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UNIT-7. Audit OF Property, Plant AND Equipment Handout

Final T21516
Accountancy (De La Salle University)

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UNIT 7
AUDIT OF PROPERTY, PLANT AND EQUIPMENT
AND RELATED VALUATION ACCOUNTS
Estimated Time: 4.5 HOURS

Discussion questions 7-1

1. Define the following terms. You should provide an example of each.
a. Qualifying assets
b. Borrowing costs
c. Revaluation
d. Impairment
2. You are making your first audit of Sigma Manufacturing Company. The
Plant and Equipment account represents a very substantial portion of the
total assets. What verification, if any, will you make of the balances of the
ledger accounts for Plant and Equipment as of the beginning of the period
under audit?
3. Prepare an audit program for the property, plant and equipment. Explain.

Problem 7-1 Capitalizable Cost

The property, plant and equipment section of ABC Corporation’s statement of
financial position at December 31, 2015 included the following items:

Land P2,500,00
0
Land Improvements 560,000
Building 3,600,000
Machinery and 6,600,000
equipment

During 2016 the following data were available to you upon your analysis of
the accounts:

Cash paid on purchase of land P10,000,0

00
Mortgage assumed on the land bought, including interest 16,000,00
at 16% 0
Realtor’s commission 1,200,000
Legal fees, realty taxes and documentation expenses 200,000
Amount paid to relocate persons squatting on the 400,000
property
Cost of tearing down an old building on the land 300,000
Amount recovered from the salvage of the building 600,000
demolished
Cost of fencing the property 440,000
Amount paid to a contractor for the building erected 8,000,000
Building permit fees 50,000
Excavation expenses 250,000
Architect’s fee 100,000
Interest that would have been earned had the money
used during the period of construction been invested in 600,000
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the money market

Invoice cost of machinery acquired 8,000,000
Freight, unloading and delivery charges 240,000
Customs duties and other charges 560,000
Allowances, hotel accommodations, etc. paid to foreign
technicians during installation and test run of machines 1,600,000
Royalty payments on machines purchased (based on
units produced and sold) 480,000

Required: Based on the above and the result of your audit, compute for the
following as of December 31, 2016:
1. Land
2. Land Improvements
3. Building
4. Machinery and Equipment
5. Total depreciable property, plant and equipment

Problem 7-2 (Acquisition of PPE, Exchange and Government Grants)

The following were discovered during your audit of DEF Company’s financial
statements for the year ended December 31, 2016:

1. (Cash Acquisition) On December 24, 2016, DEF purchased an office

equipment for P400,000, terms 2/5, n/15. No entry was made on the date
of purchase. The same was paid on December 31, 2016 and the
accountant debited Office Equipment and credited cash for P400,000.

2. (Installment Acquisition) Machine C, with a cash price of P128,000, was

purchased on January 2, 2016. The company paid P20,000 down and
P10,000 for 12 months. The last payment was made on December 30,
2016. Straight line depreciation, based on a five-year useful life and no
salvage value, was recorded at P28,000 for the year. Freight of P4,000 on
machine C was debited to the Freight in account.

3. (Acquisition through Issuance of Bonds Payable) Machine P with a cash

selling price of P360,000 was acquired on April 1, 2016, in exchange for
P400,000 face amount of bonds payable selling at 94, and maturing on
April 1, 2026. The accountant recorded the acquisition by a debit to
Machinery and a credit to Bonds Payable for P400,000. Straight line
depreciation was recorded based on a five-year economic life and
amounted to P54,000 for nine months. In the computation of depreciation,
residual value of P40,000 was used.

4. (Non-cash Acquisitions) Machine A was acquired on January 22, 2016, in

exchange for past due accounts receivable of P140,000, on which an
allowance of 20% was established at the end of 2015. The current fair
value of the machine on January 22 was estimated at P110,000. The
machine was recorded by a debit to Machinery and a credit to Accounts
Receivable for P140,000. No depreciation was recorded on Machine A,
because it was not installed and never used in operations. On February 2,
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2016, Machine A was exchanged for 1,000 shares of the company’s

outstanding capital stock with market price of P105 per share. The
Treasury Stock account was debited for P140,000 with the corresponding
credit to Machinery.

5. (Exchange: With Commercial Substance) On December 29, 2016, DEF

Company exchanged 10,000 shares of Eric, Inc. common stock, which the
Company was holding as an investment, for an equipment from Magcale
Corporation. The common stock of Eric, Inc., which had been purchased by
DEF for P45 per share, had a quoted market value of P50 per share on the
date of exchange. The equipment had a market value of P470,000. The
transaction was recorded by a debit to Equipment and a credit to
Investment in Eric, Inc.-Common for P450,000. The exchange was
assumed to be with commercial substance.

6. (Exchange: No Commercial Substance) On December 30, 2016, Machine M

with a carrying amount of P120,000 (cost P400,000) was exchanged for a
similar asset with a fair value of P150,000. In addition, DEF paid P20,000
to acquire the new machine. The exchange, which lacks commercial
substance, was recorded by a debit to Machinery and a credit to cash for
P20,000.

7. (Trade-in) Machine E was recorded at P102,000, which included the

carrying amount of P22,000 for an old machine accepted as a trade in,
and cash of P80,000. The cash price of Machine E was P90,000, and the
trade in allowance was P10,000. This transaction took place on December
31, 2016.

8. (Donation of PPE by a Shareholder) Ms. Beauty, the company’s president,

donated land and building appraised at P200,000 and P400,000,
respectively, to the company to be used as plant site. The company began
operating the plant on September 30, 2016. The building is estimated to
have a useful life of 25 years. Since no money was involved, no journal
entry was made for the above transaction.

9. (Government Grants: Land) On July 1, 2015, the national government

granted a parcel of land located in Scarborough Shoal, Zambales to DEF.
On the date of grant, the land had a fair value of P2,000,000. The grant
required DEF to construct a cold storage building on the site. DEF finished
the construction of the building, which has an estimated useful life of 25
years, on January 2, 2016. DEF appropriately recorded the cost of the
building of P4,000,000 (which include direct materials, direct labor, and
indirect cost and incremental overhead) but failed to provide depreciation
in 2016. Unaware of the accounting procedures for government grants,
the company did not reflect the grant on its books.

10.(Government Grants: Depreciable Assets) On January 1, 2016, the national

government granted a building located in Scarborough Shoal, Zambales to
DEF. On the date of grant, the building had a fair value of P10,000,000.
The grant required DEF to establish a security camp to guard the disputed
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site. The building has an estimated useful life of 20 years. Unaware of the
accounting procedures for government grants, the company did not reflect
the grant on its books.

Required: As DEF’s external auditor, you are required to prepare any

necessary adjusting journal entries as of December 31, 2016.

Problem 7-3 Cost of Land and Building

The Blue Corporation was incorporated on January 2, 2016, but was unable to
begin manufacturing activities until July 1, 2016 because the new factory
facilities were not completed until that date.

The “Land and Building” account at December 31, 2016 follows:

Date Particulars Amount
Jan. 31 Land and building P1,098,00
0
Feb. 28 Cost of removal of old building 60,000
May 2 Partial payment on new construction 700,000
May 2 Legal fees paid 15,000
Jun. 1 Second payment on new construction 600,000
Jul. 1 Claims for damages sustained during the construction 26,000
of building
Jul. 1 Final payment on new construction 200,000
Dec. 31 Asset revaluation surplus 500,00
0
P3,199,00
0
Dec. 31 Depreciation – 2016 at 1% of account balance 31,99
0
P3,167,01
0
You were able to gather the following during your audit:
A. To acquire land and building, the company paid P98,000 cash and
10,000 shares of its 9% cumulative preferred shares, P100 par value
per share. The shares were then selling at P120.
B. Legal fees covered the following:
Cost of incorporation P9,500
Examination of title covering purchase of 4,000
land
Legal work in connection with construction 1,50
contract 0
Total P15,000
C. Because of a general increase in construction materials costs after
entering into the building contract, the board of directors increased the
value of the building by P500,000, believing such increase is justified
to reflect current market value at the time the building was completed.
Retained earnings was credited for this amount.
D. Estimated useful life of the building is 25 years.
E. The Company opted to follow the cost model as its accounting policy.
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Required:
1. Prepare the necessary adjusting journal entries as of December 31, 2016.
2. Determine the adjusted balances of the following as of December 31,
2016:
a. Land
b. Carrying value of building
c. Land and building
d. Organization cost, net (presented under Noncurrent Assets)

Problem 7-4 Valuation of Property, Plant and Equipment

At the beginning of the year, Judith Company’s noncurrent assets and
accumulated depreciation accounts had the following balances:
Cost Accumulated
Depreciation
Land P 130,000
Buildings 1,200,000 P 263,101
Machinery and Equipment 775,000 200,000
Delivery Equipment 132,000 86,724
Leasehold improvements 230,000 115,000

The company’s policy regarding depreciation is:

Depreciation Method Useful Life
Land Improvements Straight-line 15 years
Buildings 150% declining 25 years
balance
Machinery and Equipment Straight-line 10 years
Delivery Equipment 150% declining 5 years
balance
Leasehold improvements Straight-line 8 years

Depreciation is to be computed to the nearest month.

Transactions for the current year are as follows:

Jan. 6 A plant consisting of land and building was acquired from

Salome Company for P600,000. 80% of the selling price was
allocated to the building.

April 6 New parking spaces were completed for the new plant at a total
cost of P240,000.

April 29 Judith exercised the renewal option to extend the lease

agreement for an additional 4 years.

July 1 Machinery and equipment were purchased at a total invoice

price of P250,000 Delivery and installation costs of P10,000 and
P30,000 were also incurred respectively.

Aug. 30 A new delivery equipment was purchased for P15,000.

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Sept. 30 A delivery equipment with a cost of P24,000 and a carrying

amount of P9,114 on the date of sale was sold for P12,000.
Depreciation for the 9 months ended September 30, 2016 was
P2,646.

Dec. 20 A machine with a cost of P20,000 and a carrying amount of

5,000 at date of disposition was scrapped.

Additional information:
The leasehold improvements were completed on December 31, 2012. The
related lease was to be terminated on December 31, 2018.

1. How much is the depreciation expense on land improvements for 2016?

2. How much is the depreciation expense on building for 2016?
3. How much is the depreciation expense on machinery and equipment for
2016?
4. How much is the carrying value on January 1 of the delivery equipment
sold on September 30?
5. How much is the depreciation expense for 2016 on delivery equipment?
6. How much is the depreciation expense on leasehold improvements for
2016?
7. How much is the total depreciation expense for 2016?
8. How much is the book value of the machinery and equipment on
December 31, 2016?

Problem 7-5 Valuation of Property, Plant and Equipment

You obtained the following information pertaining to Virginia’s property, plant
and equipment for 2016. Audited 2015 ending balances based on your
working paper are as follows:
Land P4,000,00
0
Buildings 30,000,00
0
Accumulated Depreciation – Building 6,577,531
Machinery and Equipment 22,500,00
0
Accumulated Depreciation – Machinery and 6,500,000
Equipment
Delivery Equipment 3,000,000
Accumulated Depreciation – Delivery Equipment 2,400,000

The depreciation policies being implemented by Virginia are as follows:

Depreciation Method Useful Life
Buildings 150% declining 25 years
balance
Machinery and Straight-line 10 years
Equipment
Delivery Equipment Sum of the years’ 5 years
digits
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Leasehold Straight-line 10 years

Improvements
Transactions during 2016 are as follows:
Jan. 2 Virginia purchased a new truck for P500,000 cash and traded-in
a 2-year old truck with a cost of P450,000 and a book value of
P180,000. The new truck has a cash price of P600,000. The
market value of the old truck is not known.

Apr. 1 A machine purchased for P600,000 on April 1, 2011 was

destroyed by fire. Virginia managed to recover P200,000 from its
insurance company.

May 1 Virginia incurred costs of P4,500,000 to improve the leased

office. The lease terminates on December 31, 2022.

July 1 Machinery and equipment were purchased at a total invoice cost

of P7 million. Additional costs of P150,000 and P650,000 were
incurred for freight and installation respectively.

Additional information:
Virginia determined that the delivery equipment comprising the P3,000,000
beginning balance would have been depreciated at a total amount of
P400,000 for the year.

1. How much is the accumulated depreciation – buildings as of December

31, 2016?
2. How much is the accumulated depreciation – machinery and equipment
as of December 31, 2016?
3. How much is the accumulated depreciation – delivery equipment as of
December 31, 2016?
4. How much is the accumulated depreciation – leasehold improvements as
of December 31, 2016?
5. How much is the net gain (loss) on disposal for the year ended 2016?

Problem 7-6 Self-constructed assets

On January 1, 2016, Angelo Corporation contracted with De Leon Construction
to construct a building for P40 million on a land that Angelo purchased
several years ago. The contract provides that Angelo is to make five
payments in 2016, with the last payment scheduled for the date of
completion. In order to finance the construction, Angelo entered into a 4-year
note with 12% interest on January 1, 2016 with interest compounded
quarterly. Principal of P15 million and interest are payable upon maturity. The
building was completed on December 31, 2016. Angelo made the following
payments during 2016:
January 1 P 4,000,000
March 31 8,000,000
June 30 12,000,000
September 9,000,000
30
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December 31 7,000,000
Angelo also has a P10 million 10%, 10-year note dated January 1, 2013 with
interest payable annually on December 31 and a P15 million, 12%, 5-year
note dated January 1, 2014 with interest payable annually.

1. How much is the interest that would be capitalized during 2016?

2. How much is the interest that would be expensed during 2016?

Problem 7-7 Self constructed assets

HERPETOTOMY had the following loans outstanding during 2015 and 2016:
10% specific construction loan 600,000
12% general loan 5,000,00
0
HERPETOTOMY began construction of a building for its own use on January 1,
2015 and was completed on December 31, 2016. The following expenditures
were made during 2015 and 2016:
January 1, 2015 800,000
April 1, 2015 1,000,00
0
December 1, 2015 600,000
March 1, 2016 1,200,00
0

1. Assuming that the building was completed on December 31, 2016, how
much is the cost of the building on December 31, 2016?
2. Assuming that the building was completed on June 30, 2016, how much is
the cost of the building?
3. Assuming that the building was completed on December 31, 2016 and the
specific construction loan was also used for general purposes, how much
is the cost of the building?

Problem 7-8 Wasting Assets

In 2011, Orc Corporation acquired a gold mine in Lordaeron. Because of
numerous haunting and other supernatural reasons, Orc was able to acquire
the mine for a low, low price of P50,000. Experts estimated that 4 million tons
of gold could be obtained from the mine.

In 2012, Orc constructed a road to the mine costing P5,000,000.

Improvements made to the mine in 2011 amounted to P750,000. Because of
the improvements to the mine and the surrounding land, it is estimated that
the mine can be sold for P600,000 when the mining activities are completed.

During 2013, several townhouses were constructed near the site to house the
employees. Total cost of the townhouses was P1,500,000. Estimated residual
value is P250,000.

During 2014, the first year of operations, only 5,000 tons of gold were
collected from the mine. In 2015, the employees were able to mine 1 million

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tons of gold. Geologists discovered that the mine actually contained 3 million
tons more than the original estimation. Improvements of P275,000 were
made to the mine early in 2015 to facilitate the removal of the additional
gold. Furthermore, an additional townhouse was constructed at a cost of
P225,000 for the additional employees that would be hired to obtain the
additional gold. The new townhouse was not expected to have any residual
value.

In 2016, 2.5 million tons of gold were mined and costs of P1,100,000 were
incurred at the beginning of the year for improvements to the mine.

1. How much was the depletion to be recognized in 2014?

2. How much was the depletion to be recognized in 2015?
3. How much is the depletion to be recognized in 2016?
4. How much is the depreciation to be recognized in 2015?
5. How much is the depreciation to be recognized in 2016?

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