AUDITING PROBLEMS February 28, 2007

FIRST PREBOARD EXAMINATION Sunday, 8:00 – 11:00

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PROBLEM NO. 1
On April 1, 2006, EXCEL Corporation purchased 5-year P10,000,000 10% bonds dated
January 1, 2006. The bonds were purchased to yield 12%. Interest is payable annually
every December 31. EXCEL Corporation has the positive intention and ability to hold
these bonds to maturity. The issuer paid the interest as scheduled in 2006 and 2007.
During 2008, the issuer of the bonds is in financial difficulties and it becomes probable that
the issuer will be put into administration by a receiver. On December 31, 2008, EXCEL
estimated that none of the interest will be collected and only P8,000,000 of the principal
will be collected on maturity date. No cash flows are received during 2009. At the end of
2009, the issuer is released from administration and EXCEL receives a letter from the
receiver stating that the issuer will be able to meet its remaining obligations, including
interest and repayment of principal.

QUESTIONS:
Based on the above and the result of your audit, answer the following: (Round off present
value factors to four decimal places and final answers to nearest hundred)
1. How much was the total amount paid to acquire the investment in bonds on April 1,
2006?
a. P9,307,200 c. P9,278,800
b. P9,557,200 d. P9,528,800
2. How much is the carrying amount of the investment in bonds on December 31, 2006?
a. P9,363,900 c. P9,392,300
b. P9,006,700 d. P9,420,600
3. How much should be recognized as impairment loss in 2008?
a. P3,284,000 c. P3,141,700
b. P3,972,000 d. P1,622,400
4. How much is the interest income to be recognized in 2009?
a. P682,800 c. P1,159,400
b. P765,300 d. P 0
5. How much should be recognized as reversal of impairment loss in 2009?
a. P3,141,700 c. P2,678,100
b. P3,284,000 d. P 0

PROBLEM NO. 2
On January 1, 2006, MQM Corporation purchased P4,000,000 10% bonds for P3,711,520
and designated as available-for-sale. The bonds were purchased to yield 12%. Interest is
payable annually every December 31. The bonds mature on December 31, 2010. The
bonds were selling at 99 and 98 on December 31, 2006 and 2007, respectively. Because
of the change in intention and ability, MQM reclassified the investment to held-to-maturity
on December 31, 2008. On the date of reclassification, the prevailing market interest rate
is 9%.

QUESTIONS:

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Based on the above and the result of your audit, answer the following: (Round off present
value factors to four decimal places and final answers to nearest hundred)
6. How much should be recognized in profit or loss in 2006 related to the investment in
bonds?
a. P400,000 c. P371,200
b. P445,300 d. P 0
7. How much should be recognized as component of equity as of December 31, 2007?
a. P112,300 c. P90,800
b. P208,500 d. P40,000
8. How much should be recognized interest income in 2009?
a. P366,300 c. P463,800
b. P396,400 d. P400,000
9. How much should be recognized as component of equity as of December 31, 2009?
a. P 0 c. P172,100
b. P175,700 d. P108,400
10. How much is the carrying amount of the investment in bonds on December 31, 2009?
a. P4,036,800 c. P4,006,700
b. P3,928,400 d. P4,104,100

PROBLEM NO.3
On April 1, 2005, FTA Co. purchased 25,000 common shares of DIREK Co. at P180 per
share which reflected book value as of that date. At the time of the purchase, DIREK had
100,000 common shares outstanding. The shares are intended as a long term investment.
The first quarter statement ending March 31, 2005 of DIREK recorded earnings of
P480,000. For the year ended December 31, 2005, DIREK reported net income of
P2,400,000. DIREK paid FTA dividends of P60,000 on June 1, 2005 and again P60,000
on December 31, 2005. The shares of DIREK are selling at P190 per share on December
31, 2005. On April 1, 2006, FTA sold 10,000 common shares of DIREK for P200 per
share. For the year ended December 31, 2006 the reported net income of DIREK was
P2,800,000 and dividends of P60,000 was paid to FTA on August 1, 2006. The shares of
DIREK are selling at P205 per share on December 31, 2006.

QUESTIONS:
Based on the above and the result of your audit, answer the following:
11. How much is the carrying amount of the investment in DIREK Co. as of December
31, 2005?
a. P4,750,000 c. P4,980,000
b. P4,860,000 d. P4,950,000
12. How much is the loss on sale of the investment in DIREK Co. on April 1, 2006?
a. P50,000 c. P62,000
b. P98,000 d. P14,000
13. How much is the net amount that should be recognized in 2006 profit or loss
regarding the investment in DIREK Co.?
a. P185,000 c. P221,000
b. P161,000 d. P173,000
14. How much should be recognized as component of equity as of December 31, 2006?
a. P225,000 c. P18,000
b. P 54,000 d. P 0

15. To satisfy the valuation assertion when auditing an investment accounted for by the
equity method, an auditor most likely would
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 a. Examine the audited financial statements of the investee company.
b. Inspect the stock certificates evidencing the investment.
c. Review the broker’s advice or canceled check for the investment’s acquisition.
d. Obtain market quotations from financial newspapers or periodicals.

PROBLEM NO. 4
During your audit of the records of the GML Corporation for the year ended December
31, 2006, the following facts were disclosed:

Raw materials inventory, 1/1/2006 P 720,200

Raw materials purchases 5,232,800
Direct labor 6,300,000
Manufacturing overhead applied (150% of direct labor) 9,450,000
Finished goods inventory, 1/1/2006 1,240,000
Selling expenses 8,112,800
Administrative expenses 7,377,200

Your examination disclosed the following additional information:

a) Purchases of raw materials
Month Units Unit Price Amount
January – February 55,000 P17.76 P976,800
March – April 45,000 20.00 900,000
May – June 25,000 19.60 490,000
July – August 35,000 20.00 700,000
September – October 45,000 20.40 918,000
November – December 60,000 20.80 1,248,000
265,000 P5,232,800

b) Data with respect to quantities are as follows:

Units
Explanation 1/1/06 12/31/06
Raw materials 35,000 ?
Work in process (80% completed) 0 25,000
Finished goods 15,000 40,000
Sales, 205,000 units

c) Raw materials are issued at the beginning of the manufacturing process. During the
year, no returns, spoilage, or wastage occurred. Each unit of finished goods contains
one unit of raw materials.
d) Inventories are stated at cost as follows:
 Raw materials – according to the FIFO method
 Direct labor – at an average rate determined by correlating total direct labor cost
with effective production during the period
 Manufacturing overhead – at an applied rate of 150% of direct labor cost

QUESTIONS:
Based on the above and the result of your audit, answer the following:
16. The raw materials inventory as of December 31, 2006 is
a. P1,976,000 c. P936,000
b. P1,352,000 d. P897,800
17. The work in process inventory as of December 31, 2006 is
a. P1,780,000 c. P1,885,565
b. P1,751,294 d. P1,776,000
18. The finished goods inventory as of December 31, 2006 is

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 a. P3,352,000 c. P3,553,130
b. P3,334,000 d. P3,284,588
19. The cost of goods sold for the year ended December 31, 2006 is
a. P16,897,000 c. P15,857,000
b. P16,568,304 d. P16,875,000
20. In a manufacturing company, which one of the following audit procedures would give
the least assurance of the valuation of inventory at the audit date?
a. Testing the computation of standard overhead rates.
b. Examining paid vendors’ invoices.
c. Reviewing direct labor rates.
d. Obtaining confirmation of inventories pledged under loan agreements.

PROBLEM NO. 5
The NDL Company reported income before taxes of P370,000 for 2005 and P526,000 for
2006. A later audit produced the following information.

(a) The ending inventory for 2005 included 2,000 units erroneously priced at P5.90 per
unit. The correct cost was P9.50 per unit.

(b) Merchandise costing P17,500 was shipped to the NDL Company, FOB shipping point,
on December 26, 2005. The purchase was recorded in 2005, but the merchandise
was excluded from the ending inventory because it was not received until January 4,
2006.

(c) On December 28, 2005, merchandise costing P2,900 was sold for P4,000 to Kapuso
Corp. Kapuso had asked NDL to keep the merchandise for it until January 2, when it
would come and pick it up. Because the merchandise was still in the merchandise
was still in the store at year-end, the merchandise was included in the inventory
count. The sale was recorded in December 2005.

(d) Kapamilya Company sold merchandise costing P1,500 to NDL Company. The
purchase was made on December 29, 2005, and the merchandise was shipped on
December 30. Terms were FOB shipping point. Because NDL Company bookkeeper
was on vacation, neither the purchase nor the receipt of goods was recorded on the
books until January 2006.

QUESTIONS:
Based on the above and the result of your audit, answer the following: (Disregard tax
implications)
21. The December 31, 2005 Inventory is understated by
a. P26,200 c. P21,800
b. P23,300 d. P20,300
22. The corrected net income for 2005 is
a. P390,700 c. P377,400
b. P390,300 d. P391,800
23. The net income for 2006 is overstated by
a. P20,700 c. P21,800
b. P7,400 d. P 0
24. By what amount did the total income before taxes change for the 2 years combined?
a. P4,000 c. P7,200
b. P21,800 d. P 0
25. The primary objective of an auditor's observation of the physical inventory count is to

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 a. Allow the auditor to supervise the count so as to obtain assurance that inventory
quantities are reasonably accurate.
b. Obtain direct knowledge that the inventory exists and has been properly counted.
c. Establish whether a particular inventory item or group of items has been counted.
d. Be able to appraise the quality of the merchandise on hand on the day of the count.

PROBLEM NO. 6
In connection with your examination of the financial statements of RCG, Inc. for the year
ended December 31, 2006, you were able to obtain certain information during your audit of
the accounts receivable and related accounts.

The December 31, 2006 balance of the Accounts Receivable control account is
P1,576,000.

The only entries in the Doubtful Accounts Expense account were:

 A credit for P2,592 on December 2, 2006 because Company A remitted in full for the
accounts charged off on October 31, 2006; and
 A debit on December 31 for the amount of the credit to the Allowance for Doubtful
Accounts.

The Allowance for Doubtful Accounts schedule is presented below:

Debit Credit Balance
January 1, 2006 P29,264
October 31, 2006
Uncollectible accounts:
Company A – P2,592
Company B – P6,560
Company C – P4,512 P12,064 17,200
December 31, 2006 P78,800 P96,000

An aging schedule of the accounts receivable as of December 31, 2006 is presented

below:
Age Net debit balance Amount to which the Allowance is to be
adjusted after adjustments and
corrections have been made
0 to 1 month P745,920 1 percent
1 to 3 months 614,560 2 percent
3 to 6 months 177,440 3 percent
Over 6 months 48,000 Definitely uncollectible, P8,000; P16,000
is considered 50% uncollectible; the
remainder is estimated to be 80%
collectible.

There is a credit balance in one account receivable (0 to 1 month) of P16,000; it

represents an advance on a sales contract. Also, there is a credit balance in one of the 1
to 3 months account receivable of P4,000 for which merchandise will be accepted by the
customer.

The ledger accounts have not been closed as of December 31, 2006. The Accounts
Receivable control account is not in agreement with the subsidiary ledger. The difference
cannot be located, and you decided to adjust the control account to the sum of the
subsidiaries after corrections are made.

QUESTIONS:
Based on the above and the result of your audit, answer the following:
26. How much is the adjusted balance of Accounts Receivable as of December 31,

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 2006?
a. P1,588,000 c. P1,597,920
b. P1,605,920 d. P1,586,400
27. How much is the adjusted balance of the Allowance for Doubtful Accounts as of
December 31, 2006?
a. P47,014 c. P127,104
b. P38,114 d. P 37,874
28. How much is the Doubtful Accounts expense for the year 2006?
a. P36,822 c. P116,912
b. P27,682 d. P 27,922
29. How much is the net adjustment to the Doubtful Accounts expense account?
a. P40,704 debit c. P48,286 credit
b. P48,526 credit d. P39,386 credit
30. Authorization for the write-off of accounts receivable should be the responsibility of
the
a. Credit Manager. c. Accounts receivable clerk.
b. Controller. d. Treasurer.

PROBLEM NO. 7
In connection with your audit of RGP Company, you were able to gather the following
transactions during 2006 and other information pertaining to the company’s notes
receivable:
 On January 1, 2006, RGP Company sold a tract of land to three doctors as an
investment. The land, purchased 10 years ago, was carried on RGP Company’s books
at a value of P500,000. RGP received a noninterest-bearing note for P880,000 from
the doctors. The note is due on December 31, 2007. There is no readily available
market value for the land, but the current market rate of interest for comparable notes is
10%.
 On January 1, 2006, RGP Company finished consultation services and accepted in
exchange a promissory note with a face value of P1,200,000, a due date of December
31, 2008, and a stated rate of 5%, with interest receivable at the end of each year. The
fair value of the services is not readily determinable and the note is not readily
marketable. Under the circumstances, the note is considered to have an appropriate
imputed rate of interest of 10%.
 On January 1, 2006, RGP Company sold equipment with a carrying amount of
P1,600,000 to X Company. As payment, X gave RGP Company a P2,400,000 note.
The note bears an interest rate of 4% and is to be repaid in three annual installments of
P800,000 (plus interest on the outstanding balance). The first payment was received
on December 31, 2006. The market price of the equipment is not reliably determinable.
The prevailing rate of interest for notes of this type is 14%.

QUESTIONS:
Based on the above and the result of your audit, answer the following: (Round off present
value factors to four decimal places and final answers to nearest hundred)
31. The consultation service fee revenue t be recognized in 2006 is
a. P1,050,800 c. P 901,600
b. P1,095,800 d. P1,200,000
32. The gain on sale of equipment to be recognized in 2006 is
a. P331,600 c. P412,400
b. P257,280 d. P800,000
33. The noncurrent notes receivable as of December 31, 2006 is

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 a. P2,605,706 c. P2,494,000
b. P1,825,800 d. P2,625,700
34. The current portion of long-term notes receivable as of December 31, 2006 is
a. P1,600,000 c. P1,468,200
b. P1,680,000 d. P 800,000
35. The interest income to be recognized in 2006 is
a. P464,000 c. P459,500
b. P435,800 d. P156,000

PROBLEM NO. 8
You were able to obtain the following information in connection with your audit of the Cash
account of the RMV Company as of December 31, 2006:
November 30 December 31
a. Balances per bank P742,800 P774,696
b. Balances per books 619,304 670,392
c. Outstanding checks 254,096 300,184
d. The bank statement for the month of December showed total credits of P5,401,800
while the cash receipts per books totaled P9,341,780.
e. NSF checks are recorded as a reduction of cash receipts. NSF checks which are
later redeposited are then recorded as regular receipts. Data regarding NSF checks
are as follows:
1. Returned by the bank in Nov. and recorded by the company in Dec., P1,000.
2. Returned by the bank in Dec. and recorded by the company in Dec., P25,000.
3. Returned by the bank in Dec. and recorded by the company in Jan., P9,200.
f. Check of VMR Company amounting to P9,292 was charged to the company account
by the bank in error on December 31.
g. A bank memo stated that the company’s account was credited for the net proceeds of
Oneng’s note for P8,060. This is not yet recorded on the books.
h. The company has hypothecated its accounts receivable with the bank under an
agreement whereby the bank lends the company 80% of the hypothecated accounts
receivable. The company performs accounting and collection of the accounts.
Adjustments of the loan are made from daily sales reports and deposits.
i. The bank credits the company account and increases the amount of the loan for 80%
of the reported sales. The loan agreement states specifically that the sales report
must be accepted by the bank before the company is credited. Sales reports are
forwarded by the company to the bank on the first day following the date of sale. The
bank allocates each deposit 80% to the payment of the loan, and 20% to the
company account. Thus, only 80% of each day’s sales and 20% of each collection
deposits are entered on the bank statement. The company accountant records the
hypothecation of new accounts receivable (80% of sales) as a debit to Cash and a
credit to the bank loan as of the date of sales. One hundred percent of the collection
on accounts receivable is recorded as a cash receipt; 80% of the collection is
recorded in the cash disbursements books as a payment on the loan. In connection
with the hypothecation, the following facts were determined:
 Included in the undeposited collections is cash from the hypothecation of accounts
receivable. Sales were P162,000 on November 30, and P169,000 at December
31, the balance was made up of from collections of P128,440 which was entered
on the books in the manner indicated above.
 Collections on accounts receivable deposited in December, other than deposits in
transit, totaled P4,800,000.
j. Interest on the bank loan for the month of December charged by the bank but not

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 recorded in the books, amounted to P24,560.

QUESTIONS:
Based on the above and the result of your audit, answer the following:
36. How much is the adjusted cash balance as of November 30, 2006?
a. P618,304 c. P514,624
b. P488,704 d. P359,104
37. How much is the adjusted book receipts for December, 2006?
a. P5,427,488 c. P9,370,240
b. P9,505,440 d. P9,350,260
38. How much is the adjusted book disbursements for December, 2006?
a. P9,255,992 c. P5,406,700
b. P9,246,700 d. P9,349,452
39. How much is the adjusted cash balance as of December 31, 2006?
a. P509,492 c. P612,244
b. P602,952 d. P636,804
40. An auditor ordinarily sends a standard confirmation request to all banks with which
the client has done business during the year under audit, regardless of the year-end
balance. A purpose of this procedure is to
a. Seek information about contingent liabilities and security agreements.
b. Provide the data necessary to prepare a proof of cash.
c. Request a cutoff bank statement and related checks be sent to the auditor.
d. Detect kiting activities that may otherwise not be discovered.

PROBLEM NO. 9
Your audit of EXCEL Company disclosed that your client kept very limited records.
Purchases of merchandise were paid for by check, but most other items were out of cash
receipts. The company’s collections were deposited weekly. No record was kept of cash
in the bank, nor was a record kept of sales. Accounts receivable were recorded only by
keeping a copy of the ticket, and this copy was given to the customer when he paid his
account.

On January 2, 2006 EXCEL Company started business and issued common stock, 72,000
shares with P100 par, for the following considerations:
Cash P 600,000
Building (useful life, 15 years) 5,400,000
Land 1,800,000
P7,800,000

An analysis of the bank statements showed total deposits, including the original cash
investment, of P4,200,000. The balance in the bank statement on December 31, 2006,
was P300,000, but there were checks amounting to P60,000 dated in December but not
paid by the bank until January 2007. Cash on hand on December 31, 2006 was P150,000
including customers’ deposit of P90,000.

During the year, EXCEL Company borrowed P600,000 from the bank and repaid P150,000
and P30,000 interest.

Disbursements paid in cash during the year were as follows:

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 Utilities P120,000
Salaries 120,000
Supplies 240,000
Dividends 180,000
P660,000

An inventory of merchandise taken on December 31, 2006 showed P906,000 of

merchandise.

Tickets for accounts receivable totaled P1,080,000 but P60,000 of that amount may prove
uncollectible.

Unpaid suppliers invoices for merchandise amounted to P420,000.

Equipment with a cash price of P480,000 was purchased in early January on a one-year
installment basis. During the year, checks for the down payment and all maturing
installments totaled P534,000. The equipment has a useful life of 5 years.

QUESTIONS:
Based on the above and the result of your audit, determine the following: (Disregard
income taxes)
41. Payments for merchandise purchases in 2006
a. P2,436,000 c. P3,246,000
b. P2,586,000 d. P2,646,000
42. Collections from sales in 2006
a. P4,320,000 c. P4,920,000
b. P3,720,000 d. P3,000,000
43. Net income for the year ended December 31, 2006
a. P960,000 c. P1,620,000
b. P1,770,000 d. P1,560,000
44. Stockholders’ equity as of December 31, 2006
a. P9,240,000 c. P8,580,000
b. P9,390,000 d. P9,180,000
45. Total assets as of December 31, 2006
a. P9,540,000 c. P9,450,000
b. P9,583,200 d. P9,390,000

PROBLEM NO. 10
Select the best answer for each of the following:

46. The best evidence regarding year-end bank balances is documented in the
a. Cutoff bank statement
b. Bank reconciliations
c. Interbank transfer schedule
d. Bank deposit lead schedule

47. An essential phase of the audit of the cash balance at the end of the year is the
auditor's review of cutoff bank statement. This specific procedure is not useful in
determining if
a. Lapping has occurred.
b. Kiting has occurred.
c. The cash receipts journal was held open.
d. Disbursements per the bank statement can be reconciled with total checks written.

48. Innovation Manufacturing Company’s accounts receivable clerk has a friend who is
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 also Innovation’s customer. The accounts-receivable clerk, on occasion, has issued
fictitious credit memorandums to his friend for goods supposedly returned. The most
effective procedure for preventing this type of activity is to
a. Prenumber and account for all credit memorandums.
b. Require receiving reports to support all credit memorandums before they
are approved.
c. Have all the sales department independent of the accounts-receivable
department.
d. Mail monthly statements.

49. Which of the following controls most likely addresses the completeness assertion for
inventory?
a. Work in process account is periodically reconciled with subsidiary records.
b. Employees responsible for custody of finished goods do not perform the receiving
function.
c. Receiving reports are prenumbered and periodically reconciled.
d. There is a separation of duties between payroll department and inventory
accounting personnel.

50. Which of the following controls would an entity most likely use to assist in satisfying
the completeness assertion related to long-term investments?
a. Senior management verifies that securities in the bank safe deposit box are
registered in the entity’s name.
b. The internal auditor compares the securities in the bank safe deposit box
with recorded investments.
c. The treasurer vouches the acquisition of securities by comparing brokers’ advices
with canceled checks.
d. The controller compares the current market prices of recorded investments with
the brokers’ advices on file.

- end of examination-
 Submit your answer sheet, thank you! 

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