Audit of Liabilities Problems with Solution PDF

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CHAPTER 8 – A udit of L iabilitiesProblem 1 In conjunction with your December 31, 2007 , annual audit of the financial statements of SweetHeart Company, you have obtained and examined the December 31, 2007 , accounts payable trial balance. Your examination of this trial balance disclosed the followi...

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CHAPTER 8 – Audit of Liabilities Problem 1 In conjunction with your December 31, 2007, annual audit of the financial statements of SweetHeart Company, you have obtained and examined the December 31, 2007, accounts payable trial balance. Your examination of this trial balance disclosed the following open vouchers: a. Voucher 761, containing a P380,000 credit to Accounts Payable. This voucher covered a cash transfer to the factory payroll bank account for the pay period ended December 28, 2007. The payroll cash transfer was made January 3, 2008, and payroll checks covering this pay period were distributed to factory employees on January 4, 2008. b. Voucher 778, containing an P180,000 credit to Accounts Payable. The P180,000 credit covered the principal and interest due on a ten-year installment loan. The loan was granted to SweetHeart Company on January 1, 2007. Terms of the loan agreement call for ten equal annual installment payments of P100,000, each plus interest at 8 percent. Principal and interest payments are due January 5, 2008 – 2017. The voucher indicated that the Loan Payable and Interest Expense accounts had been properly charged. c. Voucher 741, containing a credit to Accounts Payable of P50,000. This voucher covered on invoice from AC Company for a new computer machine. The computer machine was installed December 10, 2007, and the Office Equipment account was properly charged. d. Voucher 775, containing a credit to Accounts Payable in the amount of P65,480. This voucher covered income taxes withheld from employees during December 2007. e. Voucher 779, containing a credit to Accounts Payable of P41,460. This credit covered the total interest and principal due on a 180-day P40,000 note payable to the CJ Company. Charges to the Note Payable and Interest Expense had been properly handled. f.

Voucher 751, containing a P200,000 charge to Accounts Payable. This voucher represented a P200,000 advance payment to SS Company for a special order of ten boxes. The P200,000 check was mailed to SS Company on January 2, 2008.

Questions 1. Accounts payable at year-end is a. Overstated by P716,940 b. Overstated by P666,940

c. Overstated by P516,940 d. Overstated by P466,940

2. The entry to adjust Voucher # 778 is a. Accounts payable 180,000 Loans payable 100,000 Interest payable 80,000 b. Accounts payable 180,000 Loans payable 100,000 Interest expense 80,000

c. Loans payable 100,000 Interest expense 80,000 Accounts payable 180,000 d. Loans payable 100,000 Interest payable 80,000 Accounts payable 180,000

3. The entry to adjust Voucher # 741 is a. Accounts payable – others 50,000 Accounts payable

50,000

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b. Accounts payable 50,000 Accounts payable – others c. Accounts payable – others 50,000 Machinery d. No adjustment

50,000 50,000

4. The current liability of the company at year-end is a. Overstated by P340,000 c. Understated by P200,000 b. Overstated by P140,000 d. Understated by P 60,000 Solution 1. Accounts payable Salaries payable 2. Accounts payable Loans payable Interest payable 3. Accounts payable AP – others 4. Accounts payable Income tax payable 5. Accounts payable Notes payable Interest payable 6. Cash Accounts payable Answer: 1. C 2. A

380,000 380,000 180,000 100,000 80,000 50,000 50,000 65,480 65,480 41,460 40,000 1,460 200,000 200,000 3. B

4. C

Problem 2 In conjunction with your firm’s examination of the financial statements of Ronryan Company as of December 31, 2007, you obtained from the voucher register the information shown in the work paper below. Item Entry Date

Description

1.

Supplies, purchased FOB destination, 12/15/07; received, 12/17/07

12/18/07

2.

12/18/07

3.

12/21/07

4.

5.

6.

7.

2

12/21//07

12/21/07

12/26/07

12/28/07

Amount

Account Charged

15,000

Supplies on hand

24,000

Prepaid insurance

19,000

Repairs and Main.

Merchandise shipped FOB shipping point, 12/20/07; received, 12/24/07

12,300

Inventory

Payroll, 12/07/07 – 12/21/07 (12 working days)

69,000

Sal. and wages

Auto insurance, 12/15/07 to 12/15/08 Repair services; received 12/20/07

Subscription to Tax Journals for 2008

5,000

Utilities for December 2007

24,000

Dues & subs Utilities expense

8.

9.

12/28/07

12/28/07

10.

1/5/08

11.

1/10/08

12.

13.

14.

1/14/08

1/15/08

1/15/08

Merchandise shipped FOB destination, 12/24/07; received, 1/2/08

111,000

Inventory

Merchandise shipped FOB shipping point, 12/26/07; received, 1/3/08

84,000

Inventory

Payroll 12/21/07 – 1/05/08 (12 working days. 4 working days in January) Merchandise shipped FOB destination, 1/03/08, received, 1/10/08

72,000

Sal. and wages

38,000

Inventory

Interest on bank loan, 10/10/07 to 01/10/08

30,000

Interest expense

Manufacturing equipment installed, 12/29/07

254,000

Machinery

Dividends declared, 12/15/07

160,000

Dividends payable

Accrued liabilities of 12/31/07 were as follows: Accrued payroll Accrued interest payable Dividends payable

P 48,000 26,667 160,000

The accruals made on December 31, 2007 were reversed effective January 1, 2008. Review the data given above and prepare adjusting journal entries to correct the accounts on December 31, 2007. Assume that the company follows FOB terms for recording inventory purchases. Questions 1. The entry to adjust item #2 is a. Insurance expense 24,000 Prepaid insurance 24,000 b. Insurance expense 1,000 Prepaid insurance 1,000 2. The entry to adjust item #10 is a. Salaries expense 48,000 Accrued payroll 48,000 b. Accrued payroll 48,000 Salaries expense 48,000

c. Insurance expense Prepaid insurance d. No adjustment

c. Accrued payroll Salaries expense Cash d. No adjustment

1,000 1,000

48,000 24,000 72,000

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3. The entry to adjust item #12 is a. Interest expense 26,667 Interest payable 26,667 b. Interest expense 30,000 Interest payable 30,000 4. The entry to adjust item #13 a. Machinery 254,000 AP – others 254,000 b. AP – others 254,000 Machinery 254,000 5. The entry to adjust item #14 a. Dividends declared 160,000 Dividends payable 160,000 b. Dividends payable 160,000 Dividends declared 160,000 Solution 1. No Adjustment 2. Insurance expense 1,000 Prepaid insurance 3. No Adjustment 4. No Adjustment 5. No Adjustment 6. Prepaid subscription 5,000 Dues and subscription 7. No adjustment 8. Accounts payable 111,000 Inventory 9. No adjustment 10. No adjustment 11. No adjustment 12. No adjustment 13. Machinery 254,000 AP – others 14. No adjustment Answer: 1. B 2. D 3. D

c. Interest expense Interest payable Cash d. No adjustment

26,667 3,333 30,000

c. No adjustment d. No adjustment since payment was made on Jan. 15, 2008

c. No adjustment d. No adjustment since payment was made on Jan. 15, 2008.

1,000

5,000

111,000

254,000

4. A

5. C

Problem 3 - ADJUSTMENT FOR LOSS CONTINGENCIES The following items have not been reflected in the financial statements of ALTAGRACIA CORP. for the year ended December 31, 2007. You are asked if the information should be adjusted and disclosed in the financial statements, disclosed only in the financial statement, or no adjustment or disclosure. 1. Altagracia owns a small warehouse located on the banks of a river in which it stores inventory worth approximately P250,000. Altagracia is not insured against flood losses. The river last overflowed its banks 200 years ago. a. Adjusted and disclosed in the financial statements. b. Only disclosure is required in the financial statements. c. No adjustment or disclosure required in the financial statements. 2. Altagracia offers an unconditional warranty on its toys. Based on past experience, Altagracia estimates its warranty expense to be 1% of sales. Sales during 2007 were P5,000,000.

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a. Adjusted and disclosed in the financial statements. b. Only disclosure is required in the financial statements. c. No adjustment or disclosure required in the financial statements. 3. On October 30, 2007, a safety hazard related to one of Altagracia’s toy products was discovered. It is considered probable that Altagracia will be liable for an amount in the range of P50,000 to P250,000. a. Adjusted and disclosed in the financial statements. b. Only disclosure is required in the financial statements. c. No adjustment or disclosure required in the financial statements. 4. On November 29, 2007, Altagracia initiated a lawsuit seeking P125,000 in damages from a patent infringement. a. Adjusted and disclosed in the financial statements. b. Only disclosure is required in the financial statements. c. No adjustment or disclosure required in the financial statements. 5. On December 15, 2007, a former employee filed a lawsuit seeding P50,000 for unlawful dismissal. Altagracia’s attorneys believe the suit is without merit. No court date has been set. a. Adjusted and disclosed in the financial statements. b. Only disclosure is required in the financial statements. c. No adjustment or disclosure required in the financial statements. 6. On December 12, 2007, Conchita guaranteed a bank loan of P500,000 for its president’s personal use. a. Adjusted and disclosed in the financial statements. b. Only disclosure is required in the financial statements. c. No adjustment or disclosure required in the financial statements. 7. On January 5, 2008, a warehouse containing a substantial portion of Altagracia’s inventory was destroyed by fire. Altagracia expects to recover the entire loss, except for a P125,000 deductible from insurance. a. Adjusted and disclosed in the financial statements. b. Only disclosure is required in the financial statements. c. No adjustment or disclosure required in the financial statements. 8. On January 5, 2008, inventory purchased FOB shipping point from a foreign country was detained at that coutnry’s border because of political unrest. The shipment is valued at P750,000. Altagracia’s attorneys have stated that it is probable that Altagracia will be able to obtain the shipment. a. Adjusted and disclosed in the financial statements. b. Only disclosure is required in the financial statements. c. No adjustment or disclosure required in the financial statements. 9. On a. b. c.

January 30, 2008, Altagracia issued P5,000,000 bonds at a premium of P250,000. Adjusted and disclosed in the financial statements. Only disclosure is required in the financial statements. No adjustment or disclosure required in the financial statements.

10. On February 14, 2008, the BIR assessed Altagracia an additional P200,000 for the 2001 tax year. Altagracia’s attorneys and tax accountants have stated that it is likely that the BIR will agree to a P150,000 settlement.

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a. Adjusted and disclosed in the financial statements. b. Only disclosure is required in the financial statements. c. No adjustment or disclosure required in the financial statements. Solution 1. C No adjustment nor disclosure 2. A Accrue at P50,000 3. A Accrue at P50,000 4. B No adjustment – only disclosure for gain contingency 5. C No adjustment nor disclose 6. A No adjustment – disclosure is required 7. B Only disclosure – subsequent events 8. A Accrue since it is probable 9. B Only disclosure – subsequent events 10. A Accrue at P150,000

Problem 4 - BONUS COMPUTATION Maria Rosa, president of the Villa Nova Company, has a bonus arrangement with company under which she receives 10% of the net income (after deducting taxes bonuses) each year. For the current year, the net income before deducting either provision for income taxes or the bonus is P4,650,000. The bonus is deductible for purposes, and the tax rate is 32%. Questions 1. The amount of Maria Rosa’s bonus is a. P 465,000.00 b. P 364,285.71

c. P 339,270.39

2. The appropriate provision for income tax for the year is a. P 1,488,000.00 b. P 1,393,258.43 c. P 1,371,428.57 3. The entry to record the a. Bonus expense Bonus payable b. Bonus expense Bonus payable c. Bonus expense Bonus payable d. No entry

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d. P 296,069.42

d. P 1,379,433.48

bonus (which will be paid in the following year) is 296,069.42 296,069.42 339,270.39 339,270.39 465,000.00 465,000.00

Solution 1. Answer: D B = 10% (P4,650,000 – B – T) T = 32% (P4,650,000 – B) B = 10% (P4,650,000 – B – (32% x P4,650,000 – B) = 10% (P4,650,000 – B – (P1,488,000 - .32B) = 10% (P4,650,000 – B – P1,488,000 + .32B = P465,000 - .10B – P148,800 + .032B = P316,200 - .068B 1.068B = P316,200 = P296,097.42 2. Answer: B T = 32% (P4,650,000 – P296,067.42) = P1,393,258.43 3. Answer: A Bonus expense 296,097.42 Bonus payable 296,097.42

the and the tax

Problem 5 - PREMIUMS In the packages of its products, ALONDRA, INC. includes coupons that may be presented at retail stores to obtain discounts on other Alondra products. Retailers are reimbursed for the face amount of coupons redeemed plus 10% of that amount for handling costs. Alondra honors requests for coupon redemption by retailers up to 3 months after the consumer expiration date. Alondra estimates that 60% of all coupons issued will ultimately be redeemed. Information relating to coupons issued by Alondra during 2007 is as follows: Consumer expiration date Total payments to retailers as of 12/31/07 Liability for unredeemed coupons as of 12/31/07

12/31/07 165,000 99,000

Questions 1. The total face amount of coupons issued in 2007 is c. P 400,000 a. P 600,000 b. P 440,000

d. P 240,000

2. Coupons expense at year-end is a. P 440,000 b. P 400,000

d. P 240,000

c. P 264,000

4. Estimated liability for unredeemed coupons is c. P 99,000 a. P 219,000 b. P 123,000 Solution Coupons issued X Coupons to be redeemed Plus: Handling cost (10%) Total Cost Less: payment Estimated liability

400,000 – squeezed figure 60% 240,000 Answer: 24,000 1. C 2. C 264,000 165,000 99,000

d. P

3,000

3. C

Problem 6 - DEBT RESTRUCTURING: ASSET SWAP, EQUITY SWAP AND MODIFICATION OF TERMS MARIANA CORPORATION is having financial difficulty and therefore has asked NALOOY Bank to restructure its P3 million note outstanding. The presented note has 3 years remaining and pays a current rate of interest of 10%. The present market rate for a loan of this nature is 12%. The note was issued at its face value. Presented below are four independent situations. Determine the journal entry that Mariana would make for each of the following types of debt restructuring. 1. NALOOY Bank agrees to take an equity interest in Mariana by accepting common stock valued at 2,400 in exchange for relinquishing its claim on this note. The common stock has a par value of P1,200,000. a. Notes payable 3,000,000 Common stock 3,000,000 b. Notes payable 3,000,000 Common stock 1,200,000 APIC 1,800,000 c. Notes payable 3,000,000 Common stock 1,200,000 Interest expense 300,000 APIC 1,500,000

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d. No adjustment 2. NALOOY Bank agrees to accept land in exchange for relinquishing its claim on this note. The land has a book value of P2,000,000 and a fair value of P2,500,000. a. Notes payable 3,000,000 Land 2,500,000 Gain on debt restructuring 500,000 b. Notes payable 3,000,000 Land 2,000,000 Interest expense 300,000 Gain on exchange 200,000 Gain on debt restructuring 500,000 c. Notes payable 3,000,000 Land 2,000,000 Gain on exchange 500,000 Gain on debt restructuring 500,000 d. No adjustment 3. NALOOY Bank agrees to modify the terms of the note, indicating that Dolores does not have to pay any interest on the note over the 3-year period. a. Interest payable 300,000 Gain on debt restructuring 300,000 b. Loss on debt restructuring 300,000 Interest expense 300,000 c. Interest expense 900,000 Gain on debt restructuring 900,000 d. No adjustment 4. NALOOY Bank agrees to reduce the principal balance due to P2,000,000 and require interest only in the second and third year at a rate of 10%. a. Notes payable – old 3,000,000 Notes payable – new 2,400,000 Gain on debt restructuring 600,000 b. Notes payable - old 3,000,000 Notes payable – new 3,000,000 c. Notes payable – old 3,000,000 Notes payable – new 2,600,000 Gain on debt restructuring 400,000 d. No adjustment Solution 1. B Notes payable 3,000,000 Common stock APIC 2. C Notes payable 3,000,000 Land Gain on exchange Gain on debt restructuring 3. D No Adjustment 4. A Notes payable – old 3,000,000 Notes payable – new Gain on debt restructuring

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1,200,000 1,800,000

2,000,000 500,000 500,000

2,400,000 600,000

Problem 7 - CURRENT LIABILITY The December 31 trial balance of the Ruel Corporation includes, among others, the following: Long-term Notes – which are payable in annual installment of P10,000 on February 1 of each year Rental income received in advance Notes payable, which are trade notes, with the exception of P20,000 Notes payable to bank on June 30 of the following year Accounts payable which include account with debit balance of P2,000 Notes Receivable which have been reduced by notes discounted of P20,000 that are not yet due and on which the Corporation is contingently liable Accounts Receivable, which include accounts with credit balances of P10,000 and past due accounts of P6,000 on which a loss of 80% is anticipated Merchandise Inventory, which includes goods held for consignment, P8,000, and goods received on December 31 of P12,000; neither of these items having been recorded as a purchase

P 60,000 16,000 60,000 80,000

100,000

200,000

180,000

Questions 1. What is the amount of the current liabilities on December 31? a. P 190,000 b. P 184,000 c. P 178,000

d. P 170,000

2. The long-term debt at year-end is b. P 50,000 a. P 70,000

d. P 0

c. P 30,000

Solution Long-term Notes – which are payable in annual installment of P10,000 on February 1 of each year Rental income received in advance Notes payable, which are trade notes, with the exception of P20,000 Notes payable to bank on June 30 of the following year Accounts payable which include account with debit balance of P2,000 Accounts Receivable, which include accounts with credit balances of P10,000 and past due accounts of P6,000 on which a loss of 80% is anticipated Merchandise Inventory, which includes goods held for consignment, P8,000, and goods received on December 31 of P12,000; neither of these items having been recorded as a purchase TOTAL CURRENT LIABILITIES Answer: 1. A 2. Long-term liability – P50,000

P 10,000 16,000 60,000 82,000

10,000

12,000 P 190,000

Problem 8 Abam Corporation is selling audio and video appliances. The company’s fiscal year ends on March 31. The following information relates the obligations of the company as of March 31, 2007. Notes payable Abam 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 amount to P340,000 on March 31, 2007.

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Due ...