PART II: REVIEWER IN AUDITING (Intangible Assets-Liab-Income Tax-SHE)
Problem 1 (Numbers 1-5)
The accounting records of Fearless Company which was organized in 2020 include only one account for all intangible
assets. The following summary of the items debited to the said account in 2021 and 2022.
DATE
PARTICULARS
AMOUNT
July 1, 2021
Franchise with indefinite term
630,000
Oct. 1,2021
Lease advance payments (2-year term, starting October 1, 2021)
420,000
Dec. 31,2021
Net loss for 2021 including incorporation fees, P15,000, related legal fees
240,000
of organization the business, 75,000.
Jan. 2,2022
Purchased patent, useful life 10 years
1,110,000
Mar. 1,2022
Cost of developing a secret recipe
1,125,000
Apr. 1,2022
Purchased Goodwill
4,176,000
Jul. 1,2022
Legal fee for successful defense of the patent purchased in
189,750
January 2, 2022.
Additional notes acquired during the audit:
a. On December 31, 2021, the management estimates that the annual net future cash flows the franchise's continued use
was at P90,000. On December 31, 2022, this estimate was revised due to decline in product demand to P75,000 annually.
b. On December 31, 2022, the estimated annual net future cash flows from the patent's continued use was at P168,911
for its remaining life.
c. The prevailing market rate of interest as of December 31, 2021 and 2022 was consistent at 12%. (Note: Round-off PV
factors to its nearest 2(two) decimal places)
Required:
1. What is the correct carrying value of the Franchise as of December 31, 2022?
2. What is the correct carrying value of the Patent as of December 31, 2022?
4. What is the total retroactive adjustment to retained earnings beginning in 2022 as a result of your audit?
5. What is the total amount chargeable to expense for the current year 2022, as a result of your audit?
Problem 2 (Number 6-9)
The Speak Now Corp. acquired several small companies at the end of 2021 and, based on the acquisitions, reported the
following intangibles in its December 31, 2021, statement of financial position:
Computer Software
P100,000
Tradename
350,000
Goodwill
900,000
Copyright
400,000
Patent
200,000
The company's accountant determines the patent has an expected life of 10 years and no expected residual value, and
that it will generate approximately equal benefits each year. The company expects to use the copyright and tradename for
the foreseeable future. The accountant knows that the computer software is used in the company's 120 sales offices. The
company has replaced the software in 60 offices in 2022, and expected to replace the software in 40 more offices in 2023
and the remainder in 2024.
On December 31, 2022, there are no indicators of impairment of patent and computer software. The following information
relates to the other intangible assets.
a. Because of the rampant piracy, the copyright is expected to generate cash flows of just P8,000 per year.
b. The tradename is expected to generate cash flows of P15,000 per year.
c. The goodwill is associated with Speak Now's manufacturing reporting unit. The cash flows expected to be
generated by the manufacturing reporting unit is P200,000 per year for the next 25 years. The reporting unit
has a carrying amount of P3,000,000.
Based on the above and the result of your audit, determine the following: (Assume that the appropriate discount rate for
all items is 5%) Note: Round-off PV factors to its nearest 4(four) decimal places.
Required:
6. Total amortization of intangible assets in 2022.
7. Total loss on impairment in 2022.
8. Carrying amount of goodwill on December 31, 2022.
9. Carrying amount of the other intangible assets on December 31, 2022.
Problem 3 (Number 10)
During the audit of Red Company, the company’s accountant presented the following cost incurred during the current year:
Laboratory research aimed at discovery of an original technology
P100,000
Cost of activities aimed at obtaining new knowledge
24,000
Marketing research to study consumer tastes
50,000
Cost of acquired building A to be used in other research and development projects
300,000
Depreciation on the building A
25,000
Cost of equipment B acquired to be used only for one research and development project
400,000
Depreciation on the equipment B
15,000
Cost of developing and producing a prototype model
30,000
Cost of testing the prototype model for environmental and safety considerations
50,000
Cost of revising designs for defects in the prototype model
25,000
Advertising to establish recognition of the newly developed product
40,000
Trouble-shooting during commercial production
16,000
Compensation of consultants and technicians involved in research and development
40,000
Payments made to 22Corp. under contract to perform research and development to Red 40,000
Company
Cost of design, construction and operation of plant that is feasible for commercial production
22,000
Cost of incurred on search for alternatives for materials, devices, products, processes, systems 20,000
or services
Cost of engineering follow through in an early phase of commercial production
85,000
Cost of final selection of possible alternatives for a new process
16,500
Cost of design of tools, jigs, molds and dies
10,000
In addition to the items above, a cost of P60,000 incurred by the company was not yet accounted for due to lack of
judgement whether to treat the amount as either research or development cost.
Required
10. What is the correct amount of research and development expense?
Theories
11. The most effective means for the auditor to determine whether a recorded intangible asset possesses the
characteristics of an asset is
a. Vouch the purchase by reference to underlying documentation.
b. Inquire as to the status of patent application.
c. Evaluate the future revenue-producing capacity of the intangible asset.
d. Analyze the research and development expenditures to determine that only those expenditures possessing future
economic benefit have been capitalized.
12. In auditing intangible assets, an auditor most likely would review recompute amortization and determine whether
the amortization period is reasonable in support of management's financial statement assertion of
a. Valuation
b. Existence
c. Completeness
d. Rights and Obligation
13. Assuming Treacherous Company, has capitalized all research and development cost associated with patent. Taylor,
CPA, who is examining this account will probably
a. Confer with management regarding transfer of the amount from the balance sheet to the income statement.
b. Confirm that the patent is registered and on file with the intellectual property office.
c. Confer with management regarding a change in the total of the account to "goodwill."
d. Confer with management regarding ownership of the patent.
14. Which of the following comparisons would be the most appropriate audit test for the amount of recorded goodwill?
a. The purchase price and the book value of net tangible and identifiable assets purchased.
b. The purchase price and the fair value of net tangible and identifiable assets purchased
c. The figure for goodwill specified in the contract of purchase.
d. Earnings in excess of 5% of net assets for the past five years.
15. A corporate balance sheet indicates that one of the corporate assets is a patent. An auditor will most likely obtain
evidence regarding the continuing validity and existence of this patent by obtaining a written representation from
a. A patent attorney
b. The SEC
c. The patent inventor
d. The patent owner
Problem 4
SAUNA UL Company has the following transactions during 2022:
Jan 4
10
Apr 1
Paid legal fees of P233,000 to complete organization of the corporation.
Hired a clown to stand in form of the corporate office for 2 weeks and hand out pamphlets and candy to create
goodwill for the new enterprise. Clown cost, P10,000 pamphlet and candy, P5,000.
Patented a newly developed process with costs as follows:
Legal fees to obtain patent
P429,000
Patent application and licensing fees
63,500
Total
P492,500
May 1. It is estimated that in 6 years other companies will have developed improved Processes, making SAUNA UL
Company process obsolete. Acquired both a license to use a special type of container and distinctive trademark
to be printed on the container in exchange for 6,000 shares of SUANA’s no par ordinary shares selling for P50 per
share. The license is worth twice as much as the trademark, both of which may be used for 6 years
July 1 Constructed a shed for P1,310,000 to house prototypes of experimental models to be developed in future
research projects
Dec 31 Incurred salaries for an engineer and chemist involved in product development totaling P1,750,000 in 2022
Required:
1. Compute the following:
a. Cost of patent
b. Cost of licenses
c. Cost of Trademark
d. Carrying amount of Intangible assets.
e. Total amount that should be expensed when incurred.
Problem 5 (1-4)
On January 1, 2012, Red Company acquired a patent IIXII for F240,000 with an estimated useful life of 12 years and a
legal life of 10 years. The following are transactions related to the patent HXH during its life.
-On January 1, 2023, the company paid P77,000 for a patent infringement case for successfully defending the
patent.
-On January 1, (2024, the company purchased a related patent for P140,000 that is intended to prolong the life
of the original patent by 5 years.
-On September 1, 2027, it was determined that the patent was completely obsolete.
Required:
1. Compute the carrying amount of patent on December 31, 2023.
2. Compute the amortization to be recorded in 2024.
3. Compute the carrying amount of patent HXH on December 31, 2026.
4. Compute the recorded loss (in any) in 2027 due to patent obsolescence.
Problem 6 (5-9)
1999 Corporation began operations on January 1, 2014. Shown below is the company's trial balance prepared by its staff
accountant for December 31, 2022.
1989 Corporation
Unadjusted Trial Balance
December 31, 2022
Cash
Accounts Receivable
Inventory
Equipment
Accumulated depreciation- Equipment
Buildings
Accumulated depreciation- Building
Patents
Franchise Agreement
Organization Costs
Goodwill
Accounts payable
Accrued Wages payable
Accrued Taxes payable
Bonds payable
Premium on bonds payable
Preference shares, par value P100
Ordinary shares, par value P25
Premium on share capital
Retained earnings, as of January 1
Sales
Cost of goods sold
Selling and administrative expenses
Debit
P60,000
150,000
360,000
2,400,000
Credit
P750,000
3,600,000
1,200,000
1,650,000
285,000
306,000
1,035,000
36,000
15,000
180,000
1,500,000
105,000
300,000
3,300,000
660,000
1,200,000
2,700,000
1,200,000
900,000
P11,946,000
P11,946,000
Patents
The patents, acquired January 2, 2015, are being amortized over an expected useful life of years. Improvements made to
equipment covered by the patents costing P225,000 were debited to the account in January 2019. Amortization in 20192021 included amortization on the P225,000 for the remaining life of the relevant paten It is determined that the P225,000
should have been expensed in 2019. It is further determined on December 31 2021 that one of the patents has a remaining
life of only 2 years. This patent was originally assigned a cost of P630,000.
Franchise Agreement
A franchise agreement was signed on January 1, 2022. A150,000 fee was paid, covering a 5-year period, at the end of which
the company may renew the agreement by paying P150,000. A decision on renewal has not been made as of December
31,2022. The agreement calls for an annual payment of 5 revenue. An entry debiting the account for P135,000 was made
at the time of the cash payment for 2022.
Organization Costs
Organization costs include the unamortized portion of amounts paid to promote for services rendered at the inception of
the corporation. These fees have been amortized, since inception, over an estimated 40-year life. The decision is made, as
of December 31;-2022, to reduce the total period of amortization of organization costs to 12 years.
Goodwill
The goodwill account includes the following:
P135,000Legal expense relative to incorporation. These were assigned to the account in January 2014.
P600,000 Excess of cost over assigned net asset value of an enterprise acquired in early 2020 expected
to be of value for an indefinite period.
300 000 Paid to an advertising consulting firm in early 2021 for a major advertising effort expected to be
beneficial for an indefinite period.
No amortization has been taken on any amount in the Goodwill account.
Required:
1. Compute the carrying value of the Patents on December 31, 2022.
2. Compute the carrying value of the Franchise agreement on December 31, 2022.
3. Compute the carrying value of the Organization costs on December 31, 2022.
4. Compute carrying value of Goodwill on December 31, 2022.
5. Compute the total Patent amortization for 2022.
Illustrative Problem 7: Estimated Liability
Beautiful Eyes Company includes one coupon in each box of laundry soap it sells. A towel is offered as a premium to
customers who send in 10 coupons and remittance of P10. Distribution cost of premiums is P5. Experience indicated that
only 30% of the coupons will be redeemed.
Year of Sale
2021
Boxes of soap sold
2,000,000
Number of towels purchased at P 50 each
50,000
Coupons redeemed
400,000
Required:
1. Compute the premium expense for 2021.
2. Compute the amount to be reported as liability for unredeemed premiums at year end.
Illustrative Problem 8: Measurement of Provision
On November 2, 2021 a patent infringement lawsuit was filed against Beautiful Eyes Company. The company’s legal counsel
believe there is a 30% chance that the court will dismiss the case and the entity will incur no outflow of economic benefits.
However, if the court rules in favor of the claimant, the lawyers believe that there is a 20% chance that the entity will be
required to pay damages of P200,000 and an 80% chance that the entity will be required to pay damages of P100,000.
Other outcomes Are unlikely. The court is expected to rule in late December 2022. There is no indication the claimant will
settle of court. A 7% risk adjustment factor to the probability-weighted expected cash flows is considered appropriate to
reflect the Uncertainties in the cash flow estimate. A discount rate of 5% per year was applicable.
Required: What amount of provision (if any) should be recorded in 2021.
Illustrative Problem 9: Estimated Liability on Product Warranty
White Horse Co., a client, request that you compute the appropriate balance of its estimated liability for product warranty
account for a statement as of June 30, 2021. White Horse Co., manufactures television components and sells them with a
6-month warranty under which defective components will be replaces without charge, On December 31, 2020, estimated
liability for product warranty had a balance of P620,000. By June 30, 2021, this balance had been reduced to P120,400 by
debits for estimated net cost of components returned that had been sold in 2020The corporation started out in 2021,
expecting 7% of the peso volume of sales to be returned. However, due to the introduction of new models during the year,
the estimated percentage of return was increased to 10% on May 1. It is assumed that no components sold during a given
month are returned in that month. Each component is stamped with a date at time of sale so that the warranty may be
properly administered. The following table of percentages indicates the likely pattern of sales returns during the 6-month
period of the warranty, starting with the month following the sale of components.
The corporation's warranty also covers the payment of freight cost on defective components returned an on the new
components sent out as replacements. This freight cost runs approximately 5% of the sales price of the components
returned. The manufacturing cost of the components is roughly 70% of the sales price, and the salvage value of returned
components average 10% of their sales price. Returned components on hand at December 31, 2020, were.
Month Following Sales
First
Second
Third
Fourth sixth -10% each month
% of total returns expected
30%
20
20
30
100%
Gross Sales of components were as follows for the first six months of 2021
Month
Amount
Month
January
4,200,000
April
February
4,700,000
May
March
3,900,000
June
Amount
3,250,000
2,400,000
1,900,000
Illustrative Problem 10: Bonds Issued @ Interest dates
On January 1, 2021, iHeart Company issued 10% 3 year P1,000,000. Interest on these bonds are due annually.
Required: Provide the necessary Journal Entries upon
Issuance using the following assumptions
1. No quoted price, Effective rate is 8%
2. No quoted price, Effective rate is 12%
3. Bonds are quoted at 98, effective rate is 12%
Illustrative Problem 11: Bonds Issued @ Interest dates
On January 1 2021, iHeart Company issued 10% 3 yearP1,000,000 bonds. Interest on these bonds is payable Semi-annually
on June 30 and December 31. Effective Rate is 8%
Illustrative Problem 12: Serial Bonds Issued
On January 1 2021, iHeart Company issued 10% 4 year P2,000,000. Interest on these bonds is payable on December 31.
The bonds matures every December 31 each year at the rate of P500,000 per year. Yield rate is 16%.
Illustrative Problem 13: Bonds Issued between Interest Dates
On April 1, 2021, iHeart Company issued 12% 5-year P1,000,000 bonds. Interests on these bonds are payable Annually on
December 31. Yield rate for this type of bonds is 15%.
Illustrative Problem 14: Bonds Issued @ Interest dates
On January 1 2021, iHeart Company issued 10% 3 year P1,000,000 bonds. Interest on these bonds is payable Semi-annually
on June 30 and December 31. Effective Rate is 8%
Assume the bonds were retired:
1. Maturity
2. On September 1, 2022, at 103
Problem 15 (Numbers 13-17)
On January 1. 2020, Forev&Alwiz Corporation issued 2,000 of its 5-year, P1,000 face value, 11% Bonds dated January 1 at
an effective annual interest rate (yield) of 9%. Interest is payable each December 31. Forev&Alwiz Corporation uses the
effective interest method of amortization. On December 31, 2021, the 2,000 bonds were extinguished early through
acquisition in the open Market by Forev&Alwiz Corporation for P1,980,000 plus accrued interest.
On July 1, 2020, Forev&Alwiz Corporation issued 5,000 of its 6-year, 1,000 face value, 10% Convertible bonds at par. Interest
is payable every June 30 and December 31. On the date of iIssue, the prevailing market interest rate for similar debt without
conversion option is 12%. On July 1, 2021, an investor in Forev&Alwiz’s convertible bonds tendered 1,500 bonds for
Conversion into 15,000 shares of Forev&Alwiz Corporation’s ordinary shares, which had a fair Value of P105 and a par value
of P1 at the date of conversion. Based on the above and the result of your audit, determine the following: (Round off
present
Value factor to four decimal places.)
Required:
1. Compute for the issue price of the 2,000 5-year, P1,000 face value bonds On January 1, 2020.
2. Compete the carrying value of the 2,000 5-year, P1,000 face value bonds On December 31, 2020.
3. Compute the amount of gain on early retirement of bonds on December 31, 2021
4. Compute the carrying value of the 5,000 6-year, 1,000 face value bonds on December 31, 2020.
5. Compute the total increase in additional paid-in capital as a result of the Conversion of the 1,5006-year, P1,000
face value bonds on July 1, 2021.
Problem 16
Treacherous Company issued 2,000 four-year, P1,000 face value 11% bonds for P2,129,534 on March 1, 2021. The bonds
pay interest semi-annually every March 1 And September 1 and were issued to yield 9%.
Required: Note: In your solution, prepare the table of amortization for 4 years. Round off present value factors to four (4)
decimal places The company is using the calendar year.
1. Compute for the carrying value of bonds payable on December 31, 2021
2. Compute for the interest expense for the year 2021
3. Compute for the interest payable to be recorded on December 2021
4. Compute for the interest expense for the year 2022
5. Compute for the carrying value of the bonds payable on December 31, 2022
6. Compute for the interest payable on December 31, 2022
Example: Lease payments only
State of Grace Company leased an equipment on January 1, 2021 with the following Information:
P2,000,000
P2,000,000
4 years
4 years
5 years
5 years
14%
14%
12%
12%
The lease provides a transfer of ownership of the underlying asset to the lease at the End of the lease term.
Required:
1. Compute for the lease liability at the commencement of the lease.
2. Compute the depreciation of the right of use asset.
3. Prepare the necessary entries on December 31, 2021 related to the lease.
Example: Lease payments with purchase option
State of Grace Company leased an equipment on January 1, 2021 with the following Information:
P2,000,000
P2,000,000
4 years
4 years
5 years
5 years
14%
14%
12%
12%
The company has the option to purchase the equipment upon the lease expiration On December 31, 2024 by paying
P400,000. It is determined the lessee is reasonably Certain to exercise the purchase option. The equipment has an
estimated residual Value of P500,000 at the end of the 12-year useful life.
Required:
1. Compute for the lease liability at the commencement of the lease.
2. Compute the depreciation of the right of use asset.
3. Prepare the necessary entries on December 31, 2021 related to the lease.
Example: Lease payments with Guaranteed Residual value
State of Grace Company leased an equipment on January 1, 2021 with the following information:
Fixed leased payments at the end of each year
2,000,00
Lease Term
4 years
Useful life
5 years
Incremental rate
14%
Implicit rate
15%
Required:
1. Compute for the lease liability at the commencement of the lease.
2. Compute the depreciation of the right of use asset.
3. Prepare the necessary entries on December 31, 2021 related to the leases
Quiz-Lease Accounting- Problem 17
1. Customer enters into a five-year contract with Supplier for the use of a rolling stock specifically designed for Customer
X. The rolling stock is Designed to transport materials used in Customer X’s production process and is Not suitable for use
by other customers. The rolling stock is not explicitly Specified in the contract, but Supplier Y owns only one rolling stock
that is Suitable for Customer X’s use. If the rolling stock does not operate properly, The contract requires Supplier Y to
repair or replace the rolling stock. Supplier Y does not have a substantive substitution right. Is the rolling stock an identified
asset? Explain your answer.
2. On January 1, 2023, Row Co. leased a machine from Boat, Inc. Information on the lease is as follows:
Annual rent payable at the beginning of each year
200,000
Lease term
10 years
Useful life of machine.
12 years
Implicit interest rate
10%
The lease contract provides Row Co. an option to purchase the machine at the End of the lease term for P100,000. The
option price approximates the machine’s Expected fair value at the end of the lease. Row Co. is reasonably certain to the
exercise the option.
Required:
Compute the amount of interest expense should Row Co. recognize on the lease in 2023.
3. On January 1, 2023, Babson, Inc., leased two automobiles for executive use. The lease require Babson to make five
annual payments of P13,000 beginning January 1, 2023. Babson expects to pay P10,000 on the residual value guarantee.
The interest rate implicit in the lease is 9%.
Required:
Compute the recorded lease liability on initial recognition.
4. On January 1, 2023, Day Corp. entered into a 10-year lease agreement with Ward, Inc.. for a piece of industrial
equipment. Annual lease payments of P10,000 are payable at the end of each year. Day knows that the lessor expects a
10% return on the lease. Day has a 12% incremental borrowing rate. The Equipment is expected to have an estimated
useful life of 10 years. In addition, a third party, unrelated to Day, has guaranteed to pay Ward a residual value Of P5,000
at the end of the lease.
Required: Compute, the principal amount of the lease obligation in Day’s January 1, 2023, balance sheet
5. A right of use asset is initially measured at cost and subsequently measured Using the. Encircle the letter of the correct
answer.
a. cost model
b. fair value approach
c. revaluation model
d. any of these
Problem 18 (Numbers 7-8)
Presented below are lease transactions of All2Well Corporation for the year 2021:
(1) On January 1, 2021, All2Well Corporation signed a 10- year operating lease for the office space at P960,000 per year.
The lease included a provision for additional rent of 5% of annual sales in excess of P5,000,000. The sales for the current
year amounted to P6,000,000. Upon execution of the lease, the entity paid P240,000 as a bonus for the lease.
(2) All2Well Corporation acquired an asset costing P3,165,000. The asset is leased on January 1,2021 to another entity.
Five annual lease payment are due each December 31, beginning December 31, 2021. The unguaranteed residual value of
the asset at the end of the lease term on December 31, 2025 is P500,000. The asset will revert to the lessor at the end of
the lease term. The lessor’s implicit interest rate is 12%. The present value of 1 at 12% for 5 periods is .57 and the present
value of an ordinary annuity of 1 at 12% for 5 periods is 3.60.
Required:
7. Compute the total rent expense for the year ended December 31, 2021 related to lease agreement under operating
lease.
8. For lease agreement under finance lease, compute for the annual rental payment?
Problem 19 (LEASE LIABILITY)
On January 2, 2023, Snow Inc. enters into a 3-year lease of machine for an annual rent of P200,000 payable at the end of
each year. The machine has a remaining useful life of 5 years. The interest implicit in the lease is 10%, while Snow Inc’s
incremental borrowing rate is 12%. Snow Inc. uses a straight line method.
Required:
1. Provide Journal Entries necessary in 2023 to 2025.
2. Compute the December 31, 2023, carrying amount of the lease liability. (Show the current and non-current portion)
3. Compute the carrying amount of the right of use asset on December 31, 2023.
Problem 20
On January 1, 2023, Beach Co, leased a machine from Slot Inc. Information on the lease is as follows:
Annual rent
P200,000
Lease Term
10 years
Useful life
12 years
Implicit interest rate
10%
Incremental borrowing rate
12%
The lease payments are due at the end of each year. Beach Co. guarantees that Slot Inc will realize P80,000 from selling
the machine to another party at the end of the lease term. At the contract inception, Beach Co estimates that the fair value
less costs of the machine at the end of the lease term, when the machine is reverted to Slot Inc will be P50,000.
Required:
1. Compute the carrying amount of the right of use asset
2. Compute the carrying amount of the lease liability
Problem 21
On January 1, 2023, Beach Co, leased a machine from Slot Inc. Information on the lease is as follows:
Annual rent
P200,000
Lease Term
10 years
Useful life
12 years
Implicit interest rate
10%
Incremental borrowing rate
12%
The lease payments are due at the beginning of each year. The lease contract provides Beach Co an option to purchase the
machine at the end of the lease term for P100,000. Beach Co is reasonably certain to exercise the option.
Required: Compute the interest expense Beach Co should recognize in 2023.
Problem 22 (Direct Financing Lease)
Annual rental payable @ the end of each year
Lease Term & UL
Guaranteed RV
Implicit Rate
Initial Direct Cost
NO transfer of ownership
Required:
1. Gross Investment
2. Net Investment
3. Unearned Interest Income
1,500,000
5 years
500,000
12%
200,000
Problem 23
Unwire Trouble Company began operations on January 1, 2021 and reported pretax financial income of P1,000,000 as of
the year ending December 31,2021. This amount include:
Installment sales, P125,000 remained uncollected
P270,000
Rent Income
110,000
Non-taxable revenue
75,000
Warranty expense, yet to be disbursed
62,500
Depreciation expense
57,500
Non-deductible expenses
5,000
Additional information:
a. Installment sale and warranty expense are recognized on cash basis for tax purposes
b. The depreciation expense and rental income included in the tax return were higher by P42,500 and 20,000
respectively.
c. Enacted tax rate in 2021 and future years is 30%
Required:
Compute the following:
1. Financial Income Subject to tax
2. Taxable Income
3. Current tax expense
4. Deferred tax asset
5. Deferred tax liability
6. Total income tax expense
Problem 24
On December 31, 2023, Cornelia Company reported a deferred tax liability of P600,000 and a deferred tax asset of 150,000.
On December 31, 2024, the deferred tax liability is P900,000 and the tax asset is zero.
Required: Compute the deferred tax expense for 2024.
Problem 25
Afterglow Company reported the following information during the first year of operation:
Pretax financial income
9,000,000
Non-taxable interest received
1,000,000
Long term loss accrual in excess of deductible amount
1,500,000
Tax depreciation in excess of financial depreciation
2,000,000
Income tax rate
25%
Required:
Compute the following:
1. Current tax expense
2. Total tax expense
3. Deferred tax liability
4. Deferred tax asset
Problem 26
False God Company was organized on January 1, 2023. The entity had pretax accounting income of P5,000,000 and taxable
income of P7,000,000 for the current year. The only temporary difference is accrued product warranty cost that is expected
to be paid in 2024. The enacted tax rates are 30% for 2023 and 25% for 2024 and thereafter.
Compute the total income tax expense in the income statement for 2023.
Problem 27
At the end of the first year of operations, Ayalmostdu Company had taxable differences totaling P3,000,000. Of this total,
P500,000 relates to current items. The entity also has deductible temporary differences totaling P1,000,000, P250,000 of
which relates to current items. Pretax financial income for the current year was P20,000,000. The tax rate is 30%.
Required:
9. Compute the amount that should be reported as current tax expense for the current year.
10. Compute the net deferred tax expense or benefit for the current year.
a. P900,000 expense c. 600,000 expense
b. 300,000 benefit
d. 600,000 benefit
Problem 28
You were engaged by Blank Space Corporation, a publicly held company whose shares are traded on the Philippine Stock
Exchange, to conduct an audit of its financial statements. You were told by the company's controller that there were
numerous equity transactions that took place in 2021. The shareholders' equity accounts at December 31, 2020 had the
following balances:
Share capital- Preference, P100 par value, 6% cumulative; 30,000 shares authorized; 18,000
P1,800,000
shares issued and outstanding
Share capital-Ordinary, P1 par value, 1,800,000 share authorized; 1,200,000 shares issued
1,200,000
and outstanding
Share premium
2,400,000
Retained Earnings
980,000
TOTAL SHAREHOLDERS EQUITY
P6,380,000
You summarized the following transactions during 2021 and other information relating to the shareholders' equity in your
working papers as follows:
➢ JANUARY 6, 2021- Issued 45,000 ordinary shares in exchange for land. On the date issued, the shares had a market
price of 16.5 per share. The land had a carrying value of P420,000, and an assessed value for property taxes of
P490,000.
➢ JANUARY 31, 2021- Sold 2, 400, P1,000, 12% bonds due January 31, 2031, at 98 with one detachable share
warrants attached to each bond. Interest is payable annually on January 31. The fair value of the bonds without
share warrants is 95. The detachable warrants have a fair value of P50 each and expire on January 31, 2022. Each
warrant entitles the holder to purchase 10 ordinary shares at P10 per share.
➢ FEBRUARY 22, 2021- Purchased 15,000 of its own shares to be held as treasury shares for P24 per share.
➢ FERUARY 28, 2021- Subscription for 42,000 ordinary shares were received at P26 per share, payable 50% down
and the balance by March 15.
➢ MARCH 15, 2021- The balance due on 36,000 ordinary shares was received and those shares were issued. The
subscriber who defaulted on the 6,000 remaining shares forfeited the down payment in accordance with the
subscription agreement.
➢ AUGUST 30, 2021-Reissued 6,000 treasury shares for 20 per share.
➢ SEPTEMBER 14, 2021- There were 1,890 warrants detached from the bonds and exercised.
➢ NOVEMBER 30, 2021- Declared a cash dividend of P0.50 per share to all ordinary shareholders of record December
15, 2021. The dividends were paid on December 30, 2021.
➢ DECEMBER 15, 2021- Declared the annual cash dividends on preference shares for 2021. The dividend was paid
on January 15, 2022.
➢ JANUARY 8, 2022- Before closing the accounting records for 2021. Blank Space Company became aware the no
depreciation had been recorded for 2020 for a machine purchased on July 1, 2020. The machine was properly
capitalized at P960,000 and had an estimated useful life of eight years when purchased. The appropriate correcting
entry was recorded on the same date
➢ ADJUSTED net income for 2021 was P840,000
Based on the foregoing and the results of your audit, answer the following: (Ignore income tax implications)
Required: Prepare the necessary journal entries on the above transactions.
1. Compute the Share capital-ordinary at December 31, 2021.
2. Compute the total share premium as of December 31, 2021.
3. Compute the unappropriated retained earnings on December 31, 2021
4. Compute the total shareholders' equity on December 31, 2023
Problem 29
During the current year, Glitch Company issued 10,000 ordinary shares with P100 par value and 20,000 convertible
preference shares with P200 par value for P8,000,000. On the date of issuance, the ordinary shares is selling at P360 and
the preference share is selling at P270. The entity also issued 6% bonds with a maturity value of P6,000,000, together with
20,000 ordinary shares with P100 par valuer for a combined cash amount of P11,000,000. The market value of ordinary
share cannot be determined. If the bonds were issued separately, the bonds would have sold for P5,000,000 on an 8%
yield to maturity basis.
1. What amount should be reported as share premium from preference shares?
2. What amount should be reported as share premium from ordinary shares?
Problem 30
Dear Reader Company was organized at the beginning of current year with authorized capital of 100,000 shares of P200
par value. During the year, the entity had the following transactions affecting shareholders' equity:
• Issued 25,000 shares at P220 a share.
• Issued 1,000 shares for legal services when the fair value was P240 a share.
• Issued 5,000 shares for a tract of land when the fair value was P260 a share.
What amount should be reported for share premium at year-end?
Problem 31
Infidelity Company reported the following equity at the beginning of the current year:
Share capital, P10 par
5,000,000
Share premium
2,000,000
Retained earnings
1,500,000
During the current year, the entity had the following share transactions:
• Acquired 20, 000 treasury shares for P1,000,000
• Sold 15,000 treasury shares at P60 per share.
• Sold the remaining treasury shares at P45 per share
What amount should be reported as share premium at year-end?
Problem 32
On December 31, 2022, Paris Company cancelled 5,000 shares of P50 par value held in treasury at an average cost of P120
per share. Before recording the cancelation of the treasury shares, the entity had the following shareholders' equity:
Share capital, 50,000 shares originally issued at P75
2,500,000
Share premium
1,250,000
Retained earnings
1,000,000
Treasury shares, at cost
600,000
On December 31, 2022, what amount should be reported as share capital outstanding?
Problem 33
Great War Company had issued 100,000 ordinary shares. Of these, 5,000 shares were held as treasury on January 1, 2022.
During the current year, transactions involving ordinary shares were as follows:
May 1
1,000 shares if treasury were sold
Aug 1
10,000 previously unissued shares were sold
Nov 1
A 2-for-1 share split took effect.
1. On December 31, 2022, how many ordinary shares were issued?
2. On December 31, 2022 how many shares are outstanding?
Problem 34
Mastermind Company was organized on January 1, 2022. On that date, the entity issued 200,000 shares with P10 par
value at P15 per share. During the period January 1, 2022 through December 31, 2023, the entity reported net income of
P2,000,000, and paid cash dividends of P500,000. On January 5, 2023, the entity purchased 10,000 shares at P20 per share
to be held as treasury. On December 31, 2023, 5,000 treasury shares were sold at P30 per share and the remaining treasury
shares were retired. What is the total shareholders' equity on December 31, 2023?
Problem 35
The equity section of IVY Co's. statement of financial position shows the following
8% P100 Par value, Preference Shares
400,000
Ordinary shares
1,600,000
Subscribe share capital- ordinary
200,000
Additional paid-in capital-ordinary
600,000
Additional Paid-in capital- preference
100,000
Subscription receivable
100,000
Retained Earnings
400,000
Required:
1. Compute for the legal capital, assuming the ordinary shares are par value shares.
2. Compute for the legal capital, assuming the ordinary shares are no-par value shares.
Problem 36
On January 1, 2022, Sweet Company reported the following shareholders' equity
Share capital, 250,000 shares
authorized, 100,000 shares outstanding, P50 par
5,000,000
Share premium
4,000,000
Retained earnings
5,000,000
The board of directors declared a 10% stock dividend on July 1, 2022, when the market value of the share was P100. The
stock dividend was issued on October 1, 2022 when the market value of the share was P120. The entity sustained a net
loss of P2,500,000 for 2022. What amount should be reported as retained earnings on December 31, 2022?
Problem 37
Nothings Company reported the following shareholder’s equity on January 1, 2022.
Share Capital, P5 par, 600,000 shares authorized;
200,000 shares outstanding
1,000,000
Share premium
4,000,000
Retained earnings
5,000,000
On January 31, 2022, the entity reacquired 20,000 shares at P20 per share to be held as treasury. On June 30,2022, the
entity declared and issued a 100% stock dividend. On December 31, 2022, the entity paid a cash dividend of P10 per share.
The net income for 2022 was P3,000,000. What is the unappropriated balance of retained earnings?
Problem 38
On January 1, 2022, Karma Company showed the following shareholder’s equity:
Share Capital, P5 par, 300,000 shares outstanding
1,500,000
Share Premium
3,000,000
Retained earnings
5,000,000
On July 1, 2022, the entity declared a property dividend of inventory payable on March 1, 2023. The inventory had a
P1,200,000 carrying amount and a fair value less cost to distribute of P1,500,000 on July 1, 2022, P1,800,000 on December
31, 2022 and P2,000,000 on March 1, 2023. The net income for 2022 was P3,000,000.
1. What amount should be reported as retained earnings on December 31, 2022?
2. On December 31, 2022, the inventory should be reported at what amount?
3. What amount should be recognized as gain on distribution of property dividend in 2023?
Problem 39
On January 1, 2022, Labyrinth Company had ordinary and preference shares outstanding. The incorporators own ten
ordinary shares but no preference shares. On December 31, 2022, the entity declared dividends on the ordinary shares
payable on December 31, 2023. The entity decided to give the ordinary shareholders a choice between receiving a cash
dividend P500,000 per share or in the form of a noncash asset. The noncash asset is a standard model from the entity's
car fleet. Each car has a fair value of P600,000 and carrying amount of 450,000. The fair value of the car if P700,000 on
December 31, 2023. The entity estimated that 80% of the ordinary shareholders will take the option of the cash dividend
and 20% will elect for the noncash asset.
1. What amount should be recognized dividend payable on December 31, 2022?
2. What amount should be recognized as gain on distribution of property dividend in 2023 if the ordinary shareholders
elected to receive the noncash asset?
Problem 40
Oswald Company provided the following information during the current year:
• Dividends on 10% 50,000 cumulative preference shares with P100 par value have not been declared or paid for 3
years.
• Treasury ordinary shares were acquired at a cost of P1,000,000 during the year. The treasury shares had not been
reissued as at year-end.
• At year-end the entity appropriated P2,000,000 of retained earnings for the construction of a new plant.
• Also, P3,500,000 of cash was restricted for the retirement of bonds payable.
What amount of should be reported as appropriated retained earnings?
Problem 41
Shake It Off Co. was formed on July 1, 2017. It was authorized to issue 1,800,000 shares of 10 par value ordinary shares
and 600,000 shares of 8% 25 par value, cumulative and non-participating preference shares. Shake It Off Co. has a July 1June 30 fiscal year.
The following information relates to the shareholders' equity accounts of Shake It Off Co.:
Ordinary Shares
Prior to 2020-2021 fiscal year, Shake It Off Co. had 660,000 ordinary shares issued as follows:
1. 510,000 shares were issued for cash on July 1, 2018 at 31 per share
2. On July 24, 2018, 30,000 shares were exchanged for a plot of land which cost the seller 420,000 in 2011 and had
an estimated market value of 1,320,000 on July 24, 2018.
3. 120,000 shares were issued on March 1, 2019 for 42 per share
During 2020-2021 fiscal year, the following transactions regarding ordinary shares took place:
Nov. 30, 2020 – Shake It Off Co. purchased 12,000 of its own shares on the open market at 39 per share.
Dec. 15, 2020 - Shake It Off Co. declared a 5% stock dividend for shareholders of record on January 15, 2021 to be issued
on January 31, 2021. Shake It Off Co. was having a liquidity problem and could not afford a cash dividend
at the time. Shake It Off Co.'s ordinary shares were selling at 52 per share on December 15, 2020.
June 20, 2021 – Shake It Off Co. sold 3,000 of its own ordinary shares that it had purchased on November 30, 2020 for
126,000.
Preference Shares
Shake It Off Co. issued 240,000 preference shares at 44 per share on July 1, 2019.
Cash Dividends
Shake It Off Co. has a followed a schedule of declaring cash dividends in December and June, with payment being made to
shareholders of record in the following month. The cash dividends which have been declared since inception of the
company through June 30, 2021 are shown below:
Declaration Date
Dec. 15, 2019
June 15, 2020
Dec. 15, 2020
Share Capital - Ordinary
0.30 per share
0.30 per share
Share Capital -Preference
1.00 per share
1.00 per share
1.00 per share
No cash dividends were declared during June 2021 due to the company's liquidity problems.
Retained Earnings
As of June 30, 2020, Shake It Off Co.'s retained earnings account had a balance of 4,140,000. For the fiscal year ending
June 30, 2021, Shake It Off Co. reported net income of 240,000.
Required: Compute the adjusted balances of the following as of June 30, 2021:
1. Share capital – preference
5. Share premium - treasury
2. Share capital – ordinary
6. Retained earnings (before appropriation for treasury shares)
3. Share premium – preference
7. Treasury shares
4. Share premium – ordinary
8. Total shareholders' equity
Problem 42
Evermore Company was organized on January 1, 2023, with 100,000 authorized shares of P100 bar value. During 2023,
the following transactions occurred.
January 15
February 14
March 27
October 31
November 5
December 17
December 31
Sold 30,000 share at 150 per share.
Issued 2,000 shares for legal services with a fair value of P250,000. The shares are quoted at P140
per share on this date.
Purchased 5,000 treasury shares at cost of P120 per share
Issued P5,000,000 convertible bonds at 120 The bonds are quoted at 98 without the conversion
feature.
Declared a 2 for 1 share split when the market value of the share was P160.
Sold 10,000 shares at P75 per share.
The net income for the year was P2,000,000.
You are engaged to do some recalculation regarding the valuation of some equity accounts.
Required
1. Prepare the necessary journal entries for 2023 (1 point each)
2. Compute the total outstanding shares on December 31, 2023.
3.Compute the reported share capital on December 31, 2023.
4. Compute the amount recognized as share premium on December 31, 2023.
5. Compute the total shareholders' equity on December 31, 2023
Problem 43
At the beginning of year 1, Bad Blood Company grants share option to each of its 100 employees working in the sales
department. The share option will vest at the end of year 3, provided that the employees remain in the entity's employ,
and provide that the volume of sales of the product increases by an average of between 5 percent per year. If the volume
of sales of the product increases by an average of between 5 percent and 10 percent per year, each employee will receive
100 share options. If the volume of sales increases by an average of between 11 and 15 percent each year, each employee
will receive 200 share options. If the volume of sales increases by an average of 16% or more, each employee will receive
300 share options.
On grant date, Bad Blood Company estimates that the share options have a fair value of 20 per option. Bad Blood Company
also estimates that the volume of sales of the product will increase by an average of between 11 percent and 15 percent
per year, and therefore expects that, for each employee who remains in service until end of year 3, 200 share options will
vest. The entity also estimates, on the basis of a weighted average probability, that 20 percent of employees will leave
before the end of year 3.
By the end of year 1, seven employees have left, and the entity still expects that a total of 20 employees will leave by the
end of year 3. Hence, the entity expects that 80 employees will remain in service for the three-year period. Product sales
have increased by 12 percent and the entity expects this rate of increase to continue over the next 2 years.
By the end of year 2, a further five employees have left, bringing the total to 12 to date. The entity now expects only three
more employees will leave during year 3, and therefore expects a total of 85 employees will remain at the end of year 3.
Product sales have increased by 20 percent, resulting in an average of 16% over the two years to date. The entity now
expects that the sales will average 16% or more over the 3-year period, and hence expects each sales employee to receive
300 share options at the end of year 3.
By the end of year 3, a further two employees have left. Hence, 14 employees have left during the 3-year period, and 86
employees remain. The entity's sales have increased by an average of 16% over the three years.
Based on the preceding information, answer the following:
Required:
1. Compute the compensation expense for year 1
2. Compute the compensation expense for year 2
3. Compute the compensation expense for year 3
4. Compute the cumulative compensation expense for years 1,2, and 3.
5. At the end of year 2, Compute the amount the entity should report as share option outstanding.
Problem 44
On January 1, 2021, Great War Company offered management share appreciation rights equal to 50,000 shares with a
predetermined price of P100. The service period is 3 years, and exercise date is January 1, 2024.
The quoted prices per share are P124 on December 31, 2021, P151 on December 31, 2022, and P151 on December 31,
2023.
Required:
1. Compute the amount charged to compensation expense for 2023.
2. Compute the amount should be recognized as gain on reversal of share appreciation rights, assuming the market price
dropped to 120 on December 31, 2023.
Problem 45
On January 1, 2023, ME Company grants 100 cash share appreciation rights to each of its 200 employees on the condition
that the employees remain in its employ for next 3 years.
During 2023, 14 employees leave. The entity estimates that a future 24 will leave during 2024 and 2025. During 2024, 10
employees leave, and the entity estimates that future 8 will leave during 2025. During 2025, 6 employees leave. At the end
of 2025, 60 employees exercise their share appreciation rights, another 40 employees exercise the rights at the end of
2026 and the remaining employees exercise their rights at the end of 2027.
The entity estimates the fair value of the rights at the end of each year which a liability exists as shown below. At the end
of 2025 all rights held by remaining employees vest. The (which is equal to the cash payout) at intrinsic value of the rights
at the end of exercise the end of 2025, 2026 and 2027 are shown below:
Year
Fair Value
Intrinsic value
2023
P30
2024
32
2025
36
P35
2026
42
40
2027
46
Required:
1. Compute the compensation expense for year 2023-2027
Problem 46
Sad Beautiful Tragic Co. began operation on January 1, 2021. Authorized were 100,000 ordinary shares of P50 par value
and 50,000 convertible preference shares of 10% P50 par value. The following transactions involving shareholders’ equity
occurred during the first year of operations.
Jan. 1 Issued 10,000 ordinary shares to the corporation promoters in exchange for property valued at
P1,250,000 and services valued at P250,000. The property had cost the promoters P900,000 three
years before and was carried on the promoters’ books at P750,000
Feb. 22
Issued 15,000 preference shares at a price of P60 per share. Each share can be converted to five ordinary
shares. The entity paid P25,000 to an agent for selling the shares.
Mar. 10
Sold 25,000 ordinary shares for P130 per share. Issue costs were P100,000.
Apr. 10
20,000 ordinary shares were sold under share subscriptions at P175 per share. No shares certificates are
issued until a subscription contract is paid in full. No cash was received.
Jul. 15
Exchange 12,000 ordinary shares and 20,000 preference shares for a building with a fair value of
P3,500,000. The building was originally purchased for P3,250,000 by the owner and has a book value of
P2,400,000. In addition, 10,000 ordinary shares were sold for P1,500,000 in cash.
Aug. 1
Received payments in full for half of the share subscription and partial payments on the rest of the
subscription. Total cash received was P2,250,000. Share certificates were issued for the subscription paid
in full.
Aug. 31
Received notice from the holders of the share subscription for 5,000 shares that they would not pay
further on the subscription because the price of the share had fallen to P95 per share. The amount still
due on those contracts was P750,000. Amount previously paid on the contracts are forfeited according to
the agreement.
Dec. 31
Net income for the first year of operation was P1,500,000
REQUIREMENTS:
1. Prepare the necessary journal entries on the above transactions. (In your solution)
2. Based on the preceding information, determine the correct balances of the following at December 31, 2021:
1. Ordinary share capital
2. Share premium ordinary
3. Share premium- preference
4. Total shareholders’ equity
Problem 47
Style Company reported the following information on December 31, 2021:
Ordinary share capital
110,000 shares
Convertible noncumulative preference share capital
20,000 shares
10% convertible bonds payable
P2,000,000
Share options to purchase 60,000 shares at P15 were outstanding. Market price of ordinary share was P22 on December
31, 2021 and average P20 during the year. No value was assigned to the share options. The entity paid preference dividends
of P5 per share. The preference share is convertible into 40,000 ordinary shares. The 10% bonds are convertible into 30,000
ordinary shares. The net income for 2021 is P650,000. The tax rate is 30%.
Required:
1. Compute the amount that should be reported as basic earnings per share for 2021.
2. Compute the total number of potential ordinary shares.
3. Compute the amount that should be reported as diluted earnings per share for 2021.
Theories
1. In an examination of shareholders’ equity, an auditor
is most concerned that
a. Capital stack transactions are properly authorized
b. Stock splits are capitalized at par or stated value on
the dividend declaration date
c. Dividends during the year under audit were approved
by the shareholders
d. Changes in the accounts are verified by a bank serving
as a registrar and stock transfer agent
2. When a corporate client maintains its own stock
records, the auditor primarily will rely upon
a. Confirmation with the company secretary of shares
outstanding at year end
b. Review of the corporate minutes for data as to shares
outstanding
c. Confirmation of the number of shares outstanding at
year end with the appropriate state official
d. Inspection of the stock book at year-end and
accounting for all certificate number
3. An audit program for the retained earnings account
should include a step that requires verification of the
a. Fair value used to charge retained earnings to account
for a 2 for 1 stock split
b. Approval of the adjustments to the beginning balance
as a result o a write-down of an A/R
c. Authorization for both cash and stock dividends.
d. Gain or loss arising from disposition of treasury shares.
4. If the auditee has a material amount of treasury stock
on hand at year end, the auditor should
a. Count the certificates at the same time other securities
are counted
b. Count the certificates only if the company had treasury
stock transaction during the year
c. Not count the certificates if treasury stocks is a
deduction from shareholders’ equity
d. Count the certificates only if the company classifies
treasury stock with other assets
5. The auditor would not expect the client to debit
retained earnings for which of the following
transactions?
a. A 4-for-1 stock split
b. “Loss” arising disposition to treasury shares
c. A 1-for-10 stock dividend
d. Correction of error affecting prior year’s earnings
AUDIT of LIABILITY
Audit Objectives:
1.Existence/ Occurrence. To determine that all recorder
labilities on the statement of financial position are authentic
debts due to creditors of the entity.
2. Completeness. To determine that all liabilities are recorded
in the statement of financial position at the reporting date.
3. Rights and Obligations. To determine that reported
liabilities represent obligations of the entity as of the reporting
date.
4. Valuation and Allocation. To determine that all liabilities
included in the statement in financial position are recorded in
the appropriate amounts.
5. Presentation and Disclosures. Liabilities and related
accounts are properly described, classified and disclosed in the
financial statements, including notes, in accordance with the
applicable financial reporting standards.
Audit Procedures:
1. Reconcile the amounts in the subsidiary ledgers with
general ledger.
- Obtain a copy of subsidiary and general ledgers for liability
accounts. The auditor can also obtain information such as
beginning balances, additions, payment during the accounting
period and ending balances.
-The auditor should test the clerical accuracy by recalculation
(footing & cross footing). Reconcile subsidiary ledgers and
general ledgers and investigate for material difference. Check
for unusual non-standard journal entries.
Note: Addresses existence and valuation assertion.
2. Perform purchase and accounts payable cut-off
-In order to verify if liability transactions are completely
recorded in proper accounting period, the auditors should
a. Obtain and examine invoices & documents
supporting the transactions recorded in the purchase journal
and cash disbursement journal before and after the reporting
date. (check for the dates, shipping terms and other indication
of ownership)
b. Review cut-offs for goods purchased in transit.
Note: Addresses existence, completeness and obligation
assertion
3. Confirmation of Liabilities
Note: Follows the same procedures for confirmation of
receivables in terms of sending the request and receiving
of replies.
-Confirmation of accounts payable balances is necessary if:
a. Controls over the recoding of vendor's invoices and receiving
reports are ineffective.
b. There are few transactions involving large amounts
c. The are numerous long outstanding balances.
-To verify notes payable, the auditor may either:
a. Confirm the notes payable; or
b. Review of supporting documentation as to amounts owed,
terms, collateral and restrictions and the debtor's compliance
with the loan provisions and identify lien, security interest, and
assets pledged as loan collateral.
- Reconcile confirmation replies with accounting records
and resolve any differences (adjust).
Note: Addresses existence, completeness and obligation
assertion
4. Inspection of supporting documents
To ensure that recorded amounts exist and to check the
accuracy of the amounts, the auditor should vouch entries
(sample) in the voucher register or in the purchase journal to
supporting documents such as:
a. Purchase Orders
b. Receiving Reports
c. Invoice
d. Vouchers
-For leases, examine lease contracts to determine:
a. if the lease is an actual lease contract in accordance with
PFRS 16.
b. if the lease is properly classified (operating or finance)
- Verify that lease obligations are properly recorded and
disclosed.
- Inspect document of other obligations:
a. Promissory Note b. Loan Contracts c. Provisions
- Contact lender and/ or legal counsel for the entity, as
appropriate, with respect to interpretation of loan
agreements, restrictions and any other information that may
be sought regarding special provisions of notes or loan
agreements. Also, verify that these obligation are properly
recorded and disclosed.
Note: Addresses existence, valuation and obligation assertion.
5. Search for unrecorded liabilities
- Examine files (sampling) of unpaid and unrecorded invoices,
unmatched purchase orders and unmatched receiving reports
and trace it to the related journal if it was properly recorded.
(check the dates)
- Examine significant recorded purchases between the
reporting date and the date of the search for unrecorded
liabilities to determine if this purchase should be properly
included in the current year financial statements.
Note: Search for unrecorded liabilities is conducted after the
reporting date.(check for late billings, also check late recording
of payments)
Note: Addresses completeness and Obligation assertion.
- Review minutes of meetings and inspect contract to identify
unrecorded liabilities such provisions on pending litigations.
-Review cash disbursement subsequent to the reporting date
and check whether this may represent a liability that should be
reported in the current year. (to check if there are payments for
liabilities not recorded)
-Communicate to the client for material unrecorded liabilities
identified and request for appropriate adjustments.
Note: Addresses completeness and Obligation assertion.
6. Recalculate interest expense and amortization of premium
and discount.
-Recomputed the amount reported as interest expense and
interest payable using the appropriate interest rate. (nominal
and effective rate)
- For bonds payable, the auditor should prepare or
recomputed the amortization table and compare to recorded
amounts (such as carrying amount, balance of premium or
discount)
- For recurring audits, the auditor may use the prior year
working papers.
Note: Addresses valuation assertion.
7. Recalculate liabilities denominated in foreign currency
-The auditor should obtain the closing rate at the reporting
date and re-perform the translation of the foreign currency
denominated liability.
-Any gain or loss in translation should be properly reported as
part of profit or loss.
Note: Addresses valuation assertion.
8. Perform analytical procedures to liabilities and related
accounts
- Analytical review procedures can be helpful in evaluating the
overall reasonableness of liabilities and its related accounts
(e.g. interest expense, interest payable, premium and discount
balances and others)
- After comparison are made, the auditor should investigate
any significant differences, unexpected changes or the absence
of expected changes.
Note: Addresses completeness, valuation and Obligation
assertion.
Example of analytical procedures:
a. Comparison of closing balances of loans and borrowings,
creditors with corresponding figures for the previous years.
b. Comparison of the relationship between current year
accounts payable balances and the current year purchases
with the corresponding figures for the previous year
c. Comparison of actual closing balances of loans and
borrowings, creditors, etc., with the corresponding budgeted
figures, if available
d. Comparison of significant ratios relating to loans and
borrowings, creditors, etc., with the similar ratios for other
firms in the same industry, if available;
e. Comparison of significant ratios relating to loans and
borrowings, creditors, etc. with the industry norms, if available
f. Comparison of the relationship between the current year
accounts payable and the current year total current liabilities
with the corresponding figures for the previous year;
g. Comparison of the relationship between the current year
purchase discount and the current year total purchases with
the corresponding figures for the previous year,
h. Comparison of the current year interest expense to the
product of interest expense and average principal of debt
outstanding; and
i. Comparison of current year finance lease expense with the
corresponding figures for the previous year.
9. Evaluate financial statement presentation and disclosures
-Review the FS presentation of liabilities. (such as long-term
liabilities with current and non-current portion)
-Debit balances of accounts payable should be properly
reclassified as non-trade receivables.
-Ensure that the liabilities have been properly disclosed in
accordance with applicable accounting standards.
Note: Addresses presentation and disclosures assertion.
AUDIT OF SHE
Audit Objectives:
Existence or Occurrence. To determine that all recorded
shareholders’ equity balances are valid and equity transactions
actually occurred.
Completeness. To determine that all shareholders’ equity
accounts recorded reflect all data that should have been
recorded in the Statement of Financial Position.
Right and Obligation. To determine whether the entity has the
authority of execute the shareholders’ equity transactions.
Valuation and Allocation. To determine that equity accounts
are stated on the statement of financial position at the
appropriate amount.
Presentation and Disclosures. To determine that equity
accounts are properly, classified, described and disclose in the
financial statement including note, in accordance with the
applicable reporting framework.
Audit Procedures:
1. Obtain schedule of shareholders’ equity accounts and
reconcile to the general ledger balance.
- the auditor should obtain an equity reconciliation schedule
(similar to those presented in the statement of changes in
equity.
- the auditor establishes the accuracy of the schedule by
footing the schedules and reconciling the data to ledger
balances.
- the auditor should determine that changes in equity have
been properly authorized by the board of directors.
-the auditor should determine the completeness and
compliance with applicable laws and regulations.
- for treasury share transactions during the year, the auditor
should:
1. Inspect the securities on hand and examine if it is under the
name of the corporation.
2. Determine whether the reacquisition or reissuance was
authorized by board of directors.
3. Determine the legal requirement on restriction of retained
earnings and acquiring treasury shares.
4. Determine whether the price paid or received was in
accordance with price specified by the BOD. For non-cash
consideration, determine whether it was properly accounted
for under applicable PFRS or not.
- for OCI components, the auditor normally performs the
following:
1. Unrealized gain or loss on financial asset at FVTOCI - this can
be verified in conjunction with the audit of the related
investment by checking the change in fair value of the
investment;
2. Effective portion of cash flow hedge - this can be verified in
conjunction with the audit of related derivative instrument
(financial instrument).
3. Recognition or change in revaluation surplus - this can be
verified in conjunction with audit of related PPE accounts.
Note that piecemeal realization of revaluation surplus should
be traced to the retained earnings account.
4. Translation gain or loss on foreign operation - the auditor
normally by inquiring to management the date of transactions
verifies this affecting the balance reported in the financial
statement, obtaining the appropriate rate (e.g., closing rate,
historical rate, etc.) to be used: performing independent
translation and comparing it with the balance reported
5. Actuarial gain or loss employee benefits- this can be verified
in conjunction with the audit of the related plan asset and the
benefit obligation. Note that this area is considered special in
nature and the auditor may need the assistance of an expert.
Note: Addresses existence, completeness and valuation
assertions
2. Review of minutes of meetings, articles of incorporation
and by-laws. Make inquiries of legal counsel.
- the auditor should review the board of directors meeting to
obtain evidence of the authorization of shareholders’ equity
transactions.
-the auditor should examine authorization of share related
transactions such as issuance, share requisitions and dividend
declaration.
-the auditor should also examine whether restriction
provisions are observed by the client in the issuance of shares,
dividend declaration and liquidation.
- the auditor should also review shareholder and committee
meetings as well as changes in the articles of incorporation
affecting the financial statements including notes by
considering if the company maintains the shareholder records
or the entity employs registrar and stock transfer agent since
this will affect the audit procedures to be performed.
- the auditor can make inquiries with the client’s legal counsel
regarding the legalities of any changes in capitalization whose
response should preferably in writing.
Note: Addresses existence, completeness, right& obligations
and presentation and disclosure
3. Confirm shares outstanding with registrar and transfer
agents.
Some corporation employ the services of an independent
registrar and stock transfer agent. A transfer agent is
responsible for issuing and cancelling the entity's share or
bond certificates and for maintaining the record of share
transfers. The registrar maintains the shareholders' register
showing the names and addresses of registered shareholders
at any time. Often the duties of both roles are assigned to the
same party.
When these duties are performed by independent registrar
and stock transfer agent, the auditor ordinarily performs the
following audit procedures:
1. Confirm the balance at year end and transactions during the
year to the independent registrar and agent.
2. Trace replies from the confirmation request to the corporate
records
3. Agree the general ledger controlling accounts to the amount
of stock issued as reported by the independent registrar and
stock transfer agent.
The contents of the confirmation request ordinarily include the
following information:
a. The total number of each class of shares issued and
outstanding at the reporting date.
b. Details of any changes in this amount during the year.
c. The number of shares outstanding at the record date if
dividends have been declared.
d. The amount of any subscriptions receivable in respect of
share subscribed but not issue.
e. Whether any shares are being reserved for future issuance
(e.g. convertible shares and share options)
f. The amount of any unclaimed dividends
g. A list of principal shareholders for each class of shares.
Note: Addresses existence, completeness and rights &
obligations
4. Inspect share certificate books and certificates of shares
held in treasury
When the entity acts as its own transfer agent and registrar.
The auditor inspection of share certificate books will include
the following steps.
1. Examine the share certificate book to determine that (a)
stubs for shares issued and outstanding have been properly
filled out, (b) canceled certificates are attached to the original
stubs, and (3) all unissued certificate are accounted for.
2. Ascertain that changes during the year have been correctly
recorded in the shareholders’ subsidiary ledger.
3. Reconcile the total shares issued and outstanding as shown
in the share certificate books with total shares reported in the
shareholders’ ledger and share capital accounts.
If shares are held in the treasury, the auditor should inspect the
certificates at the same time other securities are counted.
Note: Addresses existence assertion
5.Perform analytical review procedures
The auditor can perform the analysis about the following ratios
and relationships:
a. Book value and earnings per share
b. Return on shareholders’ equity
c. Equity ratio
d. Dividend payment ratio
e. Price- earnings ratio
Note: Addresses completeness assertion
6. Analyze retained earnings and review appropriateness of
dividends
Transactions in retained earnings normally consist of net
income or loss, dividends, appropriations in retained earnings
and quasi-reorganizations, but they may also include
adjustments to opening retained earnings arising from changes
in accounting policy and prior period error corrections.
Audit procedures performed when auditing retained earnings
may include the following:
1. Check the opening retained earnings if they include prior
year's adjusting journal entries. For continuing auditor,
opening balance of retained earnings may be verified from the
prior year working paper and ending balance of the retained
earnings presented on the prior year audited financial
statements.
2. Check for proper authorization by appropriate official or the
board of directors for any movements in retained earnings,
including dividend declaration other than closing of net income
or loss and any prior period adjusting entries to retained
earnings.
3. Check the propriety of entries related to transactions in
retained earnings.
4. Check for proper disclosure of restricted retained earnings.
When auditing dividends, the auditor should ensure whether
the dividend has been:
1. Properly declared in accordance with the requirements of
the Revised Corporation Code of the Philippines, for example,
restricted retained earnings should not be declared as
dividends.
2. Properly authorized in accordance with the entity's
procedures.
3. Properly accounted for, in accordance with the requirements
of the applicable PFRSs, for example:
a. A debit to retained earnings account should be made at the
date of declaration
b. Amount debited to retained earnings depends on the type
of dividends (e.g., non-cash/property dividend, small and large
share dividend, scrip dividends, etc.)
c. Dividends declared on redeemable preference share should
be recorded as finance cost (interest), not as a deduction of
retained earnings
4. Complied with the requirements of applicable tax laws and
regulations.
Note: Addresses existence, valuation and presentation &
disclosure assertions.
7. Review financial statement presentation and disclosures of
shareholders’ equity items.
The auditor should check at the a minimum whether disclosure
include the following information:
a. number of shares authorized
b. issued shares and those held in treasury
c. details of par or stated value
d. share option plans
e. dividend rate
f. dividends and liquidation preference
g. dividends in arrears for cumulative preference shares
h. conversion and call provisions (unissued shares for share
options or conversions)
i. redeemable preference shares reported as financial liability
Note: Addresses presentation & disclosure assertion