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AUDITING PROBLEMS TEST BANK 2

PROBLEM NO. 1

You have been assigned to audit the financial statements of AYALA MERCHANTS
CORPORATION for the year 2017. The company is a dealer of appliances and has several
branches in Metro Manila. Its main office is located in Makati City. You were given by the
company controller the unadjusted balances of the items to be included in the company’s
statement of financial position and statement of income as of and for the year ended December
31, 2017. Audit findings are as follows:

I. AUDIT OF CASH

A cash count was conducted by your staff on January 7, 2018. The petty cash fund of
P60,000 maintained by the company on an imprest basis relected a balance of P22,750.
Unreplenished expenses totaled P37,250 of which P9,510 pertains to January 2018.

You were furnished a copy of the company’s bank reconciliation statement with Chartered
Bank as follows:
Balance per bank P277,994
Add: Deposit in transit 248,836
Bank debit memos 712,750
Returned check 63,000
Less: Outstanding checks (174,580)
Book error (72,000)
Balance per books P1,056,000

Your review of the reconciliation statement disclosed the following:

1. Postdated checks totaling P107,400 were included as part of the deposit in transit.
These represent collections from various customers whose accounts have been
outstanding for less than three months. These checks were actually deposited on
January 8, 2018.

2. Included in the deposit in transit is a check from a customer for P63,000 which was
returned by the bank on December 27, 2017 for insufficiency of funds. This account has
been outstanding for over six months. The check was replaced by the customer on
January 15, 2018.

3. The bank debited the account of Ayala Merchants for P710,000 as payment of notes
payable including interest of P10,000 due on December 26, 2017. This was not recorded
as of year-end.

4. A check was cleared by the bank as P30,900 but was recorded by the bookkeeper as
P102,900. This was in payment of accounts payable.

5. Bank service charges totaling P2,750 were not recorded.

II. AUDIT OF ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS

It is the company’s policy to provide allowance for doubtful accounts as follows:

Less than 3 months P2,500,960 1%


3 to 6 months 843,200 5%
Over 6 months 274,500 10%
Total P3,618,660
An analysis of the accounts receivable schedule showed that several long outstanding
accounts for more than a year totaling P152,460 should be written-off.
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III. AUDIT OF MARKETABLE SECURITIES – TRADING

The company’s equity portfolio as of year-end showed the following:


Total Market Value
Shares Cost per Share
Bacnotan Cement 7,000 P108,500 P16.00
Fil-Estate 10,000 195,000 19.75
Ionics 2,400 49,200 24.00
La Tondena 2,000 67,000 26.00
Selecta 8,000 31,600 1.20
Union Bank 1,600 50,880 27.50
P502,180
The securities are listed in the stock exchange. The company follows the fair value
accounting.

IV. AUDIT OF NOTES RECEIVABLE

The 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.

V. AUDIT OF PREPAYMENTS

Prepaid expenses account consists of the following:


Prepaid advertising P 640,000
Prepaid insurance 490,000
Prepaid rent 420,000
Unused office supplies 361,000
P1,911,000
Ayala Merchants renewed its contract with an advertising agency for the annual promotion
as well as the regular advertisement of its products. It paid a total of P640,000, P100,000
of which is for the Christmas promotion while the balance is for the regular promotion and
which will run for one year starting on August 1, 2017. Payment was made on July 20,
2017, and the total amount was reflected as prepaid advertising.

The company leases the main office and store in Makati City at a monthly rental of
P140,000. On November 5, 2017, a check for P420,000 was issued in payment of three-
month rental as per renewal contract which was effective on November 1, 2017. Rental
deposit remained at three months and is included under other assets.

The company’s delivery equipment is insured with Fortune Insurance Corporation for a total
coverage of P2.4 million. Total payment made on November 16, 2017 for the renewal
amounted to P490,000 which covers the period from November 1, 2017 to November 1,
2018. No adjustment has been made as of December 31, 2017.

To take advantage of volume discount ranging from 10% to 20%, the company buys office
and store supplies on a bulk basis. The staff-in-charge bought supplies worth P220,000 on
June 10, 2017 and included the same in their office supplies inventory. As at year-end,
unused office supplies amount to P102,500.
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VI. AUDIT OF INVENTORIES

A physical count of inventories was conducted simultaneously in all stores on December 29


and 20, 2017. Your review of the list submitted by the accountant disclosed the following:
1. Some deliveries made in December 2017 have not been invoiced and recorded as of
year-end. These items had a selling price of P146,940 with term of 15 days. The
corresponding cost was already deducted from the ending inventory.
2. Goods on consignment to Ayala Merchants totaling P356,000 were included in the
inventory list.
3. Some appliances worth P138,500 were recorded twice in the inventory list.
4. Goods costing P153,800 purchased and paid on December 26 was received on January
4, 2018. The goods were shipped by the supplier on December 28, FOB shipping point.

VII. AUDIT OF PROPERTY, PLANT AND EQUIPMENT

The company purchased additional equipment worth P268,000 on June 30, 2017. At the
date of purchase, it incurred the following additional costs which were charged to repairs
and maintenance account:
Freight-in P30,400
Installation cost 13,000
Total P43,400

The above equipment has an estimated useful life of ten years and estimated salvage value
of P20,000. Depreciation for the above equipment has been provided based on original
cost.

The company discarded some store equipment on October 1, 2017, realizing no salvage
value. The cost of these equipment amounted to P165,520 with an accumulated
depreciation of P138,620 on December 31, 2017. Depreciation booked from October 1,
2017 to year-end was P10,480. No entry was made on the disposal of the property.

VIII. AUDIT OF ACCRUED EXPENSES

Some expenses for December 2017 were recorded when paid in January 2018 which
included the following:
Electric bills P73,400
Commission of sales agents 57,000
Telephone charges 42,500
Minor repair of delivery equipment 21,340
Water bills 18,760
Total P213,000

IX. AUDIT OF LIABILITIES

Ayala Merchants obtained a one-year loan from Chartered Bank amounting to P2.6 million at
an interest rate of 16% per annum on October 1, 2017. Accrued interest on this loan was
not taken up at year-end.
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X. OTHER AUDIT FINDINGS

A review of the minutes of meeting showed that a 10% cash dividend was declared to
shareholders of record as of December 15, 2017, payable on January 31, 2018.

Ayala Merchants Corporation


UNADJUSTED TRIAL BALANCE
December 31, 2017

Debit Credit
Petty cash fund P 60,000
Cash in bank 1,056,000
Trading securities 483,640
Accounts receivable – trade 3,618,660
Allowance for doubtful accounts P 110,360
Notes receivable 1,300,000
Inventories 7,274,900
Prepaid advertising 640,000
Prepaid insurance 490,000
Prepaid rent 420,000
Office supplies inventory 361,000
Furniture and fixtures 1,298,400
Delivery equipment 2,770,000
Accumulated depreciation 1,177,500
Other assets 548,000
Accounts payable – trade 2,356,320
Notes payable 3,300,000
Accrued expenses 169,040
Bonds payable 5,000,000
Discount on bonds payable 500,000
Ordinary share capital 5,400,000
Retained earnings 792,160
Sales 13,078,000
Cost of goods sold 8,034,000
Operating expenses 3,357,000
Other income 1,453,500
Other charges 625,280
P32,836,880 P32,836,880

Determine the adjusted balances of the following: (Ignore tax implications)


1. Petty cash fund
A. P37,250 B. P60,000 C. P22,750 D. P32,260

2. Cash in bank
A. P522,650 B. P450,650 C. P1,056,000 D. P244,850

3. Trading securities
A. P403,640 B. P502,180 C. P491,240 D. P472,700

4. Accounts receivable
A. P3,936,000 B. P3,618,660 C. P3,783,540 D. P3,613,140

5. Allowance for doubtful accounts


A. P110,360 B. P152,640 C. P130,316 D. P88,217
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6. Notes and interest receivable


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

7. Inventories
A. P6,934,200 B. P7,274,900 C. P7,290,200 D. P6,780,400

8. Prepaid insurance
A. P449,167 B. P408,333 C. P490,000 D. P428,750

9. Prepaid rent
A. P140,000 B. P 0 C. P420,000 D. P280,000

10. Prepaid advertising


A. P325,000 B. P640,000 C. P373,334 D. P315,000

11. Office supplies inventory


A. P258,500 B. P117,500 C. P361,000 D. P102,500

12. Total current assets


A. P14,0333,612 B. P13,523,866 C. P13,677,666 D. P13,537,666

13. Property, plant, and equipment


A. P4,068,400 B. P2,905,228 C. P3,946,280 D. P3,902,880

14. Accumulated depreciation


A. P1,038,880 B. P1,041,050 C. P1,177,500 D. P1,179,672

15. Accounts payable


A. P2,525,360 B. P2,428,320 C. P2,597,360 D. P2,356,320

16. Interest payable


A. P104,000 B. P16,178 C. P4,000 D. P27,644

17. Total current liabilities


A. P6,803,798 B. P6,103,798 C. P6,054,360 D. P5,603,798

18. Sales
A. P13,068,440 B. P13,078,000 C. P13,224,940 D. P12,339,500

19. Cost of goods sold


A. P8,034,000 B. P8,236,200 C. P8,018,700 D. P8,374,700

20. Operating expenses


A. P4,296,514 B. P3,357,000 C. P4,341,514 D. P4,621,514
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PROBLEM NO. 2

To substantiate the existence of the accounts receivable balances as at December 31, 2017 of
LUKAS 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
2017. 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, 2017 cancels this. Lukas 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 Lukas Company credited
shipment of your raw materials. accounts payable for
P135,000 to record
purchases. Yakal is a
supplier.

21. If the necessary adjusting journal entry is made regarding the case of Concordia, the net
income will
A. Decrease by P18,000. C. Increase by P18,000.
B. Decrease by P90,000. D. Increase by P90,000.

22. The effect on 2017 net income of Lukas Company of its failure to record the CM involving
transaction with Falcon:
A. P30,000 over. C. P6,000 over.
B. P30,000 under. D. P6,000 under.

23. The overstatement of receivable from Lazaro is


A. P96,000 B. P24,000 C. P72,000 D. P48,000

24. The accounts receivable from Silang is


A. Correctly stated. C. P112,500 under.
B. P112,500 over. D. P225,000 under.

25. The adjusting entry to correct the receivable from Yakal is


A. Purchases 135,000
Accounts receivable 135,000
B. Accounts payable 135,000
Purchases 135,000
C. Accounts receivable 135,000
Accounts payable 135,000
D. Accounts payable 135,000
Accounts receivable 135,000
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PROBLEM NO. 3

Palito, CPA, has just accepted an engagement to audit the financial statements of Crocodile,
Inc. for the year ending December 31, 2017. After obtaining an understanding of the client’s
design of the accounting and internal control systems and their operation, he then proceeded in
performing test of controls related to production cycle.

The following questions related to test of controls of the production cycle:

26. Which of the following auditing procedures probably would provide the most reliable
evidence concerning the entity’s assertion of rights and obligations related to inventories:
A. Trace the test counts noted during the entity’s physical count to the entity’s
summarization of quantities.
B. Inspect agreements to determine whether any inventory is pledged as collateral or
subject to any liens.
C. Select the last few shipping documents used before the physical count and determine
whether the shipments were recorded as sales.
D. Inspect the open purchase order file for significant commitments that should be
considered for disclosure.

27. Which of the following internal control activities most likely addresses the completeness
assertion for inventory?
A. The work-in-process account is periodically reconciled with subsidiary inventory
records.
B. Employees responsible for custody of finished goods do not perform the receiving
function
C. Receiving reports are prenumbered and the numbering sequence is checked
periodically.
D. There is a separation of duties between the payroll department and inventory
accounting personnel.

28. From the auditor’s point of view, inventory counts are more acceptable prior to the year-
end when
A. Internal control is weak.
B. Accurate perpetual inventory records are maintained.
C. Inventory is slow moving.
D. Significant amounts of inventory are held on a consignment basis.

29. A retailer’s physical count of inventory was higher than that shown by the perpetual
records. Which of the following could explain the difference?
A. Inventory items had been counted but the tags placed on the items had not been
taken off and added to the inventory accumulation sheets.
B. Credit memos for several items returned by customers had not been recorded.
C. No journal entry had been made on the retailer’s books for several items returned to
its suppliers.
D. An item purchased FOB shipping point had not arrived at the date of the inventory
count and had not been reflected in the perpetual records.

30. An auditor will usually trace the details of the test counts made during the observation of
physical inventory counts to a final inventory compilation. This audit procedure is
undertaken to provide evidence that items physically present and observed by the auditor
at the time of the physical inventory count are
A. Owned by the client.
B. Not obsolete.
C. Physically present at the time of the preparation of the final inventory schedule.
D. Included in the final inventory schedule.
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PROBLEM NO. 4

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.

31. Number of units sold during 2017


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

32. Accounts payable balance at December 31, 2017


A. P190,100 B. P50,000 C. P199,100 D. P200,000

33. Inventory quantity on December 31, 2017


A. 5,750 B. 2,750 C. 17,084 D. 10,750

34. Cost of inventory on December 31, 2017


A. P187,450 B. P186,875 C. P192,950 D. P189,660

35. Cost of goods sold for the year ended December 31, 2017
A. P609,125 B. P609,700 C. P606,915 D. P603,625
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PROBLEM NO. 5

A depreciation schedule for semi-trucks of ISIDRO MANUFACTURING COMPANY was requested


by your auditor soon after December 31, 2017, showing the additions, retirements,
depreciation, and other data affecting the income of the company in the 4-year period 2014 to
2017, inclusive.

The following data were ascertained.


Balance of Trucks account, Jan. 1, 2014
Truck No. 1 purchased Jan. 1, 2011, cost P180,000
Truck No. 2 purchased July 1, 2011, cost 220,000
Truck No. 3 purchased Jan. 1, 2013, cost 300,000
Truck No. 4 purchased July 1, 2013, cost 240,000
Balance, Jan. 1, 2014 P940,000

The Accumulated Depreciation—Trucks account previously adjusted to January 1, 2014, and


entered in the ledger, had a balance on that date of P302,000 (depreciation on the four trucks
from the respective dates of purchase, based on a 5-year life, no salvage value). No charges
had been made against the account before January 1, 2014.

Transactions between January 1, 2014, and December 31, 2017, which were recorded in the
ledger, are as follows.

July 1, 2014 Truck No. 3 was traded for a larger one (No. 5), the agreed purchase price of
which was P400,000. Isidro Mfg. Co. paid the automobile dealer P220,000 cash
on the transaction. The entry was a debit to Trucks and a credit to Cash,
P220,000. The transaction has commercial substance.

Jan. 1, 2015 Truck No. 1 was sold for P35,000 cash; entry debited Cash and credited Trucks,
P35,000.

July 1, 2016 A new truck (No. 6) was acquired for P420,000 cash and was charged at that
amount to the Trucks account. (Assume truck No. 2 was not retired.)

July 1, 2016 Truck No. 4 was damaged in a wreck to such an extent that it was sold as junk
for P7,000 cash. Isidro Mfg. Co. received P25,000 from the insurance company.
The entry made by the bookkeeper was a debit to Cash, P32,000, and credits to
Miscellaneous Income, P7,000, and Trucks, P25,000.
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Entries for depreciation had been made at the close of each year as follows: 2014, P210,000;
2015, P225,000; 2016, P250,500; 2017, P304,000.

36. What is the total depreciation expense for the year ended December 31, 2014?
A. P180,000 B. P198,000 C. P172,000 D. P228,000

37. What is the gain (loss) on trade in of Truck #3 on July 1, 2014?


A. (P30,000) B. P10,000 C. (P60,000) D. P190,000

38. What is the net book value of the Trucks on December 31, 2017?
A. P414,000 B. P348,000 C. P228,500 D. P894,000

39. The total depreciation expense recorded for the 4-year period (2014-2017) is overstated
by
A. P185,500 B. P265,500 C. P287,500 D. P275,500

40. The books have not been closed for 2017. What is the compound journal entry on
December 31, 2017 to correct the company’s errors for the 4-year period (2014-2017)?
A. Accumulated depreciation 629,500
Trucks 480,000
Retained earnings 9,500
Depreciation expense 140,000
B. Accumulated depreciation 665,500
Trucks 480,000
Retained earnings 45,500
Depreciation expense 140,000
C. Accumulated depreciation 665,500
Trucks 480,000
Retained earnings 185,500
D. Accumulated depreciation 665,500
Trucks 665,500

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