Chapter 7 Liabilities PDF

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CHAPTER 7Audit of LiabilitiesAUDIT PROGRAM FOR ACCOUNTS PAYABLEAudit Objectives:To determine that: Accounts payable represent amounts currently payable to trade creditors for purchases of goods and services as at the end of the reporting period. Accounts payable have been properly recorded. Accounts...

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CHAPTER

7

Audit of Liabilities AUDIT PROGRAM FOR ACCOUNTS PAYABLE

Audit Objectives: To determine that: 1. Accounts payable represent amounts currently payable to trade creditors for purchases of goods and services as at the end of the reporting period. 2. Accounts payable have been properly recorded. 3. Accounts Payable are properly described and classified and adequate disclosures have been made.

Audit Procedures: 1. To obtain a list of accounts payable from the subsidiary ledger, and:  Check its footing.  Check if the list reconciles with the general ledger control account.  Trace individual balances to the subsidiary ledger.  Adjust non-trade accounts erroneously included in supplier’s accounts,  Investigate and reclassify significant debit balances. 2. Confirm accuracy of the individual balances appearing in the subsidiary ledger by requesting statements of the accounts from suppliers, and:  Reconcile supplier’s statements accounts with client records and investigate any discrepancy.  If suppliers do not respond with the requests, perform extended procedures, like:  Reviewing payments after year-end.  Checking supporting documents.  Discussing the account with appropriate officer. 3. Review correspondence with suppliers for possible adjustments. 4. Test propriety of cutoff:

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Examine purchases recorded and the suppliers’ deliveries made a week before and after the end of the reporting period and ascertain whether the purchases returned shortly after the end of the reporting period. Investigate large amounts of purchases returned shortly after the end of the reporting period.

5. Ascertain whether some payables are secured with asset pledges. 6. Compare payments after the reporting date with year schedule of accounts payable. 7. Review propriety of financial statement presentation and adequacy of disclosures. 8. Perform analytical review procedures. 9. Obtain accounts payable representation letter.

AUDIT PROGRAM FOR NONCURRENT LIABILITIES

Audit Objectives: To determine: 1. Authorization of liabilities incurred. 2. Validity of recorded liabilities. 3. Recognition and recording of significant liabilities. 4. Compliance with terms, restrictions, conditions and other requirements of debt agreements. 5. Assets pledged or mortgaged and other charges guarantees related to the noncurrent liabilities are identified. 6. Accuracy of interest charges related to noncurrent liabilities. 7. Propriety of financial statement presentation and adequacy of disclosures.

Audit Procedures: 1. Obtain or prepare schedule/s of noncurrent liabilities, indicating: As to general nature:  Description or nature of the noncurrent liabilities.

    

Creditor/s Original principal amount Interest rate Collateral and/or guarantees Terms, restrictions, conditions, and requirements imposed by the creditors

As to principal amount outstanding:  Beginning-of-the-year balance  Additions during the year  Repayments or renewals during the year  Balance at year-end As to interest:  Accrued or prepaid at the beginning of the year  Amount incurred during the year  Payments during the year  Accrued or prepaid at year-end 2. Foot or cross-foot the schedule. 3. Verify accuracy of the schedule. As to general nature:  Obtain copies or excerpts of debt instruments and trace data to the schedule. As to principal amount outstanding:  Trace beginning balances to the last year’s working papers, or in an initial audit, establish accuracy of beginning balances by:  Reference to instruments and prior year’s recordings  Tracing to beginning ledger balances  Trace proceeds to cash receipts records for new liabilities incurred in the current year.  Trace payments to cash disbursements records and canceled checks.  Vouch to supporting documents the renewals in the current year.  Agree working paper ending balances with the general ledger accounts. As to interest:  Trace beginning balances to last year’s working papers, or in an initial audit:  Establish accuracy by an independent computation based ondebt instruments.  Trace to beginning ledger balances.  Recomputed the interest:  Incurred  Accrued  Prepaid  Trace payments to cash records and cancelled checks. 4. Verify authorizations by reference to minutes of the board of directors’ meetings.

5. Confirm directly with the creditors or trustees the following:  Principal amount still outstanding  Interest rates  Interest accrued  Collateral and / or guarantees 6. Determine client’s compliance with loan agreements. 7. Account for the used or unused debt instruments like bond certificates or promissory notes. 8. Ascertain proper cancelation of paid or retired debt instruments. 9. Recompute the accuracy of any discount or premium amortization. 10. Reconcile interest payments with recorded liabilities. 10. Verify propriety of financial statement presentation and adequacy of disclosures.

P Prroblem 7-1 Current Liabilities The data below are from the records of ALMANOR, INC. On Dec. 31, 2010: Accounts payable Cash balance, ABC Bank Cash overdraft with XYZ Bank Customers’ account with credit balances Dividends in arrears on preference shares Employees’ income tax payable Estimated warranty payable Estimated premium claims outstanding Income tax payable Notes payable (issued in 2010 maturing in 20 semiannual instalments beginning on April 1, 2011) Salaries payable

P 680,000 1,240,000 80,000 25,000 400,000 100,000 50,000 90,000 400,000 4,000,000 400,000

The amount to be shown as total current liabilities on Almanor’s statement of financial position at Dec. 31, 2010, is A. P 2,225,000 C. P 2,625,000 B. P 2,025,000 D. P 2,145,000

 Solution

7-1

Cash overdraft (XYZ Bank) Notes payable due in 2011 (p4 million / 20 x 2) Accounts payable Salaries payable Employees’ income tax payable Income tax payable Estimated warranty payable Estimated premium case outstanding Customers’ accounts with credit balances Total current liabilities

P 80,000 400,000 680,000 400,000 100,000 400,000 50,000 90,000 25,000 2,225,000

Answer: A

P Prroblem 7-2 Recording Purchases: Gross Method to Net Method SAIMAA CORP. Record its purchases at gross amounts but wishes to change to recording purchases net of purchase discounts. Discounts on purchases recorded from January 1, 2010 to December 31, 2010, totalled P80,000. Of this amount, P80,000 is still available in the accounts payable balance. The balances in Saimaa’s accounts as of and for the year ended December 31, 2010, before conversions are: Purchases Purchase discounts Accounts payable

P 4,000,000 32,000 1,200,000

1. The amount of purchase discounts lost to be recognized is A. P8,000 C. P32,000 B. P 0 . D. P40,000 2. The accounts payable balance should be reduced by A. P8,000 C. P32,000 B. P80,000 D. P40,000 3. The purchases account should be reduced by A. P32,000 C. P40,000 B. P80,000 D . P8,000 4. The entry to record the conversion is A.Accounts payable 80,000 Purchases

80,000

B.Purchase discounts lost Purchases

32,000

C.Purchase discounts lost Purchase discounts Accounts payable Purchases

40,000 32,000 8,000

D.Purchase discounts lost Accounts payable Purchases

32,000 8,000

 Solution

32,000

80,000

40,000

7-2

1. Discounts on 2010 purchases Less: Discounts taken Discounts will available in the Accounts payable balance Purchase discounts lost

P 80,000 P 32,000 8,000

40,000 P 40,000

Answer: D 2. The accounts payable should be reported net of discounts still available at the end of the reporting period which amounts to P8,000. Answer: A 3. Under the net method, purchases are reported net of discounts, regardless of whether the discounts are taken or not. Hence, the purchases account should be reduced by P80,000. Answer: B 4. The entry to record the conversion is: Purchase discounts lost Purchase discounts Accounts payable Purchases Answer: C

Prroblem 7-3 P

40,000 32,000 8,000 8,000

Accrued Expenses ANGLIN CORPORATION must determine the December 31, 2010, year-end accruals for advertising and rent expenses. A P50,000 advertising bill was received January 10, 2011, comprising cost of P37,500 for advertisements in December 2010 issues, and P12,500 for advertisements in January 2011 issues of the newspaper. A store lease, effective December 16, 2009, calls for fixed rent of P120,000 per month, payable one month for the effective date and monthly thereafter. In addition, rent equal to 5% of net sales over P6,000,000 per calendar year is payable on January 31 of the following year. Net sales for 2010 were P7, 500,000. What is the total accrued liabilities that should be reported by Anglin Corporation on its statement of financial position as at December 31, 2010? A. P185,000 C. P97,500 B. P172,500 D. P110,000

 Solution

7-3

Advertising Fixed rent, Dec. 16-31 (P120,000 x ½) Variable rent (P7,500,000 – P6,000,000 = (P1,5000,000 x 5%) Total Answer: B

P 37,500 60,000 75,000 P172,000

P Prroblem 7-4 Bonus Computation Ana Rosa, president of the APOPKA COMPANY, has a bonus arrangement with the company under which she receives 10% of the net income (after deducting taxes and bonuses) each year. For the current year, the net income before deducting even the provision for income taxes or the bonus is P4,650,000. The bonus is deductible for tax purposes, and the tax rate is 30%. 1. Determine the amount of Ana Rosas’ bonus. 2. Compute the appropriate provision for income tax for the year. 3. Prepare the entry to record the bonus (which will be paid in the following year).

 Solution

7-4

1. B= Bonus; T= Tax B = 10% (P4,650,000 – B - T) T = 30% (P4,650,000 – B)

T = 1,395,000 - .30B B = 10% (4,650,000 – B – [1,395,000 - .30B]) B = 10% (4,650,000 – B – 1,395,000 + .30B) B = 465,000 - .1B – 139,500 + .03B B = 325,500 - .07B 1.07B = 325,000 B = 325,500/1.07 B = P304,206 2. T = 30% (P4,650,000 – B) T = 30% (4,650,000 – P304,2060) T = 30% x P4,345,794 T = P1,303,738 3. Bonus expense Bonus payable

304,206 304,206

P Prroblem 7-5 Premiums PUKAKI COMPANY sold 700,000 boxes of “puto mix” under a new sales promotional program. Each box contain the coupon, which if submitted with P40, entitles the customer to a kitchen knife. Pukaki pays P60 per knife and P5 for handling and shipping. Pukaki estimates that 70% of the coupons will be redeemed, even though only 250,000 coupons had been processed during 2010. How much should Pukaki report as liability for unredeemed coupons at December 31, 2010? A. P6,000,000 C. P15,600,000 B. P9,600,000 D. P12,250,000

 Solution

7-5

Boxes of “puto mix” sold Redemption rate Total coupons redeemable Coupons to be redeemed 9490,000 – 250,000) Net cost per kitchen knife (P65 – P40) Liability for unredeemed coupons Answer: A Problem 7-6

700,000 70% 490,000 240,000 x P25 P6,000,000

Premiums In packages of its products, PLACID, INC. includes coupons that may be presented at retails stores to obtain discounts on other Placid products. Retailers are reimbursed for the face amount of coupons redeemed plus 10% of that amount for handling costs. Placid honors requests for coupon redemption by retailers up to 3 months, after the consumer expiration date. Placid estimates that 60% of all coupons issued will ultimately be redeemed. Information relating to the coupons issued by Placid during 2010 is as follows: Consumer expiration date

Dec. 31, 2010

Total payments to retailers as of Dec. 31, 2010

P165, 000

Liability for unredeemed coupons as of Dec. 31, 2010

P 99, 000

What is the total face amount of coupons issued by Placid, Inc. in 2010? a. P440,000 b. P400,000

c. P600,000 d. P264,000

Solution 7-6X Liability for unredeemed coupons, Dec. 31, 2010

99,000

Add: Total payments to retailers Total Cost Less: Handling Charges (P264,000-[P264,000/110%])

165,000 264,000 24,000

To be redeemed Divide by redemption rate Total face amount of coupons issued

240,000 0.60 400,000

Answer: B

Problem 7-7 Liability for Returnable Containers OMEGA COMPANY sells its products in expensive, reusable containers. The customer is charged a deposit for each container delivered and receives a refund for each container returned within two years after the year of delivery. Omega accounts for the containers not returned within the time limit as being sold at the deposit amount. Information for 2010 is as follows: Containers held by customers at December 31, 2009, from deliveries in: 2008 85,000 2009 240,000 325,000 Containers delivered in 2010 430,000 Containers returned in 2010 from deliveries in: 2008 57,500 2009 140,000 2010 157,000 354,500

1. How much revenue from container sales should be recognized for 2010? a. P127,500 b. P267,500

c. P 27,500 d. P 85,000

2. What is the total amount of Omega Company’s liability for returnable containers at December 31, 2010? a. P373,000 b. P400,500

c. P267,500 d. P430,000

Solution 7-7 1. Containers held by customers at December 31, 2009, from deliveries in 2008 Less: Containers returned in 2010, from deliveries in 2008 Revenue from container sales

85,000 57,500 27,500

Answer: C 2. Liability for returnable containers, Dec. 31, 2009

325,00 0 430,00 0 755,00 0

Add: Deliveries in 2010 Total Less: 2010 container returns 2010 container sales (see no. 1)

354,500 27,500

Liability for returnable containers, Dec. 31, 2010

382,00 0 373,00 0

Answer: A

Problem 7-8 Various Transactions Involving Current Liabilities Described below are certain transactions of ASHBY COMPANY: Feb. 2 The company purchased goods from Happy Corp. for P150, 000 subject to cash discount terms 2/10, n/30. The company records purchases and accounts payable at net amounts after cash discounts. The invoice was paid on February 25. April 1 The company purchased a truck for P120, 000 from Broom Motors Corp., paying P12,000 in cash and signing a one-year, 12% note for the balance of the purchase price. May 1 The company borrowed P240, 000 from Manila Bank by signing a P276, 000 noninterest-bearing note due one year from May 1. Aug. 1 The company’s board of directors declared a P900, 000 cash dividend that was payable on September 10 to shareholders record on August 31. 1. Prepare all the journal entries necessary to record the transactions described above.

2. Assume that Ashby Company’s financial year ends on December 31 and that no adjusting entries relative to the transactions above have been recorded. Prepare any adjusting journal entries concerning interest that are necessary to present fair financial statements at December 31. Solution 7-8 1. Journal Entries Feb. 2 Purchases Accounts payable

147,000

Feb. 25 Accounts payable Purchase discount lost (150,000*2%) Cash

147,000 3,000

April 1 Trucks

120,000

147,000

150,000

Cash Note payable

12,000 108,000

May 1 Cash Discount on Note payable Note payable

240,000

Aug. 1 Retained Earnings Dividends Payable

900,000

36,000 276,000

900,000

2. Adjusting Entries December 31 1. Interest expense 9,720 Interest payable (108,000x12%x9/12) 2. Interest expense 24,000 Discount on notes payable (36,000x8/12) Problem 7-9

9,720

24,000

Accounting for Warranties and Premiums OLSON MUSIC EMPORIUM carries a wide variety of musical instruments, sound reproduction equipment, recorded music and sheet music. To promote the sale of its products, Olson uses two promotion techniques - premiums and warranties. Premiums The premium is offered on the recorded and sheet music. Customers receive a coupon for each P10 spent on recorded music and sheet music. Customers may exchange 200 coupons and P200 for a CD player. Olson pays P340 for each CD player and estimates that 60% of the coupons given to customers will be redeemed. A total of 6,500 CD players used in the premium program were purchased during the year and there were 1,200,000 coupons redeemed in 2010. Warranties Musical instruments and sound reproduction equipment are sold with one-year warranty for replacement of parts and labor. The estimated warranty cost, based on past expenditure, is 2% of sales. Replacement parts and labor or warranty work totaled P1,640,000 during 2010. Olson uses the accrual method to account for the warranty and premium costs for financial reporting purposes. Olson’s sales for 2010 totaled P72,000,000-P54,000,000 from musical instruments and sound reproduction equipment and P18,000,000 from recorded music and sheet music. The balances in the accounts related to warranties and premiums on January 1, 2010, were shown below: Inventory of premium CD players P399,500 Estimated premium claims outstanding 448,000 Estimated liability from warranties 1,360,000 X Based on the preceding information, determine the amounts that will be shown on the 2010 financial statement for the following: 1. Warranty expense a. P1,640,000 b. P1080,000

c. P800,000 d. P360,000

2. Estimated liability from warranties a. P1,920,000 b. P1,080,000

c. P240,000 d. P800,000

3. Premium expense a. P1,836,000

b. P840,000

c. P756,000

d. P2,189,500

4. Inventory of premium CD players a. P399,500 b. P569,500

c. P2,210,000 d. P739500

5. Estimated premium claims outstanding a. P364,000 b. P840,000

c. P756,000 d. P672,00

Solution 7-9

1. Sales of musical instruments and sound reproduction equipment Estimated warranty cost Warranty expense for 2009

P54,000,00 0 x2% P1,080,000

Answer: B 2. Estimated liability from warranties, Jan. 1, 2010 Add: 2010 warranty expense (see no.1)

P1,360,000 1,080,000

Total

2,440,000

Less: Actual warranty costs during 2010

1,640,000

Estimated liability from warranties, Dec.31, 2010

P800,000

Answer: D 3. Coupons issued(P18,000,000/10) Multiply by estimated redemption rate Estimated number of coupons to be redeemed Divide by exchange rate (200 coupons for a CD player) Estimated number of CD player to be issued Multiply by net cost of a CD player (340-200) Premium expense for 2010

P1,800,000 x 60% 1,080,000 ÷200 5,400 x P140 P756,000

Answer: C 4. Inventory of premium CD player

P399,500

Add: Premium CD players purchased during 2010 (340*6, 500)

2,210,000

Total

2,609,500

Less: Premium CD players distributed to customers during 2010 (1,200,000/200=6,000*340) Inventory of premium CD players, Dec. 31, 2010 Answer: B

2,040,000 P569,500

5. Estimated premium claims outstanding, Jan.1, 2010

P448,000

Add: 2010 premium expense (see no.3)

756,000

Total

1,204,000

Less: 2010 actual redemptions (1,200,000/200=6,000*140)

840,000

Estimated premium claims outstanding Dec. 31, 2010

P364,000

Answer: A Problem 7-10 Accounting for Noninterest-bearing Note On December 31, 2010, BAIKAL COMPANY acquired a piece of equipment from Seller Company by issuing a P1,200,000 note, pa...