) (50,000)
Net income, 2006 300,000
125,000
Retained earnings, December 31, P1,225,000 P 225,000
2006
Market value of stock: 12/31/05 P7.00 P12.00

12/31/06 6.50 15.00
QUESTIONS:
1. The income from investment in AAA, Inc. in 2006 is

a. P15,000 c. P12,500
b. P 1,000 d. P 0
APPLIED AUDITING
2. The income from investment in BBB, Inc. in 2005 is

a. P31,250 c. P2,500
b. P81,250 d. P 0
3. The carrying value of Investment in AAA, Inc. as December 31, 2006 is

a. P250,000 c. P325,000
b. P350,000 d. P252,500
4. The carrying value of Investment in BBB, Inc. as December 31, 2006 is

a. P1,250,000 c. P1,875,000
b. P1,268,750 d. P1,350,000
5. How much is the unrealized gain or loss that will be included as component
of equity as of December 31, 2006?
a. P75,000 gain c. P25,000 gain
b. P25,000 loss d. P 0
Suggested Solution:
Question No. 1
Meycauayan, Inc. owns 10% (50,000/500,000) of AAA, Inc. stock; therefore,

the cost method is used and the dividend is computed as follows:
Dividends paid by AAA, Inc. in 2006 P150,000

Multiply by % ownership
10%
Income from investment in AAA, Inc. in P 15,000
2006
Question No. 2
Meycauayan, Inc. owns 25% (125,000/500,000) of BBB Corp. stock;

therefore, the equity method is used to record the income earned.
AAA, Inc. net income in 2005 P325,000

Multiply by % ownership
25%
Income from investment in BBB Corp. in P 81,250
2005
Question No. 3
Investment in AAA, Inc. stock will be classified as available-for-sale

securities since the shares are held as long term investment and there is
reliable fair value. Therefore, the carrying value as of 12/31/06 is
P325,000 (50,000 shares x P6.50).
Question No. 4
APPLIED AUDITING
Acquisition cost (125,000 shares x P10) P1,250,000

Share in net income for 2005 (P325,000 x
25%) 81,250
Carrying value, 12/31/05 1,331,250
Dividends received in 2006 (P50,000 x (12,500)
25%)
Share in net income for 2006 (P125,000 x
25%) 31,250
Question No. 5
Fair value, 12/31/06 (50,000 shares x P 325,000

P6.50)
Acquisition cost (50,000 shares x P5) 250,000
Unrealized gain, 12/31/06 P 75,000
Answers: 1) A; 2) B; 3) C; 4) D, 5) A
PROBLEM NO. 7
On January 2, 2004, Norzagaray Company acquired 20% of the 400,000

shares of outstanding common stock of Imaw Corporation for P30 per share.
The purchase price was equal to Imaw’s underlying book value. Norzagaray
plans to hold this stock to influence the activities of Imaw.
The following data are applicable for 2004 and 2005:
2004 2005
Imaw dividends (paid Oct. 31) P 40,000 P 48,000
Imaw earnings 140,000 160,000
Imaw stock market price at 32 31
year-end
On January 2, 2006, Norzagaray Company sold 20,000 shares of Imaw stock

for P31 per share. During 2006, Imaw reported net income of P120,000, and
on October 31, 2006, Imaw paid dividends of P20,000. At December 31,
2006, after a significant stock decline, which is expected to be temporary,
Imaw’s stock was selling for P22 per share. After selling the 20,000 shares,
Norzagaray does not expect to exercise significant influence over Imaw, and
the shares are classified as available for sale.
QUESTIONS:
1. Carrying value of Investment in Imaw as of December 31, 2004

a. P12,020,000 c. P2,420,000
APPLIED AUDITING
b. P 2,500,000 d. P2,388,000
2. Carrying value of Investment in Imaw as of December 31, 2005

a. P2,442,400 c. P12,042,400
b. P2,612,000 d. P 2,372,000
3. Gain or loss on sale of Investment in Imaw on January 2, 2006

a. P2,390,600 loss c. P33,000 loss
b. P 9,400 gain d. P27,000 gain
4. The income from investment in BBB, Inc. in 2005 is

a. P 3,000 c. P4,000
b. P24,000 d. P 0
5. Net unrealized loss on available for sale securities as of December 31,

2006
a. P671,800 c. P639,000
b. P511,800 d. P459,000
Suggested Solution:
Question No. 1
Acquisition cost (400,000 x 20% x P30) P2,400,000

Dividends received(P40,000 x 20%) (8,000)
Investment income (P140,000 x 20%)
28,000
Question No. 2
Carrying value, 12/31/04 (see no. 1) P2,420,000

Dividends received (P48,000 x 20%) (9,600)
Investment income (P160,000 x 20%)
32,000
Question No. 3
Sales proceeds (20,000 x P31) P620,000

Less carrying value of investment sold
(P2,442,400 x 20/80) 610,600
Gain on sale of investment P 9,400
Question No. 4
Dividend income (P20,000 x 15%*) P3,000
* [20% - (20,000/400,000 x 100%)]

APPLIED AUDITING
Question No. 5

Less carrying value of investment sold 610,600
Carrying value, 12/31/06 - before 1,831,800
reclassification
Fair value of AFS, 12/31/06 [(80,000 - 20,000) 1,320,000
x P22]
Unrealized loss on AFS P 511,800
Answers: 1) C; 2) A; 3) B; 4) A, 5) B
PROBLEM NO. 8
You were able to gather the following in connection with your audit of Obando,
Inc. On December 31, 2005, Obando reported the following available for sale
securities:
Unrealize
Cost Market d loss
ERAP Corp., 10,000
shares of common
stock P P 220,000 P
(a 1% interest) 250,000 30,000
GMA Corp., 20,000
shares of common
stock 320,000 300,000 20,000
(a 2% interest)
FVR Corp., 50,000
shares of common
stock 1,400,000 1,350,000
(a 10% interest) 50,000
Total P1,970,000 P1,870,000 P100,000
 On April 1, 2006, ERAP issued 10% stock dividend when the market price
of its stock was P24 per share.
 On September 15, 2006, ERAP paid cash dividend of P0.75 per share.
 On August 30, 2006, GMA issued to all shareholders, stock rights on the
basis of one right per share. Market prices at date of issue were P13.50
per share of stock and P1.50 per right. Obando sold all rights on
December 1, 2006 for net proceeds of P37,600.
APPLIED AUDITING
 On July 1, 2006, Obando paid P3,040,000 for 100,000 additional shares of

FVR Corp.’s common stock which represented a 20% investment in FVR.
The fair value of all of FVR’s identifiable assets net of liabilities was equal
to their carrying amount of P12,700,000. As a result of this transaction,
Obando owns 30% of FVR and can exercise significant influence over
FVR’s operating and financial policies.
 Obando’s initial 10% interest of 50,000 shares of FVR’s common stock was
acquired on January 2, 2005 for P1,400,000. At that date, the net assets
of FVR totaled P11,600,000 and the fair values of FVR‘s identifiable assets
net liabilities were equal to their carrying amount.
 Market prices per share of the securities which are all listed in the
Philippine Stock Exchange, are as follows:
12/31/2006 12/31/2005
ERAP Corp. – common P23 P22
GMA Corp. – common 14 15
FVR Corp. – common 31 27
 FVR reported net income and paid dividends of:
Dividend
Net per share
income
Year ended December 31, 2005 P700,000 None
Six months ended June 30, 2006 400,000 None
Six months ended December 31,
2006 (dividend was paid on 740,000 P1.30
10/1/2006)
 There were no other intercompany transactions between Obando and FVR.
QUESTIONS:
1. Net unrealized gain or loss on available for sale securities as of December

31, 2006
a. P95,000 gain c. P 5,000 loss
b. P37,000 loss d. P55,000 loss
2. Net adjustment to Retained Earnings as of January 1, 2006 as a result of

the purchase of additional shares of stock of FVR Corp.
a. P 70,000 c. P58,000
b. P210,000 d. P 0
3. Net investment income from FVR Corp. for year ended December 31, 2006
APPLIED AUDITING
a. P237,500 c. P262,000
b. P225,000 d. P305,000
4. Carrying amount of Investment in FVR Corp. as of December 31, 2006

a. P4,674,500 c. P4,577,000
b. P4,677,000 d. P4,540,500
5. Gain on sale of stock rights on December 1, 2006

a. P 0 c. P7,600
b. P2,050 d. P5,600
Suggested Solution:
Question No. 1
Available-for-sale securities, P 1,870,000

1/1/06
Receipt of stock rights from GMA,
8/30 (P300,000 x 1.5/15) (30,000)
Reclassification of Investment in (1,350,000)
FVR
AFS, 12/31/06 before 490,000
mark-to-market
Fair value of AFS, 12/31/06:
GMA [(10,000 x 1.1) x 23] P253,000
ERAP (20,000 x 14) 533,000
280,000
Decrease in unrealized loss on 43,000
AFS
Unrealized loss on AFS, 12/31/05
(P100,000 - P2,000 - P50,000)
(see note below) 48,000
Unrealized loss, 12/31/06 - as P 5,000
adjusted
Note: Alternatively, the unrealized loss on AFS can be computed by

comparing the total fair value and total cost of AFS as of December 31,
2006. Incidentally, the journal entries to record the receipt of stock rights
and reclassification of the investment in FVR follow:
Stock rights P 32,000

Available for sale securities (P300,000 x 1.5/15) P30,000
Unrealized loss on AFS (P20,000 x 1.5/15) 2,000
Investment in associate P1,400,000

Available for sale securities P1,350,000
Unrealized loss on AFS 50,000
APPLIED AUDITING
Reclassification of investment in FVR (see no. 1) P1,400,000

Retroactive adjustment
(cost to equity method):
Share in NI for 2005 (P700,000 x (2)
10%) 70,000
Adjusted balance, 1/1/06 1,470,000
Cost of additional 100,000 shares 3,040,000
Net investment income for 2006:
Share in NI for six months ended
6/30 (P400,000 x 10%) P40,000
Share in NI for six months ended
12/31 [P740,000 x (10%+20%)] 222,000 262,000 (3)
Dividends received
[(50,000 shares + 100,000 shares)
x 1.3] (195,000)
Carrying value of investment in FVR, 12/31/06 P 4,577,000 (4)
Note: The excess of cost over the book value of net assets acquired will
be attributed to Goodwill. Therefore, the excess will not affect the
investment income and the carrying value of the investment since Goodwill
is not amortized.
Question No. 5

Less cost of stock rights (see no. 32,000
1)
Gain on sale of stock rights P 5,600
Answers: 1) C; 2) A; 3) C; 4) C, 5) D
PROBLEM NO. 9
Paombong Corporation purchased P200,000 8% bonds for P184,557 on

January 1, 2004. Paombong classified the bonds as available for sale. The
bonds were purchased to yield 10% interest. Interest is payable
semiannually on July 1 and January 1. The bonds mature on January 1,
2009. Paombong uses the effective interest method to amortize premium or
discount. On January 2, 2006, Paombong sold the bonds for P190,000 after
receiving interest to meet its liquidity needs.
The market values of the bonds are as follows:
December 31, 2004 P190,449

December 31, 2005 186,363
QUESTIONS:
APPLIED AUDITING

a. P14,869 c. P18,517
b. P16,000 d. P18,456
2. Unrealized gain on AFS as of December 31, 2004

a. P3,436 c. P5,892
b. P3,375 d. P 0

a. P18,775 c. P16,000
b. P15,272 d. P18,701
4. Unrealized gain or loss on AFS as of December 31, 2005

a. P8,053 gain c. P3,351 gain
b. P3,486 loss d. P1,806 loss
5. Realized gain or loss on sale of AFS on January 2, 2006

a. P6,861 loss c. P4,849 loss
b. P4,714 loss d. P9,416 gain
Suggested Solution:
Question No. 1
The following amortization schedule will be useful in computing for the

requirements:
Effective Nominal Discount Carrying

Date interest interest amortization value
01/01/04 P184,557
07/01/04 P9,228 P8,000 P1,228 185,785
12/31/04 9,289 8,000 1,289 187,074
07/01/05 9,354 8,000 1,354 188,428
12/31/05 9,421 8,000 1,421 189,849
07/01/06 9,492 8,000 1,492 191,341
12/31/06 9,567 8,000 1,567 192,908
07/01/07 9,645 8,000 1,645 194,553
12/31/07 9,728 8,000 1,728 196,281
07/01/08 9,814 8,000 1,814 198,095
12/31/08 9,905 8,000 1,905 200,000
1/1/04 to 6/30/04 (see amortization P 9,228

schedule)
7/1/04 to 12/31/04 (see amortization 9,289
schedule)
Total interest income for 2004 P18,517
APPLIED AUDITING
Note: PAS 39 par. 55(b) states that a gain or loss on an available-for-sale

financial asset shall be recognized directly in equity, through the statement
of changes in equity, except for impairment losses and foreign exchange
gains and losses, until the financial asset is derecognized, at which time
the cumulative gain or loss previously recognized in equity shall be
recognized in profit or loss. However, interest calculated using
effective interest method shall be recognized in profit or loss.
Question No. 2
Fair value the bonds, 12/31/04 P190,449

Carrying value, 12/31/04 (see amortization 187,074
schedule)
Unrealized gain on AFS, 12/31/04 P 3,375
Question No. 3
1/1/05 to 6/30/05 (see amortization P 9,354

schedule)
7/1/05 to 12/31/0 (see amortization 9,421
schedule)
Question No. 4
Fair value the bonds, 12/31/05 P186,363

Carrying value, 12/31/05 (see amortization 189,849
schedule)
Unrealized loss on AFS, 12/31/05 (P 3,486)
Incidentally, the adjusting entry on 12/31/05 follows:
Unrealized gain on AFS P 3,375

Available for sale securities P6,861
Question No. 5

Unrealized loss on AFS ( 3,486)
Net 181,514
Carrying value, 12/31/05 (fair value) 186,363
Realized loss on sale of AFS (P 4,849)
Note: PAS 39 par. 26 states that on derecognition of a financial asset in

its entirety, the difference between (a) the carrying amount and (b) the sum
of the consideration received and any cumulative gain or loss recognized
APPLIED AUDITING
directly in equity, shall be recognized in profit or loss. Incidentally, the

journal entry to record the sale is:
Cash P185,000
Realized loss on sale of AFS 4,849
Available for sale securities P186,363
Answers: 1) C; 2) B; 3) A; 4) B, 5) C
PROBLEM NO. 10
On May 1, 2003, Plaridel Corporation acquired P1,600,000 of J & B

Corporation 9% bonds at 97 plus accrued interest. Interest on bonds is
payable semiannually on March 1 and September 1, and bonds mature on
September 1, 2006. Plaridel intends to hold these bonds until they matured.
Due to an isolated event that is beyond Plaridel’s control, is non-recurring and

could not have been reasonably anticipated by Plaridel, the company sold
bonds of P480,000 for 103 plus accrued interest on May 1, 2004.
On July 1, 2005, bonds of P640,000 were exchanged for 90,000 shares of J &
B Corporation, common, no par value, quoted on the market on this date at P8
per share. Interest was received on bonds to date of exchange.
On September 1, 2006, remaining bonds were redeemed and accrued interest

was received.
QUESTIONS:
Based on the above and the result of your audit, determine the following: (Use
the straight line amortization method)
1. Total interest income for 2003 is

a. P96,000 c. P105,600
b. P86,400 d. P106,800
2. The carrying value of the investment in bonds as of December 31, 2003 is

a. P1,561,600 c. P1,562,800
b. P1,540,000 d. P1,564,000
3. The gain on sale of the bonds on May 1, 2004 is

a. P 0 c. P 2,880
b. P4,320 d. P24,480
4. The gain on exchange the bonds on July 1, 2005 is

a. P 0 c. P57,920
b. P86,720 d. P73,280
APPLIED AUDITING
5. Total cash received by the company on September 1, 2006 is

a. P501,600 c. P480,000
b. P523,200 d. P508,800
Suggested Solution:
Question No. 1
Nominal interest (P1,600,000 x 9% x 8/12) P 96,000

Discount amortization for 2003 (P48,000 x
8/40) 9,600
Question No. 2
Carrying value, 5/1/03 (P1,600,000 x 97%) P1,552,000

Add discount amortization for 2003 (see no.
1) 9,600
Question No. 3
Selling price (P480,000 x 1.03) P494,400

Less carrying value of bonds sold:
Face value P480,000
Less unamortized bond discount,
5/1/04 to 9/1/06 (P48,000 x 469,920
480/1,600 x 28/40) 10,080
Gain on sale of investment in bonds P 24,480
PAS 39 par. 52 states that whenever sales or reclassifications of more than

an insignificant amount of held-to-maturity investments do not meet any of
the conditions in par. 9, any remaining held-to-maturity investments shall be
reclassified as available for sale. Since the sale of the bonds on May 1,
2004 is due to an isolated event that is beyond Plaridel’s control, is
non-recurring and could not have been reasonably anticipated by Plaridel,
the investment is not required to be reclassified as available for sale.
Question No. 4
Fair value of stocks received (P90,000 x P720,000

P8)
Less carrying value of bonds
exchanged:
Face value P640,000
Less unamortized bond discount,
7/1/05 to 9/1/06 (P48,000 x 633,280
640/1,600 x 14/40) 6,720
APPLIED AUDITING
Gain on exchange of bonds P 86,720
Question No. 5
Face value of remaining bonds

(P1,600,000 - P480,000 - P640,000) P480,000
Interest, 3/1/06 to 9/1/06 (P480,000 x 9% x
6/12) 21,600
Total cash received, 9/1/06 P501,600
Answers: 1) C; 2) A; 3) D; 4) B, 5) A
PROBLEM NO. 11
1. Which of the following is not a control that is designed to protect investment

securities?
a. Access to securities should be vested in more than one individual.
b. Securities should be properly controlled physically in order to prevent
unauthorized usage.
c. Securities should be registered in the name of the owner.
d. Custody over securities should be limited to individuals who have
recordkeeping responsibility over the securities.
2. Which of the following controls would a company most likely use to

safeguard investment securities when an independent trust agent is not
employed?
A. The chairman of the board verifies the investment securities, which are
kept in a bank safe deposit box, each year on the balance sheet date.
B. The investment committee of the board of directors periodically reviews
the investment decisions delegated to the treasurer.
C. Two company officials have joint control of investment securities, which
are kept in a bank safe deposit box.
D. The internal auditor and the controller independently trace all purchases
and sales of investment securities from the subsidiary ledgers to the
general ledger.
3. Which of the following controls would an entity most likely use to assist in
satisfying the completeness assertion related to long-term investments?
A. The controller compares the current market prices of recorded
investments with the brokers’ advices on file.
B. Senior management verifies that securities in the bank safe deposit box
are registered in the entity’s name.
C. The internal auditor compares the securities in the bank safe deposit
box with recorded investments.
D. The treasurer vouches the acquisition of securities by comparing
brokers’ advices with canceled checks.
APPLIED AUDITING
4. Which of the following controls would an entity most likely use in

safeguarding against the loss of investment securities?
A. A designated member of the board of directors controls the securities in a
bank safe deposit box.
B. An independent trust company that has no direct contact with the
employees who have record-keeping responsibilities has possession of
securities.
C. The internal auditor verifies the investment securities in the entity’s safe
each year on the balance sheet date.
D. The independent auditor traces all purchases and sales of investment
securities through the subsidiary ledgers to the general ledger.
5.When negotiable securities are of considerable volume, planning by the

auditor is necessary to guard against
a.Substitution of securities already counted for other securities which should
be on hand but are not.
b.Substitution of authentic securities with counterfeit securities.
c.Unauthorized negotiation of the securities before they are counted.
d.Unrecorded sales of securities after they are counted.
Answers: 1) D; 2) C; 3) C; 4) B, 5) A;
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Reference:
APPLIED AUDITING
CHAPTER 5
AUDIT OF PROPERTY, PLANT AND EQUIPMENT
Objective
PROBLEM NO. 1
Aliaga Corporation was incorporated on January 2, 2006. The following items

relate to the Aliaga’s property and equipment transactions:
Cost of land, which included an old apartment

building appraised at P300,000 P3,000,000
Apartment building mortgage assumed, including
related interest due at the time of purchase 80,000
Deliquent property taxes assumed by the Aliaga 30,000
Payments to tenants to vacate the apartment 20,000
building
Cost of razing the apartment building 40,000
Proceeds from sale of salvaged materials 10,000
Architects fee for 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
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 building to house tools and materials 50,000
Cost of changes during construction to make new
building more energy efficient 90,000
Interest cost on specific borrowing incurred during
APPLIED AUDITING
construction 360,000
Payment of medical bills of employees accidentally
injured while inspecting building construction 18,000
Cost of paving driveway and parking lot 60,000
Cost of installing lights in parking lot 12,000
Premium for insurance on building during 30,000
construction
Cost of open house party to celebrate opening of
new building 50,000
Cost of windows broken by vandals distracted by
the celebration 12,000
QUESTIONS:
1. Cost of Land
a. P2,980,000 c. P3,185,000
b. P3,270,000 d. P3,205,000
2. Cost of Building
a. P10,810,000 c. P10,875,000
b. P10,895,000 d. P11,110,000
3. Cost of Land Improvements

a. P12,000 c. P122,000
b. P72,000 d. P 0
4. Amount that should be expensed when incurred

a. P 80,000 c. P62,000
b. P110,000 d. P50,000
5. Total depreciable property and equipment

a. P11,182,000 c. P10,947,500
b. P10,967,000 d. P10,882,000
Suggested Solution:
PAS 16 par. 6 defines “Property, plant and equipment” as tangible items that:
d. are held for use in the production or supply of goods or services, for
rental to others, or for administrative purposes; and
e. are expected to be used during more than one period.
Par. 15 and 16 further state that an item of property, plant and equipment that
qualifies for recognition of an asset shall be measured at its cost. The cost of
an item of PPE comprises:
a. its purchase price, including import duties and non-refundable purchase
taxes, after deducting trade discounts and rebates.
APPLIED AUDITING
b. any costs directly attributable to bringing the asset to the location and
condition necessary for it to be capable of operating in the manner
intended by management.
c. the initial estimate of the costs of dismantling and removing the item
and restoring the site on which it is located, the obligation for which an
entity incurs either when the item is acquired or as a consequence of
having used the item during a particular period for purposes other than
to produce inventories during that period.
Question No. 1
Cost of land P3,000,000

Apartment building mortgage assumed,
including related interest due at the time of 80,000
purchase
Deliquent property taxes assumed by the Aliaga 30,000
Payments to tenants to vacate the apartment 20,000
building
Cost of razing the apartment building 40,000
Proceeds from sale of salvaged materials (10,000)
Fee for title search 25,000
Survey before construction of new building 20,000
Assessment by city for drainage project 15,000
Cost of grading and leveling
50,000
Total cost of Land P3,270,000
Question No. 2
Architects fee for new building P60,000

Building permit for new construction 40,000
Excavation before construction of new building 100,000
Payment to building contractor 10,000,000
Temporary quarters for construction crew 80,000
Temporary building to house tools and 50,000
materials
Cost of changes during construction to make
new building more energy efficient 90,000
Interest cost on specific borrowing incurred
during construction 360,000
Premium for insurance on building during
construction 30,000
Total cost of Building P10,810,000
Question No. 3
Cost of paving driveway and parking lot P60,000

Cost of installing lights in parking lot 12,000
APPLIED AUDITING
Total cost of Land Improvements P72,000
Question No. 4
Payment of medical bills of employees P18,000

Cost of open house party 50,000
Cost of windows broken by vandals 12,000
Total cost amount that should be expensed P80,000
Question No. 5
Building (see no. 2) P10,810,000

Land improvements (see no. 3)
72,000
Total depreciable PPE P10,882,000
Answers: 1) B; 2) A; 3) B; 4) A, 5) D
PROBLEM NO. 2
The following items relate to the acquisition of a new machine by Bongabon

Corporation in 2006:
Invoice price of machinery P2,000,000

Cash discount not taken 40,000
Freight on new machine 10,000
Cost of removing the old machine 12,000
Loss on disposal of the old machine 150,000
Gratuity paid to operator of the old machine
who was laid off 70,000
Installation cost of new machine 60,000
Repair cost of new machine damaged in the
process of installation 8,000
Testing costs before machine was put into 15,000
regular operation
Salary of engineer for the duration of the trial 40,000
run
Operating cost during first month of regular 250,000
use
Cash allowance granted because the new
machine proved to be of inferior quality 100,000
Question:
How much should be recognized as cost of the new machine?

a. P1,985,000 c. P1,930,000
b. P1,993,000 d. P2,025,000
APPLIED AUDITING
Suggested Solution:
Invoice price of machinery P2,000,000

Cash discount not taken (40,000)
Freight on new machine 10,000
Installation cost of new machine 60,000
Testing costs 15,000
Salary of engineer for the duration of the trial 40,000
run
Cash allowance
(100,000)
Cost of the new machine P1,985,000
Answer: A
PROBLEM NO. 3
On January 1, 2005, Cabiao Corporation purchased a tract of land (site

number 101) with a building for P1,800,000. Additionally, Cabiao paid a real
state 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 value was P300,000. Shortly
after acquisition, the building was razed at a cost of P225,000.
Cabiao entered into a P9,000,000 fixed-price contract with Cabanatuan

Builders, Inc. on March 1, 2005 for the construction of an office building on the
land site 101. The building was completed and occupied on September 30,
2006. 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 date of completion and
will be depreciated using the 150%-declining-balance method.
To finance the construction cost, Cabiao borrowed P9,000,000 on March 1,

2005. The loan is payable in ten annual installments of P900,000 plus
interest at the 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, 2005 P2,700,000

For the period January 1 to September 31, 2006 6,900,000
Cabiao is using the allowed alternative treatment for borrowing cost.
QUESTIONS:
APPLIED AUDITING
1. Cost of land site number 101

a. P1,905,000 c. P2,205,000
b. P1,800,000 d. P2,151,000
2. Cost of office building

a. P10,581,000 c. P10,329,000
b. P10,360,500 d. P10,960,500
3. Depreciation of office building for 2006

a. P96,800 c. P102,800
b. P97,130 d. P 99,197
Suggested Solution:
Question No. 1
Acquisition cost P1,800,000

Real estate broker's commission 108,000
Legal fees 18,000
Title guarantee insurance 54,000
Cost of razing the existing
building 225,000
Total cost of land site 101 P2,205,000
Question No. 2
Fixed-price contract cost P 9,000,000

Plans, specifications and 36,000
blueprints
Architect's fees and design 285,000
supervision
Capitalizable borrowing cost:
Mar. 1 to Dec. 31, 2005
(P2,700,000 x 14% x 10/12) P315,00
0
Jan. 1 to Sept. 30, 2006
(P6,900,000 x 14% x 9/12)
724,500 1,039,500
Total cost of office building P10,360,500
Question No. 3
Depreciation expense [P10,360,500 x (1/40x1.5) x 3/12] P97,130
Answers: 1) C; 2) B; 3) B
APPLIED AUDITING
PROBLEM NO. 4
You noted during your audit of the Carranglan Company that the company
carried out a number of transactions involving the acquisition of several assets.
All expenditures were recorded in the following single asset account, identified
as Property and equipment:
Property and equipment

Acquisition price of land and building P 960,000
Options taken out on several pieces of 16,000
property
List price of machinery purchased 318,400
Freight on machinery purchased 5,000
Repair to machinery resulting from
damage during shipment 1,480
Cost of removing old machinery 4,800
Driveways and sidewalks 102,000
Building remodeling 400,000
Utilities paid since acquisition of building
20,800
P1,828,480
Based on property tax assessments, which are believed to fairly represent the
relative values involved, the building is worth twice as much as the land. The
machinery was subject to a 2% cash discount, which was taken and credited to
Purchases Discounts. Of the two options, P6,000 is related to the building
and land purchased and P10,000 related to those not purchased. The old
machinery was sold at book value.
QUESTIONS:
balance of the following:
1. Land
a. P644,000 c. P326,000
b. P322,000 d. P424,000
2. Building
a. P 644,000 c. P1,044,000
b. P1,040,000 d. P 722,000
3. Machinery
a. P317,032 c. P323,400
b. P318,512 d. P321,832
APPLIED AUDITING
Suggested Solution:
Questions No. 1 and 2
Land Building
Allocation of acquisition
price:
Land (P960,000 x 1/3) P320,000
Building (960,000 x 2/3) P
640,000
Option paid on property
acquired:
Land (6,000 x 1/3) 2,000
Building (6,000 x 2/3) 4,000
Cost of building remodelling
400,000
Adjusted balances P322,000 P1,044,000
Question No. 3
Net purchase price of machinery (P318,400 P312,032

x .98)
Freight on machinery purchased
5,000
Adjusted balance P317,032
Answers: 1) B; 2) C; 3) A
PROBLEM NO. 5
In connection with your audit of Cuyapo Company’s financial statements for

the year 2006, you noted the following transactions affecting the property and
equipment items of the company:
Jan. Purchased real property for P5,026,000, which

1 included a charge of P146,000 representing property
tax for 2006 that had been prepaid by the vendor; 20%
of the purchase price is deemed applicable to land and
the balance to buildings. A mortgage of P3,000,000
was assumed by Cuyapo on the purchase. Cash was
paid for the balance.
Jan. Previous owners had failed to take care of normal

15 maintenance and repair requirements on the buildings,
necessitating current reconditioning at a cost of
P236,800.
APPLIED AUDITING
Feb. Demolished garages in the rear of the building,

15 P36,000 being recovered on the lumber salvage. The
company proceeded to construct a warehouse. The
cost of such warehouse was P540,800, which was
P90,000 less than the average bids made on the
construction by independent contractors. Upon
completion of construction, city inspectors ordered
extensive modifications to the building as a result of
failure on the part of the company to comply with
building safety code. Such modifications, which could
have been avoided, cost P76,800.
Mar. The company exchanged its own stock with a fair value
1 of P320,000 (par P24,000) for a patent and a new
equipment. The equipment has a fair value of
P200,000.
Apr. The new machinery for the new building arrived. In

1 addition, a new franchise was acquired from the
manufacturer of the machinery. Payment was made
by issuing bonds with a face value of P400,000 and by
paying cash of P144,000. The value of the franchise
is set at P160,000, while the machine’s fair value is
P360,000.
May The company contracted for parking lots and waiting

1 sheds at a cost P360,000 and P76,800, respectively.
The work was completed and paid for on June 1.
Dec. The business was closed to permit taking the year-end

31 inventory. During this time, required redecorating and
repairs were completed at a cost of P60,000.
QUESTIONS:
Based on the above and the result of your audit, determine the cost of the
following:
1. Land
a. P 940,000 c. P
976,000
b. P1,005,200 d. P1,052,800
2. Buildings
a. P4,645,600 c. P4,762,400
b. P5,005,600 d. P4,681,600
3. Machinery and equipment

a. P360,000 c. P576,615
APPLIED AUDITING
b. P560,000 d. P659,692
4. Land improvements
a. P360,000 c. P436,800
b. P 76,800 d. P 0
5. Total property, plant and equipment

a. P6,764,400 c. P6,718,092
b. P6,731,200 d. P6,618,400
Suggested Solution:
Question No. 1
Total contract price P5,026,000

Less property taxes for 2006 146,000
Adjusted cost of land and building 4,880,000
Percentage applicable to land
20%
Cost of Land P 976,000
Question No. 2
Cost allocated to building (P4,880,000 x P3,904,000

80%)
Reconditioning costs prior to use 236,800
Salvage proceeds from demolition of (36,000)
garages
Construction cost of warehouse
540,800
Cost of Buildings P4,645,600
Notes:
1) The savings on construction of P90,000 should be ignored.
2) The modification costs of P76,800 and the redecorating and repair
costs of P60,000 should be expensed.
Question No. 3
Fair value of equipment acquired on Mar. P200,000

1
Fair value of machine acquired on Apr. 1 360,000
Cost of Machinery and equipment P560,000
Question No. 4
Parking lots P360,000

APPLIED AUDITING
Waiting sheds 76,800

Cost of Land improvements P436,800
Question No. 5
Land P 976,000
Buildings 4,645,600
Machinery and equipment 560,000
Land improvements
436,800
Total cost of property, plant and P6,618,400
equipment
Answers: 1) C; 2) A; 3) B; 4) C, 5) D
PROBLEM NO. 6
Gabaldon Company’s property, plant and equipment and accumulated

depreciation balances at December 31, 2005 are:
Accumulated
Cost Depreciation
Machinery and equipment P1,380,000 P 367,500
Automobiles and trucks 114,326
210,000
Leasehold improvements 108,000
432,000
Additional information follows:
Depreciation methods and useful lives:

Machinery and equipment – straight line; 10 years.
Automobiles and trucks – 150% declining balance; 5 years, all acquired
after 2001.
Leasehold improvements – straight line
Depreciation is computed to the nearest month.
Salvage values are immaterial except for automobiles and trucks which have
estimated salvage values equal to 15% of cost.
Other additional information:
a. Gabaldon entered into a 12-year operating lease starting January 1, 2003.

The leasehold improvements were completed on December 31, 2002 and
the facility was occupied on January 1, 2003.
APPLIED AUDITING
b. On July 1, 2006, machinery and equipment were purchased at a total

invoice cost of P325,000. Installation cost of P44,000 was incurred.
c. On August 30, 2006, Gabaldon purchased new automobile for P25,000.
d. On September 30, 2006, a truck with a cost of P48,000 and a carrying

amount of P30,000 on December 31, 2005 was sold for P23,500.
e. On December 20, 2006, a machine with a cost of P17,000, a carrying

amount of P2,975 on date of disposition, was sold for P4,000.
QUESTIONS:
1. The gain on sale of truck on September 30 is

a. P2,680 c. P250
b. P6,500 d. P 0
2. The gain on sale of machinery on December 20, 2006 is

a. P1,025 c. P13,000
b. P2,725 d. P 0
3. The adjusted balance of the property, plant and equipment as of December

31, 2006 is
a. P1,919,000 c. P2,307,000
b. P2,388,500 d. P2,351,000
4. The total depreciation expense for the year ended December 31, 2006 is
a. P185,402 c. P138,000
b. 245,065 d. P221,402
5. The carrying amount of the property, plant and equipment as of December

31, 2006 is
a. P1,567,497 c. P1,578,547
b. P1,290,547 d. P1,617,322
Suggested Solution:
Question No. 1

Less carrying value of
truck
Cost P48,000
Less accumulated
dep.:
Balance, 1/1/06
(P48,000 - P18,000
APPLIED AUDITING
P30,000)
Depreciation for
2006 24,750 23,250
(P30,000 x 30% x 6,750
9/12)
Gain on sale of truck P 250
Question No. 2

Less carrying value of machine sold 2,975
Gain on sale of machine P1,025
Question No. 3
Machinery and equipment:

Balance, 1/1 P1,380,00
0
Acquired, 7/1 (P325,000 + 369,000
P44,000)
Machine sold, 12/20 P1,732,000
(17,000)
Automobiles and trucks:
Balance, 1/1 210,000
Acquired, 8/30 25,000
Truck sold, 9/30 187,000
(48,000)
Leasehold improvements
432,000
Property, plant & equipment, P2,351,000
12/31/06
Question No. 4

Remaining beginning balance
[(P1,380,000 - P17,000) x 10%] P136,30
0
Machine sold, 12/20 (P17,000 x 1,700
10%)
Acquired, 7/1/06
[(P325,000 + P44,000) x 10% x P156,450
6/12] 18,450
Automobiles and trucks
Remaining beginning balance
[(P210,000-114,326-P30,000) x 19,702
30%]
Truck sold, 9/30 6,750
APPLIED AUDITING
(P30,000x30%x9/12)
Acquired, 8/30 (P25,000 x 30% x 28,952
4/12) 2,500
(P432,000/12) 36,000
Total depreciation expense for 2006 P221,402
Question No. 5
Total cost of PPE, 12/31/06 (see no. 3) P2,351,000

Less accumulated depreciation, 12/31/06:
Balance, 1/1 P367,500
Depreciation expense for 156,450
2006
Machine sold, 12/20
(P17,000 - P2,975) P509,925
(14,025)
Automobiles and trucks:
Balance, 1/1 114,326
Depreciation expense for 28,952
2006
Truck sold, 9/30 (see no. 1) 118,528
(24,750)
Balance, 1/1 108,000
Depreciation expense for
2006 36,000 144,000
772,453
Answers: 1) C; 2) A; 3) D; 4) D, 5) C
PROBLEM NO. 7
Your new audit client, Guimba Company, prepared the trial balance below as
of December 31, 2006. The company started its operations on January 1,
2005. Your examination resulted in the necessity of applying the adjusting
entries indicated in the additional data below.
Guimba Company
TRIAL BALANCE
December 31, 2006
Debits Credits
Cash P510,000
Accounts receivable – net 600,000
APPLIED AUDITING
Guimba Company
TRIAL BALANCE
December 31, 2006
Debits Credits
Inventories, December 31, 2005 669,000
Land 660,000
Buildings 990,000
Accumulated depreciation, building P19,800
Machinery 444,000
Accumulated depreciation, machinery 45,000
Sinking fund assets 75,000
Bond discount 75,000
Treasury stock, common 105,000
Accrued bond interest 11,250
First mortgage, 6% sinking fund bonds 679,500
Common stock 1,500,000
Premium on common stock 150,000
Stock donation 180,000
Retained earnings, December 31, 222,450
2005
Net sales 2,625,000
Purchases 850,500
Salaries and wages 507,000
Factory operating expenses 364,500
Administrative expenses 105,000
Bond interest
45,000
P6,000,000 P6,000,000
Additional data are as follows:
(1) The 1,500,000 common stock was issued at a 10 percent premium to the
owners of the land and buildings on December 31, 2004, the date of
organization. Stock with a par value of 180,000 was donated back by the
vendors. The following entry was made:
Treasury stock P180,000

Stock donation P180,000
The stock was donated because the proceeds from its subsequent sale
were to be considered as an allowance on the purchase price of land and
buildings in proportion to their values as first recorded. The treasury stock
was sold in 2006 for P75,000, which was credited to Treasury Stock.
(2) On December 31, 2006, a machine costing P15,000 when the business
started was removed. The machine had been depreciated at 10 percent
during the first year. The only entry made was one crediting the
Machinery account with its sales price of P6,000.
APPLIED AUDITING
(3) Depreciation is to be provided on the straight-line basis, as follows:

buildings, 2 percent of cost; machinery, 10 percent of cost. Ignore
salvage values.
QUESTIONS:
1. The correct balance of Land account as of December 31, 2006 is

a. P660,000 c. P630,000
b. P588,000 d. P 0
2. The adjusted carrying value of Building as of December 31. 2006 is

a. P907,200 c. P905,400
b. P950,400 d. P945,000
3. The adjusted carrying value of Machinery as of December 31, 2006 is

a. P399,000 c. P354,000
b. P345,000 d. P348,000
4. The adjusted depreciation expense for 2006 is

a. P648,000 c. P63,900
b. P62,400 d. P63,000
5. How much is the gain or loss on sale of machinery on December 31, 2006?
a. P6,000 loss c. P6,000 gain
b. P7,500 loss d. P7,500 gain
Suggested Solution:
Question No. 1
Land Building Total

Unadjusted balances P660,000 P990,000 P1,650,000
Proceeds from sale
of donated stock
Applied as
deduction to:
Land (P75,000 x (30,000) (30,000)
660/1,650)
Bldg. (P75,000 x
990/1,650) (45,000) (45,000)
Adjusted balances P630,000 P945,000 P1,575,000
Note: The proceeds received from sale of donated shares will not be credited
to Donated Capital account since this involves "Treasury stock subterfuge".
This occurs when excessive shares are issued for a property with the
understanding that the stockholders shall subsequently donate a portion of
their shares.
APPLIED AUDITING
Question No. 2
Adjusted cost of building (see no. 1) P945,000

Less accumulated depreciation, 12/31/06
(P945,000 x 2% x 2) 37,800
Carrying value of building, 12/31/06 P907,200
Question No. 3
Machinery, 1/1/06 (P444,000 + P6,000) P450,000

Less machinery sold on 12/31/06 15,000
Machinery, 12/31/06 435,000
Less accumulated depreciation, 12/31/06
(P435,000 x 10% x 2) 87,000
Carrying value of Machinery, 12/31/06 P348,000
Question No. 4
Depreciation on Building (P945,000 x P18,900

2%)
Depreciation on Machinery (P450,000 x 45,000
10%)
Question No. 5
Sales proceeds P 6,000

Less carrying value, 12/31/06:
Cost P15,000
Less accumulated depreciation
(P15,000 x 10% x 2) 12,000
3,000
Loss on sale of machinery P 6,000
Answers: 1) C; 2) A; 3) D; 4) C, 5) A
PROBLEM NO. 5
Jaen Corporation, a manufacturer of steel products, began operation on

October 1, 2004. The accounting department of Jaen has started the
fixed-asset and depreciation presented below.
APPLIED AUDITING
JAEN CORPORATION
Fixed Asset and Depreciation Schedule
For Fiscal Years Ended September 30, 2005, and September 30, 2006
Depreciation
Expense Year
Ended Sept. 30
Acq. Dep.
Asset Date Cos Salvag Method Lif 2005 2006
s t e e
Land 10/1/0 ? N/A N/A N/ N/A N/A
A 4 A
Bldg. 10/1/0 ? P320,0 Straight-l ? P139,6 ?
A 4 00 ine 00
Land 10/1/0 ? N/A N/A N/ N/A N/A
B 4 A
Bldg. Under ? Straight-l 30 - ?
B Const - ine
.
Donat 10/2/0 ? 24,000 150% 10 ? ?
ed 4 declining
equip. balance
Mach. 10/2/0 ? 48,000 Sum-of-t 8 ? ?
A 4 he-years
’-digits
Mach. 10/1/0 ? - Straight-l 20 - ?
B 5 ine
N/A – Not applicable
You have been asked to assist in completing this schedule. In addition in

ascertaining that the data already on the schedule are correct, you have
obtained the following information from the Company’s records and personnel:
a. Land A and Building A were acquired from a predecessor corporation.

Jaen paid P6,560,000 for the land and building together. At the time of
acquisition, the land had an appraised value of P720,000, and the building
had an appraised value of P6,480,000.
b. Land B was acquired on October 2, 2004, in exchange for 20,000 newly

issued shares of Jaen’s common stock. At the date of acquisition, the
stock had a par value of P5 per share and a fair value of P30 per share.
During October 2004, Jaen paid P128,000 to demolish an existing building
on this land so it could construct new building.
c. Construction of building B on the newly acquired land began on October 1,

2005. By September 30, 2006, Jaen has paid P2,560,000 of the
estimated total construction costs of P3,600,000. It is estimated that the
building will be completed and occupied by July 2007.
APPLIED AUDITING
d. Certain equipment was donated to the corporation by a local university.

An independent appraisal of the equipment when donated placed the fair
market value at P240,000 and the salvage value at P24,000.
e. Machinery A’s total cost of P1,319,200 includes installation expense of

P4,800 and normal repairs and maintenance of P119,200. Salvage value
is estimated at P48,000. Machinery A was sold on February 1, 2006.
f. On October 1, 2005, Machinery B was acquired with a down payment of

P45,920 and the remaining payments to be made in 11 annual installments
of P48,000 each beginning October 1, 2005. The prevailing interest rate
was 8%.
QUESTIONS:
1. The cost of Building A is

a. P5,904,000 c. P656,000
b. P6,560,000 d. P 0
2. The cost of Land B is

a. P600,000 c. P228,000
b. P728,000 d. P 0
3. The cost of Machine B is

a. P370,080 c. P388,592
b. P416,000 d. P389,776
4. The total depreciation expense for the year ended September 30, 2006 is
a. P264,296 c. P265,667
b. P415,000 d. P262,608
Suggested Solution:
Question No. 1
Cost of building A (P6,560,000 x 6,480/7,200) P5,904,000
Question No. 2
Fair value of common stock (20,000 x P600,000

P30)
Demolition costs 128,000
Cost of Land B P728,000
Question No. 3
Down payment P 45,920

Add present value of installment
APPLIED AUDITING
payments (P48,000 x 7.710) 370,080

Cost of Machine B P416,000
Question No. 4
Building A (same in 2005 since it is

straight-line depreciation) P139,600
Building B (under construction) -
Donated equipment (P240,000 x 85% x 15%) 30,600
Machine A
[(P1,319,200-P119,200-P48,000) x 7/36 x 74,667
4/12]
Machine B (P416,000/20)
20,800
Total depreciation expense P265,667
Answers: 1) A; 2) B; 3) B; 4) C
PROBLEM NO. 9
The following data relate on the Plant Assets account of Licab, Inc. at
December 31, 2005:
Plant Assets
L A R E
Original cost P87,500 P127,500 P200,000 P200,000
Year 2000 2001 2002 2004
Purchased
Useful life 10 37,500 15 years 10 years
years hours
Salvage P7,750 P7,500 P12,500 P12,500
value
Depreciation SYD Activity Straight-line Double-declining
method balance
Note: In the year an asset is purchased, Licab, Inc. does not record any
depreciation expense on the asset.
In the year an asset is retired or traded in, Licab, Inc. takes a full year
depreciation on the asset.
The following transaction occurred during 2006:
(a) On May 5, Asset L was sold for P32,500 cash.
(b) On December 31, it was determined that asset A had been used 5,250
hours during 2006.
APPLIED AUDITING
(c) On December 31, before computing depreciation expense on Asset R, the

management of Licab, Inc. decided the useful life remaining from 1/1/06
was 10 years.
(d) On December 31, it was discovered that a plant asset purchased in 2005
had been expensed completely in that year. This asset costs P55,000
and has useful life of 10 years and no salvage value. Management has
decided to use the double-declining balance for this asset, which can be
referred to as “Asset S.”
QUESTIONS:
(Disregard tax implications)
1. How much is the gain or loss on sale of Asset L?

a. P10,250 loss c. P16,050 gain
b. P10,250 gain d. P16,050 loss
2. How much is the depreciation of Asset R for 2006?

a. P15,000 c. P16,250
b. P21,429 d. P23,214
3. The adjusting entry to correct the error of failure to capitalize Asset S would
include a debit/credit to Retained Earnings of
a. P55,000 debit c. P44,000 credit
b. P55,000 credit d. P 0
4. How much is the adjusted balance of Plant Assets as of December 31,

2006?
a. P670,000 c. P615,000
b. P527,500 d. P582,500
5. How much is the total depreciation expense for 2006?

a. P83,300 c. P82,050
b. P88,479 d. P80,600
Suggested Solution:
Question No. 1

Less carrying value:
Cost P87,500
Less accumulated
depreciation 65,250 22,250
[(P87,500-P7,750) x
45/55]
Gain on sale of Asset L P10,250
APPLIED AUDITING
Question No. 2
Cost P200,000
Less accumulated depreciation,
1/1/05 [(P200,000 - P12,500) x 37,500
3/15]
Carrying value, 1/1/06 162,500
Less residual value 12,500
Remaining depreciable amount 150,000
Divide by remaining life
10
Depreciation of Asset R for 2006 P 15,000
Question No. 3
Adjusting entry:
Asset S P55,000
Retained earnings P55,000
Question No. 4
Asset L (Sold) P
-
Asset A 127,500
Asset R 200,000
Asset E 200,000
Asset S
55,000
Plant Assets, 12/31/06 P582,500
Question No. 5
Asset L [(P87,500 - P7,750) x 5/55] P 7,250

Asset A [(P127,500 - P7,500)/37,500 x 16,800
5,250]
Asset R (see no. 2) 15,000
Asset E [(P200,000 x 80%) x 20%] 32,000
Asset S (P55,000 x 20%) 11,000
Answers: 1) B; 2) A; 3) B; 4) D, 5) C
APPLIED AUDITING
PROBLEM NO. 10
Your audit of Llanera Corporation for the year 2006 disclosed the following
property dispositions:
Cost Acc. Proceeds Fair value

Dep.
Land P4,800,00 - 3,720,00 3,720,00
0 0 0
Building 1,800,000 - 288,000 -
Warehouse 8,400,000 1,320,00 8,880,00 8,880,00
0 0 0
Machine 960,000 384,000 108,000 864,000
Delivery 1,200,000 570,000 564,000 564,000
truck
Land
On January 15, a condemnation award was received as consideration for the
forced sale of the company’s land and building, which stood in the path of a
new highway.
Building
On March 12, land and building were purchased at a total cost of P6,000,000,
of which 30% was allocated to the building on the corporate books. The real
estate was acquired with the intention of demolishing the building, and this was
accomplished during the month of August. Cash proceeds received in
September represent the net proceeds from demolition of building.
Warehouse
On July 4, the warehouse was destroyed by fire. The warehouse was
purchased on January 2, 2000. On December 12, the insurance proceeds
and other funds were used to purchase a replacement warehouse at a cost of
P7,200,000.
Machine
On December 15, the machine was exchanged for a machine having a fair
value of P756,000 and cash of P108,000 was received.
Delivery Truck
On November 13, the delivery truck was sold to a used car dealer.
QUESTIONS:
Based on the above and the result of your audit, compute the gain or loss to be
recognized for each of the following dispositions:
1. Land
a. P3,720,000 gain c. P4,800,000 loss
b. P1,080,000 loss d. P 0
APPLIED AUDITING
2. Building
a. P 432,000 gain c. P1,368,000 loss
b. P2,232,000 loss d. P 0
3. Warehouse
a. P1,800,000 gain c. P5,400,000 loss
b. P 480,000 gain d. P 0
4. Machine
a. P36,000 gain c. P288,000 gain
b. P27,000 gain d. P 0
5. Delivery truck
a. P636,000 loss c. P66,000 loss
b. P636,000 gain d. P66,000 gain
Suggested Solution:
Question No. 1
Cash received P3,720,000

Cost of land
4,800,000
Loss on condemnation of land P1,080,000
Question No. 2
None. The proceeds from demolition of building will be deducted from the
cost of the land.
Question No. 3
Insurance proceeds P8,880,000

Carrying value (P8,400,000 -
P1,320,000) 7,080,000
Gain on insurance policy settlement P1,800,000
Question No. 4
Fair value of old machine P864,000

Carrying value (P960,000 - 576,000
P384,000)
Gain on exchange P288,000
Question No. 5

APPLIED AUDITING
Carrying value (P1,200,000 - 630,000

P570,000)
Loss on sale P 66,000
Answers: 1) B; 2) D; 3) A; 4) C, 5) C
PROBLEM NO. 11
1. Which of the following questions would an auditor least likely include on an

internal control questionnaire concerning the initiation and execution of
equipment transactions?
A. Are procedures in place to monitor and properly restrict access to
equipment?
B. requests for major repairs approved at a higher level than the
department initiating the request?
C. Are prenumbered purchase orders used for equipment and periodically
accounted for?
D. Are requests for purchases of equipment reviewed for consideration of
soliciting competitive bids?
2. Property acquisitions that are misclassified as maintenance expense would
most likely be detected by internal control procedures that provide for
a. Review and approval of the monthly depreciation entry by the plant
supervisor.
b. Investigation of variances within a formal budgeting system.
c. Examination by the internal auditor of vendor invoices and canceled
checks for property acquisitions.
d. Segregation of duties of employees in the accounts payable department.
3.A weakness in internal accounting control over recording retirements of

equipment may cause the auditor to
a. Trace additions to the "other assets" account to search for equipment that is
still on hand but no longer being used.
b. Inspect certain items of equipment in the plant and trace those items to the
accounting records.
c. Select certain items of equipment from the accounting records and locate
them in the plant.
d. Review the subsidiary ledger to ascertain whether depreciation was taken
on each item of equipment during the year.
4.The most significant audit step in substantiating additions to the office

furniture account balance is
a. Comparison to prior year's acquisitions.
b. Examination of vendors' invoices and receiving reports for current year's
acquisitions.
c. Review of transactions near the balance sheet date for proper period cutoff.
d. Calculation of ratio of depreciation expense to gross office equipment cost.
APPLIED AUDITING
5. An auditor is verifying the existence of newly acquired fixed assets recorded

in the accounting records. Which of the following is the best evidence to help
achieve this objective?
a. Oral evidence obtained by discussions with operating management.
b. Documentary support obtained by vouching entries to subsidiary records
and invoices.
c. Documentary support obtained by reviewing titles and tax returns.
d. Physical examination of a sample of newly recorded fixed assets.
Answers: 1) A; 2) B; 3) C; 4) B, 5) D;
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Reference:
APPLIED AUDITING
CHAPTER 6
AUDIT OF INTANGIBLE ASSETS
Objective
Solving Audit of Intangible Assets Problems
PROBLEM NO. 1
The following are items that could be included in the Intangible Assets:
20. Investment in a subsidiary company P1,500,000

21. Timberland 2,000,000
22. Cost of engineering activity required to advance the
design of a product to the manufacturing stage 120,000
23. Lease prepayments (6 months’ rent paid in 60,000
advance)
24. Cost of equipment obtained under finance lease 700,000
25. Internally generated publishing title 230,000
26. Costs incurred in the formation of the corporation 90,000
27. Operating losses incurred in the start-up of the 560,000
business
28. Training costs incurred in start-up operations 80,000
29. Purchase of a franchise 1,200,000
30. Goodwill internally generated 300,000
31. Cost of testing in search for product alternatives 65,000
32. Goodwill acquired in the purchase of a business 640,000
33. Cost of developing a patent 140,000
34. Cost of purchasing a patent from an inventor 500,000
35. Legal costs incurred in securing a patent 70,000
36. Costs of a successful legal suit to protect the patent 230,000
37. Cost of conceptual formulation of possible product
APPLIED AUDITING
alternatives 160,000
38. Cost of purchasing a copyright 900,000
39. Research and development costs 340,000
40. Long-term receivables 310,000
41. Cost of developing a trademark 61,000
42. Cost of purchasing a trademark 290,000
43. Computer software for a computer-controlled
machine that cannot operate without that specific 130,000
software
44. Operating system of a computer 10,000
Question:
How much could be recognized as Intangible Assets?

a. P3,600,000 c. P5,830,000
b. P3,740,000 d. P3,530,000
Suggested Solution:
PAS 38 par. 8 defines “Intangible asset” as an identifiable non-monetary asset

without physical substance.
Items 10, 13, 15, 16, 19 and 23 could be recognized as intangible asset.
The other items will be reported as follows:
Item 1 - Noncurrent asset in the balance sheet

Item 2 - Property, plant, and equipment in the balance sheet
Item 3 - Research and development expense in the income
statement
Item 4 - Current asset (prepaid rent) in the balance sheet
Item 6 - Not recognized. PAS 38 par. 63 states that
internally generated brands, mastheads, publishing
titles, customer lists and other items similar in
substance shall not be recognized as intangible
assets. Any costs related to creating publishing
titles incurred internally must be expensed.
Item 7 - Charge as expense in the income statement
Item 8 - Operating losses in the income statement
Item 11 - Not recognized. PAS 38 par. 48 states that
internally generated goodwill shall not be recognized
as an asset. Any costs related to creating publishing
titles incurred internally must be expensed.
statement
statement
APPLIED AUDITING

statement
statement
Item 21 - Noncurrent asset in the balance sheet
(see PAS 38 par. 4)
(see PAS 38 par. 4)
Answer: A
PROBLEM NO. 2
In connection with your audit of the Cabuyao Corporation, you noted the
following transactions during 2006:
Jan. 2 Paid legal fees of P450,000 and stock certificate

costs of P249,000 to complete organization of the
corporation.
Hired a clown to stand in front of the corporate office

15 for 2 weeks and hound out pamphlets and candy to
create goodwill for the new enterprise. Clown cost,
P30,000; pamphlets and candy, P15,000.
Apr. Patented a newly developed process with costs as

1 follows:
Legal fees to obtain patent P1,287,000

Patent application and licensing 190,500
fees
Total P1,477,500
It is estimated that in 6 years other companies will

have developed improved processes, making the
Cabuyao Corporation process obsolete.
May Acquired both a license to use a special type of

1 container and a distinctive trademark to be printed on
the container in exchange for 18,000 shares of
Cabuyao’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 Constructed a shed for P3,930,000 to house

1 prototypes of experimental models to be developed in
future research projects.
APPLIED AUDITING
Dec. Incurred salaries for an engineer and chemist

31 involved in product development totaling P750,000 in
2006.
QUESTIONS:
1. Cost of patent
a. P1,477,500 c. P1,287,000
b. P 190,500 d. P 0
2. Cost of licenses
a. P450,000 c. P600,000
b. P300,000 d. P0
3. Cost of trademark
a. P450,000 c. P600,000
b. P300,000 d. P0
4. Carrying amount of Intangible Assets as of December 31, 2006

a. P2,137,812 c. P7,432,812
b. P2,092,812 d. P 0
5. Total amount resulting from the foregoing transactions that should be

expensed when incurred
a. P2,971,500 c. P5,424,000
b. P1,494,000 d. P 0
Suggested Solution:
The following journal entries to record the foregoing transactions will be

useful in computing for the requirements:
Jan. 2
Organization expenses P 699,000
Cash P 699,000
Jan. 15
Advertising expense P 45,000
Cash P 45,000
Apr. 1
Patents P1,477,500
Cash P1,477,500
May 1
Licenses (P900,000 x 2/3) P 600,000
Trademark (P900,000 x 1/3) 300,000
APPLIED AUDITING
Common stock (18,000 x P50) P 900,000
Jul. 1
Building P3,930,000
Cash P3,930,000
Dec. 31
Research and development expense P 750,000
Cash P
750,000
Question No. 1
See journal entry for April 1.
Question Nos. 2 & 3
See journal entry for May 1.
Question No. 4
Cost:
Patent P1,477,500
Licenses 600,000
Trademark P2,377,500
300,000
Less amortization for 2006:
Patent (P492,500/6 x 9/12) 184,688
Licenses (P200,000/6 x 8/12) 66,667
Trademark (P100,000/6 x
8/12) 33,333 284,688
Carrying amount, 12/31/06 P2,092,812
Question No. 5
Organization expenses (Jan. 2 P

transaction) 699,000
Advertising expense (Jan. 15 45,000
transaction)
R and D expense (Dec. 31 transaction)
750,000
Total P1,494,000
Answers: 1) A; 2) C; 3) B; 4) B, 5) B
PROBLEM NO. 3
APPLIED AUDITING
In connection with your audit of the Liliw Corporation’s financial statements for
the year 2006, you noted the following items relative to the company’s
Intangible assets.
 A patent was purchased from Pansol Company for P4,000,000 on January

2, 2005. Liliw estimated that the remaining useful life of the patent to be
10 years. The patent was carried in Pansol’s accounting records at a
carrying value of P4,000,000 when Pansol sold it to Liliw.
 During 2006, a franchise was purchased from Makiling Company for

P960,000. In addition, 5% of the revenue from the franchise must be paid
to Makiling. Revenue from the franchise for 2006 was P5,000,000.
Carter estimates the useful life of the franchise to be 10 years and takes full
year’s amortization in the year of purchase.
 Liliw incurred research and development costs of P866,000 in 2006. Liliw

estimates that these costs will be recouped by December 31, 2009.
 On January 1, 2006, Liliw, because of the recent events in the industry,

estimates that the remaining life of the patent purchased on January 2,
2005, is only 5 years from January 1, 2006.
QUESTIONS:
1. Amortization of patent for 2006

a. P900,000 c. P720,000
b. P800,000 d. P400,000
2. Carrying amount of patent as of December 31, 2006

a. P2,880,000 c. P2,700,000
b. P2,400,000 d. P3,200,000
3. Carrying amount of intangible assets as of December 31, 2006

a. P3,264,000 c. P3,564,000
b. P4,610,000 d. P3,744,000
4. Total amount that should be charged against income in 2006

a. P2,112,000 c. P2,012,000
b. P1,066,000 d. P1,932,000
Suggested Solution:
Question No. 1
Cost of patent P4,000,000

Less amortization in 2005 (P4,000,000/10)
400,000
Divide by revised remaining useful life
APPLIED AUDITING
5
Patent amortization for 2006 P 720,000
Question No. 2
Carrying amount, 1/1/06 (see no. 1) P3,600,000

Less amortization in 2006 (see no. 1)
720,000
Question No. 3
Cost of franchise P 960,000

Less amortization in 2006 (P960,000/10)
96,000
Carrying amount of franchise, 12/31/06 864,000
Carrying amount of patent, 12/31/06 (see 2,880,000
no. 2)
Carrying amount of intangible assets, P3,744,000
12/31/06
Question No. 4
Patent amortization (see no. 1) P 720,000

Franchise amortization (see no. 3) 96,000
Periodic franchise fee (P5,000,000 x 5%) 250,000
R and D expense 866,000
Total charged against income in 2006 P1,932,000
Answers: 1) C; 2) A; 3) D; 4) D
PROBLEM NO. 4
You gathered the following information related to the Patents account of the
Majayjay Cookie Corporation in connection with your audit of the company’s
financial statements for the year 2006.
In 2005, Majayjay developed a new machine that reduces the time required to
insert the fortunes into its fortune cookies. Because the process is
considered very valuable to the fortune cookie industry, Majayjay patented the
machine. The following expenses were incurred in developing and patenting
the machine:
Research and development laboratory expenses P1,000,000

Metal used in the construction of the machine 320,000
Blueprints used to design the machine 128,000
Legal expenses to obtain patent 480,000
APPLIED AUDITING
Wages paid for the employees’ work on the

research, development, and building of the
machine (60% of the time was spent in 1,200,000
actually building the machine)
Expense of drawing required by the patent office
to be submitted with the patent application 68,000
Fees paid to the government patent office to
process application 100,000
During 2006, Majayjay paid P150,000 in legal fees to successfully defend the
patent against an infringement suit by Cookie Monster Corporation.
It is the company’s policy to take full year amortization in the year of

acquisition.
QUESTIONS:
1. Cost of patent
a. P580,000 c. P1,128,000
b. P648,000 d. P 798,000
2. Cost of machine
a. P1,236,000 c. P1,040,000
b. P1,648,000 d. P1,168,000
3. Amount that should charged to expense when incurred in connection with

the development of the patented machine
a. P1,480,000 c. P1,608,000
b. P1,000,000 d. P 0

a. P522,000 c. P1,015,200
b. P583,200 d. P 837,900
Suggested Solution:
Question No. 1
Legal expenses to obtain patent P480,000

Expense of drawing required by the patent 68,000
office
Fees paid to the government patent office 100,000
Cost of patent P648,000
Question No. 2
APPLIED AUDITING
Metal used in the construction of the P 320,000

machine
Blueprints used to design the machine 128,000
Wages paid to the employees (P1,200,000 720,000
x 60%)
Cost of machine P1,168,000
Question No. 3
Research and development laboratory P1,000,000

expenses
Wages paid to the employees (P1,200,000
x 40%) 480,000
R & D expense P1,480,000
Question No. 4
Cost of patent (see no. 1) P648,000

Less amortization (P648,000 x 2/20)
64,800
Carrying amount of patent, 12/31/06 P583,200
Notes: 1) Cost of defending the patent should be expensed.

2) Since the useful life is not given, the patent was amortized
using the legal life of 20 years.
Answers: 1) B; 2) D; 3) A; 4) B
PROBLEM NO. 5
On January 2, 1998, Nagcarlan Company spent P480,000 to apply for and

obtain a patent on a newly developed product. The patent had an estimated
useful life of 10 years. At the beginning of 2002, the company spent
P144,000 in successfully prosecuting an attempted patent infringement. At
the beginning of 2003, the company purchased for P280,000 a patent that was
expected to prolong the life of its original patent by 5 years. On July 1, 2006,
a competitor obtained rights to a patent that made the company’s patent
obsolete.
QUESTIONS:

a. P360,000 c. P369,600
b. P240,000 d. P355,200
2. Amortization of patent in 2003

APPLIED AUDITING
a. P64,000 c. P52,000
b. P64,960 d. P63,520
3. Carrying amount of patents as of December 31, 2005

a. P448,000 c. P444,640
b. P454,720 d. P364,000
4. Loss on patent obsolescence

a. P338,000 c. P448,000
b. P416,000 d. P364,000
Suggested Solution:
Question No. 1
Cost of patent P480,000

Less amortization up to 12/31/02 (P480,000 x 240,000
5/10)
Carrying amount of patent, 12/31/02 P240,000
Question No. 2
Amortization on original patent (P240,000/10) P24,000

Amortization on related patent (P280,000/10) 28,000
Total amortization in 2003 P52,000
Question No. 3
Original patent (P240,000 x 7/10) P168,000

Related patent (P280,000 x 7/10) 196,000
Carrying amount of patents, 12/31/05 P364,000
Question No. 4
Carrying amount of patents, P364,000

12/31/05
Less amortization, 1/1/06 to 7/1/06:
Original patent (P240,000/10 x P12,000
6/12)
Related patent (P280,000/10 x 14,000
6/12) 26,000
Loss on patent obsolescence P338,000
Answers: 1) B; 2) C; 3) D; 4) A
APPLIED AUDITING
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Reference:
APPLIED AUDITING
CHAPTER 7
AUDIT OF LIABILITIES
Objective
1. Solving Audit of Liabilities Problems
2. Theory of Audit of Liabilities
PROBLEM NO. 1
Atimonan Corporation is selling audio and video appliances. The company’s

fiscal year ends on March 31. The following information relates to the
obligations of the company as of March 31, 2006:
Notes payable
Atimonan has signed several long-term notes with financial institutions. The
maturities of these notes are given below. The total unpaid interest for all of
these notes amounts to P408,000 on March 31, 2006.
Due date Amount

April 31, 2006 P
720,000
July 31, 2006 1,080,000
September 1, 2006 540,000
February 1, 2007 540,000
April 1, 2007 – March 31,
2008 3,240,000
P 6,120,000
Estimated warranties
APPLIED AUDITING
Atimonan has a one-year product warranty on some selected items. The

estimated warranty liability on sales made during the 2004 – 2005 fiscal year
and still outstanding as of March 31, 2005, amounted to P302,400. The
warranty costs on sales made from April 1, 2005 to March 31, 2006, are
estimated at P756,000. The actual warranty costs incurred during 2005 –
2006 fiscal year are as follows:
Warranty claims honored on 2004 – 2005 P 302,400

sales
Warranty claims honored on 2005 – 2006 342,000
sales
Total P 644,400
Trade payables
Accounts payable for supplies, goods, and services purchases on open
account amount to P672,000 as of March 31, 2006.
Dividends
On March 10, 2006, Atimonan’s board of directors declared a cash dividend of
P0.30 per common share and a 10% common stock dividend. Both dividends
were to be distributed on April 5, 2006 to common stockholders on record at
the close of business on March 31, 2006. As of March 31, 2006, Atimonan
has 6 million, P2 par value, common shares issued and outstanding.
Bonds payable
Atimonan issued P6,000,000, 12% bonds, on October 1, 2000 at 96. The
bonds will mature on October 1, 2010. Interest is paid semi-annually on
October 1 and April 1. Atimonan uses the straight line method to amortize
bond discount.
QUESTIONS:
Based on the foregoing information, determine the adjusted balances of the

following as of March 31, 2006:
1. Estimated warranty payable

a. P414,000 c. P 302,400
b. P756,000 d. P1,058,400
2. Unamortized bond discount

a. P132,000 c. P240,000
b. P108,000 d. P120,000
3. Bond interest payable

a. P360,000 c. P180,000
b. P300,000 d. P 0
4. Total current liabilities

a. P7,734,000 c. P6,534,000
APPLIED AUDITING
b. P6,126,000 d. P4,734,000
5. Total noncurrent liabilities

a. P9,240,000 c. P9,108,000
b. P9,132,000 d. P9,000,000
Suggested Solution:
Question No. 1
Warranty payable, 3/31/05 P 302,400

Add warranty expense accrued during 756,000
2005-2006
Total 1,058,400
Less payments during 2005-2006 644,400
Question No. 2
Bond discount, 10/1/00 (P6,000,000 x .04) P240,000

Discount amortization, 10/1/00 to 3/31/06
(P240,000 x 5.5/10) 132,000
Bond discount, 3/31/06 P 108,000
Question No. 3
Bond interest payable, 10/1/05 to 3/31/06

(P6,000,000 x 12% x 6/12) P 360,000
Question No. 4
Notes payable - current (maturing up to P2,880,000

3/31/07)
Accrued interest payable – Notes payable 408,000
Estimated warranty payable (see no. 1) 414,000
Cash dividends payable (6 million shares x 1,800,000
P0.30)
Accrued interest payable – Bonds payable
360,000
Total current liabilities P6,534,000
Question No. 5
Notes payable – noncurrent P 3,240,000

Bonds payable, net of discount of P108,000
5,892,000
APPLIED AUDITING
Total noncurrent liabilities P 9,132,000
Answers: 1) A; 2) B; 3) A; 4) C, 5) B
PROBLEM NO. 2
The following information relates to Candelaria Company’s obligations as of

December 31, 2006. For each of the numbered items, determine the amount
if any, that should be reported as current liability in Candelaria’s December 31,
2006 balance sheet.
1. Accounts payable:
Accounts payable per general ledger control amounted to P5,440,000, net

of P240,000 debit balances in suppliers’ accounts. The unpaid voucher
file included the following items that not had been recorded as of December
31, 2006:
a) A Company – P224,000 merchandise shipped on December 31, 2006,

FOB destination; received on January 10, 2007.
b) B, Inc. – P192,000 merchandise shipped on December 26, 2006, FOB
shipping point; received on January 16, 2007.
c) C Super Services – P144,000 janitorial services for the three-month
period ending January 31, 2007.
d) MERALCO – P67,200 electric bill covering the period December 16,
2006 to January 15, 2007.
On December 28, 2006, a supplier authorized Candelaria to return goods

billed at P160,000 and shipped on December 20, 2006. The goods were
returned by Candelaria on December 28, 2006, but the P160,000 credit
memo was not received until January 6, 2007.
a. P5,923,200 c. P5,712,000
b. P5,601,600 d. P5,841,600
2. Payroll:
Items related to Candelaria’s payroll as of December 31, 2006 are:
Accrued salaries and wages P776,000

Payroll deductions for:
Income taxes withheld 56,000
SSS contributions 64,000
Philhealth contributions 16,000
Advances to employees 80,000
a. P776,000 c. P992,000
b. P832,000 d. P912,000
APPLIED AUDITING
3. Litigation:
In May, 2006, Candelaria became involved in a litigation. The suit being

contested, but Candelaria’s lawyer believes there is probable that
Candelaria may be held liable for damages estimated in the range between
P2,000,000 and P3,000,000, and no amount is a better estimate of
potential liability than any other amount.
a. P 0 c. P2,000,000
b. P3,000,000 d. P2,500,000
4. Bonus obligation:
Candelaria Company’s president gets an annual bonus of 10% of net

income after bonus and income tax. Assume the tax rate of 30% and the
correct income before bonus and tax is P9,600,000. (Ignore the effects of
other given items on net income.)
a. P722,600 c. P395,000
b. P2,240,000 d. P628,000
5. Note payable:
A note payable to the Bank of the Philippine Islands for P2,400,000 is

outstanding on December 31, 2006. The note is dated October 1, 2005,
bears interest at 18%, and is payable in three equal annual installment of
P800,000. The first interest and principal payment was made on October
1, 2006.
a. P800,000 c. P908,000
b. P 72,000 d. P872,000
6. Purchase commitment:
During 2006, Candelaria entered in a noncancellable commitment to

purchase 320,000 units of inventory at fixed price of P5 per unit, delivery to
be made in 2007. On December 31, 2006, the purchase price of this
inventory item had fallen to P4.40 per unit. The goods covered by the
purchase contract were delivered on January 28, 2007.
a. P0 c. P1,600,000
b. P1,408,000 d. P 192,000
7. Deferred taxes:
On December 31, 2006, Candelaria’s deferred income tax account has a

2006 ending credit balance of P772,800, consisting of the following items:
Caused by temporary differences in Deferred tax

accounting
APPLIED AUDITING
For gross profit on installment sales P376,000 Cr

For depreciation on property and 576,000 Cr
equipment
For product warranty expense 179,200 Dr
P772,800 Cr
a. P772,800 c. P952,000
b. P196,800 d. P 0
8. Product warranty:
Candelaria has a one year product warranty on selected items in its

product line. The estimated warranty liability on sales made during 2005,
which was outstanding as of December 31, 2005, amounted to P416,000.
The warranty costs on sales made in 2006 are estimated at P1,504,000.
Actual warranty costs incurred during the current 2006 fiscal year are as
follows:
Warranty claims honored on 2005 P

sales 416,000
Warranty claims honored on 2006
sales 992,000
Total warranty claims honored P1,408,000
a. P 0 c. P1,504,000
b. P96,000 d. P 512,000
9. Premiums:
To increase sales, Candelaria Company inaugurated a promotional

campaign on June 30, 2006. Candelaria placed a coupon redeemable for
a premium in each package of product sold. Each premium costs P100.
A premium is offered to customers who send in 5 coupons and a remittance
of P30. The distribution cost per premium is P20. Candelaria estimated
that only 60% of the coupons issued will be redeemed. For the six months
ended December 31, 2006, the following is available:
Packages of product sold

160,000
Premiums purchased
16,000
Coupons redeemed
64,000
a. P1,728,000 c. P1,152,000
b. P1,600,000 d. P 576,000
10. Due to Five Six Finance company:

APPLIED AUDITING
Candelaria’s accounting records show that as of December 31, 2006,

P1,280,000 was due to Five Six Finance Company for advances made
against P1,600,000 of trade accounts receivable assigned to the finance
company with recourse.
a. P 0 c. P1,600,000
b. P320,000 d. P1,280,000
Suggested Solution:
Question No. 1
Accounts payable per general ledger P5,440,000

Debit balances in suppliers' accounts 240,000
Goods in transit on 12/31/06, FOB shipping 192,000
point
Unrecorded purchase return
(160,000)
Accounts payable, as adjusted 5,712,000
Accrued janitorial expenses (P144,000 x 96,000
2/3)
Accrued utilities (P67,200 x 15/30)
33,600
Total P5,841,600
Question No. 2
Accrued salaries and wages P776,000

Income taxes withheld 56,000
SSS contributions payable 64,000
Philhealth contributions
16,000
Total P912,000
Question No. 3
Midpoint of the range [(P2,000,000 + P3,000,000)/2] P2,500,000
PAS 37 par. 36 states that the amount recognized as a provision should be

the best estimate of the expenditure required to settle the present
obligation at the balance sheet date. Par. 39 further states that where
there is a continuous range of possible outcomes, and each point in that
range is a likely as any other, the mid-point of the range is used.
Question No. 4
B = 10% (P9,600,000 - B - T)
T = 30% (P9,600,000 - B)
APPLIED AUDITING
T = P2,880,000 - .3B
B = 10% [P9,600,000 - B - (P2,880,000 - .3B)]

B = 10% (P9,600,000 - B - P2,880,000 + .3B)
B = 10% (P6,720,000 - .7B)
B = P672,000 - .07B
1.07B = P672,000
B = P628,000 (rounded off)
Question No. 5
Principal amount due, 10/1/07 P800,000

Accrued interest payable (P1,600,000 x 18%
x 3/12) 72,000
Total P872,000
Question No. 6
Estimated liability for purchase commitment

[320,000 x (P5 - P4.40)] P192,000
Question No. 7
PAS 1 par. 70 states that when an entity presents current and non-current
assets, and current and non-current liabilities, as separate classifications
on the face of the balance sheet, it shall not classify deferred tax assets
(liabilities) as current assets (liabilities).
Question No. 8

Add warranty expense accrued during 2006 1,504,000
Total 1,920,000
Less payments during 2006 1,408,000
Question No. 9
Estimated coupons to be redeemed (160,000 96,000

x 60%)
Less coupons redeemed
64,000
Coupons outstanding 32,000
Divide by exchange rate
5
Premiums to be issued 6,400
Multiply by net premium cost
(P100+P20-P30) P90
APPLIED AUDITING
Estimated liability for coupons, 12/31/06 P576,000
Question No. 10
This transaction involves assignment of accounts receivable, wherein the

company obtained a loan using the receivables as security. Accounts
receivable – assigned will be included in trade and other receivables, while
the related loan will be reported under current liabilities.
Answers: 1) D; 2) D; 3) D; 4) D, 5) D; 6) D; 7) D; 8) D; 9) D;
10) D
PROBLEM NO. 3
In your initial audit of Infanta Finance Co., you find the following ledger account
balances.
Debit Credit
12%, 25-year Bonds Payable, 2002
issue
01/01/2002 P6,400,000
Treasury Bonds
10/01/2006 P864,000
Bond Premium
01/01/2002 320,000
Bond Interest Expense

01/01/2006 P384,000
07/01/2006 384,000
The bonds were redeemed for permanent cancellation on October 1, 2006 at

105 plus accrued interest.
QUESTIONS:
Based on the above and the result of your audit, determine the following: (Use
straight line method to amortize premium or discount)
1. The adjusted balance of bonds payable as of December 31, 2006 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, 2006 is

a. P320,000 c. P256,000
b. P224,000 d. P235,200
APPLIED AUDITING
3. The total bond interest expense for the year 2006 is

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
Suggested Solution:
Question No. 1
Total bonds issued P6,400,000

Face value of bonds retired
{P864,000/[1.05 + (.12 x 3/12)]}
800,000
Adjusted balance of bonds payable, P5,600,000
12/31/06
Question No. 2
Unamortized bond premium, 12/31/06

(P320,000 x 8/64 x 20/25) P224,000
Question No. 3
Nominal interest:
Remaining bonds (P5,600,000 x P672,000
12%)
Bonds retired (P800,000 x 12% x P744,000
9/12) 72,000
Less premium amortization:
Remaining bonds (P320,000/25 x 11,200
14/16)
Bonds retired (P320,000/25 x 2/16
x 9/12) 1,200 12,400
Bond interest expense P731,600
Question No. 4
Retirement price (P800,000 x 1.05) P840,000

Carrying amount of bonds retired:
Face value P800,000
Unamortized bond premium
(P320,000 x 8/64 x 20.25/25) 832,400
32,400
Loss on bond redemption P 7,600
APPLIED AUDITING
Answers: 1) C; 2) B; 3) C; 4) A
PROBLEM NO. 4
In connection with the audit of the company’s financial statements for the year
ended December 31, 2006 the Lucban Corporation presented to you their
records. This is the first time the company has been audited. The company
issued serial bonds on April 1, 2003. Your audit showed the following details
of the issue and the accounts as of December 31, 2006:
Total face value P2,000,000

Date of bond March 1, 2002
Total proceeds P2,656,000
Interest rate 12% per annum
Interest payment date March 1
Maturity dates and amount:
Date of maturity Amount

March 1, 2006 P 500,000
March 1, 2007 500,000
March 1, 2008 500,000
March 1, 2009
500,000
P2,000,000
Since the corporation had excess cash, bonds of P500,000 scheduled to be

retired on March 1, 2008 were retired on April 1, 2006. The total amount paid
was charged to serial bonds payable account.
Serial Bonds Payable

3/01/2006 VR P500,000 4/01/2003 CR P2,656,000
4/01/2006 VR P495,000
Accrued Interest Payable

01/01/2006 GJ P200,000
Interest Expense
3/01/2006 VR P240,000
QUESTIONS:
Based on the information presented above and the result of your audit, answer
the following: (Use bond outstanding method to amortize premium or discount)
APPLIED AUDITING
1. The adjusted balance of the bonds payable account as of December 31,

2006 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, 2006 should be

a. P66,642 c. P 84,000
b. P82,444 d. P104,000
3. The accrued interest payable as of December 31, 2006 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 2006 is
a. P55,264 c. P63,801
b. P58,000 d. P59,611
5. The gain on early retirement of bonds is

a. P79,000 c. P81,170
b. P77,722 d. P 0
Suggested Solution:
Question No. 1
Total bonds issued P2,000,000

Bonds retired, 3/1/06 (500,000)
Bonds retired, 4/1/06
(500,000)
Adjusted balance of bonds payable, P1,000,000
12/31/06
Question No. 2

Less accrued interest payable
(P2,000,000 x 12% x 1/12) 20,000
Issue price 2,636,000
Less face value 2,000,000
Total bond premium 636,000
Less:
Amortization:
Prior years (2003 to 2005) P396,000
Current year (2006):
Bonds retired on
maturity (P500,000 P6,000
x .006 x 2 mos.)
Bonds retired prior to
APPLIED AUDITING
maturity (P500,000 9,000

x .006 x 3 mos.)
Remaining bonds
(P1,000,000 x .006 x 72,000 87,000 483,000
12 mos.)
Unamortized premium
cancelled on bonds retired
prior to maturity
(P500,000 x .006 x 23 69,000
mos.)
Unamortized bond premium, 12/31/06 P 84,000
Computation of amortization rate:
Bond Premium
Yea Period covered outstandin Mos Peso months amort.*
r g .
2003 04/01-12/31 P2,000,000 9 P 18,000,000 P108,000
2004 01/01/-12/31 2,000,000 12 24,000,000 144,000
2005 01/01-12/31 2,000,000 12 24,000,000 144,000
2006 01/01-02/28 2,000,000 2 4,000,000 24,000
03/01-12/31 1,500,000 10 15,000,000 90,000
2007 01/01-02/28 1,500,000 2 3,000,000 18,000
03/01-12/31 1,000,000 10 10,000,000 60,000
2008 01/01-02/28 1,000,000 2 2,000,000 12,000
03/01-12/31 500,000 10 5,000,000 30,000
2009 01/01-02/28 2
500,000 1,000,000 6,000
P106,000,000 P636,000
Amortization rate = P636,000/P106,000,000 = .006

* Peso months x .006
Question No. 3
Accrued interest payable, 12/31/06

(P1,000,000 x 12% x 10/12) P100,000
Question No. 4
Nominal interest:
Remaining bonds (P1,000,000 x 12%) P120,000
Bonds retired on maturity (P500,000 x 12% x 10,000
2/12)
Bonds retired prior to maturity (P500,000 x 15,000
12% x 3/12)
145,000
APPLIED AUDITING
Less premium amortization for 2006 (see no. 2) 87,000

Interest expense in 2006 P 58,000
Question No. 5
Retirement price (P500,000 x .98) P490,000

Carrying amount of bonds retired:
Face value P500,000
Add unamortized bond premium,
(P500,000 x .006 x 23 mos.) 569,000
69,000
Gain on early retirement of bonds P 79,000
Answers: 1) D; 2) C; 3) C; 4) B, 5) A
PROBLEM NO. 5
On January 2, 2005, the Mauban, Inc. issued P2,000,000 of 8% convertible

bonds at par. The bonds will mature on January 1, 2009 and interest is
payable annually every January 1. The bond contract entitles the
bondholders to receive 6 shares of P100 par value common stock in exchange
for each P1,000 bond. On the date of issue, the prevailing market interest
rate for similar debt without the conversion option is 10%.
On December 31, 2006, the holders of the bonds with total face value of
P1,000,000 exercised their conversion privilege. In addition, the company
reacquired at 110, bonds with a face value of P500,000.
The balances in the capital accounts as of December 31, 2005 were:
Common stock, P100 par, authorized 50,000

shares, issued and outstanding, 30,000 P3,000,000
shares
Premium on common stock 500,000
Market value of the common stock and bonds were as follows:
Date Bonds Common

stock
January 1, 2006 118 40
December 31, 110 42
2006
QUESTIONS:
Based on the above and the result of your audit, answer the following: (Round
off present value factors to 4 decimal places)
APPLIED AUDITING
1. How much of the proceeds from the issuance of convertible bonds should
be allocated to equity?
a. P634,000 c. P126,816
b. P221,664 d. P 0
2. How much is the carrying value of the bonds payable as of December 31,
2005?
a. P2,000,000 c. P1,389,400
b. P1,796,170 d. P1,900,502
3. How much is the interest expense for the year 2006?

a. P160,000 c. P138,940
b. P179,617 d. P190,050
4. The conversion of the bonds on December 31, 2006 will increase equity by
a. P365,276 c. P400,000
b. P307,893 d. P 0
5. How much is the loss on bond reacquisition on December 31, 2006?

a. P50,000 c. P96,053
b. P67,362 d. P 0
Suggested Solution:
Question No. 1

Less liability component:
Present value of the principal
(P2,000,000 x 0.6830) P1,366,00
0
Present value of the interest
[(P2,000,000 x 8% x 1,873,184
3.1699) 507,184
Equity component P 126,816
PAS 32 par. 29 states that an entity recognizes separately the components

of a financial instrument that (a) creates a financial liability of the entity and
(b) grants an option to the holder of the instrument to convert it into an
equity instrument of the entity. Par. 31 further states that equity
instruments are instruments that evidence a residual interest in the assets
of an entity after deducting all of its liabilities. Therefore, when an 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.
Question No. 2
APPLIED AUDITING

Add discount amortization for
2005:
Effective interest (P1,873,184 x P187,318
10%)
Nominal interest (P2,000,000 x 160,000
8%) 27,318
Question No. 3
Effective interest (P1,900,502 x 10%) P190,050
Question No. 4
Journal entry to record the conversion
Bonds Payable P1,000,000

Discount on bonds payable
(P1,000,000 - P965,276) P 34,724
Common stock 600,000
APIC 365,276
Carrying amount of bonds converted (P1,930,552* P965,276

x 1/2)
Less par value of common stock received
(P1,000,000/P1,000 x 6 x P100)
600,000
Amount to be credited to APIC P365,276

Add discount amortization for
2006:
Effective interest (P1,900,502 x P190,050
10%)
Nominal interest (P2,000,000 x 160,000
8%) 30,050
Carrying value, 12/31/06 P1,930,552*
Question No. 5
Reacquisiton price (P500,000 x 110%) P550,000

Carrying value of bonds reacquired (P1,930,552 482,638
x 1/4)
Loss on early retirement of bonds P 67,362
APPLIED AUDITING
Answers: 1) C; 2) D; 3) D; 4) A, 5) B
PROBLEM NO. 6
The noncurrent liabilities of Pitogo Company at December 31, 2005 included

the following:
Note payable, bank P3,600,000

Liability under finance lease 2,623,200
Note payable, supplier 1,500,000
Transactions during 2006 and other information relating to Pitogo’s liabilities

were as follows:
a) The note payable to the bank bears interest at 20% and is dated May, 1,
2005. The principal amount of P3,600,000 is payable in four equal annual
installments of P900,000 beginning May 1, 2006. The first principal and
interest payment was made on May 1, 2006.
b) The finance lease is for a ten-year period. Equal annual payments of

P750,000 are due on December 31, of each year. The interest rate implicit
in the lease is 18%. The amount of P2,623,200 represents the present
value of the six remaining lease payments (due December 31, 2006
through December 31, 2011) discounted at P18%.
c) The note payable to supplier bears interest at 19% and matures on

September 30, 2007. On February 25, 2007, after the December 31,
2006 balance sheet date, but before the 2006 statements were authorized
for issue, Pitogo Company consummated a noncancelable agreement with
a lender to refinance the 19%, P1,500,000 on a long-term basis, on readily
determinable terms that have not yet been implemented. Both parties are
financially capable of honoring the agreement, and there have been no
violations of the agreement’s provisions.
d) On April 1, 2006, Pitogo issued for P7,005,675, P6,000,000 face amount of

its 20%, P100,000 bonds. The bonds were issued to yield 15%. The bonds
are dated April 1, 2006 and mature on April 1, 2011. Interest is payable
annually on April 1.
QUESTIONS:
1. Liability under finance lease as of December 31, 2006

a. P1,873,200 c. P2,017,544
b. P2,345,376 d. P1,123,200
APPLIED AUDITING
2. Carrying amount of bonds payable as of December 31, 2006

a. P6,893,813 c. P6,856,527
b. P7,417,536 d. P7,117,536
3. Total noncurrent liabilities as of December 31, 2006

a. P12,211,357 c. P10,711,357
b. P10,154,190 d. P9,817,014
4. Current portion of long-term liabilities as of December 31, 2006

a. P3,150,000 c. P2,727,832
b. P2,812,824 d. P2,169,864
5. Total interest expense for the year 2006

a. P2,145,314 c. P1,673,139
b. P2,408,028 d. P1,673,139
Suggested Solution:
Question No. 1
Liability under finance lease, 1/1/06 P2,623,200

Less principal payment on
12/31/06:
Total payment P750,000
Less applicable to interest
(P2,623,200 x 18%) 472,176
277,824
Liability under finance lease, P2,345,376
12/31/06
Question No. 2

Less premium amortization:
Nominal interest
(P6,000,000 x 20% x 9/12) P900,000
Effective interest
(P7,005,675 x 15% x 9/12) 788,138
111,862
Question No. 3
20% Note payable, bank

Balance, 12/31/06 P2,700,000
(P3,600,000 -
P900,000)
Less installment due, P1,800,000
APPLIED AUDITING
4/1/07 900,000
Liability under finance
lease:
Balance, 12/31/06 (see 2,345,376
no. 1)
Less principal payment
due on 12/31/07:
Less applicable to
interest 2,017,544
(P2,345,376 x 422,168 327,832
18%)
20% bonds payable due
4/1/11 (see no. 2) 6,893,813
Total noncurrent
liabilities, 12/31/06 P10,711,357
Question No. 4
20% Note payable, bank - due 4/1/07 P

900,000
Finance lease liability - principal payment 327,832
due on 12/31/07 (see no. 3)
19% Note payable, bank - due 9/30/07
1,500,000
Current portion of long-term liabilities, P2,727,832
12/31/06
The Note payable to supplier was classified as current liability since it is

due within 12 months after balance sheet date and the entity does not have
an unconditional right to defer settlement of the liability for at least 12
months after the BS date (even if an agreement to refinance on a long term
basis is completed after the BS date and before the FS are authorized for
issue – such an agreement would qualify for disclosure as a non-adjusting
event after the BS date in accordance with PAS 10).
Question No. 5
20% Note payable, bank

1/1 to 4/30 (P3,600,000 x 20% x P240,00
4/12) 0
5/1 to 12/31(P2,700,000 x 20% x P 600,000
8/12) 360,000
Liability under finance lease (see no. 1) 472,176
20% bonds payable see no. 2) 788,138
19% Note payable, bank (P1,500,000 x 285,000
19%)
Total interest expense in 2006 P2,145,314
APPLIED AUDITING
Answers: 1) B; 2) A; 3) C; 4) C, 5) A
PROBLEM NO. 7
Real Inc. leases equipment to its customers under noncancelable leases. On

January 1, 2006, Real leased equipment costing P4,000,000 to Quezon Co.,
for nine years. The rental cost was P440,000 payable in advance
semiannually (January 1 and July 1), plus P20,000 semiannually for executory
costs. The equipment had an estimated life of 15 years and sold for
P5,330,250 with an estimated unguaranteed residual value of P800,000. The
implicit interest rate is 12 percent.
QUESTIONS:
1. How much is the total interest income from lease that will be earned by
Real, Inc.?
a. P2,869,988 c. P3,675,616
b. P3,389,748 d. P 0
2. Real, Inc. should report profit on the sale at

a. P1,330,252 c. P1,050,012
b. P1,044,384 d. P1,338,492
3. How much should be reported by Quezon Co. as liability under finance

lease as of December 31, 2006?
a. P4,143,593 c. P4,273,410
b. P4,446,613 d. P 0
4. How much should be reported by Quezon Co. under current liabilities as

liability under finance lease as of December 31, 2006?
a. P356,798 c. P394,252
b. P378,207 d. P 0
5. How much interest expense should be reported by Quezon Co. in relation

to the lease for the year ended December 31, 2006?
a. P508,064 c. P543,398
b. P501,793 d. P 0
Suggested Solution:
Question No. 1
Gross investment in the lease:

Minimum lease payments P7,920,00
(P440,000 x 18)
Unguaranteed residual value P8,720,000
800,000
APPLIED AUDITING
Net investment in the lease:

PV of minimum lease payments
(P440,000 x 11.4773) 5,050,012
PV of unguaranteed residual
value
(P800,000 x 0.3503) 280,240 5,330,252
Total unearned interest income P3,389,748
Question No. 2
Sales (present value of MLP) P5,050,012

Less cost of sales (P4,000,000 - P280,240)
3,719,760
Profit on sale P1,330,252
Question No. 3
Finance lease liability (P440,000 x 11.4773) P5,050,012

Less lease payment, 1/1/06
440,000
Balance, 1/1/06 4,610,012
Less principal payment on 7/1/06:
Applicable to interest
(P4,610,012 x 12% x 6/12)
276,601 163,399
Balance, 12/31/06 P4,446,613
The lease will be accounted for as finance lease because the present value
of the minimum lease payments amount to substantially all of the fair value
of the leased asset at the inception of the lease. (P5,050,012/P5,330,250 =
95%).
Question No. 4
Principal payment due, 1/1/07:

(P4,446,613 x 12% x 6/12) P173,203
266,797
Principal payment due, 7/1/07:
[(P4,446,613 - P173,203) x 12% x 183,595
6/12] 256,405
Current portion of finance lease
liability, 12/31/06 P356,798
APPLIED AUDITING
Question No. 5
1/1/06 to 6/30/06 (P4,610,012 x 12% x 6/12) P276,601

7/1/06 to 12/31/06 (P4,446,613 x 12% x 6/12) 266,797
Total interest expense P543,398
Answers: 1) B; 2) A; 3) B; 4) A, 5) C
PROBLEM NO. 8
The following information relates to the defined benefit pension plan of the
Tiaong Company as of January 1, 2005:
Projected benefit obligation (PBO) P16,150,000

Fair value of plan assets 15,135,000
Unrecognized prior service cost 1,050,000
Unrecognized net pension gain or 0
loss
Pension data for the years 2005 and 2006 follows:
2005 2006
Current service cost P 870,000 P1,150,000
Contributions to the plan 1,200,000 1,250,000
Benefits paid to retirees 1,320,000 1,400,000
Actual return on plan assets 263,500 1,800,000
Amortization of past service cost 210,000 186,667
Actuarial change increasing PBO 800,000 -
Settlement interest rate 11% 11%
Long-term expected rate of return
on plan assets 10% 10%
As of January 1, 2006, the remaining expected service life of employees was 5

years.
QUESTIONS:
Based on the above and the result of your audit, answer the following.
1. What is the 2005 net benefit expense?

a. P2,593,000 c. P1,200,000
b. P4,370,000 d. P1,343,000
2. The projected benefit obligation as of December 31, 2005 is

a. P18,276,500 c. P17,476,500
b. P16,973,000 d. P16,173,000
APPLIED AUDITING
3. The prepaid/accrued benefit cost on December 31, 2005 is

a. P1,358,000 c. P108,000
b. P3,135,000 d. P 0
4. What is the 2006 net benefit expense?

a. P1,863,702 c. P1,547,082
b. P1,250,000 d. P1,819,232
5. The prepaid/accrued benefit cost on December 31, 2006 is

a. P 0 c. P1,655,082
b. P3,143,302 d. P 721,702
Suggested Solution:
Question No. 1
Current service cost P 870,000

Interest cost (P16,150,000 x 11%) 1,776,500
Expected return on plan assets (1,513,500)
(P15,135,000 x 10%)
Amortization of past service cost
210,000
Net benefit expense for 2005 P1,343,000
Question No. 2
Projected benefit obligation, 1/1/05 P16,150,000

Current service cost 870,000
Interest cost (P16,150,000 x 11%) 1,776,500
Actuarial change increasing PBO 800,000
Benefits paid to retirees
(1,320,000)
Projected benefit obligation, 12/31/05 P18,276,500
Question No. 3
Debits
Fair value of plan assets, 12/31/05
Fair value of plan assets, 1/1/05 P15,135,000
Contributions to the plan 1,200,000
Actual return on plan assets 263,500
Benefits paid to retirees P15,278,500
(1,320,000)
Unrecognized prior service cost,
12/31/05 (P1,050,000 - P210,000) 840,000
Unrecognized net pension loss,
12/31/05
Difference between expected and
APPLIED AUDITING
actual return on plan assets

(P1,513,500 - P263,500) 1,250,000
Actuarial change increasing PBO 2,050,000
800,000
18,168,500
Credit
Projected benefit obligation, 12/31/05 (see no. 2) 18,276,500
Prepaid (Accrued) pension cost, (P108,000)

12/31/05
Alternative computation:
Debits
Fair value of plan assets, 1/1/05 P15,135,000
Unrecognized prior service cost, 1,050,000
1/1/05
16,185,000
Credit
Projected benefit obligation, 1/1/05 16,150,000
Prepaid (Accrued) pension cost, P 35,000

1/1/05
Prepaid (Accrued) pension cost, P 35,000

1/1/05
Underfunding in 2005:
Contributions to the plan P1,200,000
Net benefit expense (see no. 1) (143,000)
1,343,000
12/31/05
Question No. 4
Current service cost P1,150,000

Interest cost (P18,276,500 x 11%) 2,010,415
Expected return on plan assets
(P15,278,500 x 10%) (1,527,850)
Amortization of past service cost 186,667
Amortization of unrecognized net
pension loss:
Unrecognized net pension loss, P2,050,000
1/1/06
Less corridor (P18,276,500 x
10%) 1,827,650
Excess
222,350
Divide by remaining service life
APPLIED AUDITING
5 44,470
Net benefit expense for 2006 P1,863,702
Question No. 5

1/1/06
Underfunding in 2006:
Contributions to the plan P1,250,000
Net benefit expense (see no. 4) (613,702)
1,863,702
12/31/06
Answers: 1) D; 2) A; 3) C; 4) A, 5) D
PROBLEM NO. 9
1. A client's purchasing system ends with the assumption of a liability and the
eventual payment of the liability. Which of the following best describes the
auditor's primary concern with respect to liabilities resulting from the
purchasing system?
A. Commitments for all purchases are made only after established
competitive bidding procedures are followed.
B. Accounts payable are not materially understated.
C. Authority to incur liabilities is restricted to one designated person.
D. Acquisition of materials is not made from one vendor or one group of
vendors.
2. Which of the following functions is not appropriate for the accounts payable
department?
a. Prepare purchase orders.
b. Prepare voucher and daily summary.
c. File voucher package by due date.
d. Compare purchase requisitions, purchase orders, receiving reports, and
vendors' invoices.
3. In a properly designed accounts payable system, a voucher is prepared

after the invoice, purchase order, requisition, and receiving report are verified.
The next step in the system is to
A. Post the voucher amount to the expense ledger.
B. Cancel the supporting documents.
C. Enter the check amount in the check register.
D. Approve the voucher for payment.
4. Which of the following would be the best procedure to determine whether

purchases were properly authorized?
APPLIED AUDITING
A. Discuss authorization procedures with personnel in the controller's and

purchasing functions.
B. Review and evaluate a flowchart of purchasing procedures.
C. Determine whether a sample of entries in the purchase journal is supported
by properly executed purchase orders.
D. Vouch payments for selected purchases to supporting receiving reports.
5. In conducting a search for unrecorded liabilities, the auditor should do all

but the following:
a. Examine prior year's audit workpapers to ascertain that adjustments for
unrecorded liabilities have not been overlooked.
b. Examine invoices paid a few days prior to the balance sheet date.
c. Examine paid invoices for a short period following the balance sheet date
and trace to client's year-end adjustment for unrecorded liabilities.
d. Examine unpaid invoices for a short period following the balance sheet
date and trace to client's year-end adjustment for unrecorded liabilities.
6.An audit procedure applicable to testing the year-end cutoff of liabilities is

a. Reviewing the general journal for unusual entries recorded immediately
after year-end.
b. Examining vendor invoices received subsequent to year-end for shipment
date and terms of shipment.
c. Tracing recorded liabilities to supporting documents.
d. Preparing an aging schedule for accounts payable.
7. An auditor usually examines receiving reports to support entries in the

a. Sales journal and sales returns journal.
b. Check register and sales journal.
c. Voucher register and sales journal.
d. Voucher register and sales returns journal.
8. Which of the following is not used to test overstatements and

understatements of accounts payable?
a. Unmatched receiving reports.
b. Canceled voucher packages.
c. Cash receipts records.
d. Cash disbursement records.
9. During the course of an audit, an auditor observes that the recorded interest
expense seems excessive in relation to the balance in long-term debt.
This observation could lead the auditor to suspect that
a. Long-term debt is overstated.
b. Long-term debt is understated.
c. Premium on bonds payable is understated.
d. Discount on bonds payable is overstated.
10. An auditor's program to examine long-term debt most likely would include
steps that require
a. Correlating interest expense recorded for the period with outstanding debt.
APPLIED AUDITING
b. Inspecting the accounts payable subsidiary ledger for unrecorded

long-term debt.
c. Comparing the carrying amount of the debt to its year-end market value.
d. Verifying the existence of the holders of the debt by direct confirmation.
Answers: 1) B; 2) A; 3) D; 4) C, 5) B; 6) B; 7) D; 8) C; 9) B;
10) A
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Reference:
APPLIED AUDITING
CHAPTER 8
AUDIT OF STOCKHOLDERS’ EQUITY
Objective
1. Solving Audit of Stockholders’ Equity Problems
2. Theory of Audit of Stockholders’ Equity
PROBLEM NO. 1
Alcoy Corporation’s post-closing trial balance at December 31, 2006 was as

follows:
Alcoy Corporation
Post-Closing Trial Balance
December 31, 2006
Debit Credit
Accounts payable P 495,000
Accounts receivable P
963,000
Reserve for depreciation 360,000
Reserve for doubtful accounts 54,000
Premium on common stock 1,800,000
Gain on sale of treasury stock 450,000
Bonds payable 720,000
Building and equipment 1,980,000
Cash 396,000
Cash dividends payable on preferred 7,200
stock
Common stock (P1 par value) 270,000
Inventories 1,116,000
APPLIED AUDITING
Land 684,000
Available-for-sale securities at fair 513,000
value
Trading securities at fair value 387,000
Net unrealized loss on
available-for-sale securities 45,000
Preferred stock (P50 par value) 900,000
Prepaid expenses 72,000
Donated capital 800,000
Stock warrants outstanding 208,000
Retained earnings 415,800
Treasury stock – common, at cost
324,000
Totals P6,480,000 P6,480,000
At December 31, 2006, Alcoy had the following number of common and
preferred shares:
Common Preferred
Authorized 900,000 90,000
Issued 270,000 18,000
Outstanding 252,000 18,000
The dividends on preferred stocks are P0.40 cumulative. In addition, the

preferred stock has a preference in liquidation of P50 per share.
QUESTIONS:
Based on the above and the result of your audit, determine the following as of
December 31, 2006:
1. Additional paid-in capital

a. P3,213,000 c. P3,050,000
b. P3,258,000 d. P2,600,000
2. Total contributed capital

a. P4,428,000 c. P3,770,000
b. P4,220,000 d. P1,170,000
3. Unappropriated retained earnings

a. P415,800 c. P91,800
b. P739,800 d. P37,800
4. Total stockholders’ equity

a. P4,266,800 c. P4,888,800
b. P4,519,800 d. P4,474,800
Suggested Solution:
APPLIED AUDITING
Question No. 1
Premium on common stock P1,800,000

Gain on sale of treasury stock 450,000
Donated capital 800,000
Stock warrants outstanding
208,000
Total additional paid-in capital P3,258,000
Question No. 2
Preferred stock (P50 par value) P 900,000

Common stock (P1 par value) 270,000
Additional paid-in capital (see no. 1) 3,258,000
Total contributed capital P4,428,000
Question No. 3
Total retained earnings P415,800

Less appropriation for treasury stock 324,000
Unappropriated retained earnings P 91,800
Question No. 4
Total contributed capital (see no. P4,428,000

2)
Retained earnings:
Unappropriated (see no. 3) P 91,800
Appropriated for treasury 324,000
stock 415,800
Total 4,843,800
Less : Treasury stock 324,000
Net unrealized loss
on AFS 45,000 369,000
Total stockholders equity P4,474,800
Answers: 1) B; 2) A; 3) C; 4) D
PROBLEM NO. 2
Your audit client, Argao, Inc., is a public enterprise whose shares are traded in
the over-the-counter market. At December 31, 2005, Argao had 3,000,000
authorized shares of P10 par value common stock, of which 1,000,000 shares
were issued and outstanding. The stockholders’ equity accounts at
December 31, 2005 had a following balances.
Common stock P10,000,000

Additional paid-in capital 3,750,000
APPLIED AUDITING
Retained earnings 3,250,000
Transactions during 2006 and other information relating to the stockholders’

equity accounts were as follows:
 On January 2, 2006, Argao issued at P54 per share, 50,000 shares of P50
par value, 9% cumulative convertible preferred stock. Each share of
preferred stock is convertible into two shares of common stock. Argao
had 300,000 authorized shares of preferred stock. The preferred stock
has a liquidation value equal to its par value.
 On February 1, 2006, Argao reacquired 10,000 shares of its common stock

for P16 per share.
 On April 30, 2006, Argao sold 250,000 shares (previously unissued) of P10
par value common stock to the public at P17 per share.
 On June 15, 2006, Argao declared a cash dividend of P1 per share of

common stock, payable on July 15, 2006, to stockholders of record on July
1, 2006.
 On November 10, 2006, Argao sold 5,000 shares of treasury stock for P21
per share.
 On December 15, 2006, Argao declared the yearly cash dividend on

preferred stock, payable on January 15, 2007, to stockholders of record on
December 31, 2006.
 On January 20, 2007, before the books were closed for 2006, Argao
became aware that the ending inventories at December 31, 2005 were
understated by P150,000 (after tax effect on 2005 net income was
P90,000). The appropriate correction entry was recorded the same day.
 After correcting the beginning inventory, net income for 2006 was
P2,250,00.
QUESTIONS:
December 31, 2006:

a. P5,700,000 c. P5,500,000
b. P5,525,000 d. P5,725,000
2. Unappropriated retained earnings

a. P4,125,000 c. P4,045,000
b. P4,035,000 d. P3,955,000
APPLIED AUDITING
3. Treasury stock
a. P160,000 c. P55,000
b. P 80,000 d. P50,000

a. P22,190,000 c. P24,690,000
b. P24,770,000 d. P24,840,000
5. Book value per share of common stock

a. P17.89 c. P17.71
b. P17.82 d. P15.41
Suggested Solution:
Preferred stock P
2,500,000
Additional paid in capital 5,725,000 (1)
Retained earnings:
Appropriated P
80,000
Unappropriated 4,045,000 4,125,000 (2)
Treasury stock (3)
( 80,000
)
Total SHE, 12/31/06 P24,770,000 (4)
Prepare T-accounts for each component of the stockholders’ equity.

Place the balances as of January 1, 2006, journalize the transactions
affecting the SHE accounts, post the entries to the affected accounts, then
extract the balances.
Journal entries affecting the stockholders equity accounts during 2006:
1/2 Cash (50,000 shares x P54) P2,700,000

Preferred stock (50,000 shares x P50) P2,500,000
APIC - excess over par of preferred stock 200,000
2/1 Treasury stock (10,000 x P16) P 160,000

Cash
P 160,000
4/30 Cash (250,000 shares x P17) P4,250,000

Common stock (250,000 shares x P10) P2,500,000
APIC - excess over par of common stock 1,750,000
6/15 Retained earnings P1,240,000*

APPLIED AUDITING
Dividends payable - common P1,240,000
* [(1,000,000 + 250,000 – 10,000) x P1]
11/10 Cash (5,000 shares x P21) P 105,000

Treasury stock (5,000 shares x P16)
P80,000
APIC - from treasury stock transactions 25,000
12/15 Retained earnings (2,500,000 x 9%) P 225,000

Dividends payable - preferred P225,000
12/31 Inventory, 1/1/06 P 150,000

Retained earnings P 90,000
Income tax payable 60,000
12/31 Income summary P2,250,000

Retained earnings P2,250,000
12/31 Retained earnings P 80,000

Retained earnings - appropriated (cost of TS) P 80,000
Question No. 5
Total stockholders' equity (see no. 4) P24,770,000

Less liquidation value of preferred stock 2,500,000
Common stockholders' equity 22,270,000
Divide by common shares outstanding 1,245,000
Book value per share of common stock P 17.89
Answers: 1) D; 2) C; 3) B; 4) B, 5) A
PROBLEM NO. 3
The stockholders’ equity section of the Asturias Inc. showed the following data
on December 31, 2005: Common stock, P3 par, 300,000 shares authorized,
250,000 shares issued and outstanding, P750,000; Paid-in capital in excess of
par, P7,050,000; Additional paid-in capital from stock options, P150,000;
Retained earnings, P480,000. The stock options were granted to key
executives and provided them the right to acquire 30,000 shares of common
stock at P35 per share. Each option has a fair value of P5 at the time the
options were granted.
The following transactions occurred during 2006:

APPLIED AUDITING
Feb. Key executives exercised 4,500 options outstanding at

1 December 31, 2005. The market price per share was
P44 at this time.
Apr. The company issued bonds of P2,000,000 at par,

1 giving each P1,000 bond a detachable warrant
enabling the holder to purchase two shares of stock at
P40 each for a 1-year period. The bonds would sell at
P996 per P1,000 bond without the warrant.
July The company issued rights to stockholders (one right

1 on each share, exercisable within a 30-day period)
permitting holders to acquire one share at P40 with
every 10 rights submitted. All but 6,000 rights were
exercised on July 31, and the additional stock was
issued.
Oct. All warrants issued in connection with the bonds on

1 April 1 were exercised.
Dec. The market price per share dropped to P33 and options
1 came due. Because the market price was below the
option price, no remaining options were exercised.
Dec. Net income for 2006 was P250,500.

31
QUESTIONS:
December 31, 2006:
1. Common stock
a. P777,300 c. P833,850
b. P848,700 d. P850,050
2. Total additional paid-in capital

a. P7,522,200 c. P8,219,650
b. P8,402,800 d. P8,419,450
3. Total contributed capital

a. P8,299,500 c. P9,269,500
b. P9,053,500 d. P9,251,500
4. Retained earnings
a. P580,500 c. P730,500
b. P858,000 d. P654,150

a. P10,000,000 c. P9,030,000
APPLIED AUDITING
b. P 9,784,000 d. P9,982,000
Suggested Solution:
Common stock P (1)

850,050
Additional paid in capital (2)
8,419,450
Contributed capital 9,269,500 (3)
Retained earnings (4)
730,500
Total SHE, 12/31/06 P10,000,000 (5)
Note: Follow the same approach in Problem no. 2.
2/1 Cash (4,500 options x P35) P 157,500

APIC-stock options (4,500 x P5) 22,500
Common stock (4,500 shares x P3) P 13,500
APIC - excess over par 166,500
4/1 Cash P2,000,000

Bond discount [P2,000,000-(2,000xP996)] 8,000
Bonds payable
P2,000,000
APIC-stock warrants
8,000
7/1 Memorandum: Issued rights to shareholders permitting holder to

acquire for a 30-day period one share at P40 with every 10 rights
submitted - a maximum of 25,450 shares (254,500 shares ÷ 10).
7/31 Cash {[25,450 - (6,000/10)] x P40} P 994,000

10/1 Cash (2,000 x 2 x P40) P 160,000

APIC-stock warrants 8,000
Common stock (2,000 shares x 2 x P3) P12,000
12/1 APIC-stock options [P150,000-(4,500xP5)] P 127,500

APIC - expired stock options P127,500
12/31 Income summary P 250,500

Retained earnings P250,500
APPLIED AUDITING
Answers: 1) D; 2) D; 3) C; 4) C, 5) A
PROBLEM NO. 4
Balamban Corporation was authorized at the beginning of 2004 with 540,000

authorized shares of P100, par value common stock. At December 31, 2004,
the stockholders’ equity section of Balamban was as follows:
Common stock, par value P100 per share;

authorized 540,000 shares; issued 54,000 P5,400,000
shares
Additional paid-in capital 540,000
Retained earnings
810,000
Total stockholders’ equity P6,750,000
On May 10, 2005, Balamban issued 90,000 shares of its common stock for
P10,800,000. A 5% stock dividend was declared on September 30, 2005 and
issued on November 10, 2005 to stockholders of record on October 31, 2005.
Market value of common stock was P110 per share on declaration date. The
net income of Balamban for the year ended December 31, 2005 was
P855,000.
During 2006, Balamban had the following transactions;
Feb. Balamban reacquired 5,400 shares of its common

15 stock for P95 per share.
May Balamban sold 2,700 shares of its treasury stock for

15 P120 per share.
Jun Issued to stockholders one stock right for each share

30 held to purchase two additional shares of common
stock for P125 per share. The rights expire on
December 31, 2006.
Aug. 45,000 stock rights were exercised when the market

15 value of common stock was P130 per share.
Sep. 72,000 stock rights were exercised when the market

30 value of the common stock was P140 per share.
Dec. Balamban declared a cash dividend of P2 per share

01 payable on January 15, 2007 to stockholders of record
on December 31, 2006.
Dec. Balamban retired 1,800 shares of its treasury stock

15 and reverted them to an unused basis. On this date,
the market value of the common stock was P150 per
APPLIED AUDITING
share.
Dec. Net income for 2006 was P900,000.

31
QUESTIONS:
December 31, 2006:
1. Common stock
a. P38,520,000 c. P38,340,000
b. P26,640,000 d. P38,250,000

a. P8,329,500 c. P5,413,500
b. P8,338,500 d. P8,266,500
a. P1,080,000 c. P1,017,000
b. P1,002,600 d. P1,008,000
4. Treasury stock
a. P18,000 c. P85,500
b. P90,000 d. P0
Suggested Solution:
Common Stock Retained Treasury

APIC Earnings stock
Balances, P 5,400,000 P 540,000 P P 0
1/1/05 810,000
May 10, 9,000,000 1,800,000
2005
Sept. 30, 720,000 72,000 (792,000)
2005
Net
income-200 855,000
5
Balances, 15,120,000 2,412,000 873,000 0
12/31/05
Feb. 15 513,000
May 15 67,500 (256,500)
Aug. 15 9,000,000 2,250,000
Sep. 30 14,400,000 3,600,000
Dec. 01 (765,000)
Dec. 15 (180,000) 9,000 (171,000)
APPLIED AUDITING
Net
income-200 900,000
6
Balances, P38,340,000 P8,338,500 P1,008,000 P 85,500
12/31/06
Answers: 1) C; 2) B; 3) D; 4) C
PROBLEM NO. 5
Bogo Corporation began operations on January 1, 2006. The company was

authorized to issue 60,000 shares of P10 par value common stock and
120,000 shares of 10%, P100 par value convertible preferred stock.
In connection with your audit of the company’s financial statements, you noted
the following transactions involving stockholders’ equity during 2006:
Jan. Issued 1,500 shares of common stock to the

1 corporation promoters in exchange for equipment
valued at P510,000 and services valued at P210,000.
The property costs P270,000 3 years ago and was
carried on the promoters’ books at P150,000.
Jan. Issued 30,000 shares of convertible preferred stock at

31 P150 per share. Each share can be converted to five
shares of common stock. The corporation paid
P225,000 to an agent for selling the shares.
Feb. Sold 9,000 shares of common stock at P390 per share.

15 The corporation paid issue costs of P75,000.
May Received subscriptions for 12,000 shares of common

30 stock at P450 per share.
Aug. Issued 2,100 shares of common stock and 4,200

30 shares of preferred stock in exchanged for a building
with a fair market value of P1,530,000. The building
was originally purchased for P1,140,000 by the
investors and has a book value of P660,000. In
addition, 1,800 shares of common stock were sold for
P720,000 cash.
Nov. Payments in full for half of the subscriptions and partial

15 payments for the rest of the subscriptions were
received. Total cash received was P4,200,000.
Shares of stock were issued for the fully paid
subscriptions. The balance is collectible next year.
Dec. Declared a cash dividend of P10 per share on

APPLIED AUDITING
1 preferred stock, payable on December 31 to

stockholders of record on December 15, and P20 per
share cash dividend on common stock, payable on
January 15, 2007 to stockholders of record on
December 15.
Dec. Paid the preferred stock dividend.

31
Net income for the first year of operations was
P1,800,000.
QUESTIONS:
December 31, 2006:
1. Common stock
a. P204,000 c. P264,000
b. P144,000 d. P186,000
2. Paid-in capital in excess of par value of preferred stock

a. P1,500,000 c. P1,275,000
b. P1,545,000 d. P1,860,000
3. Paid-in capital in excess of par value of common stock

a. P 8,211,000 c. P11,121,000
b. P10,851,000 d. P10,032,000
a. P1,050,000 c. P 930,000
b. P1,170,000 d. P1,458,000

a. P17,295,000 c. P15,810,000
b. P16,950,000 d. P17,010,000
Suggested Solution:
Preferred stock P3,420,000

Common stock 204,000 (1)
Subscribed common 60,000
Additional paid in capital - 1,545,000 (2)
preferred
Additional paid in capital - 10,851,000 (3)
common
Retained earnings (4)
930,000
Total SHE, 12/31/06 P17,010,000 (5)
APPLIED AUDITING
1/1 Equipment P510,000

Organization expenses 210,000
Common stock (1,500 shares x P10) P15,000
APIC - excess over par of CS 705,000
1/31 Cash (30,000 shares x P150) P4,500,000

Preferred stock (30,000 shares x P100) P3,000,000
APIC - excess over par of PS 1,500,000
APIC - excess over par of PS P225,000

Cash P225,000
2/20 Cash (9,000 shares x P390) P3,510,000

APIC - excess over par of CS 3,420,000
APIC - excess over par of CS P75,000

Cash P75,000
5/30 Subscriptions rec. (12,000 sh. x P450) P5,400,000

Subscribed common stock (12,000 shares x P10) P120,000
APIC - excess over par of CS
5,280,000
8/30 Cash P 720,000

APIC - excess over par of CS 702,000
Building P1,530,000
APIC - excess over par of CS
[(2,100 sh x P400*)-21,000] P 819,000
Preferred stock (4,200 shares x P100) P420,000
APIC - excess over par of PS (balance) P 270,000
* (P720,000/1,800 shares)
Note: The fair value of the building should be allocated to the

preferred stock and common stock based on fair values. The
problem did not specifically mention the fair value of the common
stock. However, on the same date the company issued 1,800
common shares for P720,000 cash. Therefore, common shares
were selling at P400/share (P720,000/1,800). Since the fair value of
the preferred stock is not determinable, it will be assigned the residual
amount after deducting the fair value of common stock from the fair
value of the building.
APPLIED AUDITING
11/07 Cash P4,200,000

Subscriptions receivable P4,200,000
Subscribed common stock (120,000 x 1/2) P60,000

Common stock P 60,000
Note: Since the subscriptions receivable is collectible next year, it

will be presented under current assets. Incidentally, if the
subscriptions receivable is not collectible currently, it will be presented
under stockholders’ equity.
12/01 Retained earnings P870,000

Dividends payable - Preferred P 342,000
Dividends payable – Common 528,000
Preferred - (P3,420,000/P100 x P10)

Common - {[(P204,000 + P60,000)/P10] x P20}
Note: Shares issued plus subscribed less treasury shares are

entitled to dividends.
12/31 Income summary P1,800,000

Answers: 1) A; 2) B; 3) B; 4) C, 5) D
PROBLEM NO. 6
The Borbon Corporation has requested you to audit its financial statements for
the year 2006. During your audit, Borbon presented to you its balance sheet
as of December 31, 2005 containing the following capital section:
Preferred stock P10 par; 60,000 shares authorized

and issued, of which 6,000 are treasury shares
costing P90,000 and shown as an asset P 600,000
Common stock, par value P4; 600,000 shares
authorized, of which 450,000 are issued and 1,800,000
outstanding
Additional paid in capital (P5 per share on preferred
stock issued in 2000) 300,000
Allowance for doubtful accounts receivable 12,000
Reserve for depreciation 840,000
Reserve for fire insurance 198,000
Retained earnings 2,250,000
APPLIED AUDITING
1) Of the preferred stock, 3,000 shares were sold for P18 per share on August
30, 2006. Borbon credited the proceeds to the Preferred Stock account.
The treasury shares as of December 31, 2005 were acquired in one
purchase in 2005.
2) The preferred stock carries an annual dividend of P1 per share. The

dividend is cumulative. As of December 31, 2005, unpaid cumulative
dividends amounted to P5 per share. The entire accumulation was
liquidated in June, 2006, by issuing to the preferred stockholders 54,000
shares of common stock.
3) A cash dividend of P1 per share was declared on December 1, 2006 to

preferred stockholders of record December 15, 2006. The dividend is
payable on January 15, 2007.
4) At December 31, 2006, the Allowance for Doubtful Accounts Receivable

and Reserve for Depreciation had balances of P25,000 and P1,050,000,
respectively.
5) On March 1, 2006, the Reserve for Fire Insurance was increased by

P60,000; Retained Earnings was debited.
6) On December 31, 2006, the Reserve for Fire Insurance was decreased by
P30,000, which represents the carrying value of a machine destroyed by
fire on that date. Estimated fire cleanup costs of P6,000 does not appear
on the records.
7) The December 31, 2005 Retained Earnings consists of the following:
Donated land from a stockholder

(Market value on date of donation) P450,000
Gains from treasury stock transactions 51,000
Earnings retained in business 1,749,000
P2,250,000
8) Net income for the year ended December 31, 2006 was P1,297,500 per
company’s records.
QUESTIONS:
balances of the following as of December 31, 2006. (Disregard tax
implications)
1. Total Additional paid-in capital

a. P414,000 c. P810,000
b. P804,000 d. P864,000
2. Retained earnings - Appropriated

APPLIED AUDITING
a. P258,000 c. P228,000
b. P303,000 d. P0
3. Retained earnings - Unappropriated
a. P2,677,500 c. P2,578,500
b. P2,626,500 d. P2,623,500
4. Treasury stock
a. P45,000 c. P36,000
b. P90,000 d. P0
a. P3,700,500 c. P6,316,500
b. P5,812,500 d. P6,319,500
Suggested Solution:
Preferred stock P 600,000

Additional paid in capital 864,000 (1)
Retained earnings - Appropriated 303,000 (2)
Retained earnings - 2,578,500 (3)
Unappropriated
Treasury stock ( 45,000) (4)
Total SHE, 12/31/06 P6,316,500 (5)
1) Cash (3,000 shares x P18) P 54,000

Treasury stock-preferred
[(90,000/ 6,000 shares) x 3,000] P 45,000
2) Retained earnings P 270,000*

* [(60,000 – 6,000) x P5]
3) Retained earnings P 57,000**

Dividends payable P 57,000
** [(60,000 – 3,000) x P1]
4) Ignore
5) Retained earnings P 60,000
Retained earnings - appropriated P 60,000
6) See no. 8.
APPLIED AUDITING

APIC - donated capital P 450,000
8) Income summary P1,261,500

Net income per company's records P1,297,500

Fire loss erroneously charged to reserve for fire ( 30,00
insurance 0)
Estimated fire clean up cost ( 6,00
0)
Adjusted net income P1,261,500

Retained earnings - appropriated (cost of TS) P 45,000
Answers: 1) D; 2) B; 3) C; 4) A, 5) C
PROBLEM NO. 7
1. When no independent stock transfer agents are employed and the

corporation issues its own stocks and maintains stock records, canceled stock
certificates should
a.Be destroyed to prevent fraudulent reissuance.
b.Be defaced and sent to the SEC.
c.Not be defaced but segregated from other stock certificates and retained in a
canceled certificates file.
d.Be defaced to prevent reissuance and attached to their corresponding stubs.
2. All corporate capital stock transactions should ultimately be traced to the

a.Numbered stock certificates.
b.Minutes of the Board of Directors.
c.Cash receipts journal.
d.Cash disbursements journal.
3.Which of the following information is most important when auditing

shareholders’ equity?
a.Entries in the capital stock account can be traced to a resolution in the
minutes of the board of directors' meetings.
b.Stock dividends and/or stock splits during the year were approved by the
shareholders.
c.Stock dividends are capitalized at par or stated value on the dividend
declaration date.
d.Changes in the capital stock account are verified by an independent stock
transfer agent.
APPLIED AUDITING
4.The primary responsibility of a bank acting as registrar of capital stock is to

a.Verify that stock is issued in accordance with the authorization of the board
of directors and the articles of incorporation.
b.Act as an independent third party between the board of directors and outside
investors concerning mergers, acquisitions, and the sale of treasury stock.
c.Ascertain that dividends declared do not exceed the statutory amount
allowable in the state of incorporation.
d.Account for stock certificates by comparing the total shares outstanding to
the total in the shareholders’ subsidiary ledger.
5.The CPA's examination normally need not include

a.Determining that dividend declaration is in compliance with debt agreements.
b.Tracing the authorization for the dividends from the directors' meetings.
c.Testing the propriety of the payment to the individual stockholders.
d.Detailed checking from the dividend payment list to the capital stock records.
Answers: 1) D; 2) B; 3) A; 4) A, 5) D;
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Reference:
APPLIED AUDITING
CHAPTER 9
CASH TO ACCRUAL BASIS, SINGLE ENTRY
AND CORRECTION OF ERRORS
Objective
1. Solving Cash to Accrual Basis, Single Entry and
Correction of Errors
PROBLEM NO. 1
Zamboanga Enterprises records all transactions on the cash basis. The

company’s accountant prepared the following income statement at the end of
the company’s first year of operations:
Zamboanga Enterprises
Income Statement
For the Year Ended December 31, 2006
Sales P2,016,000
Selling and administrative expenses:
Salaries expense P624,000
Rent expense 360,000
Utilities expense 232,000
Equipment 240,000
Commission expense 302,400
Insurance expense 48,000
Interest expense 24,000 1,830,400
Net income P 185,600
You have been asked to prepare an income statement on the accrual basis.
the following information is given to you to assist in the preparation:
APPLIED AUDITING
(a) Amounts due from customers at year-end were P224,000. Of this

amount, P24,000 will probably not be collected.
(b) Salaries of P88,000 for December 2006 were paid on January 5, 2007.
(c) Zamboanga rents its building for P24,000 a month, payable quarterly in
advance. The contract was signed on January 1, 2006.
(d) The bill for December’s utility costs of P21,600 was paid January 10,
2007.
(e) Equipment of P240,000 was purchased on January 1, 2006. The

expected life is 5 years, no salvage value. Assume straight-line
depreciation.
(f) Commissions of 15% of sales are paid on the same day cash is received
from customers.
(g) A 1-year insurance policy was issued in company assets on July 1, 2006.
Premiums are paid annually in advance.
(h) Zamboanga barrowed P400,000 for one year on May 1, 2006. Interest
payments based on an annual rate of 12% are made quarterly, beginning
with the first payment on August 1, 2006.
QUESTION:
How much is the net income before income tax under the accrual basis of
accounting?
a. P526,000 c. P514,000
b. P286,000 d. P574,000
Suggested Solution:
Net income before income tax - cash P185,600

basis
AJE No. a 224,000
(24,000)
AJE No. b (88,000)
AJE No. c 72,000
AJE No. d (21,600)
AJE No. e 240,000
(48,000)
AJE No. f (30,000)
AJE No. g 24,000
AJE No. h
(8,000)
Net income before income tax - accrual P526,000
basis
APPLIED AUDITING
Adjusting journal entries (AJE) to convert cash to accrual basis:
a) Accounts receivable P224,000

Doubtful accounts expense 24,000
Sales P224,000
b) Salaries expense P 88,000

Salaries payable P 88,000
c) Prepaid rent [P360,000 - (P24,000 x 12)] P 72,000

Rent expense P 72,000
d) Utilities expense P 21,600

Utilities payable P 21,600
e) Depreciation expense (P240,000/5) P 48,000

Accumulated depreciation P 48,000
Note: The cost of the equipment should be added back to the reported
net income since it was expensed totally in 2006.
f) Commission expense [(P224,000-P24,000)x15%] P 30,000

Commission payable P 30,000
Note: No commission on doubtful accounts
g) Prepaid insurance (P48,000 x 6/12) P 24,000

Insurance expense P 24,000
h) Interest expense (P400,000 x 12% x 2/12) P 8,000

Interest payable P 8,000
Answer: A
PROBLEM NO. 2
Your audit of Camiguin Company disclosed that your client kept very limited
records. Purchases of merchandise were paid for 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 the 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, 2006 started business and issued common stock, 108,000

shares with P100 par, for the following considerations:
Cash P
900,000
APPLIED AUDITING
Building (useful life, 15 years) 8,100,000

Land
2,700,000
P11,700,000
An analysis of the bank statements showed total deposits, including the

original cash investment, of P6,300,000. The balance in the bank statement
on December 31, 2006, was P450,000, but there were checks amounting to
P90,000 dated in December but not paid by the bank until January 2007.
Cash on hand on December 31, 2006 was P225,000 including customers’
deposit of P135,000.
During the year, Camiguin 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 P180,000
Salaries 180,000
Supplies 360,000
Dividends 270,000
P990,000
An inventory of merchandise taken on December 31, 2006 showed

P1,359,000 of merchandise.
Tickets for accounts receivable totaled P1,620,000 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.
QUESTIONS:
(Disregard income taxes)
1. Payments for merchandise purchases in 2006

a. P4,869,000 c. P3,654,000
b. P3,879,000 d. P3,969,000
2. Collections from sales in 2006

a. P6,480,000 c. P5,580,000
b. P7,380,000 d. P4,500,000
APPLIED AUDITING
3. Net income for the year ended December 31, 2006

a. P2,430,000 c. P2,655,000
b. P1,440,000 d. P2,340,000
4. Stockholders’ equity as of December 31, 2006

a. P13,860,000 c. P14,085,000
b. P12,870,000 d. P13,770,000
5. Total assets as of December 31, 2006

a. P14,175,000 c. P14,374,800
b. P14,085,000 d. P14,310,000
Suggested Solution:
Question No. 1
Total deposits P6,300,000

Less adjusted cash in bank:
Balance per bank statement P450,000
Less outstanding checks
90,000 360,000
Total check disbursements 5,940,000
Less other check disbursements:
Payment of loan 225,000
Payment of interest on loan 45,000
Payment for equipment 801,000
1,071,000
Payments for merchandise P4,869,000
purchases
Question No. 2
Total deposits P6,300,000

Less deposits other collections:
Cash investment P900,000
Proceeds from bank loan
900,000 1,800,000
Collections deposited in the bank 4,500,000
Add collections not deposited:
Cash on hand, 12/31/06 225,000
Add disbursements in cash
990,000
Total 1,215,000
Less customers' deposit
135,000 1,080,000
Total collections from sales P5,580,000
Question No. 3
Sales (P3,360,000+P1,620,000) P7,200,000

APPLIED AUDITING
Less cost of sales:

Purchases (P4,869,000 + P5,499,000
P630,000)
Less inventory, 12/31/06 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 540,000
(P8,100,000/15)
Depreciation–equipment 144,000
(P720,000/5)
Interest expense
[P45,000+(P801,000-P720,000)] 126,000
1,620,000
Net income P1,440,000
Question No. 4
Common stock (108,000 shares x P10,800,000

P100)
APIC (P11,700,000 - P10,800,000) 900,000
Retained earnings (P1,440,000 -
P270,000) 1,170,000
Total stockholders' equity P12,870,000
Question No. 5
Current assets:
Cash (P360,000 + P225,000 ) P 585,000
Accounts receivable – net
(P1,620,000 - P90,000) 1,530,000
Inventory 1,359,000 P 3,474,000
Noncurrent assets:
Land 2,700,000
Building - net (P8,100,000 - 7,560,000
P540,000)
Equipment - net (P720,000 - 10,836,000
P144,000) 576,000
Total assets P14,310,000
Answers: 1) A; 2) C; 3) B; 4) B, 5) D
PROBLEM NO. 3
APPLIED AUDITING
Misamis Company’s December 31, year end financial statement contained the
following errors:
December 31,2005 December

31,2006
Ending inventory P100,000 P90,000
Depreciation understated overstated
expense 20,000 understated
An insurance premium of P75,000 was prepaid in 2005 covering the years

2005, 2006, and 2007. The same was charged to expense in full in 2005. In
addition, on December 31, 2006, a fully depreciated machinery was sold for
P160,000 cash, but the sale was not recorded until 2007. There were no
other errors during 2005, 2006 and 2007 and no corrections have been made
for any of the errors. Ignore income tax considerations.
QUESTIONS:
1. What is the total effect of the errors on the 2005 net income?
a. Understated by P130,000 c. Overstated by P70,000
b. Understated by P155,000 d. No effect
2. What is the total effect of the errors on the 2006 net income?
a. Overstated by P55,000 c. Overstated by P215,000
b. Overstated by P30,000 d. Understated by P45,000
3. What is the total effect of the errors on the company’s working capital at
December 31,2006?
4. What is the total effect of the errors on the balance of the company’s
retained earnings at December 31, 2006?
5. What is the total effect of the errors on the company’s working capital at
December 31,2007?
a. Overstated by P65,000 c. Understated by P160,000
Suggested Solution:
NI NI WC RE WC
2005 2006 12/31/06 12/31/06 12/31/07
APPLIED AUDITING
12/31/05
inventory
understated (100,000) 100,000 - - -
12/31/06
inventory
overstated - 90,000 90,000 90,000 -
2005
depreciation
understated 20,000 - - 20,000 -
Insurance
paid in 2005
for 3 years (50,000) 25,000 (25,000) (25,000) -
Sale of a
fully
depreciated
machinery
in 2006
recorded in (160,000) (160,000) (160,000)
2007 - -
Over (under) (130,000) ( 95,000) ( 75,000)
55,000 -
Answers: 1) A; 2) A; 3) A; 4) A, 5) D
PROBLEM NO. 4
The Davao Company engaged you in 2006 to examine its books and records
and to make whatever adjustments are necessary.
Your examination disclosed following:
a. Prior to any adjustments, the Retained Earnings account is reproduced

below:
RETAINED EARNINGS
Date Particulars Debit Credit Balance

2004
Jan. 1 Balance P580,000
Dec. Net income for the 310,000 890,000
31 year
2005
Jan. 31 Dividends paid 140,000 750,000
Apr. 3 Paid in capital in 90,000 840,000
excess of par
Aug. Gain on retirement of
30 preferred stock at
less than issue 64,500 904,500
price
APPLIED AUDITING
Dec. Net loss for the year 205,000 699,500

31
2006
Jan. 31 Dividends paid 100,000 599,500
Dec. Net loss for the year 165,500 P434,000
31
b. The company failed to properly recognize accruals and prepayments.

Selected accounts revealed the following information:
2003 2004 2005 2006

Prepaid
1. expenses P8,500 P6,200 P7,400 P9,500
Accrued
2. expenses 5,400 7,300 8,700 9,000
Unearned
3. income 6,900 7,800 8,900 9,600
4. Accrued income 4,700 5,600 6,200 7,800
c. Dividends had been declared on December 31 in 2004 and 2005 but had
not been entered in the books until paid.
d. The company purchased a machine worth P270,000 on April 30, 2003.

The company charged the purchase to expense. The machine has an
estimated useful life of 3 years. The company uses the straight line
method and residual values are deemed immaterial.
e. The company received a transportation equipment as donation from one of

its stockholders on September 30, 2005. The equipment was used to
deliver goods to customers. The equipment costs P750,000 and has a
remaining life of 3 years on the date of donation. The equipment has a fair
value of P240,000 and P30,000 was incurred for registering the transfer of
ownership. The company did not record the donation on its books. The
expenses paid related to the donated equipment were charged to expense.
f. The physical inventory of merchandise had been understated by P64,000

and by P44,500 at the end of 2004 and 2006, respectively.
g. The merchandise inventories at the end of 2005 and 2006 did not include
merchandise that was then in transit shipped FOB shipping point. These
shipments of P43,400 and P32,600 were recorded as purchases in
January 2006 and 2007, respectively.
QUESTIONS:
Based on the above audit findings, the adjusted balances of the following are:
(Disregard tax implications)
1. Retained earnings, 12/31/03

a. P580,900 c. P790,900
APPLIED AUDITING
b. P850,900 d. P760,900
2. Net income for 2004

a. P369,800 c. P279,800
b. P215,800 d. P373,100

a. P976,700 c. P930,700
b. P860,700 d. P720,700
4. Net loss for 2005

a. P269,700 c. P349,700
b. P379,700 d. P359,700

a. P481,000 c. P341,000
b. P411,000 d. P241,000
6. Net loss for 2006

a. P118,300 c. P148,300
b. P228,300 d. P178,300

a. P302,700 c. P252,700
b. P362,700 d. P332,700
Suggested Solution:
RE NI NL NL
2003 2004 2005 2006
Unadjusted P580,000 P310,000 (P205,000) (P165,500)
balances
(b.1) Prepaid
expense
2003 8,500 (8,500)
2004 6,200 (6,200)
2005 7,400 (7,400)
2006 9,500
(b.2) Accrued
expense
2003 (5,400) 5,400
2004 (7,300) 7,300
2005 (8,700) 8,700
2006 (9,000)
(b.3) Unearned
income
APPLIED AUDITING
RE NI NL NL
2003 2004 2005 2006
2003 (6,900) 6,900
2004 (7,800) 7,800
2005 (8,900) 8,900
2006 (9,600)
(b.4) Accrued income

2003 4,700 (4,700)
2004 5,600 (5,600)
2005 6,200 (6,200)
2006 7,800
(d) Purchase of
machinery,
expensed on April 270,000
30, 2003
Unrecorded (60,000) (90,000) (90,000) (30,000)
depr.
(e) Unrecorded
transpo equipm't.
received as
donation on
9/30/05
Expenses paid 30,000
Unrecorded (20,000) (80,000)
depr.
(f) Understatement
of inventory
2004 64,000 (64,000)
2006 44,500
Understatement of
inventory and
purchases
2005 43,400 (43,400)
(43,400) 43,400
2006 32,600
. . . (32,600)
Adjusted balances P790,900 P279,800 (P349,700) (P228,300)
Retained earnings, 1/1/04, as P 790,900 (1)

adjusted
Net income for 2004 279,800 (2)
Dividends declared ( 140,000)
Retained earnings, 12/31/04 930,700 (3)
Net loss for 2005 ( 349,700) (4)
APPLIED AUDITING
Dividends declared ( 100,000)

Retained earnings, 12/31/05 481,000 (5)
Net loss for 2006 ( 228,300) (6)
Retained earnings, 12/31/06 P 252,700 (7)
Answers: 1) C; 2) C; 3) C; 4) C, 5) A; 6) B; 7) C
PROBLEM NO. 5
Cotabato Corporation’s current assets and liabilities section of the balance

sheet as of December 31, 2006 appear as follows:
Current assets
Cash P1,200,000
Less allowance for doubtful 2,460,000
accounts 210,000
Inventories 5,130,000
Prepaid expenses
270,000
Total current assets P9,060,000
Current liabilities
Accounts payable P1,830,000
Notes payable 2,010,000
Total current liabilities P3,840,000
The following errors in the corporation’s accounting have been discovered:
a. January 2007 cash disbursements entered as of December 2006 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 P810,000 of merchandise that have been received

at December 31 but for which no purchase invoices have been received or
entered. 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 2007 in the amount of P900,000
were entered in the sales book as of December 31, 2006. Of these,
P645,000 were sales on account and the remainder were cash sales.
d. Cash, not including cash sales, collected in January 2007 and entered as
of December 31, 2006, totaled P1,059,720. 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.
QUESTIONS:
APPLIED AUDITING
1. Adjusted cash balance as of December 31, 2006

a. P1,031,880 c. P1,055,280
b. P 641,880 d. P1,286,880
2. Adjusted accounts receivable balance as of December 31, 2006

a. P2,739,000 c. P2,724,720
b. P2,529,000 d. P3,129,000
3. Adjusted accounts payable balance as of December 31, 2006

a. P3,000,000 c. P2,976,600
b. P2,190,000 d. P3,450,000
4. Adjusted working capital as of December 31, 2006

a. P4,160,880 c. P3,950,880
b. P3,500,880 d. P3,524,280
5. Net misstatement in the reported net income for the year ended December
31, 2006 as a result of the errors
a. P1,269,120 c. P1,719,120
b. P1,700,880 d. P1,250,880
Suggested Solution:
Question No. 1
Unadjusted cash balance P1,200,000

January cash payments (P1,170,000 1,146,600
x .98)
January cash sales (P900,000 – (255,000)
P645,00)
January cash collections and loan (1,059,720)
proceeds
Adjusted cash balance P1,031,880
Question No. 2
Unadjusted accounts receivable P2,670,000

January sales on account (645,000)
January collections on AR
(P699,720/.98) 714,000
Adjusted accounts receivable P2,739,000
Question No. 3
Unadjusted accounts payable P1,830,000

January payments on AP 1,170,000
Unrecorded purchases (P810,000 –
P360,000) 450,000
APPLIED AUDITING
Adjusted accounts payable P3,450,000
Question No. 4
Current assets:
Cash (see no. 1) P1,031,880
Accounts receivable (see no. 2,739,000
2)
Allowance for doubtful (210,000)
accounts
Inventories (P5,130,000- 4,770,000
P360,000)
Prepaid expenses P8,600,880
270,000
Less current liabilities:
Accounts payable (see no. 3) 3,450,000
Notes payable [P2,010,000 –
(P1,059,720 - P699,720)] 1,650,000
5,100,000
Working capital P3,500,880
Question No. 5
Over (under)
January purchase discounts P
(P1,170,000 x .02) 23,400
Goods held on consignment 360,000
Unrecorded purchases (P810,000 – 450,000
P360,000)
January sales 900,000
January sales discounts ( 14,280)
[(P699,720/.98) x .02]
Net misstatement P1,791,120
Answers: 1) A; 2) A; 3) D; 4) B, 5) C
PROBLEM NO. 6
The bookkeeper for Maguindanao Computers, Inc., reports the following

balance sheet amounts as of June 30, 2006.
Current assets P2,440,500

Noncurrent assets 6,285,500
Current liabilities 1,386,000
Noncurrent liabilities 900,000
Owners’ equity 6,440,000
A review of account balances reveals the following data.

APPLIED AUDITING
(a) An analysis of current assets discloses the following:
Cash P 422,500
Investment securities – trading 600,000
Trade accounts receivable 568,000
Inventories, including advertising
supplies of P20,000 850,000
P2,440,500
(b) Noncurrent assets include the following:
Property, plant and equipment:

Depreciated book value (cost P6,560,000) P5,490,000
Deposit with a supplier for merchandise ordered
for August delivery
21,500
Goodwill recorded on the books to cancel losses
incurred by the company in prior years 774,000
P6,285,500
(c) Current liabilities include the following:
Payroll payable P 71,500

Taxes payable 41,500
Rent payable 114,000
Trade accounts payable (net of P15,000, 6-month
note, received from a supplier who purchased
some used equipment on June 29, 2006, 999,000
Notes payable 160,000
P1,386,000
(d) Noncurrent liabilities include the following:
9% mortgage on property, plant, and equipment,

payable in semiannual installment of P90,000
through to June 30, 2011 P900,000
(e) Owners’ equity includes the following:
Preferred stock: 190,000 shares outstanding

(P20 par value) P3,800,000
Common stock: 1,600,000 shares
at P1 par value 1,600,000
Additional paid-in capital 1,040,000
P6,440,000
APPLIED AUDITING
(f) Common shares were originally issued for P3,910,000, but the losses of
the company for the past years were charged against additional paid-in
capital.
QUESTIONS:
Based on the above and the result of the audit, determine the adjusted
amounts of the following:
1. Current assets
a. P2,462,000 c. P2,477,000
b. P2,440,500 d. P2,435,500
2. Noncurrent assets
a. P5,490,000 c. P6,560,000
b. P5,511,500 d. P6,264,000
3. Current liabilities
a. P1,401,000 c. P1,602,500
b. P1,581,000 d. P1,491,000
4. Noncurrent liabilities
a. P720,000 c. P900,000
b. P810,000 d. P880,000
5. Owners’ equity
a. P7,710,000 c. P6,440,000
b. P8,750,000 d. P5,666,000
Suggested Solution:
Question No. 1
Cash P
422,500
Investment securities—trading 600,000
Note receivable 15,000
Accounts receivable 568,000
Inventory (P850,000 - P20,000) 830,000
Advertising supplies 20,000
Deposit with supplier
21,500
PAS 1 par. 57 states that an asset shall be classified as current when it

satisfies any of the following criteria:
a) it is expected to be realized in, or is intended for sale or consumption in,
the entity’s normal operating cycle;
b) it is primarily held for the purpose of being traded;
APPLIED AUDITING
c) it is expected to be realized within twelve months after the balance

sheet date; or
d) it is cash or a cash equivalent (as defined in PAS 7 Cash Flow
Statements) unless it is restricted from being exchanged or used to
settle a liability for at least twelve months after the balance sheet date.
All other assets shall be classified as non-current.
Question No. 2
Property, plant, and equipment P6,560,000

Less accumulated depreciation 1,070,000
Noncurrent assets P5,490,000
Question No. 3
Notes payable P
160,000
Accounts payable (P999,000 + P15,000) 1,014,000
Mortgage payable-current portion 180,000
(P90,000 x 2)
Payroll payable 71,500
Taxes payable 41,500
Rent payable
114,000
Current liabilities P1,581,000
PAS 1 par. 60 states that a liability shall be classified as current when it

satisfies any of the following criteria:
a) it is expected to be settled in the entity’s normal operating cycle;
b) it is held primarily for the purpose of being traded;
c) it is due to be settled within twelve months after the balance sheet date;
d) the entity does not have an unconditional right to defer the settlement of
the liability for at least twelve months after the balance sheet date.
All other liabilities shall be classified as non-current.
Question No. 4
Mortgage payable-noncurrent portion

(P900,000 - P180,000) P720,000
Question No. 5
Preferred stock, P20 par value, 190,000 P3,800,000

shares
Common stock, P1 par value, 1,600,000 1,600,000
shares
Additional paid-in capital (P3,910,000 - 2,310,000
APPLIED AUDITING
P1,600,000)
Deficit [(P2,310,000 - (2,044,000)
P1,040,000)+P774,000]
Owners’ equity P5,666,000
Answers: 1) C; 2) A; 3) B; 4) A, 5) D
PROBLEM NO. 7
In connection with your audit of the financial statements Sulu Corporation, you
were provided with the following balance sheet as of December 31, 2006:
Sulu Corporation
Balance Sheet
December 31, 2006
Assets Liabilities and Stockholders’ Equity

Current assets: Current liabilities:
Cash P 250,000 Accounts payable P
68,000
Trading securities 160,000 Other current liabs.
40,000
Accts rec., net 427,000 Total P 108,000
Inventory 620,000
Other current
assets Long-term liabilities
284,000 655,000
Total P1,741,000 Total liabilities P 763,000
Noncurrent assets: Owners’ equity:

Property, plant, and
equip., net P1,296,000 Common stock P1,000,000
Treasury stock 90,000 Retained earnings 1,636,000
Other noncurrent Total stockholders’
assets equity P2,636,000
272,000
Total P1,658,000 Total liabilities and
Total assets P3,399,000 stockholders’ equity P3,399,000
The following additional information relates to the December 31, 2006, balance
sheet.
(a) Cash includes P80,000 that has been restricted for the purchase of
manufacturing equipment (a noncurrent asset).
(b) Trading securities include P55,000 of stock that was purchased in order
to give the company significant ownership and a seat on the board of
directors of a major supplier.
APPLIED AUDITING
(c) Other current assets include a P80,000 advance to the president of the
company. No due date has been set.
(d) Long-term liabilities also include bonds payable of P200,000. Of this

amount, P50,000 represents bonds scheduled to be redeemed in 2007.
(e) Long-term liabilities also include a P140,000 bank loan. On May 15,
2007, the loan will become due on demand.
(f) On December 21, dividends in the amount of P300,000 were declared to

be paid to shareholders of record on January 25. These dividends have
not been reflected in the financial statements.
(g) Cash in the amount of P380,000 has been placed in a restricted fund for
the redemption of preferred stock in 2007. Both the cash and the stock
have been removed from the balance sheet.
(h) Property, plant, and equipment includes land costing P160,000 that is
being held for investment purposes and that is scheduled to be sold in
2007.
QUESTIONS:
amounts of the following as of December 31, 2006:
1. Total current assets

a. P1,526,000 c. P1,686,000
b. P1,821,000 d. P1,606,000
2. Total noncurrent assets

a. P2,163,000 c. P1,488,000
b. P2,003,000 d. P2,083,000
3. Total current liabilities

a. P548,000 c. P458,000
b. P298,000 d. P598,000
4. Total noncurrent liabilities

a. P515,000 c. P605,000
b. P665,000 d. P465,000
5. Total liabilities
a. P1,063,000 c. P1,263,000
b. P 763,000 d. P1,443,000

a. P2,926,000 c. P2,626,000
b. P2,246,000 d. P2,716,000
APPLIED AUDITING
7. Total liabilities and stockholders’ equity

a. P3,309,000 c. P3,609,000
b. P3,689,000 d. P3,779,000
Suggested Solution:
Question No. 1
Cash (P250,000 - P80,000) P

170,000
Trading securities (P160,000 - P55,000) 105,000
Accounts receivable, net 427,000
Inventory 620,000
Land held for resale 160,000
Other current assets (P284,000 -
P80,000) 204,000
Note: If the problem is silent, advances to officers and employees are

normally classified as current. However, since the advances to the
president has no due date, it will be classified as noncurrent.
Question No. 2
Investment in associate P
55,000
Property, plant and equipment, net
(P1,296,000 - P160,000) 1,136,000
Restricted cash - for preferred stock 380,000
Restricted cash - for equipment 80,000
Advance to company president 80,000
Other noncurrent assets
272,000
Question No. 3
Accounts payable P 68,000

Current portion of bonds payable 50,000
Loan due on demand 140,000
Dividends payable 300,000
Other current liabilities 40,000
Current liabilities P598,000
Question No. 4
Bonds payable (P200,000 - P50,000) P150,000

APPLIED AUDITING
Other noncurrent liabilities

(P655,000-P200,000-P140,000) 315,000
Noncurrent liabilities P465,000
Question No. 5
Current liabilities (see no. 3) P

598,000
Noncurrent liabilities (see no. 4)
465,000
Total liabilities P1,063,000
Question No. 6
Preferred stock P 380,000

Retained earnings (P1,636,000 - 1,336,000
P300,000)
Treasury stock ( 90,000)
Question No. 7
Total liabilities (see no. 5) P1,063,000

Total stockholders’ equity (see no. 6)
2,626,000
Total liabilities and stockholders' equity P3,689,000
Answers: 1) C; 2) B; 3) D; 4) D, 5) A; 6) C; 7) B
PROBLEM NO. 8
The following balance sheet is submitted to you for inspection and review.
Surigao Corporation
Balance Sheet
December 31, 2006
Assets
Cash P 180,200
Accounts receivable 450,000
Inventories 816,000
Prepaid insurance 35,200
Property, plant, and equipment 1,507,200
Liabilities and Owners’ Equity

Miscellaneous liabilities P 14,400
Loan payable 304,800
Capital stock 536,000
APPLIED AUDITING
Paid-in capital 1,832,400

Total liabilities and owners’ P2,988,600
equity
In the course of the review, you find the following data:
(a) The possibility of uncollectible accounts on accounts receivable has not

been considered. It is estimated that uncollectible accounts will total
P19,200.
(b) The amount of P180,000 representing the cost of large-scale news paper
advertising campaign completed in 2006 has been added to the inventory
because it is believe that this campaign will benefit sales of 2007. It is
also found that inventories include merchandise of P65,000 received on
December 31 and has not been recorded as a purchase.
(c) The books show that property, plant and equipment have a cost of
P2,227,200 with accumulated depreciation of P720,000. However,
these balances include fully depreciated equipment of P340,000 that has
been scrapped and is no longer on hand.
(d) Miscellaneous liabilities of P14,400 represent salaries payable of

P38,000, less non current advances of P23,600 made to company
officials.
(e) Loan payable represents a loan from the bank that is payable in regular
quarterly installments of P25,000.
(f) Income tax payable not shown is estimated at P73,000.
(g) Deferred tax liability arising from temporary differences totals P178,200.
This liability was not included in the balance sheet.
(h) Capital stock consists of 25,000 shares of preferred 6% stock, par P20,
and 36,000 shares of common stock, par value P1.
(i) Capital stock have been issued for a total consideration of P1,134,400;
the amount received in excess of the par values of the stock has been
reported as paid-in capital. Net income and dividends were recorded in
Paid-In Capital.
QUESTIONS:
Based on the above and the result of the audit, determine the adjusted
amounts of the following:
1. Current assets
a. P1,347,200 c. P1,217,200
b. P1,282,200 d. P1,462,200
APPLIED AUDITING
2. Noncurrent assets
a. P1,530,800 c. P1,507,200
b. P1,190,800 d. P1,167,200
3. Total assets
a. P2,878,000 c. P2,473,000
b. P2,789,400 d. P2,813,000
4. Current liabilities
a. P512,000 c. P577,000
b. P504,000 d. P600,600
5. Noncurrent liabilities
a. P383,000 c. P204,800
b. P406,600 d. P433,000
6. Total liabilities
a. P983,600 c. P895,000
b. P716,800 d. P960,000
7. Owners’ equity
a. P1,853,000 c. P2,096,200
b. P1,918,000 d. P2,368,400
Suggested Solution:
Question No. 1
Cash P
180,200
Accounts receivable, net (P450,000 - 430,800
P19,200)
Inventory (P816,000 - P180,000) 636,000
Prepaid insurance
35,200
Question No. 2
Property, plant and equipment, net

[(P2,227,200-P340,000) P1,507,200
-(P720,000-P340,000)]
Advances to officers
23,600
Question No. 3
Current assets (see no. 1) P1,282,200

APPLIED AUDITING
Noncurrent assets (see no. 2)

1,530,800
Question No. 4
Accounts payable (P301,000+P65,000) P366,000

Salaries payable 38,000
Income tax payable 73,000
Loan payable to bank, current portion
(P25,000x4) 100,000
Current liabilities P577,000
Question No. 5
Loan payable (P304,800-P100,000) P204,800

Deferred tax liability 178,200
Noncurrent liabilities P383,000
Question No. 6
Current liabilities (see no. 4) P577,000

Noncurrent liabilities (see no. 5) 383,000
Total liabilities P960,000
Question No. 7
6% Preferred stock, P20 par, 25,000 shares P 500,000

Common stock, P1 par value, 36,000 shares 36,000
Paid-in capital in excess of par
(P1,134,400-P500,000-P36,000) 598,400
Retained earnings
(P1,832,400-P598,400-P19,200-P180,000-P65,000-P
73,000-P178,200)
718,600
Total owners’ equity P1,853,000
Answers: 1) B; 2) A; 3) D; 4) C, 5) A; 6) D; 7) A
APPLIED AUDITING
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APPLIED AUDITING
CHAPTER 10
AUDIT REPORTS
Objective
1. Theory for Audit Reports
1.Which of the following is not among the ideas stated in the standard audit
report?
a.We made an examination according to GAAS.
b.We made tests of the accounting records.
c.The statements are fairly presented in conformity with GAAP.
d.We certify the accuracy of the statements.
2.Which of the following statements is correct?

a.An auditor’s responsibility to express an opinion on the financial statements
is explicitly represented in the opening paragraph of the auditor’s standard
report.
b.An auditor’s responsibility to express an opinion on the financial statements
is explicitly represented in the opinion paragraph of the auditor’s standard
report.
c.An auditor’s responsibility to express an opinion on the financial statements
is explicitly represented in the scope paragraph of the auditor’s standard
report.
d.An auditor’s responsibility to express an opinion on the financial statements
is implicitly represented in the auditor’s standard report.
3.The existence of audit risk is recognized by the statement in the auditor’s

standard report that the
APPLIED AUDITING
a.Auditor obtains reasonable assurance about whether the financial

statements are free of material misstatement.
b.Auditor is responsible for expressing an opinion on the financial statements,
which are the responsibility of management.
c.Audits include examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements.
d.Financial statements are presented fairly, in all material aspects, in
conformity with GAAP.
4.The phrase "present fairly ... in conformity with GAAP" appears in the
standard audit report. Unless modified, this phrase implies that all of the
following conditions have been met, except:
a.The financial statements are informative on matters that may affect their use,
understanding, and interpretation.
b.The accounting principles selected and applied have all been promulgated
by the Accounting Standards Council.
c.The information presented in financial statements is classified and
summarized in a reasonable manner.
d.Comparability of financial statements between periods has not been
materially affected by changes in accounting principles.
5.If the auditor has no reservations concerning the fairness of the financial
statements, the auditor should issue a (an)
a. Unqualified opinion. c. Disclaimer of opinion.
b. Qualified opinion. d. Adverse opinion.
6.When an independent auditor expresses an unqualified opinion he asserts

that:
(1)He performed the audit in accordance with generally accepted auditing
standards.
(2)The company is a profitable and viable entity.
(3)The financial statements examined are in conformity with GAAP.
(4)The financial statements are accurate and free of errors.
a.All of the above statements are true.

b.All of the above statements are false.
c.Only statements (1) and (3) are true.
d.Only statements (2) and (4) are true.
7.Under which of the following circumstances would an auditor not be required

to depart from the wording of the standard audit report?
a.The client does not want to prepare a statement of changes in financial
position.
b.The client did not allow the CPA to review the minutes of stockholders'
meetings.
c.The client did not allow confirmation of receivables, the CPA applied
alternative auditing procedures and was satisfied as to the receivables.
d.The client does not want to disclose damage to enterprise property caused
by fire which took place after the balance sheet date.
APPLIED AUDITING
8.In which of the following circumstances may the auditor issue an unqualified
standard audit report?
a.There has been a departure from GAAP.
b.There has been a lack of consistency of applying GAAP.
c.There are questions about the continued existence of the entity.
d.The auditor relies on the report of another auditor.
9.If adequate disclosure is not made by the entity regarding substantial doubt
about its ability to continue as a going concern, the auditor should include in
his report specific reference to the substantial doubt as to ability of the
company to continue as a going concern and should express:
a.Unqualified opinion with explanatory paragraph
b.Either an “except for” qualified opinion or an adverse opinion.
c.A disclaimer of opinion.
d.A subject to qualified opinion or adverse opinion.
10.If the auditor believes that the entity will not be able to continue as a going
concern and the financial statements are prepared on a going concern basis,
the auditor’s report should include:
a.Unqualified opinion with explanatory paragraph.
b.Adverse opinion.
c.Qualified opinion.
d.Disclaimer of opinion.
11.An explanatory paragraph following an opinion paragraph that describes an

uncertainty follows:
As discussed in Note X to the financial statements, the company is a

defendant in a lawsuit alleging infringement of certain patent rights and
claiming damages. Discovery proceedings are in progress. The ultimate
outcome of the litigation cannot presently be determined. Accordingly, no
provision for any liability that may result upon adjudication has been made in
the accompanying financial statements.
What type of opinion should the auditor express in this circumstance?

a. Unqualified c. Qualified
b. Disclaimer d. Adverse
12.Identify the appropriate type of opinion to issue when the auditor is satisfied
that there is a remote likelihood of a loss resulting from the resolution of an
uncertainty.
a.Qualified opinion or disclaimer of opinion, depending on whether the
uncertainty is adequately disclosed.
b.Qualified opinion or disclaimer of opinion, depending upon the materiality of
the loss.
c.Unqualified opinion.
d.Unqualified opinion with a separate explanatory paragraph.
APPLIED AUDITING
13.If an amendment to other information in a document containing audited

financial statements is necessary and the entity refuses to make the
amendment, the auditor would consider issuing:
a.Qualified or adverse opinion
b.Unqualified opinion with explanatory paragraph
c.Qualified or disclaimer of opinion
d.Unqualified opinion.
14.Consistency in application of GAAP will be affected by a

a.Change in accounting estimates.
b.Change in accounting principles.
c.Change in classification or reclassification.
d.Change expected to have a material future effect.
15.Reference to the consistency of application of accounting principles in the

audit report is not applicable when:
a.The company changed its valuation method for property and equipment from
cost to appraisal.
b.The auditor was engaged to examine only the current year’s financial
statements and another auditor examined the prior year’s statements.
c.The financial statements examined are for the initial accounting period of the
company.
d.The auditor examined both the current and prior year’s financial statements
but only the current year’s financial statements are presented.
16.The auditor should evaluate a change in accounting principle to satisfy

himself that
a.The newly adopted principle is a generally accepted accounting principle
b.The method of accounting for the effect of the change is in conformity with
GAAP.
c.Management’s justification for the change is reasonable.
d.All of the above.
17.If financial statements are to meet the requirements of adequate disclosure,

a.All information pertaining to the company must be disclosed in the financial
statements or related notes, even though some of the disclosures may be
potentially detrimental to the company or its stockholders.
b.All information believed by the auditor to be essential to the fair presentation
of the financial statements must be disclosed, no matter how confidential
management believes the data to be.
c.Statement footnotes must clearly detail any deficiencies contained in the
financial statements themselves.
d.Preparation of the financial statements should be guided by the doctrine that
more information is always better than less.
18.When part of the examination is to be performed by another auditor, the

principal auditor may decide to assume responsibility for the other auditor’s
work and make no reference to such work when:
a.The portion examined by the other auditor is material to the financial
statements audited by the principal auditor.
APPLIED AUDITING
b.The other auditor is not a correspondent of the principal auditor.

c.It is impracticable for the principal auditor to review the other auditor’s work.
d.The other auditor was retained by the principal auditor and worked under his
supervision.
19.Assume that the principal auditor decided to refer in his report the
examination of another auditor, the principal auditor is required to disclose the
a.Portion of the financial statements examined by the other auditor.
b.Name of the other auditor.
c.Nature of his inquiry into the other auditor's professional standing and extent
of his review of the auditor's work.
d.Reasons why he is unwilling to assume responsibility for the other auditor's
work.
20.The following statements relate to modifications of the standard audit

report:
I.When an auditor is unable to reach a conclusion as to the propriety of
management’s representations, he should consider issuing either a qualifying
opinion or a disclaimer of opinion.
II.When restrictions that significantly limit the scope of the audit are imposed
by the client, the auditor generally should issue an adverse opinion.
III.Qualifying language may be added to the opinion paragraph of the auditor’s
report, but it is never added to the scope paragraph.
IV.A change in accounting principle from one generally accepted accounting
principle to another would not prevent the issuance of an unqualified audit
report provided the auditor approved the change in advance and the effects of
the change were set forth in a note to the financial statements.
State whether the foregoing statements are true or false.

a.All of the statements are true.
b.Only one of the statements is true.
c.Only two of the statements are true.
d.Three of the statements are true.
21.Due to unusual circumstances, the financial statements contain a departure

from GAAP otherwise the statements would be misleading. Under the
situation, the auditor should explain the unusual circumstances in a separate
paragraph and express an opinion that is
a.Unqualified.
b.Adverse.
c.Qualified or adverse, depending on materiality.
d.Qualified.
22.In determining the type of opinion to express, an independent auditor

evaluates the nature of the reporting qualifications and the materiality of their
effects. Materiality will be the principal factor considered in the choice
between
a.An adverse opinion and a disclaimer of opinion.
b.A “subject to” opinion and a piecemeal opinion.
c.An “except for” opinion and a “subject to” opinion.
APPLIED AUDITING
d.An “except for” opinion and an adverse opinion.
23.When an independent auditor is not satisfied with the extent of his audit, the
application or interpretation by the client of an accounting principle, or with
other matter about his work and for a reason personally known to him,
provided that, the exceptions of the auditor are not sufficiently material to
nullify an opinion on the financial statements taken as a whole, the auditor
should render a
a. Piecemeal opinion. c. Qualified opinion.
b. Adverse opinion. d. Unqualified opinion.
24.An auditor's "except for" report is a type of

a. Unqualified c. Qualified
b. Disclaimer d. Adverse
25.A CPA has not been able to confirm a large account receivable. However,
he was able to satisfy himself as to the propriety of the account by means of
alternative audit procedures. In this situation, the CPA may render
a. Piecemeal opinion. c. Unqualified opinion.
b. Qualified opinion. d. None of the above.
SUGGESTED ANSWERS:
1. D 11. A 21. A
2. A 12. C 22. D
3. A 13. B 23. C
4. B 14. B 24. C
5. A 15. C 25. C
6. C 16. D
7. C 17. B
8. D 18. D
9. B 19. A
10. B 20. C
APPLIED AUDITING
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Audt3 - Applied Auditing Complete Module

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Audt3 - Applied Auditing Complete Module

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APPLIED AUDITING

CHAPTER 1 AUDIT OF CASH AND CASH EQUIVALENTS

CHAPTER 2 AUDIT OF RECEIVABLES

CHAPTER 3 AUDIT OF INVENTORIES

CHAPTER 4 AUDIT OF INVESTMENTS

CHAPTER 5 AUDIT OF PROPERTY, PLANT AND

CHAPTER 6 AUDIT OF INTANGIBLE ASSETS

CHAPTER 7 AUDIT OF LIABILITIES

CHAPTER 8 AUDIT OF STOCKHOLDERS’ EQUITY

CHAPTER 9 CASH TO ACCRUAL BASIS, SINGLE ENTRY

CHAPTER 10 AUDIT REPORTS

1. Current account at Metrobank P2,000,000

Current account at Metrobank P2,000,000

1. Commercial savings account of P1,200,000 and a commercial checking

Savings account at PS Bank P1,200,000

On deposit in current account with Real Bank P 900,000

Current account with Real Bank P 900,000

You noted the following composition of Malabon Company’s “cash account” as

Demand deposit account P2,000,000

Additional information follows:

Demand deposit account as adjusted:

Window dressing of collection (400,000) P1,900,000

Petty cash fund 10,000

The books of Manila's Service, Inc. disclosed a cash balance of P687,570 on

1. Adjusted cash in bank balance

2. Net adjustment to cash as of December 31, 2006

Balance per bank statement, P547,800

Bank error-deposit not recorded 6,000 140,250

Balance per books, 12/31/06 P687,570

Bank service charges 2,100 159,660

Unadjusted balance per books, 12/31/06 P687,570

Balance per bank, Nov. 30, 2006 P150,000

Total deposits P110,000

There were outstanding checks of P30,000 and deposits in transit of P38,000

2. How much is the December receipts per books?

3. How much is the December disbursements per books?

5. The adjusted cash in bank balance as of December 31, 2006 is

Balance per bank, Nov. 30, 2006 P150,000

Total deposits per bank statement P110,000

Total charges per bank statement P96,000

Balance per books, Nov. 30, 2006 P136,000

Balance per bank statement, 12/31/06 P164,000

Balance per books, 12/31/06 P180,400

Disbursements in July per bank statement P218,373

Based on the application of the necessary audit procedures and appreciation

1. How much is the adjusted cash balance as of June 30?

2. How much is the adjusted bank receipts for July?

3. How much is the adjusted book disbursements for July?

4. How much is the adjusted cash balance as of July 31?

5. How much is the cash shortage as of July 31?

Balance per bank

Balance per P212,529

The company’s bookkeeper prepared the following bank reconciliation as of

Bank balance – November 30, P90,800

Additional data are given as follows:

a. Company recordings for December:

b. Bank statement totals for December :

e. The December bank statement included a check drawn by Sipag Company

f. Undeposited collections on December 31, 2006 - P8,000.

i. The outstanding checks on December 31, 2006, were:

Check No. Amount Check No. Amount

1. Unadjusted cash balance per books as of December 31, 2006

2. Adjusted cash balance as of November 30, 2006

3. Adjusted book receipts for December 2006

4. Adjusted bank disbursement for December 2006

5. Adjusted cash balance as of December 31, 2006

Unadjusted book balance, 11/30/06 P77,900

presumed recorded in Dec. 173,000

Balance per bank

You obtained the following information on the current account of Parañaque

The bank statement on November 30, 2006 showed a balance of P306,000.

Based on the application of the necessary audit procedures and appreciation

1. How much is the undeposited collections as of December 31, 2006?

2. How much is the outstanding checks as of December 31, 2006?

3. How much is the adjusted cash balance as of November 30, 2006?

4. How much is the adjusted bank receipts for December?