College of Accounting Education

3/F F. Facundo Hall, B & E Bldg.

Matina, Davao City Philippines
Phone No.: (082) 305-0645

Applied Auditing
Audit of Current Payables

a. Special audit considerations for payables

(1) Confirmation. Confirmations may be sent to vendors. However, such confirmation procedures are
sometimes omitted due to the availability of externally generated evidence (e.g., both purchase
agreements and vendors’ invoices) and due to the inability of confirmations to adequately address the
completeness assertion. (Auditors are primarily concerned about the possibility of understated
payables; a major payable will not in general be confirmed if the client completely omits it from the
trial balance of payables.)

Accounts payable confirmations are most frequently used in circumstances involving (1) bad internal
control, (2) bad financial position, and (3) situations when vendors do not send month-end
statements.

However, when an auditor has chosen to confirm payables despite the existence of vendor
statements, the confirmation will generally request the vendor to send the month-end statement to
the auditor. For this reason, the balance per the client’s books is not included on such a confirmation.

Confirmations are sent to (1) major suppliers, (2) disputed accounts, and (3) a sample of other
suppliers. Major suppliers are selected because they represent a possible source of large
understatement: the client will normally have established large credit lines. The size of the recorded
payable at year-end is of less importance than for receivables.

While as a practical matter large year-end recorded balances will normally be confirmed, the emphasis
on detecting understated payables may lead the auditor to also confirm accounts with relatively low
recorded year-end balances. Also, if the payables to be confirmed are selected from a list of vendors
instead of from the recorded year-end payables, the completeness assertion as well as the existence
assertion may be addressed.

(2) The search for unrecorded liabilities. The search for unrecorded liabilities is an effort to
discover any liabilities that may have been omitted from recorded year-end payables (completeness).
Typical procedures include the following:

(a) Examination of vendors’ invoices and statements both immediately prior to and following
year-end
(b) Examination, after year-end, of the following to test whether proper cutoffs have occurred:
1] Cash disbursements
2] Purchases
3] Unrecorded vouchers (receiving reports, vendors’ invoices, purchase orders)
(c) Analytical procedures
(d) Internal control is analyzed to evaluate its likely effectiveness in preventing and detecting
the occurrence of such misstatements.

b. Typical substantive audit procedures for payables

1) Review disclosures for compliance with generally accepted accounting principles.

2) Review purchase commitments to determine whether there may be a need to either accrue a
loss and/or provide disclosure.
3) Confirm accounts payable by direct correspondence with vendors. Confirmation of payables
provides evidence relating to the occurrence, obligation, completeness, accuracy, and
valuation assertions.
4) Inspect copies of notes and note agreements.
5) Vouch balances payable to selected creditors by inspecting purchase orders, receiving reports,
and invoices to verify existence, accuracy, valuation, and to a lesser extent, completeness.
6) Review the cutoff of purchases, purchase returns, and disbursements around year-end to
verify that transactions are recorded in the proper period.
7) Perform analytical procedures to test the reasonableness of payables. Examples here are
ratios such as accounts payable divided by purchases, and accounts payable divided by total
current liabilities.
8) Perform search for unrecorded payables to determine whether liabilities have been completely
recorded.
9) Inquire of management as to the completeness of payables.
10) Foot the subsidiary accounts payable ledger to test clerical accuracy.
11) Reconcile the subsidiary ledger to the general ledger control account to verify clerical
accuracy.
 College of Accounting Education
3/F F. Facundo Hall, B & E Bldg.
Matina, Davao City Philippines
Phone No.: (082) 305-0645

12) Recalculate interest expense on interest-bearing debt.

13) Recalculate year-end accrual for payroll. A typical procedure here is to allocate the total days
in the payroll subsequent to year-end between the old and new years and to determine
whether the accrual is reasonable.
14) Recalculate other accrued liabilities. The approach for accruals is largely one of (1) testing
computations made by the client in setting up the accrual, and (2) determining that the
accruals have been treated consistently with the past. Note that the audit approach here is
somewhat different than for accounts payable that, because one or more transactions usually
directly indicate the year-end liability, do not require such a computation. Examples of
accounts requiring accrual include property taxes, pension plans, vacation pay, service
guarantees, commissions, and income taxes payable.

THEORIES
1.In auditing accounts payable, an auditor’s procedures most likely will focus primarily on management’s
assertion of
a. Existence or occurrence c. Completeness
b. Presentation and disclosure d. Valuation or allocation

2.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 c. Canceled checks
b. Vendors’ invoices d. Receiving reports

3.The primary audit test to determine if accounts payable are valued properly is
a. Confirmation of accounts payable
b. Vouching accounts payable to supporting documentation
c. An analytical procedure
d. Verification that accounts payable was reported as a current liability in the balance sheet.

4.Which of the following procedures is least likely to be performed before the balance sheet date?
a. Observation of inventory c. Search for unrecorded liabilities
b. Testing of internal control over cash d. Confirmation of receivables

5.An audit assistant found a purchase order for a regular supplier in the amount of P5,500. The purchase
order was dated after receipt of goods. The purchasing agent had forgotten to issue purchase
order. Also a disbursement of P450 for materials did not have a receiving report. The assistant
wanted to select additional purchase orders for investigation but was unconcerned about lack of
receiving report. The audit director should
a. Agree with the assistant because the amount of the purchase order exception was
considerably larger than the receiving report exception
b. Agree with the assistant because the cash disbursement clerk had been assured by the
receiving clerk that the failure to fill out a report didn’t happen very often.
c. Disagree with the assistant because two problems have an equal risk of loss associated with
them.
d. Disagree with the assistant because the lack of a receiving report has a greater risk of loss
associated with it.

6.When using confirmation to provide evidence about completeness assertion for accounts payable, the
appropriate population most likely is
a. Vendors with whom the entity has previously done business.
b. Amounts recorded in the accounts payable subsidiary ledger.
c. Payees of checks drawn in the month after the year end.
d. Invoices filed in the entity’s open invoice file.

7.Which of the following is a substantive test that an auditor is most likely to perform to verify the
existence and valuation of recorded accounts payable?
a. Investigating the open purchase order file to ascertain that pre-numbered purchase orders
are used and accounted for.
b. Receiving the client’s mail, unopened, for a reasonable period of time after year end to
search for unrecorded vendor’s invoices.
c. Vouching selected entries in the accounts payable subsidiary ledger to purchase orders and
receiving reports.
d. Confirming accounts payable balances with known suppliers who have zero balances.

8.Only one of the following four statements, which compare confirmation of accounts payable with
suppliers and confirmation of accounts receivable with debtors is false. The false statement is that
a. Confirmation of accounts receivable with debtors is a more widely accepted auditing
procedures than is confirmation of accounts payable with suppliers.
 College of Accounting Education
3/F F. Facundo Hall, B & E Bldg.
Matina, Davao City Philippines
Phone No.: (082) 305-0645

b. Statistical sampling techniques are more widely accepted in the confirmation of accounts
payable than in the confirmation of accounts receivable.
c. As compared with the confirmation of accounts receivable, the confirmation of accounts
payable will tend to emphasize accounts with zero balances at the balance sheet date.
d. It is less likely that the confirmation request sent to the supplier will show the amount owed
than that request sent to the debtor will show the amount due.

9.When title to merchandise in transit has passed to the audit client the auditor engaged in the
performance of a purchase cut-off will encounter the greatest difficulty in gaining assurance with
respect to the
a. Quantity b. Quality c. Price d. Terms

10. Which of the following audit procedures is least likely to detect an unrecorded liability?
a. Analysis and recomputation of interest expense.
b. Analysis and recomputation of depreciation expense.
c. Mailing of standard bank confirmation forms.
d. Reading of the minutes of meetings of the board directors.

11. Unrecorded liabilities are most likely to be found during the review of which of the following
documents?
a. Unpaid bills c. Bills of lading
b. Shipping records d. Unmatched sales invoices

12. Which of the following audit procedures is best for identifying unrecorded trade accounts payable?
a. Reviewing cash disbursements recorded subsequent to the balance sheet date to determine
whether the related payables apply to the prior period.
b. Investigating payables recorded just prior to and just subsequent to the balance sheet date
to determine whether they are supported by receiving reports.
c. Examining unusual relationships between monthly accounts payable balances and recorded
cash payments.
d. Reconciling vendors’ statement to the file of receiving reports to identify items received just
prior to the balance sheet date.

13. In verifying debits to perpetual inventory records of a nonmanufacturing firm, the auditor is most
interested in examining the purchase
a. Journal b. Requisitions c. Orders d. Invoices

14. Which of the following procedures relating to the examination of accounts payable could the
auditor delegate entirely to the client’s employees?
a. Test footings in the accounts payable ledger
b. Reconcile unpaid invoices to vendors statements
c. Prepare a schedule of accounts payable
d. Mail confirmations for selected account balances

15. An auditor’s purpose in reviewing the renewal of a note payable shortly after the balance sheet
date most likely is to obtain evidence concerning management’s assertions about
a. Existence or occurrence c. Completeness
b. Presentation and disclosure d. Valuation or allocation.

PROBLEM NO. 1

In the audit of the Heats Corporation’s financial statements at December 31, 2015, 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, 2016; P100,000 due on Dec. 31, 2016 500,000
Arising from advances by officers, due June 30, 2016 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
 College of Accounting Education
3/F F. Facundo Hall, B & E Bldg.
Matina, Davao City Philippines
Phone No.: (082) 305-0645

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, 2017 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, 2016, the P400,000 note payable was replaced by an 18-month note for the same amount.
Heats is considering similar action on the P100,000 note payable due on December 31, 2016. The 2015
financial statements were issued on March 31, 2016.

On December 1, 2015, a former employee filed a lawsuit seeking P200,000 for unlawful dismissal.
Heats’ attorneys believe that the suit is without merit. No court date has been set.

On January 15, 2016, the BIR assessed Heats an additional income tax of P300,000 for the 2013 tax
year. Heats’ 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, 2015:

1. Total current liabilities

2. Total noncurrent liabilities
3. Total liabilities

PROBLEM NO. 2

The following information relates to Sonic Company’s obligations as of December 31, 2015. For each
of the numbered items, determine the amount if any, that should be reported as current liability in
Sonic’s December 31, 2015 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, 2015:

a) A Company – P224,000 merchandise shipped on December 31, 2015, FOB destination; received
on January 10, 2016.
b) B, Inc. – P192,000 merchandise shipped on December 26, 2015, FOB shipping point; received
on January 16, 2016.
c) C Super Services – P144,000 janitorial services for the three-month period ending January 31,
2016.
d) MERALCO – P67,200 electric bill covering the period December 16, 2015 to January 15, 2016.

On December 28, 2015, a supplier authorized Sonic to return goods billed at P160,000 and shipped
on December 20, 2015. The goods were returned by Sonic on December 28, 2015, but the P160,000
credit memo was not received until January 6, 2016.

2. Payroll:
Items related to Sonic’s payroll as of December 31, 2015 are:
 College of Accounting Education
3/F F. Facundo Hall, B & E Bldg.
Matina, Davao City Philippines
Phone No.: (082) 305-0645

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

3. Litigation:
In May, 2015, Sonic became involved in a litigation. The suit is being contested, but Sonic’s lawyer
believes it is possible that Sonic 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.

4. Bonus obligation:
Sonic Company’s 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.)

5. Note payable:
A note payable to the Bank of the Philippine Islands for P2,400,000 is outstanding on December 31,
2015. The note is dated October 1, 2014, 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,
2015.

6. Purchase commitment:
During 2015, Sonic entered in a noncancellable commitment to purchase 320,000 units of inventory
at fixed price of P5 per unit, delivery to be made in 2016. On December 31, 2015, 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, 2016.

7. Deferred taxes:
On December 31, 2015, Sonic’s deferred income tax account has a 2015 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

8. Product warranty:
Sonic has a one year product warranty on selected items in its product line. The estimated warranty
liability on sales made during 2014, which was outstanding as of December 31, 2014, amounted to
P416,000. The warranty costs on sales made in 2015 are estimated at P1,504,000. Actual warranty
costs incurred during the current 2015 fiscal year are as follows:

Warranty claims honored on 2014 sales P 416,000

Warranty claims honored on 2015 sales 992,000
Total warranty claims honored P1,408,000

9. Premiums:
To increase sales, Sonic Company inaugurated a promotional campaign on June 30, 2015. Sonic
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. Sonic estimated that only 60% of the coupons issued will be
redeemed. For the six months ended December 31, 2015, the following is available:

Packages of product sold 160,000

Premiums purchased 16,000
Coupons redeemed 64,000

10. Due to Five Six Finance company:

Sonic’s accounting records show that as of December 31, 2015, 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.

PROBLEM NO. 3
Pirates’ Music Emporium carries a wide variety of music promotion techniques - warranties and
premiums – to attract customers.

Musical instrument and sound equipment are sold in a one-year warranty for replacement of parts and
labor. The estimated warranty cost, based on past experience, is 2% of sales.
 College of Accounting Education
3/F F. Facundo Hall, B & E Bldg.
Matina, Davao City Philippines
Phone No.: (082) 305-0645

The premium is offered on the recorded and sheet music. Customers receive a coupon for each peso
spent on recorded music or sheet music. Customers may exchange 200 coupons and P20 for an AM/FM
radio. Pirates pays P34 for each radio and estimates that 60% of the coupons given to customers will
be redeemed.

Pirates’ total sales for 2005 were P7,200,000 - P5,400,000 from musical instrument and sound
reproduction equipment and P1,800,000 from recorded music and sheet music. Replacement parts and
labor for warranty work totaled P164,000 during 2005. A total of 6,500 AM/FM radio used in the
premium program were purchased during the year and there were 1,200,000 coupons redeemed in
2005.

The accrual method is used by Pirates to account for the warranty and premium costs for financial
reporting purposes. The balance in the accounts related to warranties and premiums on January 1,
2005, were as shown below:

Inventory of Premium AM/FM radio P39,950

Estimated Premium Claims Outstanding 44,800
Estimated Liability from Warranties 136,000

QUESTIONS:

Based on the above and the result of your audit, determine the amounts that will be shown on the
2005 financial statements for the following:

1. Warranty expense

2. Estimated liability from warranties

3. Premium expense

4. Inventory of AM/FM radio

5. Estimated liability for premiums

PROBLEM NO. 4

In conjunction with your firm’s examination of the financial statements of Pistons Company as of
December 31, 2015, you obtained from the voucher register the information shown in the working paper
below.

Item Entry Date Voucher Account Charged

No. Ref. Description Amount
1 12.18.15 12-202 Supplies, purchased FOB
destination, 12.15.15; Supplies on
received, 12.17.15 20,000 hand

2 12.18.15 12-204 Auto insurance, 12.15.15 to Prepaid

12.15.16 24,000 insurance

3 12.21.15 12-206 Repair services; received Repairs and

12.20.15 24,000 maintenance

4 12.21.15 12-214 Merchandise shipped FOB

shipping point, 11.20.15;
received, 12.4.15 17,000 Inventory

5 12.21.15 12-219 Payroll, 12.6.15 to 12.20.15 Salaries and

(12 working days) 69,000 wages

6 12.26.15 12-221 Subscription to tax reporting Dues and

service for 2016 5,000 subscription
expense

7 12.28.15 12-230 Utilities for December 2015 29,000 Utilities expense

8 12.28.15 12-234 Merchandise shipped FOB

destination, 12.24.15;
received, 1.2.16 111,500 Inventory
 College of Accounting Education
3/F F. Facundo Hall, B & E Bldg.
Matina, Davao City Philippines
Phone No.: (082) 305-0645

Item Entry Date Voucher Account Charged

No. Ref. Description Amount

9 12.28.15 12-243 Merchandise shipped FOB

destination, 12.26.15;
received, 12.29.15 84,000 Inventory

10 01.02.16 01-001 Legal services, received Legal and

12.28.15 46,000 professional
expense

11 01.02.16 01-002 Medical services for

employees for December
2015 25,000 Medical expense

12 01.15.16 01-003 Merchandise shipped FOB

shipping point, 12.29.15;
received, 1.4.16 55,000 Inventory

13 01.10.16 01-004 Payroll, 12.21.15 to 01.15.16

(12 working days in total, 4 Salaries and
working days in Jan.) 72,000 wages

14 01.10.16 01-005 Merchandise shipped FOB

shipping point, 1.2.16;
received, 1.5.16 64,000 Inventory

15 01.12.16 01-006 Manufacturing royalties, Manufacturing

Dec. 2015 39,000 costs
16 01.12.16 01-007 Merchandise shipped FOB
destination, 1.3.16; received,
1.10.16 38,000 Inventory

17 01.13.16 01-008 Maintenance services, received 9,000 Repairs and

1.9.16 maintenance

18 01.14.16 01-009 Interest on bank loan,

10.12.15 to 1.10.16 30,000 Interest expense

19 01.15.16 01-010 Manufacturing equipment, Machinery and

installed on 12.29.15 254,000 equipment

20 01.15.16 01-011 Dividends declared, 12.15.15 Dividends

160,000 payable

Accrued liabilities as of December 31, 2015 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, 2016.

REQUIRED:

Prepare adjusting entries as of December 31, 2015 based on your review of the data given above.