Integrated Review Ceu PDF

8.
Audit Of Liabilities Page 1 of 28
CEU MANILA
AUDITING PROBLEMS
AUDIT OF LIABILITIES
SUBSTANTIVE AUDIT PROCEDURES FOR LIABILITIES
LIABILITIES
Existence: Recorded Completeness: All Right and obligations: Valuation and Presentation and
liabilities exist liabilities are recorded Liabilities are owned by allocation: Liabilities disclosure: Liabilities
the entity are valued in are classified and
accordance with GAAP disclosed in accordance
with GAAP
-Obtain from the client a -Perform purchases -Confirm recorded -Vouch accounts -Review financial
listing of accounts and cutoff examination liabilities directly with payable schedule statements and perform
notes payable as of -Test for unrecorded suppliers and creditors. -Test computation of analytical procedures to
year-end and reconcile liabilities -Review documentation accrued or prepaid determine whether
to the general ledger. -Perform analytical in client’s files. interest. accounts are classified
-Vouch recorded procedures. -Examine subsequent and disclosed in the
liabilities to the payments to credits. financial statements in
supplier’s statements. accordance with GAAP.
-Confirm recorded
liabilities directly with
suppliers and creditors.
Investigate differences
in liabilities reported in
the confirmations with
the recorded book
amounts.
-Examine bank
confirmations for loans.
ACCOUNTS PAYABLE AND PURCHASES

Internal Control Objectives Potential Errors and Irregularities
 Goods or services are purchased only with proper  Unauthorized purchases are incurred.
authorization.  Purchases are recorded but goods or services are not
 Goods or services received are recorded correctly as to received.
account, amount and period.  Liability is incurred but not recorded.
 Recorded acquisitions are for goods and services  Purchase amount is recorded incorrectly.
received.  Purchase is charged to wrong account or is recorded in
 Adjustments to vendor accounts are made in accordance wrong period.
with management’s authorization.  Purchases at other than favorable terms ae made to
 Only authorized goods and services are accepted and facilitate side deals for the personal benefit of
paid for. employees.
 Access to purchasing, receiving, and accounts payable  Misclassifications to conceal unauthorized purchases
records is adequately controlled to prevent or detect occurs.
duplicate or improper payments.  Purchase discounts are taken but not recorded; amount
of discounts is misappropriated.
PAYROLLS AND OTHER LIABILITIES

 Salary, wages and benefit expenses are incurred only for  Unauthorized work or work not performed is accrued.
work authorized and performed.  Accrual of employee benefits ( e.g. vacation pay, sick
 Salary, wages and benefit are calculated at the proper leave) is recorded but not earned.
rate.  There are fictitious employees on the payroll.
 Salary, wages, benefits, and related liabilities are  Employees’ earnings are over accrued or under accrued
recorded correctly as to account, amount and period. because of improper rates or computation errors
 Employee payroll withholdings and special deductions  Payroll costs, expenses, or related liabilities ae
are based on signed authorizations by employees. misclassified.
Other Liabilities  Payroll is recorded in period paid rather than in period
 Accruals for liabilities are approved by a responsible earned.
official, and detail subsidiary records are maintained and  Time cards or reports are padded.
reconciled periodically to the general ledger control Other Liabilities
accounts.  Unauthorized expenses are incurred.
 Expenses and accruals are misclassified, recorded at the
wrong amounts, or not recorded in the period incurred.
DEBT AND LEASE OBLIGATIONS

 Debt and lease obligations and related expenses are  The entity becomes obligated for debts that are not
authorized and recorded correctly as to account, amount properly authorized or that are taken on at unfavorable
and period terms.
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8. Audit Of Liabilities Page 2 of 28

 Requirements and restrictions imposed by debt  Long-term or short-term debt is misclassified
covenants and lease agreements are complied with and  Pledged assets or collateral are not identified and
monitored. disclosed; unauthorized pledging of assets occurs.
 Debt retirements and modifications have been properly  Violations of debt covenants or lease agreements result
accounted for. in default.
 Debt instruments and lease agreements are adequately  Capital leases are recorded as operating lease or vice
safeguarded. versa.
 Interest expense is recorded in the wrong period or at the
wrong amount, is not recorded, or is misclassified.
 Debt proceeds are used for purposes other than
business.
INCOME TAXES
 Provisions for income taxes and related liabilities and  Required estimated tax payments are not made.
deferrals are recorded correctly as to account, amount  Provision for income taxes or related tax liability is not
and period. reflected in the accounting records or is reflected at
 All tax returns are filed and related payments are made incorrect amounts.
in a timely manner.  Incorrect tax returns are filed; subsequent audits by
 Status of pending examinations by taxing authorities is taxing authorities result in material unrecorded liabilities.
monitored.  Tax expense is intentionally misstated to enhance results
of operations or financial position.
COMMITMENTS AND CONTINGENCIES

 Commitments and contingencies are identified and  Provisions for losses that are probable and reasonably
monitored estimable are not recorded.
 Commitments and contingencies are recorded or  Losses are incurred because of inadequate insurance
disclosed, if deemed appropriate. coverage.
 Legal and contractual matters are routed to in house or  Unfavorable claims, judgments, commitments, and
outside legal counsel. contingencies are not disclosed.
 Insurance coverage is adequate and is reviewed
regularly.
ESTIMATED LIABILITIES/ PROVISIONS (PAS 37)

- A liability whose either amount or timing is uncertain.
ACCRUED, under the following conditions:

1. Present obligation (legal or constructive) resulting from a past event or transaction (obligation event should have happened on or
before the balance sheet date)
2. It is probable that an outflow of economic benefits will be required to settle the obligation.
3. The amount of obligation should be capable of being reliable measured.
Common examples, of provision are: Product warranties and guarantees, Premiums and coupon obligations, Liability from litigations,
Guarantee of liability of others, Provisions from onerous contacts, Unlawful environment damages
ESTIMATED LIABILITIES FOR PREMIUMS/WARRANTIES/COUPONS

Total expense, per estimation policy XX
Less: Actual cost incurred to date (XX)
*Provision/Estimated Liability at year end XX
Note: for premiums, expense and liability shall be net cost (cost of prem. + additional processing costs – collections made prior to
distribution if there are any)
*Before accruing liability at year end, consider if all provision/estimated liability are still valid, that is, are still probable to be settled in the
next period (e.g. if warranty, consider warranty period)
REIMBURSEMENT OF PROBABLE LOSES UNDER PAS 37 – these are amounts expected to be received as reimbursement if entity
settles the provisions. Reimbursement shall be accounted for as follows:
1. If the entity has no obligation for the part of the expenditure to be reimbursed, the reimbursable amount shall be deducted against the
losses recognized in the income statement. The liability shall be presented in the balance sheet net of the reimbursable amount.
2. If the obligation for the amount expected to be reimbursed remains with the entity and reimbursement is Virtually Certain, the
reimbursements shall be accrued as an asset (receivable) in the balance sheet any may be offset the losses recognized in the income
statement. The amount recognized for the expected reimbursement should not exceed the liability.
3. If the obligation for the amount expected to be reimbursed remains with the entity and the reimbursement is not virtually certain, the
expected reimbursement is not recognized as an asset. The expected reimbursement may be disclosed.
CONTINGENT LIABILITIES
1. Possible obligation whose existence is to be determined in the future contingent upon the happening of a future event; or
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2. Present obligation, but is not accrued because it is either remotely possible that economic benefits will be required to settle the
obligation and / or the amount of the obligation is not capable of being reliably measured.
Recognition Criteria – Summary Asset, Liability and Contingency
Asset Virtually certain Recognize
Contingent asset Probable Disclose

Possible Do not disclose
Remote Do not disclose
Liability Virtually certain Recognize

Probable Recognize
Contingent liability Probable but not reliable Disclose

Possible Disclose
Remote Do not disclose
But Contingent liability in a business combination Probable and Reliable Recognize
Range ( Degree) of probability – IAS 37 recognize four degrees of probability for contingencies but it gives no guidance as to
the meaning of the terms, one possible interpretation could be:
Virtually certain 96% more
Probable 51% to 95%
Possible 5% to 50%
Remote Below 5%
Refinancing and Breach of Contract
Refinancing: Generally, a currently maturing obligation has to be presented as current liability. A currently maturing obligation may be
presented as a long term liability under refinancing agreement, only if:
1. The company has the prerogative/option/unconditional right to refinancing the liability OR
2. If there is no prerogative but the refinancing agreement was completed before or at the balance sheet date.
Note: Refinancing may be thru: a) extension of maturity date, b) issuance of stocks or bonds The proceeds of which is used to settle
the currently maturing obligation.
Breach of Contract: Generally, if the company breaches a covenant or contract the long-term obligation becomes due and
demandable, thus is presented as long-term only under the following conditions:
1. If the creditor agreed to give the debtor a grace period for at least 12 months after the balance sheet date
AND
2. The said grace period should have been provided on or before the balance sheet date.
BONDS PAYABLE
Bonds Issued at a Discount (Proceed < Face Value; Effective Interest > Nominal Interest)
- Discount is a transaction loss (amount received / proceed is lower than the amount to be paid / face value) to be amortized
over the remaining term of the bonds using the EFFECTIVE INTEREST METHOD.
- The amortization is added to the related expense – INTEREST EXPENSE
Dr : Interest Expense XX
Cr ; discount on bonds payable XX
- as a result of the amortization, the interest expense recognized in the income statement is higher than the interest paid and /
or accrued. The difference is the amount of amortization.
- Correct interest is computed as : (Carrying value of Bonds * Effective interest)
- Nominal interest is computed as : (Face value of Bonds * Nominal interest)
Bonds issued at a Premium (Proceeds > Face Value ; Effective Interest < Nominal Interest)
- premium is a transaction gain (amount received / proceed is higher than the amount to be paid / face value) to be amortized
over the remaining term of the bonds using the EFFECTIVE INTEREST METHOD.
- The amortization is deducted from the related expense – INTEREST EXPENSE
Dr; Premium on Bonds Payable XX
Cr; Interest Expense XX
- as a result of the amortization, the interest expense recognized in the income statement is lower than the interest paid /
accrued. The difference is the amount of amortization.
Bond Issue Costs – are deducted from net cash proceeds, thus in the process are deducted from premium or added to discount on
bonds payable (after which a new effective interest rate shall be computed)
Retirement of Bonds – if bonds are retired prior to their maturity dates, gain or loss shall be recognized in the profit or loss (difference
between the retirement price and updated amortized cost of the bonds).
Accrued Interest – in accounting for bond issuance and retirement, consider inclusion of accrued interest specifically if bonds were
issued or retired in between interest payment dates.
CONVERTIBLE BONDS
1. ISSUANCE – Proceed from the issuance of Convertible Bonds should be allocated between the debt component (bonds
payable) and the equity component (Share Premium form Bond Conversion Privilege)
using the RESIDUAL APPROACH. To wit, the pro-forma entry to record issuance is:
Dr: Cash XX
Dr: Discount on Bonds Payable XX (or)
Cr: Premium on Bonds Payable XX
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Cr: Bonds Payable XX

Cr: Share Premium from Bonds Conv. Priv. XX
2. CONVERSION – If Convertible bonds are converted into ordinary shares, the carrying value of the bonds (updated
amortized bonds payable) shall be cancelled out. The difference between the carrying value of the bonds and the aggregate
par value of the converted shares shall be credited to share premium account. An allowed alternative is the cancel out the
equity component originally credited to share premium account upon issuance of the bonds. The same shall be added to the
amount credited to the share premium account upon conversion. To wit, the pro-forma entry to the record the conversion is:
Alternative 1 Alternative 2
Dr: Bonds Payable XX Dr: Bonds Payable XX
Dr: Premium on Bonds Payable XX (or) Dr: Sh Prem from Bond Conv. Priv. XX
Cr: Discount on Bonds Payable XX Dr: Premium on Bonds Payable XX (or)
Cr: Ordinary Shares XX Cr: Discount on Bonds Payable XX
Cr: Share Premium XX Cr: Ordinary Shares XX
Cr: Share Premium XX
EARLY RETIREMENT – If Convertible bonds are retired prior to maturity date, the retirement price shall be allocated between the Bonds
and the equity component, consistent with how the original issued price was allocated (Residual Approach). The difference between the
retirement price of the allocated to the debt component and the carrying value of the bonds payable shall be recognized in the income
statement, while the difference between the retirement price allocated to the equity component and the original share premium from
bond conversion privilege shall be credited to share premium account.
Debt restructuring is a situation where the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants to
the debtor concession that would not otherwise be granted in a normal business relationship.
1. Asset Swap – Transfer of assets (noncash) in full settlement of an obligation
Carrying value of debt being liquidated

Difference represents gain on restructuring
Fair value of assets being transferred
Difference represents gain or loss on transferred
Carrying value of assets being transferred
2. Equity Swap- Issuance of equity (capital stock) to settle a liability. The amount of liabilities extinguished will be the measure for
recording.

Difference represents gain on restructuring
Fair value of equity instruments issued (priority 1)
or Fair value of liability (priority 2)
Difference represents share premium
Par value of shares capital issued
3. Modification of terms- Modification of interest or maturity value or both.

Difference represents loss on debt restructuring
Total restructured liability at Present value Difference represents gain on debt restructuring
Modification of terms:
A. Substantial Modification : When the gain or loss is at least 10% of the CV of the old liability
 Derecognize the old liability
 Recognize the new liability
 Recognize the gain or loss but adjust the gain or loss for the amount of finance loss incurred
B. No Substantial Modification : When the gain or loss is below 10% of the CV of the old liability
 No derecognition of old liability and no recognition of new liability
 Gain or loss is not recognize
 Finance cost if any is to be deferred and amortized
 Need to compute the new effective rate
FOR LEASE PROBLEMS:

 Leases are generally OPERATING, unless FINANCE under specific criteria/requirements under PAS 17:
o 1. Transfer of ownership to lessee
o 2. Bargain purchase option
o 3. Term at least 75% of life of asset
o 4. PV of minimum lease payments (MLP) is at least 90% of the FMV of the leased asset
o 5. The asset is specialized in nature that only lessee can use with very minimal alterations.
Operating Lease (guidelines)

 Lease payments including lease bonuses shall be recognized as expense (lessee) or income (lessor) over the lease term on
the straight line basis, unless a more systematic method is warranted.
 Lease escalation clauses, provision for lease/rental holidays and uneven rental payments built into the lease contract must be
accounted for on a straight line basis, unless a more systematic method is warranted.
 Contingent rentals are recognized as expense (lessee) or income (lessor) when incurred/earned.
 Lease security deposits are generally treated as receivable/other asset (lessee) or payable (lessor)
 Direct lease expense (paid for by lessor) are either recognized as outright expense or as a deferred charged (added to the CV
of leased asset, and amortized as expense over lease term).
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 Usual routinary lease related expense (depreciation, property taxes, maintenance costs) are generally incurred by lessor and
are recognized as outright expense.
Finance Lease (guidelines, books of lessee)
 Upon inception, if payments are made in arrears ( at the end of each lease period)
DR: Asset (at FV/PV of MLP, whichever is lower) xxx
CR: Finance lease liability xxx
Or, if payments are made in advance (at the beginning of each lease period)
DR: Asset xxx
CR: Cash xxx
CR: Finance lease liability xxx
 Upon periodic payments

DR: Interest expense (CV of liability x effective %)xxx
DR: Finance lease liability (balancing figure) xxx
CR: Cash xxx
 Year-end depreciation, shall be computed as (Depreciable cost/lease term or useful life)

Depreciable cost shall be: Cost – Actual Residual Value or Guaranteed Residual Value (where applicable), whichever is lower.
Lease term is used if there is no transfer of ownership, while useful life is appropriate is ownership is transferred to lessee.
PFRS for SMESs, SEC 20, LEASES

-Operating lease payments are not recognized on a straight line basis when the payments are structured to increase in line with
expected general inflation
ACCOUNTING FOR TAXES

Pro-forma Computation of Taxable Income
Financial / Accounting income – pre tax X Permanent Differences. Events which do not have tax consequences.
Amount included in accounting income but never in taxable income. The
Permanent Differences: effect of permanent differences will never reverse or turn around in
+ NonDeductible Expenses X subsequent period. They are nontaxable revenue and nondeductible
- NonTaxable Revenues (X) expenses that are recognize in financial income.
Financial income subject to tax
Examples of nontaxable revenues:
1. Interest on government securities
Temporary Differences:
2. Interest on foreign currency deposit in the Philippines
+ Deductible temporary differences X 3. Dividend received
- Taxable temporary differences (X) 4. Proceeds from life insurance policies
Taxable income XX
Examples of nondeductible expenses:
1. Fines and penalties for violation of law
1. Determine the “Taxable Income” 2. Impairment on goodwill
Current tax expense = Taxable income x Tax rate 3. Premium payment on life insurance policies
Income tax expense xxxx Charitable contributions in excess of allowed
Income tax payable xxxx
Temporary/Timing Differences. They are differences between financial
2. Determine the and taxable income arising from business events that are recognized for
“Deductible Temporary Differences/Future Deductible Amounts” both financial and tax reporting purposes but a different time periods They
are differences between book and tax basis of assets and liabilities that will
– (Accounting income < Taxable income)
reverse over time
 Financial revenue < taxable revenue Examples:
 Financial expenses > deductible expenses Revenue:
 Asset per book < Asset Per ITR a. Rental income
 Liability per book > Liability per ITR b. Royalty income
 Create deferred tax asset c. Installment sales
 Taxable income = Financial income + FDA d. Other revenues creating temporary differences
Expenses:
a. Warranty expense
Deferred tax asset= Deductible Temporary Differences x Tax rate
b. Depreciation
Deferred tax asset xxxx c. Doubtful account expense
Income tax benefit xxxx d. Other expenses creating temporary differences
3. Determine the Financial Reporting Tax Reporting

“Taxable Temporary Differences/Future Taxable Amounts” Sales Accrual Basis Installment Basis
– (Accounting Income > Taxable Income)
 Financial revenue > taxable revenue Warranty expense Estimated Actual
 Financial expenses < deductible expenses
Rent revenue Accrual Upon receipt
 Asset per book> Asset Per ITR
 Liability per book < Liability per ITR Doubtful accounts Allowance method Direct write off
 Create deferred tax liability method
 Taxable income = Financial income – FTA
Depreciation ** SYD SLM
Deferred tax liability = Taxable Temporary Differences x Tax rate ** Difference in depreciation methods ( Financial accounting uses a
Income tax expense xxxx depreciation method different form method used in tax accounting)
Deferred tax liability xxxx
4. Total income expense for the year:

Current tax expense xxx
Deferred tax expense – taxable temporary differences xxx
Income tax benefit – deductible temporary differences (xxx)
Total income tax expense xxx
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Or
Total income tax expense = Financial income subject to tax x single tax rate (if multiple tax rate is not applicable)
PFRS for SMES Income tax (Section 29)

The PFRS for SMEs requires SMEs to measure deferred tax assets and liabilities at an amount that includes the effect of possible
outcomes of a review by the tax authorities since the uncertainty about whether the tax authorities will accept the amounts reported to
them by the entity affects the amount of the current tax and deferred tax. The entity shall use the probability-weighted average amount
of all possible outcomes. The effect on deferred tax expense arising from a change in the effect of the possible outcomes of a review by
the tax authorities shall be disclosed.
PROBLEMS
PROBLEM NO. 1 – Recognition and classification of liabilities
The Comprehensive Entity’s chief accountant provided the following information:
Notes payable:
Arising from purchase of goods P304,000
Arising from 5 year-bank loans, on which marketable securities
valued at P600,000 have been pledged as security, P400,000
due on June 30, 2013; P100,000 due on Dec. 31, 2013 500,000
Arising from advances by officers, due June 30, 2013 50,000
Reserve for general contingencies 400,000
Employees' income tax withheld 20,000
Advances received from customers on purchase orders 64,000
Containers' deposit 50,000
Accounts payable arising from purchase of goods,
net debit balances of P30,000. 170,000
Accounts receivable, net of credit balances P40,000 360,000
Cash dividends payable 80,000
Share dividends payable 100,000
Dividends in arrears on preferences shares 200,000
Convertible bonds, due January 31, 2014 1,000,000
Firsmortgage serial bonds, payable in semi-annual installments of
P50,000, due April 1 and October 1 of each year 2,000,000
Overdraft with Allied Bank 90,000
Cash in bank balance with PNB 390,000
Estimated liability for damages 160,000
Estimated liability on meeting guarantee for service requirements on
merchandise sold 120,000
Estimated liability for premiums 75,000
Deferred revenue 87,000
Accrued interest on bonds payable 360,000
Share warrants outstanding 120,000
Share options outstanding 210,000
Unused letters of credit 400,000
Notes receivable discounted 200,000
On March 1, 2013, the P400,000 note payable was replaced by an 18-month note for the same amount. The entity is considering
similar action on the P100,000 note payable due on December 31, 2013. The 2012 financial statements were authorized for issue on
March 31, 2013.
On December 1, 2012, a former employee filed a lawsuit seeking P200,000 for unlawful dismissal. The entity’s attorneys believe that
the suit is without merit. No court date has been set.
REQUIRED:
Determine the following as of December 31, 2012.
1. Total current liabilities

2. Total noncurrent liabilities
Requirement No. 1
NP - Arising from purchase of goods 304,000 Trade and other payables
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NP - Arising from 5 year-bank loans, P400,000 due on June

500,000 Borrowings
30, 2013; P100,000 due on Dec. 31, 2013
NP - Arising from advances by officers, due June 30, 2013 50,000 Trade and other payables
Employees’ income tax withheld 20,000 Trade and other payables
Trade and other payables

Advances received from customers on purchase orders 64,000
or Separate item
Containers’ deposit 50,000 Trade and other payables

Accounts payable arising from purchase of goods - gross
200,000 Trade and other payables
(P170,000+P30,000)
AR with credit balance 40,000 Trade and other payables
Cash dividends payable 80,000 Trade and other payables
First mortgage serial bonds - current portion (P50,000 x 2) 100,000 Borrowings - separate item
Overdraft with Allied Bank 90,000 Borrowings
Estimated liability for damages 160,000 Provisions
Estimated liability on meeting guarantee for service
120,000 Provisions
requirements on merchandise sold
Estimated liability for premiums 75,000 Provisions
Trade and other payables

Deferred revenue 87,000
or Separate item
Accrued interest on bonds payable 360,000 Trade and other payables

Current liabilities 2,300,000
Requirement No. 2
Convertible bonds, due January 31, 2014 1,000,000 Separate item
First mortgage serial bonds - noncurrent portion (P2M - P.1M) 1,900,000 Separate item
Noncurrent liabilities 2,900,000
Items not included:

Reserve for general contingencies – Equity
AP with debit balances - Trade and other receivables
Accounts receivable gross - Trade and other receivables
Share dividends payable – Equity
Dividends in arrears on preference shares - Disclose only
Cash in bank balance with PNB - Cash and cash equivalents
Share warrants outstanding - Equity (share premium)
Share options outstanding - Equity (share premium)
Unused letters of credit - Contingent liability
Notes receivable discounted - Contingent liability
Treatment of additional information:

Note refinancing – disclose
Lawsuit filed by former employee – ignore
PROBLEM NO. 2 – Classification of liabilities
You were able to obtain the following from the accountant for Okey Corp. related to the company’s liabilities as of December 31, 2012.
Accounts payable P 650,000

Notes payable - trade 190,000
Notes payable - bank 800,000
Wages and salaries payable 15,000
Interest payable 143,000
Mortgage notes payable - 10% 600,000
Mortgage notes payable - 12% 1,500,000
Bonds payable 2,000,000
The following additional information pertains to these liabilities.
a. Bank notes-payable include two separate notes payable to Allied Bank.

1. A P300,000 8% note issued March 1, 2010, payable on demand. Interest is payable every six months.
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2. A 1-year, P500,000, 11% note issued January 2, 2012. on December 30, 2012, Okey negotiated a written agreement
with Allied Bank to replace the note with a 2-year, P500,000, 10% to be issued January 2, 2013. The interest was
paid on December 31, 2012.
b. The 10% mortgage note was issued October 1, 2009, with a term of 10 years. Terms of the note give the holder the right to demand
immediate payment if the company fails to make a monthly interest payment within 10 days of the date the payment is due. As of
December 31, 2012, Okey is three months behind in paying its required interest payment.
c. The 12% mortgage note was issued May 1, 2006, within a term of 20 years. The current principal amount due is P1,500,000.
Principal and interest payable annually on April 30. A payment of P220,000 is due April 30, 2013. The payment includes interest of
P180,000.
d. The bonds payable is 10-year, 8% bonds, issued June 30, 2003. Interest is payable semi-annually every June 30 and December 31.
REQUIRED:
Determine the following as of December 31, 2012.

Requirement No. 1
Accounts payable 650,000 Trade and other payables
Notes payable – trade 190,000 Trade and other payables
Notes payable – bank (payable on demand) 300,000 Borrowings
Wages and salaries payable 15,000 Trade and other payables
Interest payable 143,000 Trade and other payables
Mortgage notes payable – 10% (with breach of covenant) 600,000 Borrowings
Mortgage notes payable – 12% (current portion) 40,000 Borrowings - separate item
Bonds payable (due, 6/30/13) 2,000,000 Borrowings
Current liabilities 3,938,000
Requirement No. 2
Notes payable – bank (refinanced) 500,000 Separate item
Mortgage notes payable – 12% (noncurrent portion) 1,460,000 Separate item
Noncurrent liabilities 1,960,000
PROBLEM NO. 3 – Classification of liabilities
Dallas Corporation is selling audio and video appliances. The company’s fiscal year ends on March 31. The following information
relates to the obligations of the company as of March 31, 2012:
Notes payable
Dallas Corporation has signed several long-term notes with financial institutions. The maturities of these notes are given below. The
total unpaid interest for all these notes amounts to P340,000 on March 31, 2012.
Due date Amount

April 31, 2012 P 700,000
July 31, 2012 900,000
February 1, 2013 800,000
April 30, 2013 1,200,000
June 30, 2013 1,500,000
P 5,100,000
Estimated warranties
Dallas has a one-year product warranty on some selected items. The estimated warranty liability on sales made during the 2010 – 2011
fiscal year and still outstanding as of March 31, 2011, amounted to P252,000. The warranty costs on sales made from April 1, 2011 to
March 31, 2012, are estimated at P630,000. The actual warranty costs incurred during 2011 – 2012 fiscal year are as follows:
Warranty claims honored on 2010 - 2011 sales P 252,000

Warranty claims honored on 2011 - 2012 sales 285,000
Total P 537,000
Trade payables
Accounts payable for supplies, goods, and services purchases on open account amount to P560,000 as of March 31, 2012.
Dividends
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On March 10, 2012 Dallas’ board of directors declared a cash dividend of P0.30 per ordinary share and a 10% ordinary share dividend.
Both dividends were to be distributed on April 5, 2012 to ordinary shareholders on record at the close business on March 31, 2012. As
of March 2012, Dallas has 5 million, P2 par value, ordinary shares issued and outstanding.
Bonds payable
Dallas issued P5,000,000, 12% bonds, on October 1, 2006 at 96. The bonds will mature on October 1, 2016. Interest is paid semi-
annually on October 1 and April 1. Dallas uses the straight line method to amortize bond discount.
REQUIRED:
Determine the following as of March 31, 2012.

Requirement No. 1
Notes payable - current (maturing up to 3/31/13) 2,400,000
Accrued interest - notes payable 340,000
Estimated warranty payable (P252,000 + P630,000 - P537,000) 345,000
Accounts payable 560,000
Cash dividends payable (5 million shares x P0.30) 1,500,000
Accrued interest - bonds payable (P5,000,000 x .12 x 6/12) 300,000
Total current liabilities 5,445,000
Requirement No. 2
Bonds payable:
Face value 5,000,000
Unamortized bond discount (P200,000 x 4.5/10) (90,000) 4,910,000
Notes payable - non current 2,700,000
Total non current liabilities 7,610,000
PROBLEM NO. 4 - Audit of liability for premiums and warranties
Nuggets’ Music Emporium carries a wide variety of music promotion techniques warranties and premiums – to attract customers.
Musical instrument and sound equipment are sold in a one-year warranty for replacement of parts and labor. The estimated warranty
cost, based on past experience, is 2% of sales.
The premium is offered on the recorded and sheet music. Customers receive a coupon for each peso sent on recorded music or sheet
music. Customers may exchange 200 coupons and P20 for an AM/FM radio. Nuggets pays P34 for each radio and estimates that 60%
of the coupons given to customers will be redeemed.
Nuggets’ total sales for 2012 were P7,200,000 – P5,400,000 from musical instrument and sound reproduction equipment and
P1,800,000 from recorded music and sheet music. Replacement parts and labor for warranty work totaled P164,000 during 2012. A
total of 6,500 AM/FM radio used in the premium program were purchased during the year and there were 1,200,000 coupons redeemed
in 2012.
The accrual method is used by Nuggets to account for the warranty and premium costs for financial reporting purposes. The balance in
the accounts related to warranties and premiums on January 1, 2012, were as shown below:
Inventory of Premium AM/FM radio P 39,950

Estimated Premium Claims Outstanding 44,800
Estimated Liability from Warranties 136,000
REQUIRED:
Based on the above and the result of your audit, determine the amounts that will be shown on the 2012 financial statements for the
following:
1. Warranty expense
2. Estimated liability from warranties
3. Premium expense
4. Inventory of AM/FM radio
5. Estimated liability for premiums
Requirement No. 1
Warranty expense (P5,400,000 x .02) 108,000
Requirement No. 2
Estimated liability from warranties, 1/1/12 136,000
AP-8
Add warranty expense for 2012 108,000

Total 244,000
Less actual expenditures for 2012 164,000
Estimated liability from warranties, 12/31/12 80,000
Requirement No. 3
Premium expense [(1,800,000 x .6)/200 x P14] 75,600
Requirement No. 4
Inventory of premium, 1/1/12 39,950
Add premium purchases (6,500 x P34) 221,000
Total premiums available 260,950
Less premiums issued (1,200,000/200 x P34) 204,000
Inventory of premiums, 12/31/12 56,950
Requirement No. 5
Estimated premium claims outstanding, 1/1/12 44,800
Add premium expense for 2012 75,600
Total 120,400
Less premiums issued (1,200,000/200 x P14) 84,000
Estimated premium claims outstanding, 12/31/12 36,400
PROBLEM NO. 5 – Audit of provisions and contingencies
Relevant extracts from Magic Corporation’s financial statements at 31 December 2011 are as follows:
Current liabilities
Provision for warranties P 405,000
Non-current liabilities
Provision for warranties 270,000
Note 10 – Contingent liabilities

Magic is engaged in litigation with various parties in relation to allergic reactions to traces of peanuts alleged to have been found in
packets of fruit gums. Magic strenuously denies the allegations and, as at the date of authorizing the financial statements for issue, is
unable to estimate the financial effect, if any, of any costs or damages that may be payable to the plaintiffs.
The provision for warranties at 31 December 2011 was calculated using the following assumptions: There was no balance carried
forward from the prior year.
Estimated costs of repairs - products with minor defects P1,500,000

Estimated costs of repairs - products with major defects P9,000,000
Expected % of products sold during 2011 having no
defects in 2012 80%
Expected % of products sold during 2011 having minor
defects in 2012 15%
Expected % of products sold during 2011 having major
defects in 2012 5%
Expected timing of settlement of warranty payments
those with minor defects All in 2012
Expected timing of settlement of warranty payments 40% in 2012,
those with major defects 60% in 2013
During the year ended 31 December 2012 the following occurred:
1. In relation to the warranty provision of P675,000 at 31 December 2011, P300,000 was paid out of the provision. Of the amount paid,
P225,000 was products with minor defects and P75,000 was products with major defects, all of which related to amounts that had been
expected to be paid in 2012.
2. In calculating its warranty provision for 31 December 2012, Magic made the following adjustments to the assumptions used for the
prior year:
Estimated costs of repairs - products with minor defects No change

Estimated costs of repairs - products with major defects P7,500,000
AP-8
Expected % of products sold during 2012 having no

defects in 2013 85%
Expected % of products sold during 2012 having minor
defects in 2013 13%
Expected % of products sold during 2012 having major
defects in 2013 2%
Expected timing of settlement of warranty payments
those with minor defects All in 2013
Expected timing of settlement of warranty payments 20% in 2013,
those with major defects 80% in 2014
3. Magic determined that part of its plant and equipment needed an overhaul – the conveyer belt on one of its machines would need to
be replaced in about December 2013 at an estimated cost of P500,000. The carrying amount of the conveyer belt at 31 December 2011
was P280,000. Its original cost was P400,000.
4. Magic was unsuccessful in its defense of the peanut allergy case and was ordered to pay P2,000,000 to the plaintiffs. As at 31
December 2012 Magic had paid P1,500,000.
5. Magic commenced litigation against one of its advisers for negligent advise given on the original installation of the conveyers belt
referred to in (4) above. In October 2012 the court found in favor of Magic. The hearing for damages had not been scheduled as at the
date the financial statements for 2012 were authorized for issue. Magic estimated that it would receive about P500,000.
6. Magic signed an agreement with Choko Bank to the effect that Magic would guarantee a loan made by Choko Bank to Magic’s
subsidiary, UN Ltd. UN’s Ltd. Loan with Choko Bnak was P3,000,000 as at 31 December 2012. UN Ltd. Was in a strong financial
position at 31 December 2012.
REQUIRED:
Determine the following as of and for the year ended December 31, 2012.
1. Net amount to be recognized in profit or loss

2. Total current provisions
3. Total noncurrent provisions
No defects - 85% -
Minor defects (P1,500,000 x .13) 195,000 1,500,000 9,000,000
Major defects (P7,500,000 x .02) 150,000 15% 5%
Increase in provision in 2012 345,000 225,000
Unused amounts reversed in 2012 (P180,000 - P75,000) (105,000) 450,000
Warranty expense in 2012 240,000 40%
75,000 180,000 105,00
Balance, 1/1/12 (P405,000+270,000) 675,000

Amounts used in 2012 (300,000)
Increase in provision in 2012 345,000
Unused amounts reversed in 2012 (105,000)
Balance, 12/31/12 615,000
Alternative computation:
New provision 345,000
Balance of provision from 2010 payable in 2012 270,000
Balance, 12/31/12 615,000
Current portion of Provision for warranties

Balance of provision from 2011 payable in 2013 270,000
2012 provision:
Minor
defects 195,000
Major defects (P150,000 x .2) 30,000
495,000
Provision for warranties, 12/31/12 615,000

Less current provision for warranties 495,000
Noncurrrent provision for warranties 120,000
AP-8
Notes:
1. The expected overhaul is not a provision, as the entity has no present
obligation to conduct the overhaul. Rather, it is evidence that the
conveyer belt’s useful life has been shortened.
2 . The unpaid amount of P500,000 owing as a result of the peanut allergy case
should be included as part of trade and other payables as there is no uncertainty
regarding timing or amount of settlement and hence it is not a provision.
3. The entity's guarantee of the loan made by Choko Bank to UN Ltd
would be disclosed as a contingent liability rather than recorded as a provision
because UN Ltd was in a strong financial position at 31 December 2011
and therefore whilst the entity has a present obligation under the guarantee,
it is not probable that an outflow of economic benefits will be required to settle
the obligation.
PROBLEM NO. 6 – Audit of bonds payable
In your initial audit of Bulls Co., you find the following ledger account balances.
12%, 25-year Bonds Payable, 2008 issue

01/01/08 CR P 1,600,000
Treasury Bonds
10/01/12 CD P 216,000
Bond Premium
01/01/08 CR P 80,000
Interest Expense
01/01/12 CD P 96,000
07/01/12 CD 96,000
The bonds were redeemed for permanent cancellation on October 1, 2012 at 105 plus accrued interest.
REQUIRED:
1. Compute for the adjusted balances of following:

(use straight line amortization method)
a. Adjusted balance of bonds payable as of December 31, 2012
b. Unamortized bond premium on December 31, 2012
c. The total bond interest expense for the year 2012
d. The gain or loss on bond redemption
2. Adjusting entries as of December 31, 2012
Requirement No. 1.a

Total bonds issued 1,600,000
Face value of bonds retired {P216,000/[1.05 + (.12 x 3/12)]} 200,000
Adjusted balance of bonds payable, 12/31/12 1,400,000
Requirement No. 1.b

Unamortized bond premium, 12/31/12 (P80,000 x 14/16 x 20/25) 56,000
Requirement No. 1.c
Nominal interest
Remaining bonds (P1,400,000 x .12) 168,000
Bonds retired (P200,000 x .12 x 9/12) 18,000
Total 186,000
Less premium amortization
Bonds retired (P80,000/25 x 2/16 x 9/12) 300
Remaining bonds (P80,000/25 x 14/16) 2,800 3,100
Bond interest expense 182,900
AP-8
Requirement No. 1.d

Carrying amount of bonds retired
Face value 200,000
Unamortized bond premium
(P80,000 x 2/16 x
20.25/25) 8,100 208,100
Redemption price (P200,000 x 1.05) 210,000
Gain (Loss) on bond redemption (1,900)
Requirement No. 2
AJE 1 - To correct recording of bond retirement (see requirement 1.d)

Bonds payable 200,000
Premium on bonds payable 8,100
Interest expense (P200,000 x .12 x 3/12) 6,000
Loss on bond retirement 1,900
Treasury bonds 216,000
AJE 2 - To correct non-recording of premium amortization

Premium on bonds payable 15,900
Retained earnings (P80,000 x
4/25) 12,800
Interest expense (see requirement 1.c) 3,100
AJE 3 - To correct entry made on 1/1/12 on Interest expense

Retained earnings 96,000
Interest expense 96,000
AJE 4 - To correct non-accrual of interest expense at 12/31/12

Interest expense (P1.4M x .12 x 6/12) 84,000
Interest payable 84,000
PROBLEM NO. 7 – Audit of bonds payable
On January 1, 2011, Thunder Corporation issued 2,000 of its 5-year, P1,000 face value 11% bonds dated January 1 at an effective
annual interest rate (yield) of 9%. Interest is payable each December 31. Thunder uses the effective interest method of amortization.
On December 31, 2012, the 2,000 bonds were extinguished early through acquisition in the open market by Thunder for P1,980,000
plus accrued interest.
On July 1, 2011, Thunder issued 5,000 of its 6-year, P1,000 face value, 10% convertible bonds at par. Interest is payable every June
30 and December 31. On the date of issue, the prevailing market interest rate for similar debt without the conversion option is 12%. On
July 1, 2012, an investor in Thunder’s convertible bonds tendered 1,500 bonds for conversion into 15,000 ordinary shares of Thunder,
which had a fair value of P105 and a par value of P1 at the date of conversion.
REQUIRED:
Based on the above and the result of your audit, determine the following:
(Round off present value factors to four decimal places.)
1. Issue price of the 2,000 5-year bonds.

2. Carrying amount of the 2,000 5-year bonds at December 31, 2011
3. Gain on early retirement of bonds on December 31, 2012
4. Equity component of the 6-year bonds
5. Increase share premium as a result of the conversion of the 1,500 6-year
Requirement No. 1
PV of principal (P2,000,000 x 0.6499) 1,299,800
PV of interest [(P2,000,000 x .11) x 3.8897] 855,734
Issue price 2,155,534
Requirement No. 2
Carrying amount, 1/1/11 (see no. 1) 2,155,534
Less premium amortization for 2011:
Nominal interest (P2,000,000 x .11) 220,000
Effective interest (P2,155,534 x .09) 193,998 26,002
Carrying amount, 12/31/11 2,129,532
AP-8
Requirement No. 3
Retirement price 1,980,000
Carrying amount, 12/31/12:
Carrying amount, 12/31/11 (see no. 1) 2,129,532
Less premium amortization for 2012:
Nominal interest (P2,000,000 x .11) 220,000
Effective interest (P2,129,532 x .09) 191,658 28,342 2,101,190
Gain early retirement of bonds 121,190
Retirement price 1,980,000
Gain early retirement of bonds 121,286
Requirement No. 4
Total proceeds 5,000,000
Less liability component:
Present value of the principal (P5,000,000 x 0.4970) 2,485,000
Present value of the interest [(P5,000,000 x .05 x 8.3838) 2,095,950 4,580,950
Equity component 419,050
Requirement No. 5
PV of principal (P1,500,000 x 0.5584) 837,600
Par value of shares issued (15,000 shares x P1) 15,000
Net increase in share premium 1,374,608
PROBLEM NO. 8 – Convertible bonds payable
On January 1, 2007, Calauag Corporation issued a 10 per cent convertible bonds with a face value of P4,000,000 maturing on
December 31, 2016. Each P1,000 bond is convertible into ordinary shares of Calauag at a conversion price of P25 per share. Interest is
payable half-yearly in cash. At the date of issue, Calauag could have issued nonconvertible debt with a ten-year term bearing a coupon
interest rate of 11 per cent.
On January 1, 2012, the convertible bonds has a fair value of P4,400,000. Calauag makes a tender offer to the holders to repurchase
the bonds for P4,400,000. The holders of the P2,000,000 bonds accepted the offer. At the date of repurchase, Calauag could have
issued non-convertible debt with a five-year term bearing a coupon interest rate of 8 per cent.
On December 31, 2012,to induce the holders of the remaining bonds to convert the bonds promptly, Calauag reduced the conversion
price to P20 if the bonds are converted before March 1, 2013 (ie within 2 months). The market price of Calauag’s ordinary shares on
the date the terms are amended is P32 per share.
REQUIRED:
1. The proceeds from issuance of convertible bonds to be allocated to the equity component.
2. Carrying amount of the bonds at December 31, 2011
3. Amount to be recognized in profit or loss as a result of the repurchase of the bonds on January 1, 2012.
4. Decrease in equity as a result of the repurchase of the bonds on January 1, 2012
5. Amount to be recognized in profit or loss as a result of the amendment of the terms on December 31, 2012 is
Requirement No. 1
Issue price 4,000,000
Less liability component:
PV of principal (P4,000,000 x 0.3427) 0.3427 1,370,800
AP-8
PV of interest [(P4,000,000 x .05) x 11.9504] 11.9504 2,390,080

3,760,880
Equity component 239,120
Requirement No. 2
PV of interest [(P4,000,000 x .05) x 7.5376] 7.5376 1,507,520
Requirement No. 3
Carrying amount of bonds retired (P3,849,120 x 1/2) 1,924,560
PV of interest [(P2,000,000 x .05) x 8.1109] 8.1109 811,090
Retirement price - liability (Fair value of bonds retired, 1/1/12) 2,162,290 *bonds w/ out conversion right
Loss on retirement of bonds - profir or loss (237,730)
*This is the amount that you could
have paid for the early retirement of the bonds
Requirement No. 4
Retirement price (P4,400,000 x 1/2) 2,200,000
Less payment applied to liability component (see no. 3) 2,162,290
Retirement price - equity (residual amount) 37,710
Requirement No. 5
Ordinary shares to issued - amended terms (P2,000,000/P20) 100,000
Ordinary shares to issued - original terms (P2,000,000/P25) 80,000
Incremental ordinary shares to be issued 20,000
Fair value of incremental shares to be issued (20,000 x P32) 640,000
PROBLEM NO. 9 – Audit of leases
Ebony Ltd is asset rich but cash poor. In an attempt to alleviate its liquidity problems, it entered into an agreement on 1 July 2011 to sell
its processing plant to Ivory Ltd P467,100. At the date of sale, the plant had a carrying amount of P400,000 and a future useful life of
five years. Ivory Ltd immediately leased the processing plant back to Ebony Ltd. The terms of the lease agreements were:
Lease term 3 years

Economic life of plant 5 years
Annual rental payment, in arrears (commencing 30/6/12) P 165,000
Residual value of plant at end of lease term 90,000
Residual value guaranteed by Ebony Ltd 60,000
Interest rate implicit in the lease ?
The lease is cancelable, but only with permission of the lessor. At the end of the lease term, the plant is to be returned to Ivory Ltd. In
setting up the lease agreement Ivory Ltd incurred P9,414 in legal fees and stamp duty costs. The annual rental payment includes
P15,000 to reimburse the lessor for maintenance costs incurred on behalf of the lessee.
REQUIRED:
1. Interest rate implicit in the lease

2. Interest income to be recognized by the lessor for the fiscal period ended 30 June.
3. Carrying amount of the finance lease receivable to be reported by the lessor at 30 June 2012
4. Total lease-related expenses to be recognized by the lessee during the fiscal period ended 30 June 2012
5. Amount to be reported by the lessee under current liabilities as liability under finance lease as of 30 June 2012
Computation of net investment in the lease:

Fair value of asset 467,100
Initial direct cost (IDC) 9,414
476,514
Using 6%: Cash flow PVF at 6% PV
AP-8
PV of rental payments 150,000 2.6730 400,950

PV of GRV 60,000 0.8396 50,376
PV of MLP 451,326
PV of URV 30,000 0.8396 25,188
476,514
The interest rate implicit in the lease is the discount rate that, at the inception of the lease,
causes the aggregate present value of (a) the minimum lease payments and (b) the URV to be
equal to the sum of (i) the FV of the leased asset and (ii) any initial direct costs of the lessor.
Refer to the amortization schedule below.
Amortization schedule (Lessor)

Date Payment Interest (6%) Principal C.A.
7/1/11 476,514
6/30/12 150,000 28,591 121,409 355,105
6/30/13 150,000 21,306 128,694 226,411
6/30/14 240,000 13,589 226,411 -
Interest expense (see amortization schedule below) 27,080

Executory costs 15,000
Depreciation [(P451,326 - P60,000) / 3] 130,442
Lease related expenses 172,522
Amortization schedule (Lessee)

7/1/11 451,326
6/30/12 150,000 27,080 122,920 328,406
6/30/13 150,000 19,704 130,296 198,110
6/30/14 210,000 11,890 198,110 -
Interest rate implicit in the lease is the discount rate that causes the aggregate present value of the minimum lease
payment and the unguaranteed residual value ot equal the fair value of the lease asset and initial direct costs of the
lessor.
Guaranteed residual value -

Minimum lease payments
Unguaranteed residual value - ingnored in computing the depreciable amount.
URV - the present value of which is not included in the lease liability
URV - the lessee has no financial obligation but to return the leased asset to the lessor.
Executory cost
are ownership expenses such as maintenance, taxes and insurance for the leased property. Such executory costs
are expensed immediately when incurred.
PROBLEM NO. 10 – Audit of leases
Jackie Corporation has entered into an agreement to lease a machine to a Lessee Corporation. The lease agreement details are as
follows:
Length of lease 5 years

Commencement date 1 January 2012
Annual lease payment payable 31 December each year
commencing 31 December 2012 P8,000
AP-8
Fair value of the machine at 1 January 2012 P34,797

Estimated economic life of the machine 8 years
Estimated residual value of the asset at the end of its
economic life P2,000
Residual value at the end of the lease term, of which 50% is
guaranteed by Lessee Corporation P7,200
Interest rate implicit in the lease ?
The lease is cancelable, but a penalty equal to 50% of the total lease payments is payable on cancellation. Lessee Corporation does
not intend to buy the machine at the end of the lease term, Jackie Corporation incurred P1,000 to negotiate and execute the lease
agreement. Jackie Corporation purchased the machine for P34,797 just before the inception of the lease.
REQUIRED:
Based on the above and the result of your audit, answer the following:
1. The interest rate implicit in the lease is

2. Ignoring income taxes, if Jackie Corporation erroneously accounted for the transaction as an operating lease, its profit for 2012 will
be overstated by
3. The amount to be reported by Lessee Corporation under current liabilities as liability under finance lease as of December 2012 is
4. The depreciation amount to be recognized by Lessee Corporation for the year ended 31 December 2012 is
5. Ignoring income taxes, if Lessee Corporation erroneously accounted for the transaction as an operating lease, its profit for 2012 will
be overstated by
Requirement No. 1
Computation of net investment in the lease:
Fair value of asset 34,797
Initial direct cost (IDC) 1,000
35,797
Using 9%: Cash flow PVF at 9% PV

PV of GRV 3,600 0.6499 2,340
PV of MLP 33,457
PV of URV 3,600 0.6499 2,340
35,797
The interest rate implicit in the lease is the discount rate that, at the inception of the lease,
causes the aggregate present value of (a) the minimum lease payments and (b) the URV to be
equal to the sum of (i) the FV of the leased asset and (ii) any initial direct costs of the lessor.
Requirement No. 2
Profit under operating lease (As recorded)
Rent income 8,000
Depreciation [(P34,797 - P2,000)/8] (4,100)
IDC amortization (P1,000/5) (200)
3,700
Profit under finance lease (Should be)
Interest income (P35,797 x .09) 3,222
Over (Under) 478
Requirement No. 3
Computation of present value of MLP:
PV of GRV 3,600 0.6499 2,340
PV of MLP 33,457
The PV of the MLP is 96% (P33,457/P35,797) of the fair value of the leased asset.
Amortization schedule (Lessee)

1/1/12 33,457
12/31/12 8,000 3,011 4,989 28,468
12/31/13 8,000 2,562 5,438 23,030
12/31/13 8,000 2,073 5,927 17,103
AP-8
12/31/14 8,000 1,539 6,461 10,642

12/31/15 11,600 958 10,642 -
Requirement No. 4
Cost 33,457
Guaranteed residual value (3,600)
Depreciable amount 29,857
/ Lease term 5
Annual depreciation 5,971
Requirement No. 5
Expenses under operating lease (As recorded)
Rent expense 8,000
Expenses under finance lease (Should be)
Interest expense 3,011
Depreciation 5,971 8,982
Over (Under) (982)
Therefore, profit is overstated.
PROBLEM NO. 11 – Audit of income taxes
Roy Ltd has determined its accounting profit before tax for the year ended 30 June 2012 to be P256,700. Included in this profit are the
items of income and expense shown below.
Royal revenue (exempt from taxation) P 8,000

Proceeds on sale of building 75,000
Carrying amount of building sold 70,000
Entertainment expenses (non deductible) 1,700
Depreciation expense - buildings 7,600
Depreciation expense - plant 22,500
Doubtful debts expense 4,100
Annual leave expense 46,000
Insurance expense 4,200
Development expense 15,000
The company’s draft balance sheet as 30 June 2012 showed the following assets and liabilities:
Assets
Cash P 2,500
Accounts receivable 21,500
Allowance for doubtful debts (4,100) P 17,400
Inventory 31,600
Prepaid insurance 4,500
Land 75,000
Buildings 170,000
Accumulated depreciation (59,500) 110,500
Plant 150,000
Accumulated depreciation (67,500) 82,500
Deferred tax asset, (opening balance) 9,600
333,600
Liabilities
Account payable 25,000
Provision for annual leave 10,000
Deferred tax liability (opening balance) 27,270
Loan 140,000
202,270
Additional information
a. Quarterly income tax installments paid during the year were:
AP-8
28 October 2011 P18,000

28 January 2012 P17,500
28 April 2012 P18,000
with the final balance due on 28 July 2012.
b. The tax depreciation rate for plant (which cost P150,000 three years ago) is 20%. Depreciation on buildings is not deductible for
taxation purposes.
c. The building sold during the year had cost P100,000 when acquired six years ago. The company depreciates buildings at 5% p.a.,
straight-line.
d. During the year, the following cash amounts were paid:
Annual leave P52,000

Insurance 3,700
e. Bad debts of P3,500 were written off against the allowance for doubtful debts during the year.
f. The P15,000 spent (and expensed) on development during the year is not deductible for tax purposes until 30 June 2013.
g. Roy Ltd has tax losses amounting to P12,500 carried forward from prior years.
h. The company tax rate is 30%.
REQUIRED:
Compute for the following as of and for the fiscal period ended 30 June 2012:
1. Current tax expense

2. Current tax payable
3. Deferred tax liability
4. Deferred tax asset
5. Deferred tax expense (benefit)
Requirement No. 1
Accounting profit 256,700
Reversal of accounting items:
Royalty revenue (exempt from taxation) (8,000)
Gain on sale of building (P75,000 - P70,000)* (5,000)
Entertainment expense (non-deductible) 1,700
Depreciation expense - buildings 7,600
Depreciation expense - plant 22,500
Insurance expense 4,200
Development expense 15,000
344,800
Add (deduct) tax amounts:
Depreciation expense - plant (P150,000 x .2) (30,000)
Bad debts written off (item e) (3,500)
Annual leave paid (item
d) (52,000)
Insurance paid (item d) (3,700)
Tax losses from prior years (item g) (12,500)
Taxable profit 243,100
Tax rate 30%
Current tax expense 72,930
* Non assessable since depreciation is not deductible for tax purposes
Requirement No. 2
Current tax expense (see no. 1) 72,930
Less quarterly income tax installments paid 53,500
Current tax payable 19,430
Requirement No. 3
Total taxable temporary differences (see analysis below) 27,000
Tax rate 30%
Deferred tax liability, 6/30/12 8,100
AP-8
Requirement No. 4
Total deductible temporary differences (see analysis below) 29,100
Tax rate 30%
Deferred tax asset, 6/30/12 8,730
Comparison of carrying amount of asssets/liabilities and tax base

Carrying amount Tax base Difference Remarks
Accounts receivable 17,400 21,500 4,100 Deductible (4,100)
Prepaid insurance 4,500 - 4,500 Taxable 4,500
Buildings 110,500 110,500 - Permanent -
Plant 82,500 60,000 * 22,500 Taxable 22,500
Development expenditure - 15,000 15,000 Deductible (15,000)
Annual leave 10,000 - 10,000 Deductible 10,000
* P150,000 x 2/5
Requirement No. 5
Ending Beginning Inc(Dec) Effect on tax expense
Deferred tax liability 8,100 27,270 (19,170) Credit
Deferred tax asset 8,730 9,600 (870) Debit
Journal entry:
Deferred tax liability 19,170
Deferred tax asset 870
Income tax expense 18,300
PROBLEM NO. 12 – Audit of income taxes
The accounting profit before tax for the year ended December 31, 2012 for Belen Ltd amounted to P18,500 and included:
Depreciation - motor vehicle (25%) P 4,500

Depreciation - equipment (20%) 20,000
Rent revenue 16,000
Royalty revenue (exempt from tax) 5,000
Proceeds on sale of equipment 19,000
Carrying amount of equipment sold 18,000
The draft statement of financial position at December 31, 2012 contained the following assets and liabilities:
Assets 2012 2011

Cash P 11,500 P 9,500
Receivable 12,000 14,000
Allowance for doubtful debts (3,000) (2,500)
Inventory 19,000 21,500
Rent receivable 2,800 2,400
Motor vehicle 18,000 18,000
Acc. Dep. - motor vehicle (15,750) (11,250)
Equipment 100,000 130,000
Acc. Dep. - equipment -60,000 (52,000)
Deferred tax asset ? 5,550
P 135,200
2012 2011
Liabilities
Accounts payable 15,655 21,500
Provision for annual leave 4,500 6,000
Current tax liability ? 7,600
Deferred tax liability ? 2,745
37,845
AP-8
Additional information
 The company can claim a deduction of P15,000 (15%) for depreciation on equipment, but the motor vehicle is fully depreciated
for tax purposes.
 The equipment sold during the year had been purchased for P30,000 two years before the date of sale.
 The company tax rate is 30%.
REQUIRED:
Compute for the following as of and for the year ended 31 December 2012:
1. Current tax expense

2. Deferred tax liability
3. Deferred tax asset
4. Deferred tax expense (benefit)
Requirement No. 1
Accounting profit 18,500
Reversal of accounting items:
Depreciation - motor vehicle 4,500
Depreciation - equipment 20,000
Rent revenue (16,000)
Royalty revenue (exempt from taxation) (5,000)
Gain on sale of equip. (P19,000 - P18,000) (1,000)
29,800
Add (deduct) tax amounts:
Depreciation - motor vehicle -
Depreciation - equipment (15,000)
Rent revenue collected (P16,000 + P2,400 - P2,800) 15,600
Royalty revenue (exempt from taxation) -
Bad debts written off (P2,500 + P2,300 -
P3,000) (1,800)
Entertainment expense (non-deductible) -
Loss on sale of equip. - tax [P19,000 - (P30,000 x .7)] (2,000)
Annual leave paid (P5,000 + P6,000 - P4,500) (6,500)
Taxable profit 20,100
Tax rate 30%
Current tax expense 6,030
Requirement Nos. 2-4

Comparison of carrying amount of asssets/liabilities and tax base
Carrying
amount Tax base Difference Remarks
Receivables 9,000 12,000 3,000 Deductible (3,000)
Rent receivable 2,800 - 2,800 Taxable 2,800
Motor vehicle 2,250 - 2,250 Taxable 2,250
Equipment 40,000 55,000 a 15,000 Deductible (15,000)
Provision for annual leave 4,500 - 4,500 Deductible 4,500
a - [P100000-(P100000*0.15*3)]
b - (P12,000 + P3,000)
Requirement No. 2
Deferred tax liability, 12/31/12 (P5,050 x .3) 1,515
Requirement No. 3 6,750

Deferred tax asset, 12/31/12 (P22,500 x .3)
Requirement No. 4
Ending Beginning Inc(Dec) Effect on tax expense
Deferred tax liability 1,515 2,745 (1,230) Credit
Deferred tax asset 6,750 5,550 1,200 Credit
AP-8
Journal entry:
Deferred tax liability 1,230
Deferred tax asset 1,200
Income tax expense 2,430
PROBLEM NO. 13 – Audit of long term liabilities
In connection with your audit of Celtics Corporation’s financial statements for the year 2012, you noted the following liability account
balances as of December 31, 2011:
Note payable, bank P 5,600,000

Liability under finance lease 430,000
Deferrer tax liability 700,000
Transactions during 2012 and other information relating to Celtics liabilities were as follows:
a. The principal amount of the note payable is P5,600,000 and bears interest at 12%. The note is dated April 1, 2011 and
payable in four equal annual installments of P1,400,000 beginning April 1, 2012. The first principal and interest payment was
made on April 1, 2012.
b. The finance lease is for a ten-year period beginning December 31, 2009. Equal annual payments of P100,000 are due on
December 31 of each year, and the 14% interest rate implicit in the lease known by Celtics. The present value at December
31, 2011 of the seven remaining lease payments (due December 31, 2012 through December 31, 2018) discounted at 14%
was P430,000.
c. Deferred income taxes are provided in recognition of temporary differences between financial and income tax reporting. For
the year ended December 31, 2012, depreciation per tax return exceeded book depreciation by 312,500. Celtics’ effective
income tax rate before 2012 is 32%. Effective January 1, 2012, the tax rate was changed from 32% to 35%.
d. On July 1, 2012, Celtics issued for P1,774,000, P2,000,000 face amount of its 10%, P1,000 bonds. The bonds were issued to
yield 12%. The bonds are dated July 1, 2012 and will mature on July 1, 2022. Interest is payable annually on July 1.
REQUIRED:
1. Total noncurrent liabilities as of December 31, 2012

2. Current portion of long-term liabilities as of December 31, 2012
3. Total interest expense for the year 2012
4. Accrued interest payable as of December 31, 2012
Requirement No. 1
15% Note payable, bank
Balance, 12/31/12 (P5,600,000 - P1,400,000) 4,200,000
Less installment due on April 1, 2013 1,400,000 2,800,000
Liability under finance lease
Balance, 12/31/11 430,000
Less principal payment on 12/31/12:
Total payment 100,000
Applicable to interest (P430,000 x .14) 60,200 39,800
Balance, 12/31/12 (see no. 1) 390,200
Less principal payment due on 12/31/13:
Total payment 100,000
Applicable to interest (P390,200 x .14) 54,628 45,372 344,828
10% bonds payable
Add discount amortization:
Effective interest (1,774,000 x .12 x 6/12) 106,440
Nominal interest (2,000,000 x .10 x 6/12) 100,000 6,440 1,780,440
Deferred income tax liability
Balance, 12/31/11 700,000
Effect of change in tax rate [(P700,000/.32 x .35) - P700,000] 65,625
Provision for deferred income tax (P312,500 x .35) 109,375 875,000
Total noncurrent liabilities, 12/31/12 5,800,268
Requirement No. 2
Note payable, bank - due 4/1/13 1,400,000
Finance lease liability - principal payment due on 12/31/13 (see no. 2) 45,372
Current portion of long-term liabilities, 12/31/12 1,445,372
Requirement No. 3
AP-8
Note payable, bank

1/1 to 3/31 (P5,600,000 x .12 x 3/12) 168,000
4/1 to 12/31 (P4,200,000 x .12 x 9/12) 378,000 546,000
Liability under finance lease (see no. 1) 60,200
Bonds payable (1,774,000 x .12 x 6/12) 106,440
Total interest expense for 2012 712,640
Requirement No. 4
Note payable, bank (P4,200,000 x .12 x 9/12) 378,000
Bonds payable (P2,000,000 x .10 x 6/12) 100,000
Accrued interest payable, 12/31/12 478,000
PROBLEM NO. 14 – Audit of employee benefits
The following information pertain Mavericks Corporation’s, your audit client which started operations on 31 December 2008, employee
benefits.
Summarized information about its employee at 31 December 2012 includes:
Salary level for the Percentage wage

Employee Number of employees 12-month period increase effective
category in category ending 30/06/2013 form 01/07/2013
A 9 P100,000 5%
B 200 P50,000 7%
C 300 P25,000 9%
Annual salary increases are expected to continue at the same rates for the foreseeable at 31 December 2012 the appropriate discount
factors (determined using the current market yield for high quality corporate bonds) are 0.9524 for a 12-month period, 0.9009 for a 2-
month period, 0.8547 for a 36-month period and 0.8 for a 48-month period.
The entity’s employees work a five-day week. The entity’s operations close for the six mandatory public holidays. Three of the public
holidays are before 30 June.
Holiday leave
The entity’s employees are each entitled to 20 paid days’ holiday leave per year.
Category A employees can carry forward unused holiday leave for one calendar year on a first-in, first-out (FIFO) basis. Holiday leave
not taken in the prescribed period is forfeited.
Category B employees cannot forward unused holiday leave but are paid for all holiday leave not used in the previous calendar year.
The payment is made as part of the January payroll of the following year.
Category C employees cannot carry forward unused holiday leave and are not paid for unused holiday leave.
At 31 December 2012 the entity’s holiday leave records were as follows:
Average days' holiday

Employee Number of employees leave per employee
category in category unused on 31/12/2012
A 9 10
B 200 6
C 300 8
At 31 December 2012 the entity expects 25 days’ holidays leave accumulated at 31 December 2012 by employees in category A to
expire unused on 31 December 2013.
The entity expects that holiday leave will on average be taken evenly throughout the year.
Long-service awards
The entity’s employees are entitled to receive government mandated long service payments from the entity calculated at 5 per cent of
salary (as determined for the twelve months before the payment) at the end of each five-year period of continuous employment. The
payment is made as part of the December payroll in the fifth year. The entity does not fund this obligation in advance.
Employee turnover is expected to follow average historical patterns. For ease of calculation assume that staff join and leave on 31
December. Furthermore, assume that none of the employees who joined the entity after 1 January 2009 left or are expected to leave
the entity in the foreseeable future (ie all leavers were employed on 31 December 2008).
At 31 December 2012 the entity’s long-service award as follows:
AP-8
Employee Category
A B C
Employed on 31/12/2008 9 196 306
Employee turnover on 31/12/2009:
Joined 1 9 18
Left 1 8 20
Joined 0 10 11
Left 0 9 16
Joined 0 11 15
Left 0 10 12
Joined 0 10 16
Left 0 9 18
Pension plan
On 5 January 2013 the entity paid a contribution of P100,000 to a defined contribution plan ion part exchange for services performed by
the entity’s employee in December 2012.
Voluntary redundancy offer
In December 2012, with a view to reducing its workforce, the entity made an irrevocable offer to its employees of a voluntary
redundancy package. In accordance with the offer the entity will compensate any employee who accepts voluntary redundancy on or
before 30 June 2013. The compensation offered is equal to the employee’s annualized salary for the 12-month period ending 30 June
2013.
At December 2012 the entity’s voluntary redundancy records include:
Number of employees who Number of employees

Employee accepted voluntary expected to accept voluntary
category redundancy by 31/12/2012 redundancy in 2013
A 0 1
B 2 8
C 5 25
REQUIRED:
Based on the above and the result of your audit, calculate the entity’s liability for employee benefits at 31 December 2012.
1. Short-term employee benefits

2. Other long term employee benefits – Category A employees
3. Other long term employee benefits – Category B employees
4. Other long term employee benefits – Category C employees
5. Total provision for employee benefits
Requirement No. 1
Category A employees
[(32.5* days x P392.16**) + (32.5 days x P411.76***)] 26,127
Category B employees [(200 x 6 days x P50,000/255] 235,294
Category C employees (non-accumulating and non-vesting) -
Short-term employee benefits (holiday leave) 261,421
working days for the year (255) = [(365/7 x 5) - 6]

* {[(9 x 10) - 25]/2}
** P100,000/255
*** [(P100,000 x 1.05)/255]
Requirement No. 2
To be paid, 12/31/13 (Joined 12/31/08)
(P102,500* x .05 x 8 x 4/5 x 0.9524) 31,239
To be paid, 12/31/14 (Joined 12/31/09)
(P107,625* x .05 x 1 x 3/5 x 0.9009) 2,909
Other long term benefits - Category A employees 34,148
AP-8
*Computation of expected salary:

For 2013: Jan - Jun (P100,000/2) 50,000
Jul - Dec (P100,000/2 x 1.05) 52,500 102,500
For 2014: Jan - Jun (P100,000/2 x 1.05) 52,500
Jul - Dec (P52,500 x 1.05) 55,125 107,625
Requirement No. 3
To be paid, 12/31/13 (Joined 12/31/08)
(P51,750* x .05 x .77** x 196 x 4/5 x 0.9524) 297,534
To be paid, 12/31/14 (Joined 12/31/09)
(P55,373* x .05 x .77 x 9 x 3/5 x 0.9009) 10,371
To be paid, 12/31/15 (Joined 12/31/10)
(P59,250* x .05 x .77 x 10 x 2/5 x 0.8547) 7,799
To be paid, 12/31/16 (Joined 12/31/11)
(P63,398* x .05 x .77 x 11 x 1/5 x 0.8) 4,296
Other long term benefits - Category B employees 320,000

For 2013: Jan - Jun (P50,000/2) 25,000
Jul - Dec (P50,000/2 x 1.07) 26,750 51,750
For 2014: Jan - Jun (P50,000/2 x 1.07) 26,750
Jul - Dec (P26,750 x 1.07) 28,623 55,373
For 2015: Jan - Jun (P26,750 x 1.07) 28,623
Jul - Dec (P28,623 x 1.07) 30,627 59,250
For 2016: Jan - Jun (P28,623 x 1.07) 30,627
Jul - Dec (P30,627 x 1.07) 32,771 63,398
**Estimated payment for a five-year cycle (saving of 23% due to employees leaving before vesting)
Computation of saving: {[36 + (36/4)]/196}
Requirement No. 4
To be paid, 12/31/13 (Joined 12/31/08)
(P26,125* x .05 x .73** x 306 x 4/5 x 0.9524) 222,321
To be paid, 12/31/14 (Joined 12/31/09)
(P28,476* x .05 x .73 x 18 x 3/5 x 0.9009) 10,113
To be paid, 12/31/15 (Joined 12/31/10)
(P31,039* x .05 x .73 x 11 x 2/5 x 0.8547) 4,261
To be paid, 12/31/16 (Joined 12/31/11)
(P33,833* x .05 x .73 x 15 x 1/5 x 0.8) 2,964
Other long term benefits - Category C employees 239,659

For 2013: Jan - Jun (P25,000/2) 12,500
Jul - Dec (P25,000/2 x 1.09) 13,625 26,125
For 2014: Jan - Jun (P25,000/2 x 1.09) 13,625
Jul - Dec (P13,625 x 1.09) 14,851 28,476
For 2015: Jan - Jun (P13,625 x 1.09) 14,851
Jul - Dec (P14,851 x 1.09) 16,188 31,039
For 2016: Jan - Jun (P14,851 x 1.09) 16,188
Jul - Dec (P16,188 x 1.09) 17,645 33,833
**Estimated payment for a five-year cycle (saving of 27% due to employees leaving before vesting)
Computation of saving: {[66 + (66/4)]/306}
Requirement No. 5
Short-term employee benefits (see no. 1) 261,421
Other long term employee benefits (long service awards)
Category A employees (see no. 2) 34,148
Category B employees (see no. 3) 320,000
Category C employees (see no. 4) 239,659 593,807
Post-employment benefits - defined contribution plan (pension) 100,000
Termination benefits (see computation below) 1,350,000
Total 2,305,228
AP-8
*Computation of termination benefits:

Category A employees (P100,000 x 1) 100,000
Category B employees (P50,000 x 10) 500,000
Category C employees (P25,000 x 30) 750,000
1,350,000
PROBLEM NO. 15 – Theory
Select the best answer for each of the following:
1. In auditing accounts payable, an auditor’s procedures most likely will focus primarily on management’s assertion of
a. Existence
b. Presentation and disclosure
c. Completeness
d. Valuation
2. An auditor performs a test to determine whether all merchandise for which the client was billed was received. The population for this
test consists of all
a. Merchandise received
b. Vendors’ invoices
c. Canceled checks
d. Receiving reports
3. The primarily audit test to determine if accounts payable are valued properly is
a. Confirmation of accounts payable
b. Vouching accounts payable to supporting documentation
c. An analytical procedure
d. Verification that accounts payable was reported as a current liability in the balance sheet.
4. Which of the following procedure is likely to be performed before the balance sheet date?
a. Observation of inventory
b. Search for unrecorded liabilities
c. Testing of internal control over cash
d. Confirmation of receivables
5. An audit assistant found a purchase order for a regular supplier in the amount of P5,500. The purchase order was dated after receipt
of goods. The purchasing agent had forgotten to issue purchase order. Also a disbursement of P450 for materials did not have a
receiving report. The assistant wanted to select additional purchase orders for investigation but was unconcerned about lack of
receiving report. The audit director should
a. Agree with the assistant because the amount of the purchase order exception was considerably larger that the receiving report
exception
b. Agree with the assistant because the cash disbursement clerk had been assured by the receiving clerk that the failure to fill out
a report didn’t happen very often.
c. Disagree with the assistant because two problems have an equal risk of loss associated with them.
d. Disagree with the assistant because the lack of a receiving report has a greater risk of loss associated with it.
6. When using confirmation to provide evidence about completeness assertion for accounts payable, the appropriate population most
likely is
a. Vendors with whom the entity has previously done business
b. Amounts recorded in the accounts payable subsidiary ledger.
c. Payees of checks drawn in the month after the year end.
d. Invoices filed in the entity’s open invoice file.
7. Which of the following is a substantive test that an auditor is most likely to perform top verify the existence and valuation of recorded
accounts payable?
a. Investigation the open purchase order file to ascertain that pre-numbered purchase orders are used and accounted for.
b. Receiving the client’s mail, unopened, for a reasonable period of time after year-end to search for unrecorded vendor’s
invoices.
c. Vouching selected entries in the accounts payable subsidiary ledger to purchase orders and receiving reports.
d. Confirming accounts payable balances with known suppliers who have zero balances.
8. Only one of the following four statements, which compare confirmation accounts payable with suppliers and confirmation of accounts
receivable with debtors is false. The false statement is that
a. Confirmation of accounts receivable with debtors is a more widely accepted auditing procedures that is confirmation of
accounts payable with suppliers.
b. Statistical sampling techniques are more widely accepted in the confirmation of accounts payable than in the confirmation of
accounts receivable.
c. As compared with the confirmation of accounts receivable, the confirmation of accounts payable will tend to emphasize
accounts with zero balances at the balance sheet date.
d. It is likely that the confirmation request sent to the supplier will show the amount owed than that request sent to the debtor will
shoe the amount due.
9. When title to merchandise in transit has passed to the audit client the auditor engaged in the performance of a purchase cut-off will
encounter the greatest difficulty in gaining assurance with respect to the
a. Quantity
AP-8
b. Price
c. Quality
d. Terms
10. Which of the following audit procedures is least likely to detect an unrecorded liability?
A. Analysis and recomputation of interest expense.
B. Analysis and recomputation of depreciation expense.
C. Mailing of standard bank confirmation forms.
D. Reading of the minutes of meeting of the board directors.
11. Unrecorded liabilities are most likely to be found during the review of which of the following documents?
a. Unpaid bills
b. Shipping records
c. Bills of lading
d. Unmatched sales invoices
12. Which of the following audit procedures is best for identifying unrecorded trade accounts payable?
a. Reviewing cash disbursements recorded subsequent to the balance sheet date to determine whether the relate payables
apply to the prior period.
b. Investigating payables recorded just prior to and just subsequent to the balance sheet date to determine whether they are
supported by receiving reports.
c. Examining unusual relationship between monthly accounts payable balances and recorded cash payments.
d. Reconciling vendors’ statement to the file of receiving reports to identify items received just prior to the balance sheet date.
13. In verifying debits to perpetual inventory records of a nonmanufacturing firm, the auditor is most interested in examining the
purchase
a. Journal
b. Orders
c. Requisitions
d. Invoices
14. Which of the following procedures relating to the examination of accounts payable could the auditor delegate entirely to the client’s
employees?
a. Test footings in the accounts payable ledger
b. Reconcile unpaid invoices to vendors statements
c. Prepare a schedule of accounts payable
d. Mail confirmations for selected account balances
15. An auditor’s purposes in reviewing the renewal of a note payable shortly after the balance sheet date most likely is to obtain
evidence concerning management’s assertions about
a. Existence
b. Presentation and disclosure
c. Completeness
d. Valuation
16. An auditor’s program to audit long term should include steps that require
a. Examining bond trust indentures
b. Inspecting the accounts payable subsidiary ledger.
c. Investigating credits to the bond interest income account.
d. Verifying the existence of the bondholders.
17. In an audit of bonds payable, an auditor expects the trust indenture to include the
a. Auditee’s debt-to-equity ratio at the time of issuance
b. Effective yield of the bonds issued.
c. Subscription list.
d. Description of the collateral.
18. In auditing long-term bonds payable, an auditor most likely will

a. Perform analytical procedures on the bond premium and discount accounts.
b. Examine documentation of assets purchased with bond proceeds or liens.
c. Compare interest with the bonds payable amount for reasonableness.
d. Confirm the existence of individual bondholders at year-end.
19. The audit procedures used to verify accrued liabilities differ from those employed for the verification of accounts payable because
a. Accrued liabilities usually pertain to services of a continuing nature while accounts payable are the result of completed
transactions
b. Accrued liability balances are less material than accounts payable balances.
c. Evidence supporting accrued liabilities in nonexistence while evidence supporting accounts payable is readily available.
d. Accrued liabilities at year-end will become accounts payable during the following year.
20. The auditor is most likely to verify accrued commissions payable in conjunction with the
a. Sales cutoff test
b. Verification of contingent liabilities
c. Review of post balance sheet date disbursements
d. Examination of trade accounts payable
PROBLEM NO. 15 - Theory
AP-8
1C
2B
3B
4B
5D
6A
7C
8B
9C
10B
11A
12A
13D
14C
15B
16A
17D
18C
19A
20A
AP-8

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8.

Audit Of Liabilities Page 1 of 28

SUBSTANTIVE AUDIT PROCEDURES FOR LIABILITIES

ACCOUNTS PAYABLE AND PURCHASES

PAYROLLS AND OTHER LIABILITIES

DEBT AND LEASE OBLIGATIONS

Internal Control Objectives Potential Errors and Irregularities

COMMITMENTS AND CONTINGENCIES

ESTIMATED LIABILITIES/ PROVISIONS (PAS 37)

ACCRUED, under the following conditions:

ESTIMATED LIABILITIES FOR PREMIUMS/WARRANTIES/COUPONS

Contingent asset Probable Disclose

Liability Virtually certain Recognize

Contingent liability Probable but not reliable Disclose

But Contingent liability in a business combination Probable and Reliable Recognize

Refinancing and Breach of Contract

Cr: Bonds Payable XX

1. Asset Swap – Transfer of assets (noncash) in full settlement of an obligation

Carrying value of debt being liquidated

Carrying value of debt being liquidated

3. Modification of terms- Modification of interest or maturity value or both.

Carrying value of debt being liquidated

FOR LEASE PROBLEMS:

Operating Lease (guidelines)

Finance Lease (guidelines, books of lessee)

 Upon periodic payments

 Year-end depreciation, shall be computed as (Depreciable cost/lease term or useful life)

PFRS for SMESs, SEC 20, LEASES

ACCOUNTING FOR TAXES

3. Determine the Financial Reporting Tax Reporting

4. Total income expense for the year:

PFRS for SMES Income tax (Section 29)

PROBLEM NO. 1 – Recognition and classification of liabilities

The Comprehensive Entity’s chief accountant provided the following information:

Determine the following as of December 31, 2012.

1. Total current liabilities

NP - Arising from 5 year-bank loans, P400,000 due on June

Employees’ income tax withheld 20,000 Trade and other payables

Trade and other payables

Containers’ deposit 50,000 Trade and other payables

Trade and other payables

Accrued interest on bonds payable 360,000 Trade and other payables

Items not included:

Treatment of additional information:

PROBLEM NO. 2 – Classification of liabilities

Accounts payable P 650,000

The following additional information pertains to these liabilities.

a. Bank notes-payable include two separate notes payable to Allied Bank.

Determine the following as of December 31, 2012.

1. Total current liabilities

Mortgage notes payable – 10% (with breach of covenant) 600,000 Borrowings

PROBLEM NO. 3 – Classification of liabilities

Due date Amount

Warranty claims honored on 2010 - 2011 sales P 252,000

Determine the following as of March 31, 2012.

1. Total current liabilities

PROBLEM NO. 4 - Audit of liability for premiums and warranties

Inventory of Premium AM/FM radio P 39,950

Add warranty expense for 2012 108,000

PROBLEM NO. 5 – Audit of provisions and contingencies

Note 10 – Contingent liabilities

Estimated costs of repairs - products with minor defects P1,500,000

During the year ended 31 December 2012 the following occurred: