AP 5904 Investments

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CPA REVIEW SCHOOL OF THE PHILIPPINES Manila

AUDITING PROBLEMS AUDIT OF INVESTMENTS PROBLEM NO. 1 You were engaged by MISMO COMPANY to audit its financial statements for the year 2005. During the course of your audit, you noted that the following trading securities were properly reported as current assets at December 31, 2004: Cost Aquata Corporation, 10,000 shares, convertible preferred shares Andrina, Inc., 60,000 shares of common stock Attina Co., 20,000 shares of common stock

P 900,000 1,350,000 1,237,500 P3,487,500

Market P 975,000 1,485,000 900,000 P3,360,000

The following sale and conversion transactions transpired during 2005: Mar. 27

Sold 25,000 shares of Andrina for P33.75 per share.

April 15

Sold 5,000 shares of Attina for P45 per share.

Sept. 21

Converted 5,000 shares of Aquata’s preferred stock into 15,000 shares of Aquata’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 2005 dividend information pertains to stocks owned by MISMO: Jan. 12

Attina issued a 10% stock dividend when the market price of Attina’s common stock was P49.50 per share.

March 31 and Sept. 30

Aquata paid dividends of P2.50 per share on its preferred stock, to stockholders of record on March 15 and September 15, respectively. Aquata did not pay dividends on its common stock during 2005.

July 1

Andrina paid a P2.25 per share dividend on its common stock.

June 30 and Dec. 31

Adella paid semi-annual dividends of P1.50 on each of these dates. Adella’s net income for the year ended December 31, 2005 was P2,400,000.

On January 2, 2005, MISMO purchased 100,000 shares of Adella Corporation common stock for P3,600,000, representing 20% of Adella’s outstanding common stock and an underlying equity of P3,150,000 in Adella’s net assets on January 2, 2005. MISMO intends to hold Adella’s stock as a long-term investment, with the remaining investments being considered as held for trading. Market prices per share of the securities were as follows: Aquata Corp., preferred Aquata Corp., common Andrina, Inc., common Attina Co., common Adella Corp., common

12/31/2005 92.25 42.75 22.50 40.50 40.00

12/31/2004 97.50 38.25 24.75 45.00 36.75

All of the foregoing stocks are listed in the Philippine Stock Exchange. Declines in market value from cost would not be considered permanent.

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REQUIRED Based on the above and the result of your audit, you are to provide the answers to the following: 1. How much is the gain on sale of Andrina shares? a. P225,000 b. P281,250 c. P562,500

d. P0

2. How much is the gain or loss on sale of Attina shares? a. P20,455 gain b. P56,250 gain c. P56,250 loss

d. P0

3.

How much is the gain or loss on conversion of 5,000 Aquata preferred stock into 15,000 common stock? a. P93,750 loss b. P258,750 gain c. P56,250 loss d. P0

4.

How much is the total dividend income for the year 2005? a. P128,750 b. P103,750 c. P202,750

d. P728,750

5.

How much is the net investment income on investment in Adella Corp. in 2005? a. P480,000 b. P457,500 c. P577,500 d. P502,500

6.

How much is the carrying amount of MISMO’s investment in Adella Corp. as of December 31, 2005? a. P3,780,000 b. P3,600,000 c. P3,757,500 d. P4,000,000

7.

Assuming MISMO has no significant influence on Adella Corp., how much is the carrying amount of MISMO’s investment in Adella Corp. as of December 31, 2005? a. P4,000,000 b. P3,600,000 c. P3,757,500 d. P3,780,000

8.

Assuming MISMO has no significant influence on Adella Corp. and the stock of Adella has no reliable fair value, how much is the carrying amount of MISMO’s investment in Adella Corp. as of December 31, 2005? a. P3,600,000 b. P3,780,000 c. P3,757,500 d. P4,000,000

9.

Using the same assumptions in no. 8 and that Adella Corp. declared semi-annual cash dividends of P3 per share, how much is the carrying amount of MISMO’s investment in Adella Corp. as of December 31, 2005? a. P3,480,000 b. P3,757,500 c. P3,235,000 d. P3,600,000

10. The trading securities should be reported on MISMO’s December 31, 2005 balance sheet at a. P2,578,500 b. P2,587,500 c. P5,813,500 d. P2,421,000 11. How much should be reported as unrealized gain on trading securities? a. P135,545 b. P9,000 c. P118,500 d. P0 PROBLEM NO. 2 On December 31, 2004, La Cost Company’s balance sheet showed the following balances related to its securities accounts: Trading securities Available-for-sale securities (AFS) Interest receivable-Mayniladlad water bonds Unrealized gain - AFS

P1,477,500 1,180,000 12,500 100,000

La Cost’s securities portfolio on December 31, 2004, was made up of the following securities: Security 10,000 shares Yeye Bonel Corp. stock 8,000 shares Totoy Bibo Inc. stock 10% Mayniladlad water bonds (interest payable semiannually on Jan. 1 and Jul. 1)

Classification Cost Trading P750,000 Trading 550,000 Trading

250,000

Market P762,500 528,250 186,750

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Security 10,000 shares Bulaklak Inc. stock 20,000 shares Jumbo Hotdog Unlimited Inc. stock

Classification Available for sale Available for sale

Cost 590,000

Market 630,000

490,000

550,000

During 2005, the following transactions took place: Jan. 3

Receive interest on the Mayniladlad water bonds.

Mar. 1

Purchased 3,000 additional shares of Yeye Bonel Corp. stock for P229,500, classified as a trading security.

Apr. 15

Sold 4,000 shares of the Totoy Bibo Inc. stock for P69 per share.

May 4

Sold 4,000 shares of the Bulaklak Inc. stock for P62 per share.

July 1

Received interest on the Mayniladlad water bonds.

Oct. 30

Purchased 15,000 shares of Pasaway Co. stock for P832,500, classified as a trading security.

The market values of the stocks and bonds on December 31, 2005, are as follows: Yeye Bonel Corp. stock Totoy Bibo Inc. stock Pasaway Co. stock Mayniladlad water bonds Bulaklak Inc. stock Jumbo Hotdog Unlimited Inc. stock

P76.60 per share P68.50 per share P55.25 per share P205,550 P61.00 per share P27.00 per share

QUESTIONS: Based on the above and the result of your audit, determine the following: 1.

Gain or loss on sale of 4,000 Totoy Bibo Inc. shares on April 15, 2005 a. P1,000 gain b. P1,000 loss c. P11,875 gain d. P11,875 loss

2.

Net realized gain or loss on sale of 4,000 Bulaklak Inc. shares on May 4, 2005 a. P12,000 gain b. P12,000 loss c. P4,000 gain d. P4,000 loss

3.

Carrying value of Trading Securities as of December 31, 2005 a. P2,337,000 b. P2,287,800 c. P2,304,100 d. P2,297,400

4.

Carrying value of Available for Sale Securities as of December 31, 2005 a. P844,000 b. P806,000 c. P906,000 d. P944,000

5.

In 2005, what amount of unrealized gain or loss should be shown as component of income and stockholders’ equity? Income Stockholders’ equity a. P28,725 gain P62,000 gain b. P28,725 gain P22,000 loss c. P32,900 loss P122,000 loss d. P39,600 gain P78,000 gain

PROBLEM NO. 3 GUEST COMPANY has a stock investment in Marciano Corporation. Described below are the transactions pertaining to this investment: a)

On January 2, 1998, GUEST purchased 10,000 shares of P100 par value common stock at P110 per share. The company debited Investment in Stock account.

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b)

The Marciano Corporation was expanding and on March 2, 1999 it issued stock rights to its stockholders. Each right entitles GUEST to purchase one fourth (¼) 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 foregoing.

c)

On April 2, 1999, GUEST exercised all its stock rights. The Investment in Stock account was charged for the amount paid.

d)

GUEST’s accountant felt that the cash paid for the new shares was merely an assessment since GUEST’s proportionate share in Marciano 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)

GUEST received a 50% stock dividend from Marciano in December 2003. Because the shares received were expected to be sold, the company’s president instructed the accountant not to make any entry for this dividend. The company did sell the dividend shares in January 2004 for P160 per share. The proceeds from the sale were credited to income.

f)

In December 2004, Marciano’s stocks were split on a two-for-one basis and the new shares were issued as no par shares. GUEST found that each new share was worth P10 more than the P110 per share original acquisition cost. For this reason, GUEST decided to debit the Investment in Stock account with the additional shares received at P120 per share and credited revenue for it.

g)

In August 2005, GUEST sold one half (½) of its holdings in Marciano at P100 per share. The proceeds were credited to the Investment in Stock account. GUEST uses the average method in recording disposals of its investment in stock.

REQUIRED 1.

Prepare the journal entry to record the receipt of stock rights on March 2, 1999.

2.

What is the total cost of the shares acquired on April 2, 1999?

3.

What was the average cost per share of GUEST’s Investment in Stock after the exercise of the stock rights on April 2, 1999?

4.

Compute the amount of cash dividends received by GUEST for the period 1999 to 2002.

5.

Prepare the journal entry to record the stock dividend received.

6.

Determine the gain or loss on the sale of dividend shares received.

7.

How many shares were received by GUEST as a result of the two-for-one stock split?

8.

What journal entry should be made to record the stock split?

9.

How much gain or loss should have been recognized by GUEST from the sale of stocks in August 2005?

10. How much is the unadjusted balance of the Investment in Stock account on December 31, 2005? 11. How much is the adjusted balance of the Investment in Stock account on December 31, 2005?

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PROBLEM NO. 4 The LEE BUYS COMPANY had acquired interest in a promising local company, the Silver Tab Company. During your audit of the company’s accounts for the year 2005, which was a first audit, you obtained the following: Investment in Silver Tab Company 2003–Jan. 2 2004–Jul. 2 2005–Mar. 2

2005 - Aug. 10

30,000 sh @35 90,000 sh @60 30,000 sh @70

P1,050,000 2005–Jul. 15 5,400,000 2,100,000

50,000 sh @40

P2,000,000

Investment in Red Tab Company P10,000 Dividend Income 2005 January. 2 April 1 August 10 December 20

P120,000 150,000 10,000 100,000

The transactions pertaining to the foregoing for 2005 were as follows: Jan. 2

Received cash dividend (declared on December 1) of P1 per share.

Mar. 2

Bought 30,000 shares at P70 per share.

Apr. 1

Received cash dividend (declared on March 1 to stockholders of record as of March 10) of P1 per share.

July 15

Sold 50,000 shares at P40 per share.

Aug. 10

Received an “extra” dividend in stock of one share of Red Tab Company for every ten shares of Silver Tab Company. The stock dividend had a market value of P3 per share and its book value on the ledger of Silver Tab Company was P1 per share.

Dec. 20

Received cash dividend of P1 per share, declared December 1, out of Silver Tab Company’s “Reserve for Depletion”.

29

Sold 10,000 Silver Tab Company shares at P90. January 5, 2006.

Cash was received on

QUESTIONS: Based on the above and the result of your audit, determine the following: 1.

Loss on sale of 50,000 Silver Tab Company shares on July 15, 2005 a. P250,000 b. P1,300,000 c. P850,000 d. P0

2.

Gain on sale of 10,000 Silver Tab Company shares on December 29, 2005 a. P330,000 b. P310,000 c. P300,000 d. P0

3.

Adjusted balance of Investment in Silver Tab Company as of December 31, 2005 a. P5,570,000 b. P5,130,000 c. P5,580,000 d. P5,640,000

4.

Adjusted balance of Investment in Red Tab Company as of December 31, 2005 a. P10,000 b. P20,000 c. P30,000 d. P0

5.

Dividend income for the year ended December 31, 2005 a. P180,000 b. P160,000 c. P150,000

d. P280,000

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PROBLEM NO. 5 On July 1, 2005, Pir Carding Company acquired 25% of the outstanding shares of common stock of Cinderela Corporation at a total cost of P7,000,000. The underlying equity of the stock acquired by Pir Carding was only P6,000,000. Pir Carding is willing to pay more than the book value for the following reasons: a) Cinderela owned depreciable plant assets (10-year remaining economic life) with a current fair value of P600,000 more than their carrying amount. b) Cinderela owned land with current fair value of P3,000,000 more than its carrying amount. c) There are no other identifiable tangible or intangible assets with fair value in excess of book value. Accordingly, the remaining excess, if any, is to be allocated to goodwill. Cinderela earned net income of P5,400,000 evenly over the year ended December 31, 2005. On December 31, Cinderela declared and paid a cash dividend of P1,050,000 to common stockholders. Market value of Pir Carding’s share of the stock at December 31, 2005 is P7,500,000. Both companies close their accounting records on December 31. QUESTIONS: Based on the above and the result of your audit, determine the following: 1.

Total amount of goodwill of Cinderela Corporation based on the price paid by Pir Carding a. P4,000,000 b. P400,000 c. P1,000,000 d. P100,000

2.

Net investment income from Investment in Cinderela Corporation a. P675,000 b. P667,500 c. P1,335,000 d. P662,500

3.

Carrying value of Investment in Cinderela Corporation as of December 31, 2005 a. P7,412,500 b. P7,667,500 c. P7,405,000 d. P7,662,500

PROBLEM NO. 6 On June 1, 2004, You Corporation purchased as a long term investment 4,000 of the P1,000 face value, 8% bonds of Too Corporation. You Corporation has the positive intention and ability to hold these bonds to maturity. The bonds were purchased to yield 10% interest. Interest is payable semi-annually on December 1 and June 1. The bonds mature on June 1, 2010. On November 1, 2005, You Corporation sold the bonds for a total consideration of P3,925,000. QUESTIONS: Based on the above and the result of your audit, determine the following: (Round off present value factors to four decimal places) 1. The purchase price of the bonds on June 1, 2004 is a. P3,645,328 b. P3,696,736 c. P3,691,132

d. P3,624,596

2. The interest income for the year 2004 is a. P215,850 b. P212,830

d. P211,612

c. P215,521

3. The carrying value of the investment in bonds as of December 31, 2004 is a. P3,725,919 b. P3,719,986 c. P3,649,541 d. P3,671,491 4. The interest income for the year 2005 is a. P306,607 b. P311,218

c. P310,715

d. P304,748

5. The gain on sale of investment in bonds on November 1, 2005 is a. P21,196 b. P27,632 c. P80,235 d. P104,045

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PROBLEM NO. 7 Select the best answer for each of the following: 1. A client has a large and active investment portfolio that is kept in a bank safe-deposit box. If the auditor is unable to count the securities at the balance sheet date, the auditor most likely will a. Request the bank to confirm to the auditor the contents of the safe deposit box at the balance sheet date. b. Examine supporting evidence for transactions occurring during the year. c. Count the securities at a subsequent date and confirm with bank whether securities were added or removed since the balance sheet date. d. Request the client to have a bank seal the safe-deposit box until the auditor can count the securities at a subsequent date. 2. When an auditor is unable to inspect and count a client’s investment securities until after the balance sheet date, the bank where the securities are held in a safe deposit box should be asked to a. Verify any differences between the contents of the box and the balances in the client’s subsidiary ledger. b. Provide a list of securities added and removed from the box between the balance sheet date and the security count date. c. Count the securities in the box so that the auditor will have an independent direct verification. d. Confirm that there has been no access to the box between the balance- sheet date and the security-count date. 3. Which of the following is not one of the auditor’s primary objectives in an audit of trading securities? a. To determine whether securities are authentic. b. To determine whether securities are the property of the client. c. To determine whether securities actually exist. d. To determine whether securities are properly classified on the balance sheet date. 4. Apol Boba, CPA, observes the count of securities on December 31. She records the serial numbers of the securities and reconciles them and the number of shares with company records. Which fraud should be detected by this procedure? a. An investee company declared and paid a stock dividend on December 15. The stock certificate for the additional shares was received directly by the treasurer who made no record of the receipt and embezzled the shares. b. The treasurer embezzled and sold securities on April 4. She speculated successfully with the proceeds and replaced the securities on December 29. c. The treasurer borrowed securities on July 15 to use as collateral for a personal loan. He repaid the loan and returned the securities on December 2. d. The treasurer embezzled interest receipts from bonds by having the payments mailed directly to him. 5. Which of the following is the least effective audit procedure regarding the existence assertion for the securities held by the auditee? a. Examination of paid checks issued in payment of securities purchased. b. Vouching all changes during the year to supporting documents. c. Simultaneous count of liquid assets. d. Confirmation from the custodian. 6. An auditee is holding equity securities as collateral for a debt. The auditor should a. Determine from data published in the financial press that the auditee has recorded dividend income from the collateral. b. Ascertain the value of the securities.

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c. Ascertain that the amount recorded for the collateral in the investment account is equal to its fair value at the balance sheet date. d. Verify that the client has taken title to the securities. 7. Which of the following is the most effective audit procedure for verification of dividends earned on investments in equity securities? a. Tracing deposited dividend checks to the cash receipts book. b. Reconciling amount received with published dividend records. c. Comparing the amounts received with preceding year dividends received. d. Recomputing selected extensions and footings of dividend schedules and comparing totals to the general ledger. 8. In confirming with an outside agent, such as a financial institution, that the agent is holding investment securities in the client’s name an auditor most likely gathers evidence in support of management’s financial statement assertions of existence and a. Valuation c. Completeness b. Rights and obligations d. Presentation and disclosure 9. In establishing the existence and ownership of an investment held by a corporation in the form of publicity traded stock and auditor should inspect the securities or a. Obtain written representations from management confirming that the securities are properly classified as trading securities. b. Inspect the audited financial statements of the investee company. c. Confirm the number of shares held by an independent custodian. d. Determine that the investment is carried at the lower of cost or market. 10. An auditor most likely to verify the interest earned on bond investment by a. Verifying the receipt and deposit of interest checks. b. Confirming the bond interest rate with the issuer of the bonds. c. Recomputing the interest earned on the basis of face amount, interest rate, and period held. d. Testing controls relevant to cash receipts. 11. Which of the following provides the best form of evidence pertaining to the annual valuation of an investment in which the independent auditor’s client owns a 30% voting interest? a. Market quotations of the investee company’s stock. b. Current fair value of the investee company’s assets. c. Historical cost of the investee company’s assets. d. Audited financial statements of the investee company. 12. In verifying the amount of goodwill recorded by a client, the most convincing evidence an auditor can obtain is by comparing the recorded value of assets acquired with the a. Assessed value as evidenced by tax bills. b. Seller’s book value as evidenced by financial statements. c. Insured value as evidenced by insurance policies. d. Appraised value as evidenced by independent appraisals. 13. The auditor can best verify a client’s bond sinking-fund transactions and year-end balance by a. Confirmation with individual holders of retired bonds. b. Confirmation with the bond trustee. c. Recomputation of interest expense, interest payable, and amortization of bond discount or premium. d. Examination and count of the bonds retired during the year.

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14. An auditor who physically examines securities should insist that a client representative be present in order to a. Detect fraudulent securities. b. Lend authority to the auditor’s directives. c. Coordinate the return of securities to the proper locations. d. Acknowledge the receipt of securities returned. 15. In testing long-term investments, an auditor ordinarily would use analytical procedures to ascertain the reasonableness of the a. Classification between current and noncurrent portfolios. b. Valuation of marketable equity securities. c. Existence of unrealized gains or losses in the portfolio. d. Completeness of recorded investment income. 16. In performing tests of the carrying value of trading securities, the auditor would usually: a. Ask management to estimate the market value of the securities. b. Refer to the quoted market prices of the securities. c. Value the securities at cost regardless of their market prices. d. Count the securities. 17. Which of the following statements is the least accepted reason/purpose for acquiring long-term investments: a. To create specific funds. b. To yield a relatively permanent other income. c. To generate cash for operating purposes. d. To establish business relationships. 18. In testing long-term investments, an auditor would use analytical procedures to ascertain the reasonableness of the classification between current and noncurrent portfolios. In testing long-term investments, an auditor would use analytical procedures to ascertain the reasonableness of the valuation of marketable equity securities. In testing long-term investments, an auditor would use analytical procedures to ascertain the reasonableness of the existence of unrealized gains or losses in the portfolio. First statement Second statement Third statement

a. False True True

b. True True True

c. False False True

d. False False False

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