Auditing

Easy

1. Arrangements concerning which of the following are least likely to be included in engagement
letter?
a. A predecessor auditor.
b. Fees and billing.
c. CPA investment in client securities.
d. Other services to be provided in addition to the audit.

Answer: C

PSA does not suggest any arrangement concerning CPA investment in client securities; indeed such
investments are prohibited by Code of Ethics.

2. Which of the following is not a component of an entity’s internal control?

a. Control risk.
b. Control activities.
c. Monitoring.
d. Control environment.

Answer: A

While auditors assess control risk as a part of their consideration of internal control, it is not a component
of an entity’s internal control.

3. An auditor may compensate for a weakness in internal control by increasing the

a. Level of detection risk.
b. Extent of tests of controls.
c. Preliminary judgment about audit risk.
d. Extent of analytical procedures.

Answer: D

Increasing analytical procedures decreases detection risk in a manner which may counterbalance the
condition in internal control. In effect, the weakness in internal control is compensated for by increased
substantive testing.

4. Which of the following departments most likely would approve changes in pay rates and
deductions from employee salaries?
a. Personnel.
b. Treasurer.
c. Controller.
d. Payroll.

Answer: A

The personnel department, which has the primary objective of planning, controlling and coordinating
employees, will determine that proposed salary increases (often recommended by supervisors of
employees) are consistent with the company’s salary guidelines and will approve changes in deductions.

5. Which of the following is not an assertion relating to classes of transactions?

a. Accuracy.
b. Consistency.
c. Cutoff.
 d. Occurrence.

Answer: B

The assertions for classes of transactions are occurrence, completeness, accuracy, cutoff and
classification.

6. The permanent file of an auditor’s working papers generally would not include
a. Bond indenture agreements.
b. Lease agreements.
c. Working trial balance.
d. Flowchart of internal control.

Answer: C

Permanent files include information affecting a number of years’ audits, and the working trial balance
relates most directly to the current and, to a limited extent, the subsequent year’s audit.

7. An auditor most likely would analyze inventory turnover rates to obtain evidence concerning
management’s assertions about
a. Existence.
b. Rights.
c. Presentation.
d. Valuation.

Answer: D

An analysis of inventory turnover rates will provide the auditor with evidence on slow moving, excess,
defective, and obsolete items included in inventories. These items may be improperly valued.

8. A summary of findings rather than assurance is most likely to be included in

a. Agreed-upon procedures report.
b. Compilation report.
c. Examination report.
d. Review report.

Answer: A

Agreed-upon procedures reports include a summary of findings.

9. An accountant’s compilation report should be dated as of the date of

a. Completion of fieldwork.
b. Completion of the compilation.
c. Transmittal of the compilation report.
d. The latest subsequent event referred to in the notes to the financial statements.

Answer: B

PSRS require that the date of completion of the compilation should be used.

10. A number of factors influences the sample size for a substantive test of details of an account
balance. All other factors being equal, which of the following would lead to a larger sample size?
a. Greater reliance on internal control.
b. Greater reliance on analytical procedures.
c. Smaller expected frequency of errors.
d. Smaller measure of tolerable misstatement.
Answer: D

The sample size required to achieve the auditor’s objective at a given risk of incorrect acceptance
increases as the auditor’s assessment of tolerable misstatement for the balance or class decreases.

11. Which of the following methods of testing application controls utilizes a generalized audit software
package prepared by the auditors?
a. Parallel simulation.
b. Integrated testing facility approach.
c. Test data approach.
d. Exception report tests.

Answer: A

The parallel simulation method processes the client’s data using the CPA’s software.

12. Which of the following controls most likely would reduce the risk of diversion of customer receipts
by an entity’s employees?
a. A bank lockbox system.
b. Prenumbered remittance advices.
c. Monthly bank reconciliations.
d. Daily deposit of cash receipts.

Answer: A

A bank lockbox system eliminates employee contact with cash receipts, and thereby greatly reduces the
risk of diversion by employees.

13. According to the Code of Ethics for Professional Accountants in the Philippines, close family
include the following, except
a. Parent
b. Non-dependent child
c. Sibling
d. Spouse

Answer: D

Spouse is considered as an immediate family member by the Code of Ethics for Professional
Accountants in the Philippines.

14. Which of the following is the least required in attaining professional competence?
a. High standard of general education.
b. Specific education, training and examination in professionally relevant subjects.
c. Period of meaningful work experience.
d. Continuing awareness of development in the accountancy profession.

Asnwer: D

Continuing awareness of development in the accountancy profession is required for maintaining

professional competence.

15. In a financial statement audit, inherent risk represents

a. The susceptibility of an account balance to error that could be material.
b. The risk that error could occur and not be prevented or detected by the internal control
structure.
 c. The risk that error could occur and not be detected by the auditor's procedures.
d. The risk that the auditor fails to modify materially misstated financial statements.

Answer: A

Inherent risk is the susceptibility of an account balance to error that could be material assuming there are
no related internal controls.

16. Which of the following is not a component of an entity’s internal control?

a. Reporting.
b. Control activities.
c. Monitoring.
d. Control environment.

Answer: A

COSO components of internal control includes Control environment, Risk assessment, Control activities,
Information and communication, and Monitoring.

17. Occurs when a firm or a member of the assurance team could benefit from a financial interest in,
or other self-interest conflict with, an assurance client.
a. Self-interest threat
b. Advocacy threat
c. Self-review threat
d. Familiarity threat
Answer: A

Self-interest threat is the threat that a financial or other interest will inappropriately influence the
professional accountant’s judgment or behavior.

18. This refers to unintentional misstatement or omission in financial statements.

a. Error
b. Fraud
c. Illegal act
d. Anomaly

Answer: A

Errors refer to unintentional misstatements or omission in financial statements whereas fraud arises from
fraudulent financial reporting and from misappropriation of assets.

19. Who should take responsibility for the overall quality on each audit engagement?

a. Engagement quality control reviewer

b. Engagement partner
c. Engagement team
d. CPA firm

Answer: B
 PSA 220 provides that the engagement partner should take responsibility for the overall quality on
each audit engagement to which that partner is assigned.

20. Which of the following internal control components relates to an entity’s process for identifying and
responding to business risks?

a. Control activities
b. Information and communication
c. Risk assessment
d. Monitoring of controls

Answer: C
PSA 315 states that the entity’s risk assessment process forms the basis for how management
determines the risks to be managed.

Average

1. An auditor believes that an understanding with the client has not been established. In this case,
the auditor should ordinarily:
a. Perform the engagement with renewed professional skepticism.
b. Decline to accept or perform the engagement.
c. Assess control risk at a high level and rely primarily on substantive audit procedures.
d. Modify the assessment of risk due to fraud.

Answer: B
PSA 210 requires that an understanding with the client should be established. Accordingly, if
such an understanding is not reached, the auditor should decline to accept or perform the
engagement.

2. Audit program may be either predetermined or progressive. All of the following are advantages of
a predetermined audit program, except that
a. It places responsibility for each audit procedure.
b. It encourages independent, constructive thinking.
c. It results in proper audit routine and saves time.
d. It assures adherence to auditing standards and the application of GAAP.

Answer: B
Pre-determined audit programs are template programs (standard procedures) which are usually
tailored to suit an engagement. Progressive audit programs are developed as the audit
progresses. Pre-determined audit programs discourage independent, constructive thinking,
because the staff will have a tendency of just completing standard programs without considering
if additional or modified procedures would better suit an engagement.

3. Which of the following best describes due care?

a. Tact in avoiding legal liability
b. Requisite skill and diligence
c. Reasonable infallibility
d. Freedom from undue influence
 Answer: B
Due care requires auditor to conscientiously preform every aspect of the audit. It requires the
application of skill and diligence in performing an engagement.

4. Maria Cristina, CPA, has an audit client, Claveria Inc., which uses another CPA for management
services work. Maria Cristina sends her firm’s literature covering its management services
capabilities to Valencia, Inc. on an unsolicited monthly basis. In addition, Maria Cristina has
provided a list of criticisms of the work of the other CPA.
a. Maria Cristina is violating the code of professional ethics because this is a form of
advertising.
b. Maria Cristina is violating the rules on promotion of work by professional accountants.
c. Maria Cristina is violating the code of professional ethics unless she obtains the other
CPA’s permission to mail such literature to Valencia, Inc.
d. Maria Cristina is not violating the code of professional ethics.

Answer: B
Maria Cristina is violating the rules on promotion of work by CPAs, which states that CPAs should
not denigrate the work of other accountants.

5. This refers to the gathering of professionals which shall include among others, workshops,
technical lectures or subject matter meetings, non-degree training courses and scientific
meetings.
a. Seminars
b. Conventions
c. Meetings
d. Professional gathering

Answer: A
Annex C of the IRR to RA9298, Section 3(b) provides the following definitions:
Seminars shall refer to the gathering of professionals which shall include among others,
workshops, technical lectures or subject matter meetings, non-degree training courses and
scientific meetings.

6. Which of the following is not an information source for developing analytical procedures used in
the audit?
a. Relationships among financial statement elements.
b. Relationships between financial and relevant non-financial data.
c. Comparison of financial data with anticipated results (such as budgets or forecasts).
d. Comparison of current year financial data with projections for next year’s financial results.

Answer: D
Current year financial data may be compared against expectations developed from:
 Prior-year financial data
 Budget data for the same year
 Industry averages

7. Which of the following is included in the seal used by a Certified Public Accountant?
a. Professional tax receipt (PTR) number
b. Community Tax Certificate number
c. Tax identification Number (TIN)
d. CPA Registration number
 Answer: D
Choices A to C are indicated by the auditor in audit reports issued in connection with an
engagement (SEC Circular). Choice D is indicated in the lower portion of the CPA seal (refer to
Section 33 of the Implementing Rules and Regulations to RA9298).

8. The auditor’s duty of confidentiality would ordinarily preclude the reporting of fraud or error to a
third party. However, in certain circumstances, the duty of confidentiality is justifiably overridden
by the following, except:
a. Law
b. Statute
c. Courts of law
d. Pressure from a competitor of the audit client.

Answer: D
In summary, rule on confidentiality may be overridden, by the following:
 Where specific authority has been obtained from the client.
 Where disclosure is required by law.
 Where there is a professional right or duty to disclose.

For Nos. 9 to 11.

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:

9. Compensation expense for year 1

a. Php30,000
b. Php40,000
c. Php50,000
d. Php50,000

10. Compensation expense for year 2

a. Php30,000
b. Php40,000
c. Php50,000
d. Php60,000

11. Compensation expense for year 3

a. Php0
b. Php30,000
c. Php40,000
d. Php50,000

Answers for 9 to 11
9. C
10. C
11. D

Compensation Cumulative
Expense Compensation
Year Calculation for Period Expense
1 30,000 options x P5 fair value x 1⁄3 P50,000 P50,000
2 30,000 options x P5 fair value x 1⁄3 50,000 100,000
3 30,000 options x P5 fair value x 1⁄3 50,000 150,000

For Nos. 12 to 15

A portion of the SPARK COMPANY’s statement of financial position appears as follows:

December 31, 2017 December 31, 2016
Assets:
Cash P353,300 P100,000
Notes receivable 0 25,000
Inventory ? 199,875
Liabilities:
Accounts payable ? 75,000

Spark Company pays for all operating expenses with cash and purchases all inventory on credit. During
2017, cash totaling P471,700 was paid on accounts payable. Operating expenses for 2017 totaled
P220,000. All sales are cash sales. The inventory was restocked by purchasing 1,500 units per month
and valued by using periodic FIFO. The unit cost of inventory was P32.60 during January 2017 and
increased P0.10 per month during the year. Spark sells only one product. All sales are made for P50 per
unit. The ending inventory for 2016 was valued at P32.50 per unit.
Based on the preceding information, compute the following:

12. Number of units sold during 2017

a. 7,066
b. 18,400
c. 4,268
d. 13,400

13. Accounts payable balance at December 31, 2017

a. P190,100
b. P50,000
c. P199,100
d. P200,000

14. Inventory quantity on December 31, 2017

a. 5,750
b. 2,750
c. 17,084
d. 10,750

15. Cost of inventory on December 31, 2017

a. P187,450
b. P186,875
c. P192,250
d. P189,660

Answers for 12 to 15:

12. B

Cash balance, Dec. 31, 2016 P100,000

Sales (SQUEEZE) 920,000
Cash paid for operating expenses (220,000)
Cash paid on accounts payable (471,700)
Collections on notes receivable __25,000
Cash balance, Dec. 31, 2017 P353,300

Units sold (P920,000/P50) 18,400

13. D

Accounts payable:
Balance, Dec. 31, 2016 P75,000
Purchases 596,700*
Cash payments on accounts payable (471,700)
Balance, Dec. 31, 2017 P200,000

*Purchases:
Month Unit Cost Units Total Cost
January P32.60 1,500 P48,900
February 32.70 1,500 49,050
March 32.80 1,500 49,200
 April 32.90 1,500 49,350
May 33.00 1,500 49,500
June 33.10 1,500 49,650
July 33.20 1,500 49,800
August 33.30 1,500 49,950
September 33.40 1,500 50,100
October 33.50 1,500 50,250
November 33.60 1,500 50,400
December 33.70 1,500 __50,550
Total purchases 18,000 P596,700

Or (P32.60 + P33,70)/2 x (1,500 x 12) = P596,700

14. A

Inventory, Dec. 31, 2016 (P199,875/P32.50) 6,150

Purchases 18,000
Units sold (18,400)
Inventory, Dec. 31, 2017 5,750

15. C

FIFO cost of inventory, Dec. 31, 2017:

December purchases 1,500 x P33.70 P 50,550
November purchase 1,500 x P33.60 50,400
October purchase 1,500 x P33.50 50,250
September purchase 1,250 x P33.40 __41,750
5,750 P192,950

16. Chandler, CPA, has been asked to audit and report on the balance sheet of Fox Co. but not on the
statements of income, retained earnings, or cash flows. Chandler will have access to all information
underlying the basic financial statements. Under these circumstances, Chandler may

a. Not accept the engagement because it would constitute violation of the profession’s
ethical standards.
b. Not accept the engagement because it would be tantamount rendering a piecemeal
opinion.
c. Accept the engagement because such engagements merely involve limited reporting
objectives.
d. Accept the engagement but should disclaim an opinion because of an inability to apply
the procedures considered necessary.

Answer: C
The auditor may accept the engagement because the situation involves limited reporting
objectives, not a limitation on the scope of audit procedures.

17. The engagement team for the 2017 audit of the financial statements of Amihan Company are
composed of the following:
Partner: Charlotte Marquez
Manager: Katherine Perez
Senior Associate: Marie Sanchez
Audit Associate: Taylor Lopez
 Following Philippine Standards on Auditing, who among the above would be considered as the
auditor?
a. b. c. d.
Charlotte Marquez Yes Yes Yes Yes
Katherine Perez Yes No No No
Marie Sanchez No Yes No Yes
Taylor Lopez No No No No

Answer: C
PSAs refer to the auditor as the one who assumes overall responsibility in an audit. In the above
situation, this applies to the partner in charge of the engagement.

18. In planning an audit, the auditor should consider the presence of fraud risk factors relating to
misstatements arising from (1) fraudulent financial reporting and (2) misappropriation of assets. In
which of the following situations would the auditor most likely presume that a high risk of defalcation
exists?

a. ABC Company is a multinational company that does business in various countries in the
Asia-Pacific rim.
b. DEF Company does business with related parties.
c. GHI Company has a cashier who also handles accounting and authorization functions.
d. MNO Company is in an industry where the rate of change is very slow.

Answer: C
Letter C poses a high risk of defalcation due to lack of segregation of duties. Segregation of
duties require that the functions of (1) authorization; (2) record-keeping; and (3) custody of assets
should be assigned to different persons.

19. Kim, CPA, was engaged to review the financial statements of Hall Co., a nonissuer. During the
engagement Kim uncovered a complex scheme involving client illegal acts that materially affect
Hall’s financial statements. If Kim believes that modification of the standard review report is not
adequate to indicate the deficiencies in the financial statements, Kim should

a. Disclaim an opinion.
b. Issue an adverse opinion.
c. Withdraw from the engagement.
d. Issue a qualified opinion.

Answer: C
Whenever a CPA believes that modification of the standard report is not adequate to indicate the
deficiencies in the financial statements, he or she should withdraw from the review engagement
and provide no further services with respect to those financial statements.

20. Oroquieta, CPA, is planning the audit of Mambajao, Inc., a medium-sized manufacturing concern
with less than one hundred (100) shareholders, which one of the following areas would require the
least amount of audit time?
 a. Revenue
b. Assets
c. Liabilities
d. Owner’s equity

Answer: D
Owner’s equity would require the least amount of audit time while asset requires the greatest
amount of audit time.

Difficult

1. On June 30, 2017, the HOPE COPPER MINES, INC. purchased a copper mine for P14,580,000. The
estimated capacity of the mine was 1,620,000 tons. HOPE Copper Mines expects to extract 15,000
tons of ore a month with an estimated selling price of P50 per ton. Production started immediately after
some new machines costing P1,800,000 were bought on June 30, 2017. These new machines had an
estimated useful life of 15 years with a scrap value of 10% of cost after the ore estimate has been
extracted from the property, at which time the machines will already be useless. HOPE’s books show
the following expenses for 2015:

Depletion expense .......................................................P1,215,000

Depreciation—Machinery .................................................. 120,000

Recorded depletion expense was

A. Overstated by P270,000.

B. Understated by P270,000.

C. Overstated by P405,000

D. Understated by P405,000.

Answer: C

Depletion rate per ton (P14,580,000 / 1,620,000) P9

Copper ore mined in 2015 (15,000 x 6 months) x 90,000

Depletion for 2017 P 810,000

Depletion per books 1,215,000

Overstatement of depletion expense P405,000

2. FAITH COMPANY purchased a machine for P300,000 on January 1, 2014, with the following additional
items paid or incurred:
 Separation pay for laborer laid off upon acquisition of new machine ..................................... P3,600

Loss on sale of machine replaced .............................................................................................3,900

Transportation in ........................................................................................................................3,000

Installation cost ........................................................................................................................12,000

The new machine is estimated to have a useful life of 10 years and a residual value of P12,000.

On January 1, 2017, new parts which cost P37,800 were added to the machine so as to reduce its fuel
consumption, but with no change in its estimated life or residual value.

The annual depreciation charge on the machine for 2017 was

A. P34,080 B. P35,494 C. P36,450 D. P35,700

Answer: D

January 1, 2014

Total cost of machine (P300,000 + P3,000 + P12,000) P315,000

Residual value (12,000)

Depreciable cost P303,000

Estimated useful life 10 years

Annual depreciation P30,300

Depreciable cost P303,000

Depreciation, 2014 – 2017 (P30,300 x 3 years) (90,000)

Remaining depreciable cost, Jan. 1, 2015 P212,100

Cost of new parts 37,800

Total P249,900

Remaining useful life (10 years – 3 years) 7 years

Revised annual depreciation P35,700

3. LOVE COMPANY buys and sells securities expecting to earn profits on short-term differences in price.
During 2017, Love Company purchased the following trading securities:
Fair Value

Security Cost Dec. 31, 2017

A P 585,000 P 675,000
 B 900,000 486,000

C 1,980,000 2,034,000

Before any adjustments related to these trading securities, Love Company had net income of
P2,700,000.

What is Love’s net income after making any necessary trading security adjustments?

A. P2,430,000 B. P2,286,000 C. P2,934,000 D. P2,700,000

Answer: A

Net income before trading security adjustment P2,700,000

Unrealized loss (P3,465,000 cost – P3,195,000 market value) (270,000)

Net income, as adjusted P2,430,000

4. KINDNESS CO.’s portfolio of trading securities includes the following on December 31, 2016:

Cost Fair Value

15,000 ordinary shares of Jacob Co. P1,431,000 P1,251,000

30,000 ordinary shares of Esau Co. 1,638,000 1,710,000

P3,069,000 P2,961,000

All of the above securities have been purchased in 2016. In 2017, KINDNESS Co. completed the
following securities transactions:

Mar. 1 Sold 15,000 shares of Jacob Co. ordinary shares at P93, less brokerage commission of
P13,500.

April 1 Bought 1,800 ordinary shares of Israel, Inc. at P135 plus commission, taxes, and other
transaction costs of P4,950.

The KINDNESS Co. portfolio of trading securities appeared as follows on December 31, 2017:

Cost Fair Value

30,000 ordinary shares of Esau Co. P1,638,000 P1,740,000 1

1,800 ordinary shares of Israel, Inc. 247,950 225,000 2

 P1,885,950 P1,965,000
1 Net of P19,500 estimated transaction costs that would be incurred on the sale of the securities.
2 Net of P4,500 estimated transaction costs that would be incurred on the sale of the securities.

What is the gain on the sale of Jacob Co. ordinary shares on March 1, 2017?

A. P144,000 B. P27,000 C. P130,500 D. P13,500

Answer: C

Net proceeds (P93 x 15,000 = P1,395,000 – P13,500) P1,381,500

Carrying value (1,251,000)

Gain on sale P 130,500

5. On January 1, 2016, PATIENCE MFG. CO. began construction of a building to be used as its office
headquarters. The building was completed on June 30, 2017.

Expenditures on the project were as follows:

January 3, 2016 P2,500,000

March 31, 2016 3,000,000

June 30, 2016 4,000,000

October 31, 2016 3,000,000

January 31, 2017 1,500,000

March 31, 2017 2,500,000

May 31, 2017 3,000,000

On January 3, 2016, the company obtained a P5 million construction loan with a 10% interest rate. The
loan was outstanding all of 2016 and 2017. 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 2016 and 2017. The company’s fiscal
year-end is December 31.

What amount of interest should be expensed in 2016?

A. P2,736,875 B. P2,356,250
C. P2,900,000 D. P0

Answer: A
Actual borrowing cost:

Specific borrowing (P5 million x 10%) P500,000

General borrowings:

P25 million x 8% P2,000,000

P15 million x 6% 900,000 2,900,000

Total P3,400,000

Capitalization rate (P2,900,000/P40 million) 7.25%

Average expenditures – 2014 P7,250,000

Capitalizable interest – 2014:

Specific borrowing (P5 million x 10%) P500,000

General borrowings (P7,250,000 – P5,000,000 = P2,250,000 x 7.25%) 163,125

Total P663,125

2016 interest expense (P3,400,000 – P663,125) P2,736,875

6. The December 31 year-end financial statements of PERSEVERANCE COMPANY contained the

following errors:
Dec. 31, 2016 Dec. 31, 2017

Ending inventory P48,000 understated P40,500 overstated

Depreciation expense P11,500 understated -------

An insurance premium of P330,000 was prepaid in 2016 covering the years 2016, 2017, and 2018. The
entire amount was charged to expense in 2016. In addition, on December 31, 2017, a fully depreciated
machinery was sold for P75,000 cash, but the sale was not recorded until 2018. There were no other errors
during 2016 and 2017, and no corrections have been made for any of the errors. Ignore income tax effects.

What is the total effect of the errors on the amount of Perseverance’s working capital at December 31,
2017?

A. P75,500 overstatement

B. P40,500 overstatement

C. P225,500 understatement

D. P144,500 understatement

Answer: D
 Over- (Under-)statement

Overstatement of 2015 ending inventory P 40,500

Prepaid insurance charged to expense in 2014 (110,000)

Unrecorded sale of fully depreciated machinery in 2015 (75,000)

Total effect on working capital (P144,500)

7. GENTLE, INC., a dealer of household appliances, sells washing machines at an average price of
P8,100. The company also offers to each customer a separate 3-year warranty contract for P810 that
requires the company to provide periodic maintenance services and to replace defective parts. During
2016, GENTLE sold 300 washing machines and 270 warranty contracts for cash. The company
estimates that the warranty costs are P180 for parts and P360 for labor.

Assume sales occurred on December 31, 2016. GENTLE’s policy is to recognize income from the
warranties on a straight-line basis. In 2017, GENTLE incurred actual costs relative to 2016 warranty sales
of P18,000 for parts and P36,000 for labor.

What liability relative to these transactions would appear on the December 31, 2016, statement of financial
position and how would it be classified?

Current Noncurrent

A. P145,800 P72,900

B. P72,900 P72,900

C. P72,900 P145,800

D. P0 P218,700

Answer: C

Unearned warranty revenue:

Current (P810 x 270 x 1/3) P72,900

Non-current (P810 x 270 x 2/3) P145,800

8. To substantiate the existence of the accounts receivable balances as at December 31, 2017 of
CANAAN COMPANY, you have decided to send confirmation requests to customers. Below is a
summary of the confirmation replies together with the exceptions and audit findings. Gross profit on
sales is 20%. The company is under the perpetual inventory method.

Name of Balance Comments

Customer Per Books From Customers Audit Findings
Concordia P150,000 P90,000 was returned on December 30, Returned goods were
2015. Correct balance as is P60,000. received December 31, 2017.
 Falcon P30,000 Your CM representing price adjustment The CM was taken up by
dated December 28, 2015 cancels this. Canaan Company in 2018.
Lazaro P144,000 You have overpriced us by P150. Correct The complaint is valid.
price should be P300.
Silang P112,500 We received the goods only on January 6, Term is shipping point.
2018. Shipped in 2017.
Yakal P135,000 Balance was offset by our December Canaan Company credited
shipment of your raw materials. accounts payable for
P135,000 to record
purchases. Yakal is a
supplier.

The accounts receivable from Silang is

A. Correctly stated. C. P112,500 under.

B. P112,500 over. D. P225,000 under.

Answer: A

Correctly stated because the goods are considered sold in 2017.

9. A portion of the PROMISE LAND COMPANY’s statement of financial position appears as follows:

December 31, 2017 December 31, 2016

Assets:

Cash P353,300 P100,000

Notes receivable 0 25,000

Inventory ? 199,875

Liabilities:

Accounts payable ? 75,000

Promise land Company pays for all operating expenses with cash and purchases all inventory on credit.
During 2017, cash totaling P471,700 was paid on accounts payable. Operating expenses for 2017 totaled
P220,000. All sales are cash sales. The inventory was restocked by purchasing 1,500 units per month
and valued by using periodic FIFO. The unit cost of inventory was P32.60 during January 2017 and
increased P0.10 per month during the year. Promise land sells only one product. All sales are made for
P50 per unit. The ending inventory for 2016 was valued at P32.50 per unit.

Based on the preceding information, compute the following:

Number of units sold during 2017

 A. 7,066 B. 18,400 C. 4,268 D. 13,400

Answer: B

Cash balance, Dec. 31, 2016 P100,000

Sales (SQUEEZE) 920,000

Cash paid for operating expenses (220,000)

Cash paid on accounts payable (471,700)

Collections on notes receivable 25,000

Cash balance, Dec. 31, 2017 P353,300

Units sold (P920,000/P50) 18,400

10. A note receivable amounting to P1,300,000 represents a loan granted to a subsidiary. This is covered
by a promissory note with interest at 15% per annum dated November 1, 2017. No interest has been
accrued on the note as of December 31, 2017. What is the adjusted balance of Notes and interest
receivable?

Notes and interest receivable

A. P1,331,960 B. P1,332,160 C. P1,332,500 D. P1,300,000

Answer: C

Notes and interest receivable

Per books P1,300,000

*AJE 32,500

Per audit P1,332,500

*AJE

Interest receivable 32,500

Other income (Interest income) 32,500

(P1,300,000 x 15% 2/12)