Unit 7. Audit of Property, Plant and Equipment_handout_final_t21516

UNIT 7 AUDIT OF PROPERTY, PLANT AND EQUIPMENT AND RELATED VALUATION ACCOUNTS Estimated Time: 4.5 HOURS

Discussion questions 7-1 1. Define the following terms. You should provide an example of each. a. Qualifying assets b. Borrowing costs c. Revaluation d. Impairment 2. You are making your first audit of Sigma Manufacturing Company. The Plant and Equipment account represents a very substantial portion of the total assets. What verification, if any, will you make of the balances of the ledger accounts for Plant and Equipment as of the beginning of the period under audit? 3. Prepare an audit program for the property, plant and equipment. Explain. Problem 7-1 Capitalizable Cost The property, plant and equipment section of ABC Corporation’s statement of financial position at December 31, 2015 included the following items: Land Land Improvements Building Machinery and equipment

P2,500,000 560,000 3,600,000 6,600,000

During 2016 the following data were available to you upon your analysis of the accounts: Cash paid on purchase of land P10,000,000 Mortgage assumed on the land bought, including interest at 16% 16,000,000 Realtor’s commission 1,200,000 Legal fees, realty taxes and documentation expenses 200,000 Amount paid to relocate persons squatting on the property 400,000 Cost of tearing down an old building on the land 300,000 Amount recovered from the salvage of the building demolished 600,000 Cost of fencing the property 440,000 Amount paid to a contractor for the building erected 8,000,000 Building permit fees 50,000 Excavation expenses 250,000 Architect’s fee 100,000 Interest that would have been earned had the money used during the period of construction been invested in the money market 600,000 Invoice cost of machinery acquired 8,000,000 Freight, unloading and delivery charges 240,000 Customs duties and other charges 560,000 Allowances, hotel accommodations, etc. paid to foreign technicians during installation and test run of machines 1,600,000 Royalty payments on machines purchased (based on units produced and sold) 480,000

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Required: Based on the above and the result of your audit, compute for the following as of December 31, 2016: 1. Land 2. Land Improvements 3. Building 4. Machinery and Equipment 5. Total depreciable property, plant and equipment Problem 7-2 (Acquisition of PPE, Exchange and Government Grants) The following were discovered during your audit of DEF Company’s financial statements for the year ended December 31, 2016: 1. (Cash Acquisition) On December 24, 2016, DEF purchased an office equipment for P400,000, terms 2/5, n/15. No entry was made on the date of purchase. The same was paid on December 31, 2016 and the accountant debited Office Equipment and credited cash for P400,000. 2. (Installment Acquisition) Machine C, with a cash price of P128,000, was purchased on January 2, 2016. The company paid P20,000 down and P10,000 for 12 months. The last payment was made on December 30, 2016. Straight line depreciation, based on a five-year useful life and no salvage value, was recorded at P28,000 for the year. Freight of P4,000 on machine C was debited to the Freight in account. 3. (Acquisition through Issuance of Bonds Payable) Machine P with a cash selling price of P360,000 was acquired on April 1, 2016, in exchange for P400,000 face amount of bonds payable selling at 94, and maturing on April 1, 2026. The accountant recorded the acquisition by a debit to Machinery and a credit to Bonds Payable for P400,000. Straight line depreciation was recorded based on a five-year economic life and amounted to P54,000 for nine months. In the computation of depreciation, residual value of P40,000 was used. The effective interest rate is 1.06%. 4. (Non-cash Acquisitions) Machine A was acquired on January 22, 2016, in exchange for past due accounts receivable of P140,000, on which an allowance of 20% was established at the end of 2015. The current fair value of the machine on January 22 was estimated at P110,000. The machine was recorded by a debit to Machinery and a credit to Accounts Receivable for P140,000. No depreciation was recorded on Machine A, because it was not installed and never used in operations. On February 2, 2016, Machine A was exchanged for 1,000 shares of the company’s outstanding capital stock with market price of P105 per share. The Treasury Stock account was debited for P140,000 with the corresponding credit to Machinery. 5. (Exchange: With Commercial Substance) On December 29, 2016, DEF Company exchanged 10,000 shares of Eric, Inc. common stock, which the Company was holding as an investment, for an equipment from Magcale Corporation. The common stock of Eric, Inc., which had been purchased by DEF for P45 per share, had a quoted market value of P50 per share on the date of exchange. The equipment had a market value of P470,000. The transaction was recorded by a debit to Equipment and a credit to Investment in Eric, Inc.-Common for P450,000. The exchange was assumed to be with commercial substance. Auditing Practice I Workbook

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6. (Exchange: No Commercial Substance) On December 30, 2016, Machine M with a carrying amount of P120,000 (cost P400,000) was exchanged for a similar asset with a fair value of P150,000. In addition, DEF paid P20,000 to acquire the new machine. The exchange, which lacks commercial substance, was recorded by a debit to Machinery and a credit to cash for P20,000. 7. (Trade-in) Machine E was recorded at P102,000, which included the carrying amount of P22,000 for an old machine accepted as a trade in, and cash of P80,000. The cash price of Machine E was P90,000, and the trade in allowance was P10,000. This transaction took place on December 31, 2016. 8. (Donation of PPE by a Shareholder) Ms. Beauty, the company’s president, donated land and building appraised at P200,000 and P400,000, respectively, to the company to be used as plant site. The company began operating the plant on September 30, 2016. The building is estimated to have a useful life of 25 years. Since no money was involved, no journal entry was made for the above transaction. 9. (Government Grants: Land) On July 1, 2015, the national government granted a parcel of land located in Scarborough Shoal, Zambales to DEF. On the date of grant, the land had a fair value of P2,000,000. The grant required DEF to construct a cold storage building on the site. DEF finished the construction of the building, which has an estimated useful life of 25 years, on January 2, 2016. DEF appropriately recorded the cost of the building of P4,000,000 (which include direct materials, direct labor, and indirect cost and incremental overhead) but failed to provide depreciation in 2016. Unaware of the accounting procedures for government grants, the company did not reflect the grant on its books. 10. (Government Grants: Depreciable Assets) On January 1, 2016, the national government granted a building located in Scarborough Shoal, Zambales to DEF. On the date of grant, the building had a fair value of P10,000,000. The grant required DEF to establish a security camp to guard the disputed site. The building has an estimated useful life of 20 years. Unaware of the accounting procedures for government grants, the company did not reflect the grant on its books.

Required: As DEF’s external auditor, you are required to prepare any necessary adjusting journal entries as of December 31, 2016. Problem 7-3 Cost of Land and Building The Blue Corporation was incorporated on January 2, 2016, but was unable to begin manufacturing activities until July 1, 2016 because the new factory facilities were not completed until that date. The “Land and Building” account at December 31, 2016 follows: Date Particulars Jan. 31 Land and building Feb. 28 Cost of removal of old building May 2 Partial payment on new construction May 2 Legal fees paid Jun. 1 Second payment on new construction Jul. 1 Claims for damages sustained during the construction of building Auditing Practice I Workbook

Amount P1,098,000 60,000 700,000 15,000 600,000 26,000

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Jul. 1 Dec. 31

Final payment on new construction Asset revaluation surplus

Dec. 31

Depreciation – 2016 at 1% of account balance

200,000 500,000 P3,199,000 31,990 P3,167,010

You were able to gather the following during your audit: A. To acquire land and building, the company paid P98,000 cash and 10,000 shares of its 9% cumulative preferred shares, P100 par value per share. The shares were then selling at P120. B. Legal fees covered the following: Cost of incorporation P9,500 Examination of title covering purchase of land 4,000 Legal work in connection with construction contract 1,500 Total P15,000 C. Because of a general increase in construction materials costs after entering into the building contract, the board of directors increased the value of the building by P500,000, believing such increase is justified to reflect current market value at the time the building was completed. Retained earnings was credited for this amount. D. Estimated useful life of the building is 25 years. E. The Company opted to follow the cost model as its accounting policy.

Required: 1. Prepare the necessary adjusting journal entries as of December 31, 2016. 2. Determine the adjusted balances of the following as of December 31, 2016: a. Land b. Carrying value of building c. Land and building d. Organization cost, net (presented under Noncurrent Assets) Problem 7-4 Valuation of Property, Plant and Equipment At the beginning of the year, Judith Company’s noncurrent assets and accumulated depreciation accounts had the following balances: Cost Land Buildings Machinery and Equipment Delivery Equipment Leasehold improvements

P 130,000 1,200,000 775,000 132,000 230,000

The company’s policy regarding depreciation is: Depreciation Method Land Improvements Straight-line Buildings 150% declining balance Machinery and Equipment Straight-line Delivery Equipment 150% declining balance Leasehold improvements Straight-line

Accumulated Depreciation P 263,101 200,000 86,724 115,000 Useful Life 15 years 25 years 10 years 5 years 8 years

Depreciation is to be computed to the nearest month. Auditing Practice I Workbook

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Transactions for the current year are as follows: Jan. 6

A plant consisting of land and building was acquired from Salome Company for P600,000. 80% of the selling price was allocated to the building.

April 6

New parking spaces were completed for the new plant at a total cost of P240,000.

April 29

Judith exercised the renewal option to extend the lease agreement for an additional 4 years.

July 1

Machinery and equipment were purchased at a total invoice price of P250,000 Delivery and installation costs of P10,000 and P30,000 were also incurred respectively.

Aug. 30

A new delivery equipment was purchased for P15,000.

Sept. 30

A delivery equipment with a cost of P24,000 and a carrying amount of P9,114 on the date of sale was sold for P12,000. Depreciation for the 9 months ended September 30, 2016 was P2,646.

Dec. 20

A machine with a cost of P20,000 and a carrying amount of 5,000 at date of disposition was scrapped.

Additional information: The leasehold improvements were completed on December 31, 2012. The related lease was to be terminated on December 31, 2018.

1. 2. 3. 4. 5. 6. 7. 8.

How much is the depreciation expense on land improvements for 2016? How much is the depreciation expense on building for 2016? How much is the depreciation expense on machinery and equipment for 2016? How much is the carrying value on January 1 of the delivery equipment sold on September 30? How much is the depreciation expense for 2016 on delivery equipment? How much is the depreciation expense on leasehold improvements for 2016? How much is the total depreciation expense for 2016? How much is the book value of the machinery and equipment on December 31, 2016?

Problem 7-5 Valuation of Property, Plant and Equipment You obtained the following information pertaining to Virginia’s property, plant and equipment for 2016. Audited 2015 ending balances based on your working paper are as follows: Land Buildings Accumulated Depreciation – Building Machinery and Equipment Accumulated Depreciation – Machinery and Equipment Delivery Equipment Accumulated Depreciation – Delivery Equipment Auditing Practice I Workbook

P4,000,000 30,000,000 6,577,531 22,500,000 6,500,000 3,000,000 2,400,000 Third Term, AY 2015-2016 Page 7-5

The depreciation policies being implemented by Virginia are as follows: Buildings Machinery and Equipment Delivery Equipment Leasehold Improvements

Depreciation Method 150% declining balance Straight-line Sum of the years’ digits Straight-line

Useful Life 25 years 10 years 5 years 10 years

Transactions during 2016 are as follows: Jan. 2

Virginia purchased a new truck for P500,000 cash and traded-in a 2-year old truck with a cost of P450,000 and a book value of P180,000. The new truck has a cash price of P600,000. The market value of the old truck is not known.

Apr. 1

A machine purchased for P600,000 on April 1, 2011 was destroyed by fire. Virginia managed to recover P200,000 from its insurance company.

May 1

Virginia incurred costs of P4,500,000 to improve the leased office. The lease terminates on December 31, 2022.

July 1

Machinery and equipment were purchased at a total invoice cost of P7 million. Additional costs of P150,000 and P650,000 were incurred for freight and installation respectively.

Additional information: Virginia determined that the delivery equipment comprising the P3,000,000 beginning balance would have been depreciated at a total amount of P400,000 for the year.

1. How much is the accumulated depreciation – buildings as of December 31, 2016? 2. How much is the accumulated depreciation – machinery and equipment as of December 31, 2016? 3. How much is the accumulated depreciation – delivery equipment as of December 31, 2016? 4. How much is the accumulated depreciation – leasehold improvements as of December 31, 2016? 5. How much is the net gain (loss) on disposal for the year ended 2016? Problem 7-6 Self-constructed assets On January 1, 2016, Angelo Corporation contracted with De Leon Construction to construct a building for P40 million on a land that Angelo purchased several years ago. The contract provides that Angelo is to make five payments in 2016, with the last payment scheduled for the date of completion. In order to finance the construction, Angelo entered into a 4-year note with 12% interest on January 1, 2016 with interest compounded quarterly. Principal of P15 million and interest are payable upon maturity. The building was completed on December 31, 2016. Angelo made the following payments during 2016: January 1 P 4,000,000 March 31 8,000,000 June 30 12,000,000 September 30 9,000,000 December 31 7,000,000 Auditing Practice I Workbook

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Angelo also has a P10 million 10%, 10-year note dated January 1, 2013 with interest payable annually on December 31 and a P15 million, 12%, 5-year note dated January 1, 2014 with interest payable annually.

1. How much is the interest that would be capitalized during 2016? 2. How much is the interest that would be expensed during 2016? Problem 7-7 Self constructed assets HERPETOTOMY had the following loans outstanding during 2015 and 2016: 10% specific construction loan 12% general loan

600,000 5,000,000

HERPETOTOMY began construction of a building for its own use on January 1, 2015 and was completed on December 31, 2016. The following expenditures were made during 2015 and 2016: January 1, 2015 April 1, 2015 December 1, 2015 March 1, 2016

800,000 1,000,000 600,000 1,200,000

1. Assuming that the building was completed on December 31, 2016, how much is the cost of the building on December 31, 2016? 2. Assuming that the building was completed on June 30, 2016, how much is the cost of the building? 3. Assuming that the building was completed on December 31, 2016 and the specific construction loan was also used for general purposes, how much is the cost of the building? Problem 7-8 Wasting Assets In 2011, Orc Corporation acquired a gold mine in Lordaeron. Because of numerous haunting and other supernatural reasons, Orc was able to acquire the mine for a low, low price of P50,000. Experts estimated that 4 million tons of gold could be obtained from the mine. In 2012, Orc constructed a road to the mine costing P5,000,000. Improvements made to the mine in 2011 amounted to P750,000. Because of the improvements to the mine and the surrounding land, it is estimated that the mine can be sold for P600,000 when the mining activities are completed. During 2013, several townhouses were constructed near the site to house the employees. Total cost of the townhouses was P1,500,000. Estimated residual value is P250,000. During 2014, the first year of operations, only 5,000 tons of gold were collected from the mine. In 2015, the employees were able to mine 1 million tons of gold. Geologists discovered that the mine actually contained 3 million tons more than the original estimation. Improvements of P275,000 were made to the mine early in 2015 to facilitate the removal of the additional gold. Furthermore, an additional townhouse was constructed at a cost of P225,000 for the additional employees that would be hired to obtain the additional gold. The new townhouse was not expected to have any residual value. Auditing Practice I Workbook

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In 2016, 2.5 million tons of gold were mined and costs of P1,100,000 were incurred at the beginning of the year for improvements to the mine.

1. 2. 3. 4. 5.

How much was the depletion to be recognized in 2014? How much was the depletion to be recognized in 2015? How much is the depletion to be recognized in 2016? How much is the depreciation to be recognized in 2015? How much is the depreciation to be recognized in 2016?

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