(CPA REVIEW SCHOOL OF THE PHILIPPINES AP-8701, Manila ‘AUDITING PROBLEMS CPA Review! AUDIT OF SHAREHOLDERS’ EQUITY PROBLEM NO. ‘At December 31, 2019, ROBUSTA, INC. had 1,800,000 authorized shares of P10 par value ‘ordinary shares, Of which 600,000 shares were issued and outstanding. “The shareholders’ equity accounts at December 31, 2019, had the following balances. Ordinary shares. 6,000,000 Share premium. 2,250,000, Retained earnings. 1,941,000 Transactions during 2020 and other information relating to the shareholders’ equity accounts were as follows: 1. On January 7, 2020, ROBUSTA issued at P54 per share, 30,000 shares of P50 par value, 9% ‘cumulative convertible preference shares. Each share of preference is convertible, at the ‘option of the holder, into two ordinary shares. ROBUSTA had 180,000 authorized preference shares. 2. On February 2, 2020, ROBUSTA reacquired 6,000 of its ordinary shares for P16 per share. ROBUSTA uses the cost method to account for treasury shares. 3. On April 29, 2020, ROBUSTA sold 150,000 shares (previously unissued) of P10 par value ordinary shares at P17 per share. 4, On June 17, 2020, ROBUSTA declared a cash dividend of P per ordinary share, payable on July 14, 2020, to shareholders of record on July 1, 2020. (0 5, On November 12, 2020, ROBUSTA sold 3,000 treasury shares for P24 per share, 6 On December 15, 2020, ROBUSTA declared the yearly cash dividend on preference shares, payable on January 14, 2021, to shareholders of record on December 31, 2020. 7. On January 22, 2021, before the books were closed for 2020, ROBUSTA became aware that the ending inventories at December 31, 2019, were understated by P63,000. The appropriate ‘correcting entry was recorded the same day. Hogs ‘8. After correcting the beginning inventory, net income for 2020 was P1,350,000. Ignore income tax implications, Questions: 41, The retained eamings, as restated, as of January 1, 2020/15 A. P1,941,000 72,004,000 C.'P2,031,000 D. P2,034,000 2. The retained earnings balance as of December 31, 2020,%s A PLE75000 8. P2,460000 . 2,475,000 ——_—.P2,556,000 3, The share premium from preference shares as of December 31, 2020, is. ‘A. 30,000 8 90,000 C. P105,000 D. 120,000 Page 1 of 8 PagesSPAR-MANLA apt = av oF suanenoupens’eaumTy 4. The share premium from ordinary shares (including sale of treasury shares) as of December A" p50o00 8. F3a00.000 © —c. FBI5000 ——_—.-F480,000 5, Total shareholders’ equity as of December 31, 2020, is ‘A. P14,835,000 —«B. P14,851,200 " C. P14,862,000 —O.P14,910,000 '00000000000000000 PROBLEM NO. 2 yed by PETMALU CORPORATION, a publicly held company whose shares are bade one Pippi Ste Exenge, to cond an suet of fs 2000 franca axons ‘You were told by the company’s controller that there were numerous equity transactions that took lace in 2020. The shareholders equity acxunts at December 33,2019, had the flowing balances Preference share capital, P'100 par value, 6% cumulative; 1700 sores autorae; 16200 shares sd and outstanding 1,620,000 Ordinary share capital, P1 par value, 1,620,000 shares authorized; 1,080,000 shares issued and outstanding 41,080,000 ‘Sharé premium 2,160,000 Retained earnings 882,000 Total shareholders’ equity 5.742.000 You summarized the following transactions curing 2020 and other information relating to the shareholders’ equity in your werkang papers as follows: ‘+ January 6, 2020 — Issued 40,500 ordinary shares in exchange for land. On the date issued, the shares had a market price of F16.50 per share. The land had a carrying value of P378,000, ‘and an assessed value for property taxes of P44,000, * January 31, 2020 - Solé 2,160, Pi,000, 12% bonds due January 31, 2030, at 98 with one detachable share warrant attached to eact: bond. Interest is payable annually on January 31. ‘The fair value of the bonds without the share warrants is 95. The detachable worrants have ® fal value of PSO each and expire on January 31, 2021. Each warrant entitles the holder to Purchase 10 ordinary shares at P10 per share. " * February 22, 2020 ~ Purchased 13,500 of ts own ordinary shares tobe held as treasury shares or P24 per share. : * February 28, 2020 - Subscriptions for 37,800 ordinary shares were received at P26 per share, payable 50% down and the balance by March 15. * March 15, 2020 ~ The balance due on 32,400 ordinary shares was received and those Shares were issued. The subscriber who defaulted on the 5,400 remaining shares forfetted the down payment in accordance with the subscription agreement. ‘+ August 30, 2020 ~ Reissued 5,400 treasury shares for P20 per share ‘+ September 14, 2020 ~ There were 1,701 warrants detached from the bonds and exercised, ‘+ November 30, 2020 ~ Deciared 2 cash dividend of 0.50 per share to all ordinary shareholders of record December 15, 2020. ‘The dividend was paid on December 30, 2020, + December 15, 2020 ~ Declared the required anriual cash dividends on oreference shares for 2020. The dividend vias paid on January 15, 2021... aaoP LA ‘+ January 8, 2021 — Before closing the accounting records for 2019, PETMALU become ause® that no depreciation had been recorded for 2019 for a machine purchased on July 1 2075, ‘The machine wes propery cptalized at PB64,000 and had an estimated useful He of years when purchased. The appropriate correcting entry was recorded on the seme ‘+ Adjusted net income for 2020 was P756,000. ase on the preceding formation, determine the correct December 31, 2020, balances of the following: (Ignore income tax implications.) 1. Ordinary share cay Rerieeso we. pussisi0 ——C. PLAGE SHO D. P1,175,310 2. Total share premium pose ST paises C. F3.805000 3,526 80 3. Unappropriated retained earin ees poms CPLA b, 884,285 4, Legal capital (0s 17° 8 egw, pme75750 P7565 ©. P.795,310 5, Total shareholders’ equty A P7A7L245——«B P7351,875 CG. (P7,365,645 D. 7,371,045 (00000000000000000 PROBLEM NO. 3 “The shareholders’ equity section of BAHRAIN CORPORATION'S statement of financial position 2s cof December 31, 2019, s as follows: ‘Share capital—Ordinary (P10 par, 750,000 shares ‘authorized, 412,500 issued and outstanding) 4,125,000 Share premium _825,000 Total paid-in capital 4,950,000, Unappropriated retained earings 2,002,500 ‘Appropriated retained earnings 759,000 Total retained earings 2,752,500 Total shareholders’ equity Pz.702.500 Bahrain Corporation had the following shareholders’ equity transactions during 2020: Jan, 15 Completed the building renovation for which P750,000 of retained earnings had been restricted. Paid the contractor 727,500, all of which is capitalized. Mar. 3. Issued 150,000 additional ordinary shares for P18 per share. May 18. Declared a dividend of P1.50 per share to be paid on July 31, 2020, to shareholders of record on June 30, 2020. SJune19 Approved additional building renovation to be funded internally. The estimated cost of the project is P600,000, and retained earnings are to be restricted for that amount. July 31 Paid the dividend. Page 3 of PagesOO ———————— ewan Ka Nov.12. Dedared a property dividend to be paid on January 5, 2021. The dvidend is to consist of equipment that has a carrying amount of P360,000 and a fair value of 472,500 on ‘November 12. ‘Dec. 31. Net income for 2020 (before recognition of impairment oss on the equipment declared ddvdend) is P1,327,500. The equipment’ flr value less cost to distribute as property| ‘on December 31 is P330,000. 11. Share capitalordinary on December 31, 2020, is ‘A. 5,625,000 B, P4,125,000 CC. 4,950,000 D. P7,650,000 2. Share premium on December 31, 2020, is ‘A. 2,625,000 B. P825,000 . 2,025,000 . P1,200,000 +3, Unappropriated retained eamings on December 31, 2020, is A. P2,363,750 B. P2,246,250 "2,133,750 D. 2,276,250 4, The total shareholders’ equity on December 31, 2020, Is ‘A. P10,376,250 B. P10,526,250 ——C. P9,926,250 D. P7,650,000 00000000000000000 PROBLEM NO. 4 KAYA CO. began operations on January 1. Authorized were 120,000 shares of P10 par value Grdinery shares and 240,000 shares of 10%, Pi00 par value preference shires. The folowing transactions involving shareholders’ equity occurred during the first year of operations. Jan. 1. Issued 30,000 ordinary shares tothe corporation promoters in exchange for land valued at P1,020/000 and services valued at P420,000. The property had cost the promoters 'P540,000 3 years before and was carried on the promoters’ books at 300,000. Feb, 23. Issued 60,000 preference shares with a par value of P100 per share. The shares were issued at @ price of P150 per share, and the company paid P450,000 to en agent for selling the shares. Mar. 10 Sold 18,000 ordinary shares for P390 per share. Issue costs were P150,000. ‘Apr. 10 24,000 ordinary shares were sold under share subscriptions at P450 per share. No shares are issued until a subscription contract is paid in full. No cash was received. July 14. Exchanged 4,200 ordinary shares and 8,400 preference shares for a building with 2 fait value of P3,060,000. The building was originally purchased for P2,280,000 by the Investors and has a book value of P1,320,000. In addition, 3,600 ordinary shares were sold for P1, 440,000 in cash. ‘Aug, 3. Received payments in fll for haf of the share subscriptions and payments on account con the rest ofthe subscriptions. Total cash received was P8,400,000. Share certificates ‘were issued for the subscriptions paid in full, Nov. 2. Issued 5,000 ordinary shares for an outstanding bank loan of P2,100,000, including accrued interest of P100,000. KAYA CO.'s ordinary shares are quoted at P410 per share on this date. Issued 10,000 preference shares for P1,250,000, with 10,000 warrants to acquire $,000 ‘ecinory shares at P400 per share. On tis date, the warrants have 2 market value of 10, but the preference share has no known market value ex~warrant. 10 19,000 warrants isued on Nov. 10 were exercised and the remainder lapsed. Page 4of8 Pages Dec. 10Semen, presume ue 31. Net income for the first year of operations was P3,600,000. ‘31 Declared a cash dividend of P10 per share on preference shares and P20 per share on ordinary shares, payable on February 10 to shareholders of record on January 15. Based on the preceding information, calculate the balances of each of the following: Preference share capital ‘Share premium — preference shares Ordinary share capital ‘Share premium — ordinary shares Retained earnings “Total shareholders’ equity oe] a]e]s]F] ‘00000000000000000 PROBLEM NO. 5 ‘At the beginning of year 1, Entity A grants share options to each of its 100 employees working in the sales department. ‘The share options will vest at the end of year 3, provided that the employees remain in the entity’s employ, and provided that the volume of sales of a particular product increases by at least an average of 5 percent per year. If the volume of sales of the product increases by an average of between 5 percent and 10 percent per year, each employee Will receive 100 share options. Ifthe volume of sales Increases by an average of between Li ‘percent and 15 percent each yeer, each employee will receive 200 share options. If the volume Of sales increases by an average of 16 percent or more, each employee will receive 300 share ‘options. (on grant date, Entity A estimates that the share options have a fair value of P20 per option Entity A also estimates that the volume of sales of the product will increase by an average of between 11 percent and 15 percent per year, and therefore expects that, for each employee who remains in service until the end of year 3, 200 share options will vest. The entity also estimates, on the basis of a weighted average probability, that 20 percent of employees will leave before the end of year 3. By the end of year 1, seven employees have left and the entity still expects that 2 total of 20, ‘employees will leave by the end of year 3. Hence, the entity expects that 80 employees will remain in service for the three-year period, Product sales have increased by 12 percent and the entity expects this rate of increase to continue over the next 2 years. By the end of year 2, a further five employees have left, bringing the total to 12 to date. The entity now expects only three more employees will eave during year 3, and therefore expects @ total of 85 employees will remain at the end of year 3. Product sales have increased by 20 percent, resulting in an average of 16 percent over the two years to date. The entity now expects that sales will average 16 percent or more over the three-year period, and hence expects each sales employee to receive 300 share options at the end of year 3, By the end of year 3, a further two employees have left. Hence, 14 employees have left during the three-year period, and 86 employees remain. The entity's sales have increased by an average Of 16 peroent over the three years. ‘Based on the preceding information, answer the fotlowing: 1. What is the compensation expense for year 1? A, P53,333 B P106,667 cc. 160,000 D. 172,000 2. What is the compensation expense for year 2? ‘A. P168,000 B. P180,000 C. P233,333 D. 286,667 Page of 8 PagesSPAR=MANIA _______ape7o1 -avorr oF suanenoinens equity 3. What is the compensation expense for year 3? ‘A. 114,667, B. 176,000 C. 188,000 D. 282,667 4. What is the cumulative compensation expense for years 1, 2, and 3? ‘A. 172,000 B. 320,000 C. P344,000 . P516,000 5. At the end of year 2, the entity should report share options outstanding of ‘A. 226,667 B. 286,667 C. P328,000 D. P340,000 00000000000000000 PROBLEM NO. 6 On December 31, Year 1, itis expected that during the whole vesting period of three years, 10% (of the employees wil leave entity B. On December 31, Year 2, this expectation is revised to 30%, Finally, by December 31, Year 3, 20% of the employees left entity B. There is also @ performance concition in addition to the service condition. According to the Performance condition, the options only vest if entity B's share price on December 31, Year 3 ‘2xceeds Its share price on January 1, Year 1 by at least 20%. On December 31, Year 1 and on December 31, Year 2, itis expected that this target will be met. However, the target is not met by December’31, Year 3. Based on the preceding information, answer the following: 1. What amount of compensation expense should be recognized in Year 1? ‘A. P9,000, B. 14,000 CP 10,000 D. PO 2. What amount of compensation expense should be recognized in Year 2? APO 8. 9,000 C. P5,000 D. 10,000 3. What amount of compensation expense should be recognized in Year 3? A. 14,000 . 10,000 CP 9,000 D. PO (00000000000000000 eeigty grants 100 cash share appreciation rights (SARS) to each ofits 400 employees, on Condition that the employees remain in ts employ for the next three years. employees exercised ther SARs, another 50 employees exercised their SARS at the end of year 4 and the remaining 64 employees exercised their SARS atthe end of year © ‘The entty estimates the fair value ofthe SARs at the end of each year in which a lablity exsts 2s shown below. The fair value ofthe rights at the grant date was P10.10. At the end of year 3, all SARs held by the remaining employees vested. ‘The intrinsic values of the SARs at the date of exercise (which equal the cash paid out) at the end of years 3, 4 and § are also shown below, Year Fai Value Intrinsic Value 1 10.40 2 31.30 Page 6 of 8 PagesGPAR-MANILA ___ara7on— pir oF SHARENOUDERS EQUITY, ; 1420 pu.00 ‘ 16.60 15.80 2 47.10 1690 REQUIRED: Sompute the amounts of compensation erense and tabity thatthe entity should report in years 120000000000000000 PROBLEM NO. 8 1. An audit program forthe aust of the retained earnings account should include a step that requires verification of ‘A. Market value used to charge retained earnings to account for a 2-for-1 stock spt BL Approval of the adjustment to the beginning balance as a result of a write-down of an ‘account receivable. C. Authorization for both cash and stock dividends. ._ Gain or loss resutting from disposition of treasury shares. 2. In.an examination of shareholders’ equity, an auditor is mast concerned that AA. Capital stock transactions are properly authorized. BL. Stock splits are capitalized at par or stated vaiue on the dividend declaration date, C._ Dividends during the year under audit were approved by the shareholders. . Changes in the accounts are verfied by a bank serving as a registrar and stock transfer agent. 3. In an audit of a medium-sized manufacturing concer, which one of the following areas can be expected to require the least amount of audit time? A. Owner's equity B. Assets C. Revenue D. Uabilties 4, When a corporate client maintains its own stock records, the auditor primarily will rely upon ‘A. Confirmation with the company secretary of shares outstanding at year-end. B. Review of the corporate minutes for data as to shares outstanding. C. Confirmation of the number of shares outstanding at year-end with the appropriate state official. . Inspection of the stock book at year-end and accounting for all certificate numbers. 5, Choose the correct statement. ‘A. When an entity does not maintain its own stock records, the auditor should obtain written confirmation from the transfer agent and registrar conceming restrictions on the payment of dividends. B. When an entity does not maintain its own stock records, the auditor should obtain written confirmation from the transfer agent and registrar concerning the number of shares issued and outstanding. C. When an entity does not maintain its own stock records, the auditor should obtain written confirmation from the transfer agent and registrar conceming guarantees of preference share liquidation value. . When an entity does not maintain its own stock records, the auditor should obtain written confirmation from the transfer agent and registrar concerning the number of ‘shares subject to agreements to repurchase. 6. With respect to treasury shares, the auditor should net object to which of the following? ‘A. Restrictions on retained earnings have not been met. Dividends have been paid on treasury shares. CC. The treasury share certificates have been destroyed, D. Treasury shares are recorded at cost rather than par value. Page 7 of 8 PagesSPAR-MANA a7 01 - AUDIT OF SHAREMOLDERS’ EQUITY 7. A dient company dedared and paid @ stock dividend, Its independent external auditor ‘should determine that A Shareholders reoaved ther atonal shares by conring yearend hldngs wth B. The stock dividend was properly recorded by means of a memorandum entry only. C. The officers authorized the issuance of the stock dividend. D. Appropriate amounts were transferred from retained earnings to share capital and share premium. ‘8. During an aucit of an entity's shareholders’ equity accounts, the auditor determines whether there are restrictions on retained eamings resuiting from loans, agreements, or law. This ‘udit procedure most likely is intended to verify management's assertion of A. Existence BL Completeness © Valuation . Presentation and disclosure ‘9. Which of the following statements is correct? ‘A. When a company has treasury share certificates on hand, a year-end count of the certificates by the auditor is always required. 'B, When a company has treasury share certificates on hand, a year-end count of the certificates by the auditor is required when the company classifies treasury shares with other assets. C. When @ company has treasury share certificates on hand, a year-end count of the certificates by the auditor is not required if the treasury share is a deduction from shareholders’ equity. . When a company has treasury share certificates on hand, a year-end count of the certificates by the auditors required when the company had treasury share transactions, during the year. 10, In performing tests concerning the granting of stock options, an auditor should ‘A. Confirm the transaction with the Securities and Exchange Commission. Verify the existence of option holders in the entity's payroll records or stock ledgers. C. Determine that sufficient treasury stock is available to cover any new stock issued . Trace the authorization for the transaction to a vote of the board of directors. 111, The auditor does not expect the dient to debit retained earnings for which of the following ‘transactions? A. A 10% stock dividend. An appropriation of retained earnings for treasury shares. . Alarge stock dividend. D. A four-for-one stock spit. 12, Where no independent stock transfer agents are employed and the corporation issues its ‘own stocks and maintains stock records, cancelled stock certificates should |A. Not be defaced, but segregated from other stock certificates and retained in a cancelled certificates file. 8. Be destroyed to prevent fraudulent reissuance. C. Be defaced and sent to the Secretary of the Department of Finance. D. Be defaced to prevent reissuance and attached to their corresponding stubs. 13. Meyor, CPA, is auditing shareholders equity. Tests typically Indude all the following except ‘A. Tracing individual dividend payments to the share capital records. 'B. Reviewing the bank reconciliation forthe imprest dividend account. CC. Verifying the authorization of dividends by inspecting the minutes of meetings of the board of directors. . Determining that dividend dectarations comply with debt agreements. Page 8of 8 Pages