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JOSE RIZAL UNIVERSITY

ACCOUNTANCY asa cpa


FINANCING CYCLE
Long term Liabilities

Learning Objectives:
At the end of this module, you will be able to:
Discuss the controls over stockholders' equity transactions.
Describe the nature of the substantive audit procedures involved in the audit of stockholders'
equity.

T
he financing cycle includes transactions and events whereby cash is obtained from or repaid to
creditors (debt financing) or owners (equity financing). Financing activities would include, for
example, acquiring debt, capital leases, issuing bonds, or issuing preferred or common stock.
Financing activities would also include payments to retire debt, reacquiring stock (treasury
stock), and the payment of dividends.

The financing cycle interfaces with the expenditure cycle when cash is disbursed for bond interest, the
redemption of bonds, payment of cash dividends, and the purchase of treasury stock. The audit
objectives for the financing cycle are:

Specific Audit Objectives


Transaction Objectives
Occurrence. Recorded debt (EO1), interest cost (EO2), and equity (EO3)
represent transactions that occurred during the year.
Completeness. All debt (C1) and interest costs incurred (C2), and equity
transactions (C3) that occurred during the period were recorded.
Accuracy. Debt (VA1), interest costs (VA2), and equity transactions (VA3)
transactions are accurately valued using GAAP and correctly journalized,
summarized and posted.
Cutoff. All debt (EO1 and C1), interest cost (EO2 and C2), and equity
transactions (EO3 and C3) have been recorded in the correct accounting period.
Classification. All debt (PD1), interest cost (PD2), and equity transactions
(PD3) have been recorded in the proper accounts.

Balance Objectives
Existence. Recorded debt (EO4) and equity (EO5) exist at the balance sheet
date.
Completeness. All debt (C4) and equity (C5) is recorded at the balance sheet
date.
Rights and Obligations. All recorded debt balances are the obligations of the
entity (RO1), and equity balances represent owners claims on the reporting
entitys assets (RO2).
Valuation and Allocation. Debt (VA4), and equity (VA5) balances are properly
valued in accordance with GAAP.

Disclosure Objectives
Occurrence and Rights and Obligations. Debt (PD4) and equity (PD8)
disclosures have occurred and pertain to the entity.
Completeness. All debt (PD5) and equity (PD9) disclosures that should have
been included in the financial statements have been included.
Understandability. All debt (PD6) and equity (PD10) information is
appropriately presented and information in disclosures is understandable to users.
Accuracy and Valuation. Debt (PD7) and equity (PD 11) information is
disclosed accurately and at appropriate amounts.

T
here is considerable variation in the importance of long-term debt in financial statements. In
some companies with strong free cash flows, debt is immaterial. In other companies, such as
public utilities, long-term debt may be more than 50% of total equities. Stockholders equity is
clearly material to the balance sheet. The income statement effects and the effect of dividends
on the retained earnings statement is often material. Inherent risk for financing transactions is
generally moderate as transactions occur infrequently.

FINANCING CYCLE AUDIT | BASIC AUDITING PRACTICE MODULE 1


JOSE RIZAL UNIVERSITY
ACCOUNTANCY asa cpa
Following are several examples of analytical procedures and how they might be used to identify
potential misstatements in debt financing transactions.

Ratio Audit Significance


Free Cash Flow Negative free cash flows indicate the need for, and
approximate amount of, expected financing to prevent
drawing down on cash or investments.
Interest Bearing Provides a reasonableness of the entitys proportion of
Debt to Total Assets debt that may be compared with prior years experience
or industry data.
Shareholders Provides a reasonableness of the entitys proportion of
Equity to Total equity that may be compared with prior years
Assets experience or industry data.
Comparing Return If a company is able to generate a higher rate of return
on Assets with the on assets than its incremental cost of debt, this is a
Incremental Cost of signal that an entity may use debt financing to expand
Debt the assets and earnings of the entity.
Current Portion of A test of the entitys ability to service its financing
Debt and Dividends obligations. Ratios less than 1.0 indicate potential
to Cash Flow from liquidity problems.
Operations
Times Interest A test of the entitys ability to generate earnings to cover
Earned cost of debt service. Ratios less than 1.0 indicate that
the entitys earnings are insufficient to cover financing
costs.
Interest Expense to A reasonableness test of recorded interest expense that
Interest Bearing should approximate the entitys average cost of debt
Debt capital.

Control risk as also low as financing transactions receive considerable attention from senior
management and the board of directors that carefully monitor the acquisition and retirement of debt.

The functions that relate to financing cycle transactions include:


Authorizing bonds and capital stock
Issuing bonds and capital stock
Paying bond interest and cash dividends
Redeeming and reacquiring bonds and capital stock
Recording financing transactions

Because of the nature and materiality most types of long-term debt transactions, inherent risk is often
moderate to high for all related account balance assertions. Based on consideration of these factors
and any relevant control risk assessments, an appropriate level of detection risk is determined for each
significant assertion related to long-term debt balances. Many auditors follow a primarily substantive
approach to long-term debt because of the efficiency and effectiveness of using confirmations to audit
a small population size.

The substantive tests that apply to the existence or occurrence and valuation or allocation assertions
for long-term debt balances are.
EO VA
Verify accuracy of balances, schedules, and X
subsidiary ledgers (perform initial procedures)
Perform analytical procedures. X X
Vouch entries in long term debt and related X X
income statement accounts
Review authorizations and contracts X X
Confirm debt with lenders and bond trustees X X
Recalculate interest expense X

In vouching entries to long-term debt accounts, the direction of the substantive test is from recorded
entries to supporting documentation. This test pertains to the existence or occurrence, completeness,
rights and obligations, and valuation or allocation assertions.

FINANCING CYCLE AUDIT | BASIC AUDITING PRACTICE MODULE 2


JOSE RIZAL UNIVERSITY
ACCOUNTANCY asa cpa
In confirming debt, the auditor has direct communication with lenders and bond trustees and the
responses are returned directly to the auditor. This test relates to four assertions: existence or
occurrence, completeness, rights and obligations, and valuation or allocation.

In recalculating interest expense, the auditor re-performs the computations made by the client. This
test relates primarily to valuation or allocation.

Various value-added services that the auditor might offer to a client related to the investing and
financing cycles include:
Benchmarking the return generated by investing activities against competitors.
Independent review of strategic plans for investing activities.
Explanation of the advantages and disadvantages of bank financing, mortgage financing, lease
financing, financing that may be available from insurance companies or other entities, or various
classes of preferred stock.
Many investments are accomplished through merger or acquisition. A CPA firm may provide
expertise in guiding a company through a merger or acquisition. This service would include
identifying possible acquisitions candidates, helping an entity evaluate the potential benefits and
risks associated with an acquisitions, as well as how to structure the acquisition.

PROBLEM 1
The client is authorized to issue 200 bonds, with par value of P1,000 each. The bonds were dated May
1,2005 and are due May 1,2015. Interest at 12% annum is due semi-annually on May 1 and November
1. The December 31,2007 balance of P95,000 represents proceeds on issue of 100 bonds on November
1,2006.

Client's Ledger
Date Documents/Transactio Bonds Payable Interest Expense
ns Debit Credit Debit Credit
12/31/0 Balance P95,00
7 CV - 120 0 P6,000
05/01/0 Issuance P 400
8 CV - 531 21,000 7,200
07/01/0
8
PROBLEM 11/01/0 2
On January 8 1, 2010,
Ellison Co. issued eight-year bonds with a face value of $1,000,000 and a stated interest rate
of 6%, payable semiannually on June 30 and December 31. The bonds were sold to yield 8%.
Table values are:
Present value of 1 for 8 periods at 6%.............................. .627
Present value of 1 for 8 periods at 8%.............................. .540
Present value of 1 for 16 periods at 3%............................ .623
Present value of 1 for 16 periods at 4%............................ .534
Present value of annuity for 8 periods at 6%.................... 6.210
Present value of annuity for 8 periods at 8%.................... 5.747
Present value of annuity for 16 periods at 3%.................. 12.561
Present value of annuity for 16 periods at 4%.................. 11.652

FINANCING CYCLE AUDIT | BASIC AUDITING PRACTICE MODULE 3


JOSE RIZAL UNIVERSITY
ACCOUNTANCY asa cpa
1. The present value of the principal is
2. The present value of the interest is
3. The issue price of the bonds is

PROBLEM 3
Everhart Company issues $10,000,000, 6%, 5-year bonds dated January 1, 2010 on January 1,
2010. The bonds pays interest semiannually on June 30 and December 31. The bonds are
issued to yield 5%. What are the proceeds from the bond issue?
2.5% 3.0% 5.0% 6.0%
Present value of a single sum for 5 .88385 .86261 .78353 .74726
periods
Present value of a single sum for 10 .78120 .74409 .61391 .55839
periods
Present value of an annuity for 5 4.6458 4.5797 4.3294 4.2123
periods 3 1 8 6
Present value of an annuity for 10 8.7520 8.5302 7.7217 7.3600
periods 6 0 3 9
On December 31, 2008, Nolte Co. is in financial difficulty and cannot pay a note due that day.
It is a $600,000 note with $60,000 accrued interest payable to Piper, Inc. Piper agrees to
accept from Nolte a building that has a fair value of $590,000, an original cost of $530,000,
and accumulated depreciation of $130,000.

1. Nolte should recognize a gain or loss on the disposal of the building of


2. Nolte should recognize a gain on the settlement of the debt of

Mann, Inc., which owes Doran Co. $600,000 in notes payable with accrued interest of
$54,000, is in financial difficulty. To settle the debt, Doran agrees to accept from Mann
equipment with a fair value of $570,000, an original cost of $840,000, and accumulated
depreciation of $195,000.

Instructions
(a) Compute the gain or loss to Mann on the settlement of the debt.
(b) Compute the gain or loss to Mann on the transfer of the equipment.
(c) Prepare the journal entry on Mann 's books to record the settlement of this debt.
(d) Prepare the journal entry on Doran's books to record the settlement of the receivable.

PROBLEM 4: LIABILITIES (2013 BOARD EXAM)


Your auditing Mamalola Corp.s various liability accounts. The following schedule of liabilities
was presented to you by the companys accountant in relation to your audit:
Accounts payable P460
Warranties payable 153,2
Salaries payable 268,5
10%, Note payable bank 2,000

Audit notes:
a. You have rendered a purchases cut-off to ascertain the completeness of the
companys accounts payable balance. The following is the summary of the entries 10
days before and after the balance sheet date and your audit observations:
Purchases Journal Entries: Dec. 20 Dec. 31, 2012:

Receiving Report Suppliers Invoice Amount FOB Term/


Date Date
Dec. 20, 2012 Dec. 19, 2012 60,000 Shipping Poin
Dec. 23, 2012 Dec. 20, 2012 42,000 From Consign
FINANCING CYCLE AUDIT | BASIC AUDITING PRACTICE MODULE 4
JOSE RIZAL UNIVERSITY
ACCOUNTANCY asa cpa
Dec. 28, 2012 Dec. 26, 2012 45,000 Destination
Jan. 3, 2013 Dec. 29, 2012 30,000 Destination
Purchases Journal Entries: Jan. 2 Jan. 10, 2013:
Receiving Report Suppliers Invoice Amount FOB Term/
Date Date
Jan. 3, 2013 Dec. 28, 2012 P 20,000 From Consig
Jan. 5, 2013 Dec. 3, 2012 55,000 Shipping Poi
Jan. 6, 2013 Jan. 3, 2013 84,000 Shipping Poi
*note: assume suppliers invoice date as suppliers shipment date of goods and ending
inventories were appropriately established through an inventory count.

b. The company started its 2-year warranty program for merchandise sold starting
2011. The company estimates that it will incur P350 in part and labor for repairing each
70% of the units sold shall be returned for repairs and that 40% of the warranty costs
shall be incurred in the year of sale with 60% to be incurred in the year following the
year of sale. The following information is deemed relevant for your audit:
2011
Number of units sold 1,250
Actual warranty costs 153,000

The balance of the warranties payable is the accrued warranty cost at the end of 2011.
Actual warranty costs were charged to current year warranty expense. Adjusting entry
at the end of 2012 is yet to be made.
c. Salaries payable reflects the probable unused sick leaves and vacation leaves in
2011 and prior to 2011 carried over 2012. No entry had been made during the current
year affecting the salaries payable account. Employees are allowed to carry over
unused leaves over 2 years from year of grant, thereafter, it shall expire. Salary rates
increased for the current year by 10%. An analysis of the cumulative unused sick leaves
and vacation leaves are as follows:
Prior to 2011 leaves carried over to 2012 270 days
2011 leaves carried over to 2012 625 days
Prior to 2012 leaves used in 2012* 700 days
Leaves earned in 2012 carried over 2013 550 days

*from prior to 2012 leaves used in 2012, 200 were earned by employees prior to
2011.

d. The 12% note payable to the bank was originated on June 30, 2010 and is due on
June 30, 2013. Semi-annual interest on the note is payable every June 30 and
December 31. On December 31, 2012 the company has the option of refinancing the
liability by issuing another long-term debt security to the same bank due on June 30,
2016. The proceeds of the loan to be made, as per agreement shall not exceed 80% of
the fair market value of the property to be attached to the loan as a collateral. As of the
balance sheet date, the said property has a fair value of P2,000,000 and is not
expected to materially change until the refinancing transaction is completed.
e. The Board of Directors approved through a resolution, additional incentive to key
officers in the form of a bonus which shall be at 10% of the adjusted net income after
30% income tax and after bonus. The net income of the company before any
adjustments were made is at P2,032,700.

Required:
1. What is the adjusted balance of the accounts payable account?
2. What is the balance of the warranties payable as of December 31, 2012?
FINANCING CYCLE AUDIT | BASIC AUDITING PRACTICE MODULE 5
JOSE RIZAL UNIVERSITY
ACCOUNTANCY asa cpa
3. What is the correct balance of the salaries payable in the form of liability for
compensated absences as of December 31, 2012?
4. How much from the 10% notes payable shall be presented as non-current?
5. What is the correct amount of bonus to key officers?

PROBLEM 5: LIABILITIES
Adelaida Inc. had the following unadjusted liability balances as of December 31, 2012:
Accounts payable P540,000
Premiums payable 140,000
Deferred taxes (42,000)
10% Bonds 5,500,000
Payable Audit notes:
a. Accounts payable is net of P50,000
credit balance In one of the companys suppliers accounts due to an overpayment
made. The agreement with the supplier simply calls for the supplier to deliver
additional merchandise to Adelaida Inc. to offset the overpayment. No deliveries
were made as of the balance sheet date.
b. The company started a promotional program in 2011 where an eco-friendly tote bag
shall be given to customers upon presenting 6 product labels plus P5 cash. The
following information are deemed relevant in relation to the program:
2011 2012
Sales P7,200,000 P8,400,00
Total cost of the tote bags purchased (P25 per tote bag) 375,000 500,00
Tote bags actually distributed 9,000 19,00
Estimated tote bags to be distributed the following year 7,000 5,00
The balance of the premiums liability account, reflects the accrual at the end of the
previous year (2011), no entry had been made during the current year affecting the
said account.
c. Deferred tax balance appearing above is the result of the deferred tax created by
the premiums liability n the previous year which is tax deductible upon settlement.
Adjustments are yet to be made to the said account to reflect the movement in the
account balance during the year. However, another temporary difference arising
during the year created by the companys excess tax depreciation over financial
depreciation for the period amounted to P150,000. The income tax rate is at 30%.
d. The balance of the bonds payable account was the total proceeds from its issuance
on January 1, 2012. The bonds which shall mature on December 31, 2016 have a
total face value of P5,000,000 and are convertible into ordinary shares at the rate of
P1,000 bond to 10, P50 par value ordinary shares. On the issuance date the
effective yield rate on similar securities without the convertibility option was at 8%
while each ordinary shares were selling at P75 per share. The only other entry made
by the client in relation to the bonds was the payment of interest on December 31,
as interest are payable annually every December 31.
Required:
1. What is the correct premiums expense for 2012?
2. What is the total deferred tax liability as of December 31, 2012?
3. What is the total current liability to be reported in the 2012 statement of financial
position?
4. What is the correct credit to the shareholders equity account as a result of the
issuance of the bonds on January, 2012?
5. Assuming that the bonds were converted on January 2, 2014, what is the total credit to
share premium as a result of the conversion?
6. Assuming that the bonds were retired on January 2, 2014 at 105, when the prevailing
market rate of interest for similar securities without conversion option is at 12%, how
much should be reported in the profit or loss as a result of the retirement?

FINANCING CYCLE AUDIT | BASIC AUDITING PRACTICE MODULE 6


JOSE RIZAL UNIVERSITY
ACCOUNTANCY asa cpa

FINANCING CYCLE
STOCKHOLDERS' EQUITY

Learning Objectives:
At the end of this module, you will be able to:
Discuss the controls over stockholders' equity transactions.
Describe the nature of the substantive audit procedures involved in the audit of stockholders'
equity.

CONSIDERING INTERNAL CONTROL

O
ne of the major sources of funds is the issuance of shares of stocks. Thus, the audit of SHE
typically involved substantial reliance on substantive tests of transactions and balances. It
consists primarily of substantive tests. The auditor's concerns are those controls that relate to
authorization, recordkeeping, and custody of stock certificates. The auditor's knowledge of
the system is documented through internal control questionnaires to highlight any control deficiencies
and narratives to document procedures.

AUTHORIZATION
Transactions must require specific authorization by entity's BOD and in some cases, the stockholders.
The
BOD determines the type, amount and number of shares to be issued and the issue date. BODs
determine the type of dividends to be declared, the amount per share, and the record and payment
dates.

RECORDKEEPING AND CUSTODY


The stock certificates are in a bound book, called the stock certificate book. The printer serially
numbers the certificates, and each has a perforated stub (like checkbook) where the stockholders'
name and other pertinent information are entered. The certificates that are still attached are unissued
stock certificates. They should be issued in numerical sequence and signed by designated officers only
at the of issuance. Canceling the old certificate, attaching it to its stub, and issuing a new one should
effect changes in stock ownership.

The BOD should designate an officer (corporate secretary) who will have custody of the SCB. This is to
avoid using blank certificates for collateral to obtain loans or sell and misappropriate the proceeds.
Most companies keep detailed records of their stockholders (stockholder ledger) that indicates the
number of shares by stockholder. Another detailed record is the stock and transfer book, where the
names of holders, installment paid and unpaid, dtae of payment and transfers of stocks are entered
and require and constant update and periodically reconciled with the stock certificate book.

SUBSTANTIVE TESTS OF SHE


Relating assertions, audit objectives, and Substantive Tests in the audit of SHE

Assertions Specific Audit Objectives Substantive Tests


Existence or SHE accounts represent all amounts paid in for Analyses of
occurrence share capital issued, amounts paid in for share accounts
Obligations premium, undistributed earnings and amounts paid Confirmation
Completenes by the company for treasury shares. Vouching
s There is compliance with legal requirements
Valuation related to corporate requirement capital.
All share capital transactions during the period are
authorized and properly recorded.

FINANCING CYCLE AUDIT | BASIC AUDITING PRACTICE MODULE 7


JOSE RIZAL UNIVERSITY
ACCOUNTANCY asa cpa
Presentation SHE accounts are properly described and classified Review FS to
and in the FS and adequate disclosures concerning determine
Disclosures these amounts have been made in accordance with compliance with
PAS/PFRS. PAS/PFRS.

Inherent risk for stockholders' equity balances should be low. However, the acceptable level of
detection risk for the existence or occurrence and completeness assertions for capital stock are likely to
be high when the company uses a registrar and transfer agent. For the other assertions, detection risk
may be moderate. Again, many auditors follow a primarily substantive approach to auditing
shareholders equity because of the efficiency and effectiveness of using confirmations (registrar or
transfer agent) to audit a small population size.
The substantive tests that apply to the existence or occurrence and completeness assertions for
stockholders' equity balances are
EO C
Perform analytical procedures X X
Vouch entries to capital stock accounts X
Vouch entries to retained earnings X
Review articles of incorporation and bylaws X
Review authorizations and terms of stock issues X
Confirm shares outstanding with registrar and transfer agent X X
Inspect stock certificate book X X
Inspect certificates of shares held in treasury X X

Following a several examples of analytical procedures and how they might be used to identify potential
misstatements in shareholders equity transactions.

Ratio Audit Significance


Return on common Provides a measure of the rate of return generated on the common
stockholders equity shareholders investment. Auditors should understand the
competitiveness factors that allow a company to obtain unusually high
returns.
Equity to total Provides a reasonableness of the entitys proportion of equity that may
liability and equity be compared with prior years experience or industry data.
Dividend payout Auditors would normally expect low dividend payout rates for high
rate growth companies that need reinvested earnings to fund investments
in working capital and long-term assets.
Earnings per share Earnings per share is useful for comparisons with price per share. This
ratio can be compared with industry price earnings ratios for
reasonableness.
Sustainable growth Provides an estimate of rate of sales growth that can be obtained
rate without changing the entitys profitability or financing structure. The
auditor should expect changes in the financing structure when sales
grow significantly faster than the sustainable growth rate.

PROBLEM 1
On January 1,2008, CALEB Corporation was organized with 20,000 common shares, Par P100, was
authorized. On that date, 10,000 shares were issued at P120 per share. During the year, The
Corporation had earned net income of P300,000 and declared and paid cash dividends P100,000. On
January 15,2009, it purchases 200 shares of its own stock at P100 per share. On December 31,2009, all
treasury shares were sold at P80 per share. The 2009 net income amounted to P580,000.

What should be TSHE of the Corporation as of December 31,2009?

PROBLEM 2

FINANCING CYCLE AUDIT | BASIC AUDITING PRACTICE MODULE 8


JOSE RIZAL UNIVERSITY
ACCOUNTANCY asa cpa
You are engaged in the audit of JOSHUA corporation, a new client, at the close of its 1st fiscal year, April
30,2009. The books had been closed prior to the time you began your year-end fieldwork. You review
the SHE accounts in the GL.:

Date Ref Share Capital Retained Earnings Income Summary


Debit Credit Debit Credit Debit Credit
05/01/08 CR P1,200,0
09/14/08 CD P 00
02/02/09 CR 110,000 P 52,500
04/28/09 J P109,000
04/30/09 J 109,000 800,000 P5,200,0 P6,000,0
00 00
800,000

Additional information:
1. From the articles of incorporation: authorized share capital, 30,000 shares; par value, P100.
2. Directors' minutes include the following resolutions: 04/30/08, authorized the issue of 10,000 shares
at P120/share; 09/13/08, authorized the acquisition of 1,000 shares at P110; 02/01/09, authorized
reissue of 500 treasury shares at P105; 04/28/09, declare 10% stock dividend, payable May
31,2009, to stockholders on record as of April 30,2009 - the market value of the Corporation's share
on April 28,2009, was P130 per share.

REQUIRED:
Adjusting journal entries as of April 30,2009.

Problem No. 3
Presented below are three independent cases relating to the audit of shareholders equity.
Answer the question/s at the end of each case
CASE 1.
KANDABA COMPANY began operations on January 1, 2012, by issuing at P15 per share one-
half of the 480,000 ordinary shares (P1 par value) that had been authorized for issue. In
addition, Kandaba has 250,000 6% preference share (P5 par value) authorized. During 2012,
Kandaba reported net income of P735,000 and declared dividends of P112,250.

During 2013, Kandaba completed the following transactions:


Jan. 10 Issued an additional 35,000 ordinary shares for P16.50 per share.
Apr. 02 Issued 80,000 preference shares for P7 per share.
July 21 Authorized the acquisition of a custom-made machine to be delivered in January
2014.
Kandaba appropriated P147,500 of retained earnings for the purchase of the machine.
Oct. 25 Issued an additional 20,000 preference shares for P10 per share.
Dec. 31 Reported P732,000 of net income and declared a dividend of P420,000 to
shareholders of
record on January 31, 2014, to be paid on February 4, 2014.

1. What is the total shareholders equity on December 31,2013?


2. What is the unappropriated retained earnings balance on December 31, 2013?

CASE 2
BULDOG CO. is authorized to issue 300,000 of P2 par value ordinary shares. The company has
the following transaction:
a. Issued 60,000 shares at P32 per share; received cash.
b. Issued 1,000 shares, selling at P36 per share, to lawyers for services in connection with
the organization of the corporation. The value of the legal services was P35,000.
c. Issued 1,500 shares, valued objectively at P33,000, to the employees instead of paying
them cash wages
d. Issued 137,500 shares in exchange for a building valued at 885,000 and land valued at
P240,000. (The building was originally acquired by the invesyor for P750,000 and has
P300,000 of accumulated depreciation; the land was originally acquired for 90,000.)
e. Received cash for P29,500 shares issued at P38 per share.
FINANCING CYCLE AUDIT | BASIC AUDITING PRACTICE MODULE 9
JOSE RIZAL UNIVERSITY
ACCOUNTANCY asa cpa

1. The statement of financial position will report the share premium of

CASE 3
TAGOGO COMPANY has been paying regular quarterly dividends of P1.50 and wants to pay the
same amount in the third quarter of 2013. The following information relates to the companys
equity:

Jan. 1 Shares outstanding, 500,000; P2 par (900,000 shares authorized).


Feb. 15 Issued 30,000 new shares at P10.50.
Mar. 31 Paid quarterly dividend of P1.50 per share.
May 12 Converted P1,000,000 bonds to ordinary shares at the rate of P50 shares per
P1,000 bond
June 15 Issued a 10% share dividend
30 Paid quarterly dividend of P2 per share

1. What is the total amount that Tagogo will have to pay in dividends in the third quarter
in order to pay P2 per share?
2. What is the total amount of dividends to be distributed during the year assuming no
equity transactions occur after June 30?

Problem No. 8
At the beginning of 2013, an entity grants 50 share options each to 500 employees. The grant
is conditional upon the employees remaining in the entitys employ during a vesting period of
three years.

The exercise price at grant date is estimated at P60. However, the exercise price drops to P10
if the entitys earnings increase by at least an average of 10% per year over the three-year
period.

On grant date, the entity estimates that the fair value of the share options, with an exercise
price of P40, is P20 per option. If the exercise price is P60, the entity estimates that the share
options have a fair value of P18 per option.

2013
30 employees have left. The entity proceeds expects, on the basis of a weighted
average probability that a further 30 employees will leave during 2014 and 2015,
respectively.
The entitys earnings increased by 12% and the entity expects that earnings will
continue to increase at this rate over the next two years. The entity therefore expects
that the earnings target will be achieved, and hence, the share options will have an
exercise price of P40.
2014
At year end, a further 35 employees have resigned. The entity expects that a further 30
employees will leave during 2015.
The entitys earnings increased by 13%, and it continues to expect that the earnings
target will be achieved.
2015
A further 28 employees have left by the end of the year
Due to a general decrease in market demand, the entitys earnings increased by only
3%. Because the earnings target was not achieved, the 50 vested share options for
each employee have exercise price of P60

Based on the preceding information, determine the following:


1. Compensation expense for 2013
2. Compensation expense for 2014
3. Compensation expense for 2015
FINANCING CYCLE AUDIT | BASIC AUDITING PRACTICE MODULE 10
JOSE RIZAL UNIVERSITY
ACCOUNTANCY asa cpa
4. Share options outstanding at the end of 2014
5. Share options outstanding at the end of 2015

PROBLEM 4: STOCKHOLDERS EQUITY


Laida Corp. has two classes of share capital outstanding: 12%, P100 par value preference share and P50 par value ordinary share.
Balances on January 1, 2012, were:
Preference Share Capital 5,000 shares issued P 500,000
Ordinary Share Capital - 50,000 shares issued 2,500,000
Share Premium PS 200,000
Share Premium OS 2,000,000
Accumulated Profits 4,000,000

The following data summarize the transactions for 2012:


a. Issued 20,000 shares of ordinary at P70 per share on January 20.
b. Purchased of 5,000 of the companys own ordinary shares from stockholders at P60 per share on February 20.
c. Declared 10% ordinary share dividends on ordinary shares March 1 to stockholders as of the same date to be
issued on March 25 at P74 per share.
d. Split ordinary shares on a 2 for 1 basis on April 1.
e. Reissued 4,000 of the reacquired shares at P40 per share on May 3.
f. Declared cash dividends to preference shares and P3 per share dividends to ordinary on November 30 to
stockholders as of December 20 payable on January 30 of the next year.
The total comprehensive income for the year after audit adjustments was P1,050,000 which is net of an unrealized holding loss
from remeasurement of the companys financial asset at fair value through other comprehensive income at P200,000.
Requirements:
6. What is the adjusted balance of the Ordinary share account on December 31, 2012?
7. How much is the credit to Share premium account from the reissuance of shares on May 3?
8. What is the total Additional Paid-in Capital as of December 31, 2012?
9. How much is the total dividends payable to Ordinary shareholders?
10. What is the balance of the Accumulated Profits, unappropriated account at the end of 2012?
11. What is the total Stockholders Equity as of December 31, 2012?
PROBLEM 5: STOCKHOLDERS EQUITY (2013 CPA BOARD EXAM)
The following information has been taken from the Accumulated Profits ledger accounts of Mama Corp. in connection with your
audit of its financial statements as of and fro the period ended December 31, 2012.
a. Total net income since incorporation in 2011 P6,400,000
b. Total cash dividends paid since 2011 (300,000)
c. Carrying value of the companys equipment declared as property dividend in 2012 (1,200,000)
d. Proceeds from sale of 10,000 reacquired shares in 2011 reissued in 2012 300,000
e. Aggregate par value of stock dividends declared and distributed in 2012 (500,000)
f. Gain on conversion of 10,000 preference shares to 25,000 ordinary 75,000
g. Appropriated for plant expansions 700,000
h. Excess of proceeds from new shares issued over par 275,000
i. Share issuance expenses related to h. 50,000

Additional notes:
The company reacquired 40,000 ordinary shares in 2011 at P40 per share. No other treasury share transactions except for
item d.
The equipment declared in c. as dividends had a fair value of P900,000 as of the date of declaration and a fair value of
P900,000 as of the date of declaration and a fair value of P1,000,000 on date of payment. The property dividends were
recorded as follows:
Declaration: Accumulated Profits 1,200,000
Dividends Payable 1,200,000
Payments: Dividends Payable 1,200,000
Equipment 1,200,000
The stock dividends distributed in e. was based on a 10% share dividend. On the date of declaration the total ordinary
shares issued was at 230,000 with 30,000 shares still in the treasury. The shares have a P25 par value. The market value
of shares on the date of declaration was at P42 per share.
The 10,000, P50 par value preference shares in f. converted into 25,000 ordinary shares were originally issued at P75 per
share.

FINANCING CYCLE AUDIT | BASIC AUDITING PRACTICE MODULE 11


JOSE RIZAL UNIVERSITY
ACCOUNTANCY asa cpa

12. How much should be the correct debit to retained earnings for the property dividends upon declaration?
a. 900,000 c. 1,100,000
b. 1,000,000 d. 1,200,000
13. How much is the gain/loss to be recognized in the profit or loss upon the settlement of the property dividends payable?
a. None. c. 200,000
b. 300,000 d. 100,000
14. How much should be the correct debit to retained earnings for the share dividends?
a. 840,000 c. 460,000
b. 966,000 d. 400,000
15. How much is the correct balance of the accumulated profits unappropriated as of December 31, 2012?
a. 3,260,000 c. 2,460,000
b. 3,160,000 d. 2,060,000
PROBLEM 8:
1. When an entity has few capital transactions during the year, the continuing auditor usually carries out
a. A complete review of the related internal controls and performs test of the controls on which the entity relies.
b. A complete review of the related internal controls and performs analytical review tests to verify current-year
capital transactions.
c. A preliminary review of the related internal controls and performs a thorough examination of the balance at the
beginning of the year.
d. A preliminary review of the related internal controls and performs extensive tests of current-year capital
transactions.
2. In performing substantive audit procedures concerning the declaration and distribution of a 3 for 1 share split, an auditor
should:
a. Confirm the transaction with the Secretary.
b. Verify issuance of the additional shares as a result of the share split to the stock ledgers.
c. Determine that sufficient accumulated profits is available to cover any new stock issued.
d. Trace the authorization for the transaction to a vote of the board of directors.
3. An auditor vouched entries from the purchases journal to the voucher package which contains the purchase order, the
suppliers sales invoice and the receiving report. The objective of this test is to verify which assertion?
a. Completeness
b. Existence/Occurrence
c. Valuation/Accuracy
d. Cut-off and Classification
4. For effective internal control, the account payable department generally should:
a. Stamp, perforate, or otherwise cancel supporting documentation after payment is mailed.
b. Ascertain that each requisition is approved as to price, quantity and quality by an authorized employee.
c. Obliterate the quantity ordered on the receiving department copy of the purchase order.
d. Establish the agreement of the vendors invoice with the receiving report and purchase order.

FINANCING CYCLE AUDIT | BASIC AUDITING PRACTICE MODULE 12