AP - Liabilities

7/29/2019 AP - Liabilities

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AP-5902

CPA REVIEW SCHOOL OF THE PHILIPPINESM a n i l a

AUDITING PROBLEMS

AUDIT OF LIABILITIES

PROBLEM NO. 1

In the audit of the Heats Corporations financial statements at December 31, 2005, thechief accountant of the said corporation provided the following information:

Notes payable:Arising from purchase of goods 304,000Arising from 5 year-bank loans, on which marketable securitiesvalued at P600,000 have been pledged as security, P400,000 dueon J une 30, 2006; P100,000 due on Dec. 31, 2006 500,000

Arising from advances by officers, due J une 30, 2006 50,000Reserve for general contingencies 400,000

Employees income tax withheld 20,000Advances received from customers on purchase orders 64,000Containers deposit 50,000Accounts payable arising from purchase of goods,

net of debit balances of P30,000 170,000Accounts receivable, net of credit balances P40,000 360,000Cash dividends payable 80,000Stock dividends payable 100,000Dividends in arrears on preferred stock, not yet declared 200,000Convertible bonds, due J anuary 31, 2007 1,000,000First mortgage serial bonds, payable in semi-annual installments

of P50,000, due April 1 and October 1 of each year 2,000,000Overdraft with Allied Bank 90,000Cash in bank balance with PNB 390,000Estimated damages to be paid as a result of unsatisfactory

performance on a contract 160,000Estimated expenses on meeting guarantee for service

requirements on merchandise sold 120,000Estimated premiums payable 75,000Deferred revenue 87,000Accrued interest on bonds payable 360,000

Common stock warrants outstanding 120,000Common stock options outstanding 210,000Unused letters of credit 400,000Deficiency VAT assessment being contested 500,000Notes receivable discounted 200,000

On March 1, 2006, the P400,000 note payable was replaced by an 18-month note for thesame amount. Heats is considering similar action on the P100,000 note payable due onDecember 31, 2006. The 2005 financial statements were issued on March 31, 2006.

On December 1, 2005, a former employee filed a lawsuit seeking P200,000 for unlawful

dismissal. Heats attorneys believe that the suit is without merit. No court date has beenset.

On J anuary 15, 2006, the BIR assessed Heats an additional income tax of P300,000 forthe 2003 tax year. Heats attorneys and tax accountants have stated that it is likely thatthe BIR will agree to a P200,000 settlement.


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REQUIRED:

Based on the above and the result of your audit, compute for the following as of December31, 2005:

1. Total current liabilitiesa. P2,500,000 b. P2,100,000 c. P2,300,000 d. P2,400,000

2. Total noncurrent liabilitiesa. P3,300,000 b. P2,900,000 c. P3,000,000 d. P3,400,000

3. Total liabilitiesa. P5,200,000 b. P5,000,000 c. P5,400,000 d. P5,800,000

PROBLEM NO. 2

The following information relates to Sonic Companys obligations as of December 31,2005. For each of the numbered items, determine the amount if any, that should bereported as current liability in Sonics December 31, 2005 balance sheet.

1. Accounts payable:Accounts payable per general ledger control amounted to P5,440,000, net of P240,000debit balances in suppliers accounts. The unpaid voucher file included the followingitems that not had been recorded as of December 31, 2005:

a) A Company P224,000 merchandise shipped on December 31, 2005, FOBdestination; received on J anuary 10, 2006.

b) B, Inc. P192,000 merchandise shipped on December 26, 2005, FOB shippingpoint; received on J anuary 16, 2006.

c) C Super Services P144,000 janitorial services for the three-month period ending

J anuary 31, 2006.d) MERALCO P67,200 electric bill covering the period December 16, 2005 toJ anuary 15, 2006.

On December 28, 2005, a supplier authorized Sonic to return goods billed at P160,000and shipped on December 20, 2005. The goods were returned by Sonic on December28, 2005, but the P160,000 credit memo was not received until J anuary 6, 2006.

a. P5,923,200 b. P5,712,000 c. P5,601,600 d. P5,841,600

2. Payroll:Items related to Sonics payroll as of December 31, 2005 are:

Accrued salaries and wages P776,000Payroll deductions for:

Income taxes withheld 56,000SSS contributions 64,000Philhealth contributions 16,000Advances to employees 80,000

a. P776,000 b. P992,000 c. P832,000 d. P912,000

3. Litigation:In May, 2005, Sonic became involved in a litigation. The suit is being contested, butSonics lawyer believes it is possible that Sonic may be held liable for damages

estimated in the range between P2,000,000 and P3,000,000, and no amount is a betterestimate of potential liability than any other amount.

a. P0 b. P2,000,000 c. P3,000,000 d. P2,500,000


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4. Bonus obligation:Sonic Companys president gets an annual bonus of 10% of net income after bonusand income tax. Assume the tax rate of 30% and the correct income before bonus andtax is P9,600,000. (Ignore the effects of other given items on net income.)

a. P722,600 b. P395,000 c. P2,240,000 d. P628,000

5. Note payable:A note payable to the Bank of the Philippine Islands for P2,400,000 is outstanding onDecember 31, 2005. The note is dated October 1, 2004, bears interest at 18%, and ispayable in three equal annual installment of P800,000. The first interest and principalpayment was made on October 1, 2005.

a. P800,000 b. P908,000 c. P72,000 d. P872,000

6. Purchase commitment:During 2005, Sonic entered in a noncancellable commitment to purchase 320,000 unitsof inventory at fixed price of P5 per unit, delivery to be made in 2006. On December31, 2005, the purchase price of this inventory item had fallen to P4.40 per unit. The

goods covered by the purchase contract were delivered on J anuary 28, 2006.a. P0 b. P1,600,000 c. P1,408,000 d. P192,000

7. Deferred taxes:On December 31, 2005, Sonics deferred income tax account has a 2005 ending creditbalance of P772,800, consisting of the following items:

Caused by temporary differences in accounting Deferred taxFor gross profit on installment sales P376,000 Cr.For depreciation on property and equipment 576,000 CrFor product warranty expense 179,200 Dr

P772,800 Cr.a. P772,800 b. P952,000 c. P196,800 d. P0

8. Product warranty:Sonic has a one year product warranty on selected items in its product line. Theestimated warranty liability on sales made during 2004, which was outstanding as ofDecember 31, 2004, amounted to P416,000. The warranty costs on sales made in2005 are estimated at P1,504,000. Actual warranty costs incurred during the current2005 fiscal year are as follows:

Warranty claims honored on 2004 sales P 416,000Warranty claims honored on 2005 sales 992,000

Total warranty claims honored P1,408,000

a. P0 b. P1,504,000 c. P96,000 d. P512,000

9. Premiums:To increase sales, Sonic Company inaugurated a promotional campaign on J une 30,2005. Sonic placed a coupon redeemable for a premium in each package of productsold. Each premium costs P100. A premium is offered to customers who send in 5coupons and a remittance of P30. The distribution cost per premium is P20. Sonicestimated that only 60% of the coupons issued will be redeemed. For the six monthsended December 31, 2005, the following is available:

Packages of product sold 160,000Premiums purchased 16,000Coupons redeemed 64,000

a. P1,728,000 b. P1,152,000 c. P1,600,000 d. P576,000


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10. Due to Five Six Finance company:Sonics accounting records show that as of December 31, 2005, P1,280,000 was dueto Five Six Finance Company for advances made against P1,600,000 of trade accountsreceivable assigned to the finance company with recourse.

a. P0 b. P1,600,000 c. P320,000 d. P1,280,000

PROBLEM NO. 3

In conjunction with your firms examination of the financial statements of PistonsCompany as of December 31, 2005, you obtained from the voucher register theinformation shown in the working paper below.

ItemNo.

EntryDate

VoucherRef. Description Amount

AccountCharged

1 12.18.05 12-202 Supplies, purchased FOBdestination, 12.15.05;received, 12.17.05 20,000

Supplies onhand

2 12.18.05 12-204 Auto insurance, 12.15.05 to12.15.06 24,000

Prepaidinsurance

3 12.21.05 12-206 Repair services; received12.20.05 24,000

Repairs andmaintenance

4 12.21.05 12-214 Merchandise shipped FOBshipping point, 11.20.05;received, 12.4.05 17,000 Inventory

5 12.21.05 12-219 Payroll, 12.6.05 to 12.20.05(12 working days) 69,000

Salaries andwages

6 12.26.05 12-221 Subscription to tax reporting

service for 2006 5,000

Dues and

subscriptionexpense

7 12.28.05 12-230 Utilities for December 2005 29,000 Utilities expense

8 12.28.05 12-234 Merchandise shipped FOBdestination, 12.24.05;received, 1.2.06 111,500 Inventory


10 01.02.06 01-001 Legal services, received

12.28.05 46,000

Legal and

professionalexpense

11 01.02.06 01-002 Medical services foremployees for December2005 25,000 Medical expense

12 01.05.06 01-003 Merchandise shipped FOBshipping point, 12.29.05;received, 1.4.06 55,000 Inventory

13 01.10.06 01-004 Payroll, 12.21.05 to 01.05.06(12 working days in total,

4 working days in J an.) 72,000

Salaries and

wages14 01.10.06 01-005 Merchandise shipped FOB

shipping point, 1.2.06;received, 1.5.06 64,000 Inventory

15 01.12.06 01-006 Manufacturing royalties,Dec. 2005 39,000

Manufacturingcosts


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AP-5902

ItemNo.

EntryDate

VoucherRef. Description Amount

AccountCharged


17 01.13.06 01-008 Maintenance services,

received 1.9.06

9,000 Repairs and

maintenance18 01.14.06 01-009 Interest on bank loan,

10.12.05 to 1.10.06 30,000 Interest expense

19 01.15.06 01-010 Manufacturing equipment,installed on 12.29.05 254,000

Machinery andequipment

20 01.15.06 01-011 Dividends declared,12.15.05 160,000

Dividendspayable

Accrued liabilities as of December 31, 2005 were as follows:

Accrued payroll 48,000

Accrued interest payable 26,667Dividends payable 160,000Accrued royalties payable 39,000

The Accrued payroll, Accrued interest payable, and Accrued royalties payable accountswere reversed on J anuary 1, 2006.

REQUIRED:

Prepare adjusting entries as of December 31, 2005 based on your review of the data givenabove.

PROBLEM NO. 4

During your regular annual audit ofRockets Companyfor the year ended December 31,2005, you obtain the following evidence and data relative to your examination of the bondspayable and related accounts.

From your permanent file working papers:

Client is authorized to issue 20,000 bonds with par value of P1,000 each. Bonds are datedMay 1, 2002 and are due May 1, 2012. Interest at 12% per annum is due semiannually

every May 1 and November 1.The December 31, 2004 balance of P9,500,000 represents proceeds from issuance of10,000 bonds on November 2, 2003.

From the clients ledger:

12%, 10-year Bonds Payable12/31/2004 Balance P9,500,00007/01/2005 CR 2,100,000

Interest Expense05/01/2005 CV-120 P600,000 07/01/2005 CR P40,00011/01/2005 CV-531 720,000


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From supporting documents:

CR Cash receipts entry for issuance of 2,000 bonds for a total of P2,100,000 onJ uly 1, 2005. Trustees remittance statement attached.

Entry recordedCash P2,140,000

Bonds Payable P2,100,000Interest expense 40,000

CV-120 Cash payment to trustee for November 1, 2004 through April 30, 2005 interest.Paid check to trustee attached.

CV-531 Cash payment to trustee for May 1, 2005 through October 31, 2005 interest.Paid check to trustee attached.

REQUIRED:

1. Adjusting journal entries as of December 31, 2005. Use the straight line method to

amortize bond discount and premium, if any.2. Compute for the adjusted balances of the following as of December 31, 2005:

a. Bonds payable d. Accrued interest

b. Bond discount e. Interest expense

c. Bond premium

PROBLEM NO. 5

Wizards Company presented to you their records in connection with the audit of thecompanys financial statements for the year ended December 31, 2005. This is the firsttime the company has been audited. The company floated a serial bond issue in 2003.Your audit showed the following details of the issue and the accounts as of December 31,2005:

Total amount P5,000,000Date of issue October 2, 2003Proceeds from issue P4,900,000Interest rate 5% per annumInterest payment date October 1Maturity date P1,000,000 annually, starting October 1, 2005

5% Serial Bonds Payable10/02/2005 VR P1,000,000 10/02/2003 CR P4,900,000

Accrued Interest Payable01/02/05 P62,500

REQUIRED:

1. Adjusting journal entries as of December 31, 2005. Use the bond outstandingmethod to amortize bond discount and premium, if any.

2. Compute for the adjusted balances of the following as of December 31, 2005:a. Bonds payableb. Bond discountc. Accrued interest payabled. Bond interest expense


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PROBLEM NO. 6

On J anuary 2, 2004, the Suns, Inc. issued P2,000,000 of 8% convertible bonds at par.The bonds will mature on January 1, 2008 and interest is payable annually every J anuary1. The bond contract entitles the bondholders to receive 6 shares of P100 par valuecommon stock in exchange for each P1,000 bond. On the date of issue, the prevailingmarket interest rate for similar debt without the conversion option is 10%.

On December 31, 2005, the holders of the bonds with total face value of P1,000,000exercised their conversion privilege. In addition, the company reacquired at 110, bondswith a face value of P500,000.

The balances in the capital accounts as of December 31, 2004 were:

Common stock, P100 par, authorized 50,000 shares, issuedand outstanding, 30,000 shares P3,000,000

Premium on common stock 500,000

Market value of the common stock and bonds were as follows:

Date Bonds Common stockDecember 31, 2004 118 40December 31, 2005 110 42

QUESTIONS:

Based on the above and the result of your audit, answer the following:

1. How much of the proceeds from the issuance of convertible bonds should be allocated

to equity?a. P634,000 b. P126,816 c. P221,664 d. P0

2. How much is the carrying value of the bonds payable as of December 31, 2004?a. P2,000,000 b. P1,389,400 c. P1,796,170 d. P1,900,502

3. How much is the interest expense for the year 2005?a. P160,000 b. P138,940 c. P179,617 d. P190,050

4. The entry to record the conversion on December 31, 2005 will include a credit to APICofa. P365,276 b. P400,000 c. P307,893 d. P0

5. How much is the loss on bond reacquisition on December 31, 2005?a. P50,000 b. P96,053 c. P67,362 d. P0

PROBLEM NO. 7

In connection with your audit ofGinebra Corporations financial statements for the year2005, you noted the following liability account balances as of December 31, 2004:

Note payable, bank P 5,600,000Liability under finance lease 430,000Deferred income taxes 700,000

Transactions during 2005 and other information relating to Ginebras liabilities were asfollows:

a. The principal amount of the note payable is P5,600,000 and bears interest at 12%.The note is dated April 1, 2004 and is payable in four equal annual installments ofP1,400,000 beginning April 1, 2005. The first principal and interest payment wasmade on April 1, 2005.


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b. The capitalized lease is for a ten-year period beginning December 31, 2002. Equalannual payments of P100,000 are due on December 31 of each year, and the 14%interest rate implicit in the lease known by Ginebra. The present value at December31, 2004 of the seven remaining lease payments (due December 31, 2005 throughDecember 31, 2011) discounted at 14% was P430,000.

c. Deferred income taxes are provided in recognition of timing differences betweenfinancial and income tax reporting of depreciation. For the year ended December 31,2005, depreciation per tax return exceeded book depreciation by P312,500.Ginebras effective income tax rate for 2004 was 32%.

d. On J uly 1, 2005, Ginebra issued for P1,774,000, P2,000,000 face amount of its 10%,P1,000 bonds. The Bonds were issued to yield 12%. The bonds are dated J uly 1,2004 and will mature on J uly 1, 2014. Interest is payable annually on J uly 1. Ginebrauses the interest method to amortize bond discount.

QUESTIONS:

Based on the above and the result of your audit, determine the following:1. Liability under finance lease as of December 31, 2005

a. P381,600 b. P390,200 c. P344,828 d. P330,000

2. Total noncurrent liabilities as of December 31, 2005a. P5,610,440 b. P5,770,640 c. P5,931,328 d. P5,725,268

3. Current portion of long-term liabilities as of December 31, 2005a. P1,445,372 b. P1,400,000 c. P1,500,000 d. P1,446,576

4. Accrued interest payable as of December 31, 2005a. P484,440 b. P432,628 c. P532,628 d. P478,000

5. Total interest expense for the year 2005a. P652,440 b. P707,068 c. P712,640 d. P699,760

PROBLEM NO. 8

Select the best answer for each of the following:

1. In auditing accounts payable, an auditors procedures most likely will focus primarily onmanagements assertion ofa. Existence or occurrence c. Completeness

b. Presentation and disclosure d. Valuation or allocation

2. An auditor performs a test to determine whether all merchandise for which the client wasbilled was received. The population for this test consists of alla. Merchandise received c. Canceled checksb. Vendors invoices d. Receiving reports

3. The primary audit test to determine if accounts payable are valued properly isa. Confirmation of accounts payableb. Vouching accounts payable to supporting documentationc. An analytical procedured. Verification that accounts payable was reported as a current liability in the balance

sheet.

4. Which of the following procedures is least likely to be performed before the balance sheetdate?a. Observation of inventory c. Search for unrecorded liabilitiesb. Testing of internal control over cash d. Confirmation of receivables


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5. An audit assistant found a purchase order for a regular supplier in the amount of P5,500.The purchase order was dated after receipt of goods. The purchasing agent hadforgotten to issue purchase order. Also a disbursement of P450 for materials did not havea receiving report. The assistant wanted to select additional purchase orders forinvestigation but was unconcerned about lack of receiving report. The audit directorshoulda. Agree with the assistant because the amount of the purchase order exception was

considerably larger than the receiving report exceptionb. Agree with the assistant because the cash disbursement clerk had been assured by

the receiving clerk that the failure to fill out a report didnt happen very often.c. Disagree with the assistant because two problems have an equal risk of loss

associated with them.d. Disagree with the assistant because the lack of a receiving report has a greater risk

of loss associated with it.

6. When using confirmation to provide evidence about completeness assertion for accountspayable, the appropriate population most likely isa. Vendors with whom the entity has previously done business.b. Amounts recorded in the accounts payable subsidiary ledger.c. Payees of checks drawn in the month after the year end.d. Invoices filed in the entitys open invoice file.

7. Which of the following is a substantive test that an auditor is most likely to perform toverify the existence and valuation of recorded accounts payable?a. Investigating the open purchase order file to ascertain that pre-numbered purchase

orders are used and accounted for.b. Receiving the clients mail, unopened, for a reasonable period of time after year end

to search for unrecorded vendors invoices.c. Vouching selected entries in the accounts payable subsidiary ledger to purchase

orders and receiving reports.

d. Confirming accounts payable balances with known suppliers who have zerobalances.

8. Only one of the following four statements, which compare confirmation of accountspayable with suppliers and confirmation of accounts receivable with debtors is false. Thefalse statement is thata. Confirmation of accounts receivable with debtors is a more widely accepted auditing

procedures than is confirmation of accounts payable with suppliers.b. Statistical sampling techniques are more widely accepted in the confirmation of

accounts payable than in the confirmation of accounts receivable.c. As compared with the confirmation of accounts receivable, the confirmation of

accounts payable will tend to emphasize accounts with zero balances at the

balance sheet date.d. It is less likely that the confirmation request sent to the supplier will show theamount owed than that request sent to the debtor will show the amount due.

9. When title to merchandise in transit has passed to the audit client the auditor engaged inthe performance of a purchase cut-off will encounter the greatest difficulty in gainingassurance with respect to thea. Quantity b. Quality c. Price d. Terms

10. Which of the following audit procedures is least likely to detect an unrecorded liability?a. Analysis and recomputation of interest expense.b. Analysis and recomputation of depreciation expense.

c. Mailing of standard bank confirmation forms.d. Reading of the minutes of meetings of the board directors.

11. Unrecorded liabilities are most likely to be found during the review of which of thefollowing documents?a. Unpaid bills c. Bills of ladingb. Shipping records d. Unmatched sales invoices


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12. Which of the following audit procedures is best for identifying unrecorded trade accountspayable?a. Reviewing cash disbursements recorded subsequent to the balance sheet date to

determine whether the related payables apply to the prior period.b. Investigating payables recorded just prior to and just subsequent to the balance

sheet date to determine whether they are supported by receiving reports.c. Examining unusual relationships between monthly accounts payable balances and

recorded cash payments.d. Reconciling vendors statement to the file of receiving reports to identify items

received just prior to the balance sheet date.

13. In verifying debits to perpetual inventory records of a nonmanufacturing firm, the auditoris most interested in examining the purchasea. J ournal b. Requisitions c. Orders d. Invoices

14. Which of the following procedures relating to the examination of accounts payable couldthe auditor delegate entirely to the clients employees?a. Test footings in the accounts payable ledgerb. Reconcile unpaid invoices to vendors statements

c. Prepare a schedule of accounts payabled. Mail confirmations for selected account balances

15. An auditors purpose in reviewing the renewal of a note payable shortly after the balancesheet date most likely is to obtain evidence concerning managements assertions abouta. Existence or occurrence c. Completenessb. Presentation and disclosure d. Valuation or allocation.

16. An auditors program to audit long term debt should include steps that requirea. Examining bond trust indenturesb. Inspecting the accounts payable subsidiary ledger.c. Investigating credits to the bond interest income account.

d. Verifying the existence of the bondholders.

17. In an audit of bonds payable, an auditor expects the trust indenture to include thea. Auditees debt-to-equity ratio at the time of issuance.b. Effective yield of the bonds issued.c. Subscription list.d. Description of the collateral

18. In auditing long-term bonds payable, an auditor most likely willa. Perform analytical procedures on the bond premium and discount accounts.b. Examine documentation of assets purchased with bond proceeds or liensc. Compare interest with the bond payable amount for reasonableness.

d. Confirm the existence of individual bondholders at year-end.

19. The audit procedures used to verify accrued liabilities differ from those employed for theverification of accounts payable becausea. Accrued liabilities usually pertain to services of a continuing nature while accounts

payable are the result of completed transactionsb. Accrued liability balances are less material than accounts payable balances.c. Evidence supporting accrued liabilities in nonexistence while evidence supporting

accounts payable is readily available.d. Accrued liabilities at year-end will become accounts payable during the following

year.

20. The auditor is most likely to verify accrued commissions payable in conjunction with thea. Sales cutoff testb. Verification of contingent liabilitiesc. Review of post balance sheet date disbursementsd. Examination of trade accounts payable

End of AP-5902

AP - Liabilities

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