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
(no entries were made on receipts of checks) 75,000
P2,865,000
APPLIED AUDITING

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

Note: Advances to affiliated companies are normally presented under

noncurrent assets.
APPLIED AUDITING

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
b. P420,000 d. P580,000
APPLIED AUDITING

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
Customer accounts written off as uncollectible
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
Accounts receivable P4,100,000
Allowance for doubtful accounts 100,000
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 700,000
allowances
Net sales 14,300,000
Multiply by bad debt rate 1 1/2%
Bad debt expense P 214,500

Question No. 2

Accounts receivable P17,500,000

Amount estimated to be (1,800,000)
uncollectible
Net realizable value P15,700,000

Question No. 3

Allowance for doubtful accounts 1/1/06 P170,000

Establishment of accounts written off in prior 80,000
years
APPLIED AUDITING

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

Customer accounts written off as uncollectible
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

Accounts receivable P4,100,000

Percentage 3%
Bad debt expense, before adjustment 123,000
Allowance for doubtful accounts (debit 100,000
balance)
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
Accounts receivable P1,000,000
Allowance for bad debts P40,000

Additional information:

 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.
APPLIED AUDITING

 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:

Based on the above and the result of your audit, answer the following:

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

Accounts receivable, 12/31/06 P3,000,000

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
APPLIED AUDITING

Question No. 3

Accounts receivable, 12/31/06 P3,000,000

Less: Allowance for doubtful P180,000
accounts
Allowance for sales 6,000 186,000
discounts
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:

Accounts receivable P3,600,000

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.
 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.
APPLIED AUDITING

Questions:

Based on the above and the result of your audit, answer the following:

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
pledged as collateral 1,200,000 33,400,000
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
APPLIED AUDITING

Allowance for doubtful accounts, 12/31/06 P136,000

Question No. 3

Accounts receivable, 12/31/06 P8,640,000

Less allowance for doubtful accounts, 136,000
12/31/06
Net realizable value, 12/31/06 P8,504,000

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
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

APPLIED AUDITING

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:

Based on the above and the result of your audit, answer the following:

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:

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 (8,000)
APPLIED AUDITING

difference
Adjusted 818,000 818,000 0 360,000 354,000 104,000
balances

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 – 4,000 26,680
P48,000)
Doubtful Accounts expense for P74,680
2006

Answers: 1) A; 2) A; 3) A

PROBLEM NO. 6

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:

APPLIED AUDITING

Debit Credit Balance

January 1, 2006 P14,632
October 31, 2006
Uncollectible accounts:
Company A –
P1,296
Company B – P6,032 8,600
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.

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:

Based on the above and the result of your audit, answer the following:

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
APPLIED AUDITING

2. How much is the adjusted balance of the Allowance for Doubtful Accounts
as of December 31, 2006?
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
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
APPLIED AUDITING

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

Add (deduct) adjustments:
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

Questions No. 4 & 5

Balance per books P38,104

(P39,400-P1,296)
Add (deduct) adjustments:
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
APPLIED AUDITING

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

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%
APPLIED AUDITING

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 2,400,000 P 61,200 P 2,400 P 58,800
2003 6,000,000 148,800 9,600 139,200
2004 7,200,000 204,000 12,000 192,000
P15,600,000 P414,000 P24,000 P390,000

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
APPLIED AUDITING

Question No. 4

Accounts receivable, 12/31/06 P3,600,000

Required allowance for doubtful accounts
(see computation below) 184,800
Net realizable value, 12/31/06 P3,415,200

(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
Allowance for doubtful accounts 184,800

2002 2003 2004 2005 Total

D/A exp P 13,200 P 60,000 P139,200 P172,800 P 385,200
provided
Less - 2,400 9,600 12,000 24,000
recoveries
Net 13,200 57,600 129,600 160,800 361,200
Should be
D/A exp
(Sales x 60,000 150,000 180,000 195,000 585,000
2.5%)
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
APPLIED AUDITING

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 57,416 Four notes
1 12 mos. 18% 100,000 to settle
Oct. 18 mos. 18% 100,000 past due
1 24 mos. 18% 100,000 account.
Oct. 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
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
10 381,476 payable at
maturity
P3,036,915
APPLIED AUDITING

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
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 2,584 P 2,584
57,416
APPLIED AUDITING

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% 4,005 4,005
10
) 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.

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:

Based on the above and the result of your audit, you are to provide the
answers to the following:

1. The adjusted balance of Notes Receivable as of December 31, 2006 is

APPLIED AUDITING

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
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
APPLIED AUDITING

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 5,760
14
) 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:

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
APPLIED AUDITING

corporation was P4,500,000. The collection of the installments on this note

is reasonably assured.

QUESTIONS:
Based on the above and the result of your audit, determine the following:

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

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
APPLIED AUDITING

(P4,200,000 x 462,000 891,750 3,308,250

11%)
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
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.
APPLIED AUDITING

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

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.
APPLIED AUDITING

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:

Installment sales for 2005 P4,341,650

Less cost of installment sales (P2,260,000 - 2,160,000
P100,000)
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
Less uncollected 2005 note, net -
12/31/06 (P1,800,000-P278,950) 1,521,050 1,220,600
Principal amount collected on 2006 1,279,400
note
Uncollected 2006 note, net – 12/31/06
(P3,000,000-P402,150) 2,597,850
Installment sales for 2006 P3,877,250

Question No. 4

Principal amount collected in 2006 on 2005 note P1,220,600

Multiply by gross profit rate in 2005 50.25%
Realized gross profit in 2006 on 2005 inst. sales P 613,352

Question No. 5

Principal amount collected in 2006 on 2006 note P1,279,400

Multiply by gross profit rate in 2006 43.23%
Realized gross profit in 2006 on 2006 inst. sales P 553,085

Computation of gross profit rate in 2006:

APPLIED AUDITING

Installment sales for 2006 P3,877,250

Less cost of installment sales (P2,601,000 - 2,201,000
P400,000)
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
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
APPLIED AUDITING

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 330,000
11%)
Carrying amount, 12/31/06 3,330,000
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, 400,000 5 years 0.5935 237,400
2011
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
APPLIED AUDITING

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
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
APPLIED AUDITING

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.

 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
APPLIED AUDITING

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%) 45,000 2,755,000
Note payable, 12/31/06 P1,745,000

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
Accounts receivable P1,550,000

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 30,000
6/12)
Maturity value 630,000
Less discount (P630,000 x 12% x 4/12) 25 200
Proceeds from note receivable discounting P604,800
APPLIED AUDITING

Answers: 1) A; 2) A; 3) B; 4) A, 5) C

PROBLEM NO. 14

Select the best answer for each of the following:

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.
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;
APPLIED AUDITING

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Reference:
Compilation of lecture notes by
Dean Rene Boy R. Bacay , CPA, CrFA, CMC, MBA, FRIAcc