A.2807 Liabilities PDF

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AUDITING PROBLEMS OCAMPO/CABARLES/SOLIMAN/OCAMPOAP 07 - Audit of Liabilities MAY 2020SUBSTANTIVE AUDIT OF LIABILITIESExistence: Recorded liabilities exist Obtain from the client a listing of accounts and notes payable as of year-end and reconcile to the general ledger. Vouch recorded liabilities to ...

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Since 1977

AUDITING PROBLEMS

OCAMPO/CABARLES/SOLIMAN/OCAMPO

AP.2807 - Audit of Liabilities

MAY 2020 SUBSTANTIVE AUDIT OF LIABILITIES

Existence: Recorded liabilities exist

Rights and obligations: Liabilities are owed by the entity

1.

Obtain from the client a listing of accounts and notes payable as of year-end and reconcile to the general ledger.

8.

Confirm recorded liabilities directly with suppliers and creditors.

9.

Review documentation in client’s files.

2.

Vouch recorded liabilities to the suppliers’ statements.

3.

Confirm recorded liabilities directly with suppliers and creditors. Investigate differences in liabilities reported in the confirmations with the recorded book amounts.

10. Examine subsequent payments to credits.

4.

Examine bank confirmations for loans.

Valuation and allocation: accordance with GAAP

Liabilities

are

valued

in

11. Vouch accounts payable schedule. 12. Test computation of accrued or prepaid interest.

Completeness: All liabilities are recorded 5.

Perform purchases cutoff examination.

6.

Test for unrecorded liabilities.

7.

Perform analytical procedures.

Presentation and disclosure: Liabilities are classified and disclosed in accordance with GAAP 13. Review financial statements and perform analytical procedures to determine whether accounts are classified and disclosed in the financial statements in accordance with GAAP.

INTERNAL CONTROL MEASURES Current Liabilities Accounts payable 1. A proper system of requisitioning, purchase order placement and approval, receiving, invoice approval, and approval for payment should be well-defined and established. 2. Subsidiary accounts payable records or unpaid vouchers should be reconciled with controlling account at frequent intervals. 3. Check mathematical accuracy of suppliers’ invoices prior to recording. 4. Adjustments to accounts payable should be properly approved. 5. Debit balances in accounts payable should be reviewed and resolved. Notes payable 1. Borrowings on notes payable should be properly authorized. (Specify the institutions from which money may be borrowed and designate the officers authorized to sign notes) 2. Unissued notes should be properly safeguarded. 3. Adequate and well organized records for notes specifying the details should be maintained. 4. Subsidiary notes payable records should be reconciled with controlling account at frequent intervals. 5. Paid notes should be properly cancelled and preserved. Long-Term Liabilities 1. 2. 3. 4.

5.

Long-term obligation should be properly authorized by the board of directors or by a required majority of the shareholders. There should be proper control over issued and unissued obligations as in bonds, by an independent bond trustee or transfer agent. Redeemed bonds should be cancelled, property mutilated and retained for audit in order to prevent the unauthorized issuance. Bond ledger should be used in which details of bonds issued, cancelled and outstanding are shown. A subsidiary bondholders’ ledger should also be maintained by the issuing corporation or the bond trustee for bonds registered, as to principal and interest. Proper control should be exercised over the payment of interest on long-term liabilities. Payment may be done by an independently engaged interest-paying agent. - end -

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AP.2807

EXCEL PROFESSIONAL SERVICES, INC.

PROBLEM NO. 1

5.

In auditing accounts payable, an auditor’s procedures most likely will focus primarily on management’s assertion of a. Existence c. Completeness b. Presentation and disclosure d. Valuation

6.

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

7.

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

8.

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 b. Presentation and disclosure c. Valuation or allocation d. Completeness

Dallas 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 Dallas has signed several 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 February 1, 2021 April 30, 2021 June 30, 2021

Amount 700,000 900,000 800,000 1,200,000 1,500,000 P 5,100,000 P

Estimated warranties Dallas 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 PROBLEM NO. 2 285,000 P 537,000

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, Dallas’ board of directors declared a cash dividend of P0.30 per ordinary share and a 10% ordinary share dividend. Both dividends were to be distributed on April 5, 2020 to ordinary shareholders on record at the close of business on March 31, 2020. As of March 31, 2020, Dallas has 5 million, P2 par value, ordinary shares issued and outstanding. Bonds payable Dallas 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. Dallas 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, 2020: 1.

2.

3.

4.

Estimated warranty payable a. P252,000 b. P345,000

c. d.

P630,000 P882,000

Total current liabilities a. P6,445,000 b. P5,105,000

c. d.

P5,445,000 P3,945,000

Trade and other payables a. P5,445,000 b. P5,100,000

c. d.

P3,045,000 P2,700,000

Total noncurrent liabilities a. P7,700,000 b. P7,500,000

c. d.

P7,590,000 P7,610,000

Relevant extracts from Magic Corporation’s financial statements at 31 December 2019 are as follows: Current liabilities Provision for warranties

P405,000

Non-current liabilities Provision for warranties

270,000

Note 10 - Contingent liabilities Magic is engaged in litigation with various parties in relation to allergic reactions to traces of peanuts alleged to have been found in packets of fruit gums. Magic strenuously denies the allegations and, as at the date of authorizing the financial statements for issue, is unable to estimate the financial effect, if any, of any costs or damages that may be payable to the plaintiffs. The provision for warranties at 31 December 2019 was calculated using the following assumptions: There was no balance carried forward from the prior year. Estimated costs of repairs - products with minor defects Estimated cost of repairs - products with major defects Expected % of products sold during 2019 having no defects in 2020 Expected % of products sold during 2019 having minor defects in 2020 Expected % of products sold during 2019 having major defects in 2020 Expected timing of settlement of warranty payments - those with minor defects Expected timing of settlement of warranty payments - those with major defects

P1,500,000 P9,000,000 80% 15% 5% All in 2020 40% in 2020, 60% in 2021

During the year ended 31 December 2020 the following occurred:

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AP.2807

EXCEL PROFESSIONAL SERVICES, INC. 1.

2.

In relation to the warranty provision of P675,000 at 31 December 2019, P300,000 was paid out of the provision. Of the amount paid, P225,000 was for products with minor defects and P75,000 was for products with major defects, all of which related to amounts that had been expected to be paid in 2020.

4.

5.

6.

The provision for warranties to be reported noncurrent liability as of December 31, 2020 is a. P120,000 c. P390,000 b. P225,000 d. P495,000

5.

Total provisions to be reported in the statement of financial position as of December 31, 2020 is a. P 720,000 c. P 615,000 b. P1,770,000 d. P2,040,000

In calculating its warranty provision for 31 December 2020, Magic made the following adjustments to the assumptions used for the prior year: Estimated cost of repairs - products with minor defects Estimated cost of repairs - products with major defects Expected % of products sold during 2020 having no defects in 2021 Expected % of products sold during 2020 having minor defects in 2021 Expected % of products sold during 2020 having major defects in 2021 Expected timing of settlement of warranty payments - those with minor defects Expected timing of settlement of warranty payments - those with major defects

3.

4.

No change P7,500,000 85%

PROBLEM NO. 3 In your initial audit of Bulls Co., you find the following ledger account balances. 12%, 25-year Bonds Payable, 2016 issue 01/01/2016 CR P 1,600,000

13% 2%

10/01/2020 All in 2021 20% in 2021, 80% in 2022

Magic determined that part of its plant and equipment needed an overhaul – the conveyer belt on one of its machines would need to be replaced in about December 2021 at an estimated cost of P500,000. The carrying amount of the conveyer belt at 31 December 2020 was P280,000. Its original cost was P400,000. Magic was unsuccessful in its defense of the peanut allergy case and was ordered to pay P2,000,000 to the plaintiffs. As at 31 December 2020 Magic had paid P1,500,000. Magic commenced litigation against one of its advisers for negligent advice given on the original installation of the conveyers’ belt referred to in (4) above. In October 2020 the court found in favor of Magic. The hearing for damages had not been scheduled as at the date the financial statements for 2020 were authorized for issue. Magic estimated that it would receive about P500,000. Magic signed an agreement with Choko Bank to the effect that Magic would guarantee a loan made by Choko Bank to Magic's subsidiary, UN Ltd. UN’s Ltd. loan with Choko Bank was P3,000,000 as at 31 December 2020. UN Ltd. was in a strong financial position at 31 December 2020.

1.

2.

3.

The warranty expense in 2020 is a. P150,000 b. P240,000

c. d.

01/01/2020 07/01/2020

The provision for warranties to be reported as current liability as of December 31, 2020 is a. P330,000 c. P225,000 b. P600,000 d. P495,000

Treasury Bonds P 216,000

CR

P 80,000

Bond Interest Expense CD P 96,000 CD 96,000

The bonds were redeemed for permanent cancellation on October 1, 2020 at 105 plus accrued interest. QUESTIONS: Based on the above and the result of your audit, answer the following: (Use straight line amortization method) 1.

The adjusted balance of bonds payable as of December 31, 2020 is a. P1,400,000 c. P1,600,000 b. P1,000,000 d. P1,384,000

2.

The unamortized bond premium on December 31, 2020 is a. P80,000 c. P64,000 b. P56,000 d. P58,800

3.

The total bond interest expense for the year 2020 is a. P189,100 c. P182,900 b. P188,800 d. P182,800

4.

The gain or loss on partial bond redemption is a. P1,900 loss c. P1,900 gain b. P18,100 loss d. P18,100 gain

5.

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.

6.

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

P600,000 P345,000

The provision for warranties as of December 31, 2020 is a. P870,000 c. P345,000 b. P720,000 d. P615,000

CD

Bond Premium 01/01/2016

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

as

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AP.2807

EXCEL PROFESSIONAL SERVICES, INC.

7.

8.

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.

SOLUTION #1:

Which of the following audit procedures is least likely to detect an unrecorded liability? a. Analysis and recomputation of interest expense. b. Mailing of standard bank confirmation forms. c. Reading of the minutes of meetings of the board directors. d. Analysis and recomputation of depreciation expense.

SOLUTION #3:

PROBLEM NO. 4 On January 1, 2019, Thunder 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. Thunder uses the effective interest method of amortization. On December 31, 2020, the 2,000 bonds were extinguished early through acquisition in the open market by Thunder for P1,980,000 plus accrued interest. On July 1, 2019, Thunder issued 5,000 of its 6-year, P1,000 face value, 10% convertible bonds at par. Interest is payable every June 30 and December 31. On the date of issue, the prevailing market interest rate for similar debt without the conversion option is 12%. On July 1, 2020, an investor in Thunder’s convertible bonds tendered 1,500 bonds for conversion into 15,000 ordinary shares of Thunder, which had a fair value of P105 and a par value of P1 at the date of conversion. QUESTIONS: Based on the above and the result of your audit, determine the following: (Round off present value factors to four decimal places.) 1.

The issue price of the 2,000 5-year, P1,000 face value bonds on January 1, 2019 is a. P2,155,534 c. P2,000,000 b. P1,844,434 d. P2,147,800

2.

The carrying amount of the 2,000 5-year, P1,000 face value bonds on December 31, 2019 is a. P1,898,434 c. P2,000,000 b. P2,129,534 d. P2,121,100

3.

The gain on early retirement of bonds on December 31, 2020 is a. P 20,000 c. P121,286 b. P112,000 d. P 0

4.

The issuance of the 6-year, P1,000 face value bonds on July 1, 2019 increased equity by a. P419,050 c. P371,050 b. P411,300 d. P 0

5.

The conversion of the 1,500 6-year, P1,000 face value bonds on July 1, 2020 increased share premium by a. P1,485,000 c. P1,415,054 b. P1,374,608 d. P1,377,697

PV of P (P2M x 0.6499) PV of I (P2M x .11 x 3.8897) Issue price

P 1,299,800 855,734 P2,155,534

SOLUTION #2: PV of P (P2M x 0.7084) PV of I (P2M x .11 x 3.2397) CA, 12/31/19

PV of P (P2M x 0.7722) PV of I (P2M x .11 x 2.5313) CA, 12/31/20 Retirement price Gain on retirement

P 1,416,800 712,734 P2,129,534

P 1,544,400 556,886 2,101,286 ( 1,980,000) P 121,286

SOLUTION #4: PV of P (P5M x 0.4970) PV of I (P5M x .05 x 8.3838) Issue price without Issue price with Issue price without Equity component

P2,485,000 2,095,950 P4,580,950 P5,000,000 ( 4,580,950) P 419,050

SOLUTION #5: PV of P (P1.5M x 0.5584) PV of I (P1.5M x .05 x 7.3601) CA of bonds converted Par value of shares issued Share premium

P

837,600 552,008 1,389,608 ( 15,000) P1,374,608

PROBLEM NO. 5 Jackie Corporation has entered into an agreement to lease a machine to a Lessee Corporation. The lease agreement details are as follows: Length of lease Commencement date Annual lease payment payable 31 December each year commencing 31 December 2020 Fair value of the machine at 1 January 2020 Estimated economic life of the machine Estimated residual value of the asset at the end of its economic life Residual value at the end of the lease term, of which 50% is guaranteed by Lessee Corporation Interest rate implicit in the lease

5 years 1 January 2020

P8,000 P34,797 8 years P2,000

P7,200 ?

The lease is cancellable, but a penalty equal to 50% of the total lease payments is payable on cancellation. Lessee Corporation does not intend to buy the machine at the end of the lease term, Jackie Corporation incurred P1,000 to negotiate and execute the lease agreement. Jackie Corporation purchased the machine for P34,797 just before the inception of the lease. QUESTIONS: Based on the above and the result of your audit, answer the following: (Round off present value factors to four decimal places)...