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AUDIT OF LIABILITIES

PROBLEM NO. 1
In the audit of the First Corporations financial statements at December 31, 2005, the
chief accountant of the said corporation provided the following information:
Notes payable:
Arising from purchase of goods 304,000
Arising from 5 year-bank loans, on which marketable securities
valued at P600,000 have been pledged as security, P400,000 due
on June 30, 2006; P100,000 due on Dec. 31, 2006 500,000
Arising from advances by officers, due June 30, 2006 50,000
Reserve for general contingencies 400,000
Employees income tax withheld 20,000
Advances received from customers on purchase orders 64,000
Containers deposit 50,000
Accounts payable arising from purchase of goods,
net of debit balances of P30,000 170,000
Accounts receivable, net of credit balances P40,000 360,000
Cash dividends payable 80,000
Stock dividends payable 100,000
Dividends in arrears on preferred stock, not yet declared 200,000
Convertible bonds, due January 31, 2007 1,000,000
First mortgage serial bonds, payable in semi-annual installments
of P50,000, due April 1 and October 1 of each year 2,000,000
Overdraft with Allied Bank 90,000
Cash in bank balance with PNB 390,000
Estimated damages to be paid as a result of unsatisfactory
performance on a contract 160,000
Estimated expenses on meeting guarantee for service
requirements on merchandise sold 120,000
Estimated premiums payable 75,000
Deferred revenue 87,000
Accrued interest on bonds payable 360,000
Common stock warrants outstanding 120,000
Common stock options outstanding 210,000
Unused letters of credit 400,000
Deficiency VAT assessment being contested 500,000
Notes receivable discounted 200,000

On March 1, 2006, the P400,000 note payable was replaced by an 18-month note for the
same amount. First is considering similar action on the P100,000 note payable due on
December 31, 2006. The 2005 financial statements were issued on March 31, 2006.

On December 1, 2005, a former employee filed a lawsuit seeking P200,000 for unlawful
dismissal. First attorneys believe that the suit is without merit. No court date has been set.

On January 15, 2006, the BIR assessed First an additional income tax of P300,000 for the
2003 tax year. First attorneys and tax accountants have stated that it is likely that the BIR
will agree to a P200,000 settlement

REQUIRED:
Based on the above and the result of your audit, compute for the following as of December
31, 2005:
1. Total current liabilities
a. P2,500,000 b. P2,100,000 c. P2,300,000 d. P2,400,000
2. Total noncurrent liabilities
a. P3,300,000 b. P2,900,000 c. P3,000,000 d. P3,400,000
3. Total liabilities
a. P5,200,000 b. P5,000,000 c. P5,400,000 d. P5,800,000

PROBLEM NO. 2
The following information relates to Second Companys obligations as of December 31,
2005. For each of the numbered items, determine the amount if any, that should be
reported as current liability in Seconds December 31, 2005 balance sheet.

1. Accounts payable:
Accounts payable per general ledger control amounted to P5,440,000, net of P240,000
debit balances in suppliers accounts. The unpaid voucher file included the following
items that not had been recorded as of December 31, 2005:
a) A Company P224,000 merchandise shipped on December 31, 2005, FOB
destination; received on January 10, 2006.
b) B, Inc. P192,000 merchandise shipped on December 26, 2005, FOB shipping
point; received on January 16, 2006.
c) C Super Services P144,000 janitorial services for the three-month period ending
January 31, 2006.
d) MERALCO P67,200 electric bill covering the period December 16, 2005 to
January 15, 2006.
On December 28, 2005, a supplier authorized Second to return goods billed at
P160,000 and shipped on December 20, 2005. The goods were returned by Second on
December
28, 2005, but the P160,000 credit memo was not received until January 6, 2006.
a. P5,923,200 b. P5,712,000 c. P5,601,600 d. P5,841,600

2. Payroll:
Items related to Seconds payroll as of December 31, 2005 are:
Accrued salaries and wages P776,000
Payroll deductions for:
Income taxes withheld 56,000
SSS contributions 64,000
Philhealth contributions 16,000
Advances to employees 80,000
a. P776,000 b. P992,000 c. P832,000 d. P912,000

3. Litigation:
In May, 2005, Second became involved in a litigation. The suit is being contested, but
Seconds lawyer believes it is possible that Second may be held liable for damages
estimated in the range between P2,000,000 and P3,000,000, and no amount is a better
estimate of potential liability than any other amount.
a. P0 b. P2,000,000 c. P3,000,000 d. P2,500,000

4. Bonus obligation:
Second Companys president gets an annual bonus of 10% of net income after bonus
and income tax. Assume the tax rate of 30% and the correct income before bonus and
tax is P9,600,000. (Ignore the effects of other given items on net income.)
a. P722,600 b. P395,000 c. P2,240,000 d. P628,000

5. Note payable:
A note payable to the Bank of the Philippine Islands for P2,400,000 is outstanding on
December 31, 2005. The note is dated October 1, 2004, bears interest at 18%, and is
payable in three equal annual installment of P800,000. The first interest and principal
payment was made on October 1, 2005.
a. P800,000 b. P908,000 c. P72,000 d. P872,000

6. Purchase commitment:
During 2005, Second entered in a noncancellable commitment to purchase 320,000
units of inventory at fixed price of P5 per unit, delivery to be made in 2006. On
December
31, 2005, the purchase price of this inventory item had fallen to P4.40 per unit. The
goods covered by the purchase contract were delivered on January 28, 2006.
a. P0 b. P1,600,000 c. P1,408,000 d. P192,000

7. Deferred taxes:
On December 31, 2005, Seconds deferred income tax account has a 2005 ending
credit balance of P772,800, consisting of the following items:
Caused by temporary differences in accounting Deferred tax
For gross profit on installment sales P376,000 Cr.
For depreciation on property and equipment 576,000 Cr
For product warranty expense 179,200 Dr
P772,800 Cr.
a. P772,800 b. P952,000 c. P196,800 d. P0

8. Product warranty:
Second has a one year product warranty on selected items in its product line. The
estimated warranty liability on sales made during 2004, which was outstanding as of
December 31, 2004, amounted to P416,000. The warranty costs on sales made in
2005 are estimated at P1,504,000. Actual warranty costs incurred during the current
2005 fiscal year are as follows:
Warranty claims honored on 2004 sales P 416,000
Warranty claims honored on 2005 sales 992,000
Total warranty claims honored P1,408,000
a. P0 b. P1,504,000 c. P96,000 d. P512,000

9. Premiums:
To increase sales, Second Company inaugurated a promotional campaign on June 30,
2005. Second placed a coupon redeemable for a premium in each package of product
sold. Each premium costs P100. A premium is offered to customers who send in 5
coupons and a remittance of P30. The distribution cost per premium is P20. Second
estimated that only 60% of the coupons issued will be redeemed. For the six months
ended December 31, 2005, the following is available:
Packages of product sold 160,000
Premiums purchased 16,000
Coupons redeemed 64,000
a. P1,728,000 b. P1,152,000 c. P1,600,000 d. P576,000

10. Due to Five Six Finance company:


Seconds accounting records show that as of December 31, 2005, P1,280,000 was due
to Five Six Finance Company for advances made against P1,600,000 of trade
accounts receivable assigned to the finance company with recourse.
a. P0 b. P1,600,000 c. P320,000 d. P1,280,000

PROBLEM NO. 3
In conjunction with your firms examination of the financial statements of Third Company
as of December 31, 2005, you obtained from the voucher register the information shown in
the working paper below.
Item Entry Voucher Account
No. Date Ref. Description Amount Charged
1 12.18.05 12-202 Supplies, purchased FOB
destination, 12.15.05; Supplies on
received, 12.17.05 20,000 hand
2 12.18.05 12-204 Auto insurance, 12.15.05 to Prepaid
12.15.06 24,000 insurance
3 12.21.05 12-206 Repair services; received Repairs and
12.20.05 24,000 maintenance
4 12.21.05 12-214 Merchandise shipped FOB
shipping point, 11.20.05;
received, 12.4.05 17,000 Inventory
5 12.21.05 12-219 Payroll, 12.6.05 to 12.20.05 Salaries and
(12 working days) 69,000 wages
6 12.26.05 12-221 Subscription to tax reporting Dues and
service for 2006 5,000 subscription
expense
7 12.28.05 12-230 Utilities for December 2005 29,000 Utilities expense
8 12.28.05 12-234 Merchandise shipped FOB
destination, 12.24.05;
received, 1.2.06 111,500 Inventory
9 12.28.05 12-243 Merchandise shipped FOB
destination, 12.26.05;
received, 12.29.05 84,000 Inventory
10 01.02.06 01-001 Legal services, received Legal and
12.28.05 46,000 professional
expense
11 01.02.06 01-002 Medical services for
employees for December
2005 25,000 Medical expense
12 01.05.06 01-003 Merchandise shipped FOB
shipping point, 12.29.05;
received, 1.4.06 55,000 Inventory
13 01.10.06 01-004 Payroll, 12.21.05 to 01.05.06
(12 working days in total, Salaries and
4 working days in Jan.) 72,000 wages
14 01.10.06 01-005 Merchandise shipped FOB
shipping point, 1.2.06;
received, 1.5.06 64,000 Inventory
15 01.12.06 01-006 Manufacturing royalties, Manufacturing
Dec. 2005 39,000 costs
Item Entry Voucher Account
No. Date Ref. Description Amount Charged
16 01.12.06 01-007 Merchandise shipped FOB
destination, 1.3.06;
received, 1.10.06 38,000 Inventory
17 01.13.06 01-008 Maintenance services, 9,000 Repairs and
received 1.9.06 maintenance
18 01.14.06 01-009 Interest on bank loan,
10.12.05 to 1.10.06 30,000 Interest expense
19 01.15.06 01-010 Manufacturing equipment, Machinery and
installed on 12.29.05 254,000 equipment
20 01.15.06 01-011 Dividends declared, Dividends
12.15.05 160,000 payable

Accrued liabilities as of December 31, 2005 were as follows:


Accrued payroll 48,000
Accrued interest payable 26,667
Dividends payable 160,000
Accrued royalties payable 39,000

The Accrued payroll, Accrued interest payable, and Accrued royalties payable accounts
were reversed on January 1, 2006.

REQUIRED:
Prepare adjusting entries as of December 31, 2005 based on your review of the data
givenabove.

PROBLEM NO. 4
During your regular annual audit of Fourth Company for the year ended December 31,
2005, you obtain the following evidence and data relative to your examination of the
bonds payable and related accounts.
From your permanent file working papers:
Client is authorized to issue 20,000 bonds with par value of P1,000 each. Bonds are
dated
May 1, 2002 and are due May 1, 2012. Interest at 12% per annum is due semiannually
every May 1 and November 1.
The December 31, 2004 balance of P9,500,000 represents proceeds from issuance of
10,000 bonds on November 2, 2003.
From the clients ledger:
12%, 10-year Bonds Payable
12/31/2004 Balance P9,500,000
07/01/2005 CR 2,100,000

Interest Expense
05/01/2005 CV-120 P600,000 07/01/2005 CR P40,000
11/01/2005 CV- 531 720,000

From supporting documents:


CR Cash receipts entry for issuance of 2,000 bonds for a total of P2,100,000 on
July 1, 2005. Trustees remittance statement attached.
Entry recorded
Cash P2,140,000
Bonds Payable P2,100,000
Interest expense 40,000
CV-120 Cash payment to trustee for November 1, 2004 through April 30, 2005 interest.
Paid check to trustee attached.
CV-531 Cash payment to trustee for May 1, 2005 through October 31, 2005 interest.
Paid check to trustee attached.
REQUIRED:
1. Adjusting journal entries as of December 31, 2005. Use the straight line method to
amortize bond discount and premium, if any.
2. Compute for the adjusted balances of the following as of December 31, 2005:
a. Bonds payable d. Accrued interest
b. Bond discount e. Interest expense
c. Bond premium

PROBLEM NO. 5
Fifth Company presented to you their records in connection with the audit of
thecompanys financial statements for the year ended December 31, 2005. This is the
first time the company has been audited. The company floated a serial bond issue in
2003.
Your audit showed the following details of the issue and the accounts as of December
31, 2005:
Total amount P5,000,000
Date of issue October 2, 2003
Proceeds from issue P4,900,000
Interest rate 5% per annum
Interest payment date October 1
Maturity date P1,000,000 annually, starting October 1, 2005
5% Serial Bonds Payable
10/02/2005 VR P1,000,000 10/02/2003 CR P4,900,000

Accrued Interest Payable


01/02/05 P62,500

REQUIRED:
1. Adjusting journal entries as of December 31, 2005. Use the bond outstanding
method to amortize bond discount and premium, if any.
2. Compute for the adjusted balances of the following as of December 31, 2005:
a. Bonds payable
b. Bond discount
c. Accrued interest payable
d. Bond interest expense

PROBLEM NO. 6
On January 2, 2004, the Sixth, Inc. issued P2,000,000 of 8% convertible bonds at par.
The bonds will mature on January 1, 2008 and interest is payable annually every January
1. The bond contract entitles the bondholders to receive 6 shares of P100 par value
common stock in exchange for each P1,000 bond. On the date of issue, the prevailing
market interest rate for similar debt without the conversion option is 10%.

On December 31, 2005, the holders of the bonds with total face value of P1,000,000
exercised their conversion privilege. In addition, the company reacquired at 110, bonds
with a face value of P500,000.

The balances in the capital accounts as of December 31, 2004 were:


Common stock, P100 par, authorized 50,000 shares, issued
and outstanding, 30,000 shares P3,000,000
Premium on common stock 500,000

Market value of the common stock and bonds were as follows:

Date Bonds Common stock


December 31, 2004 118 40
December 31, 2005 110 42

QUESTIONS:
Based on the above and the result of your audit, answer the following:
1. How much of the proceeds from the issuance of convertible bonds should be allocated
to equity?
a. P634,000 b. P126,816 c. P221,664 d. P0
2. How much is the carrying value of the bonds payable as of December 31, 2004?
a. P2,000,000 b. P1,389,400 c. P1,796,170 d. P1,900,502
3. How much is the interest expense for the year 2005?
a. P160,000 b. P138,940 c. P179,617 d. P190,050
4. The entry to record the conversion on December 31, 2005 will include a credit to APIC
of
a. P365,276 b. P400,000 c. P307,893 d. P0
5. How much is the loss on bond reacquisition on December 31, 2005? a.
P50,000 b. P96,053 c. P67,362 d. P0

PROBLEM NO. 7
In connection with your audit of Seventh Corporations financial statements for the year
2005, you noted the following liability account balances as of December 31, 2004:
Note payable, bank P 5,600,000
Liability under finance lease 430,000
Deferred income taxes 700,000
Transactions during 2005 and other information relating to Sevenths liabilities were as
follows:
a. The principal amount of the note payable is P5,600,000 and bears interest at 12%.
The note is dated April 1, 2004 and is payable in four equal annual installments of
P1,400,000 beginning April 1, 2005. The first principal and interest payment was
made on April 1, 2005.
b. The capitalized lease is for a ten-year period beginning December 31, 2002. Equal
annual payments of P100,000 are due on December 31 of each year, and the 14%
interest rate implicit in the lease known by Seventh. The present value at December
31, 2004 of the seven remaining lease payments (due December 31, 2005 through
December 31, 2011) discounted at 14% was P430,000.
c. Deferred income taxes are provided in recognition of timing differences between
financial and income tax reporting of depreciation. For the year ended December 31,
2005, depreciation per tax return exceeded book depreciation by P312,500.
Sevenths effective income tax rate for 2004 was 32%.
d. On July 1, 2005, Seventh issued for P1,774,000, P2,000,000 face amount of its 10%,
P1,000 bonds. The Bonds were issued to yield 12%. The bonds are dated July 1,
2004 and will mature on July 1, 2014. Interest is payable annually on July 1. Seventh
uses the interest method to amortize bond discount.
QUESTIONS:
Based on the above and the result of your audit, determine the following:
1. Liability under finance lease as of December 31, 2005
a. P381,600 b. P390,200 c. P344,828 d. P330,000
2. Total noncurrent liabilities as of December 31, 2005
a. P5,610,440 b. P5,770,640 c. P5,931,328 d. P5,725,268
3. Current portion of long-term liabilities as of December 31, 2005
a. P1,445,372 b. P1,400,000 c. P1,500,000 d. P1,446,576
4. Accrued interest payable as of December 31, 2005
a. P484,440 b. P432,628 c. P532,628 d. P478,000
5. Total interest expense for the year 2005
a. P652,440 b. P707,068 c. P712,640 d. P699,760