Chapter 5 Audit of Property, Plant and Equipment

 

APPLIED AUDITING

CHAPTE CHAP TER R5 AUDI AU DIT T OF PR PROP OPER ERTY TY PL PLAN ANT T AND AND EQ EQUI UIPM PMEN ENT T

Objective 1. Solving Audit of Inventories Problems 2. Theory of Audit of Inventories

PROBLEM NO. 1  Aliaga Corporation was incorporated on January 2, 2006. The following items relate to the Aliaga’s property and equipment transactions: Cost of land, which include included d an old apartm apartment ent building appraised at P300,000  Apartment building mortgage assumed, including related ted inter terest due at th the e time of purchase Deli De liqu quen entt pr prop oper erty ty ta tax xes as assu sume med d by th the e Al Alia iaga ga Payments Payme nts to tenan tenants ts to vaca vacate te the apartment

P3,000,000 80,0 ,00 00 30 30,0 ,000 00 20,000

building Cost of razing the apartment building Proceeds from sale of salvaged materials  Architects fee for new building Building permit for new construction Fee for title search Survey before construction of new building Exca Ex cava vati tion on be befo fore re co cons nstr truc ucti tion on of ne new w bu buil ildi ding ng Payment to building contractor  Assessment by city for drainage project Cost of grading and leveling Temporary quarters for construction crew Temp Te mpor orar ary y bu buil ildi ding ng to ho hous use e to tool ols s an and d ma mate teri rial als s Cost of changes during construction to make new

40,000 10,000 60,000 40,000 25,000 20,000 10 100, 0,00 000 0 10,000,000 15,000 50,000 80,000 50 50,0 ,000 00

building more energy efficient Interest cost on specific borrowing incurred during

90,000

 

APPLIED AUDITING construction Payment of medical bills of employees accidentally inju injure red d wh whil ile e insp inspec ecti ting ng bu buil ildi ding ng co cons nstr truc ucti tion on Cost of paving driveway and parking lot Cost of installing lights in parking lot Premium for insurance on building during construction Cost of open house party to celebrate opening of  new building Cost of windows broken by vandals distracted by the celebration

360,000 18 18,0 ,000 00 60,000 12,000 30,000

50,000 12,000

QUESTIONS: Based on the above and the result of your audit, determine the following: 1. Co Cost st of La Land nd a. P2,980,000 b. P3,270,000

c. P3,185,000 d. P3,205,000

2. Cost Cost o off Bu Build ilding ing a. P10,810,000 b. P10,895,000 3. Cost of L Land and IImprov mprovements ements a. P12,000 b. P72,000

c. P10,875,000 d. P11,110,000

c. P122,000 d. P 0

4. Amoun Amountt that shou should ld be expe expensed nsed w when hen incu incurred rred a. P 80,000 c. P62,000 b. P110,000 d. P50,000 5. Total de deprec preciable iable pr property operty a and nd equi equipment pment a. P11,182,000 c. P10,947,500 b. P10,967,000 d. P10,882,000 Suggested Solution: PAS 16 par. 6 define defines s “Property, plant and equip equipment ment”” as tangible items that: a. ar are e he held ld for us use e in the pro produ duct ctio ion n or su supp pply ly of go good ods s or se serv rvic ices es,, fo for  r  rentall to other renta others, s, or for admi administra nistrative tive purpose purposes; s; and  b. are expe expected cted to be us used ed duri during ng more tha than n one peri period. od. Par. 15 and 16 further state that an item of property, plant and equipment that  qualifies quali fies for recog recognition nition of an asset sh shall all be measu measured red at its cost. The cos costt of  an item of PPE comprises: a. its purchas purchase e price, including impo import rt duties and non-refund non-refundable able purch purchase ase taxes, after deducting trade discounts and rebates.

 

APPLIED AUDITING b. any cost costs s dir direct ectly ly attrib attributa utable ble to bri bringi nging ng the ass asset et to the loca locatio tion n and  cond co nditi ition on ne nece cess ssar ary y for it to be ca capa pabl ble e of op oper erati ating ng in th the e mann manner  er  intended by management. c. the initi initial al est estim imate ate of the costs of dis disman mantlin tling g and removin removing g the item and restoring the site on which it is located, the obligation for which an entity incurs either when the item is acquired or as a consequence of  having used the item during a particular period for purposes other than to produce inventories during that period. Question No. 1 Cost of land  Apartment building mortgage assumed, including related interest due at the time of  purchase Deli De liqu quen entt prop proper erty ty taxe taxes s as assu sume med d by th the e Al Alia iaga ga Payments to tenants to vacate the apartment building Cost of razing the apartment building Proceeds from sale of salvaged mater terials Fee for title search

P3,000,000

Survey before constr tru ucti tio on of new building  Assessment by city for drainage project Cost of grading and leveling Total cost of Land

20,000 15,000 50,000 P3,270,000

80,000 30 30,0 ,000 00 20,000 40,000 (10,000) 25,000

Question No. 2   Architects fee for new building Building permit for new construction Exca Ex cava vati tion on be befo fore re co cons nstr truc ucti tion on of ne new w bu buil ildi ding ng Payment to building contractor Temporary quarters for construction crew Temporary building to house tools and materials Cost of changes during construction to make new building more energy efficient Interest cost on specific borrowing incurred during construction Premium for insurance on building during construction Total cost of Building

P60,000 40,000 10 100, 0,00 000 0 10,000,000 80,000 50,000

90,000 360,000 30,000 P10,810,000

Question No. 3 Cost of paving driveway and parking lot Cost of installing lights in parking lot

P60,000 12,000

Total cost of Land Improvements

P72,000

 

APPLIED AUDITING

Question No. 4 Payment of medical bills of employees Cost of open house party Cost of windows broken by vandals Tota To tall cos ostt am amou oun nt th that at sh sho ould be ex expe pen nse sed d

P18,000 50,000 12,000 P8 P80 0,0 ,00 00

Question No. 5  Building (see no. 2) Land improvements (see no. 3) Total depreciable PPE

P10,810,000 72,000 P10,882,000

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

PROBLEM NO. 2 The following items relate to the acquisition of a new machine by Bongabon Corporation in 2006: Invoice price of machinery Cash discount not taken Freight on new machine Cost of removing the old machine Loss on disposal of the old machine Gratuity paid to operator of the old machine who was laid off Installation cost of new machine Repair cost of new machine damaged in the process of installation Testing costs before machine was put into regular operation Salary of engineer for the duration of the trial run Operating cost during first month of regular  use Cash allowance granted because the new mach ma chin ine e prov proved ed to be of infe inferi rior or qua uali lity ty

P2,000,000 40,000 10,000 12,000 150,000 70,000 60,000 8,000 15,000 40,000 250,000

10 100 0,0 ,00 00

Question: How much should be recognized as cost of the new machine? a. P1,985,000 c. P1,930,000 b. P1,993,000 d. P2,025,000 Suggested Solution: Solution:

 

APPLIED AUDITING Invoice price of machinery Cash discount not taken Freight on new machine Installation cost of new machine Testing costs Salary of engineer for the duration of the trial run Cash allowance Cost of the new machine

P2,000,000 (40,000) 10,000 60,000 15,000 40,000 (100,000) P1,985,000

 Answer:   A

PROBLEM NO. 3 On Ja Janu nuar ary y 1, 20 2005 05,, Ca Cabi biao ao Co Corp rpor orat atio ion n pu purc rcha hase sed d a tr trac actt of la land nd (site (site numberr 101) with a building for P1,80 numbe P1,800,00 0,000. 0. Addit Additional ionally, ly, Cabiao pai paid d a real st state ate br brok oker er’s ’s co comm mmis issi sion on of P1 P108 08,0 ,000 00,, le lega gall fe fees es of P1 P18, 8,00 000 0 an and d ti title tle guarantee guara ntee insur insurance ance of P54,000. The closin closing g statemen statementt indicated that the land value val ue was P1, P1,500 500,00 ,000 0 and the build building ing valu value e was P300 P300,00 ,000. 0. Shortly Shortly afte after  r  acquisitio acqui sition, n, the build building ing was raze razed d at a cost of P225,0 P225,000. 00. Cabiao Cabi ao en ente tere red d into into a P9 P9,0 ,000 00,00 ,000 0 fix fixed ed-p -pri rice ce co cont ntra ract ct wi with th Ca Caba bana natu tuan an Builders, Inc. on March 1, 2005 for the construction of an office building on the land lan d sit site e 101 101.. The buil buildin ding g was comp complet leted ed and occ occupi upied ed on Sep Septem tember ber 30, 2006. Addi Additional tional const constructi ruction on costs were incurred as follows: Plan Plans, s, sp spec ecif ific icat atio ions ns an and d blue bluepr prin ints ts P 36 36,0 ,000 00  Architect’s fees for design and supervision 285,000 The building is estimated to have a forty-year life from date of completion and will be depreciated using the 150%-declining-balance method. To finance the construction cost, Cabiao borrowed P9,000,000 on March 1, 2005. The loan is payable in ten annual instal installment lments s of P900, P900,000 000 plus intere interest st at the rate of 14% 14%.. Cab Cabiao iao use used d part of the loa loan n proce proceeds eds for work working ing cap capita itall re req quire uireme men nts. ts. Cab abia iao o’s av aver erag age e am amou ount nts s of ac accu cum mul ula ate ted d bu buil ildi ding ng construction expenditures were as follows: For the For the pe peri riod od Ma Marc rch h 1 to De Dece cemb mber er 31 31,, 20 2005 05 Forr the Fo the pe peri riod od Ja Janu nuar ary y 1 to Se Sept ptem embe berr 31 31,, 2006 2006

P2 P2,7 ,700 00,0 ,000 00 6, 6,90 900,0 0,000 00

Cabiao is using the allowed alternative treatment for borrowing cost. QUESTIONS: Based on the above and the result of your audit, determine the following: 1. Cost Cost of lan land d site n numb umber er 101 a. P1,905,000

c. P2,205,000

 

APPLIED AUDITING b. P1,800,000 2. Cost Cost of of offic fice e bui buildi lding ng a. P10,581,000 b. P10,360,500

d. P2,151,000

c. P10,329,000 d. P10,960,500

3. Depre Depreciati ciation on of offi office ce buil building ding fo forr 2006 a. P96,800 c. P102,800 b. P97,130 d. P 99,197 Suggested Solution: Question No. 1  Acquisition cost Real Re al es esta tate te brok broker er's 's co comm mmis issi sion on Legal fees Title guarantee insurance Cost of razing the existing building Total cost of land site 101

P1,800,000 10 108, 8,00 000 0 18,000 54,000 225,000 P2,205,000

Question No. 2  Fixed-price contract cost Plans, specifications and blueprints  Architect's fees and design supervision Capitalizable borrowing cost: Mar. 1 to Dec. 31, 2005 (P (P2, 2,70 700, 0,00 000 0 x 14 14% % x 10 10/1 /12) 2)

P 9,000,000 36,000 285,000

P3 P315 15,0 ,00 0 0

Jan. 1 to Sept. 30, 2006 (P6,900,000 x 14% x 9/12) Total cost of office building

724,500

1,039,500 P10,360,500

Question No. 3 Deprec Dep reciat iation ion exp expens ense e [[P10 P10,36 ,360,5 0,500 00 x ((1/4 1/40x 0x1.5) 1.5) x 3 3/12 /12]]  Answers: 1  Answers:  1)) C C;; 2) B; 3) B

PROBLEM NO. 4

P97 P97,13 ,130 0

 

APPLIED AUDITING You noted during your audit of the Carranglan Company that the company carried out a number of transactions involving the acquisition of several assets.  All expenditures were recorded in the following single asset account, identified as Property and equipment: Property and equipment  Acquisition price of land and building Options taken out on several pieces of  property List price of machinery purchased Freight on machinery purchased Repair to machinery resulting from damage during shipment Cost of removing old machinery Driveways and sidewalks Building remodeling Utili tiliti ties es pa paid id sinc since e acq cqui uis sit itio ion n of bu buil ildi ding ng

P 960,000 16,000 318,400 5,000 1,480 4,800 102,000 400,000 20 20,8 ,800 00 P1,828,480

Based on property tax assessments, which are believed to fairly represent the relative relativ e values invol involved, ved, the buildin building g is worth twic twice e as much as the land. The machinery was subject to a 2% cash discount, which was taken and credited to Purchases Purcha ses Disc Discounts ounts.. Of the two options, P6,000 is relate related d to the buildi building ng and land land pu purc rcha hase sed d an and d P1 P10, 0,00 000 0 rela relate ted d to th thos ose e no nott purc purcha hase sed. d. Th The e ol old d machinery was sold at book value. QUESTIONS: Based Base d on th the e ab abov ove e an and d the the re resu sult lt of yo your ur audi audit, t, dete determ rmin ine e the ad adju just sted ed balance of the following: 1. La Land nd a. P644,000 b. P322,000

c. P326,000 d. P424,000

2. Buildi Building ng a. P 6 64 44, 4,0 000 c. P1 P1,,04 044 4,0 ,00 00 b. P1,040,000 d. P 722,000 3. Machin Machinery ery a. P317,032 b. P318,512

Suggested Solution:

c. P323,400 d. P321,832

 

APPLIED AUDITING Questions No. 1 and 2  Land  Allocation of acquisition price: Land (P960,000 x 1/3) Building (960,000 x 2/3) Option paid on property acquired: Land (6,000 x 1/3) Building (6,000 x 2/3) Cost of building remodelling  Adjusted balances

Building

P320,000 P 640,000

2,000 4,000 400,000 P322,000 P1,044,000

Question No. 3 Net purchase price of machinery (P318,400 x .98) Freight on machinery purchased  Adjusted balance

P312,032 5,000 P317,032

 Answers: 1  Answers:  1)) B B;; 2) C; 3) A PROBLEM NO. 5 In connection with your audit of Cuyapo Company’s financial statements for  the year 2006, you noted the following transactions affecting the property and equipment items of the company: J an. 1

Purchased real property fo forr P5,026,0 ,00 00, which includ inc luded ed a cha charge rge of P14 P146,0 6,000 00 rep repres resent enting ing pro proper perty ty tax for 2006 that had been prepaid by the vendor; 20% of the purchase price is deemed applicable to land and the balanc balance e to build building ings. s. A mor mortga tgage ge of P3, P3,000 000,00 ,000 0 was assume assumed d by Cuy Cuyapo apo on the purch purchase ase.. Cas Cash h was paid for the balance.

Jan. Ja n. 15

Prev Previo ious us ow owne ners rs ha had d fa fail iled ed to ta take ke ca care re of norm normal al maintenance and repair requirements on the buildings, nece ne cess ssit itat atin ing g cu curr rren entt reco recond ndit itio ioni ning ng at a co cost st of  P236,800.

Feb. Fe b. 15 Dem emo olish lished ed garag arages es in th the e re rea ar of th the e bu buil ildi ding ng,, P36,000 P36,0 00 being rec recovere overed d on the lumber salv salvage. age. The compan com pany y pro procee ceeded ded to const construc ructt a wa wareh rehous ouse. e. The cost co st of su such ch wa ware reho hous use e wa was s P5 P540 40,8 ,800 00,, wh whic ich h wa was s P90, P9 0,00 000 0 less less th than an th the e av aver erag age e bi bids ds ma made de on th the e cons co nstr truc ucti tion on by inde indepe pend nden entt co cont ntra ract ctor ors. s. Up Upon on completio comple tion n of con constr struct uction ion,, cit city y ins inspec pectors tors ord ordere ered d

 

APPLIED AUDITING extensiv exten sive e mod modific ificati ations ons to the bui buildi lding ng as a res result ult of  fa fail ilur ure e on th the e pa part rt of th the e co comp mpan any y to co comp mply ly wi with th building build ing safety cod code. e. Such modi modificati fications, ons, whic which h could have been avoided, cost P76,800. Mar.. 1 Mar

The com compan pany ye exc xchan hanged ged its own sto stock ck wit with h a fair val value ue of P3 P320 20,0 ,000 00 (par (par P2 P24, 4,00 000) 0) fo forr a pa pate tent nt an and d a ne new w equipment. The equipment has a fair value of  P200,000.

 Apr.

1

The new machinery for the new building arrived. In addi ad diti tion on,, a ne new w fr fran anch chis ise e wa was s ac acqu quir ired ed fr from om th the e manufactu manuf acturer rer of the machine machinery. ry. Payme Payment nt was made by issuing bonds with a face value of P400,000 and by paying payi ng cash of P144, P144,000. 000. The valu value e of the franchis franchise e is sett at P1 se P160 60,0 ,000 00,, wh whil ile e th the e ma mach chin ine’ e’s s fa fair ir va valu lue e is P360,000.

May Ma y

1

Th The e com compa pany ny c con ontr trac acte ted d for pa park rkin ing g lot lots s and w wai aiti ting ng sheds at a cost P360,000 and P76,800, respectively. The work was completed and paid for on June 1.

Dec.. 31 The bu Dec busin siness ess w was as clo closed sed to pe permi rmitt takin taking g the yea year-e r-end nd inventory inve ntory.. Durin During g this time, requi required red redec redecoratin orating g and repairs repai rs were compl completed eted at a cost of P60,0 P60,000. 00. QUESTIONS: Based on the above and the result of your audit, determine the cost of the following: 1. La Land nd a. P 940,000 b. P1,005,200

c. P 976,000 d. P1,052,800

2. Buildi Buildings ngs a. P4,645,600 b. P5,005,600

c. P4,762,400 d. P4,681,600

3. Mach Machinery inery and equi equipment pment a. P360,000 b. P560,000

c. P576,615 d. P659,692

4. Land improv improvement ements s a. P360,000 b. P 76,800

c. P436,800 d. P 0

5. Total p proper roperty, ty, pla plant nt and eq equipme uipment nt a. P6,764,400 b. P6,731,200

c. P6,718,092 d. P6,618,400

 

APPLIED AUDITING

Suggested Solution: Question No. 1 Total contract price Less property taxes for 2006  Adjusted cost of land and building Percentage applicable to land Cost of Land

P5,026,000 146,000 4,880,000 20% P 976,000

Question No. 2  Cost allocated to building (P4,880,000 x 80%) Reconditioning costs prior to use Salvage proceeds from demolition of  garages Construction cost of warehouse

P3,904,000

Cost of Buildings

P4,645,600

236,800 (36,000) 540,800

Notes: 1) The savin savings gs on constr construction uction of P90,0 P90,000 00 shoul should d be ignored. 2) Th The e mo modi difi fica cati tion on co cost sts s of P7 P76, 6,80 800 0 an and d th the e re rede deco cora rati ting ng an and d re repa pair  ir  costs of P60,000 should be expensed. Question No. 3 Fair value of equipment acquired on Mar. 1 Fair Fa ir va valu lue e of ma mach chin ine e ac acqu quir ired ed on Ap Apr. r. 1 Cost of Machinery and equipment

P200,000 36 360, 0,00 000 0 P560,000

Question No. 4 Parking lots Waiting sheds Cost of Land improvements

P360,000 76,800 P436,800

Question No. 5  Land Buildings Machinery and equipment Land improvements Total cost of property, plant and

P 976,000 4,645,600 560,000 436,800 P6,618,400

 

APPLIED AUDITING equipment  Answers: 1  Answers:  1)) C; C; 2) A; 3) B; 4) C, 5) D

PROBLEM NO. 6 Gabald Gaba ldon on Co Comp mpan any’ y’s s prop proper erty ty,, plan plantt an and d eq equi uipm pmen entt an and d ac accu cumu mula lated ted depreciation balances at December 31, 2005 are:

Machin Mach iner ery y an and d eq equi uipm pmen entt  Automobiles and trucks Leasehold improvements

 Accumulated Cost Depreciation P1 P1,3 ,380 80,0 ,000 00 P 36 367, 7,50 500 0 114,326 210,000 108,000 432,000

 Additional information follows: Depreciation methods and useful lives: Machinery and equipment – straight line; 10 years.  Automobiles and trucks – 150% declining balance; 5 years, all acquired after 2001. Leasehold improvements – straight line Depreciation is computed to the nearest month. Salvage values are immaterial except for automobiles and trucks which have estimated salvage values equal to 15% of cost. Other additional information: a. Gaba Gabaldon ldon enter entered ed into a 12-year opera operating ting lease star starting ting Janu January ary 1, 2003. The leasehold improvements were completed on December 31, 2002 and the facility was occupied on January 1, 2003. b. On Ju July ly 1, 20 2006 06,, ma mach chin iner ery y an and d eq equi uipm pmen entt were were purc purcha hase sed d at a to tota tall invoice invo ice cost of P325,000. Insta Installation llation cos costt of P44,000 P44,000 was incurred incurred.. c. On Augus Augustt 30, 2006, Gabald Gabaldon on purcha purchased sed new autom automobile obile for P25,00 P25,000. 0. d. On Sept Septem embe berr 30 30,, 20 2006 06,, a tru truck ck with a co cost st of P48, P48,00 000 0 an and d a ca carr rryi ying ng amountt of P30,000 on Dece amoun December mber 31, 2005 was sold for P23,500. e. On De Dece cemb mber er 20 20,, 20 2006 06,, a ma mach chin ine e wi with th a co cost st of P1 P17, 7,00 000, 0, a ca carr rryi ying ng amount of P2,975 on date of disposition, was sold for P4,000. QUESTIONS:

 

APPLIED AUDITING Based on the above and the result of your audit, answer the following: 1. The ga gain in on sale of truck on Sept September ember 3 30 0 is a. P2,680 c. P250 b. P6,500 d. P 0 2. The ga gain in on sale of ma machine chinery ry on Dece December mber 20 20,, 2006 is a. P1,025 c. P13,000 b. P2,725 d. P 0 3. The adjus adjusted ted balan balance ce of the property, plan plantt and equipmen equipmentt as of Decem December  ber  31, 2006 is a. P1,919,000 c. P2,307,000 b. P2,388,500 d. P2,351,000 4. The total depr depreciat eciation ion expe expense nse for the year ended Dec December ember 31, 200 2006 6 is a. P185,402 c. P138,000 b. 245,065 d. P221,402 5. The carry carrying ing amoun amountt of the property, plan plantt and equipm equipment ent as of Decemb December  er  31, 2006 is a. P1,567,497 b. P1,290,547

c. P1,578,547 d. P1,617,322

Suggested Solution: Question No. 1 Sales proceeds Less carrying value of  truck Cost Less accumulated dep.: Balance, 1/1/06 (P48,000 P30,000) Depreciation for  2006 (P30,000 x 30% x 9/12) Gain on sale of truck

P23,500

P48,000

P18,000

6,750

24,750

P

Question No. 2  Sales proceeds Less Le ss car arry ryin ing g valu alue of ma mach chin ine e sold old Gain on sale of machine

23,250

P4,000 2, 2,9 975 P1,025

250

 

APPLIED AUDITING

Question No. 3 Machinery and equipment: Balance, 1/1  Acquired, 7/1 (P325,000 P44,000) Machine sold, 12/20

+

P1,380,00 0 369,000 P1,732,000 (17,000)

 Automobiles and trucks: Balance, 1/1  Acquired, 8/30 Truck sold, 9/30

210,000 25,000 187,000 (48,000)

Leasehold improvements Property, plant & equipment, 12/31/06

432,000 P2,351,000

Question No. 4 Machinery and equipment: Remaining beginning balance [(P1, [(P 1,38 380, 0,00 000 0 - P1 P17, 7,00 000) 0) x 10 10%] %] Machin Mach ine e so sold ld,, 12 12/2 /20 0 (P (P17 17,0 ,000 00 x 10%)  Acquired, 7/1/06 [(P325,000 + P44,000) x 10% x 6/12]  Automobiles and trucks Remaining beginning balance [(P210,000-114,326-P30,000) x 30%] Truck sold, 9/ 30 (P30,000x30%x9/12)  Acquired, 8/30 (P25,000 x 30% x 4/12) Leasehold improvements (P432,000/12) Total depreciation expense for 2006

P1 P136 36,3 ,30 0 0 1,700

P156,450 18,450

19,702 6,750 2,500

28,952 36,000 P221,402

Question No. 5  Total cost of PPE, 12/31/06 (see no. 3) Less accumulated depreciation, 12/31/06: Machinery and equipment: Balance, 1/1 P367,500 Depreciation expense for 156,450

P2,3 ,35 51,000

 

APPLIED AUDITING 2006 Machine sold, 12/20 (P17,000 - P2,975)  Automobiles and trucks: Balance, 1/1 Depreciation expense for  2006 Truck sold, 9/30 (see no. 1) Leasehold improvements Balance, 1/1 Depreciation expense for  2006

(14,025)

P509,925

114,326 28,952 (24,750)

118,528

108,000 36,000

144,000 772,453

Carrying value, 12/31/06

P1,578,547

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

PROBLEM NO. 7 Your new audit client, Guimba Company, prepared the trial balance below as of December December 31, 2006. The comp company any sta starte rted d its operati operations ons on Jan Januar uary y 1, 2005. 200 5. Yo Your ur exa examin minati ation on res result ulted ed in the nece necessi ssity ty of app applyi lying ng the adjus adjustin ting g entries indicated in the additional data below. Guimba Company TRIAL BALANCE December 31, 2006 Debits Cash P510,000  Accounts receivable – net 600,000 Inventories, December 31, 2005 669,000 Land 660,000 Buildings  Accumulated depreciation, building Machinery  Accumulated depreciation, machinery Sinking fund assets Bond discount Treasury stock, common  Accounts payable  Accrued bond interest First mortgage, 6% sinking fund bonds Common stock Premium on common stock Stock donation Retained earnings, December 31, 2005 Net sales

990,000

Credits

P19,800

444,000 45,000 75,000 75,000 105,000 567,000 11,250 679,500 1,500,000 150,000 180,000 222,450 2,625,000

 

APPLIED AUDITING Guimba Company TRIAL BALANCE December 31, 2006 Debits Purchases 850,500 Salaries and wages 507,000 Factory operating expenses 364,500  Administrative expenses 105,000 Bond interest 45,000 P6,000 P6, 000,00 ,000 0

Credits

P6 P6,00 ,000,0 0,000 00

 Additional data are as follows: (1) The 1,500,000 common stock was issued at a 10 percent premium to the owne ow ners rs of the land land an and d bu buil ildi ding ngs s on De Dece cemb mber er 31, 31, 20 2004 04,, the date of  organizat organ ization. ion. Stoc Stock k with a par value of 180,00 180,000 0 was donated bac back k by the vendors. vend ors. The follo following wing ent entry ry was made: Treasury stock Stock donation

P180,000 P180,000

The stock was donated because the proceeds from its subsequent sale were to be considered as an allowance on the purchase price of land and buildings buildi ngs in proport proportion ion to their values as first recorded. The treasu treasury ry stock was sold in 2006 for P75,00 P75,000, 0, which was credited to Treasury Stock. (2) On December 31, 2006, a machine costing P15,000 when the business starte sta rted d was remo removed ved.. The mach machine ine had been de depre precia ciated ted at 10 per percen centt during the first first year. The only entry mad made e was one crediting the Mac Machiner hinery y account with its sales price of P6,000. (3 (3)) D Dep epre reci ciat atio ion n is to be prov provid ided ed on th the e stra straig ightht-li line ne ba basi sis, s, as fo foll llow ows: s: buildings, buildi ngs, 2 percen percentt of cost; mach machinery inery,, 10 perce percent nt of cost. Ignore sal salvage vage values. QUESTIONS: Based Base d on the the ab abov ove e an and d th the e resu result lt of yo your ur audi audit, t, you you ar are e to pr prov ovid ide e th the e answers to the following: 1. The corr correct ect balan balance ce of Land acco account unt as of Dece December mber 31, 200 2006 6 is a. P660,000 c. P630,000 b. P588,000 d. P 0 2. The adju adjusted sted car carrying rying v value alue of Buildi Building ng as of Decemb December er 31. 2006 is a. P907,200 c. P905,400 b. P950,400 d. P945,000 3. The adju adjusted sted car carrying rying v value alue of Machi Machinery nery as of Dece December mber 31, 200 2006 6 is a. P399,000 c. P354,000

 

APPLIED AUDITING b. P345,000

d. P348,000

4. The adj adjusted usted de depreci preciation ation ex expense pense fo forr 2006 is a. P648,000 c. P63,900 b. P62,400 d. P63,000 5. How muc much h is the gain or loss on sale of mac machiner hinery y on Decemb December er 31, 2006 2006? ? a. P6,000 loss c. P6,000 gain b. P7,500 loss d. P7,500 gain Suggested Solution: Question No. 1

Unadju Unad just sted ed ba bala lan nces Proceeds from sale of  donated stock  Applied as deduction to: Land (P75,000 x 660/1,650) Bldg. (P75,000 x 990/1,650)  Adjusted balances

Land B Bu uilding Total P6 P66 60, 0,0 000 P9 P990 90,,00 000 0 P1 P1,6 ,650 50,0 ,00 00

(30,000)

(30,000) (45,000)

(45,000)

P630,000 P945,000 P1,575,000

Note: The procee proceeds ds receiv received ed from sale of donat donated ed shares will not be credited  to Dona Donated ted Capital accou account nt since this invol involves ves "Treasu "Treasury ry stock subterfu subterfuge". ge". This Th is oc occu curs rs wh when en ex exce cess ssiv ive e sh shar ares es are are is issu sued ed fo forr a pr prop oper erty ty wi with th th the e unders und erstan tandin ding g that the sto stockh ckhold olders ers sha shallll sub subseq sequen uently tly don donate ate a por portio tion n of  their shares.

Question No. 2   Adjusted cost of building (see no. 1) Less accumulated depreciation, 12/31/06 (P945,000 x 2% x 2) Car arry ryin ing g value alue of bu buil ildi ding ng,, 12 12/3 /31 1/0 /06 6

P945,000 37,800 P9 P907 07,2 ,200 00

Question No. 3 Machin Mach iner ery, y, 1/1/ 1/1/06 06 (P44 (P444, 4,00 000 0 + P6 P6,0 ,000 00)) Less machinery sold on 12/31/06 Machinery, 12/31/06 Less accumulated depreciation, 12/31/06 (P435,000 x 10% x 2) Carr Ca rryi ying ng va valu lue e of Ma Mach chin iner ery, y, 12 12/3 /31/ 1/06 06

P4 P450 50,0 ,000 00 15,000 435,000 87,000 P3 P348 48,0 ,000 00

 

APPLIED AUDITING Question No. 4 Depreciation on Building (P945,000 x 2%) Depreciation on Machinery (P450,000 x 10%) Tota To tall de dep pre rec ciati iation on ex expe pens nse e fo forr 20 200 06

P18,900 45,000 P6 P63 3,9 ,90 00

Question No. 5  Sales proceeds Less carrying value, 12/31/06: Cost Less accumulated depreciation (P15,000 x 10% x 2) Loss on sale of machinery

P 6,000 P15,000 3,000

12,000 P 6,000

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

PROBLEM NO. 5 Jaen Co Jaen Corp rpor orat atio ion, n, a ma manu nufa fact ctur urer er of st stee eell pr prod oduc ucts ts,, be bega gan n op oper erat atio ion n on Octo Oc tobe berr 1, 20 2004 04.. Th The e ac acco coun unti ting ng de depa part rtme ment nt of Ja Jaen en ha has s star starte ted d th the e fixed-asset and depreciation presented below.

JAEN CORPORATION Fixed Asset and Depreciation Schedule For Fiscal Years Ended September 30, 2005, and September 30, 2006

Depreciation Expense Year  Ended Sept. 30  Acq. Date

 Asset s Land  A Bldg.  A Land B Bldg.

10/1/0 4 10/1/0 4 10/1/0 4 Under 

B Donat

Const . 10/2/0

Cos t ? ?

Salvag e N/A

Dep. Method N/A

Lif  e N/  A ?

?

P320,0 Straight-l 00 ine N/A N/A

?

Straight-l

N/  A 30

ine 150%

10

?

24,000

2005

2006

N/A

N/A

P139,6 00 N/A

? N/A

-

?

?

?

 

APPLIED AUDITING ed equip. Mach.  A

4 10/2/0 4

?

Mach. 10/1/0 ? B 5 N/A – Not applicable

declining balance 48,000 Sum-of-t he-years ’-digits - Straight-l ine

8

?

?

20

-

?

You ha You have ve be been en as aske ked d to as assi sist st in co comp mple leti ting ng th this is sche schedu dule le.. In addi additi tion on in asce as certa rtain inin ing g tha thatt the da data ta alre alread ady y on th the e sche schedu dule le ar are e corr correc ect, t, yo you u ha have ve obtained the following information from the Company’s records and personnel: a. La Land nd A an and d Bu Buil ildi ding ng A we were re ac acqu quir ired ed fr from om a pr pred edec eces esso sorr co corp rpor orat atio ion. n. Jaen Jae n paid P6,5 P6,560, 60,000 000 for the land and buil buildin ding g tog togeth ether. er. At the time of  acquisition, the land had an appraised value of P720,000, and the building had an appraised value of P6,480,000. b. Land Land B was acq acquir uired ed on Oct Octobe oberr 2, 2004, in ex excha change nge for 20,00 20,000 0 new newly ly is issu sued ed shar shares es of Ja Jaen en’s ’s co comm mmon on st stoc ock. k. At th the e da date te of acqu acquis isit itio ion, n, the stock had a par value of P5 per share and a fair value of P30 per share. During October 2004, Jaen paid P128,000 to demolish an existing building on this land so it could construct new building. c. Cons Constructi truction on of buildin building g B on the newly acqui acquired red land beg began an on Octobe Octoberr 1, 2005.. By Septem 2005 September ber 30, 2006, Jaen has paid P2,560 P2,560,000 ,000 of the estimated total constructi construction on costs of P3,600 P3,600,000. ,000. It is estimated that the buildi building ng will be completed and occupied by July 2007. d. Certa Certain in equip equipment ment w was as donat donated ed to the cor corporat poration ion by a loca locall unive university rsity.. An indep ind epend endent ent ap appra praisa isall of the equ equipm ipment ent wh when en don donate ated d pla placed ced the fair  markett value at P240, marke P240,000 000 and the salvage value at P24,0 P24,000. 00. e. Machin Machinery ery A’s tota totall cos costt of P1, P1,319 319,20 ,200 0 inc includ ludes es ins instal tallati lation on exp expens ense e of  P4,800 P4,80 0 and normal repair repairs s and maintenan maintenance ce of P119,200 P119,200.. Salva Salvage ge value is estimated estimated at P48,000 P48,000.. Machinery Machinery A was sold on Februa February ry 1, 2006. f. On Octo October ber 1, 2005 2005,, Mach Machine inery ry B was acq acquir uired ed with a down pay paymen mentt of  P45,920 and the remaining payments to be made in 11 annual installments of P48 P48,00 ,000 0 eac each h beg beginn inning ing Octo October ber 1, 200 2005. 5. The prev prevail ailing ing inter interest est rate was 8%. QUESTIONS: Based on the above and the result of your audit, answer the following: 1. The cost cost o off Bui Buildi lding ng A is a. P5,904,000 b. P6,560,000

c. P656,000 d. P 0

 

APPLIED AUDITING 2. The cos costt of L Land and B is a. P600,000 b. P728,000

c. P228,000 d. P 0

3. The cost cost o off Mac Machin hine e B is a. P370,080 b. P416,000

c. P388,592 d. P389,776

4. The total depr depreciat eciation ion expe expense nse for the year ended Sep Septembe temberr 30, 2006 is a. P264,296 c. P265,667 b. P415,000 d. P262,608 Suggested Solution: Question No. 1 Costt o Cos off bu build ilding ing A ((P6, P6,560 560,00 ,000 0 x 6,4 6,480/ 80/7,2 7,200) 00)

P5, P5,904 904,00 ,000 0

Question No. 2  Fair value of common stock (20,000 x

P600,000

P30) Demolition costs Cost of Land B

128,000 P728,000

Question No. 3 Down payment  Add present value of installment payments (P48,000 x 7.710) Cost of Machine B

P 45,920 370,080 P416,000

Question No. 4 Building A (same A  (same in 2005 since it is straight-line depreciation)   Building B (under B  (under construction)   Dona Do nate ted d eq equi uipm pmen entt (P (P24 240, 0,00 000 0 x 85 85% % x 15 15%) %) Machine A [(P1,319,200-P119,200-P48,000) x 7/36 x 4/12] Machine B (P416,000/20) Total depreciation expense  Answers: 1  Answers:  1)) A; A; 2) B; 3) B; 4) C PROBLEM NO. 9

P139,600 30 30,6 ,600 00 74,667 20,800 P265,667

 

APPLIED AUDITING The fo The foll llow owin ing g da data ta rela relate te on th the e Plan Plantt As Asse sets ts ac acco coun untt of Li Lica cab, b, In Inc. c. at December 31, 2005:

Origina inal cost Year  Purchased Useful life Salvage value Depreciation method

Plant Assets L A R P87,500 P127,500 P200,000 2000 2001 2002 10 years P7,750

37,500 hours P7,500

SYD

Ac Acti tiv vit ity y

E P200,0 ,00 00 2004

15 years

10 years

P12,500

P12,500

Stra Straig ight ht-l -lin ine e Do Doub uble le-d -dec ecli lin nin ing g balance

Note No te:: In th the e ye year ar an as asse sett is pu purc rcha hase sed, d, Li Lica cab, b, In Inc. c. do does es no nott re reco cord rd an any  y  depreciation expense on the asset. In the year an asset is retired or traded in, Licab, Inc. takes a full year  depreciation on the asset. The following transaction occurred during 2006: (a) On May 5, Asset L was sold for P32,500 cash. (b) On December 31, it was determined that asset A had been used 5,250 hours during 2006. (c) On December 31, before computing depreciation expense on Asset R, the management of Licab, Inc. decided the useful life remaining from 1/1/06 was 10 years. (d) On December 31, it was discovered that a plant asset purchased in 2005 had been expensed expensed comp completel letely y in that year year.. This asse assett costs P55,000 and has useful useful life of 10 years and no salvage value value.. Manag Management ement has deci decided ded to use the double-declining balance for this asset, which can be referred to as “Asset S.” QUESTIONS: Based Base d on the the ab abov ove e an and d th the e resu result lt of yo your ur au audi dit, t, answ answer er th the e fo foll llow owin ing: g: (Disregard tax implications) 1. How much much is th the e gai gain n or loss on s sale ale of As Asset set L? a. P1 P10,2 0,250 50 lossc lossc.. P1 P16, 6,05 050 0 ga gain in b. P10,250 gain d. P16,050 loss 2. How mu much ch is the depr depreciati eciation on of Ass Asset et R for 2006? a. P15,000 b. P21,429

c. P16,250 d. P23,214

 

APPLIED AUDITING

3. The adju adjusting sting entr entry y to correct the error of failure to capit capitalize alize As Asset set S would include a debit/credit to Retained Earnings of  a. P55,000 debit c. P44,000 credit b. P55,000 credit d. P 0 4. Ho How w mu much ch is the adj adjus uste ted d ba bala lanc nce e of Pl Plan antt As Asse sets ts as of Dece Decemb mber er 31 31,, 2006? a. P670,000 c. P615,000 b. P527,500 d. P582,500 5. How mu much ch is the total d deprec epreciation iation e expen xpense se for 2006 2006? ? a. P83,300 c. P82,050 b. P88,479 d. P80,600 Suggested Solution: Question No. 1 Sales proceeds Less carrying value:

P32,500

Cost Less accumulated depreciation [(P87,500-P7,750) x 45/55] Gain on sale of Asset L

P87,500 65,250

22,250

P10,250

Question No. 2  Cost Less accumulated depreciation, 1/1/05 [(P200,000 - P12,500) x 3/15] Carrying value, 1/1/06 Less residual value Remaining depreciable amount Divide by remaining life Depreciation of Asset R for 2006

Questi Que stion on No. 3  Adjusting entry:  Asset S P55,000 Retained earnings

P55,000

P200,000 37,500 162,500 12,500 150,000 10 P 1 15 5,000

 

APPLIED AUDITING Question No. 4  Asset L (Sold)  Asset A  Asset R  Asset E  Asset S

P 127,500 200,000 200,000 55,000

Plant Assets, 12/31/06

P582,500

Question No. 5   Asset L [(P87,500 - P7,750) x 5/55]  Asset A [(P127,500 - P7,500)/37,500 x 5,250]  Asset R (see no. 2)  Asset E [(P200,000 x 80%) x 20%]  Asset S (P55,000 x 20%) Tota To tall de depr prec ecia iati tion on ex expe pens nse e fo forr 20 2006 06

P 7,250 16,800 15,000 32,000 11,000 P8 P82, 2,05 050 0

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

PROBLEM PROBL EM NO. 10 Your audit of Llanera Corporation for the year 2006 disclosed the following property dispositions: Cost Land Building Ware Wa reho hou use Machine Delivery truck

P4,800,00 0 1,800,000 8,40 8,400, 0,0 000 960,000 1,200,0 ,00 00

Acc. Dep. 1,3 1,320 20,0 ,00 0 0 3 38 84,000 570,00 ,000

Procee Pro ceeds ds Fai Fairr va value lue 3,720,00 0 288,000 8,880,00 0 108,000 564,0 ,00 00

3,720,00 0 8,880,00 0 864,000 564,000

Land On January 15, a condemnation award was received as consideration for the forced sale of the company’s land and building, which stood in the path of a new highway. Building On March 12, land and building were purchased at a total cost of P6,000,000, of which 30% was allocate allocated d to the bui buildi lding ng on the corp corpora orate te book books. s. The real

 

APPLIED AUDITING estate was acquired with the intention of demolishing the building, and this was acco ac comp mpli lish shed ed du duri ring ng th the e mo mont nth h of Au Augu gust st.. Ca Cash sh pr proc ocee eeds ds re rece ceiv ived ed in September represent the net proceeds from demolition of building. Warehouse On Ju July ly 4, the the wa ware reho hous use e wa was s de dest stro roye yed d by fi fire re.. Th The e war areh ehou ouse se wa was s purchased purcha sed on January 2, 2000. On Decembe Decemberr 12, the insuran insurance ce proceeds and oth other er fun funds ds we were re us used ed to pu purc rcha hase se a re repl plac acem emen entt wa ware reho hous use e at a co cost st of  P7,200,000. Machine On December 15, the machine was exchanged for a machine having a fair  value of P756,000 and cash of P108,000 was received. Delivery Truck On November 13, the delivery truck was sold to a used car dealer. QUESTIONS: Based on the above and the result of your audit, compute the gain or loss to be recognized for each of the following dispositions: 1. La Land nd a. P3,720,000 gain b. P1,080,000 loss

c. P4,800,000 loss d. P 0

2. Buildi Building ng a. P 432,000 gain b. P2,232,000 loss

c. P1,368,000 loss d. P 0

3. Wareho Warehous use e a. P1,800,000 gain b. P 480,000 gain

c. P5,400,000 loss d. P 0

4. Ma Mach chin ine e a. P36,000 gain b. P27,000 gain

c. P288,000 gain d. P 0

5. Delive Delivery ry truc truck k a. P636,000 loss b. P636,000 gain

c. P66,000 loss d. P66,000 gain

Suggested Solution: Question No. 1 Cash received Cost of land

P3,720,000 4,800,000

 

APPLIED AUDITING Loss Lo ss on co cond ndem emna nati tion on of land land

P1 P1,0 ,080 80,0 ,000 00

Question No. 2  None. The proce proceeds eds from demol demolition ition of buildin building g will be dedu deducted cted from the cost of the land. Question No. 3 Insurance proceeds Carrying value (P8,400,000 P1,320,000) Gain Gai n on ins insura urance nce pol policy icy set settlem tlement ent

P8,880,000 7,080,000 P1, P1,800 800,00 ,000 0

Question No. 4 Fair value of old machine Carrying value (P960,000 P384,000)

P864,000 576,000

Gain on exchange

P288,000

Question No. 5  Sales proceeds Carrying value (P1,200,000 P570,000) Loss on sale

P564,000 630,000 P 66,000

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

PROBLEM PROBL EM NO. 11 Select the best answer for each of the following: 1. Which of the following questions would an auditor least likely include on an inter interna nall co cont ntro roll qu ques esti tion onna nair ire e co conc ncer erni ning ng the in init itia iatio tion n an and d ex exec ecuti ution on of  equipment transactions?  A. Are procedures in place to monitor and properly restrict access to equipment? B. re req que ues sts fo forr ma majo jorr re repa pair irs s ap app pro rov ved at a hi hig ghe herr le lev vel th tha an th the e department initiating the request? C. Are prenumbered purchase orders used for equipment and periodically accounted for? D. Are requests for purchases of equipment reviewed for consideration of  soliciting competitive bids?

 

APPLIED AUDITING 2. Property acquisitions that are misclassified as maintenance expense would most likely be detected by internal control procedures that provide for  a. Revie Review w and ap approv proval al of the mo monthly nthly d deprec epreciation iation entry by by the pla plant nt supervisor. b. Inves Investigat tigation ion of v varianc ariances es with within in a forma formall budg budgeting eting s system ystem.. c. Exami Examinatio nation n by the iinterna nternall audit auditor or of ven vendor dor inv invoices oices a and nd canc canceled eled checks for property acquisitions. d. Segre Segregatio gation n of duties of em employ ployees ees in the acc accounts ounts p payabl ayable e depar department tment.. 3.A wea weakne kness ss in inte interna rnall acc accoun ountin ting g con contro troll ove overr rec record ording ing ret retire iremen ments ts of  equipment may cause the auditor to a. Trace additions to the "other assets" account to search for equipment that is still on hand but no longer being used. b. Inspect certain items of equipment in the plant and trace those items to the accounting records. c. Select certain items of equipment from the accounting records and locate them in the plant. d. Review the subsidiary ledger to ascertain whether depreciation was taken on each item of equipment during the year. 4. 4.Th The e mo most st sign signifi ifica cant nt au audi ditt st step ep in su subs bsta tant ntia iatin ting g ad addi diti tion ons s to the off offic ice e furniture account balance is a. Comparison to prior year's acquisitions. b. Exami Examinat nation ion of ve vendo ndors' rs' inv invoic oices es and rec receiv eiving ing report reports s for cur curren rentt year's year's acquisitions. c. Review of transactions near the balance sheet date for proper period cutoff. d. Calculation of ratio of depreciation expense to gross office equipment cost. 5. An auditor is verifying the existence of newly acquired fixed assets recorded in the accounting accounting recor records. ds. Which of the follow following ing is the best evidenc evidence e to help achieve this objective? a. Oral evidence obtained by discussions with operating management. b. Documentary support obtained by vouching entries to subsidiary records and invoices. c. support of obtained by of reviewing titles and tax returns. d. Documentary Physical examination a sample newly recorded fixed assets.

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

 

APPLIED AUDITING

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Compi ompila lati tion on of le lect ctur ure e no note tes s by Dean Rene Boy R Bacay   CPA CrFA CMC MBA FRIAcc