San Sebastian College Recoletos

Canlubang Campus

Auditing Problems

AUDIT OF SHAREHOLDERS' EQUITY

PROBLEM NO. 1

BEBE CO. was formed on July 1, 2010. It was authorized to issue 1,800,000 shares of P10
par value ordinary shares and 600,000 shares of 8 percent P25 par value, cumulative and
nonparticipating preference shares. BEBE CO. has a July 1 - June 30 fiscal year.

The following Information relates to the shareholders' equity accounts of BEBE CO.:

Ordinary Shares
Prior to the 2012-2013 fiscal year, BEBE CO. had 660,000 ordinary shares issued as
follows:

1. 510,000 shares were issued for cash on July 1, 2010, at P31 per share.
2. On July 24, 2010, 30,000 shares were exchanged for a plot of land which cost the seller
P420,000 in 2004 and had an estimated market value of P1,320,000 on July 24, 2010.
3. 120,000 shares were issued on March 1, 2011, for P42 per share.

During the 2012-2013 fiscal year, the following transactions regarding ordinary shares took
place:

November 30, 2012 BEBE CO. purchased 12000 of its own shares on the open market at
P39 per share.

December 15, 2012 BEBE Co. declared a 5% share dividend for shareholders of record
on January 15, 2013, to be issued on January 31, 2013. BEBE CO.
was having a liquidity problem and could not afford a cash dividend
at the time. BEBE CO.'s ordinary shares were selling at P52 Der
share on December 15, 2012.

June 20, 2013 BEBE CO. sold 3,000 of its own ordinary shares that it had
purchased on November 30, 2012, for P126,000.

Preference Shares
BEBE CO. issued 240,000 preference shares at P44 per share on July 1, 2011.

Cash Dividends
BEBE CO. has followed a schedule of declaring cash dividends in December and June, with
payment being made to shareholders of record in the following month. The cash dividends
which have been declared since inception of the company through June 30, 2013, are shown
below:

Declaration Date Share Capital Ordinary Share Capital Preference

12/15/11 P 0.30 per share P1.00 per share
06/15/12 P 0.30 per share P1.00 per share
12/15/12 ---- P1.00 per share

No cash dividends were declared during June 2013 due to the company's liquidity problems.

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Retained Earnings
As of June 30, 2012, BEBE CO's retained earnings account had a balance of P4,140,000.
For the fiscal year ending June 30, 2013, BEBE CO, reported net income of P240,000.

Required: Compute the adjusted balances of the following as of June 30, 2013:

a. Share capital preference

b. Share capital ordinary
c. Share premium preference
d. Share premium ordinary
e. Share premium treasury
f. Retained Earnings (before appropriation for treasury shares)
g. Treasury shares
h. Total shareholders equity

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PROBLEM NO. 2

The shareholders' equity section of BAHRAIN CORPORATION'S statement of financial

position as of December 31, 2012, is as follows:

Share capitalOrdinary (P10 par, 750,000 shares

authorized, 412,500 issued and outstanding) P4,125,000
Share premium 825.000
Total paid-in capital P4,950,000
Unappropriated retained earnings P2,002,500
Appropriated retained earnings 750 000
Total retained earnings P2,752,500
Total shareholders' equity P7,792,300

Bahrain Corporation had the following shareholders' equity transactions during 2013:

Jan. 15 Completed the building renovation for which P750,000 of retained earning's
had been restricted. Paid the contractor P727,500, all of which is capitalized.

Mar. 3 Issued 150,000 additional ordinary shares for P18 per share.

May 18 Declared a dividend of P1.50 per share to be paid on July 31, 2013, to
shareholders of record on June 30, 2013.

June 19 Approved additional building renovation to be funded internally. The

estimated cost of the project is P600,000, and retained earnings are to be
restricted for that amount.

July 31 Paid the dividend.

Nov. 12 Declared a property dividend to be paid on January 5, 2014. The dividend is

to consist of equipment that has a carrying amount of P360,000 and a fair
value of P472,500 on November 12

Dec 31 Net income for 2013 (before recognition of impairment loss on the
equipment declared as property dividend) is P1,327,500. The equipment fair
value less cost to distribute on December 31 is P330,000.

1. Share capital - ordinary on December 31, 2013, is

A. P5,625,000 B. P4,125,000 C. P4,950,000 D. P7,650,000

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2. Share premium on December 31, 2013, is
A. P2,625,000 B. P825,000 C. P2,025,000 D. P1,200,000

3. Unappropriated retained earnings on December 31, 2013, is

A. P2,163,750 B. P2,246,250 C. P2,133,750 D. P2,276,250

4 The total shareholders' equity on December 31, 2013, is

A. P10,376,250 B. P10,526,250 C P9,926,250 D. P7,650,000

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PROBLEM NO. 3

You were engaged by CITY CORPORATION, a publicly held company whose shares are
traded on the Philippine Stock Exchange, to conduct an audit of its 2013 financial
statements. You were told by the company's controller that there were numerous equity
transactions that took place in 2013. The shareholders` equity accounts at December 31,
2012, had the following balances:

Share capital--Preference, P100 par value, 6% cumulative;

30,000 shares authorized; 18,000 shares issued
and outstanding P1,800,000
Share capital--Ordinary, P1 par value, 1,800,000 shares authorized;
1,200,000 shares issued and outstanding 1,200,000
Share premium 2,400,000
Retained earnings 980,000
Total shareholders' equity P6,380,000

You summarized the following transactions during 2013 and other information relating to
the shareholders' equity in your working papers as follows:

January 6, 2013 - Issued 45,000 ordinary shares in exchange for land. On the date issued,
the shares had a market price of P16.50 per share. The land had a carrying value of
P420,000, and an assessed value for property taxes of P490,000.

January 31, 2013 - Sold 2,400, P1,000,12% bonds due January 31, 2023, at 98 with one
detachable share warrant attached to each bond. Interest is payable annually on January
31. The fair value of the bonds without the share warrants is 95. The detachable warrants
have a fair value of P50 each and expire on January 31, 2014. Each warrant entitles the
holder to purchase 10 ordinary shares at P10 per share.

February 22, 2013 - Purchased 15,000 of its own ordinary shares to be held as treasury
shares for P24 per share.

February 28, 2013 - Subscriptions for 42,000 ordinary shares were received at P26 per
share, payable 50% down and the balance by March 15.

March 15, 2013 - The balance due on 36,000 ordinary shares was received and those
shares were issued. The subscriber who defaulted on the 6,000 remaining shares forfeited
the down payment in accordance with the subscription agreement.

August 31, 2013 - Reissued 6,000 treasury shares for P20 per share.

September 14, 2013 - There were 1,890 warrants detached from the bonds and exercised.

November 30, 2013 - Declared a cash dividend of P0.50 per share to all ordinary
shareholders of record December 15, 2013. The dividend was paid on December 30, 2013.

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 December 15, 2013 - Declared the required annual cash dividends on preference shares
for 2013. The dividend was paid on January 15, 2014.

January 81 2014 - Before closing the account' records for 2013, CITY became aware that
no depreciation had been recorded for 2012 and 2013 for a machine purchased on July 1.
2012. The machine was properly capitalized at P960,000 and had an estimated useful life
of eight years when purchased. The appropriate correcting entry was recorded on the same
date.

Adjusted net income for 2013 was P840,000.

Based on the foregoing and the result of your audit, answer the following: (Ignore income
tax implications)

1. Share capitalordinary at December 31, 2013, is

A. P1,290,900 B. P1,305,900 C. P1,281,030 D.P1,299,900

2. How much is the total share premium as of December 31, 2013?

A. P4,239,600 B. P4,317,600 C. P4,363,200 D. P4,065,100

3. The unappropriated retained earnings on December 311 2C13,

A. P982,550 B. P622,550 C. P766,550 D. P790,550

4. How much is the total shareholders' equity on December 31, 2013?

A. P8,184,050 B. P7,968,050 C. P8,168,750 D. P8,190,050

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PROBLEM NO. 4

A CPA was engaged by BIRDIE Company in 2013 to examine its Pocks and records and
to make whatever corrections are necessary. An examination of the accounts discloses the
following:

a) Dividends had been declared on December 15 in 2011 and 2012 but had not been entered
in the books until paid.

b) Improvements in buildings and equipment of P32,400 had been debited to expense at the
end of April 2010. Improvements are estimated to have 12-year life. The company uses the
straight-line method in recording depreciation and computes depredation to the nearest
month.

c) The physical inventory of merchandise had been understated by P9,600 at the end of
2011 and by P14,250 at the end of 2012.

d) The merchandise inventories at the end of 2012 and 2013 did not include merchandise
that was then in transit and to which the company had title. These shipments of P6,300 and
P8,700 were recorded as purchases in January of 2013 and 2014. respectively.

e) The company had failed to record sales commissions payable of P10,800 and P3,300 at
the end of 2012 and 2013, respectively

f) The company had failed to recognize supplies on hand of P2,550 and P5,160 at the end
of 2012 and 2013, respectively.

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The retained earnings account appeared as shown below on the date the CPA began me
examination.
Retained Earnings
Date Item Debit Credit Balance
2011
Jan. 1 Balance P195,000
Dec. 31 Net Income for year P84,000 279,000
2012
Jan. 10 Dividends paid P46,500 232,500
Mar. 6 Stock sold excess over par P63,000 295,500
Dec. 31 Net loss for year 53,400 242,100
2013
Jan. 10 Dividends paid 46,500 195,600
Dec. 31 Net loss for year 57,900 137,700

1. What is the corrected 2011 net income?

A. P124,200 B. P90,900 C. P121,500 D. P71,700

2. What is the corrected 2012 net loss?

A. P53,400 B. P66,000 C. P54,300 D. P59,700

3. What is the corrected 2013 net loss?

A. P64,740 B. P62,340 C. P56,040 D. P71,040

4. What is the corrected retained earnings on December 31, 2012?

A. P226,200 B. P163,800 C. P100,800 D. P183,060

5, What is the corrected retained earnings on December 31, 2013?

A. P63,000 B. P99,060 C. P92,760 D. P36,060

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PROBLEM NO. 5

At the beginning of year 1, Entity A grants share options to each of its 100 employees
working in the sales department. The share options will vest at the end of year 3, provided
that the employees remain in the entity's employ, and provided that the volume of sales of
the particular product increases by at least an average of 5 percent per year. If the volume
of sales of the product increases by an average of between 5 percent and 10 percent per
year, each employee will receive 100 share options. If the volume of sales increases by an
average of between 11 percent and 15 percent each year, each employee will receive 200
share options. If the volume of sales increases by an avenge of 16 percent or more, each
employee will receive 300 share options.

On grant date, Entity A estimates that the share options have a fair value of P20 per option.
Entity A also estimates that the volume of sales of the product will Increase by an average
of between 11 percent and 15 percent per year, and therefore expects that, for each employee
who remains in service until the end of year 3, 200 share options will vest. The entity also
estimates, on the basis of a weighted average probability, that 20 percent of employees will
leave before the end of year 3.

By the end of year 1, seven employees have left and the entity still expects that total of 20
employees will leave by the end of year 3. Hence, the entity expect that employees will
remain in service for the three-year period, Product sales have increased by 12 percent and
the entity expects this rate of Increase to continue over the next 2 years.

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By the end of year 2, a further five employees have left, bringing the total to 12 to date. The
entity now expects only three more employees will leave during year 3, and therefore
expects a total of 85 employees will remain at the end of year 3. Product sales have increased
by 20 percent resulting in an average of 16 percent over the two years to date. The entity
now expects that sales will average 16 percent or more over the three-year period, and hence
expects each sales employee to receive 300 share options at the end of year 3.

By the end of year 3, a further two employees have left. Hence, 14 employees have left
during the three-year period and 86 employees remain. The entity's sales have increased by
an average of 16 percent over the three years.

Based on the preceding information, answer the followings

1. What is the compensation expense for year 1?
A. P106,667 B. P53,333 C. P160,000 D. P172,000

2. What is the compensation expense for year 2?

A. P286,667 B. P180,000 C. P233,333 D. P168,000

3. What is the compensation expense for year 3?

A. P114,667 B. P176,000 C. P282,667 D. P188,000

4. What is the cumulative compensation expense for years 1, 2, and 3?

A. P320,000 B. P516,000 C. P344,000 D. P172,000

5. At the end of year 2, the entity should report snare options outstanding of
A. P328,000 B. P226,667 C. P286,667 D. P340,000

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PROBLEM NO. 6

An entity grants 100 cash share appreciation rights (SARs) to each of its 500 employees,
on condition that the employees remain in its employ for the next three years.

During year 1, 35 employees have left. The entity estimates that a further 60 will leave
during years 2 and 3. During year 2, 40 employees have left and the entity estimates that a
further 25 will leave during year 3. During year 3, 22 employees have left. At the end of
year 3, 150 employees exercised their SARs, another 140 employees exercised their SARs
at the end of year 4 and the remaining 113 employees exercised their SARs at the end of
year 5.

The entity estimates the fair value of the SARs at the end of each year in which a liability
exists as shown below. At the end of year 3, all SARs held by the remaining employees
vested. The intrinsic values of the SARs at the date of exercise (which equal the cash paid
out) at the end of years 3, 4 and 5 are also shown below.

Year Fair Value Intrinsic Value

1 P14.40
2 15.50
3 18.20 15.00
4 21.40 20.00
5 25.00

REQUIRED:
Compute the amounts of compensation expense and liability that the entity should report
in years 1 to 5.

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PROBLEM NO. 7
An entity grants to an employee the right to choose either 1,000 phantom shares (Lest a
right to a cash payment equal to the value of 11000 shares) or 11200 shares with a par value
of P10 per share. The grant is conditional upon the completion of three years' service. If the
employee chooses the share after alternative, the shares must be held for three years after
vesting date.

At grant date, the entity's share puce is P50 is per share. At the end of years 1,2, and 3, the
share price is P52, P55 and P60 respectively. The entity does not expect to pay dividends
in the next five years. After taking into account the effects of the post vesting transfer
restrictions, the entity estimates that the grant date fair value of the share alternative is 48
per share.

At the end of year 3, the employee chooses:

Scenario 1: The cash alternative
Scenario 2: The equity alternative

Based on the preceding information, answer the following:

1. What is the total fair value of the equity component as a result of the shares-based
payment transaction with settlement alternatives?
A. P7,600 B. P10,000 C. P2,400 D. P 0

2. What is the compensation expense in year 1?

A. P17,333 B. P19,866 C. P19,333 D. P23,334

3. What Is the compensation expense in year 2?

A. P19,866 B. P17,333 C. P21,867 D. P19,333

4. What Is the compensation expense in year 3?

A. P23,334 B. P25,867 C. P19,333 D. P19,866

5. If the employee has chosen the cash alternative, the amount to be paid at the end of year
3 should be
A. P55,000 B. P67,600 C. P52,000 D. P60,000

6. If the employee has chosen the share alternative, the amount of share premium to be
recognized Is
A. P7,600 B. P55,600 C. P60,000 D. P67,600

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PROBLEM NO. 8
1. In an examination of shareholders' equity, an auditor is most concerned that
A. Capital stock transactions are properly authorized.
B. Stock splits are capitalized at par or stated value on the dividend declaration date.
C. Dividends during the year under audit were approved by the shareholders.
D. Changes in the accounts are verified by a bank serving as a registrar and stock
transfer agent.

2. In an audit of a medium-sized manufacturing concern, which one of the following areas

can be expected to require the least amount of audit time?
A. Owner's equity
B. Assets
C. Revenue
D. Labilities

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3. When a corporate client maintains its own stock records, the auditor primarily will rely
upon
A. Confirmation with the company secretary of shares outstanding at year end.
B. Review of the corporate minutes for data as to shares outstanding.
C. Confirmation of the number of shares outstanding at year-end with the appropriate
state official.
D. Inspection of the stock book at year-end and accounting for all certificate numbers.

4. When a client company does not maintain its own stock records, the auditor should
obtain written confirmation from the transfer agent and registrar concerning
A. Restrictions on the payment of dividends.
B. The number of shares issued and outstanding.
C. Guarantees of preferred stock liquidation value,
D. The number of shares subject to agreement to repurchase,

5. The auditor is concerned with establishing that dividends are paid to client corporation
shareholders owning stock as of the
A. Issue date C. Record date
B. Declaration date D. Payment date

6. An audit program for the retained earnings account should include a step that requires
verification of the
A. Fair value used to charge retained earnings to account for a two-for-one stock split.
B. Approval of the adjustment to the beginning balance as a result of a write-down of an
account receivable.
C. Authorization for both cash and stock dividends.
D. Gain or loss arising from disposition of treasury shares.

7. During an audit of an entity's shareholders' equity accounts, the auditor determines

whether there are restrictions on retained earnings resulting from loans, agreements, or law.
This audit procedure most likely is intended to verify management's assertion of
A. Existence
B. Completeness
C. Valuation
D. Presentation and disclosure

8. If the auditee has a material amount of treasury stock on hand at year-end, the a should
A. Count the certificates at the same time other securities are counted.
B. Count the certificates only if the company had treasury stock transactions during the
year.
C. Not count the certificates if treasury stock is a deduction from shareholders equity.
D. Count the certificates only if the company classifies treasury stock with other assets.

9. In performing tests concerning the granting of stock options, an auditor should

A. Confirm the transaction with the Securities and Exchange Commission.
B. Verify the existence of option holders in the entitys payroll records or stock ledgers.
C. Determine that sufficient treasury stock is available to cover any raw stock issued.
D. Trace the authorization for the transaction to a vote of the board of directors.

10. The auditor would not expect the client to debit retained earnings for which of the
following transactions.
A. A 4-for-1, stock split.
B. "Loss" arising from disposition of treasury shares.
C. A 1-for-l0 stock dividend.
D. Correction of error affecting prior years earnings.

***END***

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