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Applied Auditing by Cabrera Chapter10 - Answer
Applied Auditing by Cabrera Chapter10 - Answer
SUBSTANTIVE TESTS OF
10 INVESTMENTS
10-1. The CPAs would accept a confirmation of the securities on hand from the
custodian in lieu of their personal inspection of the securities after they had
investigated and satisfied themselves as to the standing of the custodian. The
CPAs would probably be satisfied if they found the custodian to be a well-known,
reliable financial institution, completely independent of the client and with
resources substantially larger in amount than the securities of the CPAs client that
are on deposit.
10-2. The auditors can make an independent computations of dividends earned during
the year by reference to dividend record books published by investment advisory
services.
10-3. Securities owned by the client may not be on hand at the balance sheet date
because they are held by others for safekeeping, pledged as collateral for loans,
deposited as assurance of performance under contracts, or in the hands of brokers
or others for transfer.
10-4. When the inspection of securities cannot be made for two weeks after the balance
sheet date, the client at the auditors suggestion may instruct the bank that the safe
deposit box is not to be opened until the time of the auditors inspection. A letter
may be obtained from the bank stating that the box has not been opened between
the balance sheet date and the auditors arrival. If the securities are in the clients
office, it will be necessary to verify any security transactions between the date of
inspection and the balance sheet date and to reconcile the results of the inspection
with the securities owned at the balance sheet date. The count of cash and other
negotiable assets should be coordinated with the inspection of securities.
(2) The banks record of persons entering the deposit box should be
examined to determine that only authorized persons have had access to
the box and that there was no entry to the box between December 31 and
January 11. Entry to the box between those dates may be an indication
that a security was returned to safekeeping after being borrowed at
year-end. The security may have been borrowed and used as collateral
to obtain cash to cover a shortage at December 31.
(3) The assistant should be instructed to insist that the treasurer be present
while the securities are being examined. Most auditors prefer to obtain a
signed statement that all investments inspected were returned at the
completion of the inspection made in the presence of the custodian. In
any event, the working papers should note the date of the inspection and
the name of the witness to the inspection.
(4) The following details of the securities should be examined:
a) The name of the registered owner appearing on each security other
than bearer bonds should be noted to determine that Pink
Corporation is a registered owner and that securities belonging to
another owner have not been substituted.
b) The name of the corporation issuing the security and the class of the
security (Class A, Par Value, 1st Preference, etc.) should be noted for
assurance that a lower priced security (perhaps somewhat similar in
corporate name or a different security of the issuing corporation) has
not been substituted for a higher priced security.
c) The face value of bonds and the number of shares represented by
each share certificate should be compared with the client record to
determine that the entire amount of the corporations holdings of
each security is on hand.
d) The serial numbers of the securities should be compared with those
on the record and, for those securities carried over from the prior
year, compared with the serial numbers of securities listed in the
prior years working papers. A change in serial numbers that cannot
be properly explained may be an indication of manipulation of the
securities. Verification of serial numbers also helps establish the
cost of securities sold under either the FIFO or specific identification
cost method.
e) The certificates should be read to ascertain the interest rates and
payment dates for bonds and the dividend rates and payment dates, if
given, for preference shares. This information may be used later in
the verification of investment revenue.
f) Bonds should be examined to determine maturity dates. Maturity
dates are needed for verifying the computation of the amortization of
bond premiums or discounts. In addition, the maturity dates will
disclose whether any bonds on hand have matured. The presence of
matured bonds may be a sign of internal control weakness or may
indicate that the bonds are in default.
Substantive Tests of Investments 10-3
g) Coupon bonds should be inspected to determine that no past-due
interest coupons are unclipped and all future interest coupons are
attached. The presence of past-due coupons may be caused by poor
internal control and may indicate an understatement of interest
revenue. On the other hand, past-due coupons may indicate the
interest is in default and that the principal is uncollectible. Missing
future interest coupons may be an indication of an irregularity.
h) The auditors should be alert for any obvious alterations to securities
or forged certificates. Although auditors usually are not held
responsible for the genuineness of the certificates, any apparent
forgeries (or exceptions noted in the foregoing audit procedures)
may point out the need for obtaining confirmations from the
corporations issuing the certificates.
(b) The treasurers entry into the safe deposit box on January 4 has violated
the auditors control over negotiable assets which must be inspected or
counted simultaneously or kept under control until counted to avoid the
substitution of a counted asset for an uncounted asset in an attempt to
conceal a shortage. The auditors would probably apply the following
additional procedures:
(1) Reconcile bank balances at both year-end and at the date of
inspecting securities.
(2) Obtain a bank confirmation as of the inspection date.
(3) Examine cash journals between year-end and the inspection date for
any unusual entries.
(4) Examine all investment transactions taking place between the
balance sheet date and the inspection date to verify the amount of the
investment at the balance sheet date.
(5) If the client keeps a large fund of cash on hand, make a surprise
count of the cash fund.
(6) Review the transactions since year-end relating to any other
negotiable assets, such as notes receivable, to determine if any
substitutions have been made.
10-6. (a) (4) Having the securities held in safekeeping by a bank provides strong
internal control because the bank has no direct contact with the
employees responsible for maintaining the accounting record of the
securities and that individual has no access to the securities. Thus the
separation of the custody of securities from the accounting function is
complete.
(b) (1) The investment committee of the board of directors is not involved in the
routine of making buy and sell decisions and can therefore review the
transactions objectively. On the other hand, the chief operating officer,
the controller, and the treasurer may be closely associated on a daily
basis with the financial executive responsible for the investment
decisions.
10-4 Solutions Manual to Accompany Applied Auditing, 2006 Edition
Requirement (a)
COLOR COMPANY
Investment
12.31.06
I N V E S T M E N T
Per Books Adjustments As Adjusted Adjustments to Other Accounts
Date Transactions Dr Cr Dr Cr Dr (Cr) Name of Account Dr Cr
2006
Jan. 3 Purchased 100 shares, National Motors P 4,500 P 4,500
5 Purchased 100 shares, Major Electronics 500 (13) 500 - Loss on investment on
Major Electronics (13) 500
Mar. 31 Cash dividend, National Motors P 50 (1) 50 - Dividend income (1) 50
Apr. 5 Sold 100 shares, National Motors 4,800 (2) 300 (4,500) Gain on sale of investment (2) 300
6 Purchased 100 shares, Ace Investment 2,300 2,300
6 Purchased 100 shares, General Utility 2,400 (3) 120 2,280 Investment in rights issues (3) 120
May 1 Received 100 rights issues, General Utility 100 (4) 100 - Miscellaneous income (4) 100
July 2 Purchased 10 shares, General Utility 130 (5) 60 190 Investment in rights issues (5) 60
15 Purchased 50 shares, Acme Laboratories 1,900 1,900
18 Purchased 20 shares, The Kalayaan Corp. 3,000 (6) 3,000 - Treasury shares (6) 3,000
Aug. 15 Sold 10 shares, The Kalayaan Corporation 1,550 (7) 1,550 - Treasury shares (7) 1,500
Dec. 8 Received 2 shares, Acme Laboratories 80 (8) 80 - Additional paid on Capital -
TS trans. (7) 50
8 Cash dividend, Acme Laboratories 20 (9) 2 ( 18) Gain on sale of fractional (9) 2
shares
15 Cash dividend, Ace Investment 90 (10) 80 ( 10) Dividend income (10) 80
31 Cash dividend, General Utility 120 (11) 120 - Miscellaneous income (11) 120
Dividends receivable (12) 110
Dividend income (12) 110
Loss on expiration of rights
issues (14) 60
Investment in rights issues (14) 60
_______ _______ ________ ________ ________
15,030 6,510 2,04 3,920 Adjusting Journal Entry
2
8,520 1,87 Unrealized holding loss on
8
Balance P 15,030 P 15,030 P 3,920 P 3,920 P 6,642 SAS (Equity) (15) 1,142
Substantive Tests of Investments 10-8
Securities Fair Value
Adjustment SAS (15) 1,142
10-9 Solutions Manual to Accompany Applied Auditing, 2006 Edition
Requirement (2)
CANADA CORPORATION
Bank Reconciliation
March 31, 2005
Requirement (3)
2005
Mar. 31 Cash 1,600.00
Notes Receivable 1,500.00
Interest Revenue 100.00
c.
Belle Manufacturing Company
Investment in Laribee Industries
December 31, 2006
No. of Shares
12/31/06: Final balance - 1,000 shares P 50,000 < 1,000
1/2/07: Purchased 1,500 shares 75,000 * @ 1,500
12/31/07: Ledger balance 125,000 2,500
AJE No. 1 210,000 _____
12/31/07: Audited balance P335,000 2,500 &
To WPH
10-12 Solutions Manual to Accompany Applied Auditing, 2006 Edition
AJE 1
Investment in Laribee Ordinary P210,000
Dividend Revenue 40,000
Equity in Income of Unconsolidated
Subsidiary P250,000
To adjust investment account for excess
of Belles share of Laribee income over
Laribee dividends.
Dividends:
4/1/07 (P 12,500) #
7/1/07 (P 12,500) #
10/1/07 (P 15,000) #
(P 40,000)
Income:
25% of P1 million P250,000 X
P210,000
Requirement (1)
Analen, Inc.
Income Before Income Taxes from Investment in Bel Company
For the Year Ended December 31, 2006
Requirement (2)
Analen, Inc.
Income Before Income Taxes From Investment in Bel Company
For the Years Ended December 31, 2007, and 2006, Restated
Requirement (1)
July 2005: purchase of investment in trading security:
Investment in trading security: Celebrity Corp. bonds
(P1,000 x 8 x 1.02)................................................... 8,160
Interest receivable (P8,000 x 9% x 2/12;
May 1 July 1)......................................................... 120
Cash................................................................... 8,280
Requirement (2)
November 2005 - Interest collected:
Cash (P8,000 x 9% x 6/12)............................................ 360
Interest revenue......................................................... 240
10-14 Solutions Manual to Accompany Applied Auditing, 2006 Edition
Requirement (3)
Dec. 31, 2005: accrue interest on the Celebrity Corp. bonds held
as a trading securities investment:
Interest receivable (P8,000 x 9% x 2/12, Nov. Dec.).. 120
Interest revenue......................................................... 120
* Investment in Bonds:
Original cost.............................................................. P8,000
Fair value................................................................... 7,760
Unrealized loss.......................................................... P 240
Previously recorded unrealized loss.......................... 0
DR<CR> to valuation allowance.............................. P 240
Requirement (4)
Income Statement for 2005:
Interest revenue (P200 + P100)..................................... P 300
Unrealized loss on investment in trading securities...... <240>
Computation:
(P220,000 P200,000) = P20,000; (P20,000 x 0.30)
10 yrs. = P600
Computation:
[(P260,000 P250,000) = P10,000] x 0.30 = P3,000
Requirement (2)
January 1, 2006 To record sale of 500 shares of Zash shares:
Cash [(500 shares x P18), Zash Corp............................ 9,000
Long-term investment in equity-basis company:
Zash Corp............................................................... 8,250
Gain on disposal of long-term securities.................. 750
Computation:
Balance in investment account (P153,000 + P6,600
P2,400 P600 P3,000 P1,500 P3,000 P600) ....
= P140,500.
P148,500 x 500/9,000 shares = P8,250
Requirement (3)
Balance sheet:
Investment in equity-basis company
(P153,000 + P6,600 P2,400 (P153,600 P1,500 P3,000
- P600 P3,000)................................... P600)..............................
P153,600 P148,500
* Investment income for 2006 is not known, as no data are given for this year.
Requirement (1)
Assuming other income is zero, then the entire P74 million for 2006 and the
P127 million for 2005 are equity in the income of affiliated companies:
2006 2005
Equity in income of affiliated companies....................................... P 74 P127
Less: Undistributed equity in income of affiliated companies...... 27 84
Maximum amount of dividends that could be received................. P 47 P 43
If dividends were zero, then all of the equity in income of affiliated companies
would be retained. Since the amount actually retained was P27 million, the
amount of other income is P74 million less P27 million, or P47 million.
Substantive Tests of Investments 10-17
Requirement (2)
Investment at December 31, 2006........................................... P1,456
Investment at December 31, 2005........................................... 1,332
Increase in investment in equity.............................................. P 124
Amount of increase resulting from undistributed equity
in income of affiliated companies.................................... 27
Amount of increase (decrease) in investment from other
sources.............................................................................. P 97
It appears Del either increased its equity holdings in its affiliated companies, or
made advances which had been recorded in the Investments account.
Requirement (3)
Rate of return on average investment in equity-basis companies = P74 / ([P1,332
+ P1,456] / 2) = 0.053%
Requirement (4)
If the investment at equity represents a 50% owned joint venture with no goodwill
or adjustment for book value to fair value of net assets, the total shareholders
equity (TSE) can be approximated as:
Investment in Affiliate, at equity = 50% x TSE of Affiliate Joint Venture
TSE of Affiliate = P1,456 / 0.50 = P2,912 million.
Knowing the percentage owned allows estimates of the net assets of the equity-
basis companies to be made, assuming there are no adjustments or goodwill
involved.
The unrealized gains and losses resulting from changes in the fair value of
available-for-sale securities are recorded in an unrealized holding gain or loss
account that is reported as other comprehensive income and as a separate
component of shareholders equity until realized. Therefore, the following
adjusting entry should be made at the year-end: