CHAPTER

15
15-1.

SUBSTANTIVE TESTS OF OWNERS EQUITY ACCOUNTS

(a) Procedures applicable to the existence or occurrence of shareholders equity balances are: (1) review authorizations and terms of share issues, ( ) confirm shares outstandin! with re!istrar and transfer a!ent, (") inspect share certificate boo#, and ($) inspect certificates of shares held in treasury% (b) Procedures applicable to ri!hts and obli!ations are (1) ma#e inquiries of le!al counsel, and ( ) review articles of incorporation and by&laws%

15-2.

'n vouchin! dividend entries, the auditor should (a) establish that preferential or other ri!hts of shareholders and any restrictions on dividend distributions have been reco!nized, (b) establish the number of shares outstandin! on the date of record and verify the accuracy of the total dividend declaration by recalculation, (c) ascertain the propriety of the entry to record the declaration, and (d) trace dividend payments to canceled chec#s and other documentation% (he procedures consist of: (a) review minutes of board of directors meetin!s and (b) compare statement presentation with )**P% Earla Company a% (1) +ertificates may have been surrendered in exchan!e for others without attachin! the surrendered certificates to the stub boo#% ( ) (he excess certificates may have been issued under proper authority for services or for property and not recorded in the financial boo#s% (") (hey may have been issued improperly in exchan!e for cash, services or property, or without consideration% (he impropriety mi!ht result from oversi!ht or from fraudulent desi!n% ($) (he error may have occurred because an item which should have been posted to the share capital account was not in fact so posted% (,) *n error may have occurred in enterin! the number of shares issued on the certificate stub% (-) *dditional shares may have been issued near the end of ..- but the cash received was not recorded until ../%

15-3. 15-4.

15-2

Solutions Manual to Accompany Applied Auditing, 2006 Edition b% (1) 0a#e a quic# inspection of open stubs to determine whether they provide a ready clue to the reason for difference, e%!%, one certificate issued for 1.,... shares% 'f so, investi!ate the facts re!ardin! its issue% ( ) 'f a quic# inspection fails to provide a clue, refer to a list of shareholders supportin! the entries in the cash receipts boo# for the / ,... shares ori!inally sold% +hec# this list item by item a!ainst stubs for shares ori!inally issued and mar# the stubs so chec#ed% (hen chec# returned certificates attached to stubs a!ainst new stubs issued in exchan!e for those certificates, mar#in! the new stubs% Prepare a list of unmar#ed stubs% (his should total 1.,... shares and serve to identify the outstandin! certificates with respect to which shares are not recorded in the !eneral led!er% (") 'f errors are found in the number of shares issued, as shown by stubs in the share certificate boo# after comparison with the cash receipts entries, it may be necessary to circularize the ori!inal shareholders to determine how many shares were actually issued% (he cash receipts boo# and !eneral 1ournal for the first few days of ../ should be examined for entries which may be for shares issued late in ..-% ($) 'f it is found that excess shares have been issued, inquiry should be made of responsible officers with respect to the circumstances in which they were issued% (he answers obtained should be substantiated by appropriate evidence, e%!%, resolutions of the board, etc%

15-5.

(he proposal for the limitation of procedure is not 1ustified by the stated facts% *lthou!h the transfer a!ent and the re!istrar #now the number of shares issued, they do not necessarily #now the number of shares outstandin!% 2urthermore, the audit of share capital includes more than determinin! the number of shares outstandin!% 2or example, the auditor must determine what authorizations exist for the issuance of shares, what assets were received in payment of shares, how the transactions were recorded, and what subscription contracts have been entered into% +onfirmation from the re!istrar could not help in determinin! these thin!s% 'n addition to confirmation from the re!istrar, the audit of share capital mi!ht include the followin! procedures for which the purposes are briefly indicated: (1) 3xamine the corporation charter to determine the number of shares authorized and the special provisions relatin! to each class of shares if more than one class is authorized% ( ) 3xamine minutes of shareholders and directors meetin!s to determine authorization for appointments of the re!istrar and the transfer a!ent, and to determine authorization for the issuance or reacquisition of shares%

Substantive Tests of Owners E!uity Accounts

15-3

(") 3xamine provisions relatin! to share capital in the corporation law of the state of incorporation to determine any special provisions such as, for example, those relatin! to the issuance of no&par shares% ($) *nalyze the share capital accounts to obtain an orderly picture of share transactions for use as a !uide to other auditin! procedures and as a permanent record% (,) (race the consideration received for share capital into the records to determine what consideration has been received and how it has been recorded% (-) 3xamine and schedule treasury shares and review entries for treasury shares to determine the existence of treasury shares, as authorized, and to determine that a proper record has been made% (/) 4eview re!istrars invoices and cash disbursements to determine that ori!inal issue taxes have been paid% (5) +ompare dividends with shares outstandin! at dividend dates to determine that dividends have been properly paid and also to substantiate the shares outstandin!% (6) 4eview subscription and option contracts, etc%, to determine the facts in re!ard to subscriptions and options and to determine that these facts have been properly recorded and that they are adequately disclosed% 15-6. Talisay Corporation 7ased on the limited data made available in the problem, the 7alance 8heet is presented as follows: (alisay +orporation 7alance 8heet 9ecember "1, ..Assets +urrent assets (includin! share subscriptions receivable) :oncurrent assets ;and <ther fixed assets (net of accumulated depreciation of P1-,...) (otal assets "iabilities and S#are#olders E!uity +urrent liabilities ;on!&term liabilities (otal liabilities 8hareholders equity 1.= Preference shares (P1. par value> 1,... shares authorized, issued, and outstandin!) P .,... 5,... P 5,... P 1.,... P "$,... 6,... $.,... P 5",...

15-4

Solutions Manual to Accompany Applied Auditing, 2006 Edition <rdinary shares (P par value> $,,.. shares authorized, $,... shares issued, and ", ,. outstandin!) <rdinary shares subscribed (,.. shares) Paid&in capital in excess of par (preference) Paid&in capital in excess of par (ordinary) 9onated capital 4etained earnin!s ;ess: (reasury shares (/,. shares at cost) (otal liabilities and shareholders equity ????????????????????? a ,.. shares x P par value @ P1,...
b

5,... 1,... a ,... ., ,. b 6,... 16,/,. c (1,,...) d P 5",...

*mount on issued ordinary shares AP15,... & ($,... x P )B *mount on subscribed ordinary shares AP1.,... & (,.. x P )B 8ale of treasury shares ( ,. x P ,) +ost of treasury shares sold ( ,. x P .)
c d

P1.,... 6,... P16,... P -, ,. ( ,,...) 1, ,. P ., ,.

P .,... & P1, ,. (improper !ain) C P1,... (improper loss) P16,/,. P1,,... total cost P . cost per share @ /,. shares

15-7.

Hope, Inc. Dope, 'nc% 8hareholders 3quity *s of 8eptember "., ../ P +umulative redeemable preference shares (P1, par value> ,..,... shares authorized> 5,... shares issued and outstandin!) <rdinary shares (P1. par value> 1,...,... shares authorized, 11$,,.. shares issued, 11.,... shares outstandin!) <rdinary shares subscribed, 1.,... shares Paid&in capital in excess of par (ordinary) 9iscount on preference shares 4etained earnin!s (reasury shares ($,,.. shares at cost)

P 1 .,.... 1,1$,,... 1..,... 1/,,.. ( .,...) -/1,... (1 1,,..) P ,11 ,...

$a% &reference S#ares Sc#edule ' of S#ares Amount

Substantive Tests of Owners E!uity Accounts 7alance 6E".E.8hares issued to purchase land 8hares redeemed 7alance 6E".E./ $b% 7alance 6E".E.(% 8antos 7alance 6E".E./ $c% 7alance 6E".E.8ale to (% 8antos A$,,.. x (P , & P1.)B 8ubscription by F% 4eyes A1.,... x ( , & P1.)B $,... 5,... ($,...) 5,...

15-5

P -.,... 1 .,... (-.,...) P1 .,...

Ordinary S#ares Sc#edule ' of S#ares Amount 11.,... P1,1..,... $,,.. $,,... 11$,,.. P1,1$,,...

&aid(in )apital Sc#edule Amount &.& P -/,,.. 1,.,... P 1/,,..

$d% *etained Earnings Sc#edule Amount 7alance 6E".E.P- ,... :et income ,.,... Preference shares redemption A$,... x (P15 & ( 1 ,...) P1,)B +ash dividend G ordinary (11.,... x P1%,.) (1-,,...) +ash dividend G preference (1 ,... x P ) ( $,...) P-/1,... 15-8. Baguio Company 7a!uio +ompany 8hareholders 3quity 9ecember "1, ../ <rdinary shares (1, par value> 1..,... shares authorized, and outstandin!) Paid&in capital in excess of par 4etained earnin!s (from 9ec% "1, ../) P1,,..,... ,$ ,,... H &.&

(otal 8hareholders 3quity P",6 ,,... ?????????????????????? H <ri!inal balance P1,/,.,... 4eduction of par value of ordinary shares (P1. x 1..,...) 1,...,... *dditional contribution -..,...

15-6

Solutions Manual to Accompany Applied Auditing, 2006 Edition 3limination of deficit Paid&in capital in excess of par HH <ri!inal deficit ;oss on revaluation of plant assets 9eficit to be eliminated Paraaque Company 4etained 3arnin!s before ad1ustments *dd (9educt) *d1ustments: (a) Premium on share capital credited to retained earnin!s (b) )ain on sale of treasury shares incorrectly char!ed (c) *ppraisal increase of land incorrectly credited to 4etained 3arnin!s (otal ad1ustments 4etained 3arnin!s after ad1ustments *nswer: a ") c $) a ,) d -) a /) c 5) b 6) b 1.) d (6 ,,...) HH P ,$ ,,... P/,.,... 1/,,... P6 ,,... P 1"1,...

15-9.

(P 1,,...) ( 1.,...) ( ".,...) P( ,,,...) P /-,...

15-10. 15-11.

1) c ) b

A4 Corporation *e!uirement $+% Part a 1% % "% (he le!al capital is P$1/,... (P 1.,... C P ./,...)% (he avera!e issuance price of the preference share is P1.6 per share A(P 1.,... C P15,6..) ,1.. sharesB% (he number of ordinary shares issued is 6,... shares (P ./,... P ")%

*e!uirement $2% Part b *$ +orporation +ontributed +apital 8ection of the 7alance 8heet 9ecember "1, ..+ontributed +apital 5= Preference shares, P1.. par (-,... shares authorized, ,,,. shares issued and outstandin!) <rdinary shares, no par $,... shares authorized, 1.,5.. shares issued and outstandin!)

P ,,,... --,.,. H

Substantive Tests of Owners E!uity Accounts Premium on preference shares *dditional paid&in capital from share subscription default *dditional paid&in capital from treasury shares (otal contributed capital H P ./,... C P 6,/.. C P1",-.. C P1,,/,. @ P --,.,. P15,6.. C P5,5.. G P1,1.. C P1, ,. @ P /,5,.

15-7

/,5,. 1.. 1,... P,,.,...

(he above schedule is supported by the followin! entries for the transactions that occurred in ..-: 2006 0ar% +ash (P1. x $..) 8ubscriptions 4eceivable (P11 x $..) Preference 8hares 8ubscribed (P1.. x $..) Premium on Preference 8hares +ash (P"" x 6..) <rdinary 8hares, no par (6.. shares) ;and (P"$ x $..) <rdinary 8hares, no par ($.. shares) +ash (P11 x ",.) Preference 8hares 8ubscribed (P1.. x ",.) 8ubscriptions 4eceivable Preference 8hares, P1.. par Preference 8hares 8ubscribed (,. x P1..) Premium on Preference 8hares (,. x P ) 8ubscriptions 4eceivable (,. x P11 ) +ash (,. x .%5 x P1.) *dditional Paid&in +apital from 8hare 8ubscriptions 9efault (reasury 8hares G <rdinary +ash (,.. x P"/) +ash <rdinary 8hares, no par (,.. shares) Preference 8hares, P1.. par Premium on Preference 8hares $,... $$,5.. $.,... 5,5.. 6,/.. 6,/.. 1",-.. 1",-.. "6, .. ",,... "6, .. ",,... ,,... 1,1.. ,,-.. $.. 1.. 15,,.. 15,,.. /,... 1,,/,.H 1.,... 1, ,.

*pr% " 1" 0ay 1

Iune 1 <ct% 16

,.. x P", (,.. x P",) C (1.. x P1 ,)

15-8

Solutions Manual to Accompany Applied Auditing, 2006 Edition H <rdinary shares: P /,... x Preference shares: P /,... x
1.. x P1 , (,.. x P",) C (1.. x P1 ,)

@ P1,,/,. @ P11, ,. P /,... 15,,.. 1,... 1,-..H 1,-.. @ P 1,-.. .,$..H .,$.. @ P .,$..

:ov%1- +ash (P"6 x ,..) (reasury 8hares *dditional Paid&in +apital from (reasury 8hares 9ec%"1 4etained 3arnin!s +ash

16,,..

H <rdinary dividends: (6,... C 6.. C $.. C ,..) x P "1 H 15-12. 4etained 3arnin!s +ash Preferred dividends: ( ,1.. C ",. C 1..) x (.%.5 x P1..)

Partner Corporation Partner +orporation 8hareholders 3quity 9ecember "1, ..8hare capital Preference shares, P$ cumulative, par value P,. per share> authorized ,.,... shares, issued and outstandin! 1.,... shares <rdinary shares, par value P1 per share> authorized ,..,... shares, issued 1,.,... shares, and outstandin! 1$.,... shares (otal share capital *dditional paid&in capital G ordinary 'n excess of par value 2rom sale of treasury shares (otal paid&in capital 4etained earnin!s *ccumulated other comprehensive income (loss) Jnrealized decrease in value of available for sale securities (otal paid&in capital, retained earnin!s, and accumulated other comprehensive income (loss) ;ess: (reasury shares, 1.,... shares at cost

P ,..,... 1,.,... P -,.,... 1,,-.,... ,.,... P ,$-.,... "1,... ( ,,...) P ,---,... (15.,...)

Substantive Tests of Owners E!uity Accounts (otal shareholders equity

15-9

P ,$5-,...

15-13.

Del ! Company *e!uirement $+% 9el&K +ompany 8tatement of 4etained 3arnin!s 2or Lear 3nded 9ecember "1, ..4etained earnin!s, as previously reported, Ianuary 1, ..;ess: +orrection of overstatement of previous net income (net of P,,$.. income tax credit) *d1usted retained earnin!s, Ianuary 1, ..*dd: :et income ;ess: +ash dividends 8hare dividends 4eduction due to retirement of preference shares 4etained earnin!s, 9ecember "1, ..- (8ee :ote *) *e!uirement $2% ,ote A: 4etained earnin!s are restricted in the amount of P1$,..., the cost of the ordinary shares bein! held as treasury shares% P 6,... -,... $.,... P .-,... (1 ,-..) P16",$.. ,5,... P ,1,$.. (,,,...) P16-,$..

15-14.

"IC# Corporation *e!uirement $+% a% Mrite&down of property and equipment 4etained 3arnin!s (P5.,... G P$,,...) *ccumulated 9epreciation b% Mrite&down of inventories 4etained 3arnin!s +urrent *ssets (inventories) c% Mrite&down of accounts receivable -,... -,... ",,... ",,...

15-10

Solutions Manual to Accompany Applied Auditing, 2006 Edition 4etained 3arnin!s +urrent *ssets (accounts receivable) ",... ",...

d%

+han!e in par value of ordinary shares <rdinary 8hares, P1. par <rdinary 8hares, P1 par *dditional Paid&in +apital on <rdinary 8hares 1..,... 1.,... 6.,...

e%

3limination of retained earnin!s deficit *dditional Paid&in +apital on <rdinary 8hares 4etained 3arnin!s H 11$,... 11$,...

H P11$,... @ P/.,... deficit C P",,... C P-,... C P",... *e!uirement $2% 4'+L +orporation 7alance 8heet 9ecember "1, ..+urrent assets Property and equipment ;ess: *ccumulated depreciation (otal assets ;iabilities <rdinary shares, P1 par *dditional paid&in capital on ordinary shares 4etained earnin!s (see :ote *) (otal liabilities and shareholders equity :otes to 2inancial 8tatements ,ote A: 4etained earnin!s as of 9ecember "1, ..- has a zero balance due to a quasi&reor!anization on that date% *t that time, net assets were revalued, the par value of ordinary share was reduced from P1. to P1 per share, and a P11$,... deficit was char!ed a!ainst additional paid&in capital% 15-16. $TC Company P 11,... 11.,... (-,,...) P ,-,... P ".,... 1.,... 1-,... . P ,-,...

Substantive Tests of Owners E!uity Accounts *e!uirement $+% &reference P .,... P .,... P$.,... .,... P-.,... P .,... .,... $,... P$$,...

15-11

Ordinary P-.,... P-.,... .,... P .,...

a% Preferred dividend ( ,... x .%1. x P1..) 4emainder to ordinary (P5.,... G P .,...) (otal b% 9ividends in arrears ( x ,... x .%1. x P1..) +urrent preferred dividend ( ,... x .%1. x P1..) 4emainder to ordinary (P5.,... G P-.,...) (otal c% 9ividends in arrears (1 x ,... x .%1. x P1..) +urrent preferred dividends <rdinary proportional share (.%1. x ".,... x P1.) 4emainder shared H (P5.,... G P/.,...) (otal

P".,... -,... P"-,... @ P$,...

H Preference: P1.,... extra dividend x ( ,... x P1..) C (".,... x P1.) H <rdinary: P1.,... extra dividend x
P"..,... P,..,...

,... x P1..

@ P-,... P .,... P".,... 1.,... 1,,... ,,... P".,... P,.,...

d% Preference dividend <rdinary proportional share (.%1. x ".,... x P1.) Preference extra (.%., x P ..,...) <rdinary extra (.%., x P"..,...) 4emainder to ordinary (P5.,... G P/,,...)

*e!uirement $2% 9ividend yield Preference share: @

9ividends per share 0ar#et price per share P .,... E ,... P1 ,

P1. P1 ,

5=

<rdinary share:

P-.,... E ".,... P .

P P .

1.=

15-12
15-16.

Solutions Manual to Accompany Applied Auditing, 2006 Edition Empire Plastics 4ate of return on ordinary share equity: P 1",/15 P5/,,... C P"/,,... @ P 1",/15 P1, ,.,... @ 1/%1=

P1",,... @ 1"%,= P1,...,... 3mporia Plastics, 'nc% is tradin! on the equity successfully, since its return on ordinary share equity is !reater than interest paid on bonds% 4ate of interest paid on bonds payable: 15-17. M A C!"#!"$%&!' 0;* +orporation 8D*43D<;9348 3NJ'(L 9ecember "1, ../ Paid&in +apital: Preference shares, P1.. par value 1.,... shares authorized, $,... shares issued O outstandin! <rdinary shares, P,. par value 1,,... shares authorized, 5,... shares issued /,/.. shares outstandin! *dditional Paid&in +apital: Paid&in capital in excess of parP preference Paid&in capital in excess of parP ordinary Paid&in capital from treasury sharesP preference (otal Paid&in +apital 4etained 3arnin!s: ;ess cost of treasury shares (".. sharesPordinary) (otal 8hareholders 3quity HP-1.,... G P"1 ,-.. G (P- Q 1,... shares)

P$..,...

$..,...

P 5..,...

, ,... -1,... $,/.. 11/,/.. 61/,/.. ",,$..H 1,1,",1.. 16,5.. P1,1"","..

Substantive Tests of Owners E!uity Accounts 15-18. O()**+), I'-. (a) 7asic formulas: Kalue of bonds without warrants Kalue of bonds without warrants C Kalue of warrants Kalue of warrants Kalue of bonds without warrants C Kalue of warrants P1"-,... P1"-,... C P $,... P $,... P1"-,... C P $,...

15-13

Q 'ssue price @ Kalue assi!ned to bonds

Q 'ssue price @ Kalue assi!ned to warrants Kalue assi!ned to bonds Kalue assi!ned to warrants (otal

Q P1, ,... @ P1 6, .. ,5.. Q P1, ,... @ P1, ,...

+ash%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%% 9iscount on 7onds Payable%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%% (P1/.,... G P1 6, ..) 7onds Payable%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%% Paid&in +apitalP8hare Marrants%%%%%%%%%%%

1, ,... $.,5.. 1/.,... ,5..

(b) Mhen the warrants are non&detachable, separate reco!nition is not !iven to the warrants% (he accountin! treatment parallels that !iven convertible debt because the debt and equity element cannot be separated% (he entry if warrants were non&detachable is: +ash%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%% 9iscount on 7onds Payable%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%% 7onds Payable%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%% 15-19. %immy Corporation *e!uirement $a% :et income for year *dd: *d1ustment for interest (net of tax) H 0aturity value P6,,..,... "$,...H P6,/"$,... P,,...,... 1, ,... 15,... 1/.,...

15-14

Solutions Manual to Accompany Applied Auditing, 2006 Edition 8tated rate +ash interest 9iscount amortization A(1%.. G %65) Q P,,...,... Q 1E1.B 'nterest expense 1 G tax rate (",=) *fter&tax interest P,,...,...EP1,... @ ,,... debentures Q /= ",.,... 1.,... "-.,... Q .%-, P "$,...

'ncrease in diluted earnin!s per share denominator: ,,... Q 15 6.,... 3arnin!s per share: 7asic 3P8 9iluted 3P8 *e!uirement $b% 'f the convertible security were preference shares, basic 3P8 would be the same assumin! there were no preference dividends declared or the preference was noncumulative% 2or diluted 3P8, the numerator would be the net income amount and the denominator would be ,.6.,...% P6,,..,... R ,...,... @ P$%/, P6,/"$,... R ,.6.,... @ P$%--