AUDITING THEORY AND PROBLEMS (QUALIFYING ROUND)

EASY

1. It is the process designed to provide an objective evaluation, on or before the date of the auditor's
report, of the significant judgments the engagement team made and the conclusions it reached in
formulating the auditor's report.

a. Assurance Quality Control Review

b. Audit Quality Control Review
c. Engagement Quality Control Review
d. External Quality Control Review

Answer: D

2. The letter of audit inquiry should be:

a. Prepared and sent by the auditor

b. Prepared by the management and sent by the auditor
c. Prepared and sent by management
d. Prepared by the auditor and sent by management

Answer: B

3. All are the relevant assertions for income statement accounts and related disclosures, except:

a. Occurrence
b. Measurement
c. Valuation
d. Presentation and Disclosure

Answer: C

4. Which of the following is the correct order of steps in the audit process?

I. Perform tests of control

II. Develop an overall strategy for the expected conduct and scope of audit
III. Obtain client’s written representation
IV. Prepare engagement letter
V. Perform substantive tests

a. IV, I, II, V, III

b. IV, II, I, V, III
c. IV, II, III, I, V
d. IV, II, V, I, III

Answer: B
5. Subsequent events for reporting purposes occur after:

a. The balance sheet date but before the date of the auditor’s report.
b. The balance sheet date.
c. The date the report is approved and the date the report is issued.
d. The balance sheet date and the date the report is issued.

Answer: A

6. The CFO of a company has a bonus arrangement in which he will receive 17.5% of the net
income (after deducting taxes and bonus) each year. For the current year, income before
deducting taxes and bonus is P3,900,000. Bonus is deductible for tax purposes. Tax rate is 30%.
How much is the bonus given to the CFO?

a. 477,750
b. 425,612
c. 682,500
d. 536,274

Answer: B

B = 0.175(3.9M - B - T)
T = .30(3.9M - B)
T = 1170000 - .30B
B = 0.175(3.9M - B - (1170000 - .30B))
B = 0.175(2730000 -.70B)
B = 477750 - 0.1225B
1.1225B = 477750
B = 425,612

7. The following information is from BIG 3’s first year of operations:

Merchandise purchased P520,000

Ending merchandise inventory P193,000
Collections from customers P220,000
All sales are on account and
goods sell at 25% above cost 25%

What is the accounts receivable balance at the end of the company’s first year of operations?

a. P182,000
b. P188,750
c. P41,600
d. P107,000

Answer: B
 Purchases P520,000
Merchandise inventory, ending (193,000)
Cost of goods sold 327,000
Multiply by sales ratio 125%
Sales 408,750
Collections from customers 220,000
Accounts receivable, ending P188,750

8. On December 31, 20X6, DAY1 Co. shipped to a customer merchandise with selling price of
P37,500; terms net 30, FOB shipping point. The sale which is 125% of cost was recorded in
January 20X7 when the check was received from the customer. Ending inventory was determined
by physical count on December 31, 20X6

As a result of the above transactions, DAY1 Co.’s cost of goods sold for the year ended
December 31, 20X6 was:

a. Understated by P30,000
b. Overstated by P30,000
c. Overstated by P37,500
d. Correctly stated

Answer: D

Since ending inventory has been determined through physical count, the goods in transit would
not be included and cost of goods sold would be correctly stated.

9. Panda’s December 31, 20X6 audited statement of financial position reported retained earnings of
P150,000. Net income for 2016 was P85,000 and dividends of P60,000 were declared and paid in
2016. ABC Company’s accountant discovered that net income for 20X5 had been understated by
P25,000 due to error in recording depreciation expense in 20X5. The amount of retained earnings
per books as of December 31, 20X5 amounted to?

a. P150,000
b. P200,000
c. P125,000
d. P100,000

Answer: D

Retained earnings per book, December 31, 20X5 (Squeeze) P100,000

Adjustment for depreciation error in 20X5 25,000
Retained earnings as adjusted, December 31, 20X5 125,000
Net income in 20X6 85,000
Dividends declared and paid in 20X6 (60,000)
Retained earnings per audit, December 31, 20X6 P150,000
10. Roshe NMD provides the following information for 20X6:

Cash received from customers P9,600,000

Rent received 500,000
Cash paid to suppliers and employees 4,150,000
Interest paid on long term debt 600,000
Cash paid for property purchased 1,000,000

Under the direct method, cash provided by operating activities was

a. 5,350,000
b. 4,350,000
c. 5,950,000
d. 4,950,000

Answer: C
Cash received from customers P9,600,000
Rent received 500,000
Cash paid to suppliers and employees (4,150,000)
Cash provided by operating activities 5,950,000
AVERAGE

1. Which of the following does not have to be considered in determining the initial sample size of a
test of details?

a. tolerable misstatement
b. acceptable risk of incorrect rejection
c. estimate of misstatements in the population
d. acceptable audit risk

Answer: B

2. A procedure to test for a cash receipts cutoff error is:

a. reconciling the bank statement.

b. performing a four-column proof-of-cash.
c. observing the counting of cash at the balance sheet date.
d. tracing recorded cash receipts to bank deposits on the bank statement of a different period.

Answer: D

3. Auditors often use analytical procedures in gathering audit evidence. For example, an unexplained
decrease in the amount of accounts receivable may indicate:

a. Sales were overstated.

b. Inventory purchases were curtailed.
c. Cost of Goods sold was overstated.
d. Accounts Receivables were sold.

Answer: D

4. An auditor performs a test to determine whether all merchandise for which the client was billed was
received. The population for this test consists of all:

a. merchandise received.
b. vendors' invoices.
c. canceled checks.
d. receiving reports.

Answer: B
5. Slam Corporation is a dealer of basketball equipment. On January 1 ,2016, an equipment was
leased to Dunk Company with the following provisions:

Annual rental payable at the end of the year 2,400,000

Lease rental and useful life of machinery 5 years
Cost equipment 4,800,000
Guaranteed residual value 560,000
Implicit interest rate 10%
PV of an ordinary annuity of 1 for 5 periods at 10% 3.79
PV of 1 for 5 period at 10% 0.62

At the end of the lease term on December 31, 2020, the equipment will be revert to the lessor. On
such date, the fair value of the asset is P420,000. The perpetual inventory system is used. The
lessor incurred initial direct cost of P340,000 in finalizing the lease agreement. What amount
should be reported as profit on sale for 2016?

a. 4,303,200
b. 3,956,000
c. 2,556,800
d. 2,236,000

Answer: A

PV of rent (2.4M x 3.790) 9,096,000

PV of GRV (560,000 x .62) 347,200
Net Investment 9,443,200
Cost of sale (4,800,000)
Initial direct cost (340,000)
Profit 4,303,200

6. On January 1, 2015, Fred Perry acquired a machine at a cost of $800,000. It is to be depreciated

on the straight-line method over a five-year period with no residual value. Because of a
bookkeeping error, no depreciation was recognized in Fred Perry's 2015 financial statements. The
oversight was discovered during the preparation of Fred Perry's 2016 financial statements.
Depreciation expense on this machine for 2016 should be

a. 0
b. 160,000
c. 200,000
d. 320,000

Answer: B

800,000 / 5 = 160,000
7. On July 1, 2016, Muzikwer Co. issued a five-year note payable with a face amount of P2,500,000
with interest rate of 10%. The terms of the note require Muzikwer to make five annual payments of
P500,000 plus accrued interest, with the first payment due June 30, 2017. With respect to the note,
the current liabilities section of Muzikwer's December 31, 2016, balance sheet should include:

a. 250,000
b. 500,000
c. 625,000
d. 750,000

Answer: C

(2.5M x .10 x 6/12) + 500,000 = 625,000

8. TUMI Inc. reported depreciation of P2,500,000 in its 2016 tax return. However, in its 2016 income
statement, TUMI Inc. reported depreciation of P1,000,000. The difference in depreciation is
temporary difference that will reverse over the time. The tax rate is constant at 30%. What
amount should be added to the deferred tax liability in TUMI Inc.’s December 31, 2016 statement
of financial position?

a. P300,000
b. P400,000
c. P350,000
d. P450,000

Answer: D

1,500,000 x 30% = P450,000

9. Secret Lagoon has determined that its electronics division is a cash generating unit. The entity
calculated the value in use of the division to be P8,000,000. The assets of the cash generating
unit at carrying amount are as follows:

Building 5,000,000
Equipment 3,000,000
Inventory 2,000,000

Secret Lagoon has also determined that the fair value less cost to sell of the building is
P4,500,000. What is the impairment loss to be allocated to the equipment?

a. P900,000
b. P800,000
c. P1,000,000
d. P7000,000

Answer: A

Total Book Value of CGU 10,000,000

Value in Use 8,000,000
Impairment 2,000,000
Impairment for Building (500,000)
Impairment for Equipment and Inventory 1,500,000
For Equipment (1,500,000 x 3/5 ) P900,000
10. GONE Company Uses accrual accounting and has the following information:

Net Sales P1,000,000

COS P500,000
Operating Expense P200,000
Income Tax P87,000

Depreciation is 30% of Gross profit.

What is the depreciation expense if GONE Company uses CASH BASIS accounting?

a. P0
b. P15,000
c. P150,000
d. P100,000

Answer: C

Depreciation is not affected.

DIFFICULT

1. Makibao acquired a 10-hectare vineyard on January 1, 2016 for P

= 1.20 million. The purchase price of
the vineyard was attributed as follows:

Land P
= 0.78 million
Vineyard Improvement 0.13 million
Grape Vines 255,000
Grapes 35,000

At the end of December 31, 2016, Makibao needs to determine the fair value of the grapes growing
on the vines in accordance with IAS 41 and invites two equally skilled professional valuers to
determine their value.

December 31, 2016 Valuer 1 Valuer 2

(in hundred thousands)
Fair value of an average 10-hectare vineyard 1,105 1,100
Adjustment for soil and climatic conditions 135 150
Estimated fair value of Entity A's vineyard 1,240 1,250

Fair value of the land (830) (825)

Fair value of vineyard improvements (135) (125)
Fair value of grape vines (245) (250)

The notional value of the grapes growing on the vines is?

a. Valuer 1: P
= 30,000 Valuer 2: P
= 45,000
b. Valuer 1: P
= 45,000 Valuer 2: P
= 30,000
c. Valuer 1: P
= 30,000 Valuer 2: P
= 50,000
d. Valuer 1: P
= 50,000 Valuer 2: P
= 30,000

Answer: C

December 31, 2016 Valuer 1 Valuer 2

(in hundred thousands)
Fair value of an average 10-hectare vineyard 1,105 1,100
Adjustment for soil and climatic conditions 135 150
Estimated fair value of Entity A's vineyard 1,240 1,250

Fair value of the land (830) (825)

Fair value of vineyard improvements (135) (125)
Fair value of grape vines (245) (250)
Grapes growing on the vines 30 50
2. You have been assigned to audit the accounts receivable of XYZ Company for the financial year
ending December 31, 2016. You received the following confirmation replies from the company’s
customers on January 24, 2016.

Customer X: The inventory was received
on January 7, 2017. We have agreed that
the terms of the delivery will be FOB
destination.
Based on your examination of documents, the
sale amounted to P
= 400,000. Freight is paid by
XYZ Company amounting to P = 3,500.

Customer Y: We have already paid the Based on your testing of the journal entries, you
outstanding balance on December 23, have noted that the accountant failed to record the
2016. collections amounting to P
= 345,000.

Customer Z: We have not bought any
products during the year.
Based on your testing, you have noted that the
accountant erroneously recorded the sale to
Customer Z instead to Customer A amounting to
P
= 908,000.

What is the correct accounts receivable as at December 31, 2016 if the record shows P
= 14,520,000?

a. P
= 12,867,000
b. P
= 14,120,000
c. P
= 13,775,000
d. P
= 14,175,000

Answer: C

AR, uncorrected 14,520,000.00

Customer X (400,000.00) no sale yet
Customer Y (345,000.00) no collections recorded
Customer Z (908,000.00) reclass
Customer A 908,000.00 reclass
13,775,000.00

3. Sion Co. operates a defined benefit pension plan for its employees. The following details relate to the
plan.

Present value of obligation at start of 2016 (P

= '000) 40,000
Market value of plan assets at start of 2016 (P= '000) 40,000

2016 2017
P
= '000 P
= '000
Current service cost 2,500 2,860
Benefits paid out 1,974 2,200
Contributions paid by entity 2,000 2,200
Present value of obligation at end of the year 46,000 40,800
Market value of plan assets at end of the year 43,000 35,680
Yield on corporate bonds at end of year 8% 9%
 During 2016, the benefits available under the plan were improved. The resulting increase in the present
value of the defined benefit obligation was P
= 2 million.

On the final day of 2017, Sion Co. divested of part of its business, and as part of the sale agreement,
transferred the relevant part of its pension fund to the buyer. The present value of the defined benefit
obligation transferred was P
= 11.4 million and the fair value of plan assets transferred was P
= 10.8million.
Sion also made a cash payment of P = 400,000 to the buyer in respect of the plan.

Assume that all transactions occur at the end of the year.

The remeasurement losses to be recognized in OCI on changes in the present value of obligation for
2017 and 2016 are?

a. P
= 274,000 and P
= 1,400,000, respectively
b. P
= 1,400,000 and P
= 274,000, respectively
c. P
= 226,000 and P
= 390,000, respectively
d. P
= 390,000 and P
= 226,000, respectively

Answer: A
2016 2017
PBO, beg 40,000.00 46,000.00
Interest 8% 3,200.00 4,140.00
Current Service Cost 2,500.00 2,860.00
Past Service Cost 2,000.00 (11,400.00)
Benefits Paid (1,974.00) (2,200.00)
45,726.00 39,400.00
Remeasurement Loss through OCI 274.00 1,400.00
PBO, end 46,000.00 40,800.00

4. MEGATRON Inc. reported inventory of P360,000 on December 31, 2016. The following data were
gathered to confirm the reported inventory figure.

Inventory, December 31, 2015 P320,000

Purchases during 2016 1,410,000
Cash sales during 2016 350,000
Shipment received on December 26, 2016 included 10,000
in physical inventory but not recorded as purchases
Deposit made with suppliers, entered as purchased; 20,000
goods were not received during 2016
Collections on accounts receivable during 2016 1,800,000
Accounts receivable, December 31, 2015 250,000
Accounts receivable, December 31, 2016 300,000
Gross profit percentage on sales 40%

What is the estimated inventory shortage on December 31, 2016?

a. P60,000
b. P50,000
c. P40,000
d. P5,000

ANSWER: C
 Collections on accounts receivable during 2016 1,800,000
Accounts receivable, December 31, 2015 (250,000)
Accounts receivable, December 31, 2016 300,000
Cash Sales during 2015 350,000
Total Sales 2,200,000
Cost of Goods Sold (3,700,000 x 60%) 1,320,000

Purchases (1,410,000+10,000-20,000) 1,400,000

Inventory, December 31, 2015 320,000
Cost of Goods Available for Sale 1,720,000
Ending Inventory estimated 400,000
Ending Inventory, per physical count (360,000)
Estimated inventory shortage P40,000

5. In the tax jurisdiction of Mack, a public limited company, a tax deduction is allowed for the intrinsic
value of share options issued to employees. The Company issued options on January 1, 2016, worth
P15,000,000 to employees. They vest in three years. The share option’s intrinsic value at December
31, 2016 was P21,000,000. The tax rate in the jurisdiction is 30%. What is the tax effect of the above
issue of share options at December 31, 2016?

a. P2,100,000 million tax benefit to income

b. P2,100,000 million recognized in equity
c. P1,500,000 million tax benefit to income, P600,000 million recognized in equity
d. P1,500,000 million recognized in equity, P600,000 million tax benefit to income

ANSWER: C

Total tax benefit

(P21,000,000 x 1/3 x 30%) P2,100,000
Portion recognized in profit or loss
(P15,000,000 x 1/3 x 30%) (1,500,000)
Portion recognized in equity P600,000

PAS 12 Income taxes provides that when an entity receives a tax deduction that relates to
remuneration paid in shares, share options/other equity instruments of the entity, the current and
deferred tax should be recognized as income/expense and included in profit/loss for the period.
However, if the amount of the tax deduction exceeds the amount of the related cumulative
remuneration expense, the excess of the associated current/deferred tax should be recognized
directly in equity.

6. In 2016, Happy Company’s goods were sold for P10 Million. Experience indicate that 90% of products
sold requires no warranty repairs; 6% of products require minor repairs costing 30% of the sales
price; and 4% of products sold require major repairs/replacement costing 70% of sales price. The
expenditures for warranty repairs and replacements for products sold in 2016 are expected to be
made 60% in 2017, 30% in 2018, and 10% in 2019, in each case at the end of the period. Because
the cash flows already reflect the probabilities of cash flows, and assuming there are no other risks or
uncertainties that must be reflected, to determine the PV of cash flows the entity uses a “risk-free”
discount rate based on government bonds with the same term as expected cash flows (6% for 1-year
bonds and 7% for 2-year and 3-year bonds). What amount of provision on warranty should Happy Co.
report in its SFP for the year ended December 31, 2016?

a. P418,457
b. P380,907
c. P260,378
d. P120,529
 Answer: A

Estimated Cost of Warranty

P10,000,000 x 6% x 30% 180,000
P10,000,000 x 4% x 70% 280,000
460,000
Present value of cash flows
2016: 460,000 x 60% x 0.9434 (6%) 260,378
2017: 460,000 x 30% x 0.8734 (7%) 120,529
2018: 460,000 x 10% x 0.8163 (7%) 37,550
P418,457

7. On January 2, 2015, Chimix Corporation purchased land with valuable natural ore deposits for
P10,000,000. The estimated residual value of the land was P2,000,000. At the time of purchase, a
geological survey estimated 2 million tons of removable ore were under the ground. Early in 2012,
roads were constructed on the land to aid in the extraction and transportation of the mined ore at a
cost of P750,000. In 2015, 50,000 tons were mined.

In 2016, Chimix fired its mining engineer and hired a new expert. A new survey made at the end of
2016 estimated 3 million tons of ore was available for mining. In 2016, 150,000 tons were mined. All
the ore mined was sold.

Compute the amount of depletion for 2016?

a. P372,000
b. P433,500
c. P426,000
d. P406,500

Answer: D

Purchase price P10,000,000

Residual value (2,000,000)
Road Construction 750,000
Total Cost 8,750,000
Depletion – 2016 (8,750,000/2,000,000 x 50,000) (218,750)
Remaining depletable cost 8,531,250
Divide by remaining tons – 2016
(3,000,000 +150,000) 3,150,000
Depletion per ton 2.71
Multiply by no. of tons mined – 2016 150,000
Depletion 406,500

8. In January 2016, Contract Corporation acquired 20% of the outstanding ordinary shares of XYZ
Corporation for P2,457,600. This investment gave Contract Corporation the ability to exercise
significant influence over XYZ. The book value of the acquired shares was P2,022,400. The excess of
cost over book value was attributed to the building which was undervalued on XYZ’s balance sheet
and that had a remaining useful life of ten years.

For the year ended December 31, 2016, XYZ reported income net of tax of P504,000 and paid cash
dividends of P112,000 on its ordinary share. Income tax rate is 32%. By what amount was XYZ
Company’s building was understated?
 a. P-0-
b. P435,000
c. P640,000
d. P3,200,000

Answer: D

Cost of acquisition P2,457,600

Book value (2,022,400)
Excess of cost over book value after tax 435,200
(depreciable tangible asset)
Divide by net of tax rate (100%-32%) 68%
Building – representing 20% P640,000
Divide by percent of interest 20%
Total understatement in building P3,200,000

9. On December 31, 2016, Ronnin Company has 200,000 ordinary shares outstanding with a par value
of P100 per share. Information revealed that Ronnin had a 9% convertible debenture, P1,000,000
face value bonds. The bond has a carrying value of P1,067,830 as of January 2, 2016 based on a
prevailing rate of 7%. Each 1,000 bond is convertible into 20 ordinary shares. The bonds were dated
January 1, 2016. Net income after tax of 32% for 2015 was P418,000.

How much should Ronnin Company report as diluted earnings per share in its financial statements?

a. P1.90
b. P2.09
c. P2.13
d. P2.89

Answer: B

Basic earnings per share (P418,000/200,000) P2.09

Diluted earnings per share:

Net income after tax 418,000
Interest after tax of convertible debt
P1,067,380 x 7% x (1-32%) 50,807
Total 468,807
Outstanding shares if bond was converted from the beginning 220,000
[200,000 + (1,000,000/1,000 x 20)]
Earnings per share 2.13

Diluted earnings per share P2.09

10. The condensed income statement of Millennium Falcon, Inc. for the year ended Dec. 31, 2016, is
presented below:

Millennium Falcon Inc.

Income Statement
For the Year Ended December 31, 2016

Sales P 1,000,000
Cost of Goods Sold 600,000
Gross profit 400,000
Operating expenses 150,000
Net Income 250,000

The December 31, 2016 audit of the company’s financial statements disclosed the following errors:

i. Sales of P5,000 were not recorded until Jan. 2017, although the goods were shipped in
December 2016, and were excluded from the December 31 physical inventory
ii. December 31,2016, inventory understated P31,000
iii. A machine was sold for P10,000 on July 1,2016, and the proceeds were credited to the
Sales account. The machine was acquired on Jan. 1, 2013 for P 60,000. At that time, it
had an estimated life of 6 years with no residual value. No depreciation was recorded on
this machine in 2016, and it remained in the books at year end.
iv. Accrued expenses of P4,000 and prepaid expenses of P6,000 were not recognized in the
company’s books
v. Purchases of P30,000 made in December 2016, were not recorded although the goods
were received and properly included in the December 31 physical inventory

What is the corrected net income for the year ended December 31, 2016?

a. 297,000 b. 228,000 c. 298,000 d. 313,000

Answer: B

Unadjusted NI 250,000
i. 5,000
ii. 31,000
iii. (30,000)
iv. 2,000
v. (30,000)
Adjusted NI 228,000