Page 1 of 11

CEBU CPAR CENTER

Mandaue CIty

AUDITING PROBLEMS
AUDIT OF LIABILITIES
PROBLEM NO. 1
In the audit of the Heats 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
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
Arising from advances by officers, due June 30, 2006
Reserve for general contingencies
Employees income tax withheld
Advances received from customers on purchase orders
Containers deposit
Accounts payable arising from purchase of goods,
net of debit balances of P30,000
Accounts receivable, net of credit balances P40,000
Cash dividends payable
Stock dividends payable
Dividends in arrears on preferred stock, not yet declared
Convertible bonds, due January 31, 2007
First mortgage serial bonds, payable in semi-annual installments
of P50,000, due April 1 and October 1 of each year
Overdraft with Allied Bank
Cash in bank balance with PNB
Estimated damages to be paid as a result of unsatisfactory
performance on a contract
Estimated expenses on meeting guarantee for service
requirements on merchandise sold
Estimated premiums payable
Deferred revenue
Accrued interest on bonds payable
Common stock warrants outstanding
Common stock options outstanding
Unused letters of credit
Deficiency VAT assessment being contested
Notes receivable discounted

304,000
500,000
50,000
400,000
20,000
64,000
50,000
170,000
360,000
80,000
100,000
200,000
1,000,000
2,000,000
90,000
390,000
160,000
120,000
75,000
87,000
360,000
120,000
210,000
400,000
500,000
200,000

On March 1, 2006, 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, 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. Heats attorneys believe that the suit is without merit. No court date has been
set.
On January 15, 2006, the BIR assessed Heats an additional income tax of P300,000 for
the 2003 tax year. Heats attorneys and tax accountants have stated that it is likely that
the BIR will agree to a P200,000 settlement.

AP-5902

Page 2 of 11

REQUIRED:
Based on the above and the result of your audit, compute for the following as of December
31, 2005:
1.
2.
3.

Total current liabilities

a. P2,500,000
b. P2,100,000

c. P2,300,000

d. P2,400,000

Total noncurrent liabilities

a. P3,300,000
b. P2,900,000

c. P3,000,000

d. P3,400,000

Total liabilities
a. P5,200,000

c. P5,400,000

d. P5,800,000

b. P5,000,000

PROBLEM NO. 2
The following information relates to Sonic 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 Sonics 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 Sonic to return goods billed at P160,000
and shipped on December 20, 2005. The goods were returned by Sonic 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 Sonics payroll as of December 31, 2005 are:
Accrued salaries and wages
Payroll deductions for:
Income taxes withheld
SSS contributions
Philhealth contributions
Advances to employees
a. P776,000
b. P992,000

P776,000
56,000
64,000
16,000
80,000
c. P832,000

d. P912,000

3. Litigation:
In May, 2005, Sonic became involved in a litigation. The suit is being contested, but
Sonics 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.
a. P0
b. P2,000,000
c. P3,000,000
d. P2,500,000

AP-5902

Page 3 of 11

4. Bonus obligation:
Sonic 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, 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 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, Sonics deferred income tax account has a 2005 ending credit
balance of P772,800, consisting of the following items:
Caused by temporary differences in accounting
For gross profit on installment sales
For depreciation on property and equipment
For product warranty expense
a. P772,800

b. P952,000

Deferred tax
P376,000 Cr.
576,000 Cr
179,200 Dr
P772,800 Cr.
c. P196,800
d. P0

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 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
Warranty claims honored on 2005 sales
Total warranty claims honored
a. P0
b. P1,504,000

c. P96,000

P 416,000
992,000
P1,408,000
d. P512,000

9. Premiums:
To increase sales, Sonic Company inaugurated a promotional campaign on June 30,
2005. 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, 2005, the following is available:
Packages of product sold
Premiums purchased
Coupons redeemed
a. P1,728,000
b. P1,152,000

160,000
16,000
64,000
c. P1,600,000
d. P576,000

AP-5902

Page 4 of 11

10. Due to Five Six Finance company:

Sonics 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 Pistons
Company as of December 31, 2005, you obtained from the voucher register the
information shown in the working paper below.
Item
No.
1

Entry
Date
12.18.05

Voucher
Ref.
12-202

12.18.05

12-204

12.21.05

12-206

12.21.05

12-214

12.21.05

12-219

12.26.05

12-221

12.28.05
12.28.05

12-230
12-234

12.28.05

12-243

10

01.02.06

01-001

11

01.02.06

01-002

12

13

14

15

01.05.06

01.10.06

01.10.06

01.12.06

01-003

01-004

01-005

01-006

Description
Supplies, purchased FOB
destination, 12.15.05;
received, 12.17.05
Auto insurance, 12.15.05 to
12.15.06
Repair services; received
12.20.05
Merchandise shipped FOB
shipping point, 11.20.05;
received, 12.4.05
Payroll, 12.6.05 to 12.20.05
(12 working days)
Subscription to tax reporting
service for 2006
Utilities for December 2005
Merchandise shipped FOB
destination, 12.24.05;
received, 1.2.06
Merchandise shipped FOB
destination, 12.26.05;
received, 12.29.05
Legal services, received
12.28.05
Medical services for
employees for December
2005
Merchandise shipped FOB
shipping point, 12.29.05;
received, 1.4.06
Payroll, 12.21.05 to 01.05.06
(12 working days in total,
4 working days in Jan.)
Merchandise shipped FOB
shipping point, 1.2.06;
received, 1.5.06
Manufacturing royalties,
Dec. 2005

Amount

Account
Charged

Supplies on
hand
Prepaid
24,000
insurance
Repairs and
24,000
maintenance
20,000

17,000 Inventory
Salaries and
69,000
wages
Dues and
5,000 subscription
expense
29,000 Utilities expense

111,500 Inventory

84,000 Inventory
Legal and
46,000
professional
expense

25,000 Medical expense

55,000 Inventory
Salaries and
72,000
wages

64,000 Inventory
Manufacturing
39,000
costs

AP-5902

Page 5 of 11

Item
No.

Entry
Date

Voucher
Ref.

16

01.12.06

01-007

17

01.13.06

01-008

18

01.14.06

01-009

19

01.15.06

01-010

20

01.15.06

01-011

Description
Merchandise shipped FOB
destination, 1.3.06;
received, 1.10.06
Maintenance services,
received 1.9.06
Interest on bank loan,
10.12.05 to 1.10.06
Manufacturing equipment,
installed on 12.29.05
Dividends declared,
12.15.05

Amount

Account
Charged

38,000 Inventory
9,000 Repairs and
maintenance
30,000 Interest expense
Machinery and
254,000
equipment
Dividends
160,000
payable

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

Accrued payroll
Accrued interest payable
Dividends payable
Accrued royalties payable

48,000
26,667
160,000
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 given
above.
PROBLEM NO. 4
During your regular annual audit of Rockets 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
07/01/2005 CR

05/01/2005
11/01/2005

CV-120
CV-531

Interest Expense
P600,000 07/01/2005
720,000

CR

P9,500,000
2,100,000

P40,000

AP-5902

Page 6 of 11

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
Bonds Payable
Interest expense

P2,140,000
P2,100,000
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

c.

Bond premium

e. Interest expense

PROBLEM NO. 5
Wizards Company presented to you their records in connection with the audit of the
companys 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
Date of issue
Proceeds from issue
Interest rate
Interest payment date
Maturity date
10/02/2005

VR

P5,000,000
October 2, 2003
P4,900,000
5% per annum
October 1
P1,000,000 annually, starting October 1, 2005
5% Serial Bonds Payable
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.

method to amortize bond discount and premium, if any.

Use the bond outstanding

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

AP-5902

Page 7 of 11

PROBLEM NO. 6
On January 2, 2004, the Suns, 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
Premium on common stock

P3,000,000
500,000

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

Date
December 31, 2004
December 31, 2005

Bonds
118
110

Common stock
40
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 Ginebra Corporations financial statements for the year
2005, you noted the following liability account balances as of December 31, 2004:
Note payable, bank
Liability under finance lease
Deferred income taxes

P 5,600,000
430,000
700,000

Transactions during 2005 and other information relating to Ginebras 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

AP-5902

Page 8 of 11

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 Ginebra. 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.
Ginebras effective income tax rate for 2004 was 32%.

d.

On July 1, 2005, Ginebra 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. Ginebra
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

d. P699,760

c. P712,640

PROBLEM NO. 8
Select the best answer for each of the following:
1.

In auditing accounts payable, an auditors procedures most likely will focus primarily on
managements 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

AP-5902

Page 9 of 11

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 didnt 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 entitys 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 clients mail, unopened, for a reasonable period of time after year end
to search for unrecorded vendors 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.
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

AP-5902

Page 10 of 11

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 clients 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 auditors purpose in reviewing the renewal of a note payable shortly after the balance
sheet date most likely is to obtain evidence concerning managements assertions about
a.
Existence or occurrence
c. Completeness
b.
Presentation and disclosure
d. Valuation or allocation.
16. An auditors program to audit long term debt should include steps that require
a.
Examining bond trust indentures
b.
Inspecting the accounts payable subsidiary ledger.
c.
Investigating credits to the bond interest income account.
d.
Verifying the existence of the bondholders.
17. In an audit of bonds payable, an auditor expects the trust indenture to include the
a.
Auditees debt-to-equity ratio at the time of issuance.
b.
Effective yield of the bonds issued.
c.
Subscription list.
d.
Description of the collateral
18. In auditing long-term bonds payable, an auditor most likely will
a.
Perform analytical procedures on the bond premium and discount accounts.
b.
Examine documentation of assets purchased with bond proceeds or liens
c.
Compare interest with the bond payable amount for reasonableness.
d.
Confirm the existence of individual bondholders at year-end.
19. The audit procedures used to verify accrued liabilities differ from those employed for the
verification of accounts payable because
a.
Accrued liabilities usually pertain to services of a continuing nature while accounts
payable are the result of completed transactions
b.
Accrued liability balances are less material than accounts payable balances.
c.
Evidence supporting accrued liabilities in nonexistence while evidence supporting
accounts payable is readily available.
d.
Accrued liabilities at year-end will become accounts payable during the following
year.
20. The auditor is most likely to verify accrued commissions payable in conjunction with the
a.
Sales cutoff test
b.
Verification of contingent liabilities
c.
Review of post balance sheet date disbursements
d.
Examination of trade accounts payable

AP-5902

Page 11 of 11

End of AP-5902

AP-5902