JOSE MARIA COLLEGE

COLLEGE OF BUSINESS EDUCATION

SEMI-FINAL EXAMINATION
AUDIT PROBLEM

Audit Theory
Select and write the letter of your choice which corresponds to the best answer in the
Answer Sheet duly provided.

1. In auditing financial assets that are held for trading for proper valuation, the auditor
would most likely:
a. Recalculate gain or loss on disposal.
b. Confirm securities held in safekeeping off the client’s premises.
c. Compare cost and market by reference to year end market values for selected
securities.
d. Vouch purchases and sales of securities by tracing to brokers’ advices an
cancelled checks

2. Which of the following is the most effective audit procedure for verification of
dividends earned on investments in marketable securities?
a. Tracing deposit of dividend checks to cash receipts book.
b. Reconciling the amounts received with published dividend records.
c. Comparing the amounts received with preceding year dividends received.
d. Recomputing selected transactions extensions and footings of dividend
schedules and comparing totals to the general ledger.

3. An auditor testing long term investments would ordinarily use analytical procedures
to ascertain the reasonableness of the
a. Valuation of marketable equity securities.
b. Completeness of recorded investment income.
c. Existence of unrealized gains or losses in the portfolio
d. Classification between current and noncurrent portfolios.

4. Of the following, which is the most efficient audit procedure for testing accrued
interest earned on bond investments?
a. Recalculating interest earned.
b. Vouching the receipt and deposit of interest checks.
c. Confirming interest rate with the issuer of the bonds.
d. Tracing interest declarations to an independent record book.

5. In establishing the existence and ownership of a long-term investment in the form of

publicly-traded stock, an auditor should inspect the securities or
a. Inspect the audited financial statements of the investee company
b. Determine that the investment is carried at the lower of cost or market

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 c. Correspond with the investee company to verify the number of shares owned
d. Confirm the number of shares owned that are held by an independent custodian.

6. Which statement is incorrect regarding valuation and disclosure of long term

investments?
a. If market quotations exceed the carrying amounts, the auditor would consider
whether a write down is required.
b. When long term investments are material to the financial statements, the auditor
should obtain sufficient appropriate audit evidence regarding their valuation and
disclosure
c. If there is an uncertainty as to whether the carrying amount will be recovered,
the auditor would consider whether appropriate adjustments and/or disclosures
have been made.
d. Audit procedures regarding long-term investments ordinarily include considering
evidence as to whether the entity has the ability to continue to hold the
investments on a long-term basis.

7. When negotiable securities are of considerable volume, planning by the auditor is

necessary to guard against
a. Unrecorded sales of securities after they are counted.
b. Unauthorized negotiation of the securities before they are counted.
c. Substitution of authentic securities with counterfeit securities.
d. Substitution of securities already counted for other securities which should be on
hand but are not.

8. A client has a large and active investment portfolio that is kept in a bank safe deposit
box. If the auditor is unable to count the securities at the balance sheet date, the
auditor most likely will
a. Examine supporting evidence for transactions occurring during the year.
b. Request the bank to confirm to the auditor the contents of the safe deposit box
at the balance sheet date.
c. Count the securities at a subsequent date and confirm with the bank that there
has been no access to the box since the balance sheet date.
d. Count the securities at a subsequent date and confirm with the bank whether
securities were added or removed since the balance sheet date.

9. In verifying the amount of goodwill recorded by a client, the most convincing

evidence an auditor can obtain is by comparing the recorded value of assets
acquired with the
a. Assessed value as evidenced by tax bills.
b. Insured value as evidenced by insurance policies.
c. Seller’s book value as evidenced by financial statements.
d. Appraised value as evidenced by independent appraisal.

10. An auditor who is testing the valuation assertion of an investment in associate will

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 most likely rely on
a. Analytical procedures
b. Market quotations of the securities
c. Financial statements of the investee company
d. Market value of the net assets of the investee company.

11. In confirming with an outside agent, such as a financial institutions, that the agent is
holding investment securities in the client’s name, an auditor most likely gathers
evidence in support of management’s financial statement assertion of existence and
a. Valuation or allocation
b. Completeness
c. Rights and obligations
d. Presentation and disclosure

12. When an auditor is unable to inspect and count a client’s investment securities until
after the end of the reporting period, the bank where the securities are held in a safe
deposit box should be asked to
a. Confirm that there has been no access to the box between the end of epoting
period date and the security-count date.
b. Count the securities in the box so the auditor will have an independent direct
verification.
c. Verify any differences between the contents of the box and the balances in the
client’s subsidiary ledger.
d. Provide a list of securities added and removed from the box between the end of
reporting period date and the security-count date.

13. The audit procedure that will give the least assurance of the validity of the general
ledger balance of investment in stocks and bonds at the audit date is
a. Inspection and count of stocks and bonds.
b. Confirmation from the broker.
c. Vouching all charges during the year to the broker’s advices and statements.
d. Examination of paid checks issued in payment of securities purchased.

14. In auditing investments for proper valuation, the auditor should do all but the
following
a. Vouch purchases and sales of securities by tracing to broker’s advices and
canceled checks.
b. Compare cost and market by reference to year e nd and market values for
selected securities.
c. Confirm securities held in safekeeping off the client’s premises.
d. Recalculate gain or loss on disposals.

15. Which statement is incorrect regarding valuation and disclosure of long-term

investments?

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 a. When long term investments are material to the financial statements, the auditor
should obtain sufficient appropriate audit evidence regarding their valuation and
disclosure.
b. Audit procedures regarding long-term investments ordinarily include considering
evidence as to whether the entity has the ability to continue hold the investments
on a long term basis.
c. If there is uncertainty as to whether the arrying amount will be recovered, the
auditor would consider whether appropriate adjustments and/ort disclosures
have been made.
d. If market quotations exceed the carrying amounts, the auditor would consider
whether a write-down is required.

16. Which statement is correct regarding auditing fair value measurements and
disclosures?
a. The statement of fair value may be relatively simple for assets that are bought
an sold in active and open markets.
b. Assumptions used in fair value measurements are different in nature to those
required when developing other accounting estimates.
c. Underlying the concept of fair value measurements is a presumption that the
entity will be liquidated.
d. Many measurements based on estimates, including fair value measurements
are inherently precise.

17. Which of the following is not objective evidence of impairment of a financial asset?
a. Observable data, indicating that there is a measurable decrease in the estimated
future cash flows from a group of financial assets although the decrease cannot
yet be associated with any individual financial assets.
b. Significant financial difficulty of the issuer or obligor.
c. A break of contract, such as a default of delinquency in interest or principal
payments.
d. A decline in the fair value of the asset below its previous carrying amount.

18. An auditor usually determines whether dividend income from publicly-held

investments is reasonable by computing the amounts that should have been
received by referring to
a. Stock ledgers maintained by independent registrars.
b. Dividend records on file with the SEC.
c. Records produced by investment services.
d. Minutes of the investee’s board of directors.

19. To satisfy the valuation assertion when auditing an investment accounted for by the
equity method, an auditor most likely would
a. Inspect the stock certificates evidencing the investments.

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 b. Examine the audited financial statements of the investee company
c. Review the broker’s advice or cancelled checks for he investment’s acquisition.
d. Obtain market quotations from financial newspapers or periodicals.

20. The auditor’s count of the client’s investment securities should be simultaneous
with the
a. Confirmation of accounts receivables.
b. Count of cash balances.
c. Count of inventories.
d. Confirmation of accounts payable.

21. A company holds bearer bonds as temporary investments. Responsibility for the
custody of these bonds and submission of coupons for interest collections should be
delegated to the
a. Chief accountant
b. Company president
c. Company treasurer
d. Internal auditor

Audit Problem
Read carefully the information given and thoroughly analyze what is required. All
answers should be duly supported with a solution presented in a traceable form.
Arrange your solutions in proper order be it handwritten or in excel type. Be sure to
write your name in every page that you submit. Your final answers are to be written in
the Answer Sheet duly provided. The Answer Sheet is to be turned in the Google
Classroom for purposes of determining your compliance of the time limit. Thereafter,
send again your Answer Sheet and your traceable solutions to the undersigned’s email.

Every minute of delay in the submission of the Answer Sheet in the Google Classroom
would mean a 5 points deduction.

PROBLEM 1
Out of the 800,000 outstanding shares of Cow Company, Sheep Company purchases
100,000 shares for P30 per share on April 15, 2017. Sheep incurred P80,000 as
broker’s fees. The fair market value of the shares at the end of 2017, 2018, 2019 and
2020 are P33, P39, P40 and P36 per share, respectively. Cow declared dividends of
P1,600,000 and P1,200,000 on 2018 and 2020, respectively.

Required:
Case 1:
The investment is accounted for under PFRS 9 and Cow Company did not exercise the
option to carry the option to carry the investment through other comprehensive income
or loss.
22. How much shall the investment be initially recognized?
23. What is the carrying value of the investment at the end of 2019?
24. What is the net income (loss) related to the investment to be recognized in the
income
statement for 2020.

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25. Should the entity sell the investment on December 2, 2020 for P38 per share, what
is the gain (loss) to be recognized from the disposal?

Case 2:
The investment is accounted for under PFRS 9 and Cow Company exercised the option
to carry the investment through other comprehensive income or loss
26. How much shall the investment b initially recognized?
. What is the net income (loss) related to the investment to be recognized in the income
statement of 2019.
27. What is the unrealized holding gain (loss) to be presented in the income statement
for 2020?
28. Should the entity sell the investment on December 2, 2020 for P38 per share, what
is
gain (loss) to be recognized from the disposal?

PROBLEM 2
On January 2, 2018, Lion Corporation purchased 4 year, 7% bonds of Tiger, Inc with
face value totaling to P6,000,000 at 90. Lion incurred additional P29,400 as direct
costs, resulting to a yield rate of 10%. Interest is paid by Tiger Inc. every December 31.

The bonds are quoted at 95 and 93 on December 31, 2018 and 2019, respectively. The
entity sold the bonds on January 2, 2020 at 94.

Required:
Case 1:
Lion Corporation has a business model of holding the financial asset to collect
contractual cash flows consisting solely of payments of principal and interest.
29. What is the initial cost of the investment?
30. How much income related to the investment must be presented in the 2018 income
Statement?
31. What is the carrying value of the investment as of December 31, 2019?
32. How much is the gain (loss) on disposal?

Case 2:
Lion Corporation has a business model of holding the financial asset to collect
contractual cash flows consisting of payment of principal and interest, and to sell the
financial asset.
33. What is the initial cost of the investment?
34. What is the carrying value of the investment as of December 31, 2018?
35. How much unrealized gain (loss) must be presented as a component of other
comprehensive income for 2018?
36. How much unrealized gain (loss) must be presented as a component of other
comprehensive income for 2019?
37. How much is the gain (loss) on disposal?

PROBLEM 3
On December 31, 2017, Antelope Corporation’s statement of financial position showed
the following balances related to its securities account:

FA-FVPL P 738,750
FA-FVOCI 590,000
Interest receivable – C bonds 6.250
Unrealized gain – FVOCI 50,000

Antelope Corporation’s securities portfolio on December 31, 2017 was made up

of the following securities:

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 Classification Cost Fair Value
5,000 A Corp shares FVPL 375,000 381,250
4,000 B Inc. shares FVPL 275,000 264,125
10% C bonds (interest payable semi-
annually on Jan. 1 and July 1 FVPL 125,000 93,375
5,000 D Co. shares FVOCI 295,000 315,000
10,000 E Inc. shares FVOCI 245,000 275,000

During 2018, the following transactions took place:

January 3` Received interest on the C bonds
March 1 Purchased 1,500 additional shares of A Corp for P114,750
classified
as held for trading
April 15 Sold 2,000 shares of B Inc. for P69 per share
May 4 Sold 2,000 shares of D Co. for P62 per share
July 1 Received interest on the C bonds
Oct 30 Purchased 7,500 shares of F Corp. stock for P416,250 classified as
held for trading

The fair values of the shares and bonds on December 31, 2018 are as follows:
A Corp P 76.00 per share
B Inc 68.50 per share
C bonds 102,775
D Co. 61.00 per share
E Inc. 27.00 per share
F Corp 55.25 per share
Required: Determine the following
38. Gain (loss) that should be recognized in P&L on sale of 2,000 B Inc.’s shares.
39. Gain (loss) that should be recognized in P & L on sale of 2,000 D Co. shares.
40. Carrying amount of FA – FVPL as of December 31, 2018.
41. Carrying amount of FV-FVOCI as of December 31, 2018.
42. Amount of unrealized gain (loss) that should be recognized in 2018 profit or loss.
43. Amount of accumulated gain (loss) that should be presented in the equity section of
the 2018 statement of financial position.

PROBLEM 4
On January 1, 2018, Deer Corp. purchased a 10 year 9% P1,000,000 bonds of Giraffe,
Inc. for an amount resulting to a yield rate of 10%. Interest is collected by Deer Corp
every December 31. The effective rate of the bonds are as follows:

Date Rate
December 31, 2018 8%
December 31, 2019 12%
December 31, 2020 11%

Case 1:
The company carried the investment at amortized cost, then, subsequently reclassified
the investment at fair value through other comprehensive income on December 31,
2019.
44. What is the interest income for 2019?

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45. What is the carrying value of the investment as of December 31 2019?
46. What is the carrying value of the investment as of January 1, 2020? How much is
the gain (loss) on reclassification to be presented in the income statement?
47. How much is the unrealized gain (loss) to be presented as a component

Case 2::
The company carried the investment at fair value through other comprehensive income,
then, subsequently reclassified the investment at amortized cost on December 31,
2019.
48. What is the carrying value of the investment as of December 31, 2019?
48. What is the carrying value of the investment as of January 1, 2020?
49. How much is the gain (loss) on reclassification to be presented in the income
statement?
50. How much is the interest income for 2020?
51. What is the carrying value of the investment as of December 31, 2020?

PROBLEM 5
On January 4, 2018, Oasis Corporation purchased 50,000 shares of Sand Inc. out of
the 200,000 shares outstanding, giving Oasis a significant influence over Sand. The
book value of the net assets of Sand on the date of acquisition is P15,000,000. Oasis
bought the shares for P4,000,000 which is more than the share of Oasis in the net
assets of Sand, apparently because of:

● A land with a fair value which is P1,800,000 more than its carrying value;
● A building with an estimated useful life of 8 years as of the acquisition date, and
a fair market value which is P1,200,000 less than its carrying value;
● Inventories with fair market value which is P200,000 more than its carrying value;
● And goodwill.

The net income of Sand Inc. amounted to P2,150,000 and P3,050,000 for 2018 and
2019, respectively. The other comprehensive income for 2018 and 2019 totaled
P2,150,000 and P3,050,000 for 2018 and 2019, respectively. The other comprehensive
income for 2018 and 2019 totaled to P500,000 and P600,000, respectively.

Sand declared dividends on June 30, 2018 and May 11, 2019 for P8.40/share and
P9.15/share, respectively.

Required:
52. What is the initial cost of the investment?
53. How much is the total goodwill?
54. How much income (loss) from the investment must be reported in the income
statement for 2018 and 2019?
55. How much income (loss) from the investment must be reported as part of other
comprehensive income for 2018 and 2019?
56. What is the carrying value of the investment as of December 31, 2018 and 2019?

PROBLEM 6
On January 2, 2017. Snow Company purchased for P500,000 cash a 10% interest on
Flake Corp. This investment was appropriately classified as a non-trading equity
investment. On that date, the net assets of Flake had a book value of P3,750,000. The
excess cost over the underlying equity in net assets is attributable to undervalued
depreciable assets having a remaining life of 10 years from the date of Snow’s
purchase.

The fair value of Snow’s investment in Flake’s securities is as follows:

December 31, 2017, P570,000
December 31, 2018, P515,000

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During 2017 and 2018, the following occurred:
Dividends paid by Flake
Year Flake’s Net Income to Snow
2017 P350,000 P15,000
2018 400,000 20,000
On January 2, 2019, Snow purchased an additional 30% of Flake’s tock for P1,545,000
cash when the book value of Flake’s net assets was P4,150,000. The excess was
attributable to the depreciable assets having a remaining life of 8 years. Flake reported
net income of P500,000 and paid cash dividends of P400,000 in 2019.

Required:
57. Investment income to be recognized in 2017, 2018, 2019
58. The carrying value of the securities on December 31, 2018.
59. The carrying value of the securities on December 31, 2019.

PROBLEM 7
On January 1, 2017, Cloud Company issued its 8%, 5-year convertible debt instrument
with a face amount of P8,000,000 for P7,700,000. Interest is payable every December
31 of each year. The debt instrument is convertible into 50,000 ordinary shares with a
par value of P100. When the debt instruments were issued, the prevailing market rate
of interest for similar debt without conversion option is 10%.

On December 31, 2019, all the convertible debt instrument were retired for P8,000,000.
The prevailing rate of interest on a similar debt instrument as of December 31, 2019 is
9% without the conversion option.
Required:
60. On the date of issue, what amount of the proceeds represents the equity
component?
61. What is the carrying value of the debt instrument as of December 31, 2017?
62. On the date of retirement, what amount of the proceeds represent the equity
component?
63. How much is the gain (loss) that should be reported in the profit or loss on the
retirement of the convertible debt instruments?
64. How much is the gain on cancellation of the equity component to be reported in
shareholder’s equity?

PROBLEM 8
Pechay Co. purchased 40% of MU Corp. on April 1, 2017, for P500,000 when MU’s
book value was P1,260,000. On the date of acquisition, the market value of MU’s net
assets equaled their book values except for the following:

● MU’s equipment has a fair value of P50,000 les than its book value. The
equipment has a remaining useful life of 10 years.
● MU’s building has a fair value of P40,000 more than its book value. The building
has a remaining useful life of 20 years.

MU’s results of operations in 2017 and 2018 are as follows:

2017 net income P 150,000
2018 net loss 30,000

MU paid cash dividends of P20,000 and P10,000 in 2017 and 2018, respectively.

Required:

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65. What amount of investment income should be reported on Pechay Co.’s income
statement for the year ended December 31, 2017?
66. The investment has to be reported in Pechay Co.s 2018 income statement?
67. What is the carrying value of the stock investment on December 31, 2017?
68. What is the carrying value of the stock investment on December 31, 2018?

PROBLEM 9
Kangkong Company purchased 250,000 shares of Secret Co. ordinary shares on July
1, 2017, at P66 per share, which reflected book value as of that date. At the time of
purchase, Secret Co. had 1,000,000 ordinary shares outstanding. Kangkong had no
ownership interest in Secret prior to this purchase. Secret reported net income of
P3,360,000 for the six months ended June 30, 2017. Kangkong received a dividend of
P420,000 from Secret on August 1, 2017. Secret reported net income of P7,200,000 for
the year ended December 31, 2017, and again paid Kangkong dividends of P420,000.

On January 1, 2018, Kangkong sold 100,000 ordinary shares of Secret for P68 per
share and reclassified the remaining stock as at fair value through other comprehensive
income. The quoted market price of such investment on January 1, 2018 was P69 per
share. Secret reported net income of P7,440,000 for the year ended December 31,
2018, and paid Kangkong dividends of P240,000. The fair value of Secret ordinary
shares at December 31, 2018 was P70 per share.
Required:
69. What is the carrying value of the stock investment at December 31, 2017?
70. Determine the total amount of gain to be reported in the 2018 income statement.
71. What amount of unrealized gain should be reported in the 2018 statement of
comprehensive income as component of other comprehensive income?
72. Compute the carrying value of the retained investment to be shown in the
statement
of financial position on December 31, 2078.

SMILE *** END OF EXAMINATION *** SMILE

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