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Chapter11 - Answer
Chapter11 - Answer
11-1. Factors which facilitate the auditors’ verification of plant and equipment but are
not applicable to audit work on current assets include the following:
(a) High peso amount of individual items. A relatively few transactions may
support a large balance sheet amount.
(b) Usually little change in property accounts year to year. Land, buildings, and
equipment often remain unchanged for many years; hence there is little
accounting activity to verify. In contrast, such current assets as accounts
receivable and inventory may have a complete turnover several times a year.
(c) Minor effect on net income from cutoff errors. Cutoff errors in recording
transactions in plant and equipment are much less likely to have a material
effect on net income than are errors in the cutoff of transactions for purchase
and sale of merchandise. For example, a cutoff error which causes a
P30,000 year-end sales transaction to be recorded a day prior to shipment
may cause a P30,000 overstatement of the current year’s pretax income.
11-2. The auditors must question the service lives adopted by the client for plant assets.
To do otherwise would be to fail in the collection of sufficient competent evidence
for the client’s depreciation policies and procedures.
11-3. The principal objective of the auditors in analyzing a Maintenance and Repairs
expense account is to disclose any capital expenditures which were erroneously
recorded as expense.
11-4. Documentary evidence usually available in the client’s office to substantiate legal
ownership of property, plant, and equipment includes deeds, policies of title
insurance or abstract of title and an attorney’s opinion as to title, property tax bills,
insurance policies, purchase contracts, purchase orders, invoices, and paid checks.
The auditors may also secure written representations from the client as to
ownership of these assets.
11-5. The auditors employ the following substantive tests to detect unrecorded
retirements of property, plant, and equipment:
(a) If major additions of plant and equipment have been made during the year,
ascertain whether old equipment was traded in or superseded by the new
units.
(b) Analyze the Miscellaneous Revenue account to locate any cash proceeds
from sale of plant assets.
11-2 Solutions Manual to Accompany Applied Auditing, 2006 Edition
(c) If any of the company’s products have been discounted during the year,
investigate the disposition of plant facilities formerly used in manufacturing
such products.
(d) Inquire of executives and supervisors whether any plant assets have been
retired during the year.
(e) Examine retirement work orders or other source documents for authorization
by the appropriate official or committee.
(f) Investigate any reduction of insurance coverage to see whether this was
caused by retirement of plant assets.
(a) This is the first audit of Kris Corporation by Ian and Ronna. Moreover, the
company has not been audited by other public accountants during the two
previous years of operation. Under these circumstances, the auditors must
investigate fully transactions relating to plant and equipment during the two
prior years of the company’s existence, as well as the records of the year
under audit. The adequacy of internal control over plant acquisitions and
disposals would be an important part of this review. Since Kris is a relatively
new company, this study of prior years’ transactions can be completed within
reasonable time limits.
The review of prior years’ transactions relating to plant and equipment would
include analysis of the Repairs and Maintenance expense account and should
bring to light the erroneous treatment of plant acquisitions as revenue
expenditures during Years 1 and 2.
If Ian and Ronna did not investigate the property transactions of the two prior
years and the internal controls in force, there would be no satisfactory support
for the balances of the property accounts at the end of Year 3, or for the
depreciation expense of the year under audit. Remember that one of the
auditors’ basic objectives for plant and equipment is to determine that the
property accounts (including the amounts carried forward from prior years)
are fairly stated.
(b) Both the income statement and the balance sheet prepared at the end of Year 3
would be affected by the errors made in Years 1 and 2. In the balance sheet,
the plant and equipment and also the total assets would be understated by the
undepreciated cost of the assets which were improperly expensed. Current
liabilities and total liabilities would be understated by the additional income
taxes applicable to the understatement of prior periods’ net income due to the
accounting errors. The retained earnings and total shareholders’ equity would
be understated by the difference between the understatement of total assets
and the understatement of total liabilities. In the Kris income statement,
depreciation expense would be understated, income taxes expense overstated,
and net income overstated.
Substantive Tests of Property, Plant and Equipment 11-3
11-7. Sparrow Company
1. Change in depreciation method is considered change in accounting estimate
--cumulative effect adjustment:
a. No correcting entry
b. Depreciation Expense 25,750
Accumulated Depreciation: Machine 25,750
To record depreciation for 2006.
Previous depreciation amount
2004 P400,000 x (2 x 10%) P 80,000
2005 (P400,000 - P80,000) x (2 x 10%) = 64,000
P144,000
Cost P400,000
Less: Accumulated depreciation 144,000
Carrying value 12.31.05 P256,000
256,000 – 50,000
Depreciation in 2006 = 8 = P25,750
Requirement (1)
Accumulate
Annual d
Depreciatio Years Depreciatio
Truck Cost Life n Owned n
1 P120,000 5 P24,000 3 P 72,000
2 104,000 5 20,800 2½ 52,000
3 128,000 5 25,600 1 25,600
4 150,000 5 30,000 ½ 15,000
P164,600
July 1, 2003
Correct entry:
Cash 10,000
Accumulated Depreciation: Trucks
[P72,000 + (P24,000 x ½)] 84,000
Loss 26,000
Trucks 120,000
Entry made:
Cash 10,000
Trucks 10,000
January 1, 2004
Correct entry:
Accumulated Depreciation:
Trucks (P25,600 + P25,600) 51,200
Trucks (new) 120,000
Cash 17,800
Substantive Tests of Property, Plant and Equipment 11-5
Trucks (old) 128,000
Gain on exchange 25,400
Entry made:
Trucks 17,800
Cash 17,800
July 1, 2005
Correct entry:
Accumulated Depreciation: Trucks
(P15,000 + P30,000 + P30,000 + P15,000) 90,000
Cash 10,000
RE on disposition of trucks 50,000
Trucks 150,000
Entry made:
Cash 10,000
Miscellaneous Revenue 500
Trucks 9,500
Correct depreciation:
2003 P26,000
2004 P15,360
2005 P50,500 + P14,860 = P65,360
2006 P14,360
Requirement (2)
Compound AJE:
Note: This question requires knowledge that corrections of errors in prior years
are recorded to Retained Earnings.
Adjusting entries at December 31, 2007, to correct the books. The building and
machinery should be recorded in separate accounts. Ignore effect on income
taxes.
Requirement (1)
Machinery (cost)
Raw materials used P13,600
Labor 9,800
Installation cost 1,400
Materials used in trial runs 600
Factory overhead (incremental) 2,900
Total P28,300
Less: Cash discount on materials 400
Net P27,900
Composition:
A D - Machine acquired on 9/30/02 P 5,270.00
- Machine acquired on 6/30/03 5,488.00
- Machine acquired on 6/30/04 3,810.00
Total P14,568.00
Supporting Analysis:
Date
Acquired Cost 2002 2003 2004 2005 2006
1/1/02 P 5,240 P 1,048.00 P1,048.00 P 524.00 P 0.00 P 0.00
4,000 800.00 800.00 800.00 800.00 600.00
4,400 880.00 880.00 880.00 0.00 0.00
9/30/02 6,200 310.00 1,240.00 1,240.00 1,240.00 1,240.00
6/30/03 7,840 0.00 784.00 1,568.00 1,568.00 1,568.00
6/30/04 7,620 0.00 0.00 762.00 1,524.00 1,524.00
Total correct
depreciation provision P 3,038.00 P4,752.00 P 5,774.00 P5,132.00 P4,932.00
Provision by client 3,248.00 5,158.40 5,126.72 3,626,38 2,741.10
(Over) Underprovision P (210.00) P (406.40) P 647.28 P1,505.62 P2,190.90
b. The audit objectives for examining the asset and related accumulated
depreciation accounts are:
(1) Existence or occurrence: To establish the physical presence of the assets
and the validity of the purchase and sale transactions.
(2) Rights and obligations: To ascertain that Sunlight owns the trucks.
(3) Valuation or allocation: To determine that the company has properly
recorded the acquisitions and disposals, and that depreciation has been
properly calculated for 2006.
(4) Presentation and disclosure: To resolve that all trucks are used in the
company’s operations; that fully-depreciated trucks are removed from the
books if no longer in use; that trucks and accumulated depreciation are
reflected as operating assets; and that depreciation expense is reflected as
an operating expense.
entries and bank statement credits for 2006 disposals; and recompute
depreciation expense and gain/loss on disposals.
(2) Presentation and disclosure: Examine subsidiary ledger for fully depreciated
assets and inquire as to whether in use. Reclassify as necessary.
11-18 Solutions Manual to Accompany Applied Auditing, 2006 Edition
11-13. Sunlight Service Center (CONTINUED. . . . Requirements a and c)
SUNLIGHT SERVICE CENTER
TRUCKS
December 31, 2006
Final Final
Balances Balances Gain (loss)
Description 12/31/01 Additions Disposals 12/31/02 on Disposals
Assets:
Delivery Trucks P150,000 P 60,000 P51,000 P160,000 P 2,000 *
Service Trucks P375,000 P 27,500 P25,000 P377,500 (P2,000) (A)
P525,000 & P 87,500 P76,000 P537,500 P 0
F F F F
12/31/06: Ledger balance P602,500 (A)
AJE No. 1 P 65,000 Cost P25,000
12/31/06: Audited balances P537,500 Accum. Depr:
WP G 2003 2,500 (1/2 yr.)
2004 5,000
2005 5,000
2006 2,500 (1/2 yr.)
Accumulated Depreciation: 15,000
Delivery Trucks P 95,000 P 26,000 (B) P 50,000 P 71,000
Service Trucks P225,000 P 75,250 (C) 15,000 (A) P285,250 Book Value P10,000
P320,000 & P101,250 P 65,000 P356,250 Sales Price 8,000 *
Loss P 2,000
F F F F
12/31/06: Ledger balances P 95,000 P415,000
AJE No. 1 P 6,250 P 58,750 (B)
P101,250 P356,250 2 x 10,000 20,000
1 x 6,000 6,000 (1/2 yr.)
Evaluated depreciation policy and estimated lives for reasonableness. No exception: WP G P 26,000
AJE No. 1
Depreciation expense - trucks P 6,250 14 x 5,000 70,000
Accum. depreciation - trucks 58,750 1 x 2,500 2,500 (1/2 yr.)
Trucks P65,000 1 x 2,750 2,750 (1/2 yr.)
P 75,250
& Traced to last year’s working trial balance F Footed and crossfooted
* Traced to remittance advice and cash receipts Examined invoices and titles
Substantive Tests of Property, Plant and Equipment 11-19
11-14. Tatty Company’s
Requirement (1)
Tatty Company
Analysis of Land Account
for 2007
Tatty Company
Analysis of Buildings Account
for 2007
Tatty Company
Analysis of Leasehold Improvements Account
for 2007
Tatty Company
Analysis of Machinery and Equipment Account
for 2007
Requirement (2)
Items in the fact situation which were not used to determine the answer to
Requirement 1 above, and where, or if, these items should be included in Tatty’s
financial statements are as follows:
a. Land site number 623, which was acquired for P600,000, should be included
in Tatty’s balance sheet as land held for resale.
b. Painting of ceilings for P10,000 should be included as a normal operating
expense in Tatty’s income statement.
c. Royalty payments of P13,000 should be included as a normal operating
expense in Tatty’s income statement.
Cash 500,000
Notes Payable 500,000
Building 700,000
Cash 700,000
Substantive Tests of Property, Plant and Equipment 11-21
(2) Machine 430,000
Accumulated Depreciation 135,000
Machine 500,000
Cash 60,000
Gain on exchange 5,000
Inventory 480,000
Accounts Payable 480,000
NIKKO COMPANY
Income Statement
For Year Ended December 31, 2006
NIKKO COMPANY
Statement of Retained Earnings
For Year Ended December 31, 2006
NIKKO COMPANY
Balance Sheet
December 31, 2006
Assets
a
Cash P 587,500
b
Inventory 580,000
Land 175,000
Building 742,000
Machine P430,000
Less: Accumulated depreciation (75,000) 355,000
Total Assets P2,439,500
Substantive Tests of Property, Plant and Equipment 11-23
Liabilities and Equities
c
Accounts payable P 480,000
Notes payable 500,000
Interest payable 60,000
Income taxes payable 90,600
Total Liabilities P1,130,600
d
Ordinary shares, P10 par P 370,000
e
Additional paid-in capital 620,000
Retained earnings 318,900
Total Shareholders’ Equity P1,308,900
Total Liabilities and Shareholders’ Equity P2,439,500
a
P540,000 + P500,000 – P700,000 – P60,000 + P800,000 – P400,000 – P92,500
= P587,500
b
P450,000 – P350,000 + P480,000 = P580,000
c
P400,000 – P400,000 + P480,000 = P480,000
d
P300,000 + P70,000 = P370,000
e
P515,000 + P105,000 = P620,000
Requirement 1
P150,000 – P10,000
= 700,000
Requirement 2
Requirement 3
P1,820,000 + P100,000
= 500,000
P1,920,000
=
500,000
= P3.84 per ton
P128,000
500,000
Substantive Tests of Property, Plant and Equipment 11-25
=
January 1, 2001
Equipment 5,000,000
Cash 5,000,000
December 31, 2001
Depreciation Expense 500,000
Accumulated Depreciation 500,000
December 31, 2002
Depreciation Expense 500,000
Accumulated Depreciation 500,000
January 1, 2003
Equipment 625,000
Accumulated Depreciation 125,000
Revaluation Surplus 500,000
December 31, 2003
Depreciation Expense 562,500
Accumulated Depreciation 562,500
Requirement (a)
Cost P9,000,000
Accumulated depreciation 1,000,000
Carrying amount 8,000,000
Fair value 4,800,000
Loss in impairment P3,200,000
Requirement (b)
Requirement (c)
Cost P9,000,000
Accumulated depreciation
(P1,000,000 + P2,000,000) 3,000,000
Net carrying value, 12.31.07 P6,000,000
Substantive Tests of Property, Plant and Equipment 11-27
Fair value, 12.31.07 P5,100,000
Carrying value, 12.31.07 3,600,000
Recovery of impairment loss P1,500,000
Requirement (1)
BOBBY CORPORATION
Land Account (Site Number 501)
As of September 30, 2007
Requirement (2)
BOBBY CORPORATION
Capitalized Cost of Office Building
As of September 30, 2007
Requirement (3)
BOBBY CORPORATION
Computation of Depreciation of Office Building
Using 150% Declining Balance Method
For the Year Ended December 31, 2007