Pamantasan ng Lungsod ng Valenzuela

College of Business Administration, Accounting and Public Administration

Practical Auditing
Name Equivalent
Section BSA 4 – 1 Date 27– FEBRUARY 2018

SUBSTANTIVE TEST OF PROPERTY, PLANT & EQUIPMENT

PROBLEM 1
On January 2, 2019, Brand X Corporation purchased a tract of land (site number 501) with a
building for P600,000. Additionally, Brand X paid a real estate broker’s commission of P36,000,
legal fees of P6,000, and title guarantee insurance of P18,000. The closing statement indicated
that the land value was P500,000 and the building value was P100,000. Shortly after acquisition,
the building was razed at a cost of P75,000.

Brand X entered into a P3,000,000 fixed-price contract with Brand X Builders, Inc. on March 2,
2019 for the construction of an office building on land site number 501. The building was
completed and occupied on September 30, 2020. Additional construction costs were incurred as
follows:

Plans, specifications, and blueprints P12,000

Architects’ fees for design and supervision 95,000

The company estimates that the building will have a 40-year life from date of completion and
decides to use the 150% declining-balance depreciation method.

To finance the construction cost, Brand X borrowed P3,000,000 on March 2, 2019. The loan is
payable in 10 annual installments of P300,000 plus interest at the rate of 14%. Brand X’s average
amounts of accumulated building construction expenditures were as follows:

For the period March 2 to December 31, 2019 P900,000

For the period January 1 to September 30, 2020 2,300,000

REQUIRED:
1. Prepare a schedule that discloses the individual costs making up the balance in the Land
account with respect to land site number 501 as of September 30, 2020.

2. Prepare a schedule that discloses the individual costs that the company should capitalize
in the Office Building account as of September 30, 2020. Show supporting computations
in good form.

3. Prepare a schedule showing the deprecation expense computation of the office building
for the year ended December 31, 2020.

PROBLEM 2
At December 31, 2019, certain accounts included in the property, plant, and equipment section
of the Brand X Company’s balance sheet had the following balances:

Land P100,000 Leasehold improvements P500,000

Buildings 800,000 Machinery and equipment 700,000

During 2020 the following transactions occurred:

1. Land site number 621 was acquired for P1,000,000. Additionally, to acquire the land Brand
X paid a P60,000 commission to a real estate agent. Costs of P15,000 were incurred to
clear the land. During the course of clearing the land, timber and gravel were recovered
and sold for P5,000.

2. A second tract of land (site number 622) with a building was acquired for P300,000. The
closing statement indicated that the land was P200,000 and the building value was,
P100,000. Shortly after acquisition, the building was demolished at a cost of P30,000. A
new building was constructed for P150,000 plus the following costs:
 Excavation fees P11,000
Architectural design fees 8,000
Building permit fee 1,000

The building was completed and occupied on September 29, 2020.

3. A third tract of land (site number 623) was acquired for P600,000 and was put on the
market for resale.

4. Extensive work was done to a building occupied by Brand X under a lease agreement that
expires on December 31, 2020. The total cost of the work was Pl 25,000, which consisted
of the following:

Painting of the ceilings P10,000 (estimated useful life is one year)

Electrical work 35,000 (estimated useful life is ten years)
Construction of extension to
current working area 80,000 (estimated useful life is thirty years)
P125,000

The lessor paid one-half of the costs incurred in connection with the extension to the
current working area.

5. During December 2020, costs of P65,000 were incurred to improve leased office space.
The related lease will terminate on December 31, 2013, and is not expected to be
renewed.

6. A group of new machines was purchased under a royalty agreement which provides for
payment of royalties based on units of production for the machines. The invoice price of
the machines was P75,000, freight costs were P2,000, unloading charges were P1,500,
and royalty payments for 2020 were P13,000.

REQUIRED:
1. Prepare a detailed analysis of the changes in each of the following balance sheet accounts
for 2020: (a) Land (b) Leasehold improvements (c) Buildings, and (4) Machinery and
equipment. Disregard the related accumulated depreciation accounts.

2. List the items in the fact situation which were not used to determine the answer to
Requirement 1, and indicate where, or if, these should be included in Brand X’s financial
statements.

PROBLEM 3
The Brand X Company’s December 31, 2018 balance sheet follows:

Assets
Cash P540,000
Inventory 450,000
Prepaid rent 60,000
Machine P500,000
Less: Accumulated depreciation 135,000
P1,415,000

Liabilities and Equities

Accounts payable P400,000
Ordinary shares, P10 par 300,000
Additional paid-in capital 515,000
Retained earnings 200,000
P1,415,000

During 2019, the following transactions occurred:

1. To avoid paying monthly rent of P5,000 on existing plant facilities, the company decided
to buy a tract of land and construct a building of its own on it. On January 2, 2019, Brand
X exchanged 7,000 shares of its ordinary shares to acquire the land; the share was selling
 for P25 per share. Construction of the building also began on January 2, 2019. At the time,
Brand X borrowed funds by issuing a one-year, P500,000 note at 12% to help finance the
project. The principal and interest on the note are due January 2, 2020. Construction costs
(paid in cash) that occurred evenly throughout the year totaled P700,000. The building
was completed on December 30, 2019 and the move-in to the new building was to occur
during the next week.

2. On January 2, 2019, Brand X exchanged its one existing machine plus P60,000 for a
newer, similar machine with a fair value of P430,000. The exchange was with another
company in the same industry. The new machine is to be depreciated using straight-line
depreciation based on an economic life of 5 years and a residual value of P55,000.

3. Brand X-uses a FIFO perpetual inventory system. Brand X sold P350,000 of its inventory
for P800,000 cash, paid for its beginning accounts payable, and purchased P480,000 of
inventory on account during the year.

4. On July 31, 2019, Brand X declared and paid a P2.50 per share cash dividend to its
shareholders.

5. Brand X is subject to a 30% income tax rate, and income taxes are accrued at year-end.

REQUIRED:
Prepare Brand X’s income statement and statement of retained earnings for the fiscal year ended
December 31,2019 and a balance sheet as of December 31, 2019. Show all supporting Journal
entries and computations made during 2019.

PROBLEM 4
An equipment was acquired on January 1, 2014 for P5,000,000 and is expected to have a 10-
year life. Straight-line depreciation will be used.

On January 1, 2016, the asset is appraised at a gross replacement cost of P5,625,000 or

P4,500,000 sound value.

On January 1, 2019, the asset is appraised at a sound value of P2,000,000.

REQUIRED: Provide the entries to record the foregoing events.

PROBLEM 5
Presented below is information related to equipment owned by Brand X Company at December
31, 2019.

Cost P9,000,000
Accumulated depreciation to date 1,000,000
Expected future net cash flow 7,000,000
Fair value 4,800,000

Assume that Brand X will continue to use this asset in the future. As of December 31, 2019, the
equipment has a remaining useful life of 4 years.

REQUIRED:
1. Prepare the journal entry (if any) to record the impairment of the asset at December 31,
2019.
2. Prepare the journal entry to record depreciation expense for 2020.
3. The fair value of the equipment at December 31, 2020, is P5,100,000. Prepare the journal
entry (if any) necessary to record this increase in fair value.

PROBLEM 6
During 2019, the controller of the Brand X Company asked you to prepare correcting journal
entries for the following three situations:

1. Machine A was purchased for P400,000 on January 1, 2017. It had an estimated residual
value of P50,000 and an estimated service life of 10 years. It has been depreciated under
 the double-declining-balance method for 2 years. Now, at the beginning of the third year,
Brand X has decided to change to the straight-line method.

2. Machine B was purchased for P500,000 on January 1, 2014. Straight-line depreciation

has been recorded for 5 years, and the Accumulated Depreciation account has a balance
of P250,000. The estimated residual value remains at P50,000, but the service life is now
estimated to be 1 year longer than estimated originally.

3. Machine C was purchased for P200,000 on January 1, 2018. Double-declining-balance

depreciation has been recorded for 1 year. The estimated residual value of the machine
is P20,000 and the estimated service life is 5 years. The computation of the depreciation
erroneously included the estimated residual value.

REQUIRED:
Prepare any necessary correcting journal entries for each situation. Also prepare the journal entry
necessary for each situation to record the depreciation for 2019. (Assume that the debit is to
Depreciation Expense).

PROBLEM 7
Soon after December 31, 2019, the auditor requested a depreciation schedule for trucks of the
Brand X Trucking Company, showing the additions, retirements, depreciation, and other data
affecting the income of the company in the 4-year period 2016 to 2019, inclusive. The following
data were in the truck account as of January 1, 2016:

Truck no. 1 Purchased January 1, 2004 P120,000

Truck no. 2 Purchased July 1, 2004 104,000
Truck no. 3 Purchased January 1, 2015 128,000
Truck no. 4 Purchased July 1, 2015 150,000
Balance January 1, 2016 P502,000

The Accumulated Depreciation -Trucks account, previously adjusted to January 1, 2016 and duly
entered in the ledger, had a balance on that date of P164,600. This amount represented the
straight-line depreciation on the four trucks from the respective dates of purchase, based on a 5-
year life and no residual value. No debits had been made to this account prior to January 1, 2016.

Transactions between January 1, 2016 and December 31, 2019 and their record in the ledger
were as follows:

1. July 1, 2016: Truck no. 1 was sold for P10,000 cash. The entry was a debit to Cash and
a credit to Trucks, P10,000.

2. January 1, 2017: Truck no. 3 was traded for a larger one (no. 5) with a 5-year life. The
agreed purchase price was P120,000. The Brand X Company paid the other company
(which was also a trucking company) P17,800 cash on the transaction. The entry was a
debit to Trucks, P17,800, and a credit to Cash, P17,800.

3. July 1, 2018: Truck no. 4 was damaged in a wreck to such an extent that it was sold as
junk for P500 cash. Brand X Company received P9,500 from the insurance company. The
entry made by the bookkeeper was a debit to Cash, P10,000, and credits to Miscellaneous
Revenue, P500, and Trucks, P9,500.

4. July 1, 2018: A new truck (no. 6) was acquired for P120,000 cash and debited at that
amount to the Trucks account. The truck has a 5-year life.

Entries for depreciation had been made at the close of each year as follows: 2016, P88,400; 2017,
P54,360; 2018, P41,460; 2019, P28,560.

REQUIRED:
1. For each of the 4 years, calculate separately the increase or decrease in earnings arising
from the company’s errors in determining or entering depreciation or in recording
transactions affecting trucks.
 2. Prove your work by one compound journal entry as of December 31, 2019; the adjustment
of the Trucks account is to reflect the comet balances, assuming that the books have not
been closed for 2019.

PROBLEM 8
As the first auditor of the BRAND X Company you discover that the following entries have been
made in the property, plant, and equipment account:

Property, Plant, and Equipment

2018 Plant purchased 60,000 2018 Depreciation 6,310
Legal fees 700
Insurance 2,400
2019 Repairs 2,000 2019 Depreciation 6,879
Additional to building 10,000
2020 Repairs 3,000 2020 Machine sold 500
Insurance 2,800 Depreciation 7,421
Machine purchase 7,000

Additional information is discovered as follows:

1. The purchase of the plant included a building and machinery: When the plant was
purchased, an appraisal showed that the building was valued at P39,000 and the
machinery at P26,000.

2. Depreciation has been recorded each year at 10% of the balance in the account. The 10%
was chosen because the property is being depreciated over 10 years for tax purposes.
Subsequent investigation indicates that the expected lives at the time of acquisition were:
building 20 years, machinery 8 years.

3. Each insurance payment was made on January 1 and was for a 2-year account.

4. The machine that was sold in 2017 had an original cost of: P800.

5. All purchases and sales of property, plant, and equipment Items occurred at the beginning
of the year indicated.

REQUIRED:
Prepare adjusting entries at December 31, 2020, to correct the books assuming they have not
been closed for the year.

PROBLEM 9
The BRAND X Manufacturing Company started in business on January 1, 2015, by acquiring
three machines having costs of P52,400, P40,000, and P44,000, respectively. Since that date the
company has computed depreciation at 20% on the balance of the asset account at the end of
each year, which amount has been credited directly to the asset account. All purchases since
January 1, 2015, have been debited to the machinery account and the cash received from sales
has been credited to the account.

The following transactions took place.

a) On September 30, 2015, a machine was purchased on an installment basis. The list price
was P60,000, but 12 payments of P6,000 each were made by the company. Only the
monthly payments were recorded in the machinery account starting with September 30,
2015. Freight and installation charges of P2,000 were paid-and entered in the machinery
account on October 10, 2015.

b) On June 30, 2016, a machine was purchased for P80,000, 2/10, n/30, and recorded at
P80,000 when paid for on July 7, 2016.

c) On June 30, 2017, the machine acquired for P52,400 was traded for a larger one having
a list price of P93,000. Allowance of P43,000 was received on the old machine, the
balance of the list price being paid in cash and charged to the machinery account.
 d) On January 1, 2018, the machine which cost P44,000 was sold for P25,000, but because
the cost of removal and crating was P1,250, the machinery account was credited with only
P23,750.

e) On October 1, 2019, the machine purchased for P40,000 was sold for cash and the cash
received amounting to P8,000 was credited to the account.

REQUIRED: Prepare adjusting entries to correct the accounts as of December 31, 2019. Assume
a 5-year useful life for the machines purchased. Show supporting computations in good form.