AUDITING PROBLEMS
AP07
AUDIT OF LIABILITIES
Audit of Liabilities
Substantive Test of Liabilities
When auditing Liabilities the principal objective for the substantive tests is to determine the following:
EXISTENCE
All recorded liabilities on the statement of financial position are
authentic debts due to creditors of the entity.
COMPLETENESS
All liabilities owned by the entity at the reporting date are included on
the statement of financial position.
VALUATION AND Liabilities are included on the statement of financial position at
ALLOCATION
appropriate amounts.
RIGHTS
AND Liabilities reported in the statement of financial position represent
OBLIGATIONS
obligations of the entity at the reporting date.
PRESENTATION
Liabilities and related accounts are properly classified, described, and
AND DISCLOSURE disclosed in the financial statements, including notes, in accordance
with the applicable PFRS.
Audit of Liabilities
The auditor's primary substantive procedures for liabilities will typically include the
following:
1. Reconciling general ledger and subsidiary ledger.
2. Performing purchase and accounts payable cut-off.
3. Confirming liabilities to debtor.
4. Inspecting supporting documents such as contracts, invoices, receiving reports, etc.
5. Searching for unrecorded liabilities.
6. Testing the accuracy of interest expense, interest payable, amortization of discount
and premium.
7. Evaluating valuation of liabilities denominated in foreign currencies.
8. Reviewing compliance with terms of debt agreements.
9. Performing analytical review procedures to liabilities and related accounts.
10. Evaluatiing proper financial statement presentation and adequacy of disclosure.
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MULTIPLE CHOICE QUESTIONS
THEORY
1. In auditing accounts payable, an auditor’s procedures most likely will focus primarily on management’s
assertion of
a. 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 was billed was
received. The population for this test consists of all
a. Merchandise received
c. Canceled checks
b. Vendors’ invoices
d. Receiving reports
3. The primary audit test to determine if accounts payable are valued properly is
a. Confirmation of accounts payable
b. Vouching accounts payable to supporting documentation
c. An analytical procedure
d. 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 sheet date?
a. Observation of inventory
c. Search for unrecorded liabilities
b. Testing of internal control over cash
d. Confirmation of receivables
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 had forgotten to issue purchase order.
Also a disbursement of P450 for materials did not have a receiving report. The assistant wanted to
select additional purchase orders for investigation but was unconcerned about lack of receiving
report. The audit director should
a.
Agree with the assistant because the amount of the purchase order exception was considerably
larger than the receiving report exception
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b.
Agree with the assistant because the cash disbursement clerk had been assured by the receiving
clerk that the failure to fill out a report didn’t 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 accounts payable, the
appropriate population most likely is
a.
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 entity’s open invoice file.
7. Which of the following is a substantive test that an auditor is most likely to perform to verify 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 client’s mail, unopened, for a reasonable period of time after year end to search
for unrecorded vendor’s 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 zero balances.
8. Only one of the following four statements, which compare confirmation of accounts payable with
suppliers and confirmation of accounts receivable with debtors is false. The false statement is that
a.
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.
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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 the amount 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 in the performance
of a purchase cut-off will encounter the greatest difficulty in gaining assurance with respect to the
a.
10.
11.
12.
Quantity
b. Quality
c. Price
d. Terms
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.
Unrecorded liabilities are most likely to be found during the review of which of the following
documents?
a.
Unpaid bills
b.
Shipping records
c. Bills of lading
d. Unmatched sales invoices
Which of the following audit procedures is best for identifying unrecorded trade accounts payable?
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.
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13.
In verifying debits to perpetual inventory records of a nonmanufacturing firm, the auditor is most
interested in examining the purchase
a.
14.
15.
16.
17.
Journal
b. Requisitions
c. Orders
d. Invoices
Which of the following procedures relating to the examination of accounts payable could the auditor
delegate entirely to the client’s employees?
a.
Test footings in the accounts payable ledger
b.
Reconcile unpaid invoices to vendors statements
c.
Prepare a schedule of accounts payable
d.
Mail confirmations for selected account balances
An auditor’s purpose in reviewing the renewal of a note payable shortly after the balance sheet date
most likely is to obtain evidence concerning management’s assertions about
a.
Existence or occurrence
c. Completeness
b.
Presentation and disclosure
d. Valuation or allocation.
An auditor’s program to audit long term debt should include steps that require
a.
Examining bond trust indentures
b.
Inspecting the accounts payable subsidiary ledger.
c.
Investigating credits to the bond interest income account.
d.
Verifying the existence of the bondholders.
In an audit of bonds payable, an auditor expects the trust indenture to include the
a.
Auditee’s debt-to-equity ratio at the time of issuance.
b.
Effective yield of the bonds issued.
c.
Subscription list.
d.
Description of the collateral
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18.
19.
20.
In auditing long-term bonds payable, an auditor most likely will
a.
Perform analytical procedures on the bond premium and discount accounts.
b.
Examine documentation of assets purchased with bond proceeds or liens
c.
Compare interest with the bond payable amount for reasonableness.
d.
Confirm the existence of individual bondholders at year-end.
The audit procedures used to verify accrued liabilities differ from those employed for the verification
of accounts payable because
a.
Accrued liabilities usually pertain to services of a continuing nature while accounts payable are
the result of completed transactions
b.
Accrued liability balances are less material than accounts payable balances.
c.
Evidence supporting accrued liability is nonexistence while evidence supporting accounts
payable is readily available.
d.
Accrued liabilities at year-end will become accounts payable during the following year.
The auditor is most likely to verify accrued commissions payable in conjunction with the
a.
Sales cutoff test
b.
Verification of contingent liabilities
c.
Review of post balance sheet date disbursements
d.
Examination of trade accounts payable
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PRACTICAL QUESTIONS
Problem 1
In the audit of the SMB Corporation’s financial statements at December 31, 2020, the chief accountant of
the said corporation provided the following information:
Notes payable:
Arising from purchase of goods
Arising from 5 year-bank loans, on which marketable securities
valued at P600,000 have been pledged as security, P400,000 due
on June 30, 2021; P100,000 due on Dec. 31, 2021
Arising from advances by officers, due June 30, 2021
Reserve for general contingencies
Employees’ income tax withheld
Advances received from customers on purchase orders
Containers’ deposit
Accounts payable arising from purchase of goods,
net of debit balances of P30,000
Accounts receivable, net of credit balances P40,000
Cash dividends payable
Stock dividends payable
Dividends in arrears on preferred stock, not yet declared
Convertible bonds, due January 31, 2022
First mortgage serial bonds, payable in semi-annual installments
of P50,000, due April 1 and October 1 of each year
Overdraft with Allied Bank
Cash in bank balance with PNB
Estimated damages to be paid as a result of unsatisfactory
performance on a contract
Estimated expenses on meeting guarantee for service
requirements on merchandise sold
Estimated premiums payable
Deferred revenue
Accrued interest on bonds payable
Common stock warrants outstanding
Common stock options outstanding
Unused letters of credit
Deficiency VAT assessment being contested
Notes receivable discounted
304,000
500,000
50,000
400,000
20,000
64,000
50,000
170,000
360,000
80,000
100,000
200,000
1,000,000
2,000,000
90,000
390,000
160,000
120,000
75,000
87,000
360,000
120,000
210,000
400,000
500,000
200,000
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On March 1, 2021, the P400,000 note payable was replaced by an 18-month note for the same amount.
SMB is considering similar action on the P100,000 note payable due on December 31, 2021. The 2020
financial statements were issued on March 31, 2021.
On December 1, 2020, a former employee filed a lawsuit seeking P200,000 for unlawful dismissal. SMB’s
attorneys believe that the suit is without merit. No court date has been set.
On January 15, 2021, the BIR assessed SMB an additional income tax of P300,000 for the 2018 tax year.
SMB’s attorneys and tax accountants have stated that it is likely that the BIR will agree to a P200,000
settlement.
Based on the above and the result of your audit, compute for the following as of December 31, 2020:
1.
Total current liabilities
2.
Total noncurrent liabilities
3.
Total liabilities
Problem 2
DND Corporation is selling audio and video appliances. The company’s fiscal year ends on March 31.
The following information relates to the obligations of the company as of March 31, 2020:
Notes payable
DND has signed several long-term notes with financial institutions. The maturities of these notes are given
below. The total unpaid interest for all of these notes amounts to P340,000 on March 31, 2020.
Due date
April 31, 2020
July 31, 2020
September 1, 2020
February 1, 2021
April 1, 2021 – March 31, 2022
Amount
P 600,000
900,000
450,000
450,000
2,700,000
P 5,100,000
Estimated warranties
DND has a one-year product warranty on some selected items. The estimated warranty liability on sales
made during the 2018 – 2019 fiscal year and still outstanding as of March 31, 2019, amounted to
P252,000. The warranty costs on sales made from April 1, 2019 to March 31, 2020, are estimated at
P630,000. The actual warranty costs incurred during 2019 – 2020 fiscal year are as follows:
Warranty claims honored on 2018 – 2019 sales
Warranty claims honored on 2019 – 2020 sales
Total
P 252,000
285,000
P 537,000
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Trade payables
Accounts payable for supplies, goods, and services purchases on open account amount to P560,000 as of
March 31, 2020.
Dividends
On March 10, 2020, DND’s board of directors declared a cash dividend of P0.30 per common share and a
10% common stock dividend. Both dividends were to be distributed on April 5, 2020 to common
stockholders on record at the close of business on March 31, 2020. As of March 31, 2020, DND has 5
million, P2 par value, common shares issued and outstanding.
Bonds payable
DND issued P5,000,000, 12% bonds, on October 1, 2014 at 96. The bonds will mature on October 1, 2024.
Interest is paid semi-annually on October 1 and April 1. DND uses the straight line method to amortize
bond discount.
Based on the foregoing information, determine the adjusted balances of the following as of March 31, 2020:
1.
Estimated warranty payable
2.
Unamortized bond discount
3.
Bond interest payable
4.
Total current liabilities
5.
Total noncurrent liabilities
Problem 3
Purefoods’ Music Emporium carries a wide variety of music promotion techniques - warranties and
premiums – to attract customers.
Musical instrument and sound equipment are sold in a one-year warranty for replacement of parts and labor.
The estimated warranty cost, based on past experience, is 2% of sales.
The premium is offered on the recorded and sheet music. Customers receive a coupon for each peso spent
on recorded music or sheet music. Customers may exchange 200 coupons and P20 for an AM/FM radio.
Purefoods pays P34 for each radio and estimates that 60% of the coupons given to customers will be
redeemed.
Purefoods’ total sales for 2020 were P7,200,000 - P5,400,000 from musical instrument and sound
reproduction equipment and P1,800,000 from recorded music and sheet music. Replacement parts and
labor for warranty work totaled P164,000 during 2020. A total of 6,500 AM/FM radio used in the premium
program were purchased during the year and there were 1,200,000 coupons redeemed in 2020.
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The accrual method is used by Purefoods to account for the warranty and premium costs for financial
reporting purposes. The balance in the accounts related to warranties and premiums on January 1, 2020,
were as shown below:
Inventory of Premium AM/FM radio
Estimated Premium Claims Outstanding
Estimated Liability from Warranties
P39,950
44,800
136,000
Based on the above and the result of your audit, determine the amounts that will be shown on the 2020
financial statements for the following:
1.
Warranty expense
2.
Estimated liability from warranties
3.
Premium expense
4.
Inventory of AM/FM radio
5.
Estimated liability for premiums
Problem 4
On January 2, 2019, the Jansport, Inc. issued P2,000,000 of 8% convertible bonds at par. The bonds will
mature on January 1, 2023 and interest is payable annually every January 1. The bond contract entitles the
bondholders to receive 6 shares of P100 par value common stock in exchange for each P1,000 bond. On
the date of issue, the prevailing market interest rate for similar debt without the conversion option is 10%.
On December 31, 2020, the holders of the bonds with total face value of P1,000,000 exercised their
conversion privilege. In addition, the company reacquired at 110, bonds with a face value of P500,000.
The balances in the capital accounts as of December 31, 2019 were:
Common stock, P100 par, authorized 50,000 shares, issued and
outstanding, 30,000 shares
Premium on common stock
P3,000,000
500,000
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?
2. How much is the carrying value of the bonds payable as of December 31, 2019?
3. How much is the interest expense for the year 2020?
4. The entry to record the conversion on December 31, 2020 will include a net credit to APIC of
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5. How much is the loss on bond reacquisition on December 31, 2020?
Problem 5
In connection with your audit of Android Corporation’s financial statements for the year 2020, you noted
the following liability account balances as of December 31, 2019:
Note payable, bank
Liability under finance lease
Deferred income taxes
P 5,600,000
430,000
700,000
Transactions during 2020 and other information relating to Android’s liabilities were as follows:
a.
The principal amount of the note payable is P5,600,000 and bears interest at 12%. The note is dated
April 1, 2019 and is payable in four equal annual installments of P1,400,000 beginning April 1, 2020.
The first principal and interest payment was made on April 1, 2020.
b.
The capitalized lease is for a ten-year period beginning December 31, 2017. Equal annual payments
of P100,000 are due on December 31 of each year, and the 14% interest rate implicit in the lease
known by Android. The present value at December 31, 2019 of the seven remaining lease payments
(due December 31, 2020 through December 31, 2026) discounted at 14% was P430,000.
c.
Deferred income taxes are provided in recognition of timing differences between financial and
income tax reporting of depreciation. For the year ended December 31, 2020, depreciation per tax
return exceeded book depreciation by P312,500. Android’s effective income tax rate for 2019 was
32%.
d.
On July 1, 2020, Android 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 July 1, 2019 and will mature on July 1,
2029. Interest is payable annually on July 1. Android uses the interest method to amortize bond
discount.
Based on the above and the result of your audit, determine the following:
1. Liability under finance lease as of December 31, 2020
2. Total noncurrent liabilities as of December 31, 2020
3. Current portion of long-term liabilities as of December 31, 2020
4. Accrued interest payable as of December 31, 2020
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5. Total interest expense for the year 2020
Problem 6
Shell Company presented to you their records in connection with the audit of the company’s financial
statements for the year ended December 31, 2020. This is the first time the company has been audited. The
company floated a serial bond issue in 2018. Your audit showed the following details of the issue and the
accounts as of December 31, 2020:
Total amount
Date of issue
Proceeds from issue
Interest rate
Interest payment date
Maturity date
10/02/2020
VR
P5,000,000
October 2, 2018
P4,900,000
5% per annum
October 1
P1,000,000 annually, starting October 1, 2020
5% Serial Bonds Payable
P1,000,000
10/02/2018
CR
Accrued Interest Payable
01/02/2020
P4,900,000
P62,500
Compute for the adjusted balances of the following as of December 31, 2020:
1. Bonds payable
2. Bond discount
3. Accrued interest payable
4. Bond interest expense
Problem 7
In the audit process, the following data were obtained from the books of the Caltex Company which uses
a voucher system. All invoices are subject to term 2/10, n/30 and are entered net with the discount entered
in the Purchase Discount column of the voucher register. The accountant in charge of the books went on
leave to attend to his family based in New Jersey. A fresh accounting graduate has been assigned to record
the transactions. At year-end, the substitute accountant finds that the unpaid vouchers do not agree with
the Vouchers Payable control account. You are called to adjust the matter.
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A schedule of unpaid vouchers as of December 31, 2020, all of which are net of discount, is presented to
you:
Date
Voucher No.
Supplier
Amount
Nov. 27
797
Duncan Supply Co.
P 78,400
Dec. 02
821
Ginobili Distributors
19,600
11
829
Parker Sales
44,100
20
836
Mohamed Dealers
17,150
21
842
Bowen Merchandising
22,050
22
856
Horry Mercantile
80,850
31
865
Jackson Traders
78,400
P340,550
Vouchers Payable (control account)
Cash disbursements
P1,309,500 Purchases journal
Purchase returns journal
P1,645,000
36,750*
* Voucher Nos. 821 and 836 cancelled as goods were returned in December.
Based on the above and the result of your audit, compute for the following as of December 31, 2020:
1.
Adjusted balance of Vouchers Payable
2.
Purchase discounts lost on unpaid vouchers
3.
Purchase discounts lost on paid vouchers
4.
Adjusting journal entry or entries to correct the accounts will include
a. A debit to Purchase Discounts Lost of P11,250.
b. A debit to Purchase Discounts Lost of P5,050.
c. A credit to Vouchers Payable of P8,000.
d. A credit to Vouchers Payable of P11,250.
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Problem 8
In your initial audit of Flying V Finance Co., you find the following ledger account balances.
12%, 25-year Bonds Payable, 2016 issue
01/01/2016
CR
P 1,600,000
CR
P 80,000
Treasury Bonds
10/01/2020
CD
P 216,000
Bond Premium
01/01/2016
Bond Interest Expense
01/01/2020
CD
P 96,000
07/01/2020
CD
96,000
The bonds were redeemed for permanent cancellation on October 1, 2020 at 105 plus accrued interest. Use
straight line method to amortized the premium.
Based on the above and the result of your audit, determine the following:
1.
The adjusted balance of bonds payable as of December 31, 2020 is
2.
The unamortized bond premium on December 31, 2020 is
3.
The total bond interest expense for the year 2020 is
4.
The gain or loss on partial bond redemption is
“Work hard in silence. Let success be your noise.” –Frank Ocean
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