Audit of Long-Term Liabilities

ACCT 514 - APPLIED AUDITING
AUDIT OF
LONG-TERM LIABILITIES
Leading Innovations, Transforming Lives

AUDIT OF LONG-TERM LIABILITIES
Audit Procedures
1. Obtain analyses of long-term debt accounts

and related interest, premium and discount
accounts
2. Review debt agreements and confirm with
payees or appropriate third party the
principal, interest rates, maturity date, etc.
3. Inspect bonds redeemed, retired or
surrendered during the period
4. Trace authorization for issuance of debt to
credits to the long-term debt account.

Audit Procedures
5. Vouch borrowing and repayment transactions

to supporting documents and review
transactions occurring near year-end
6. Review minutes of board of directors' meeting
7. Review payments of principals and renewals
after the statement of financial
8. Recalculate interest expense and amortization
of premium or discount

Audit Procedures
9. Ascertain the amount of long-term debt

maturing within one year requiring currents
asset
10.Evaluate financial statement presentation
and adequacy of disclosure of long-term
debt.

Non-current Liabilities
This includes:
1. Bonds payable
2. Long-term notes payable
3. Mortgage payable
4. Finance Lease Liability
7. Long-term obligation to officers
8. Deferred tax liability
9. Long-term deferred revenues

BONDS PAYABLE
Initial Measurement:
General rule: Fair value minus DAC
FV = Present value
DAC = Bonds issue costs***
***includes promotion costs, engraving and

printing cost, underwriter commission, legal
fees, and fees paid to accountants for
registration

BONDS PAYABLE
Initial Measurement:
General rule: Fair value minus DAC
FV = Present value
DAC = Bonds issue costs***
***under effective interest method (amortized

cost model) - added to discount on BP /
deducted from premium on BP
***under fair value option, bond issue cost is
expensed

BONDS PAYABLE
Under effective interest method:
Discount Premium
Present Value < Present Value > Face

Face amount amount
Effective Rate > Effective Rate <

Nominal Rate Nominal Rate
Interest Expense > Interest Expense <

Interest Paid Interest Paid

BONDS PAYABLE
Subsequent Measurement:
1. Amortized Cost under effective interest
method
2. Fair value through profit or loss

BONDS PAYABLE
Amortized Cost under effective interest method

*Interest expense equals carrying amount times
effective rate
*Interest paid equals face value times nominal rate
*Difference between interest expense and interest
paid is discount or premium amortization
*Discount amortization increases Interest expense &
Carrying amount of bonds payable
*Premium amortization decreases Interest expense &
Carrying amount of bonds payable

BONDS PAYABLE
Fair value option

*Carrying amount is stated at its fair value at
the reporting date
*No amortization
*Interest expense is computed by multiplying
face amount to stated rate
*Any change in fair value is presented in profit
or loss, unless the portion is due to credit risk,
thus presented in other comprehensive income

BONDS PAYABLE
Bond retirement
*Settlement of bonds payable
*Requires cancelation of bonds payable and all
other related accounts
such as:
any unamortized discount/premium
payment of any accrued interest
any asset set aside for payment of bonds
payable

COMPOUND FINANCIAL INSTRUMENTS
Bonds with share warrants

Total issue price with warrants xx
Less: Market value of bonds payable w/out SW (xx)
Share warrants outstanding (Share premium) xx
Convertible Bonds
Total issue price with CP xx
Less: Market value of bonds payable w/out CP (xx)
Share premium from conversion privilege xx

DEBT RESTRUCTING
Asset swap
Under IFRS
Carrying amount of liability xx
Less: Carrying amount of asset (xx)
Gain or loss on extinguishment xx
Under US GAAP
Carrying amount of liability xx
Less: fair value of asset (xx)
Gain or loss on debt restructure xx
Fair value of asset xx

Less: Carrying amount of asset (xx)
Gain or loss on exchange xx
DEBT RESTRUCTING
Equity swap
Order of priority
1. Fair value of the shares
2. Fair value of the liability
3. Par value of the shares
Fair value of shares / fair value of the liability xx

Less: Par value of shares (xx)
Share premium xx

DEBT RESTRUCTING
Modification of terms
Carrying amount of old liability xx
Less: Present value of new liability (orig. ER) (xx)
Gain or loss on extinguishment xx
*if gain or loss is less than 10% of the old liability, no

extinguishment, gain or loss is not recognized

LEASES IAS 17
Operating lease Finance Lease
Rent expense in lessee Lease liability in lessee
Rent income in lessor Lease receivable in lessor

Ownership may or may
No transfer of ownership
not be trasferred
May have bargain
No bargain purchase
purchase
< 75% USL = > 75% USL
< 90% fair value of the > 90% fair value of the
asset asset
Depreciation is recorded
No depreciation for lessee
by lessee
LEASES IFRS 16 (new)
Leases accounted by Lessee is no longer

classified as operating / finance.
IFRS 16 recognizes the right of use (ROU) of

asset and the lease liability. Thus, requiring
the recognition of depreciation expense and
interest on lease liability.

LEASES IFRS 16 (new)
General Rule:
Under IFRS 16, lease liability are recognized

and amortized using effective interest
method.
Exception:
To elect the Straight line amortization
For leases of 12mos or less, leased assets
accounted by class
For low-value leased assets, leased assets
accounted by leases-by-leases
LEASES
Cost of asset / Lease liability =
lower between PV of MLP & FV of Asset

*Initial direct cost paid by lessee is added to
the cost of asset but not to lease liability

LEASES
Sales type lease - Lessor

Gross investment =
gross rentals plus residual value whether
guaranteed / unguaranteed
**however, it title is transferred to the lessee,
Residual value is ignored
Gross investment xx U.I.I
Net investment (PV of GR + PV of RV) xx
Cost of asset + IDC paid by lessor xx G. P.

LEASES
Direct financing lease Lessor
Gross investment xx
U.I.I
Net investment (PV of GR + PV of RV) xx

INCOME TAXES
Financial Income xx
Less: Permanent difference (xx)
Financial Income subject to Income tax xx
Temporary difference -
Future taxable temp. diff. (xx)
Future deductible temp. diff. xx
Taxable Income xx

INCOME TAXES
Financial Income xx
-
PD (xx)
-
Total tax
FI to IT xx
expense
TD
x Tax
-
rate -
Deferred tax expense
FTTD (xx)
(Inc. in DTL)
Deferred tax benefit
FDTD xx
(Inc. in DTA)
Current tax
Taxable Income xx
expense

INCOME TAXES
Deferred tax liability = future taxable

amount x future enacted tax rate
Deferred tax asset = future deductible

amount x future enacted tax rate

EMPLOYEE BENEFITS
Service cost = CSC, PSC & gain or loss on plan

settlement
Net interest = interest expense on PBO - interest income
on FVPA
Employee Benefit expense = SC + NI + Int. on effect of
Asset ceiling
-
Remeasurements = actuarial gain / loss on PBO +
Difference bet. Actual Return
and Int. income + any change in the effect of asset
ceiling
-
Defined benefit cost = EBE +/- Remeasurements

EMPLOYEE BENEFITS
Projected Benefit Obligation

Beginning balance xx
CSC xx
PSC xx
NI xx
Actuarial loss xx
Less: Benefits paid (xx)
Less: Actuarial gain (xx)
Ending balance xx

EMPLOYEE BENEFITS
Fair value of plan assets

Beginning balance xx
Contributions xx
Actual return xx
Less: Benefits paid (xx)
Ending balance xx
IF PBO > FVPA = pension liability / accrued benefit cost
IF FVPA > PBO = pension asset / prepaid benefit cost

SAMPLE PROBLEM
Kalma Corporation issued P800,000 of 12% face value

bonds. The bonds were dated and issued April 2016, are
due March 31, 2020, and pay interest semiannually on
September 30 and March 31. The company sold the bonds
to yield 10%
Required:
1. Prepare a bond interest expense and premium
amortization schedule using
effective interest method
2. Prepare journal entries for 2016
3. Assume the company retires the bonds on June 30,
2017, at 102 plus accrued interest, prepare journal entries

SAMPLE PROBLEM
Chill Company leased equipment under capital lease

for a period of seven years, contracting to pay
P120,000 rent in advance at the start of the lease
term on December 31, 2015, and P120,000 annually
on December 31 of each of the next year six years.
The implicit discount rate is 11%. Chill Company
amortizes its liability under capital lease using
effective interest method.
Required:
1. Prepare Journal entries for 2015, 2016 and 2017.

2. Present the Lease liability on the financial position.

SAMPLE PROBLEM
KalmaKalang Corporations income statement for the year ended
December 31, 2016 shows pretax book income of P400,000. The
following items for 2016 are treated differently on the tax return
and on the books: Per tax return Per book
Royalty income P 20,000 P 40,000
Depreciation expense 125,000 100,000

*tax rate is 30%
Required:
a. Of CalmaKalang Corporations total income tax expense, how
much should be reported as current portion of income taxes in
KalmaKalang Corporations 2016 income statements?
b. Of CalmaKalang Corporations total income tax expense, how

much should be reported as deferred income taxes in KalmaKalang
Corporations 2016 income statements?
SAMPLE PROBLEM
Included in PapaSakarin Corporations liability account balances at
December 31, 2015 were the following:
Notes payable, Bank P 2,800,000
Finance lease liability 430,000
Deferred tax liability 360,000
Transactions during 2016 and other information relating to

PapaSakarins liabilities were as follows:
1. The principal amount of the notes payable is P2,800,000 and

bears interest at 15%. The note is dated April 1, 2015 and is
payable in four equal instalments of P700,000 beginning April 1,
2016. The first principal and interest payment was made on April
1, 2016.

SAMPLE PROBLEM

2. The capitalized lease is for 10-year period beginning December

31, 2013. Equal payments of P100,000 are due on December of
each year, and the 14% interest rate implicit in the lease is known
by PapaSakarin. The present value at December 31, 2015, of the
seven remaining lease payment (due December 31, 2016, through
December 31, 2022) discounted at 14% was P430,000.

SAMPLE PROBLEM

3. Deferred income taxes are provided in recognition of timing

difference between financial statement and income tax reporting
of depreciation. For the year ended December 31, 2016
depreciation per tax return exceeded book depreciation by
P90,000. PapaSakarins effective income tax rate for 2016 was
30%.

SAMPLE PROBLEM

4. On July 1, 2016, Papasakin 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, 2016 and mature on July
1, 2026. Interest is payable annually on July 1. PapaSakarin uses
the interest method to amortize bond discount.

SAMPLE PROBLEM
Required:
a. What total amount should be reported as long-term liabilities
on December 31, 2016?
b. What total amount should be reported as current liabilities on

December 31, 2016?
c. What total amount should be reported as expenses related to
long-term liabilities on December 31, 2016?

SAMPLE PROBLEM
On January 1, 2016, Jewel Company sold 11% bonds

when the market rate of interest for comparable
securities was 10%. Jewel sold 10,000, P1,000 face
value bonds. The bonds pay interest semi-annually on
June 30 and December 31, and mature 20years from
the date they were issued.
Required:
a. Compute the price at which the bonds sold.
b. Prepare journal entries for 2016 and 2017.

SAMPLE PROBLEM
On January 1, 2016, WagmaInip Corporation is delinquent on a

P300,000 note to the TiwalaLang Bank on which P72,000 of
interest has accrued. On January 2, 2016, WagmaInip enter into a
debt restructuring agreement with the bank.
Required: Prepare the journal entries for WagmaInip to record

the restructuring agreement assuming:
a. The bank accepts 10,000 shares of WagmaInips P10 par
ordinary share that is currently selling for P35 per share in full
settlement of debt.
b. The bank accepts land with a fair value of P342,000 in full
settlement of the debt. The land is being carried on WagmaInips
books at a cost of P324,000.

SAMPLE PROBLEM
Tangent Company reports the following revenues and

expenses in its pretax financial income for the year ended
December 31, 2016:
Revenues P 229,600
Expenses (160,100)
Pretax financial income P 69,500
The revenues included in the pretax financial income are the

same amount as the revenues included in the companys
taxable income. A reconciliation of the expenses reported
for pretax financial income to the expenses reported for
taxable income, however reveals four differences:

SAMPLE PROBLEM
1. Depreciation deducted for financial reporting exceeded

depreciation deducted for income taxes by P11,000
2. Percentage of depletion deducted for income taxes
exceeded depletion deducted for financial reporting by
P015,600
3. Warranty cost deducted for income taxes exceeded
warranty expenses deducted for financial reporting by
P8,900
4. Legal expenses for P9,800 was deducted for financial
reporting; it will be deducted for income taxes when
paid in a future year.

SAMPLE PROBLEM
The company expects its percentage depletion to exceed its

cost depletion in each of the next 5 years by the same
amount as in 2016. At the end of 2016, the other three
expenses are results in the total future taxable or deductible
amounts as follows:
1. Future taxable amounts depreciation expense
difference P63,000
2. Future deductible amounts warranty expense difference
P48,400
3. Future deductible amounts legal expense difference
P9,800

SAMPLE PROBLEM
At the beginning of 2016, the company had a deferred tax liability

of P22,200 related to the depreciation difference and a deferred
tax asset of P17,190 related to the warranty difference. The
income tax rate for 2016 is 30%, but in 2015, Congress enacted a
25% rate for 2017 and future years.
Required:
a. Compute the Tangent Companys taxable income for 2016.
b. Prepare the income tax journal entry for 2016
c. Prepare a condensed 2016 income statement.

AUDIT OF AP, NP & OTHER CL
- - - End of Presentation - - -
Prepared by:
Falo, Daniel John F. Falo, CPA, MBA
Batangas State University Main 1
Reference:
Cabrera, M.E. B; Applied Auditing.Manila, Philippines.2016

Audit of Long-Term Liabilities

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ACCT 514 - APPLIED AUDITING

Leading Innovations, Transforming Lives

1. Obtain analyses of long-term debt accounts

Leading Innovations, Transforming Lives

5. Vouch borrowing and repayment transactions

Leading Innovations, Transforming Lives

9. Ascertain the amount of long-term debt

Leading Innovations, Transforming Lives

Leading Innovations, Transforming Lives

***includes promotion costs, engraving and

Leading Innovations, Transforming Lives

***under effective interest method (amortized

Leading Innovations, Transforming Lives

Under effective interest method:

Present Value < Present Value > Face

Effective Rate > Effective Rate <

Interest Expense > Interest Expense <

Leading Innovations, Transforming Lives

Leading Innovations, Transforming Lives

Amortized Cost under effective interest method

Leading Innovations, Transforming Lives

Fair value option

Leading Innovations, Transforming Lives

Leading Innovations, Transforming Lives

COMPOUND FINANCIAL INSTRUMENTS

Bonds with share warrants

Leading Innovations, Transforming Lives

Fair value of asset xx

Fair value of shares / fair value of the liability xx

Leading Innovations, Transforming Lives

*if gain or loss is less than 10% of the old liability, no

Leading Innovations, Transforming Lives

Operating lease Finance Lease

Rent expense in lessee Lease liability in lessee

Rent income in lessor Lease receivable in lessor

LEASES IFRS 16 (new)

Leases accounted by Lessee is no longer

IFRS 16 recognizes the right of use (ROU) of

Leading Innovations, Transforming Lives

LEASES IFRS 16 (new)

Under IFRS 16, lease liability are recognized

Cost of asset / Lease liability =

lower between PV of MLP & FV of Asset

Leading Innovations, Transforming Lives

Sales type lease - Lessor

Leading Innovations, Transforming Lives

Direct financing lease Lessor

Leading Innovations, Transforming Lives

Leading Innovations, Transforming Lives

Leading Innovations, Transforming Lives

Deferred tax liability = future taxable

Deferred tax asset = future deductible

Leading Innovations, Transforming Lives

Service cost = CSC, PSC & gain or loss on plan

Leading Innovations, Transforming Lives

Projected Benefit Obligation

Leading Innovations, Transforming Lives

Fair value of plan assets

IF PBO > FVPA = pension liability / accrued benefit cost

IF FVPA > PBO = pension asset / prepaid benefit cost

Leading Innovations, Transforming Lives

Kalma Corporation issued P800,000 of 12% face value

Leading Innovations, Transforming Lives