Audit Qualifying Exam 3-7 PDF

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Qualifying Exam for Auditing THEORIES AND PROBLEMS Hard level 7 A CPA Company’s quality control procedures pertaining to the acceptance of a prospective audit client would most likely includes a. Inquiry of management as to whether disagreements between the predecessor auditor and the prospective cl...

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Qualifying Exam for Auditing THEORIES AND PROBLEMS Hard level 7

1. A CPA Company’s quality control procedures pertaining to the acceptance of a prospective audit client would most likely includes a. Inquiry of management as to whether disagreements between the predecessor auditor and the prospective client were resolved satisfactorily. b. Consideration of whether sufficient competent evidential matter may be obtained to afford a reasonable basis for opinions and effectiveness. c. Inquiry of third parties, such as the prospective client’s bankers and attorneys, about information regarding the prospective client and its management. d. Letter A and C is wrongs 2. An auditor who has been invited to submit a proposal for an audit engagement is a/an a. external auditor c. internal auditor b. successor auditor d. business auditor 3. The degree of certainty that the practitioner has attained and wishes to convey is called: a. Management risk b. assurance c. materiality d. trust and love 4. The information below was taken from the bank transfer schedule prepared during the audit of BAY Co.’s financial statements for the year ended December 31, 2011. Assume all checks are dated and issued on December 30, 2011. Disbursement Receipt date date Check No. From

To

Per BooksPer Bank Per Books Per Bank

101

National

Federal

202

County

State

303

Federal American

404

State

Republic

Dec. 30

Jan. 4

Dec. 30

Jan. 3

Jan. 2

Dec. 30 Dec. 31

Dec. 31

Jan. 3

Jan. 2

Jan. 2

Jan. 2

Jan. 2 Dec. 31

Which of the above checks might indicate kiting? a. #101 and #303. b. #202 and #404. c. #101 and #404. d. #404 and #303

Jan. 3

Jan. 2

5. Which of the following is most likely to be effective in detecting kiting? a. Bank Confirmation b. Bank transfer schedule prepared using only the cash receipts and cash disbursements journals c. Comparison of bank cutoff statement to the cash receipts and disbursements records d. C & A are suspicious 6. The work-in process inventory of RHODE ISLAND Constructions Co., was completely destroyed by fire on April 1, 2014. You were able to establish the physical inventory figures as follows: January 1, 2014

April 1, 2014

Raw materials

30,000

60,000

Work in process

100,000

-

Finished goods

140,000

120,000

Sales from January 1 to March 31, were P 300,000. Purchases of raw materials were P 100,000 and freight on purchases, P 10,000. Direct labor during the period was P 80,000. It was agreed with the insurance adjusters that an average gross profit rate of 32.5% be used and that manufacturing overhead was 45% of direct labor cost. The value of goods manufactured and completed as of April 1, 2014: a. P 70,000 b. P 180,000 c. P 190,000 d. none of the above

7. On December 31, 2009, Alcoa Co. purchased equity securities as trading securities. Pertinent data are as follows: Fair value Cost 12/31/11 12/31/10 P Company P 900,000 P 780,000 P 880,000 Q Company 1,100,000 1,240,000 1,120,000 B Company 2,000,000 1,720,000 1,920,000 Total P4,000,000 P3,740,000 P3,920,000

On December 31, 2011, Alcoa transferred its investment in security B from trading to availablefor-sale because Alcoa intends to retain security B as a long-term investment. QUESTION: What total amount of gain or loss on its securities should be included in Alcoa’s 2011 profit or loss?

a. b. c. d.

P 20,000 gain P 260,500 loss P180,000 loss No loss or gain

Suggested Solution: Total fair value, 12/31/11 Total fair value, 12/31/10 Unrealized loss on trading securities

P3,740,000 3,920,000 P 180,000

Summary of reclassifications of financial assets (based on amended PAS 39 par. 50 to 54):







An entity: a) Shall not reclassify a derivative financial instrument into or out of the FVTPL category while it is held. b) Shall not reclassify any financial instrument out of the FVTPL category if upon initial recognition it was designated by the entity as at fair value through profit and loss; and c) May, if a financial asset is no longer held for the purpose of selling it in the near term (notwithstanding that the financial asset may have been acquired principally for the purpose of selling it in the near term), reclassify that financial asset out of the FVTPL category only in rare circumstances (arising from a single event that is unusual and highly unlikely to recur in the near term). If an entity reclassifies a financial asset out of the FVTPL category, the financial asset shall be reclassified at its fair value on the date of reclassification. Any gain or loss already recognized in profit or loss shall not be reversed. The fair value of the financial asset on the date of reclassification becomes its new cost. An entity shall not reclassify any financial instrument into the FVTPL category after initial recognition.

Since the reason for the transfer of the investment from trading to available for sale is not a rare situation, the investment should be accounted for under its original classification.

8. Bridgestone Company bought 20% of Spiratone Corporation’s ordinary shares on January 1, 2011 for P11,400,000. Carrying amount of Spiratone’s net assets at purchase date totaled P50,000,000. Fair value and carrying amounts were the same for all items except for plant and inventory, for which fair values exceed their carrying amount by P10,000,000 and P2,000,000 respectively. The plant has a 5-year life. All inventory was sold during 2011. During 2011, Spiratone reported profit of P30,000,000 and paid a P10,000,000 cash dividend. QUESTIONS: Based on the above and the result of your audit, answer the following: What amount should Bridgestone report as net income related to this investment in 2011? a. b. c. d.

P5,200,000 P6,200,000 P5,400,000 Both C&B Share of profit (P30,000,000 20%) Amortization of excess – Inventory Amortization of excess – Plant (P2,000,000/5) Income from acquisition (see below) Net investment income

P6,000,000 ( 400,000) ( 400,000) 1,000,000 P6,200,000

Acquisition cost Less carrying amount of net assets acquired (P50,000,000 20%) Excess Attributed to : Undervalued plant asset (P10,000,000 20%) Undervalued inventory (P2,000,000 20%) Negative goodwill (income from acquisition)

P11,400,000 10,000,000 1,400,000 ( 2,000,000) ( 400,000) (P1,000,000)

Any excess of the investor’s share of the net fair value of the associate’s identifiable assets, liabilities and contingent liabilities over the cost of the investment is excluded from the carrying amount of the investment and is instead included as income in the determination of the investor’s share of the associate’s profit and loss in the period in which the investment is acquired. (PAS 28 par. 23)

9. On January 1, 2011, Mazda Motor Corporation created a special building fund by depositing a single sum of P200,000 with an independent trustee. The purpose of the fund is to provide resources to build an addition to the older office building during the latter part of 2015. The company anticipates a total construction cost of P1,000,000 and completion by January 1, 2016. The company plans to make equal annual deposit from December 31, 2011 through 2015, to accumulate the P1,000,000. The independent trustee will increase the fund each December 31 at an interest rate of 10%. The accounting periods of the company and the fund end on December 31. QUESTION: How much is the annual deposit to the fund? (Round off present value factors to four decimal places) a. b. c. d.

P163,700 P100,950 P131,038 All of the answers given are wrong

Suggested Solution: Target amount Less future value of P200,000 (P200,000 1.6105) Balance Divide by future value of ordinary annuity of P1 to 10% for 5 periods Annual deposit

P1,000,000 322,100 677,900 6.1051 P 111,038

10. Morningstar Company took out a P10,000,000 insurance policy on the life of its president on January 2, 2009. The company’s accounting period is the calendar year. The annual premium on the policy is P160,000. Data regarding dividends and cash surrender value are given below: 2011 2012 Dividend received on December 31 10,000 12,000 Cash surrender value 84,000 ? Life insurance expense ? 138,000 QUESTIONS: Based on the above and the result of your audit, answer the following: The life insurance expense in 2011 is a. P160,500 b. P122,000 c. P150,700 d. P800,000 Annual premium Dividend received in 2011

P160,000 (10,000)

Increase in cash surrender value pertaining to 2011 (P84,000 1/3) Life insurance expense for 2011

(28,000) P122,000

11. Morningstar Company took out a P10,000,000 insurance policy on the life of its president on January 2, 2009. The company’s accounting period is the calendar year. The annual premium on the policy is P160,000. Data regarding dividends and cash surrender value are given below: 2011 2012 Dividend received on December 31 10,000 12,000 Cash surrender value 84,000 ? Life insurance expense ? 138,000 The cash surrender value at December 31, 2012 is a. P206,000 b. P0 c. P 94,000 d. None of the above Annual premium P160,000 Dividend received in 2012 (12,000) Life insurance expense for 2012 (138,000) Increase in cash surrender value for 10,000 2012 Cash surrender value, 12/31/11 84,000 Cash surrender value, 12/31/12 P94,000

12. Morningstar Company took out a P10,000,000 insurance policy on the life of its president on January 2, 2009. The company’s accounting period is the calendar year. The annual premium on the policy is P160,000. Data regarding dividends and cash surrender value are given below: 2011 2012 Dividend received on December 31 10,000 12,000 Cash surrender value 84,000 ? Life insurance expense ? 138,000 Assuming the president dies on July 1, 2012 and the face of the policy is collected on July 31, 2012, the gain on life insurance settlement is a. P 9,831,000 b. P 0 c. P 9,819,000 d. P50,000 Face amount Unexpired insurance (P160,000 6/12) Cash surrender value, 7/1/12 [P84,000+(P10,000 6/12)] Gain on life insurance settlement

P10,000,000 (80,000) (89,000) P 9,831,000

13. The following items relate to the acquisition of a new machine by Spar Corporation in 2011: Invoice price of machinery Cash discount not taken Freight on new machine Cost of removing the old machine Loss on disposal of the old machine Gratuity paid to operator of the old machine who laid off Installation cost of new machine Repair cost of new machine damaged in the process of installation Testing costs before machine was put into regular operation Salary of engineer for the duration of the trial run Operating cost during first month of regular use Cash allowance granted because the new machine proved to be inferior quality

P2,000,000 40,000 10,000 12,000 150,000 70,000 60,000 8,000

15,000 40,000 250,000 100,000

QUESTION: How much should be recognized as cost of the new machine? a. b. c. d.

P1,985,000 P1,993,000 P0 P2,025,000

Suggested Solution: Invoice price of machinery Cash discount not taken Freight on new machine Installation cost of new machine Testing costs Salary of engineer for the duration of the trial run Cash allowance Cost of the new machine

P2,000,000 (40,000) 10,000 60,000 15,000 40,000 (100,0000) P1,985,000

14. In connection with your audit of the Polycom Corporation’s financial statements for the year 2011 you noted the following items relative to the company’s intangible assets.  A patent was purchased from Polymer Company for P4,000,000 on January 2, 2010. Polycom estimated that the remaining useful life of the patent to be 10 years. The patent was carried in Polymer’s accounting records at a carrying value of P4,000,000 when Polymer sold it to Polycom. 

During 2011, a franchise was purchased from Safeland Company for P960,000. In addition, 5% of the revenue from the franchise must be paid to Safeland. Revenue from the franchise for 2011 was P5,000,000. Polycom estimates the useful life of the franchise to be 10 years and takes full year’s amortization in the year of purchase.



Polycom incurred research and development costs of P866,000 in 2011. Polycom estimates that these costs will be recouped by December 31, 2014.



On January 1, 2011, Polycom, because of the recent events in the industry, estimates that the remaining life of the patent purchased on January 2, 2010, is only 5 years from January 1, 2011.

QUESTIONS: Based on the above and the result of your audit, determine the following: Amortization of patent for 2011 a. P0 b. P800,000 c. P720,000 d. P400,000 Cost of patent Less amortization in 2010 (P4,000,000/10) Carrying amount, 1/1/11 Divide by revised remaining useful life Patent amortization for 2011

P4,000,000 400,000 P3,600,000 5 P 720,000

15. On January 2, 2003, Bambino Company spent P480,000 to apply for and obtain a patent on a newly developed product. The patent had an estimated useful life of 10 years. At the beginning of 2007, the company spent P144,000 in successfully prosecuting an attempted patent infringement. At the beginning of 2008, the company purchased for P280,000 a patent that was expected to prolong the life of its original patent by 5 years. On July 1,2011, a competitor obtained rights to a patent that made the company’s patent obsolete. QUESTIONS: Based on the above and the result of your audit, determine the following: Carrying amount of patent as of December 31, 2007 a. b. c. d.

P0 P240,000 P369,600 P355,200

Question No. 1 Cost of patent Less amortization up to 12/31/07 (P480,000 5/10) Carrying amount of patent, 12/31/07

P480,000 240,000 P240,000

16. Perkins Corporation authorized the sale of P2,000,000 of 12%, 10 year debentures on January 1, 2006. Interest is payable on January 1 and July 1. The entire issue was sold on April 1, 2006, at 102 plus accrued interest. On April 1, 2011, P1,000,000 of the bond issue was reacquired and retired at 99 plus accrued interest. On June 30, 2011, the remaining bonds were reacquired at 97 plus accrued interest and refunded with an issue of P1,600,000 of 9% bonds which were sold at 100. QUESTIONS: Based on the above and the result of your audit, determine the following: (Use straight line method to amortize premium or discount) 1. Total cash received from the sale of P2 million bonds on April 1, 2006 a. P2,100,000 b. P2,000,000 c. P0 d. P2,120,000

Question No. 1 Issue price (P2,000,000 1.02) Accrued interest (P2,000,000 12% 3/12) Total cash received from sale of bonds

P2,040,000 60,000 P2,100,000

17. Intel Inc., leases equipment to its customers under noncancelable leases. On January 1, 2011, Intel leased equipment costing P4,000,000 to Asus Co., for nine years. The rental cost was P440,000 payable in advance semiannually (January 1 and July 1), plus P20,000 semiannually for executor 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: Based on the foregoing and the result of your audit, compute for the following: (Round off present value factors to four decimal places). How much is the total interest income from lease that will be earned by Intel, Inc.? a. b. c. d.

P2,869,988 P3,389,748 P3,675,616 P 0 Suggested Solution:

Gross investment in the lease: Minimum lease payments (P440,000 18) Unguaranteed residual value Net investment in the lease: PV of minimum lease payments (P440,000 11.4773) PV of unguaranteed residual value (P800,000 0.3503) Total unearned interest income

P7,920,000 800,000

P8,720,000

5,050,012 280,240

P5,330,252 P3,389,748

18. At the beginning of 2011, Golem Company grants 100 share options to each of its 200 employees. Each grant is conditional upon the employees working for the entity over the next three years. The entity estimates that the fair value of each share option is P45. On the basis weighted average probability, the entity estimated that 25 percent of employees will leave during the three-year period and therefore forfeit their rights to the share options. During 2011, 10 employees leave. The entity revises its estimate of total employee departure over the three-year period from 25 percent to 20 percent. During 2012, a further 8 employees leave. The entity revises its estimate of total employee departure over the three-year period from 20 percent to 15 per cent. During 2013, a further 6 employees leave. Questions: Based on the above and result of the audit, determine the following: Compensation expense in 2011 a. P 240,000 b. P 225,000

c. P 720,000 d. P 0

Compensation expense in 2011 (200 employees 100 options 80% P45 1/3)

P240,000

19. The income statement of BrightStar Corporation for 2011 included the following items:

Interest income Salaries expense Insurance expense

P2,101,000 1,650,000 277,200

The following balances have been excerpted from BrightStar Corporation’s statement of financial position:

Accrued interest receivable Accrued salaries payable Prepaid insurance

12/31/2010 P 165,000 92,400 33,000

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

The cash received for interest during 2011 was a. P1,900,800 c. P2,065,800 b. P0 d. None of the above

12/31/2011 P 200,200 195,800 24,200

Question No. 1 Interest income Accrued interest receivable, 12/31/10 Accrued interest receivable, 12/31/11 Cash received for interest during 2011

P2,101,000 165,000 (200,200) P2,065,800

20. In your audit of Saga Company’s statement of comprehensive income for the year ended December 31, 2011, you noted that company reported profit of P10,000,000. You raised questions about the following amounts that had been included in profit: Unrealized loss on decline in value of available for sale securities Loss on write-off of inventory due to a government ban net of tax Adjustment of profit of prior year net-debit Loss from expropriation of property, net of tax Exchange differences gain on translating foreign operations Realized revaluation surplus

P 500,000

1,500,000 2,000,000 3,500,000 4,500,000 1,000,000

The loss from expropriation was unusual in occurrence in Sagas line of business. QUESTIONS: Saga Company’s 2011 statement of comprehensive income should report profit at a. P9,000,000 b. P6,500,000 c. P7,000,000 d. None of the above Question No. 1 Reported profit P10,000,000 Unrealized loss on decline in value of available for sale securities 500,000 Adjustment of profit of prior year net-debit 2,000,000 Exchange differences gain on translating foreign operation (4,500,000) Realized revaluation surplus (1,000,000) Adjusted profit P7,000,000...