1

MABINI COLLEGES, INC.

Daet, Camarines Norte

College of Business Administration and Accountancy

AUDITING PROBLEMS
Final Pre-Board Examination

Name: __________________________________________ Course/Year:______________________

Instructor: _______________________________________ Date:____________________________

Instruction: Properly highlight the best possible answer.

Caselet 1

Items A to E are situation that James Dy, CPA has encountered during his audit of wellness Inc. Select as the best
answer for each item the auditor would normally take.

A. Dy hired an actuary to assist in corroborating Wellness’ complex pension calculations concerning accrued
pension liabilities that account for 35% of the client’s total liabilities. The actuary’s findings are reasonably close
to Wellness’ calculations and support the financial statements.

B. Wellness holds a note receivable consisting of principal and accrued interest payable in 2022. The note’s maker
recently filed a voluntary bankruptcy petition, but wellness failed to reduce the recorded value of the note to its
net realizable value, which is approximately 20% of the recorded amount.

C. Dy was engaged to audit a client’s financial statement after the annual physical inventory count. The accounting
records were not sufficiently reliable to enable him to become satisfied as to the year-end inventory balances.

D. Dy found an immaterial adjustment relating to inventory. Wellness has refused to adjust the financial
statements to reflect this immaterial item.

E. Wellness’ Financial statements do not disclose certain long term lease obligations. Dy determined that he
omitted disclosures are required by PFRS.

Questions:
1) The type of opinion that he ordinarily would issue in Situation A is
a. An adverse opinion.
b. An “except for” qualified opinion.
c. A disclaimer of opinion.
d. An unqualified opinion.

2) The report modification (if any) that would be necessary in Situation B is

a. Describe the circumstances in an explanatory paragraph and modify the opinion paragraph.
b. Describe the circumstances in an explanatory paragraph without modifying the three standard
paragraphs.
c. Describe the circumstances in an explanatory paragraph and modify the scope and opinion paragraphs.
d. Issue the standards auditor’s report without modification.

3) The report modification ( if any ) in Situation C is

a. Issue the standard auditor’s report without modification.
b. Describe the circumstances in an explanatory paragraph without modifying the three standard
paragraphs.
c. Describe the circumstances in an explanatory paragraph and modify the scope and opinion paragraphs.
d. Describe the circumstances in an explanatory paragraph and modify the introductory, scope, and
opinion paragraphs.
4) In Situation D, the type of report modification ( if any) is
a. Issue the standard auditor’s report without modification.
b. Describe the circumstances in an explanatory paragraph without modifying the three standard
paragraphs.
c. Describe the circumstances in an explanatory paragraph and modify the opinion paragraph.
d. Describe the circumstances in an explanatory paragraph and modify the scope and opinion paragraphs.

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5) In Situation E, the type of opinion that the auditor would ordinarily issue is
a. Either an “except for” qualified opinion or an adverse opinion.
b. An unqualified opinion.
c. Either an adverse opinion or a disclaimer of opinion.
d. Either a disclaimer of opinion or an “except for” qualified opinion.

Caselet 2

This caselette is designed to test your competence in the preparation of audit report.

You are the audit partner of five clients and will have to make a decision as to the appropriate type of audit
opinion that should be issued relative to their financial statement. The pertinent data for these clients follow;

Client No. 1: Zap batteries

During your examination of Zap batteries, you conclude there is a possibility that inventory is materially
overstated. The client refuses to allow you to expand the scope of your examination sufficiently to verify whether the
balance is actually misstated.

Client No. 2: Gummy sweet Company

You were engaged to examine the Gummy sweet Company’s financial statements after the close of the
corporation’s fiscal year. Because you were engaged after the balance sheet date, you were not able to physically
observe inventory, which is highly material. On the completion of your audit, you are satisfied that Gummy’s financial
statements are presented fairly, including inventory about which you were able to satisfy yourself by the use of
alternative audit procedures.

Client No. 3: XYZ Company

As part of your post balance sheet ate audit procedures, you learned of heavy damage to one of XYZ Company’s
two plants due to a recent fire. The loss will not be reimbursed by insurance. The newspapers described the event in
detail. The financial statements and appended notes as prepared by the client did not disclose the loss caused by fire.
The damaged plant constitutes a material portion of the total assets.

Client No.4: Max Auto Parts Company

Om January 2, 2022, the Max Auto Parts Company received a notice from its primary suppliers that effective
immediately, all wholesale prices would be increased 10 percent. On the basis of the notice, Max Auto Parts revalued its
December 31, 2021, inventory to reflect the higher costs. The inventory constituted a material portion of total assets.
The effect however of the revaluation was material to current assets but not to total assets or net income. The increase
in valuation is adequately disclosed in the footnotes.

Client No. 5: Advanced Research Corporation

During 2022, the research staff of advanced research Corporation devoted its entire efforts toward developing a
new pollution control device. All cost that could be attribute directly to the project were accounted for as deferred
charges and classified on the balance sheet at December 31, 2022, as a noncurrent asset. In the course of your audit of
the corporation’s 2022 financial statements, you found persuasive evidence that the research conducted to date would
probably result in a marketable product. The deferred research charges are significantly material in relation to both
income and total assets.

Questions:

6) The appropriate audit report on the financial statement of client No. 1 will contain
a. An unqualified opinion.
b. Either an “except for” qualified opinion or disclaimer.
c. An adverse opinion.
d. A disclaimer of opinion.

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7) The appropriate audit report on the financial statement of client No. 2 will contain
a. An unqualified opinion.
b. An “except for” qualified opinion.
c. An adverse opinion.
d. A disclaimer of opinion.

8) The appropriate audit report on the financial statement of client No. 3 will contain
a. An unqualified opinion.
b. Either an “except for” qualified opinion or an adverse opinion.
c. An adverse opinion.
d. A disclaimer of opinion.

9) The appropriate audit report on the financial statement of client No. 4 will contain
a. An unqualified opinion.
b. Either an “except for” qualified opinion or an adverse opinion.
c. An adverse opinion.
d. A disclaimer of opinion.

10) The appropriate audit report on the financial statement of client No. 5 will contain
a. An unqualified opinion.
b. An “except for” qualified opinion.
c. An adverse opinion.
d. A disclaimer of opinion.

Caselet 3

The auditor is auditing the financial statements of Jokoz Corporation for the year ended December 31,2019 and
is completing the audit in early March 2020. Each of the following independent subsequent events came to the auditors
attention.

Item 1

On Feb 12, 2020, the client agreed to an out-of-court settlement of a property damage suit resulting from an accident
caused by one of its delivery trucks. The accident occurred on Nov 30, 2019. An estimated loss of P30,000 was accrued in
the 2019 financial statements. The settlement was for P50,000

Item 2

On Feb 12, 2020, the client agreed to an out-of-court settlement of a property damage suit resulting from an accident
caused by one of its delivery trucks. The accident occurred on Jan 1, 2020 and no other loss was incurred. The
settlement was for P50,000

Item 3

A major customer filed for bankruptcy on Feb 26,2020. The bankruptcy was caused by an adverse court decision on Feb
15,2020 involving a product liability lawsuit initiated in 2019 arising from products sold in 2017.

Item 4

The client purchased raw materials that were received just before year-end. The purchase was recorded based on its
estimated value. The invoice was not received until Jan 31,2020, and the cost was substantially different than was
estimated

Item 5

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A major customer was killed in a boating accident on Jan 25,2020. The customer had pledged his boat as collateral. The
boat, which was destroyed in the accident, was not insured. The allowance for doubtful accounts is not adequate to
cover the anticipated loss

Questions:

11. For item 1, the financial statements

a. Should be adjusted
b. Should be adjusted and the event disclosed
c. Should disclose the event
d. Need not be adjusted nor the event disclosed

12. For item 2, the financial statements

a. Should be adjusted
b. Should be adjusted and the event disclosed
c. Should disclose the event
d. Need not be adjusted nor the event disclosed

13. For item 3, the financial statements

a. Should be adjusted
b. Should be adjusted and the event disclosed
c. Should disclose the event
d. Need not be adjusted nor the event disclosed

14. For item 4, the financial statements

a. Should be adjusted
b. Should be adjusted and the event disclosed
c. Should disclose the event
d. Need not be adjusted nor the event disclosed

15. For item 5 , the financial statements

a. Should be adjusted
b. Should be adjusted and the event disclosed
c. Should disclose the event
d. Need not be adjusted nor the event disclosed

Caselet 4

The Bulacan Company made a lump sum purchase of three pieces of machinery for P1,150,000 from an unaffiliated
company. At the time of acquisition, Bulacan paid P50,000 to determine the appraisal value of the machinery.
The appraisal disclosed the following values:
Machine A P 700,000
Machine B 420,000
Machine C 280,000

16. What cost should be assigned to machines A, B, and C, respectively?

a. P400, 000; P400, 000; P400, 000.
b. P575, 000; P345, 000; P230, 000.
c. P600, 000; P360, 000; P240, 000.
d. P700, 000; P420, 000; P280, 000.

17 & 18. Cubao Company purchased real property for P8, 600,000 which included P180, 000 of realty tax arrears for
prior years. A mortgage of P4, 000,000 was assumed by Cubao Company on the purchase. Twenty percent of the
purchase price should be allocated to the land and the balance to the building.

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In order to make the building suitable for the use of Cubao, remodelling costs had to be incurred in the amount
of P900, 000. This however, necessitated the demolition of a portion of the building, which resulted in recovery of
salvage material sold for P30, 000 cash.
Landscaping and parking lot cost the company a total of P320, 000, while repairs in the main hall were P45, 000.

Questions:
17. The cost of the land was
a. P1, 664,000. c. P2, 040,000.
b. 1,720,000. d. P2, 400,000.
18. The cost of the building was
a. P6, 330,000. c. P7, 750,000.
b. P7, 795,000. d. P7, 570,000.

On April 1, 2017, Mila Corporation purchased for P2, 700,000 a tract of land on which was located a warehouse and an
office building. The following data were collected regarding the property:
Current Assessed Vendor's
Valuation Original cost
Land P 875,000 P 700,000
Warehouse 375,000 400,000
Office building 1,000,000 900,000
P2, 250,000 P2, 000,000
19. What are the appropriate amounts that Mila should record for the land, warehouse, and office building,
respectively?
a. Land, P 700, 000; warehouse, P 400,000; office building, P 900,000.
b. Land, P 875, 000; warehouse, P 375,000; office building, P 1,000,000.
c. Land, P 945, 000; warehouse, P 540,000; office building, P 1, 215,000.
d. Land, P 1,050, 000; warehouse, P 450,000; office building, P 1,200,000.

20. On December 30, 2016, Diamond Company traded in an old machine with a book value of P10,000 for a similar new
machine having a list price of P32,000, and paid a cash difference of P19,000, Diamond should record the new machine
at
a. P32, 000. c. P22, 000.
b. P29, 000. d. P19, 000.

Caselet 5

Carr Company pays its outside salespersons fixed monthly salaries and commissions on net sales. Sales commission are
computed and paid on a monthly basis (in the following the month of sale) this purpose. However, if the fixed salaries
for salespersons exceed their sales commissions earned for a month, such excess is not charged back to them. Pertinent
data for the month of March 2017 for the three salesperson in sales region 101 are the following:

Salesperson Fixed salary Net sales Commission rate

A P 2,500 P 100,000 2%
B 3,500 200,000 3%
C 4,500 300,000 3%
P10,500 P 600,000

21. In respect of sales region 101, what total amount should Carr accrue for sales commission’s payable at March 31,
2017?
a. P6,500 c. P17,000
b. 7,000 d. P17,500

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Garson Corporation’s income statement for the year ended December 31, 2017 shows pretax book income of P400,000.
The following items for 2017 are treated differently on the tax return and on the books:

Per tax return Per books___

Royalty income P 20, 000 P 40, 000
Depreciation expense 125, 000 100, 000
Amortization of goodwill None -

Tax rate is 40%

Questions:
22. Of Garson’s total income tax expense, how much should be reported as
current portion of income taxes I n Garson’s 2017 income statements?
a. P142, 000 b. P160,000
c. P148, 000 d. P166,000

23. Of Garson’s total income tax expense, how much should be reported as deferred income taxes in Garson’s 2017
income statement?
a. P8,000 b. P12,000
b. P10,000 d. P18,000

During 2016, Cory Company introduced a new line machine that carries a two year warranty against manufacturer’s
defect. Based on industry experience, the estimated warranty cost related to peso sales are as follows:
Year if sale 4%
Year after sale 6%
Sales and actual warranty expenditures for the years ended December 31, 2016 and 2017 were as follows:

Actual warranty
Sales expenditures
2016 P 500,000 P 15,000
2017 700,000 47,000
P1,200,000 P 62,000

24. What amount should Cory report as its estimated warranty liability at December 31, 2017?
a. P 0 c. P42,000
b. P16, 000 d. P58,000

Perfection Company (a widely –held corporation) provides a special bonus for its executive officers based on 15% of its
net income before bonus but after income tax. Net income for 2017 before bonus and income tax was P90,000. Tax rate
is 25%.

25. The special bonus due to the executive officers for 2017 amounted to:
a. P10,519.48 c. P13,500
b. P10,125.0000 d. None of these

Caselet 6

The following are selected unadjusted account balances and adjusting information of TANYING CORP. for the
year ended December 31, 2015.

Retained earnings, January 1, 2015 P 1,322,010

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Sales salaries and commissions 75,000

Advertising expense 48,270
Legal services 6,675
Insurance and licenses 23,040
Travel expense – sales representatives 13,680
Depreciation expense – sales/delivery equipment 18,300
Depreciation expense – office equipment 12,600
Interest revenue 1,650
Utilities 19,200
Telephone and postage 4,425
Office supplies inventory 6,540
Miscellaneous selling expenses 8,220
Dividends 99,000
Dividend revenue 15,450
Interest expense 13,560
Allowance for doubtful accounts (credit balance) 480
Officers’ salaries 109,800
Sales 1,353,000
Sales returns and allowances 11,700
Sales discounts 2,640
Gain on sale of assets 23,460
Inventory, January 1, 2015 269,100
Inventory, December 31, 2015 61,650
Purchases 424,800
Freight in 16,575
Accounts receivable, December 31, 2015 783,000
Income from discontinued operations (before income taxes) 120,000
Loss on sale of equipment 217,800
Ordinary shares outstanding 117,000

Adjusting information:

(a) Cost of inventory in the possession of consignees as of December 31, 2015,

was not included in the ending inventory balance.................................................P55,800

(b) After preparing an analysis of aged accounts receivable, a decision was made
to increase the allowance for doubtful accounts to a percentage of the ending
accounts receivable balance.......................................................................................2%

(c) Purchase returns and allowances were unrecorded. They are computed as a
percentage of purchases (not including freight in).......................................................6%

(d) Sales commissions for the last day of the year had not been accrued. Total
sales for the day...................................................................................................P9,180
Average sales commissions as a percent of sales.........................................................3%

(e) No accrual had been made for a freight bill received on January 2, 2016, for
goods received on December 29, 2015..................................................................P1,710

(f) An advertising campaign was initiated November 2, 2015. This amount was
recorded as “Prepaid advertising” and should be amortized over a six-month
period. No amortization was recorded...................................................................P5,454

Freight charges paid on sold merchandise were netted against sales. Freight
charges on sales during 2015..............................................................................P10,500

(g) Interest earned but not accrued............................................................................P1,680

(h) Depreciation expense on a new forklift purchased March 1, 2015, had not
been recognized. (Assume all equipment will have no salvage value and the
straight-line method is used. Depreciation is calculated to the nearest month.)
Purchase price....................................................................................................P23,400
Estimated life in years.................................................................................................10

(i) A “real” account is debited upon the receipt of office supplies. Office supplies on hand at
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year-end..............................................................................................................P3,675

(j) Income tax rate (on all items)..................................................................................30%

Compute the adjusted balances of the following:

26. Net sales

A. P1,363,500 B. P1,349,160 C. P1,353,000 D. P1,342,500

27. Cost of goods available for sale

A. P684,900 B. P824,697 C. P686,697 D. P779,913

28. Inventory, December 31, 2015

A. P61,500 B. P61,350 C. P56,250 D. P117,450

29. Distribution costs

A. P181,649 B. P167,513 C. P178,013 D. P176,453

30. Administrative expenses

A. P207,345 B. P193,785 C. P194,265 D. P194,595

31. Allowance for doubtful accounts

A. P15,660 B. P16,140 C. P15,180 D. P480

32. Total income

A. P817,143 B. P811,653 C. P779,913 D. P822,153

33. Income from continuing operations before taxes

A. P231,360 B. P436,795 C. P218,995 D. P239,695

34. Office supplies inventory

A. P6,540 B. P3,675 C. P2,865 D. P 0

35. Net income

A. P237,296 B. P210,299 C. P250,289 D. P216,296

Caselet 7

On January 1, 2014, SAMSON MFG. CO. began construction of a building to be used as its office headquarters.
The building was completed on June 30, 2015.

Expenditures on the project were as follows:

January 3, 2014 P2,500,000

March 31, 2014 3,000,000
June 30, 2014 4,000,000
October 31, 2014 3,000,000
January 31, 2015 1,500,000
March 31, 2015 2,500,000
May 31, 2015 3,000,000

On January 3, 2014, the company obtained a P5 million construction loan with a 10% interest rate. The loan
was outstanding all of 2014 and 2015. The company’s other interest-bearing debts included a long-term note
of P25 million with an 8% interest rate, and a mortgage of P15 million on another building with an interest
rate of 6%. Both debts were outstanding during all of 2014 and 2015. The company’s fiscal year-end is
December 31.

36. What is the amount of capitalizable interest in 2014?

A. P3,400,000 B. P1,043,750 C. P663,125 D. P500,000

37. What is the amount of capitalizable interest in 2015?

A. P630,625 B. P654,663 C. P361,707 D. P799,663

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38. What amount of interest should be expensed in 2014?

A. P2,736,875 B. P2,356,250 C. P2,900,000 D. P 0

39. What amount of interest should be expensed in 2015?

A. P2,769,375 B. P3,038,293 C. P2,600,337 D. P2,745,337

40. What is the total cost of the building (including the interest capitalized in 2014 and 2015)?
A. P24,600,000 B. P20,817,788 C. P20,905,457 D. P20,630,625

Caselet 8

At the beginning of year 1, an entity grants to a senior executive 30,000 share options. The grant is
conditional upon the executive remaining in the entity’s employ until the end of year 3.

The share options can be exercised if the entity’s share price increases from P20 at the beginning of year 1 to
above P30 at the end of year 3. If the share price is above P30 at the end of year 3, the share options can be
exercised at any time during the next five years, i.e., by the end of year 8.

The entity estimates the fair value of the share options on grant date to be P5 per option. This estimate takes
into account the following market condition:
The possibility that the share price will exceed P30 at the end of year 3, i.e., the share options become
exercisable; and
The possibility that the share price will not exceed P30 at the end of year 3, i.e., the share options will be
forfeited.

The following actual events occurred in years 1 to 3:

Year 1

The share price has increased to P24.

The entity’s estimate of the fair value of the options is P4 at the end of year 1. This takes into account
whether the market condition will be satisfied by the end of year 3.

Year 2

The share price has decreased to P22. However, the entity remains optimistic that the share price target
will be met by the end of year 3.
The estimated fair value of the share options is P3. Again, this estimate takes into account the market
condition noted above.

Year 3

The share price only reaches P28 by the end of year 3.

The estimated fair value of the share options is zero, as the market condition has not been satisfied.

Based on the preceding information, determine the following:

41. Compensation expense for year 1

A. P30,000 B. P40,000 C. P50,000 D. P60,000

42. Compensation expense for year 2

A. P30,000 B. P40,000 C. P50,000 D. P60,000

43. Compensation expense for year 3

A. P 0 B. P30,000 C. P40,000 D. P50,000

44. Share options outstanding at the end of year 2

A. P70,000 B. P80,000 C. P90,000 D. P100,000

45. Cumulative compensation expense for the three-year period

A. P 0 B. P70,000 C. P100,000 D. P150,000

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Caselet 9

The following independent situations relate to the audit of shareholders’ equity. Answer the questions at the
end of each situation.

BRANDY CO. was organized at the beginning of the current year. The following shareholders’ equity accounts
are included in the entity’s year-end trial balance.

Preference share capital, P100 par, authorized 100,000 shares,

issued and outstanding, 66,000 shares P6,600,000
Preference share capital subscribed, 6,000 shares 600,000
Share premium – preference 240,000
Subscriptions receivable – preference 360,000
Ordinary share capital, P10 par value, authorized 200,000 shares,
issued and outstanding, 72,000 shares 720,000
Ordinary share capital subscribed, 72,000 shares 720,000
Share premium – ordinary 2,850,000
Subscriptions receivable – ordinary 1,080,000

The following current year transactions relate to Brandy Co.’s shareholders’ equity:

 Immediately after Brandy Co. was organized, it received subscriptions to 60,000 preference shares.
Subscriptions to ordinary shares were also received on the same date.

 During the year, subscriptions were received for an additional 12,000 preference shares at a price of P120
per share.

 Cash payments were received from subscribers at frequent intervals for several months after subscription.
The company’s policy is to issue share certificates only upon full payment of the share subscription.

 Also during the current year, Brandy Co. issued 24,000 ordinary shares in exchange for a tract of land with
a fair value of P690,000.

46. What is the total subscription price of the ordinary shares originally subscribed?
A. P4,290,000 B. P3,840,000 C. P3,600,000 D. P4,050,000

47. How much was collected from the subscribers of preference shares?
A. P1,440,000 B. P5,640,000 C. P7,440,000 D. P7,080,000

48. The company’s statement of financial position at the end of the current year should report contributed
capital of
Preference Ordinary
A. P7,440,000 P4,290,000
B. 7,080,000 3,210,000
C. 6,480,000 2,490,000
D. 6,840,000 360,000

The following shareholders’ equity accounts are included in the statement of financial position of CONDESSA
CO. on December 31, 2014.

Preference share capital, 8%, P100 par (200,000 shares authorized,

60,000 shares issued and outstanding) P6,000,000
Ordinary share capital, P5 par (2,000,000 shares authorized,
600,000 shares issued and outstanding) 3,000,000
Share premium 3,750,000
Retained earnings 3,500,000
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Total P16,250,000

During 2015, Condessa took part in the following transactions concerning equity.

1. Paid the annual 2014 P8 per share dividend on preference shares and a P2 per share dividend on
ordinary shares. These dividends had been declared on December 31, 2014.

2. Purchased 81,000 shares of its own outstanding ordinary shares for P40 per share.

3. Reissued 21,000 treasury shares for land valued at P900,000.

4. Issued 15,000 preference shares at P105 per share.

5. Declared a 10% stock dividend on the outstanding ordinary shares when the shares are selling for P45
per share.
6. Issued the stock dividend.

7. Declared the annual 2015 P8 per share dividend on preference shares and the P2 per share dividend on
ordinary shares. These dividends are payable in 2016.

8. Reported net income of P9,900,000 for the current year.

49. What is the retained earnings balance (before appropriation for treasury shares) on December 31, 2015?
A. P9,182,000 B. P718,000 C. P6,782,000 D. P11,000,000

50. What amount should be reported as total shareholders’ equity on December 31, 2015?
A. P25,997,000 B. P23,597,000 C. P21,197,000 D. P14,415,000

***END OF EXAMINATION***

EXAMINER:

REXMAR CHRISTIAN L. BERNARDO, CPA

PRC License No. 175542

FINAL PREBOARD EXAMINATION – AUDITING PROBLEMS