Auditing Problems Test Bank 2
AUDITING PROBLEMS TEST BANK 2 PROBLEM NO. 1 You have been assigned to audit the financial statements of AYALA MERCHANTS CORPORATION for the year 2017. The company is a dealer of appliances and has several branches in Metro Manila. Its main office is located in Makati City. You were given by the company controller the unadjusted balances of the items to be included in the company’s statement of financial position and statement of income as of and for the year ended December 31, 2017. Audit findings are as follows: I. AUDIT OF CASH A cash count was conducted by your staff on January 7, 2018. The petty cash fund of P60,000 maintained by the company on an imprest basis relected a balance of P22,750. Unreplenished expenses totaled P37,250 of which P9,510 pertains to January 2018. You were furnished a copy of the company’s bank reconciliation statement with Chartered Bank as follows: Balance per bank Add: Deposit in transit Bank debit memos Returned check Less: Outstanding checks Book error Balance per books
P277,994 248,836 712,750 63,000 (174,580) (72,000) P1,056,000
Your review of the reconciliation statement disclosed the following: 1. Postdated checks totaling P107,400 were included as part of the deposit in transit. These represent collections from various customers whose accounts have been outstanding for less than three months. These checks were actually deposited on January 8, 2018. 2. Included in the deposit in transit is a check from a customer for P63,000 which was returned by the bank on December 27, 2017 for insufficiency of funds. This account has been outstanding for over six months. The check was replaced by the customer on January 15, 2018. 3. The bank debited the account of Ayala Merchants for P710,000 as payment of notes payable including interest of P10,000 due on December 26, 2017. This was not recorded as of year-end. 4. A check was cleared by the bank as P30,900 but was recorded by the bookkeeper as P102,900. This was in payment of accounts payable. 5. Bank service charges totaling P2,750 were not recorded. II. AUDIT OF ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS It is the company’s policy to provide allowance for doubtful accounts as follows: Less than 3 months 3 to 6 months Over 6 months Total
P2,500,960 843,200 274,500 P3,618,660
1% 5% 10%
An analysis of the accounts receivable schedule showed that several long outstanding accounts for more than a year totaling P152,460 should be written-off.
III. AUDIT OF MARKETABLE SECURITIES – TRADING
The company’s equity portfolio as of year-end showed the following:
Bacnotan Cement Fil-Estate Ionics La Tondena Selecta Union Bank
Total Shares 7,000 10,000 2,400 2,000 8,000 1,600
The securities are listed in the stock exchange. accounting.
Market Value Cost P108,500 195,000 49,200 67,000 31,600 50,880 P502,180
per Share P16.00 19.75 24.00 26.00 1.20 27.50
The company follows the fair value
IV. AUDIT OF NOTES RECEIVABLE The note receivable amounting to P1,300,000 represents a loan granted to a subsidiary. This is covered by a promissory note with interest at 15% per annum dated November 1, 2017. No interest has been accrued on the note as of December 31, 2017. V. AUDIT OF PREPAYMENTS Prepaid expenses account consists of the following: Prepaid Prepaid Prepaid Unused
advertising insurance rent office supplies
P 640,000 490,000 420,000 361,000 P1,911,000
Ayala Merchants renewed its contract with an advertising agency for the annual promotion as well as the regular advertisement of its products. It paid a total of P640,000, P100,000 of which is for the Christmas promotion while the balance is for the regular promotion and which will run for one year starting on August 1, 2017. Payment was made on July 20, 2017, and the total amount was reflected as prepaid advertising. The company leases the main office and store in Makati City at a monthly rental of P140,000. On November 5, 2017, a check for P420,000 was issued in payment of threemonth rental as per renewal contract which was effective on November 1, 2017. Rental deposit remained at three months and is included under other assets. The company’s delivery equipment is insured with Fortune Insurance Corporation for a total coverage of P2.4 million. Total payment made on November 16, 2017 for the renewal amounted to P490,000 which covers the period from November 1, 2017 to November 1, 2018. No adjustment has been made as of December 31, 2017. To take advantage of volume discount ranging from 10% to 20%, the company buys office and store supplies on a bulk basis. The staff-in-charge bought supplies worth P220,000 on June 10, 2017 and included the same in their office supplies inventory. As at year-end, unused office supplies amount to P102,500.
Page 3 VI. AUDIT OF INVENTORIES A physical count of inventories was conducted simultaneously in all stores on December 29 and 20, 2017. Your review of the list submitted by the accountant disclosed the following: 1.
Some deliveries made in December 2017 have not been invoiced and recorded as of year-end. These items had a selling price of P146,940 with term of 15 days. The corresponding cost was already deducted from the ending inventory.
Goods on consignment to Ayala Merchants totaling P356,000 were included in the inventory list.
Some appliances worth P138,500 were recorded twice in the inventory list.
Goods costing P153,800 purchased and paid on December 26 was received on January 4, 2018. The goods were shipped by the supplier on December 28, FOB shipping point.
VII. AUDIT OF PROPERTY, PLANT AND EQUIPMENT The company purchased additional equipment worth P268,000 on June 30, 2017. At the date of purchase, it incurred the following additional costs which were charged to repairs and maintenance account: Freight-in P30,400 Installation cost 13,000 Total P43,400 The above equipment has an estimated useful life of ten years and estimated salvage value of P20,000. Depreciation for the above equipment has been provided based on original cost. The company discarded some store equipment on October 1, 2017, realizing no salvage value. The cost of these equipment amounted to P165,520 with an accumulated depreciation of P138,620 on December 31, 2017. Depreciation booked from October 1, 2017 to year-end was P10,480. No entry was made on the disposal of the property. VIII. AUDIT OF ACCRUED EXPENSES Some expenses for December 2017 were recorded when paid in January 2018 which included the following: Electric bills P73,400 Commission of sales agents 57,000 Telephone charges 42,500 Minor repair of delivery equipment 21,340 Water bills 18,760 Total P213,000 IX. AUDIT OF LIABILITIES Ayala Merchants obtained a one-year loan from Chartered Bank amounting to P2.6 million at an interest rate of 16% per annum on October 1, 2017. Accrued interest on this loan was not taken up at year-end.
Page 4 X. OTHER AUDIT FINDINGS A review of the minutes of meeting showed that a 10% cash dividend was declared to shareholders of record as of December 15, 2017, payable on January 31, 2018. Ayala Merchants Corporation UNADJUSTED TRIAL BALANCE December 31, 2017 Petty cash fund Cash in bank Trading securities Accounts receivable – trade Allowance for doubtful accounts Notes receivable Inventories Prepaid advertising Prepaid insurance Prepaid rent Office supplies inventory Furniture and fixtures Delivery equipment Accumulated depreciation Other assets Accounts payable – trade Notes payable Accrued expenses Bonds payable Discount on bonds payable Ordinary share capital Retained earnings Sales Cost of goods sold Operating expenses Other income Other charges
Debit P 60,000 1,056,000 483,640 3,618,660 1,300,000 7,274,900 640,000 490,000 420,000 361,000 1,298,400 2,770,000 548,000
8,034,000 3,357,000 625,280 P32,836,880
1,177,500 2,356,320 3,300,000 169,040 5,000,000 5,400,000 792,160 13,078,000 1,453,500 P32,836,880
Determine the adjusted balances of the following: (Ignore tax implications) 1. Petty cash fund A. P37,250
2. Cash in bank A. P522,650
3. Trading securities A. P403,640
4. Accounts receivable A. P3,936,000
5. Allowance for doubtful accounts A. P110,360 B. P152,640
Page 6. Notes and interest receivable A. P1,331,960 B. P1,332,160
7. Inventories A. P6,934,200
8. Prepaid insurance A. P449,167
9. Prepaid rent A. P140,000
B. P 0
11. Office supplies inventory A. P258,500 B. P117,500
12. Total current assets A. P14,0333,612
13. Property, plant, and equipment A. P4,068,400 B. P2,905,228
14. Accumulated depreciation A. P1,038,880 B. P1,041,050
15. Accounts payable A. P2,525,360
16. Interest payable A. P104,000
17. Total current liabilities A. P6,803,798 B. P6,103,798
18. Sales A. P13,068,440
19. Cost of goods sold A. P8,034,000
20. Operating expenses A. P4,296,514
10. Prepaid advertising A. P325,000
PROBLEM NO. 2 To substantiate the existence of the accounts receivable balances as at December 31, 2017 of LUKAS COMPANY, you have decided to send confirmation requests to customers. Below is a summary of the confirmation replies together with the exceptions and audit findings. Gross profit on sales is 20%. The company is under the perpetual inventory method. Name of Customer Concordia
Balance Per Books P150,000
Comments From Customers P90,000 was returned on December 30, 2017. Correct balance as is P60,000. Your CM representing price adjustment dated December 28, 2017 cancels this. You have overpriced us by P150. Correct price should be P300. We received the goods only on January 6, 2018. Balance was offset by our December shipment of your raw materials.
Audit Findings Returned goods were received December 31, 2017. The CM was taken up by Lukas Company in 2018. The complaint is valid. Term is shipping point. Shipped in 2017. Lukas Company credited accounts payable for P135,000 to record purchases. Yakal is a supplier.
21. If the necessary adjusting journal entry is made regarding the case of Concordia, the net income will A. Decrease by P18,000. B. Decrease by P90,000.
C. Increase by P18,000. D. Increase by P90,000.
22. The effect on 2017 net income of Lukas Company of its failure to record the CM involving transaction with Falcon: A. P30,000 over. B. P30,000 under.
C. P6,000 over. D. P6,000 under.
23. The overstatement of receivable from Lazaro is A. P96,000
24. The accounts receivable from Silang is A. Correctly stated. B. P112,500 over.
C. P112,500 under. D. P225,000 under.
25. The adjusting entry to correct the receivable from Yakal is A. Purchases Accounts receivable B. Accounts payable Purchases C. Accounts receivable Accounts payable D. Accounts payable Accounts receivable
135,000 135,000 135,000 135,000
135,000 135,000 135,000 135,000
Page 7 PROBLEM NO. 3 Palito, CPA, has just accepted an engagement to audit the financial statements of Crocodile, Inc. for the year ending December 31, 2017. After obtaining an understanding of the client’s design of the accounting and internal control systems and their operation, he then proceeded in performing test of controls related to production cycle. The following questions related to test of controls of the production cycle: 26. Which of the following auditing procedures probably would provide the most reliable evidence concerning the entity’s assertion of rights and obligations related to inventories: A. Trace the test counts noted during the entity’s physical count to the entity’s summarization of quantities. B. Inspect agreements to determine whether any inventory is pledged as collateral or subject to any liens. C. Select the last few shipping documents used before the physical count and determine whether the shipments were recorded as sales. D. Inspect the open purchase order file for significant commitments that should be considered for disclosure. 27. Which of the following internal control activities most likely addresses the completeness assertion for inventory? A. The work-in-process account is periodically reconciled with subsidiary inventory records. B. Employees responsible for custody of finished goods do not perform the receiving function C. Receiving reports are prenumbered and the numbering sequence is checked periodically. D. There is a separation of duties between the payroll department and inventory accounting personnel. 28. From the auditor’s point of view, inventory counts are more acceptable prior to the yearend when A. Internal control is weak. B. Accurate perpetual inventory records are maintained. C. Inventory is slow moving. D. Significant amounts of inventory are held on a consignment basis. 29. A retailer’s physical count of inventory was higher than that shown by the perpetual records. Which of the following could explain the difference? A. Inventory items had been counted but the tags placed on the items had not been taken off and added to the inventory accumulation sheets. B. Credit memos for several items returned by customers had not been recorded. C. No journal entry had been made on the retailer’s books for several items returned to its suppliers. D. An item purchased FOB shipping point had not arrived at the date of the inventory count and had not been reflected in the perpetual records. 30. An auditor will usually trace the details of the test counts made during the observation of physical inventory counts to a final inventory compilation. This audit procedure is undertaken to provide evidence that items physically present and observed by the auditor at the time of the physical inventory count are A. Owned by the client. B. Not obsolete. C. Physically present at the time of the preparation of the final inventory schedule. D. Included in the final inventory schedule.
Page 8 PROBLEM NO. 4 A portion of the SPARK COMPANY’s statement of financial position appears as follows: Assets: Cash Notes receivable Inventory Liabilities: Accounts payable
December 31, 2017
December 31, 2016
P353,300 0 ?
P100,000 25,000 199,875
Spark Company pays for all operating expenses with cash and purchases all inventory on credit. During 2017, cash totaling P471,700 was paid on accounts payable. Operating expenses for 2017 totaled P220,000. All sales are cash sales. The inventory was restocked by purchasing 1,500 units per month and valued by using periodic FIFO. The unit cost of inventory was P32.60 during January 2017 and increased P0.10 per month during the year. Spark sells only one product. All sales are made for P50 per unit. The ending inventory for 2016 was valued at P32.50 per unit. 31. Number of units sold during 2017 A. 7,066
32. Accounts payable balance at December 31, 2017 A. P190,100
33. Inventory quantity on December 31, 2017 A. 5,750
34. Cost of inventory on December 31, 2017 A. P187,450
35. Cost of goods sold for the year ended December 31, 2017 A. P609,125
PROBLEM NO. 5
A depreciation schedule for semi-trucks of ISIDRO MANUFACTURING COMPANY was requested by your auditor soon after December 31, 2017, showing the additions, retirements, depreciation, and other data affecting the income of the company in the 4-year period 2014 to 2017, inclusive. The following data were ascertained. Balance of Trucks account, Jan. 1, 2014 Truck No. 1 purchased Truck No. 2 purchased Truck No. 3 purchased Truck No. 4 purchased Balance, Jan. 1, 2014
Jan. 1, 2011, cost July 1, 2011, cost Jan. 1, 2013, cost July 1, 2013, cost
P180,000 220,000 300,000 240,000 P940,000
The Accumulated Depreciation—Trucks account previously adjusted to January 1, 2014, and entered in the ledger, had a balance on that date of P302,000 (depreciation on the four trucks from the respective dates of purchase, based on a 5-year life, no salvage value). No charges had been made against the account before January 1, 2014. Transactions between January 1, 2014, and December 31, 2017, which were recorded in the ledger, are as follows. July 1, 2014
Truck No. 3 was traded for a larger one (No. 5), the agreed purchase price of which was P400,000. Isidro Mfg. Co. paid the automobile dealer P220,000 cash on the transaction. The entry was a debit to Trucks and a credit to Cash, P220,000. The transaction has commercial substance.
Jan. 1, 2015
Truck No. 1 was sold for P35,000 cash; entry debited Cash and credited Trucks, P35,000.
July 1, 2016
A new truck (No. 6) was acquired for P420,000 cash and was charged at that amount to the Trucks account. (Assume truck No. 2 was not retired.)
July 1, 2016
Truck No. 4 was damaged in a wreck to such an extent that it was sold as junk for P7,000 cash. Isidro Mfg. Co. received P25,000 from the insurance company. The entry made by the bookkeeper was a debit to Cash, P32,000, and credits to Miscellaneous Income, P7,000, and Trucks, P25,000.
Page 10 Entries for depreciation had been made at the close of each year as follows: 2014, P210,000; 2015, P225,000; 2016, P250,500; 2017, P304,000. 36. What is the total depreciation expense for the year ended December 31, 2014? A. P180,000
37. What is the gain (loss) on trade in of Truck #3 on July 1, 2014? A. (P30,000)
38. What is the net book value of the Trucks on December 31, 2017? A. P414,000
39. The total depreciation expense recorded for the 4-year period (2014-2017) is overstated by A. P185,500
40. The books have not been closed for 2017. What is the compound journal entry on December 31, 2017 to correct the company’s errors for the 4-year period (2014-2017)? A. Accumulated depreciation Trucks Retained earnings Depreciation expense B. Accumulated depreciation Trucks Retained earnings Depreciation expense C. Accumulated depreciation Trucks Retained earnings D. Accumulated depreciation Trucks
480,000 9,500 140,000 480,000 45,500 140,000 480,000 185,500 665,500
Page 11 PROBLEM NO. 6 The cash account of NUNAL COMPANY shows the following activities: Date Nov. 30 Dec. 2 4 15 20 21 31 31
Balance November bank charges November bank credit for notes receivable collected NSF check Loan proceeds December bank charges Cash receipts book Cash disbursements book RECEIPTS
Date Dec. 1 2 3 4 5 8 9 10 11 12 15 16 17 18 19 22 23 23 23 26 28 28 29 29 29 Totals
OR No. 110-120 121-136 137-150 151-165 166-190 191-210 211-232 233-250 251-275 276-300 301-309 310-350 351-390 391-420 421-480 481-500 501-525 526-555 556-611 612-630 -
Debit P P 30,000 145,500 2,121,900
CASH BOOKS Amount P 33,000 63,900 60,000 168,000 117,000 198,000 264,000 231,000 63,000 90,000 165,000 24,000 57,000 27,000 51,000 63,000 96,000 222,000 15,000 114,000 P2,121,900
Credit 150 3,900 180 1,224,000
Balance P345,000 344,850 374,850 370,950 516,450 516,270 2,638,170 1,414,170
PAYMENTS Check No. 801 802 803 804 805 806 807 808 809 810 811 812 813 814 816 817 818 819 820 821 822 823 824 825 826
Amount P 6,000 9,000 3,000 9,000 36,000 57,000 78,000 90,000 183,000 21,000 24,000 48,000 60,000 66,000 108,000 33,000 150,000 21,000 12,000 9,000 36,000 39,000 87,000 6,000 33,000 P1,224,000
Page 12 BANK STATEMENT Date Dec. 1 2 3 4 5 8 9 10 11 12 15 16 17 18 19 22 23 23 23 26 28 28 29 29 29 Totals
Check 792 802 804 EC 805 CM 16 799 DM 57 808 803 809 DM 61 813 CM 20 815 816 811 801 814 818 DM 112 821 CM 36 820
Charges P 7,500 9,000 9,000 243,000 36,000 21,150 3.900 90,000 3,000 183,000 180 60,000 18,000 108,000 24,000 6,000 66,000 150,000 360 9,000 12,000 P1,059,090
Additional information: 1. 2. 3. 4. 5. 6. 7.
DMs 61 and 112 are for service charges. EC is error corrected. DM 57 is for an NSF check. CM 20 is for loan proceeds, net of P450 interest charges for 90 days. CM 16 is for the correction of an erroneous November bank charge. CM 36 is for customers’ notes collected by bank in December. Bank balance on December 31 is P1,776,810
Credits P 25,500 33,000 63,900 60,000 243,000 285,000 36,000 462,000 231,000 63,000 255,000 24,000 57,000 145,500 141,000 96,000 222,000 15,000 36,000 P2,493,900
Based on the preceding information, determine the following: 41. Outstanding checks at November 30 A. P39,150
C. P 0
D. P 0
42. Outstanding checks at December 31 A. P459,000
43. Deposit in transit at November 30 A. P58,500
44. Deposit in transit at December 31 A. P114,000
45. Adjusted book balance at November 30 A. P410,850
46. Adjusted bank receipts for the month of December A. P2,297,400
47. Adjusted book disbursements for the month of December A. P1,228,440
48. Adjusted bank balance at December 31 A. P1,449,810
49. Unadjusted bank balance at November 30 A. P555,060
50. The best evidence regarding year-end bank balances is documented in the A. B. C. D.
Cutoff bank statements. Bank reconciliations. Interbank transfer schedule. Bank deposit lead schedule.
Page 14 PROBLEM NO. 7 MINA MINING CO. has acquired a tract of mineral land for P50,000,000. Mina Mining estimates that the acquired property will yield 150,000 tons of ore with sufficient mineral content to make mining and processing profitable. It further estimates that 7,500 tons of ore will be mined the first and last year and 15,000 tons every year in between. (Assume 11 years of mining operations.) The land will have a residual value of P1,550,000. Mina Mining builds necessary structures and sheds on the site at a total cost of P12,000,000. The company estimates that these structures can be used for 15 years but, because they must be dismantled if they are to be moved, they have no residual value. Mina Mining does not intend to use the buildings elsewhere. Mining machinery installed at the mine was purchased secondhand at a total cost of P3,600,000. The machinery cost the former owner P9,000,000 and was 50% depreciated when purchased. Mina Mining estimates that about half of this machinery will still be useful when the present mineral resources have been exhausted but that dismantling and removal costs will just about offset its value at that time. The company does not intend to use the machinery elsewhere. The remaining machinery will last until about one-half the present estimated mineral ore has been removed and will then be worthless. Cost is to be allocated equally between these two classes of machinery. 51. What are the estimated depletion and depreciation charges for the 1st year? Depletion Depreciation A. P4,845,000 P870,000 B. P4,845,000 P780,000 C. P2,422,500 P870,000 D. P2,422,500 P780,000 52. What are the estimated depletion and depreciation charges for the 5th year? Depletion Depreciation A. P2,422,500 P1,740,000 B. P2,422,500 P1,560,000 C. P4,845,000 P1,560,000 D. P4,845,000 P1,740,000 53. What are the estimated depletion and depreciation charges for the 6th year? Depletion Depreciation A. P2,422,500 P1,560,000 B. P2,422,500 P1,740,000 C. P4,845,000 P1,560,000 D. P4,845,000 P1,740,000 54. What are the estimated depletion and depreciation charges for the 7th year? Depletion Depreciation A. P2,422,500 P1,380,000 B. P2,422,500 P1,560,000 C. P4,845,000 P1,380,000 D. P4,845,000 P1,560,000 55. What are the estimated depletion and depreciation charges for the 11th year? Depletion Depreciation A. P4,845,000 P1,380,000 B. P4,845,000 P690,000 C. P2,422,500 P1,380,000 D. P2,422,500 P690,000
Page 15 PROBLEM NO. 8 The HVR Company included the following in its notes receivable on December 31, 2017: Note receivable from sale of land Note receivable from consultation Note receivable from sale of equipment
P2,640,000 3,600,000 4,800,000
The following transactions during 2017 and other information relate to the company’s notes receceivable: a) On January 1, 2017, HVR Company sold a tract of land to Triple X Company. The land, purchased 10 years ago, was carried on HVR’s books at P1,500,000. HVR received a noninterest-bearing note for P2,640,000 from Triple X. The note is due on December 31, 2018. There was no established exchange price for the land. The prevailing interest rate for this note on January 1, 2017 was 10%. b) On January 1, 2017, HVR Company received a 5%, P3,600,000 promissory note in exchange for the consultation services rendered. The note will mature on December 31, 2019, with interest receivable every December 31. The fair value of the services rendered is not readily determinable. The prevailing rate of interest for a note of this type was 10% on January 1, 2017. c) On January 1, 2017, HVR Company sold an old equipment with a carrying amount of P4,800,000, receiving P7,200,000 note. The note bears an interest rate of 4% and is to be repaid in 3 annual installments of P2,400,000 (plus interest on the outstanding balance). HVR received the first payment on December 31, 2017. There is no established market value for the equipment. The market interest rate for similar notes was 14% on January 1, 2017. Note: Round off present value factors to four decimal places and final answers to the nearest hundred. 56. What amount of consultation fee revenue should be recognized in 2017? A. P3,600,000
57. What amount should be reported as gain on sale of equipment? A. P994,800
58. The amount to be reported as noncurrent notes receivable on December 31, 2017 is A. P7,482,200
59. The amount to be reported as current notes receivable on December 31, 2017 is A. P4,800,000
60. How much interest income should be recognized in 2017? A. P974,200
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