Audit of Liabiities and She-1

SUCCEED REVIEW CENTER Audit of Liabilities and She PROBLEM 1 You were able to obtain the following from the accountant for Royal Crown Corp. related to the company’s liabilities as of December 31,2012. Accounts payable Notes payable – trade Notes payable – bank Wages and salaries payable Interest payable Mortgage notes payable – 10% Mortgage notes payable – 12% Bonds payable

P650,000 190,000 800,000 15,000 ? 600,000 1,500,000 2,000,000

The following additional information pertains to these liabilities. a. All trade notes payable are due within six months from the end of the reporting period. b. Bank notes-payable include two separate notes payable to Allied Bank. (a)

A P300,000, 8% note issued March 1,2010, payable on demand. Interest is payable every six months.

(b)

A 1-year, P500,000, 11 ½% note issued January 2,2012.

On December 30, 2012, Royal Crown negotiated a written agreement with Allied Bank to replace the note with a two-year P500,000, which was issued January 2, 2013. Royal Crown paid the interest on this note on December 31, 2012. c.

The 10% mortgage note was issued October 1,2009, with a term of 10 years. Terms of the note give the holder the right to demand immediate payment if the company fails to make a monthly interest payment within 10 days of the date the payment is due. As of December 31,2012, Royal Crown is three months behind in playing its required interest payment.

d. The 12% mortgage note was issued May 1,2006, with a term of 20 years. The current principal amount due is P1,500,000. Principal and interest payable annually on April 30. A payment of P220,000 is due April 30,2013. The payment includes interest of P180,000. e. The bonds payable is 10-year, 8% bonds, issued June 30,2003. Interest is payable semi-annually every June 30 and December 31. QUESTIONS: 1. Interest payable as of December 31,2012 is a. P155,000 b. P203,000 c. P143,000 d. P215,000 2. The portion of the Note Payable-bank to be reported under current liabilities as of December 31,2012 is a. P300,000 b. P800,000 c. P500,000 d. P0 3. Total current liabilities as of December 31,2012 is a. P3,950,000 b. P3,938,000 c. P4,138,000 d. P3,998,000 4. Total noncurrent liabilities as of December 31, 2012 is a. P1,760,000 b. P3,960,000 c. P2,560,000 d. P1,960,000 PROBLEM 2 MUSIC AND ME COMPANY 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 31,2013: Notes payable Dallas has signed several long-term notes with financial institutions. The maturities of those notes are given below. The total unpaid interest for all of these notes amounts to P340,000 on March 31,2013. Due date April 31,2013 July 31,2013 September 1,2013

Amount P600,000 900,000 450,000

February 1,2014 April 1,2013 – March 31,2015 .

450,000 2,700,000 P 5,100,000

Estimated warranties MUSIC AND ME has a one-year product warranty on some selected items. The estimated warranty liability on sales made during the 2011 – 2012 fiscal year and still outstanding as of March 31,2012, amounted to P252,000. The warranty costs on sales made from April 1,2012 to March 31,2013, are estimated at P630,000. The actual warranty costs incurred during 2012 – 2013 fiscal year are as follows: Warranty claims honored on 2011 – 2012 sales Warranty claims honored on 2012 – 2013 sales Total

P252,000 285,000 P537,000

Trade payables Accounts payable for supplies, goods, and services purchases on open account amount to P560,000 as of March 31,2013. Dividends On March 10,2013, Music and Me’s board of directors declared a cash dividend of P0.30 per ordinary share and a 10% ordinary share dividend. Both dividends were to be distributed on April 5,2013 to ordinary shareholders on record at the close of business on March 31,2013. As of March 31,2013, Music and Me has 5,000,000 P2 par value, ordinary shares issued and outstanding. Bonds payable Music and Me issued P5,000,000, 12% bonds on October 1,2010 at a price that yields 10%. . The bonds will mature on October 1,2020. Interest is paid semi-annually on October 1 and April 1. QUESTIONS: Based on the above and the result of your audit, determine the adjusted balances of the following as of March 31,2013: 1. 2. 3. 4. 5. 6.

Estimated warranty liability Total interest payable Interest expense relating to the bonds for the year ended March 31, 2013. The unamortized bond premium or discount on March 31, 2013 Total current liabilities at March 31, 2013 Total non-current liabilities at March 31, 2013.

PROBLEM 3 NOW AND THEN carries a wide variety of music promotion techniques – warranties and premiums – to attract customers. Musical instrument and sound equipment are sold with a one-year warranty for replacement of parts and labor. The estimated warranty cost, based on past experience, is 2% of sales. The premium is offered on the recorded and sheet music. Customers receive a coupon for each P20 spent on recorded music or sheet music. Customers may exchange 200 coupons and P140 for a radio. Now and Then pays P340 for each radio and estimates that 60% of the coupons given to customers will be redeemed. Now and Then’s total sales for 2012 were P58,000,000, of which P45,000,000 were from sales of musical instrument and sound reproduction equipment. Replacement parts and labor for warranty work totaled P1,300,000 during 2012. A total of 3,000 units of radio used in the premium program were purchased during the year and there were 700,000 coupons redeemed in 2012. The accrual method is used by Dolores to account for the warranty and premium costs for financial reporting purposes. The balance in the accounts related to warranties and premiums o January 1,2012, were as shown below: Inventory of Premium - radio Estimated Premium Claims Outstanding Estimated Liability for Warranties

P340,000 160,000 1,088,000

QUESTIONS: Based on the above and the result of your audit, determine the amounts that will be shown on the 2012 financial statements for the following:

2. 3. 4. 5. 6.

1. Warranty expense Estimated liability for warranties Estimated liability for warranties Premium expense Inventory of premium - radio Estimated liability for premiums

PROBLEM 4 On January 1,2011, Thunder Corporation issued 2,000 of its 5 – year, P1,000 face value, 11% bonds dated January 1 at an effective annual interest rate (yield) of 9%. Interest is payable each December 31. Thunder uses the effective interest method of amortization. On December 31,2012, the 2,000 bonds were extinguished early through acquisition in the open market by Thunder for P1,980,000 plus accrued interest. On July 1,2011, Thunder issued 5,000 of its 6-year, P1,000 face value, 10% convertible bonds at par. Interest is payable every June 30 and December 31. On the date of issue, the prevailing market interest rate for similar debt without the conversion option is 12%. On July 1,2012, an investor in Thunder’s convertible bonds tendered 1,500 bonds for conversion into 15,000 ordinary shares of Thunder, which had a fair value of P105 and a par value of P1 at the date of conversion. QUESTIONS: Based on the above and the result of your audit, determine the following: (Round off present value factors to 4 decimal places). 1. The process from issuance of convertible bonds to be allocated to the equity component is a. P235,520 b.P239,120 c. P136,760 d. P0 2. The carrying amount of the bonds on December 31,2011 is a. P3,849,120 b. P3,885,940 c. P3,113,180 d. P4,000,000 3. The amount to be recognized in profit or loss as a result of the repurchase of the bonds on January 1,2012 is a. P200,000 b. P203,880 c. P180,400 d. P237,730 4. The repurchase of the bonds on January 1,2012 decreased equity by a. P439,530 b. P37,710 c. P76,630 d.P0 5. The amount to be recognized in profit or loss as a result of the amendment of the terms on December 31,2012 is a. P640,000 b. P10,000 c. P64,000 d. P0

Problem 5 In your initial audit of National Finance Company, you find the following ledger account balances. 12% Bonds Payable – Due 10 years from 01-01-2009 : 10/01/12 CD

01.02.09

CRP

01.01.12 CD 07.01.12 CD

01.02.09 CR

P 5,000,000

1,110,000

529,697

P

Bond Discount :

Bond Interest Expense 300,000 : 300,000 :

The bonds were redeemed for permanent cancellation on October 1, 2012 at 108 plus accrued interest. Based on your computation, the bonds were originally issued to yield 14%. REQUIRED: (a) A

Compute the following:

B

(b)

1. 2. 3. 4. 5.

The adjusted balance of bonds payable as of December 31, 2012 The adjusted balance of the bond discount on December 31, 2012. The bond interest expense for the year 2012 The loss on bond redemption. The balance of interest payable on December 31, 2012

Prepare audit adjusting entry as of December 31, 2012.

PROBLEM 6 The following information relates to the obligations of Lakers Corporation as of December 31,2012. ● Accounts payable for goods and services purchased ao open account amounted to P35,000 at December 31,2012. ● On December 15,2012, Lakers declared a cash dividend of P.05 per share, payable on January 12,2013, to shareholders of record as of December 31,2012. Lakers had 1 million ordinary shares issued and outstanding. ● On December 31,2012, Lakers entered into a six-year finance lease on a warehouse and made the first annual lease payment of P100,000. The incremental borrowing rate was 12%, and the interest rate implicit in the lease, which was known to Lakers, was 10%. The rounded present value factors for an annuity due for six years are 4.6 at 12% and 4.8 at 10%. ● On July 1,2012, Lakers issued P500,000, 8% bonds for P440,000 to yield 10%. The bonds pay interest annually every June 30. At December 31,2012, the bonds were trading on the open market at 86 to yield 12%. Lakers uses the effective interest method. ● Lakers’ 2012 accounting profit was P850,000 and its taxable profit was P600,000. The difference is due to P100,000 permanent differences and P150,000 of temporary differences related to noncurrent assets. At December 31,2012, Lakers had cumulative taxable differences of P300,000 related to noncurrent assets. Lakers’ effective tax rate is 30%. Lakers made no estimated tax payments during the year. QUESTIONS: Based on the above and the result of your audit, determine the following as of and for the year ended December 31,2012: 1. Carrying amount of finance lease liability a. P480,000 b. P428,000 c. P380,000 2. Carrying amount of bonds payable a. P446,400 b. P444,000 c. P442,000 3. Current liabilities a. P342,200 b. P327,000 c. P367,000 4. Noncurrent liabilities a. P850,000 b. P854,400 c. P895,000 5. Interest expense a. P92,000 b. P70,000 c. P44,000 PROBLEM 7

d. P360,000 d. P430,000 d. P347,000 d. P902,800 d. P22,000

The capital structure of Red Ribbon Corporation on December 31, 2011 follows:

Preference 12% Share Capital, P200 par, 30,000 shares issued and outstanding Ordinary Share Capital, P50 par, 100,000 shares Issued and outstanding Share Premium-Preference Share Premium-Ordinary Retained Earnings

P 6,000,000 5,000,000 1,800,000 1,500,000 2,200,000

During 2012, the following selected transactions occurred: a. b. c. d.

Purchased and retired 4,000 preference shares at P280 per share. Purchased 8,000 shares of its own ordinary share at P75 per share when each share is selling in the market at P78 each. A 2-for-1 share split on the ordinary share was approved by the shareholders, thereby reducing the par value to P25. Reissued 6,000 treasury shares at P45 each.

e. f. g.

Shareholders donated 4,000 ordinary shares when the market price was P46 per share. Two thousand of the donated shares were issued for P48 per share. The profit for 2012 was P2,000,000. No dividends were declared.

REQUIRED: Determine the following at December 31, 2012 – (a) (b) (c) (d)

Total shareholders’ equity Number of preference shares issued; number of preference shares outstanding Number of ordinary shares issued; number of ordinary shares outstanding Cost of remaining treasury shares (acquired by purchase)

PROBLEM 8 Red Heart Corporation was organized at the beginning of 2010 with 300,000 authorized shares of P100 par value ordinary share capital. At December 31, 2010, the shareholders’ equity section of Red Heart was as follows:

Ordinary Share Capital , P100 par, 30,000 shares issued Share Premium Retained Earnings Total Shareholders’ Equity

P3,000,000 300,000 450,000 P3,750,000

On June 15, 2011, Red Heart issued 50,000 ordinary shares for P6,000,000. A 5% bonus issue was declared on September 30, 2011 and issued on November 10, 2011 to shareholders of record on October 31, 2011. The market value of the ordinary share was P110 each on the declaration date. The profit of Red Heart for the year ended December 31, 2011 was P1,175,000.

During 2012, Red Heart had the following transactions:

March 1

Red Heart acquired 3,000 of its own ordinary share for P95 each.

May 1

Red Heart sold 1,500 shares of its treasury for P120 per share.

August 10

Issued shareholders one stock right for each share held to purchase two additional ordinary shares for P125 per share. The rights expire on December 31, 2012.

September 15 15,000 stock rights were exercised when the market value of ordinary share was P130 each. October 31

40,000 stock rights were exercised when the market value of ordinary share was P140 each.

December 10

Red Heart declared cash dividends of P5 per share payable on January 5, 2013.

December 20

Red Heart retired 1,000 shares of its treasury and reverted them to an unissued basis. On this date, the market value of the ordinary share was P150 each.

Profit for 2012 was P1,200,000. REQUIRED: (a) (b) 3.25.

Journal entries for years 2011 and 2012. Shareholders’ equity section of the statement of financial position at December 31, 2012.

The Red Santa Company began 2012 with P13,000,000 retained earnings account, of which P4,000,000 is appropriated for plant expansion. During the year 2012, the following events occurred: 1. 2.

A material error was discovered in the financial statements for the year 2011, which caused depreciation of 2011 to be understated by P200,000. The company’s income tax rate is 30%. Cash dividends of P5 per share on the 300,000 P100 par ordinary shares outstanding were declared and distributed, after paying the required annual dividend on its 200,000 shares of 8% P100 par preference share.

3. 4. 5.

6. 7.

10,000 shares of preference share capital were retired at P150 per share. These shares were originally issued at P130 per share. The company completed its plant expansion project and released the retained earnings previously appropriated for this purpose. A bonus issue of 45,000 shares of ordinary share capital was distributed to shareholders. The shares sell at P150 per share on date of declaration and P140 per share on the date of distribution. There were 300,000 shares issued and outstanding before the bonus issue. During 2012, the company issued P20,000,000 10-year 12% bonds. The bond indenture provides that Red Santa shall restrict P2,000,000 of retained earnings annually for the accumulation of enough funds for this indebtedness. Profit for the year was P3,000,000.

REQUIRED: Compute the retained earnings balance that will be shown on the statement of financial position at December 31, 2012. How much of this balance is unavailable for further distribution of dividends? PROBLEM 9 ELEGANT BUILDERS You have been engaged to examine the financial statements of Elegant Builders, Inc., a company incorporated only on December 27, 2004. The company is a distributor of construction materials. You were given a copy of the unadjusted trial balance for the year ended December 31, 2012. As senior in charge of the audit, you were provided the following summarized information. A.

A surprise count of cash and other items conducted by your audit staff on January 4, 2013 disclosed the following composition: Bills and coins IOU notes of several employees, All dated December 2012 Paid petty cash vouchers No. Date Description 125 Dec. 29 Representation and Advertising 126 Dec. 30 Office and Store Supplies 127 Dec. 31 Repairs of computers 128 Jan. 03 Transportation expense 129 Jan. 04 Representation

B.

P 4,255 5,600 Amount P 5,200 3,054 6,500 260 131

The company maintains accounts with the East-West Bank and you were given a copy of the bank reconciliation statement which showed the following: Balance per bank statement Add: deposits in transit Bank charges Total Less: outstanding checks Balance per ledger

P3,500,000 375,250 142,100 P4,017,350 546,750 P3,470,600

Your further examination disclosed the following: 1. 2. 3. 4. 5.

Postdated checks totaling P84,200 were included in the deposit in transit. These represent collections of accounts receivable whose accounts are aged as not due. The checks were actually deposited on January 10, 2013. Various bank debit memos totaling P140,000 were for drafts purchased for payment of imported panel doors. These purchases were previously credited to accounts payable. Bank service charges for December amounting to P2,100 were not yet taken up in the books. Included in the outstanding checks are checks in payment of accounts payable for P226,000. These checks were prepared and recorded in December 2012 but were released only in January 2013. A check issued to a supplier for P32,300 was recorded in the cash payments journal as P33,200. This check is one of the outstanding checks.

C.

Trade accounts which are not due based on customers’ subsidiary ledgers have total debit balances of P1,480,000. An account becomes overdue 45 days after date of shipment. Among the recorded cash collections was the full recovery of a P36,000 receivable from Jun de Leon, a customer whose account had been written off as worthless late in 2011. The account was not reinstated upon recovery. An examination of the shipping records disclosed that goods with an invoice price of P35,000 recorded as a sale in December was shipped out only on January 4, 2013. These goods cost P27,000. Goods sold for 20,000 on December 23, 2012 were returned on December 28, 2012. The goods were included in the ending inventory at selling price although cost was only P13,200. The sales return was recorded only on January 5, 2013. There is a credit balance in one account receivable of P14,000. It represents an advance received on December 26 on a sales contract. Delivery was made by the company on January 14, 2013. Advances of P120,000 to officers and affiliates were released on December 30, 2012 and were included in the accounts receivable. These advances are not currently collectible. After careful study of all past due accounts, the management estimated that the probable loss contained therein was 10%. In addition, 2% of current accounts receivable might prove uncollectible.

D.

A physical count of merchandise on hand was made on December 30 and 31 which reflected a balance of P2,540,000. During the course of your examination of inventory, you found the following: Merchandise costing P100,000 were not included in the inventory of December 31, 2012, inasmuch as the goods had been invoiced to customers and recorded in the company’s sales books at P145,000 under date of December 31, 2012. The goods were actually shipped January 2, 2013. Not included in the inventory of December 31 2012 was merchandise shown by the receiving records to have been received in the afternoon of December 31, 2012, costing P60,000. The invoice was recorded as purchases of January 2013.

E.

The company bought 18,000 shares of PS Bank Company for P540,000 and 12,000 shares of SM Holdings for P132,000 in July, 2012 from Metro Securities, Inc. a member of the stock exchange. PS Bank declared a 10% bonus issue on December 1, 2012 when the market price of each share is P48. On September 30, 2012 2,000 shares of SM Holdings were sold for P15 per share, net of tax and commissions. This was recorded as a credit to Trading Securities. No cash dividends were received during the year. Market values as of December 31 were P32 for PS Bank and P16 for SM Holdings.

F.

On January 2, 2012, the company purchased air-conditioning units with cash invoice price of P120,000. Depreciation on these units was provided using the straight-line method over an estimated useful life of 8 years. The company paid delivery and installation on such airconditioning units at P3,600 and P11,000 respectively. These costs were charged to Transportation Expense and Repairs and Maintenance, respectively.

G.

On January 2, 2006, Elegant Builders completed the construction of a small warehouse on the leased premises. The improvement cost P580,000. The lease is to terminate on January 2, 2016, while the improvement had an estimated life of 12 years. The lease term is renewable for an additional five years, and during the year 2012, Elegant Builders exercised its renewal option. Elegant Builders already recorded in 2012 P58,000 depreciation on this improvement.

H.

Subsequent payments made and recorded in January 2013 included the following: Electric bills for December 2012 P39,500 Sales commissions from November to December 26,350 Water bills for November and December 4,900 Minor repair on a vehicle done in December 3,820

The company obtained a short-term loan of P900,000 from the bank to augment cash requirements. This was valued on November 6, 2012 payable after 120 days. Interest rate is 9% per annum. No accrual was recorded at yearend. (Use 365 day year). I.

On October 5, 2012, the Elegant Builders exchanged 50,000 ordinary shares for a parcel of land to be used as a future site for a new office and store. The shares had a fair market value of P120 per share (par value P100). The company received P40,000 when an existing building on the land was sold for scrap. The land was capitalized at P6,000,000 and Elegant Builders recorded a gain of P1,000,000 on the issue of its ordinary shares and P40,000 on the sale of the scrap.

J.

The Other Operating Income is composed of the following: Dividend Income Gain on Sale of Ordinary Shares Sale of Scrap

P

86,400 1,000,000 40,000

J.

On December 20, 2012, the company declared a P15 dividend per share on its ordinary shares, payable on January 20, 2013 to shareholders of record as of the close of business on December 29, 2012.

K.

Income tax rate is 30%. Elegant Builders Trial Balance December 31, 2012 P

Petty Cash Fund Cash in Bank Trading Securities Accounts Receivable Allowance for Doubtful Accounts Other Receivables Merchandise Inventory, January 1 Prepaid expenses Land Leasehold Improvements Equipment Accumulated depreciation – leasehold improvements Accumulated depreciation – equipment Other non-current financial assets Trade payables and accrued expenses Notes payable and accrued interest Dividends payable Income tax payable Ordinary Share Capital, P100 par Additional paid in capital Retained earnings, January 1, 2012 Net sales Net purchases Salaries expense Representation and advertising Depreciation and amortization Rent Expense Repairs and Maintenance Supplies Expense Bank Charges Transportation Expense Utilities Expense Interest expense Other Operating expenses and losses Other operating income Income tax expense

25,000 3,470,600 728,400 4,800,000 P

406,000 690,000 1,460,000 900,000 11,000,000 950,000 1,800,000 9,200,000 6,495,000 1,200,000 320,000 153,000 432,000 60,000 70,000 12,000 5,000 240,000 64,000 1,126,400 P 27,686,320

Additional information:

Merchandise inventory per count conducted on December 30 and 31, P2,540,000. Items to be answered: 1.

What is the correct balance of deposits in transit?

153,920

25,000 2,025,400 60,920 6,000,000 580,000 920,000

P27,686,320

2. 3.

4. 5.

A. P459,450 B. P339,250 C. P375,250 D. P291,050 What is the correct balance of outstanding checks? A. P319,850 B. P320,750 C. P321,650 D. P546,750 In the statement of cash flows, how would the declaration of bonus issue be shown? A. not shown B. as outflow under operating activities C. as outflow under investing activities D. as outflow under financing activities Over how many years would the remaining book value of the leasehold improvements be depreciated effective 2012? A. 10 B. 12 C. 9 D. 6 Using the function of expense method, how much cost of sales would be presented on the statement of comprehensive income? A. P5,788,720 B. P5,887,200 C.P5,894,000 D. P5,947,200

Compute for the adjusted balances of the following: (in peso values) Answer 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27 28 29. 30. 31. 32. 33. 34 35 36 37 38. 39. 40.

Petty cash fund Cash in bank Trading securities, at cost Trading securities, at market Unrealized gain or loss on trading securities Accounts receivable Allowance for doubtful accounts Other Receivables – current Merchandise inventory Prepaid expenses Land Equipment Accumulated Depreciation – Equipment Net book value of leasehold improvements Other Non-current Financial Assets Trade Payables and Accrued Expenses Notes Payable and Accrued Interest Dividends Payable Income Tax Payable Additional Paid in Capital Retained Earnings Net Sales Net Purchases Salaries and Commissions Repairs and Maintenance Supplies Expense Bank Charges Interest Expense Other Operating Income Transportation Expense Depreciation and Amortization Doubtful Accounts Expense Representation & Advertising Ordinary Share Capital Profit