Auditing and Assurance: Concepts and

Application 1

Ishmael Y. Reyes, CPA

 Table of Contents

Module 9: Audit of Property, Plant and Equipment 1

Introduction 141
Learning Objectives 141
Lesson 1. Audit Objectives 142
Lesson 2. Audit Procedures 142
Lesson 3. Sample Problem 9-1: Bradpit Inc, etc. 144
Lesson 4. Sample Problem 9-2: French Horn Company, etc. 150
Lesson 5. Sample Problem 9-3: Saxophone Company 153
Lesson 6. Sample Problem 9-4: Bassoon Company 155
Lesson 7. Sample Problem 9-5: Carillon Company 157
Lesson 8. Sample Problem 9-6: Bagnet Incorporated 160
Assessment Task 162
Summary 163
References 164

Module 10: Audit of Property, Plant and Equipment 2

Introduction 166
Learning Objectives 166
Lesson 1. Sample Problem 10-1: Gong Company 167
Lesson 2. Sample Problem 10-2: Maracas Company 168
Lesson 3. Sample Problem 10-3: Cabara Company 171
Lesson 4. Sample Problem 10-4: Fiddle Company 174
Lesson 5. Sample Problem 10-5: Bugle Company 177
Lesson 6. Sample Problem 10-6: Bagpipe Manufacturing
Company 180
Assessment Task 185
Summary 187
References 190
 MODULE 9
AUDIT OF PROPERTY, PLANT AND
EQUIPMENT 1

Introduction

The term property, plant and equipment (fixed assets) include all tangible assets with
a service life of more than one year that are used in the operation of the business and are not
acquired for the purpose of resale. Three major subgroups of such assets are generally
recognized. Fixed asset constitute a significant proportion of the total assets of many
organizations particularly those engaged in manufacturing activities. Audit of fixed asset is,
therefore generally considered to be an important part of an independent financial audit.
Though the number of transactions involving fixed assets is smaller in number, the amount
involved in these transactions will be very high. Hence the auditor has to give more attention
while auditing the transactions relating to fixed asset.

Learning Outcomes

At the end of this module, students should be able to:

1. Determine the audit objectives and procedures involved in the audit of property, plant and
equipment;
2. Solve auditing problems involving the examination of opening balances and current year
transactions, on acquisition/ self-construction of PPE, correcting entries for PPE,
exchange transactions and
3. Construct a working paper for solving problems involving property, plant and equipment.

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Lesson 1. Audit Objectives (Roque, 2018)

The objectives of audit of property, plant, and equipment are to determine that:

1. All property, plant, and equipment on the statement of financial position (including assets
that are leased under finance leases) are:
a) Owned by the entity; and
b) Held by the entity or by others for the entity
2. All property, plant, and equipment owned or leased under finance leases by the entity at
year-end are included in the statement of financial position.
3. Property, plant, and equipment are reported at the appropriate amount
4. The cost of property, plant, and equipment is allocated to the appropriate accounting
periods in a systematic and rational manner.
5. Impaired property, plant, and equipment are recorded at estimated recoverable value.
6. Property, plant, and equipment held for disposal are carried at the lower of their carrying
amount or fair value less cost to sell.
7. Property, plant, and equipment and related accounts are properly described, classified, and
disclosed in the financial statements, including notes, in conformity with PFRS.

Lesson 2. Audit Procedures (Roque, 2018)

 Examination of Opening Balances:

1. For a recurring engagement:

 Trace opening balances to last year’s working papers
2. For an initial audit where the previous years were audited:
 Vouch significant transactions to ascertain:
 Authorization
 Propriety of accounting
 Accounting principles applied
 Obtain permission from the client to refer to the working papers of the predecessor auditor.
 Vouch documents evidencing ownership.
3. For an initial audit where the previous years were unaudited:

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 To the extent necessary to form an opinion on the accuracy of the opening balances,
vouch significant transactions to ascertain:
 Authorization
 Propriety of accounting
 Accounting policies applied
 Vouch documents evidencing ownership.

 Examination of current year transactions

1. Obtain or prepare schedules of the property, plant, and equipment accounts and:
 Check footings and cross-footings.
 Determine if the schedules are in agreement with the general ledger control accounts.
 Trace individual balances to the detailed records or property cards.
 Consider physical inspection of significant items.

2. For acquisitions or debits to property, plant, and equipment accounts:

 Determine authorization by examining invoices, capital expenditure authorizations,
leases, and other evidence (eg, in-house construction work orders) supporting additions
to property, plant, and equipment during the period.
 Test calculations of capitalized interest to determine the appropriateness of rates,
amounts, and capitalization periods used.
 Ascertain the business reasons for unusual additions.

3. For disposals or credits to property, plant, and equipment accounts:

 Examine authorizations and other data supporting retirements, sales, and other disposals
of property, plant, and equipment items.
 Test the computations of the resulting gains and losses.
 Determine that the assets disposed of and the related accumulated depreciation have
been properly derecognized

 Ascertain the business reasons for unusual disposals.

4. For impaired property, plant, and equipment:
 Determine whether management has appropriately identified indications of impairment.

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 Determine that the methods and assumptions used by management in estimating
recoverable value are reasonable.
 Ascertain if the impairment was properly recorded.

5. Examine lease contracts to determine whether leases are properly classified as finance or
operating and determine whether the proper accounting has been performed and appropriate
disclosures have been made.

6. Examine support for significant charges to repairs, maintenance, and other expense
accounts to determine if they should be capitalized to property, plant, and equipment.

7. Test computations of depreciation, depletion, and amortization to determine the

appropriateness of the methods and estimated lives used. Determine if they are consistent
with the methods and lives used in prior periods.

8. Review minutes of meetings, legal documents, and other evidence for evidence of liens,
pledges, and restrictions on property, plant, and equipment.

9. Search for unrecorded retirements by:

 Examination of cash receipts, tax declarations, insurance records, credits to scrap sales,
and inquiry of knowledgeable company personnel.
 A tour of the company plant to observe indications of equipment removals.

10. Identify properties that are:

 Idle
 No longer in use
 Obsolete and determine proper accounting recognition

11. Reconcile payments to government for taxes and registration fees with recorded assets.

12. Ascertain that fully depreciated assets still in use or those that are held for sale are not
further depreciated.

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13. Determine and discuss with appropriate official, the adequacy of insurance coverage.

14. Determine that property, plant, and equipment that are being held for disposal are carried
at appropriate amounts.

15. Determine propriety of financial statement presentation and adequacy of disclosures.

Lesson 3. Sample Problem 9-1: Bradpit Inc, etc (Roque, 2018)

The following independent situations relate to the acquisition/self-construction of various

property, plant and equipment items.

 Answer the question/s at the end of each situation

1. BRADPIT, INC. has constructed a production equipment needed for the company ’ s
expansion program. Bradpit received a P1,500,000 bid from reputable manufacturer for the
construction of the equipment.

The costs of direct material and direct labor incurred to construct the equipment were
P960,000 and 600,000, respectively. It is estimated that incremental overhead costs for
construction amount to 140% of direct labor costs.

Fixed cost (excluding interest) of P2,100,000 were incurred during the construction period.
This amount was allocated to construction on the basis of total prime costs- the sum of direct
labor and direct material. The prime costs incurred to construct the new equipment amounted
to 35% of the total prime costs incurred for the period. The company’s policy is to capitalize
all possible costs on self-construction projects.

To assists in financing the construction of the production equipment. Bradpit borrowed P1.5
million at the beginning of the 6-month construction period. The loan was for 2 years with
interest of 10%
What is the total costs of the self-constructed equipment?
a) 3,210,000

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b) 2,610,000
c) 3,021,000
d) 3,285,000

2. The following transactions relate to IMPO COMPANY.

The national government grants the company a large tract of land to be used as plant site.
The land’s fair value determined to be P1,620,000.
Impo company issued 280,000 ordinary shares (par value, P50) in exchange for land and
building. The fair value of the property is determined to be P16,200,000 with the following
allocation:
Land P3,600,000
Building 12,6000,000
P16,200,000

Impo Company’s ordinary shares are not listed on the stock exchange, but its records show
that a block exchange, but its records show that a block of 2,000 shares was sold by a
shareholder a year at P70 per share, and another of 4,000 shares was sold by another
shareholder 8 months ago at P63 per share.

Impo Company Constructed machinery during the year. No entry was made to remove from
the accounts for materials, labor, and overhead the following costs that are properly
chargeable to the machinery account.
Raw material used P250,000
Factory supplies used 18,000
Direct labor costs incurred 320,000
Incremental overhead caused by construction of
machinery (excluding factory supplies used) 54,000
Fixed overhead rate applied to regular
Manufacturing operations 60% of direct
Labor costs
The cost of similar machinery would be P880,000 if it had been purchased from a dealer.
The entries required to record these transactions should include debits to.

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 Land Buildings Machinery
a) P5,540,000 P13,720,000 P834,000
b) P5,975,556 P15,244,444 P816,000
c) P5,757,778 P14,482,222 P780,000
d) P5,220,000 P12,600,000 P834,000

3. HAGAI COMPANY is a major supplier of computer parts and accessories. To improve

delivery services to customers, the company acquired four new trucks on July 1,2018.
Described below are the terms of acquisition for each truck.

Truck List Price Terms

No.1 P600,000 Acquired for cash payment of P556,000
No.2 P800,000 Acquired for a down payment of P80,000 cash and a 1-year,
non- interest-bearing note with a face amount of P720,000.
There was no established cash price for the equipment. The
prevailing interest rate for this type of note is 10 %.
No.3 P640,000 Acquired in exchange for a computer package that the company
carries inventory. The computer package cost P480,000
and is normally sold by Hagai Co. for P608,000.
No.4 P560,000 Acquired by issuing 40,000 of Hagai Co.’s ordinary shares. The
shares have a par value per share P10 and a market
value per share of P13.

What is the total cost of the trucks purchased on July 1,2018?

a) 2,418,545
b) 2,458,545
c) 2,484,000
d) 2,524,000

4. On March 11,2018, RAMBO COMPANY acquired the plant assets of Ina Corporation in
exchange for 25,000 ordinary shares (P100 par value), which had a fair value per share of

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P180 on the date of the purchase of the property. The property had the following appraised
value:

Land P800,000
Building P2,400,000
Machinery and equipment P1,600,000

Below is summary of Rambo’s cash outflows between the acquisition date and December 29,
the date when it first occupied the building.
Repairs to building P210,000
Construction of bases for machinery
to be installed later 270,000
Driveways and parking lots 244,000
Remodeling of office space in
building including new partitions and walls 322,000
Special assessment by the city government
on land 36,000

On December 27, Rambo paid cash for machinery, P560,000 subject to 2% cash discount)
and freight on machinery of P21,000.

Compute the total cost of each of the following:

a) Land
b) Buildings
c) Machinery and Equipment

Answers / Solutions:
1. Direct material P960,000
Direct Labor 600,000
Variable overhead (P600,000x140%) 840,000

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Fixed overhead (P2,100,00 x 35%) 735,000
Interest on specific borrowing
(P1,500,000 x 10% x 6/12) 75,000
Total cost of self-constructed equipment P3,210,000

2. JOURNAL ENTRIES
a) Land 1,620,000
Deferred income- government grant 1,620,000

b) Land 3,600,000
Buildings 12,600,000
Ordinary share capital (P50 x 280,000) 14,000,000
Share premium 2,200,000

c) Machinery 834,000
Raw materials 250,000
Direct Labor 320,000
Factory Overhead 264,000*

*Applied overhead (60% x P320,000) P192,000

Variable overhead 54,000
Factory supplies used 18,000
Total P264,000

3. Truck No.1 P556,000

Truck No.2
Down payment P80,000
Present value of note issued
(P720,000 x 0.90909) 654,545 734,545
Truck No.3 608,000
Truck No.4 (P13 x 40,000 shares) 520,000
Total Cost P2,418,545
Answer: A.

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4.
a. Land
Acquisition cost P750,000*
Special assessment by city 36,000
Total Cost P786,000

b. Building
Acquisition cost P2,250,000*
Repairs to building 210,000
Remodeling of office space in building 322,000
Total Cost P2,782,000

c. Machinery and equipment

Acquisition cost (March 11) P1,500,000*
Construction of bases for machinery 270,000
Acquisition cost (Dec.27) (P1,120,000 x 98%) 1,097,600
Freight 42,000
Total cost P2,909,600

*Acquisition cost of plant asset acquired on March 11

(P180/share fair value x 25,000 shares issued) P4,500,00

Allocation of total acquisition cost based on appraised values:

Land (8/48 x P4,500,000) P750,000
Building (24/48 x P4,500,000) 2,250,000
Machinery and equipment (16/48 x P4,500,000) 1,500,000
Total acquisition cost P4,500,000

Lesson 4. Sample Problem 9-2: French Horn Company, etc.

(Roque, 2018)

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The following are PPE acquisitions for selected companies:

1. FRENCH HORN COMPANY acquired a land, buildings, and equipment from a financially
distressed company, Bankrupt Corp., for a lump sum price of P 2,800,000. On the acquisition
date, Bankrupt’s assets had the following book and fair values:

Book Values Fair Values

Land P800,000 P600,000
Buildings 1,000,000 1,400,000
Equipment 1,200,000 1,200,000

French Horn decided to take a conservative position by recording the lower values for each
PPE item acquired. The following entry was made:

Land 600,000
Buildings 1,000,000
Equipment 1,200,000
Cash 2,800,000
2. TRUMPET INC purchased factory equipment by making a P200,000 cash down payment
and signing a 3-year P300,000, 10% note payable. The acquisition was recorded as follows:

Factory Equipment 530,000

Cash 200,000
Note Payable 300,000
Interest Payable 30,000

3. TUBA CO. purchased store equipment for P800,000, terms 2/10, n/30. The company took
the discount made the following entry when it paid for the acquisition:
Store equipment 800,000
Cash 784,000
Purchase discount 16,000

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4. FLUTE CORP. constructed a building at a total cost of P43,000,000. The building could
have been purchased for P45,000,000. The company’s controller made the following entry:

Building 45,000,000
Cash 43,000,000
Profit from construction 2,000,000

Prepare the necessary correcting entry for each acquisition.

Answers / Solutions:

Correcting Entries
1. Buildings 225,000
Land 75,000
Equipment 150,000

Fair Value Allocated Cost* Amount Adjustment DR

Recorded (CR)
Land P600,000 P525,000 P600,000 P(75,000)
Buildings 1,400,000 1,225,000 1,000,000 225,000
Equipment 1,200,000 1,050,000 1,200,000 (150,000)
Totals P3,200,000 P2,800,000 P2,800,000 P ----

The total acquisition price of assets acquired at a “lump sum price” or “basket price” should
be allocated to the assets on the basis of their relative fair value.

*Land (600,000/3,200,000 x P2,800,000) P525,000

Buildings (P1,400,000/3,200,000 x P2,800,000) 1,225,000
Equipment (P1,200,000/3,200,000 x P2,800,000) 1,050,000

2. Interest payable 30,000

Factory equipment 30,000

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The interest on the note payable issued should be recognized as interest expense over the
term of the note.

3. Purchase discount 16,000

Store equipment 16,000

An item of PPE acquired on credit (or on account) should be recognized net of any cash
discount irrespective of whether the discount is taken or not.

4 Profit on Construction 2,000,000

Buildings 2,000,000

The cost of a self-constructed asset is determined by applying the same principles for an
acquired asset. Any internal profit is eliminated to arrive at the cost of the asset.

The “profit” recognized by the company is actually a saving on a construction that can be
realized through lower depreciation charges on the asset.

Lesson 5. Sample Problem 9-3: Saxophone Company

(Roque, 2018)

SAXOPHONE COMPANY acquires a new manufacturing equipment on January 1, 2018, on

installment basis. The deferred payment contract provides for a down payment of P300,000
and an 8-year note for P3,104,160. The note is to be paid in 8 equal annual installment
payments of P388,020, including 10% interest. The payments are to be made on December
31 of each year, beginning December 31, 2018. The equipment has a cash price equivalent
of P2,370,000. Saxophone’s financial year-end is December 31.

1. What is the acquisition cost of the equipment?

a) 3,404,160
b) 2,804,160
c) 2,370,000
d) 3,104,160
2. The amount to be recognized on January 1, 2018, as discount on note payable is

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 a) P1,034,160
b) P310,416
c) P827,160
d) P 0
3. The amount of interest expense to be recognized in 2018 is
a) P 0
b) P188,898
c) P310,416
d) P207,000
4. The amount of interest expense to be recognized in 2019 is
a) P310,416
b) P188,898
c) P207,000
d) P 0
5. The carrying value of the note payable at December 31, 2019, is
a. P1,689,858
b. P1,888,980
c. P1,312,062
d. P1,700,082

Answers / Solutions:

1. Acquisition cost of equipment (cash price equivalent)

P2,370,000

PAS 16 (Property, Plant, and Equipment) states that the cost of an item of PPE is its cash
price equivalent. If payment is deferred beyond normal credit terms, the difference between
the cash price equivalent and the total payment is recognized as interest expense over the
credit term unless such interest is capitalized in accordance with PAS 23.

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2. Cost of equipment (cash price equivalent) P2,370,000
Less: Down payment 300,000
Amount assigned to note payable 2,070,000
Face value of note 3,104,160
Discount on note payable, Jan. 1, 2018 P1,034,160

The entry to record the acquisition is:

Equipment 2,370,000
Discount on note payable 1,034,160
Note payable 3,104,160
Cash 300,000

3. Interest expense for 2018:

Carrying value of note payable, Jan. 1, 2018

(P3,104,160 – P1,034,160) P2,070,000
Interest rate x10%
Discount amortization for 2018 P207,000

The entry to record the discount amortization is:

Interest expense 207,000

Discount on note payable 207,000

4. Interest expense for 2019:

Note Payable, Jan. 1, 2018 P3,104,160

Less: Payment made on Dec. 31, 2018a 388,020
Note payable, Dec. 31, 2018 2,716,140
Discount on note payable, Dec. 31, 2018
(P1,034,160 – P207,000) (827,160)
Carrying value of note, Dec. 31, 2018 1,888,980

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Interest rate x10%
Discount amortization (interest expense) for 2019 P188,898

5. Carrying value of note, Dec. 31, 2018 (see no. 4) P1,888,980

Discount amortization for 2019 (see no. 4) 188,898
Payment made on Dec. 31, 2019 (388,020)
Carrying value of note, Dec. 31, 2019 P1,689,858

Lesson 6. Sample Problem 9-4: Bassoon Company

(Roque, 2018)

Various equipment used by BASSOON CO. in its operations are either purchased from
dealers or self-constructed. The following items for two different types of equipment were
recorded during the calendar year 2018.

Manufacturing equipment (self-constructed):

Materials and purchased parts at gross invoice price
(Bassoon failed to take the 2% cash discount) P450,000
Imputed interest on funds used during construction
(stock financing) 36,000
Labor costs 185,000
Overhead costs (fixed-P40,000; variable-P60,000) 100,000
Gain on self-construction 74,000
Installation cost 8,600

Store equipment (purchased):

Cash paid for equipment P175,000

Freight and insurance cost while in transit 3,500
Cost of moving equipment into place at store 1,200
Wage cost for technicians to test equipment 7,000
Insurance premium paid during first year of operation
on this equipment 5,200

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Special plumbing fixtures required for the equipment 8,200
Repair cost incurred in first year of operations related
to this equipment 1,450

1. What is the total cost of the self-constructed equipment?

a) P674,600
b) P770,600
c) P734,600
d) P743,600
2. What is the total cost of the store equipment purchased?
a) P200,100
b) P193,700
c) P191,400
d) P194,900

Answers / Solutions:

1. Manufacturing equipment (self-constructed):

Materials and parts (P450,000 x 98%) P441,000
Labor costs 185,000
Overhead costs 100,000
Installation cost 8,600
Total cost P734,600
2. Store equipment (purchased):
Cash paid for equipment P175,000
Freight and insurance cost while in transit 3,500
Cost of moving equipment into place at store 1,200
Wage cost for technicians to test equipment 7,000
Special plumbing fixtures required for this
equipment 8,200
Total cost P194,900

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Lesson 7. Sample Problem 9-5: Carillon Company (Roque, 2018)

CARILLON COMPANY is contemplating to exchange a machine used in its operations.

Carillon received the following offers from interested companies.

1. Ayi Company offered to exchange a similar machine plus P345,000 cash.

2. Butsoy Company offered to exchange a similar machine.
3. Oneng Company offered to exchange a similar machine, but wanted P120,000 in addition
to Carillon’s machine.

In addition, Carillon inquired from Soraya Corp., a dealer in machines. Carillon is to pay
P1,395,000 cash plus the trade in of its old machine in order to acquire a new unit.
Presented below are the machine’s cost, accumulated depreciation, and fair value:

Carillon Ayi Butsoy Oneng Soraya

Cost P2,400,000 P1,800,000 P2,205,000 P2,400,000
P1,950,000
Accumulated 750,000 675,000 1,065,000 1,125,000 ---
depreciation
Fair value 1,380,000 1,035,000 1,380,000 1,500,000 2,775,000

For each of the above exchange situations, prepare the journal entries to record the exchange
on the books of each company. Assume that all exchange situations have commercial
substance.

Answers / Solutions:

1. CARILLON COMPANY
Cash P345,000
Machinery – new (P1,380,000 – P345,000) 1,035,000
Accumulated Depreciation 750,000
Loss on exchange (P1,650,000 BV – P1,380,000 FV) 270,000
Machinery – old 2,400,000

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AYI COMPANY
Machinery – new (P1,035,000 + P345,000) 1,380,000
Accumulated Depreciation 675,000
Loss on exchange (P1,125,000 BV – P1,035,000 FV) 90,000
Cash 345,000
Machinery – old 1,800,000

2. CARILLON COMPANY
Machinery – new P1,380,000
Accumulated Depreciation 750,000
Loss on exchange (P1,650,000 BV – P1,380,000 FV) 270,000
Machinery – old 2,400,000

BUTSOY COMPANY
Machinery – new 1,380,000
Accumulated Depreciation 1,065,000
Gain on exchange (P1,125,000 BV – P1,035,000 FV) 240,000
Machinery – old 2,205,000

3. CARILLON COMPANY
Machinery – new (P1,380,000 – P120,000) P1,500,000
Accumulated Depreciation 750,000
Loss on exchange (P1,650,000 BV – P1,380,000 FV) 270,000
Machinery – old 2,400,000
Cash 120,000

ONENG COMPANY
Cash 120,000
Machinery – new (P1,500,000 + P120,000) 1,380,000
Accumulated Depreciation 1,125,000
Gain on exchange (P1,125,000 BV – P1,035,000 FV) 225,000
Machinery – old 2,400,000

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4. CARILLON COMPANY
Machinery – new (P1,380,000 – P120,000) P2,775,000
Accumulated Depreciation 750,000
Loss on exchange (P1,650,000 BV – P1,380,000 FV) 270,000
Cash 1,395,000
Machinery – old 2,400,000

SORAYA COMPANY
Cash 1,395,000
Used machine inventory (P2,775,000 – P1,395,000) 1,380,000
Sales 2,775,000

Cost of goods sold 1,950,000

Inventory 1,950,000

The Cost of an item property, plant, and equipment acquired in an exchange transaction is
measured at fair value unless:
a) the exchange transaction lacks commercial substance, or
b) the air value of neither the asset received nor the asset given up is reliably measurable.

An exchange transaction has commercial substance if:

a) The configuration (risk, timing and amount) of the cash flows of the asset received differs
from the configuration of the cash flows of the asset transferred and the difference is
significant relative to the fair value of the assets exchanged, or
b) The entity-specific value (i.e., the present value of the cash flows an entity expects to
arise from the continuing use of an asset and from its disposal at the end of its useful life)
of the portion of the entity’s operations affected by the transaction changes as a result of
the changes and the change is significant relative to the fair value of the assets
exchanged.

If an entity is able to determine reliably the fair value of either the asset received or the asset
given up, then the fair value of the asset given up is used to measure the cost of the asset
received unless the fair value of the asset received is more clearly evident.

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If cash is involved in an exchange transaction, the cost of the asset received is the fair value
of the asset given up, adjusted by the amount of cash transferred.

Lesson 8. Sample Problem 9-6: Bagnet Incorporated

(Roque, 2018)

On July 1, 2018, BAGNET, INC. exchanged machines with Bondat Company. The following
facts pertain to these assets.
Bagnet’s Asset Bondat’s Asset
Original cost P288,000 P330,000
Accumulated depreciation 135,000 156,000
(to date of exchange)
Fair market value at date of exchange 180,000 225,000
Cash paid by Bagnet 45,000
Cash received by Bondat 45,000

Although the fair values of the assets involved in the exchange had been reliably determined,
certain cash flow calculations made by both companies proved that this exchange transaction
lacks commercial substance.

What entry should be made on the books of each company to record the exchange?

Answers / Solutions:

BAGNET, INC.
Machinery – new P198,000
Accumulated Depreciation 750,000
Cash 1,395,000
Machinery – old 2,400,000

Cost of machines given up P288,000

Less: Accumulated Depreciation 135,000
Book value 153,000

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Add: Cash paid 45,000
Cost of machines acquired P198,000

BONDAT COMPANY
Cash 45,000
Machinery – new 129,000
Accumulate Depreciation 156,000
Machinery – old 330,000

Cost of machines given up P330,000

Less: Accumulated Depreciation 156,000
Book value 174,000
Add: Cash received 45,000
Cost of machines acquired P129,000

If the asset acquired in an exchange transaction is not measured at fair value (either it lacks
commercial substance or the fair values of the assets exchanged are not reliably measurable),
the cost of the asset received is measured at the carrying amount of the asset given up,
adjusted by the amount of cash transferred. No gain or loss is recognized on the exchange.

Assessment Task 9

BANJO COMPANY was organized in June 2018. In your audit of the company's books, you
find the following land, buildings and equipment account :
LAND BUILDINGS AND EQUIPMENT
Debit Credit
2018
June 7 Organization fees P60,000
15 Land site and old building 945,000
30 Corporate organization costs. 90,000
July 3 Title clearance fees 55,200
Aug 29 Cost of razing old building 60,000

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Sept. 1 Salaries of Banjo Company executives 180,000
Dec. 15 Stock bonus to corporate promoters,
6,000 ordinary shares,
P50 per share market value 300,000
15 Real property tax 43,200
20 Cost of new building completed
and occupied on this date 5,250,000

Your analysis of this account and other accounts disclosed the following additional information
:
a) Banjo paid P60,000 for the demolition of the old building. It sold the scrap for P36,000
and credited the proceeds to miscellaneous income.
b) Banjo executives did not participate in the construction of the new building.
c) The property tax was for the period July 1 - December 31, 2018.

1. The amount to be reported as organization expenses in Banjo's 2018 income statement is

a) P60,000
b) P390,000
c) P450,000
d) 90,000
2. Banjo's Land account should be adjusted by a
a) Net debit of P1,000,200
b) Net debit of P962,400
c) Net debit of P1,060,200
d) Credit of P36,000
3. The cost of the new building is
a) P5,415,000
b) P5,535,000
c) P5,355,000
d) P5,274,000

Summary

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Initial measurement at cost.
Cost of PPE shall include:
a) Cost of acquisition"
b) Incidental cost in bringing the asset to its present location and condition necessary for
use.
c) Present value of the initial estimate of dismantling, removal or site restoration cost (to the
extent that the company has incurred an obligation over these future costs, credit goes to
a provision account asset retirement obligation)

*Cost of acquisition depends on the mode of acquisition

a) Cash purchase = Cash price + import duties + nonrefundable taxes (net of discount and
rebates)
b) On account = at cash price equivalent (net of discounts whether taken or not taken)
c) Installment/Deferred payment basis - at cash price equivalent or at present value of
deferred payment
d) Share/Bond issue - at fair value of asset received, if not determinable, at fair value of
shares issued
e) Exchange with commercial substance - at fair value of asset received (which is equal to
the fair value of asset given-up + cash paid or - cash received)
f) Exchange without comm. substance - at book value of asset given-up + cash paid or -
cash received
g) Donation where the donor is a related party - at fair value (credit to APIC/Donated capital)
h) Donation where the donor is a non-related party (eg Government Grant) - at fair value
(credit to Income, if unconditional grant or Deferred Income, if conditional grant)

Subsequent measurement
a) Cost method: At Cost, net of accumulated depreciation, and impairment loss
b) Appraisal/Revaluation method: At fair market value

References

164
Espenilla. et. al. (2017). Auditing Problems Reviewer. ReSA. Sampaloc, Manila.

Roque, G. (2018). CPA Examination Reviewer: Auditing Problems, CM Recto Avenue,

Manila, Philippines. GIC Enterprises & Co., Inc.

MODULE 10

165
 AUDIT OF PROPERTY, PLANT \AND
EQUIPMENT 2

Introduction

This section is a continuation of the previous section on the audit of property, plant,
and equipment. This module focuses solely on solving board-exam type problems using audit
procedures and techniques.

This module includes problems on capitalization of interest, subsequent expenditures,

depreciation methods and other related accounts. The summary section also provides you
with pro-forma structure of computations that will help you in constructing your audit working
paper.

Learning Outcomes

At the end of this module, students should be able to:

1. Solve auditing problems on capitalization of interest, subsequent expenditures,

depreciation methods and other related accounts; and

2. Construct a working paper for solving problems involving property, plant, and equipment.

Lesson 1. Sample Problem 10-1: Gong Company (Roque, 2018)

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GONG COMPANY started construction on its administration building at an estimated cost of
P 50,000,000 on January 1, 2018. The construction is expected to be completed by December
31, 2020. Gong has the following debt obligation outstanding during 2018:

Construction loan -12% interest, payable

semiannually, issued December 31, 2017 P
20,000,000

Short-term loan – 10% interest, payable

Monthly, and principal payable at maturity
On May 31,2017
14,000,000

Long-term loan – 11% interest, payable on

January 1 of each year. Principal payable
on January 1, 2022
10,000,000

Assume that the weighted-average of the accumulated expenditures during 2018 was P
36,000,000.

What amount of interest incurred in 2018 would be included in the cost of the building being
constructed?
a) 4,900,000
b) 4,067,200
c) 2,400,000
d) 0

Answers/ Solutions:

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COMPUTATION OF CAPITALIZATION RATE:
Interest Principal
Short-term loan 1,400,000
14,000,000
Long-term loan 1,100,000
10,000,000
Total 2,500,000
24,000,000

Capitalization Rate (P2,000,000/P24,000,000) 10.42%

COMPUTATION OF AVOIDABLE INTEREST:

Construction loan- specific borrowing(P 20,000,000 x 12%) P
2,400,000
General Borrowings:
Weighted Average accumulated
expenditures P 36,000,000
Less: Amount related to construction
loan 20,000,000
Amount related to general borrowings 16,000,000
Capitalization rate x 10.42% 1,667,200

Total P
4,067,200

COMPUTATION OF ACTUAL INTEREST:

Construction loan (P 20,000,000 x 12%) P

2,400,000
Short-term loan (P 14,000,000 x 10%) 1,400,000
Long-term loan (P 10,000,000 x 11%) 1,100,000

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Total P
4,900,000

The amount of interest to be capitalized is the avoidable interest of P 4,000,000. Under PAS
23: Borrowing Costs, the amount of borrowing costs capitalized during a period should not
exceed the amount borrowing costs incurred during that period.

Lesson 2. Sample Problem 10-2: Maracas Company

(Roque, 2018)

MARACAS COMPANY constructs its own buildings. In 2017, a total of P 1,228,500 interest
was included as part of the cost of a new building just being completed.

The following is a summary of construction expenditures in 2018:

Accumulated in 2017, including capitalized interest

18,228,500
March 1 7,000,000
September 1 4,000,000
December 31 5,000,000

Total
34,228,500

Maracas has the following outstanding loans at December 31, 2018

12% note related directly to new building;

term, 5 years from beginning of construction
10,000,000

General borrowings:
10% note issued prior to construction

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 new building; term, 10 years 5,000,000
8% note issued prior to construction of
new building; term. 5 years
10,000,000

1. The capitalization rate is

a) 8.67%
b) 10%
c) 12%
d) 8%
2. The average accumulated expenditures in 2018 is
a) 25,811,834
b) 24,166,667
c) 34,228,500
d) 25,395,167
3. The amount of avoidable interest for 2018 is
a) 3,656,500
b) 2,500,000
c) 2,739,517
d) 2,739,517
4. The amount of capitalizable interest in 2018 is
a) 2,500,000
b) 2,534,761
c) 2,739,517
d) 1,200,000
5. The total cost of the new building is
a) 35,500,000
b) 36,728,500
c) 36,763,261
d) 27,895,167

Answers/ Solutions:

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1. Principal Interest Cost
10% note 5,000,000 500,000
8% note 10,000,000 800,000
15,000,000 1,300,000

Capitalization rate(P1,300,000/P 15,000,000) 8.67%

2. Months
Date Expenditures Outstanding Amount
Accumulated in
2015 18,228,500 12 218,742,000
Mar 1,2016 7,000,000 10 70,000,000
Sept 1,2016 4,000,000 4 16,000,000
Dec 31,2016 5,000,000 0 0
Total 34,228,500 304,742,000

Average expenditures (P304,742,000/12) 25,395,167

3. Note related directly to new building –

Specific borrowing (P 10,000,000 x 12%) 1,200,000
General borrowings:
Average Expenditures 25,395,167
Less: Amount related to
specific borrowing 10,000,000
Amount related to general
Borrowings 15,395,167
Capitalization rate x 8.67% 1,334,761
Total 2,534,761

4. COMPUTATION OF ACTUAL INTEREST FOR 2018:

12% note (P 10,000,000 X 12%) 1,200,000
10% note (P 5,000,000 x 10%) 500,000
8 % note (P 10,000,000 X 8%) 800,000

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Total 2,500,000

The amount that should be capitalized in 2108 should be the actual borrowing cost of
P2,500,000. Again, under PAS 23, the amount of borrowing costs capitalized should not
exceed the actual borrowing costs incurred during the period.

5. Construction Costs, including interest

capitalized prior to 2018 (see no. 2) 34,228,500
Capitalized interest in 2018 (see no. 4) 2,500,000
Total cost of building 36,728,500

Lesson 3. Sample Problem 10-3: Cabara Company

(Roque, 2018)

CABARA COMPANY, whose accounting year ends on December 31, provides delivery
services for packages to be taken between the city and the airport.

On January 1, 2017, the company acquired a delivery van from Togo Trucks. The company
paid cash of 1,020,000 to Togo, which included registration fees of 20,000. Insurance costs
for the first year amounted to P24,000. The truck is expected to have a useful life of five years.
At the end of its useful life, the asset is expected to be sold for P480,000, with costs relating
to the sale amounting to P8,000.

On January 1, 2018, Cabara’s management decided to add another vehicle, a flat-top, to the
fleet. This vehicle was acquired from a liquidation auction at a cash price of P600,000. The
vehicle needed some repairs for the elimination of rust (cost P46,000) and the replacement
of all tires (cost P12,400). The company believed it would use the flat-top for another two
years and then sell it. Expected selling price was P300,000, with selling costs estimated to be
P8,000.
On January 1, 2018, a radio communication system was installed in both vehicles at a cost
per vehicle of P6,000. This was not expected to have any material effect on, the future selling
price of either vehicle.
Insurance costs for 2018 were P24,000 for first vehicle and P18,000 for the newly acquired
vehicle.

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On January 1, 2019, the flat-top that had been acquired at auction broke down. The company
thought about acquiring new vehicle to replace this one but, after considering the costs,
decided to repair the flat-top instead. The vehicle was given a major overhaul at a cost of
P130,000. Although this was a major expense, management believed that the company would
keep the vehicle for another two years. The estimated selling price in three years’ time is
P240,000, with selling costs estimated at P6,000. Insurance costs for 2019 were the same as
for the previous year.

1. On January 1, 2017, Cabara should record the delivery van at

a) 1,044,000
b) 1,052,000
c) 1,020,000
d) 1,000,000
2. What is the total cost of the flat-top vehicle?
a) 664,400
b) 600,000
c) 612,400
d) 646,000
3. What is the depreciation expense for 2017?
a) 109,600
b) 105,600
c) 114,400
d) 104,000
4. What is the depreciation expense for 2018?
a) 300,600
b) 291,200
c) 293,000
d) 293,300
5. What is the depreciation expense for 2019?
a) 231,833
b) 293,300
c) 212,500

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 d) 230,333

Answers/ Solutions:

1. Cash paid 1,020,000

Less: Vehicle registration fee 20,000
Cost of delivery van 1,000,000

2. Cash price 600,000

Repairs for the elimination of rust 46,000
Replacement of all tires 12,400
Cost of communication system 6,000
Cost of flat-top vehicle 664,400

3. Cost of delivery van (see no.1) 1,000,000

Less: Residual value (P480,000 – PP8,000) 472,000
Depreciable cost 528,000
Divide by estimated useful life ÷ 5 years
Depreciation for 2017 105,600

4. Delivery van:
Remaining depreciable cost, Jan 1, 2018
(P528,000 – P105,600) 422,400
Add: Cost of communication system 6,000
Total 428,400
Divide by remaining useful life (5-1) ÷ 4 years 107,100
Flat-top vehicle:
Total cost 664,400
Less: Residual value (P300,000 – P8,000) 292,000
Depreciable cost 372,400
Divide by estimated useful life ÷ 2 years 186,200

Total depreciation for 2018 293,300

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5. Delivery van (same as previous year) 107,100
Flat-top vehicle:
Book value, Jan. 1 (P664,400 – P186,200) 478,200
Major overhaul 130,000
Total 608,200
Less: Residual value (P240,000 – P 6,000) 234,000
Remaining depreciation cost 374,200
Divide by revised remaining life ÷ 3 years 124,733

Total depreciation for 2019 231,833

Lesson 4. Sample Problem 10-4: Fiddle Company

(Roque, 2018)

FIDDLE COMPANY uses a large number of machines designed to produce garments. These
machines are generally depreciated at 10% per annum on a straight-line method. In general
machines are estimated to have a residual value on disposal of 10% of cost. At January 1,
2018 Fiddel had a total of 73 machines and its statement of financial position showed a total
cost of P1, 260,000 and accumulated depreciation of P390,000.

During 2018 the following transactions occurred:

 On March 1 2018, a new machine was acquired for P45,000. This machine replaced two
other machines. One of the two replaced machines was acquired on January 1, 2015, for
P24,600. It was traded in on the new machine with Fiddler making a cash payment of
P26,400 on the new machine. The second replaced machine had cost P27,000 on
October 1, 2015 and was sold for 21,900

 On July 1, 2018 a machine that had cost P12,000 on January 1, 2009 was retired from
use and sold for scrap for P1,500

 On July 1, 2018 machine that had been acquired on July 1, 2015 for P21,000 was repaired
because its motor had been damaged from overheating. The motor was replaced at a

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 cost of P14,400. It was expected that this would extend the life of the machine by an extra
two years

 On October 1, 2016, Fiddle fitted a new form of arm to a machine used for putting special
designs onto garments. The arm cost 3,600. The machine had been acquired on October
1, 2015 for P30,000. The arm can be used on a number of other machines when acquired
and has a 15-year life. It will not be sold when any particular machine is retired, but
retained for use on other machines.

1. What amount of gain (loss) should be recognized on the sale of second replaced machine
on March 1, 2018?
a) 772
b) 1,425
c) (772)
d) (1,425)
2. What amount of gain (loss) should be recognized on the machine sold for scrap on July 1,
2018?
a) (900)
b) 240
c) 900
d) (240)
3. What amount of depreciation should be provided in 2018 on the machine whose motor was
replaced on July 1, 2018?
a) 1,890
b) 2,431
c) 2,972
d) 7,634
4. What amount of depreciation should be provided in 2018 on the machine arm installed on
October 1, 2018?
a) 129
b) 54
c) 60
d) 0

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5. In testing for unrecorded retirement of equipment, an auditor is most likely to
a) Select items of equipment from the accounting records and then locate them during
the plant tour
b) Compare depreciation journal entries with similar prior-year entries in search of fully
depreciated equipment
c) Inspect items of equipment observe during the plant tour and then trace them to the
equipment subsidiary ledger
d) Scan the general journal for unusual equipment additions and excessive debits to
repairs and maintenance expense.

Answers/Solutions:

1. Proceeds from sale 21,900

Carrying value:
Cost 27,000
Accumulated depreciation,
Oct. 1, 2015 – Mar. 1, 2018
5
(P27,000 × 90% × 10% × 2 12) (5,872) 21,128
Gain on sale 772

2. Proceeds from sale 1,500

Carrying value:
Cost 12,000
Accumulated depreciation,
January 1, 2019 – July 1, 2018
6
(P12,000 × 90% ×10% × 9 12) 10,260 1,740
Loss on sale (240)

3. Depreciation on machine overhauled:

1
Jan. 1 – July 1 (P21,000 × 90% × 10% ×2) 945
1 1
July 1 – Dec. 31 (P29,730* × 90% = P26,757 × 9 × 2) 1,486
Total 2,431

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*Cost 21,000
Accumulated depreciation, July 1, 2015 -
July 1, 2018 (P21,000 × 90% × 10% × 3) 5,670
Book value, July 1, 2018 15,330
Add: New motor 14,400
Total 29,730

4. Depreciation on arm:
1 3
(P3,600 × 15 × 12) 60

5. Select items of equipment from the accounting records and they locate them during the
plant
tour.
Answer: A

Lesson 5. Sample Problem 10-5: Bugle Company (Roque, 2018)

BUGLE COMPANY’s property, plant and equipment and related accumulated depreciation
accounts had the following balances at December 31, 2017:

Class of PPE Cost Accumulated depreciation

Land P3,900,000
Buildings 36,000,000 P7,962,000
Machinery and equipment 23,250,000 5,886,000
Transportation equipment 3,960,000 2,586,000
Leasehold improvements 6,630,000 3,315,000

Class of PPE Depreciation method Useful life

Land improvements Straight-line 12 years
Buildings 150% declining balance 25 years
Machinery and equipment Straight-line 10 years
Transportation equipment 150% declining balance 5 years

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 Leasehold improvements Straight-line 8 years

Bugle computes depreciation to the nearest month. The salvage values of the depreciable
assets are considered immaterial.

Transactions during 2018 and other information are described below:

a) On January 25, 2018 a plant facility consisting of land and a building was purchased from
Torotot company for P18,000,000 of this amount, 20% was allocated to land.

b) On April 3, 2018, new parking lots, streets and sidewalks at the purchased plant facility
were completed at a total cost of P5,760,000. These expenditures had an estimated
useful life of 1 years.

c) The leasehold improvements were completed on December 31, 2014, and had an
estimated useful life of 8 years. The related lease which would have terminated on
December 31, 2020, was renewable for an additional 4-year term. On April 30, 2018
Bugle exercised the renewal option.

d) On July 1, 2018 machinery and equipment were purchased at a total invoice cost of
P7,500,000. Additional cost of P300,000 for delivery and P900,000 for installation were
incurred.

e) On August 31, 2018, Bugle purchased a new automobile for P450,000.

f) On September 29, 2018, a truck with a cost of P720,000 and a carrying amount of
P234,000 on the date of sale was sold for P345,000. Depreciation for 9 months ended on
September 30, 2018, was P70,560.

g) On December 22, 2018, a machine with a cost of P510,000 and a carrying amount of
P89,250 at a date of disposition was scrapped without cash recovery.

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Based on the proceeding information calculate the 2018 depreciation expense on each of the
following classes of PPE.

1. Land improvements
a) P480,000
b) P360,000
c) P320,000
d) P120,000
2. Buildings
a) P2,546,280
b) P3,024,000
c) P2,762,280
d) P1,682,280
3. Machinery and equipment
a) P2,325,000
b) P3,195,000
c) P1,597,000
d) P2,760,000
4. Transportation equipment
a) P363,132
b) P454,860
c) P433,692
d) P527,760
5. Leasehold improvements
a) 828,750
b) 552,500
c) 663,000
d) 1,326,00

Lesson 6. Sample Problem 10-6: Bagpipe Manufacturing

Company (Roque, 2018)

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BAGPIPE MANUFACTURING COMPANY began operations on October 1, 2016. The
company’s accountant has started to gather pertinent information about each of the company
’s property, plant and equipment as shown below. When he was about to prepare a schedule
of PPE and depreciation, he was assigned to maintain the books of the company’s foreign
operations. You have been asked to assist in the preparation of the schedule. In addition to
ascertaining that the summarized data below are correct, you have accumulated the following
information from the company’s records and personnel.

a) Bagpipe computes depreciation from the first of the month of acquisition to the first of the
month of disposition.
b) Land A and Building A were purchased from Pobre Company. Bagpipe paid P12, 300,000
for the land and building together. At the time of acquisition, the land had a fair value of
P1,350,000 and the building had a fair value of P12,150,000
c) Land B was acquired on October 3, 2016, in exchange for 37,500 ordinary shares of
Bagpipe. On the acquisition date, Land B had a fair value of P1, 365,000 and the company
’s P5 par value ordinary shares had a fair value of P35 per share.
d) Construction of Building B on the newly acquired land began on October 1, 2017. By
September 30, 2018, Bagpipe had paid P4, 800,000 of the estimated total construction
costs of P6, 750,000. It is estimated that the building will be completed and occupied by
July 2019.
e) Certain equipment was donated to the corporation by the national government. An
independent appraisal of the equipment when donated placed the fair market value at
P450, 000 and the salvage value at P45, 000.
f) Machinery A’s total cost of P2,473,500 includes installation cost of P9,000 and normal
repairs and maintenance of P223,500. Salvage value is estimated at P90,000. It was sold
on February 1, 2018, for P1,600,000.
g) On October 1, 2017, Machinery B was acquired with a down payment of P86,100 and the
remaining payments to be made in 11 annual installments of P90,000 each, beginning
October 1, 2017. The prevailing interest rate was 8%. The following data were abstracted
from present value tables (rounded):
10 years 11 years 15 years
Present value of 1 at 8% 0.463 0.429 0.315
Present value of an ordinary annuity of 1 at 8% 6.710 7.139 8.559

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Land A
Acquisition date: October 1, 2016

Building A
Acquisition date: October 1, 2016
Salvage value: P600,000
Depreciation method Straight- line
Depreciation expense:
Year ended Sept. 30, 2017 P261,750

Land B
Acquisition date: October 3, 2016

Building B
Acquisition date: Under construction
Cost: P4,800,000 to date
Depreciation method: Straight- line
Salvage value: 0
Estimated life: 30 years
Depreciation expense:
Year ended Sept. 30, 2017 P0

Donated equipment
Acquisition date: October 2, 2016
Salvage value: P45,000
Depreciation method: 150% declining balance
Estimated life: 10 years

Machinery A
Acquisition date: October 2, 2016
Salvage value: P90,000

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Depreciation method: Sum- of- the- years’- digit (SYD)
Estimated life: 8 years

Machinery B
Acquisition date: October 1, 2016
Salvage value: P0
Depreciation method: Straight- line
Estimated life: 20 years

1. What is the cost of Land A?

a) 1,350,000
b) 12,150,000
c) 11,070,000
d) 1,230,000
2. What is the cost of Building A?
a) 1,350,000
b) 12,150,000
c) 11,070,000
d) 1,230,000
3. What is the estimated useful life of Building A?
a) 42 years
b) 40
c) 44
d) 46
4. What is the depreciation expense of Building A for the year ended September 30, 2018?
a) 261,750
b) 288,750
c) 523,500
d) 577,500

5. What is the cost of Land B?

a) 1,552,500
b) 427,500

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 c) 1,365,000
d) 1,125,000
6. What is the depreciation expense on Building B for the year ended September 30, 2018?
a) 120,000
b) 168,750
c) 288,750
d) 0
7. At what amount should be donated equipment is measured and recognized?
a) 450,000
b) 405,000
c) 495,000
d) 0
8. What is the depreciation expense on the donated equipment for the year ended September
30, 2017?
a) 0
b) 74, 250
c) 60,750
d) 67,500
9. What is the depreciation expense on the donated equipment for the year ended September
30, 2018?
a) 60,750
b) 51, 638
c) 57,375
d) 67,500
10. What is the cost of Machinery A?
a) 2,473,500
b) 2,250,000
c) 2,160,000
d) 2,151,000
11. What is the depreciation expense on Machinery A for the year ended September 30,
2017?
a) 500,000
b) 529,667

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 c) 480,000
d) 478,000
12. What is the depreciation expense on Machinery A for the year ended September 30,
2018?
a) 140,000
b) 113,426
c) 130,926
d) 175,000
13. What amount of gain (loss) should be recognized on the sale of Machinery A on February
1, 2018?
a) 0
b) 60,000
c) 5,000
d) (30,000)
14. What is the cost of Machinery B?
a) 728,610
b) 731,670
c) 780,000
d) 685,434
15. What is the depreciation expense on Machinery B for the year ended September 30,
2018?
a) 36,430
b) 39,000
c) 36,584
d) 34,272

Assessment Task 10

185
The Quezon Manufacturing Company was incorporated on January 2, 2014, but was unable
to begin manufacturing activities until July 1, 2014 because new factory facilities were not
completed until that date.

The land and building account at December 31, 2014 were as follows:
Date Particulars Amount
1-3 Land and building acquisition P1,108,000
1-15 Property taxes paid on the real property 20,000
2-5 Option payments 20,000
2-28 Cost of removal of the old building 22,000

3-1 Partial payment on new construction to induce the

start of construction 700,000
3-1 Legal fees pai 15,000
3-1 Insurance premium for 1 year (3/1/14-2/28/15) 24,000
6-1 Second payment on new construction 600,000
6-30 General expenses 60,000
7-1 Final payment on new construction 200,000
7-1 Construction gain 500,000

Total P3,269,000
12-31 Depreciation at 1% of the balance (32,690)

Carrying value P3,236,310

Your audit investigation revealed the following information:

a) To acquire the land and building the company paid P108,000 cash and 10,000 shares
of its 10% preference shares with par value of P100 per share. The shares were then
selling at P120 per share.
b) The property taxes paid was for two years covering 2013 and 2014.
c) P15,000 from the total option payments were for the property acquired while the
balance were for other real properties not acquired.

186
d) Legal fees covered the following: cost pf incorporation, P9,500; examination of the title
covering purchase of land, P4,000; legal work in connection with the construction
contract, P1,500.
e) General expenses covered the salaries for the period from Jan 1 to June 30 of the:
President P20,000
Plant superintendent while supervising construction 12,000
Office staff 28,000
f) A gain month e construction was recognized for the difference of the actual payments
made to the contractor against the fair value of the asset upon completion.
g) The estimated useful life of the building is 25 years.

Required: What is the adjusted balances of the following:

1. Land
a) 1,350,000
b) 1,359,000
c) 1,337,000
d) 1,364,000
2. Building
a) 1,545,500
b) 1,521,500
c) 1,543,500
d) 1,500,500
3. Correct depreciation expense on the building for the year 2014
a) 30,910
b) 30,340
c) 30,270
d) 30,870

Summary

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Depreciation Methods
1. Uniform/Fixed Charge Method
Straight line - Depreciable cost/Useful life
2. Variable Charge Methods
Working hours - Depreciable cost/ life in terms of working hours * actual hours used
Output method - Depreciable cost / life in terms of total output * actual output
3. Diminishing balance Methods
SYD - Depreciable cost * SYD rate
Declining balance Cost DB rate (consider salvage value only on the last year of depr.)
4. Others (useful for depreciating small tools and similar items)
Inventory method - Beg tools + Purchases - End tools - Proceeds from disposal of
tools
Replacement method - Tools disposed Cost of latest purchases - Proceeds from
disposal
Retirement method - Tools disposed Cost of earlier purchases - Proceeds from
disposal

**For the computation of depreciation, where there are several transactions happening during
the period
List down all the items which became outstanding at one time or another during the
period
 Disposed (Depreciate from Jan. I to date of disposal)
 Newly Acquired (Depreciate from Date of acquisition to Dec 31)
 Outstanding during the entire year

Impairment loss
An asset is impaired if only if the Carrying value is that the Net recoverable value
*Net recoverable value is the higher between the Fair Value less Cost to Sell or the
value in use
*Fair Value less Cost to Sell - Estimated Selling Price Estimated Cost to Sell
*Value in use - PV of the future net cash flows from the continued use of the
asset and from its ultimate disposal using a pre-tax discount
rate

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Revaluation/appraisal
a) If asset have an active market, thus FMV is readily determinable
Fair value of Asset
Less: Carrying Value
Revaluation Surplus
b) If asset have no active market, thus appraisal is determined through the current
replacement cost
Replacement Cost XX - XX Original Cost Replacement
AD (XX) - (XX) Accum Depr. on Cost
Fair Value/Sound Value XX - XX Carrying Value

Fair Value/Sound Value = Replacement cost Condition Percent

Condition Percent = (remaining life/total life, original estimate) or
(carrying value/depreciable cost, original estimate)
Transfer of Revaluation Surplus credit to retained earnings)
c) Piecemeal. RS/Remaining life of depreciation asset
d) Lump sum Realize upon disposal or retirement

Impairment with subsequent revaluation

a) Recognized impairment loss on the year of incurrence
b) Continue Depreciation based on the impaired value
c) Upon revaluation, recognize the gain on recovery = CV had there been no impairment -
CV based on impaired value
d) Recognize as revaluation surplus (under revaluation method) Fair Value CV had there
been no impairment

Revaluation with subsequent impairment

a) Recognize the revaluation surplus in the stockholders equity
b) Continue Depreciation based on the revalued amount realize revaluation surplus on a
piecemeal basis if applicable)
c) Upon impairment, write off the remaining rev surplus = CV based on revalued amt. - CV
had there been no revaluation

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d) Recognize as impairment loss in the income statement = CV had there been no
revaluation - Impaired value/Fair value

Compensation for Impairment Loss of PPE

a) Compensation for impairment loss of PPE shall be recognized as an asset in the 65 and
income in the IS, when and only when it becomes virtually certain when it becomes
receivable)
b) The impairment loss shall be recognized separately at gross amount in the income
statement
c) The impairment loss and the compensation shall be separately recognized and are not to
be offset

References

Espenilla. et. al. (2017). Auditing Problems Reviewer. ReSA. Sampaloc, Manila.

Roque, G. (2018). CPA Examination Reviewer: Auditing Problems, CM Recto Avenue,

Manila, Philippines. GIC Enterprises & Co., Inc.

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