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CPA REVIEW SCHOOL OF THE PHILIPPINESM a n i l a AUDITING PROBLEMSAUDIT OF PROPERTY, PLANT & EQUIPMENT AND INTANGIBLE ASSETSPROBLEM NO. 1The property, plant and equipment section of White Corporation’s balance sheet at December 31, 2004 included the following items:Land P 2,500, Land improvem...

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CPA REVIEW SCHOOL OF THE PHILIPPINES Manila

AUDITING PROBLEMS AUDIT OF PROPERTY, PLANT & EQUIPMENT AND INTANGIBLE ASSETS PROBLEM NO. 1 The property, plant and equipment section of White Corporation’s balance sheet at December 31, 2004 included the following items: Land Land improvements Building Machinery and equipment

P 2,500,000 560,000 3,600,000 6,600,000

During 2005 the following data were available to you upon your analysis of the accounts: Cash paid on purchase of land Mortgage assumed on the land bought, including interest at 16% Realtor’s commission Legal fees, realty taxes and documentation expenses Amount paid to relocate persons squatting on the property Cost of tearing down an old building on the land Amount recovered from the salvage of the building demolished Cost of fencing the property Amount paid to a contractor for the building erected Building permit fees Excavation expenses Architect’s fee Interest that would have been earned had the money used during the period of construction been invested in the money market Invoice cost of machinery acquired Freight, unloading, and delivery charges Customs duties and other charges Allowances, hotel accommodations, etc., paid to foreign technicians during instillation and test run of machines Royalty payment on machines purchased (based on units produced and sold)

P10,000,000 16,000,000 1,200,000 200,000 400,000 300,000 600,000 440,000 8,000,000 50,000 250,000 100,000 600,000 8,000,000 240,000 560,000 1,600,000 480,000

REQUIRED: Based on the above and the result of your audit, compute for the following as of December 31, 2005: 1. Land 2. Land improvements 3. Building 4. Machinery and equipment 5. Total depreciable property, plant and equipment

PROBLEM NO. 2 The following were discovered during your audit of Black Company’s financial statements for the year ended December 31, 2005: a.

On December 24, 2005, Black purchased an office equipment for P400,000, terms 2/5, n/15. No entry was made on the date of purchase. The same was paid on December 31, 2005 and the accountant debited Office Equipment and credited cash for P400,000.

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b.

Machine C, with a cash price of P128,000, was purchased on January 2, 2005. The company paid P20,000 down and P10,000 for 12 months. The last payment was made on December 30, 2005. Straight line depreciation, based on a five-year useful life and no salvage value, was recorded at P28,000 for the year. Freight of P4,000 on machine C was debited to the Freight in account.

c.

Machine P with a cash selling price of P360,000 was acquired on April 1, 2005, in exchange for P400,000 face amount of bonds payable selling at 94, and maturing on April 1, 2015. The accountant recorded the acquisition by a debit to Machinery and a credit to Bonds Payable for P400,000. Straight line depreciation was recorded based on a five-year economic life and amounted to P54,000 for nine months. In the computation of depreciation, residual value of P40,000 was used.

d.

Machine A was acquired on January 22, 2005, in exchange for past due accounts receivable of P140,000, on which an allowance of 20% was established at the end of 2004. The current fair value of the machine on January 22 was estimated at P110,000. The machine was recorded by a debit to Machinery and a credit to Accounts Receivable for P140,000. No depreciation was recorded on Machine A, because it was not installed and never used in operations. On February 2, 2005, Machine A was exchanged for 1,000 shares of the company’s outstanding capital stock with market price of P105 per share. The Treasury Stock account was debited for P140,000 with the corresponding credit to Machinery.

e.

On December 29, 2005, the company exchanged 10,000 shares of Emong, Inc. common stock, which Black was holding as an investment, for an equipment from De Leon Corporation. The common stock of Emong, Inc., which had been purchased by Black for P45 per share, had a quoted market value of P50 per share on the date of exchange. The equipment had a market value of P470,000. The transaction was recorded by a debit to Equipment and a credit to Investment in Emong, Inc.-Common for P450,000.

f.

On December 30, 2005, Machine M with a carrying amount of P120,000 (cost P400,000) was exchanged for a similar asset with a fair value of P150,000. In addition, Black paid P20,000 to acquire the new machine. The exchange, which lacks commercial substance, was recorded by a debit to Machinery and a credit to cash for P20,000.

g.

Machine E was recorded at P102,000, which included the carrying amount of P22,000 for an old machine accepted as a trade in, and cash of P80,000. The cash price of Machine S was P90,000, and the trade in allowance was P10,000. This transaction took place on December 31, 2005.

h.

Ms. Beauty, the company’s president, donated land and building appraised at P200,000 and P400,000, respectively, to the company to be used as plant site. The company began operating the plant on September 30, 2005. The building is estimated to have a useful life of 25 years. Since no money was involved, no journal entry was made for the above transaction.

i.

On July 1, 2004, the national government granted a parcel of land located in Baliuag, Bulacan to Black. On the date of grant, the land had a fair value of P2,000,000. The grant required Black to construct a cold storage building on the site. Black finished the construction of the building, which has an estimated useful life of 25 years, on January 2, 2005. Black appropriately recorded the cost of the building of P4,000,000 (which include direct materials, direct labor, and indirect cost and incremental overhead) but failed to provide depreciation in 2005. Unaware of the accounting procedures for government grants, the company did not reflect the grant on its books.

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REQUIRED: As Black’s external auditor, you are required to prepare any necessary adjusting journal entries as of December 31, 2005. PROBLEM NO. 3 The Blue Corporation was incorporated on January 2, 2005, but was unable to begin manufacturing activities until July 1, 2005 because the new factory facilities were not completed until that date. The “Land and Building” account at December 31, 2005 follows: Date Jan. 31 Feb. 28 May 02 02 June 01 July 01 01 Dec. 31

Particulars Land and building Cost of removal of old building Partial payment on new construction Legal fees paid Second payment on new construction Fire insurance premium – 1 year Final payment on new construction Asset write-up

Dec. 31

Depreciation – 2005, at 1% of account balance

Amount P 1,098,000 60,000 700,000 15,000 600,000 26,000 200,000 500,000 P 3,199,000 31,990 P 3,167,010

You were able to gather the following during your audit: a. To acquire land and building, the company paid P98,000 cash and 10,000 shares of its 9% cumulative preferred shares, P100 par value per share. The shares were then selling at P120. b. Legal fees covered the following: Cost of incorporation Examination of title covering purchase of the land Legal work in connection with construction contract

P 9,500 4,000 1,500 P 15,000

c. Because of a general increase in construction costs after entering into the building contract, the board of directors increased the value of the building by P500,000, believing such increase is justified to reflect current market value at the time the building was completed. Retained earnings was credited for this amount. d. Estimated useful life of the building is 25 years. REQUIRED: 1. Prepare the necessary adjusting journal entries as of December 31, 2005. 2. Determine the adjusted balances of the following as of December 31, 2005: a. Land and building b. Land c. Carrying value of building d. Organization cost, net (presented under Noncurrent Assets)

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PROBLEM NO. 4 In the audit of the books of Green Company for the year 2005, the following items and information appeared in the Production Machines account of the auditee: Date 2005 Jan. 01 Aug 31

Particulars

Debit

Balance–Machines 1, 2, 3, and 4 at P90,000 each Machine 5 Machine 1 Machine 6 Machines 7 and 8 at P216,000 each Machine 2 Balance

Sept 30 Dec 01 Dec 01 31

Credit

P 360,000 198,000 P 3,000 96,000 432,000 21,000 . 1,062,000 P1,086,000 P1,086,000

The Accumulated Depreciation account contained no entries for the year 2005. balance on January 1, 2005 per your audit, was as follows: Machine 1 Machine 2 Machine 3 Machine 4 Total

The

P 84,375 39,375 33,750 22,500 P 180,000

Based on your further inquiry and verification, you noted the following: 1.

Machine 5 was purchased for cash; it replaced Machine 1, which was sold on this date for P3,000.

2.

Machine 2 was destroyed by the thickness of engine oil used leading to explosion on December 1, 2005. Insurance of P21,000 was recovered. Machine 7 was to replace Machine 2.

3.

Machine 3 was traded in for Machine 6 at an allowance of P12,000; the difference was paid in cash and charged to Production Machine account.

4.

Depreciation rate is recognized at 25% per annum.

REQUIRED: Determine the adjusted balance of the Production Machine as of December 31, 2005 and Depreciation Expense for the year 2005.

PROBLEM NO. 5 You obtain the following information pertaining to Red Co.’s property, plant, and equipment for 2005 in connection with your audit of the company’s financial statements. Audited balances at December 31, 2004: Land Buildings Accumulated depreciation – buildings Machinery and equipment Accumulated depreciation – Machinery and Equipment Delivery Equipment Accumulated Depreciation – Delivery Equipment

Debit P 3,750,000 30,000,000

Credit P 6,577,500

22,500,000 6,250,000 2,875,000 2,115,000

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Depreciation Data: Buildings Machinery and Equipment Delivery Equipment Leasehold Improvements

Depreciation Method 150% declining – balance Straight-line Sum-of-the-years’-digits Straight-line

Useful Life 25 years 10 years 4 years -

Transaction during 2005 and other information are as follows: a.

On January 2, 2005, Red purchased a new truck for P500,000 cash and traded-in a 2-year-old truck with a cost of P450,000 and a book value of P135,000. The new truck has a cash price of P600,000; the market value of the old truck is not known.

b.

On April 1, 2005, a machine purchased for P575,000 on April 1, 2000 was destroyed by fire. Red recovered P387,500 from its insurance company.

c.

On May 1, 2005, cost of P4,200,000 were incurred to improve leased office premises. The leasehold improvements have a useful life of 8 years. The related lease terminates on December 31, 2011.

d.

On July 1, 2005, machinery and equipment were purchased at a total invoice cost of P7,000,000; additional cost of P125,000 for freight and P625,000 for installation were incurred.

e.

Red determined that the delivery equipment comprising the P2,875,000 balance at January 1, 2005, would have been depreciated at a total amount of P450,000 for the year ended December 31, 2005.

The salvage values of the depreciable assets are immaterial. The policy of the Red Co. is to compute depreciation to the nearest month. QUESTIONS: Based on the above and the result of your audit, answer the following: 1.

How much is the Accumulated depreciation – Buildings as of December 31, 2005? b. P7,982,850 c. P8,377,500 d. P7,103,700 a. P7,777,500

2.

How much is the Accumulated depreciation – Machinery and Equipment as of December 31, 2005? d. P8,556,875 a. P8,844,375 b. P8,614,375 c. P8,830,000

3.

How much is the Accumulated depreciation – Delivery Equipment as of December 31, 2005? a. P2,715,000 b. P2,400,000 c. P2,490,000 d. P2,805,000

4.

How much is the Accumulated depreciation – Leasehold Improvements as of December 31, 2005? a. P420,000 b. P525,000 c. P350,000 d. P630,000

5.

How much is the net gain (loss) from disposal of assets for the year ended December 31, 2005? a. P100,000 b. (P35,000) c. P65,000 d. (P65,000)

PROBLEM NO. 6 In connection with your audit of the Josef Mining Corporation for the year ended December 31, 2005, you noted that the company purchased for P10,400,000 mining property estimated to contain 8,000,000 tons of ore. The residual value of the property is P800,000.

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