Liabilities

Applied Auditing

Prof. J.M. Tang

Audit of Liabilities

2nd Semester – SY 2013-2014

Problem 1: Current and Noncurrent Liabilities In the audit of the Alpha Corporation’s financial statements at December 31, 2013, the chief accountant of the said corporation provided the following information: Notes payable: Arising from purchase of goods Arising from bank loans, on which marketable securities valued at P600,000 have pledged as security, due Dec. 31, 2014 Arising from advances by officers, due June 30, 2014 Reserve for general contingencies Employees’ income tax withheld Advances received from customers on purchase orders Containers’ deposit Accounts payable arising from purchase of goods, net of debit balances of P30,000 Accounts receivable, net of credit balances P40,000 Cash dividends payable Stock dividends payable Dividends in arrears on preferred stock, not yet declared Convertible bonds, due January 31, 2015 First mortgage serial bonds, payable in semi-annual installments of P50,000, due April 1 and October 1 of each year Overdraft with Allied Bank Cash in bank balance with PNB Estimated damages to be paid as a result of unsatisfactory performance on a contract Estimated expenses on meeting guarantee for service requirements on merchandise sold Accrued interest on bonds payable Common stock warrants outstanding Common stock options outstanding Unused letters of credit Deficiency income tax assessment being contested Notes receivable discounted

120,000 500,000 50,000 400,000 20,000 64,000 50,000 170,000 360,000 80,000 100,000 200,000 1,000,000 2,000,000 90,000 390,000 160,000 120,000 360,000 120,000 210,000 80,000 500,000 200,000

Based on the above and result of your audit, determine the following: 1. 2. 3.

Total current liabilities Total noncurrent liabilities Total liabilities

Problem 2: Cut-off Test In conjunction with your firm’s examination of the financial statements of Beta Company as of December 31, 2013, you obtained from the voucher register the information shown in the working paper below. Item Voucher No. Entry Date Ref. Description Amount Account Charged 1

12.18.13

12-202

Supplies, purchased FOB destination, 12.15.13; received, 12.17.13

20,000

Supplies on hand

2 3 4

12.18.13 12.21.13 12.21.13

12-204 12-206 12-214

5

12.21.13

12-219

6

12.26.13

12-221

7 8

12.28.13 12.28.13

12-230 12-234

9 10

01.02.14 01.02.14

01-001 01-002

11

01.05.14

01-003

12

01.10.14

01-004

13

01.10.14

01-005

14 15

01.12.14 01.12.14

01-006 01-007

16 17 18

01.13.14 01.14.14 01.15.14

01-008 01-009 01-010

19

01.15.14

01-011

Auto insurance, 12.15.13 to 12.15.14 Repair services; received 12.20.13 Merchandise shipped FOB shipping point, 11.20.13; received, 12.4.13 Payroll, 12.6.13 to 12.20.13 (12 working days) Subscription to tax reporting service for 2014 Utilities for December 2013 Merchandise shipped FOB destination, 12.24.13; received, 1.2.14 Legal services, received 12.28.13 Medical services for employees for December 2013 Merchandise shipped FOB shipping point, 12.29.13; received, 1.4.14 Payroll, 12.21.13 to 01.05.14 (12 working days in total, 4 working days in January) Merchandise shipped FOB shipping point, 1.2.14; received, 1.5.14 Manufacturing royalties, Dec. 2013 Merchandise shipped FOB destination, 1.3.14; received, 1.10.14 Maintenance services, received 1.9.14 Interest on bank loan, 10.12.13 to 1.10.14 Manufacturing equipment, installed on 12.29.13 Dividends declared, 12.15.13

24,000 24,000 17,000

Prepaid insurance Repairs and maintenance Inventory

69,000

Salaries and wages

5,000

Dues and subscription expense

29,000 111,500

Utilities expense Inventory

46,000 25,000

Legal and professional expense Medical expense

55,000

Inventory

72,000

Salaries and wages

64,000

Inventory

39,000 38,000

Manufacturing costs Inventory

9,000 30,000 254,000

Repairs and maintenance Interest expense Machinery and equipment

160,000

Dividends payable

Accrued liabilities as of December 31, 2013 were as follows: Accrued payroll Accrued interest payable Dividends payable Accrued royalties payable

48,000 26,667 160,000 39,000

The Accrued payroll, Accrued interest payable, and Accrued royalties payable accounts were reversed on January 1, 2014. Required: Prepare adjusting entries as of December 31, 2013 based on your review of the data given above.

Problem 3: Current Liabilities Mix Corporation began operations in January 2012. During the course of your audit, the following information was gathered in relation to its Mix’s various product lines and segments: Segment A The company sells colored televisions with a brand name “TIBAYTO” that carry a two-year warranty. Management projects that 3% of the televisions will require repairs in the first year and 8% in the second year at an average cost of P5,000 per television. The television sell for P45,000.

Sales and warranty repairs for 2012 and 2013 are recorded as follows:

Televisions sold Actual warranty repairs

2012 250 P96,000

2013 290 P105,500

Segment B You learned that in order to promote the company’s new product, the company offered a special promo by giving out a special gift to each customer who returns 10 wrappers of their new customer item plus a remittance of P15. The company estimates that out of the 250,000 units of the new product sold in 2013, 75% of the wrappers will be redeemed. In addition, you were able to gather the following information for 2013: Special gifts purchased by Segment B Special gifts distributed to customers

20,000 units 7,000 units

P 560,000

Segment C The company sells its products in expensive, reusable containers. The customer is charged a deposit for each container delivered and receives a refund for each container returned within two years after the year of delivery. The company accounts for the containers not refunded within the time limit was being sold at the deposit amount. Information for 2013 is as follows: Containers held by customers at December 31, 2012, From deliveries in: Containers delivered in 2013 Containers returned in 2013 from deliveries in:

2011 2012

P50,000 240,000

2011 2012 2013

P23,500 140,000 157,000

P290,000 420,000 320,500

Other information was also disclosed during your audit: Mix Corporation provides an incentive compensation plan under which its President is to receive a bonus equal to 10% of Mix’s income in excess of P100,000 before deducting income taxes but after deducting the bonus. The adjusted net income before income taxes and the bonus is P320,000. In the middle of 2013, Mix became involved in a litigation. The suit being contested, but Mix’s lawyer believes that it is possible that Mix may be held liable for damages estimated in the range between P2,000,000 and P3,000,000, and no amount is a better estimate of potential liability than any other amount. Based on the above and result of your audit, determine the following: 1.

How much is the warranty expense for the year ended December 31, 2012?

2. 3. 4. 5. 6. 7. 8. 9.

How much is the warranty expense for the year ended December 31, 2013? What is the adjusted balance of the estimated warranty liability account as of December 31, 2013? What is the amount of liability that should be reported on the 2013 balance sheet in connection with the premium offer? What is the amount of premium expense that should be reported on the income statement for the year ended 2013? How much revenue from container sales should be recognized in 2013? What is the total amount of liability for returnable containers at December 31, 2013? What is the amount of the bonus for the year 2013? How much should be accrued as provisions for estimated liability in relation to the lawsuit filed against Mix Corporation?

Problem 4: Current Liabilities BROKEN COMPANY was incorporated on February 14, 2013. It promotes quality service by engaging in repairs and reconditioning of broken machineries at an affordable price. During your audit of its liabilities account, the following transactions relevant to your examination for the year ended 2013 were gathered as follow: 

Notes Refinancing On December 31, 2013, BROKEN Co. has P4,000,000 of short-term notes payable due on February 28, 2014. On December 23, 2013, BROKEN arranged a line of credit with CUPID Bank which allows BROKEN to borrow up to P3,500,000 at one percent above the prime rate for three years. On February 2, 2014, BROKEN borrowed P2,500,000 from CUPID Bank and used P500,000 additional cash to liquidate P3,000,000 of the short-term notes payable. The statement of financial position was issued on March 15, 2014.



Compensated Absences BROKEN gives each of its 50 employees 12 days of vacation a year if they are employed at the end of the year. The vacation accumulates and may be taken starting January 1 of the next year. The employees work 8 hours per day. In 2012, they made P14 per hour and in 2013 they made P16 per hour. During 2013, they took an average of 9 days of vacation each. The company’s policy is to record the liability existing at the end of each year at the wage rate for that year. No employees left during the two-year period.



Gift Certificates BROKEN Company sells gift certificates, redeemable for store merchandise that expires one year after their issuance. BROKEN has the following information pertaining to its gift certificate sales and redemptions: Unredeemed at 12/31/2012 2013 sales 2013 redemptions of prior year sales 2013 redemptions of current year sales

750,000 2,500,000 250,000 1,750,000

BROKEN's experience indicates that 10% of gift certificates sold will not be redeemed. Requirement: Determine the amount of current liabilities to be reported at December 31, 2013. Problem 5: Bond Issuance and Retirement In the course of your initial examination of the accounts of HIRAP CORPORATION, you obtain the following information related to the company’s bonds payable as of December 31, 2014: Bonds Payable 03/31/2013

10/01/2014

CD

CR

P 800,000

CR

P 59,306

Treasury Bonds P 109,000

Bond Premium 03/31/2013

01/01/2014 07/01/2014

CD CD

Bond Interest Expense P 48,000 42,000

The following information was noted during the course of your audit: On March 31, 2013, HIRAP Corporation issued 800 of its 12%, P1,000 bonds. The bonds are dated January 1, 2013 with a term of 5 years and pays interest every January 1 and July 1. The effective rate on the date of issuance was 10% The treasury bonds were acquired at a price of 106 plus accrued interest. The treasury bonds are not to be reissued.

 

Based on the above information and result of your audit, determine the following: (Round off present value factors to four decimal places) 1. 2. 3. 4.

Total proceeds from bond issuance on March 31, 2013 Carrying value of the bonds at the end of December 31, 2013 and 2014 Bond interest expense for the year 2014 The gain or loss on partial redemption of bonds

Problem 6: Compound Financial Instrument During your audit of RELAX CORPORATION’s bonds payable account, you have noted the following transactions that took place during the year 2013: 

RELAX Corporation issued 5,000 of its 10% P1,000 face amount, 10-year bonds on January 2, 2013 for P5,100,000. Each bond carries five detachable stock purchase warrants, each of which entitles the holder to purchase one ordinary share of RELAX Corporation with a par value of P25 for P60. On that date, the bonds yield at a rate of 12% while the market prices of the company’s ordinary share and warrant were P50 and P5, respectively.



RELAX issued 2,000 of its P1,000 of its 8%, 5-year convertible bonds on March 31, 2013 at 102. The bond pays interest every April 1. Each bond is convertible into two ordinary shares of RELAX Corporation. The effective rate of the bond is 10%.



On June 30, 2013, 2,000 holders of bonds issued at the beginning of the year exercised their warrants. The corresponding shares were issued on July 2. On the same date, shares of RELAX were selling at P85 per share.



On December 29, 2013, half of the bonds issued on March were converted into ordinary shares. The fair value of RELAX’s ordinary share at the end of the year was P90 per share.



The remaining warrants were no longer exercised by the bondholders at the end of the year. No entry was made by the company to account for the expired warrants.

Based on the above and result of your audit, answer the following: 1. 2. 3. 4.

How much of the proceeds from bonds issued will be allocated to equity? How much is the carrying value of the bonds payable on December 31, 2013? How much should be credited to additional paid in capital account resulting to exercise of warrants on June 30, 2013? How much will total shareholders’ equity increase as a result of bond conversion?

Problem 7: Lease Liability YEHEY Company leased equipment from YUHOO Company on January 1, 2013 under a lease with the following pertinent information: Annual rental payable at the end of each year Lease term Useful life of equipment Implicit interest rate Incremental borrowing rate

500,000 8 years 10 years 12% 11%

YEHEY Company has the option to purchase the equipment on January 1, 2021 by paying P400,000 which is significantly less than the expected fair value of the equipment on the option exercise date. There is reasonable certainty that YEHEY Company shall exercise the option. On January 1, 2013, YEHEY Company incurred initial direct cost of P300,000 and the fair value of the equipment is P3,000,000. Based on the above information, determine the following: 1. 2. 3. 4.

Initial cost of the equipment on January 1, 2013 Lease liability to be recognized on January 1, 2013 Carrying value of the lease liability on December 31, 2013 (determine how much should be presented as current and noncurrent) Interest expense for the year 2013