APPLIED AUDITING
CHAPTER 7
AUDIT OF LIABILITIES
Objective
1. Solving Audit of Liabilities Problems
2. Theory of Audit of Liabilities
PROBLEM NO. 1
Atimonan 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, 2006:
Notes payable
Atimonan 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 P408,000 on March 31, 2006.
Due date
April 31, 2006
July 31, 2006
September 1, 2006
February 1, 2007
April 1, 2007 – March 31,
2008
Amount
P 720,000
1,080,000
540,000
540,000
3,240,000
P 6,120,000
Estimated warranties
Atimonan has a one-year product warranty on some selected items. The
estimated warranty liability on sales made during the 2004 – 2005 fiscal year
APPLIED AUDITING
and still outstanding as of March 31, 2005, amounted to P302,400. The
warranty costs on sales made from April 1, 2005 to March 31, 2006, are
estimated at P756,000. The actual warranty costs incurred during 2005 –
2006 fiscal year are as follows:
Warranty claims honored on 2004 – 2005
sales
Warranty claims honored on 2005 – 2006
sales
Total
P 302,400
342,000
P 644,400
Trade payables
Accounts payable for supplies, goods, and services purchases on open
account amount to P672,000 as of March 31, 2006.
Dividends
On March 10, 2006, Atimonan’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, 2006 to common stockholders on record at
the close of business on March 31, 2006. As of March 31, 2006, Atimonan has
6 million, P2 par value, common shares issued and outstanding.
Bonds payable
Atimonan issued P6,000,000, 12% bonds, on October 1, 2000 at 96. The
bonds will mature on October 1, 2010. Interest is paid semi-annually on
October 1 and April 1. Atimonan uses the straight line method to amortize
bond discount.
QUESTIONS:
Based on the foregoing information, determine the adjusted balances of the
following as of March 31, 2006:
1. Estimated warranty payable
a. P414,000
b. P756,000
c. P 302,400
d. P1,058,400
2. Unamortized bond discount
a. P132,000
b. P108,000
c. P240,000
d. P120,000
3. Bond interest payable
a. P360,000
b. P300,000
c. P180,000
d. P 0
4. Total current liabilities
a. P7,734,000
b. P6,126,000
c. P6,534,000
d. P4,734,000
APPLIED AUDITING
5. Total noncurrent liabilities
a. P9,240,000
b. P9,132,000
c. P9,108,000
d. P9,000,000
Suggested Solution:
Question No. 1
Warranty payable, 3/31/05
Add warranty expense accrued during
2005-2006
Total
Less payments during 2005-2006
Warranty payable, 3/31/06
P 302,400
756,000
1,058,400
644,400
P 414,000
Question No. 2
Bond discount, 10/1/00 (P6,000,000 x .04)
Discount amortization, 10/1/00 to 3/31/06
(P240,000 x 5.5/10)
Bond discount, 3/31/06
P240,000
132,000
P 108,000
Question No. 3
Bond interest payable, 10/1/05 to 3/31/06
(P6,000,000 x 12% x 6/12)
P 360,000
Question No. 4
Notes payable - current (maturing up to
3/31/07)
Accrued interest payable – Notes payable
Estimated warranty payable (see no. 1)
Accounts payable
Cash dividends payable (6 million shares x
P0.30)
Accrued interest payable – Bonds payable
Total current liabilities
P2,880,000
408,000
414,000
672,000
1,800,000
360,000
P6,534,000
Question No. 5
Notes payable – noncurrent
Bonds payable, net of discount of P108,000
Total noncurrent liabilities
Answers: 1) A; 2) B; 3) A; 4) C, 5) B
P 3,240,000
5,892,000
P 9,132,000
APPLIED AUDITING
PROBLEM NO. 2
The following information relates to Candelaria Company’s obligations as of
December 31, 2006. For each of the numbered items, determine the amount if
any, that should be reported as current liability in Candelaria’s December 31,
2006 balance sheet.
1. Accounts payable:
Accounts payable per general ledger control amounted to P5,440,000, net
of P240,000 debit balances in suppliers’ accounts. The unpaid voucher file
included the following items that not had been recorded as of December 31,
2006:
a) A Company – P224,000 merchandise shipped on December 31, 2006,
FOB destination; received on January 10, 2007.
b) B, Inc. – P192,000 merchandise shipped on December 26, 2006, FOB
shipping point; received on January 16, 2007.
c) C Super Services – P144,000 janitorial services for the three-month
period ending January 31, 2007.
d) MERALCO – P67,200 electric bill covering the period December 16,
2006 to January 15, 2007.
On December 28, 2006, a supplier authorized Candelaria to return goods
billed at P160,000 and shipped on December 20, 2006. The goods were
returned by Candelaria on December 28, 2006, but the P160,000 credit
memo was not received until January 6, 2007.
a. P5,923,200
b. P5,601,600
c. P5,712,000
d. P5,841,600
2. Payroll:
Items related to Candelaria’s payroll as of December 31, 2006 are:
Accrued salaries and wages
Payroll deductions for:
Income taxes withheld
SSS contributions
Philhealth contributions
Advances to employees
a. P776,000
b. P832,000
P776,000
56,000
64,000
16,000
80,000
c. P992,000
d. P912,000
3. Litigation:
In May, 2006, Candelaria became involved in a litigation. The suit being
contested, but Candelaria’s lawyer believes there is probable that
APPLIED AUDITING
Candelaria may be held liable for damages estimated in the range between
P2,000,000 and P3,000,000, and no amount is a better estimate of
potential liability than any other amount.
a. P 0
b. P3,000,000
c. P2,000,000
d. P2,500,000
4. Bonus obligation:
Candelaria Company’s president gets an annual bonus of 10% of net
income after bonus and income tax. Assume the tax rate of 30% and the
correct income before bonus and tax is P9,600,000. (Ignore the effects of
other given items on net income.)
a. P722,600
b. P2,240,000
c. P395,000
d. P628,000
5. Note payable:
A note payable to the Bank of the Philippine Islands for P2,400,000 is
outstanding on December 31, 2006. The note is dated October 1, 2005,
bears interest at 18%, and is payable in three equal annual installment of
P800,000. The first interest and principal payment was made on October 1,
2006.
a. P800,000
b. P 72,000
c. P908,000
d. P872,000
6. Purchase commitment:
During 2006, Candelaria entered in a noncancellable commitment to
purchase 320,000 units of inventory at fixed price of P5 per unit, delivery to
be made in 2007. On December 31, 2006, the purchase price of this
inventory item had fallen to P4.40 per unit. The goods covered by the
purchase contract were delivered on January 28, 2007.
a. P0
b. P1,408,000
c. P1,600,000
d. P 192,000
7. Deferred taxes:
On December 31, 2006, Candelaria’s deferred income tax account has a
2006 ending credit balance of P772,800, consisting of the following items:
Caused by temporary differences in
accounting
For gross profit on installment sales
For depreciation on property and
equipment
For product warranty expense
Deferred tax
P376,000 Cr
576,000 Cr
179,200 Dr
APPLIED AUDITING
P772,800 Cr
a. P772,800
b. P196,800
c. P952,000
d. P 0
8. Product warranty:
Candelaria has a one year product warranty on selected items in its
product line. The estimated warranty liability on sales made during 2005,
which was outstanding as of December 31, 2005, amounted to P416,000.
The warranty costs on sales made in 2006 are estimated at P1,504,000.
Actual warranty costs incurred during the current 2006 fiscal year are as
follows:
Warranty claims honored on 2005
sales
Warranty claims honored on 2006
sales
Total warranty claims honored
a. P 0
b. P96,000
P 416,000
992,000
P1,408,000
c. P1,504,000
d. P 512,000
9. Premiums:
To increase sales, Candelaria Company inaugurated a promotional
campaign on June 30, 2006. Candelaria placed a coupon redeemable for
a premium in each package of product sold. Each premium costs P100. A
premium is offered to customers who send in 5 coupons and a remittance
of P30. The distribution cost per premium is P20. Candelaria estimated
that only 60% of the coupons issued will be redeemed. For the six months
ended December 31, 2006, the following is available:
Packages of product sold
Premiums purchased
Coupons redeemed
a. P1,728,000
b. P1,600,000
160,000
16,000
64,000
c. P1,152,000
d. P 576,000
10. Due to Five Six Finance company:
Candelaria’s accounting records show that as of December 31, 2006,
P1,280,000 was due to Five Six Finance Company for advances made
against P1,600,000 of trade accounts receivable assigned to the finance
company with recourse.
a. P 0
b. P320,000
c. P1,600,000
d. P1,280,000
APPLIED AUDITING
Suggested Solution:
Question No. 1
Accounts payable per general ledger
P5,440,000
Debit balances in suppliers' accounts
240,000
Goods in transit on 12/31/06, FOB shipping
192,000
point
Unrecorded purchase return
(160,000)
Accounts payable, as adjusted
5,712,000
Accrued janitorial expenses (P144,000 x
96,000
2/3)
Accrued utilities (P67,200 x 15/30)
33,600
Total
P5,841,600
Question No. 2
Accrued salaries and wages
Income taxes withheld
SSS contributions payable
Philhealth contributions
Total
P776,000
56,000
64,000
16,000
P912,000
Question No. 3
Midpoint of the range [(P2,000,000 + P3,000,000)/2]
P2,500,000
PAS 37 par. 36 states that the amount recognized as a provision should be
the best estimate of the expenditure required to settle the present
obligation at the balance sheet date. Par. 39 further states that where there
is a continuous range of possible outcomes, and each point in that range is
a likely as any other, the mid-point of the range is used.
Question No. 4
B = 10% (P9,600,000 - B - T)
T = 30% (P9,600,000 - B)
T = P2,880,000 - .3B
B = 10% [P9,600,000 - B - (P2,880,000 - .3B)]
B = 10% (P9,600,000 - B - P2,880,000 + .3B)
B = 10% (P6,720,000 - .7B)
B = P672,000 - .07B
1.07B = P672,000
B = P628,000 (rounded off)
Question No. 5
APPLIED AUDITING
Principal amount due, 10/1/07
Accrued interest payable (P1,600,000 x 18%
x 3/12)
Total
P800,000
72,000
P872,000
Question No. 6
Estimated liability for purchase commitment
[320,000 x (P5 - P4.40)]
P192,000
Question No. 7
PAS 1 par. 70 states that when an entity presents current and non-current
assets, and current and non-current liabilities, as separate classifications
on the face of the balance sheet, it shall not classify deferred tax assets
(liabilities) as current assets (liabilities).
Question No. 8
Warranty payable, 12/31/05
Add warranty expense accrued during 2006
Total
Less payments during 2006
Warranty payable, 12/31/06
P 416,000
1,504,000
1,920,000
1,408,000
P 512,000
Question No. 9
Estimated coupons to be redeemed (160,000
x 60%)
Less coupons redeemed
Coupons outstanding
Divide by exchange rate
Premiums to be issued
Multiply by net premium cost
(P100+P20-P30)
Estimated liability for coupons, 12/31/06
96,000
64,000
32,000
5
6,400
P90
P576,000
Question No. 10
This transaction involves assignment of accounts receivable, wherein the
company obtained a loan using the receivables as security. Accounts
receivable – assigned will be included in trade and other receivables, while
the related loan will be reported under current liabilities.
Answers: 1) D; 2) D; 3) D; 4) D, 5) D; 6) D; 7) D; 8) D; 9) D; 10) D
APPLIED AUDITING
PROBLEM NO. 3
In your initial audit of Infanta Finance Co., you find the following ledger account
balances.
12%, 25-year Bonds Payable, 2002
issue
01/01/2002
Treasury Bonds
10/01/2006
Debit
Credit
P6,400,000
P864,000
Bond Premium
01/01/2002
Bond Interest Expense
01/01/2006
07/01/2006
320,000
P384,000
384,000
The bonds were redeemed for permanent cancellation on October 1, 2006 at
105 plus accrued interest.
QUESTIONS:
Based on the above and the result of your audit, determine the following: (Use
straight line method to amortize premium or discount)
1. The adjusted balance of bonds payable as of December 31, 2006 is
a. P5,536,000
c. P5,600,000
b. P6,400,000
d. P4,000,000
2. The unamortized bond premium on December 31, 2006 is
a. P320,000
c. P256,000
b. P224,000
d. P235,200
3. The total bond interest expense for the year 2006 is
a. P756,400
c. P731,600
b. P755,200
d. P731,200
4. The gain or loss on partial bond redemption is
a. P 7,600 loss
c. P 7,600 gain
b. P72,400 loss
d. P72,400 gain
Suggested Solution:
Question No. 1
APPLIED AUDITING
Total bonds issued
Face value of bonds retired
{P864,000/[1.05 + (.12 x 3/12)]}
Adjusted balance of bonds payable,
12/31/06
P6,400,000
800,000
P5,600,000
Question No. 2
Unamortized bond premium, 12/31/06
(P320,000 x 8/64 x 20/25)
P224,000
Question No. 3
Nominal interest:
Remaining bonds (P5,600,000 x
12%)
Bonds retired (P800,000 x 12% x
9/12)
Less premium amortization:
Remaining bonds (P320,000/25 x
14/16)
Bonds retired (P320,000/25 x 2/16
x 9/12)
Bond interest expense
P672,000
72,000
P744,000
11,200
1,200
12,400
P731,600
Question No. 4
Retirement price (P800,000 x 1.05)
Carrying amount of bonds retired:
Face value
Unamortized bond premium
(P320,000 x 8/64 x 20.25/25)
Loss on bond redemption
P840,000
P800,000
32,400
832,400
P 7,600
Answers: 1) C; 2) B; 3) C; 4) A
PROBLEM NO. 4
In connection with the audit of the company’s financial statements for the year
ended December 31, 2006 the Lucban Corporation presented to you their
records. This is the first time the company has been audited. The company
issued serial bonds on April 1, 2003. Your audit showed the following details
of the issue and the accounts as of December 31, 2006:
Total face value
Date of bond
Total proceeds
Interest rate
Interest payment date
P2,000,000
March 1, 2002
P2,656,000
12% per annum
March 1
APPLIED AUDITING
Maturity dates and amount:
Date of maturity
March 1, 2006
March 1, 2007
March 1, 2008
March 1, 2009
Amount
P 500,000
500,000
500,000
500,000
P2,000,000
Since the corporation had excess cash, bonds of P500,000 scheduled to be
retired on March 1, 2008 were retired on April 1, 2006. The total amount paid
was charged to serial bonds payable account.
3/01/2006
4/01/2006
VR
VR
Serial Bonds Payable
P500,000 4/01/2003
P495,000
Accrued Interest Payable
01/01/2006
3/01/2006
VR
CR
P2,656,000
GJ
P200,000
Interest Expense
P240,000
QUESTIONS:
Based on the information presented above and the result of your audit, answer
the following: (Use bond outstanding method to amortize premium or discount)
1. The adjusted balance of the bonds payable account as of December 31,
2006 is
a. P2,000,000
c. P1,500,000
b. P1,084,000
d. P1,000,000
2. The unamortized bond premium as of December 31, 2006 should be
a. P66,642
c. P 84,000
b. P82,444
d. P104,000
3. The accrued interest payable as of December 31, 2006 is
a. P150,000
c. P100,000
b. P120,000
d. P200,000
4. The bond interest expense that should be reported by the corporation for
the year 2006 is
a. P55,264
c. P63,801
b. P58,000
d. P59,611
APPLIED AUDITING
5. The gain on early retirement of bonds is
a. P79,000
c. P81,170
b. P77,722
d. P 0
Suggested Solution:
Question No. 1
Total bonds issued
Bonds retired, 3/1/06
Bonds retired, 4/1/06
Adjusted balance of bonds payable,
12/31/06
P2,000,000
(500,000)
(500,000)
P1,000,000
Question No. 2
Total proceeds
Less accrued interest payable
(P2,000,000 x 12% x 1/12)
Issue price
Less face value
Total bond premium
Less:
Amortization:
Prior years (2003 to 2005)
Current year (2006):
Bonds retired on
maturity (P500,000
P6,000
x .006 x 2 mos.)
Bonds retired prior to
maturity (P500,000
9,000
x .006 x 3 mos.)
Remaining bonds
(P1,000,000 x .006 x
72,000
12 mos.)
Unamortized premium
cancelled on bonds retired
prior to maturity
(P500,000 x .006 x 23
mos.)
Unamortized bond premium, 12/31/06
P2,656,000
20,000
2,636,000
2,000,000
636,000
P396,000
87,000
483,000
69,000
P
84,000
Computation of amortization rate:
Yea
r
Period covered
Bond
outstandin
g
Mos
.
Peso months
Premium
amort.*
APPLIED AUDITING
Bond
Yea Period covered outstandin Mos
r
g
.
2003
04/01-12/31 P2,000,000 9
2004 01/01/-12/31
2,000,000 12
2005
01/01-12/31
2,000,000 12
2006
01/01-02/28
2,000,000 2
03/01-12/31
1,500,000 10
2007
01/01-02/28
1,500,000 2
03/01-12/31
1,000,000 10
2008
01/01-02/28
1,000,000 2
03/01-12/31
500,000 10
2009
01/01-02/28
500,000 2
Peso months
Premium
amort.*
P 18,000,000
24,000,000
24,000,000
4,000,000
15,000,000
3,000,000
10,000,000
2,000,000
5,000,000
1,000,000
P106,000,000
P108,000
144,000
144,000
24,000
90,000
18,000
60,000
12,000
30,000
6,000
P636,000
Amortization rate = P636,000/P106,000,000 = .006
* Peso months x .006
Question No. 3
Accrued interest payable, 12/31/06
(P1,000,000 x 12% x 10/12)
P100,000
Question No. 4
Nominal interest:
Remaining bonds (P1,000,000 x 12%)
Bonds retired on maturity (P500,000 x 12% x
2/12)
Bonds retired prior to maturity (P500,000 x
12% x 3/12)
Less premium amortization for 2006 (see no. 2)
Interest expense in 2006
P120,000
10,000
15,000
145,000
87,000
P 58,000
Question No. 5
Retirement price (P500,000 x .98)
Carrying amount of bonds retired:
Face value
Add unamortized bond premium,
(P500,000 x .006 x 23 mos.)
Gain on early retirement of bonds
Answers: 1) D; 2) C; 3) C; 4) B, 5) A
P490,000
P500,000
69,000
569,000
P 79,000
APPLIED AUDITING
PROBLEM NO. 5
On January 2, 2005, the Mauban, Inc. issued P2,000,000 of 8% convertible
bonds at par. The bonds will mature on January 1, 2009 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, 2006, 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, 2005 were:
Common stock, P100 par, authorized 50,000
shares, issued and outstanding, 30,000
shares
Premium on common stock
P3,000,000
500,000
Market value of the common stock and bonds were as follows:
Date
Bonds
January 1, 2006
December 31,
2006
118
110
Common
stock
40
42
QUESTIONS:
Based on the above and the result of your audit, answer the following: (Round
off present value factors to 4 decimal places)
1. How much of the proceeds from the issuance of convertible bonds should
be allocated to equity?
a. P634,000
c. P126,816
b. P221,664
d. P 0
2. How much is the carrying value of the bonds payable as of December 31,
2005?
a. P2,000,000
c. P1,389,400
b. P1,796,170
d. P1,900,502
3. How much is the interest expense for the year 2006?
a. P160,000
c. P138,940
b. P179,617
d. P190,050
4. The conversion of the bonds on December 31, 2006 will increase equity by
a. P365,276
c. P400,000
b. P307,893
d. P 0
APPLIED AUDITING
5. How much is the loss on bond reacquisition on December 31, 2006?
a. P50,000
c. P96,053
b. P67,362
d. P 0
Suggested Solution:
Question No. 1
Total proceeds
Less liability component:
Present value of the principal
(P2,000,000 x 0.6830)
Present value of the interest
[(P2,000,000 x 8% x
3.1699)
Equity component
P2,000,000
P1,366,00
0
507,184
1,873,184
P 126,816
PAS 32 par. 29 states that an entity recognizes separately the components
of a financial instrument that (a) creates a financial liability of the entity and
(b) grants an option to the holder of the instrument to convert it into an
equity instrument of the entity. Par. 31 further states that equity
instruments are instruments that evidence a residual interest in the assets
of an entity after deducting all of its liabilities. Therefore, when an initial
carrying amount of a compound financial instrument is allocated to its
equity and liability components, the equity component is assigned the
residual amount after deducting from the fair value of the instrument as a
whole the amount separately determined for the liability component.
Question No. 2
Carrying value, 1/2/05 (see no. 1)
Add discount amortization for
2005:
Effective interest (P1,873,184 x
10%)
Nominal interest (P2,000,000 x
8%)
Carrying value, 12/31/05
P1,873,184
P187,318
160,000
27,318
P1,900,502
Question No. 3
Effective interest (P1,900,502 x 10%)
Question No. 4
Journal entry to record the conversion
P190,050
APPLIED AUDITING
Bonds Payable
P1,000,000
Discount on bonds payable
(P1,000,000 - P965,276)
Common stock
APIC
P 34,724
600,000
365,276
Carrying amount of bonds converted (P1,930,552* P965,276
x 1/2)
Less par value of common stock received
(P1,000,000/P1,000 x 6 x P100)
600,000
Amount to be credited to APIC
P365,276
Carrying value, 1/1/06 (see no. 2)
Add discount amortization for
2006:
Effective interest (P1,900,502 x
10%)
Nominal interest (P2,000,000 x
8%)
Carrying value, 12/31/06
P1,900,502
P190,050
160,000
30,050
P1,930,552*
Question No. 5
Reacquisiton price (P500,000 x 110%)
Carrying value of bonds reacquired (P1,930,552
x 1/4)
Loss on early retirement of bonds
P550,000
482,638
P 67,362
Answers: 1) C; 2) D; 3) D; 4) A, 5) B
PROBLEM NO. 6
The noncurrent liabilities of Pitogo Company at December 31, 2005 included
the following:
Note payable, bank
Liability under finance lease
Note payable, supplier
P3,600,000
2,623,200
1,500,000
Transactions during 2006 and other information relating to Pitogo’s liabilities
were as follows:
a) The note payable to the bank bears interest at 20% and is dated May, 1,
2005. The principal amount of P3,600,000 is payable in four equal annual
APPLIED AUDITING
installments of P900,000 beginning May 1, 2006. The first principal and
interest payment was made on May 1, 2006.
b) The finance lease is for a ten-year period. Equal annual payments of
P750,000 are due on December 31, of each year. The interest rate implicit
in the lease is 18%. The amount of P2,623,200 represents the present
value of the six remaining lease payments (due December 31, 2006
through December 31, 2011) discounted at P18%.
c) The note payable to supplier bears interest at 19% and matures on
September 30, 2007. On February 25, 2007, after the December 31, 2006
balance sheet date, but before the 2006 statements were authorized for
issue, Pitogo Company consummated a noncancelable agreement with a
lender to refinance the 19%, P1,500,000 on a long-term basis, on readily
determinable terms that have not yet been implemented. Both parties are
financially capable of honoring the agreement, and there have been no
violations of the agreement’s provisions.
d) On April 1, 2006, Pitogo issued for P7,005,675, P6,000,000 face amount of
its 20%, P100,000 bonds. The bonds were issued to yield 15%. The bonds
are dated April 1, 2006 and mature on April 1, 2011. Interest is payable
annually on April 1.
QUESTIONS:
Based on the above and the result of your audit, determine the following:
1. Liability under finance lease as of December 31, 2006
a. P1,873,200
c. P2,017,544
b. P2,345,376
d. P1,123,200
2. Carrying amount of bonds payable as of December 31, 2006
a. P6,893,813
c. P6,856,527
b. P7,417,536
d. P7,117,536
3. Total noncurrent liabilities as of December 31, 2006
a. P12,211,357 c. P10,711,357
b. P10,154,190 d. P9,817,014
4. Current portion of long-term liabilities as of December 31, 2006
a. P3,150,000
c. P2,727,832
b. P2,812,824
d. P2,169,864
5. Total interest expense for the year 2006
a. P2,145,314
c. P1,673,139
b. P2,408,028
d. P1,673,139
Suggested Solution:
APPLIED AUDITING
Question No. 1
Liability under finance lease, 1/1/06
Less
principal
payment
on
12/31/06:
Total payment
Less applicable to interest
(P2,623,200 x 18%)
Liability under finance lease,
12/31/06
P2,623,200
P750,000
472,176
277,824
P2,345,376
Question No. 2
Carrying amount, 4/1/06
Less premium amortization:
Nominal interest
(P6,000,000 x 20% x 9/12)
Effective interest
(P7,005,675 x 15% x 9/12)
Carrying amount, 12/31/06
P7,005,675
P900,000
788,138
111,862
P6,893,813
Question No. 3
20% Note payable, bank
Balance, 12/31/06
P2,700,000
(P3,600,000 P900,000)
Less installment due,
900,000 P1,800,000
4/1/07
Liability under finance
lease:
Balance, 12/31/06 (see
2,345,376
no. 1)
Less principal payment
due on 12/31/07:
Total payment
P750,000
Less applicable to
interest
422,168
327,832
2,017,544
(P2,345,376 x
18%)
20% bonds payable due
4/1/11 (see no. 2)
6,893,813
Total noncurrent
liabilities, 12/31/06
P10,711,357
Question No. 4
APPLIED AUDITING
20% Note payable, bank - due 4/1/07
Finance lease liability - principal payment
due on 12/31/07 (see no. 3)
19% Note payable, bank - due 9/30/07
Current portion of long-term liabilities,
12/31/06
P 900,000
327,832
1,500,000
P2,727,832
The Note payable to supplier was classified as current liability since it is
due within 12 months after balance sheet date and the entity does not have
an unconditional right to defer settlement of the liability for at least 12
months after the BS date (even if an agreement to refinance on a long term
basis is completed after the BS date and before the FS are authorized for
issue – such an agreement would qualify for disclosure as a non-adjusting
event after the BS date in accordance with PAS 10).
Question No. 5
20% Note payable, bank
1/1 to 4/30 (P3,600,000 x 20% x
4/12)
5/1 to 12/31(P2,700,000 x 20% x
8/12)
Liability under finance lease (see no. 1)
20% bonds payable see no. 2)
19% Note payable, bank (P1,500,000 x
19%)
Total interest expense in 2006
P240,00
0
360,000
P 600,000
472,176
788,138
285,000
P2,145,314
Answers: 1) B; 2) A; 3) C; 4) C, 5) A
PROBLEM NO. 7
Real Inc. leases equipment to its customers under noncancelable leases. On
January 1, 2006, Real leased equipment costing P4,000,000 to Quezon Co.,
for nine years.
The rental cost was P440,000 payable in advance
semiannually (January 1 and July 1), plus P20,000 semiannually for executory
costs. The equipment had an estimated life of 15 years and sold for
P5,330,250 with an estimated unguaranteed residual value of P800,000. The
implicit interest rate is 12 percent.
QUESTIONS:
1. How much is the total interest income from lease that will be earned by
Real, Inc.?
a. P2,869,988
c. P3,675,616
b. P3,389,748
d. P 0
2. Real, Inc. should report profit on the sale at
APPLIED AUDITING
a. P1,330,252
b. P1,044,384
c. P1,050,012
d. P1,338,492
3. How much should be reported by Quezon Co. as liability under finance
lease as of December 31, 2006?
a. P4,143,593
c. P4,273,410
b. P4,446,613
d. P 0
4. How much should be reported by Quezon Co. under current liabilities as
liability under finance lease as of December 31, 2006?
a. P356,798
c. P394,252
b. P378,207
d. P 0
5. How much interest expense should be reported by Quezon Co. in relation
to the lease for the year ended December 31, 2006?
a. P508,064
c. P543,398
b. P501,793
d. P 0
Suggested Solution:
Question No. 1
Gross investment in the lease:
Minimum lease payments
(P440,000 x 18)
Unguaranteed residual value
Net investment in the lease:
PV of minimum lease payments
(P440,000 x 11.4773)
PV of unguaranteed residual
value
(P800,000 x 0.3503)
Total unearned interest income
P7,920,00
800,000 P8,720,000
5,050,012
280,240
5,330,252
P3,389,748
Question No. 2
Sales (present value of MLP)
Less cost of sales (P4,000,000 - P280,240)
Profit on sale
P5,050,012
3,719,760
P1,330,252
Question No. 3
Finance lease liability (P440,000 x 11.4773)
Less lease payment, 1/1/06
Balance, 1/1/06
Less principal payment on 7/1/06:
Total payment
P440,000
Applicable to interest
P5,050,012
440,000
4,610,012
APPLIED AUDITING
(P4,610,012 x 12% x 6/12)
Balance, 12/31/06
276,601
163,399
P4,446,613
The lease will be accounted for as finance lease because the present value
of the minimum lease payments amount to substantially all of the fair value
of the leased asset at the inception of the lease. (P5,050,012/P5,330,250 =
95%).
Question No. 4
Principal payment due, 1/1/07:
Total payment
Applicable to interest
(P4,446,613 x 12% x 6/12)
Principal payment due, 7/1/07:
Total payment
Applicable to interest
[(P4,446,613 - P173,203) x 12% x
6/12]
Current portion of finance lease
liability, 12/31/06
P440,000
266,797
P173,203
P440,000
256,405
183,595
P356,798
Question No. 5
1/1/06 to 6/30/06 (P4,610,012 x 12% x 6/12)
7/1/06 to 12/31/06 (P4,446,613 x 12% x 6/12)
Total interest expense
P276,601
266,797
P543,398
Answers: 1) B; 2) A; 3) B; 4) A, 5) C
PROBLEM NO. 8
The following information relates to the defined benefit pension plan of the
Tiaong Company as of January 1, 2005:
Projected benefit obligation (PBO)
Fair value of plan assets
Unrecognized prior service cost
Unrecognized net pension gain or
loss
P16,150,000
15,135,000
1,050,000
0
Pension data for the years 2005 and 2006 follows:
Current service cost
Contributions to the plan
2005
P 870,000
1,200,000
2006
P1,150,000
1,250,000
APPLIED AUDITING
Benefits paid to retirees
Actual return on plan assets
Amortization of past service cost
Actuarial change increasing PBO
Settlement interest rate
Long-term expected rate of return
on plan assets
1,320,000
263,500
210,000
800,000
11%
1,400,000
1,800,000
186,667
11%
10%
10%
As of January 1, 2006, the remaining expected service life of employees was 5
years.
QUESTIONS:
Based on the above and the result of your audit, answer the following.
1. What is the 2005 net benefit expense?
a. P2,593,000
c. P1,200,000
b. P4,370,000
d. P1,343,000
2. The projected benefit obligation as of December 31, 2005 is
a. P18,276,500 c. P17,476,500
b. P16,973,000 d. P16,173,000
3. The prepaid/accrued benefit cost on December 31, 2005 is
a. P1,358,000
c. P108,000
b. P3,135,000
d. P 0
4. What is the 2006 net benefit expense?
a. P1,863,702
c. P1,547,082
b. P1,250,000
d. P1,819,232
5. The prepaid/accrued benefit cost on December 31, 2006 is
a. P 0
c. P1,655,082
b. P3,143,302
d. P 721,702
Suggested Solution:
Question No. 1
Current service cost
Interest cost (P16,150,000 x 11%)
Expected return on plan assets
(P15,135,000 x 10%)
Amortization of past service cost
Net benefit expense for 2005
P 870,000
1,776,500
(1,513,500)
210,000
P1,343,000
Question No. 2
Projected benefit obligation, 1/1/05
Current service cost
P16,150,000
870,000
APPLIED AUDITING
Interest cost (P16,150,000 x 11%)
Actuarial change increasing PBO
Benefits paid to retirees
Projected benefit obligation, 12/31/05
1,776,500
800,000
(1,320,000)
P18,276,500
Question No. 3
Debits
Fair value of plan assets, 12/31/05
Fair value of plan assets, 1/1/05
Contributions to the plan
Actual return on plan assets
Benefits paid to retirees
Unrecognized prior service cost,
12/31/05 (P1,050,000 - P210,000)
Unrecognized net pension loss,
12/31/05
Difference between expected and
actual return on plan assets
(P1,513,500 - P263,500)
Actuarial change increasing PBO
P15,135,000
1,200,000
263,500
(1,320,000)
840,000
1,250,000
800,000
Credit
Projected benefit obligation, 12/31/05 (see no. 2)
Prepaid (Accrued) pension
12/31/05
P15,278,500
2,050,000
18,168,500
18,276,500
cost,
(P108,000)
Alternative computation:
Debits
Fair value of plan assets, 1/1/05
Unrecognized prior service cost,
1/1/05
P15,135,000
1,050,000
16,185,000
Credit
Projected benefit obligation, 1/1/05
Prepaid
1/1/05
(Accrued) pension
16,150,000
cost,
Prepaid (Accrued) pension cost,
1/1/05
Underfunding in 2005:
Contributions to the plan
Net benefit expense (see no. 1)
Prepaid (Accrued) pension cost,
12/31/05
P
P
P1,200,000
1,343,000
35,000
35,000
(143,000)
(P108,000)
APPLIED AUDITING
Question No. 4
Current service cost
Interest cost (P18,276,500 x 11%)
Expected return on plan assets
(P15,278,500 x 10%)
Amortization of past service cost
Amortization of unrecognized net
pension loss:
Unrecognized net pension loss,
1/1/06
Less corridor (P18,276,500 x
10%)
Excess
Divide by remaining service life
Net benefit expense for 2006
P1,150,000
2,010,415
(1,527,850)
186,667
P2,050,000
1,827,650
222,350
5
44,470
P1,863,702
Question No. 5
Prepaid (Accrued) pension cost,
1/1/06
Underfunding in 2006:
Contributions to the plan
Net benefit expense (see no. 4)
Prepaid (Accrued) pension cost,
12/31/06
(P108,000)
P1,250,000
1,863,702
(613,702)
(P721,702)
Answers: 1) D; 2) A; 3) C; 4) A, 5) D
PROBLEM NO. 9
Select the best answer for each of the following:
1. A client's purchasing system ends with the assumption of a liability and the
eventual payment of the liability. Which of the following best describes the
auditor's primary concern with respect to liabilities resulting from the
purchasing system?
A. Commitments for all purchases are made only after established
competitive bidding procedures are followed.
B. Accounts payable are not materially understated.
C. Authority to incur liabilities is restricted to one designated person.
D. Acquisition of materials is not made from one vendor or one group of
vendors.
2. Which of the following functions is not appropriate for the accounts payable
department?
a. Prepare purchase orders.
b. Prepare voucher and daily summary.
c. File voucher package by due date.
APPLIED AUDITING
d. Compare purchase requisitions, purchase orders, receiving reports, and
vendors' invoices.
3. In a properly designed accounts payable system, a voucher is prepared
after the invoice, purchase order, requisition, and receiving report are verified.
The next step in the system is to
A. Post the voucher amount to the expense ledger.
B. Cancel the supporting documents.
C. Enter the check amount in the check register.
D. Approve the voucher for payment.
4. Which of the following would be the best procedure to determine whether
purchases were properly authorized?
A. Discuss authorization procedures with personnel in the controller's and
purchasing functions.
B. Review and evaluate a flowchart of purchasing procedures.
C. Determine whether a sample of entries in the purchase journal is supported
by properly executed purchase orders.
D. Vouch payments for selected purchases to supporting receiving reports.
5. In conducting a search for unrecorded liabilities, the auditor should do all
but the following:
a. Examine prior year's audit workpapers to ascertain that adjustments for
unrecorded liabilities have not been overlooked.
b. Examine invoices paid a few days prior to the balance sheet date.
c. Examine paid invoices for a short period following the balance sheet date
and trace to client's year-end adjustment for unrecorded liabilities.
d. Examine unpaid invoices for a short period following the balance sheet
date and trace to client's year-end adjustment for unrecorded liabilities.
6.An audit procedure applicable to testing the year-end cutoff of liabilities is
a. Reviewing the general journal for unusual entries recorded immediately
after year-end.
b. Examining vendor invoices received subsequent to year-end for shipment
date and terms of shipment.
c. Tracing recorded liabilities to supporting documents.
d. Preparing an aging schedule for accounts payable.
7. An auditor usually examines receiving reports to support entries in the
a. Sales journal and sales returns journal.
b. Check register and sales journal.
c. Voucher register and sales journal.
d. Voucher register and sales returns journal.
8. Which of the following is not used to test overstatements and
understatements of accounts payable?
a. Unmatched receiving reports.
b. Canceled voucher packages.
c. Cash receipts records.
d. Cash disbursement records.
APPLIED AUDITING
9. During the course of an audit, an auditor observes that the recorded interest
expense seems excessive in relation to the balance in long-term debt.
This observation could lead the auditor to suspect that
a. Long-term debt is overstated.
b. Long-term debt is understated.
c. Premium on bonds payable is understated.
d. Discount on bonds payable is overstated.
10. An auditor's program to examine long-term debt most likely would include
steps that require
a. Correlating interest expense recorded for the period with outstanding debt.
b. Inspecting the accounts payable subsidiary ledger for unrecorded
long-term debt.
c. Comparing the carrying amount of the debt to its year-end market value.
d. Verifying the existence of the holders of the debt by direct confirmation.
Answers: 1) B; 2) A; 3) D; 4) C, 5) B; 6) B; 7) D; 8) C; 9) B; 10) A
 To have an information about Introduction of Audit of Liabilities.
https://youtu.be/xevGBLbnz1M
 This Video is all about Solving Current Liabilities
https://youtu.be/4deZo4lg7VU
 This video is all about Non-Current Liabilities
https://youtu.be/RMTGXxUocT0
Reference:
Compilation of lecture notes by
Dean Rene Boy R. Bacay , CPA, CrFA, CMC, MBA, FRIAcc